Item 1. Business
Company Overview
Kennedy Wilson is a global real estate investment company. We own, operate and develop high-quality real estate across growing markets in the Western United States, the United Kingdom and Ireland with the objective of generating long-term risk-adjusted returns for our shareholders and partners. For the year ended December 31, 2022, our 230 employees managed a total of $23.0 billion of Real Estate Assets Under Management ("AUM"), which includes 37,781 multifamily units (including 4,994 units under lease up or in process of being developed), 11.7 million office square feet, 10.6 million industrial square feet and 3.9 million retail square feet (including 1.7 million square feet under lease up or in process of being developed), and $2.5 billion of development, residential and other. For the year ended December 31, 2022, the $20.5 billion of operating properties within our AUM as of December 31, 2022 produced total revenue of $1.4 billion (KW's share of which was $706.0 million) compared to $18.7 billion of operating properties as of December 31, 2021 with total revenue of $1.2 billion (KW's share of which was $583.0 million) during the same period in 2021. Our global team, located in offices throughout the United States, the United Kingdom, Ireland, Spain and Jersey, also managed the consummation of $1.9 billion of gross acquisitions and $970.0 million of loan investments (KW's ownership interest of 51% and 5%, respectively) and $1.3 billion of gross dispositions and $412.8 million of loan repayments (KW's ownership interest of 40% and 9%, respectively) during the year ended December 31, 2022.
Our global real estate portfolio is primarily comprised of multifamily communities (57%), commercial properties (39%) and hotel and other properties (4%) based on our share of net operating income ("NOI"). The Western United States represents 61% of our portfolio, with a focus on the Mountain West region, our largest global region which includes our investments in Idaho, Utah, Nevada, Arizona, and New Mexico. We also invest in the Pacific Northwest, including the state of Washington, and Northern and Southern California. In Europe, our portfolio is focused in the United Kingdom (16%) and Ireland (21%).
Our investment activities in our Consolidated Portfolio (as defined below) involve ownership of multifamily units, office, retail and industrial space and one hotel. Our ownership interests in such consolidated properties make up our Consolidated Portfolio ("Consolidated Portfolio") business segment as discussed in detail throughout this report.
In addition to investing our shareholder's capital, we invest capital on behalf of our partners in real estate and real estate related assets through our Co-Investment Portfolio ("Co-Investment Portfolio"). This fee-bearing capital represents total third-party committed or invested capital that we manage in our joint ventures and commingled funds that entitle us to earn fees, including, without limitation, asset management fees, construction management fees, acquisition and disposition fees and/or promoted interest, if applicable. As of December 31, 2022, our fee-bearing capital was $5.9 billion and we recognized $44.8 million in recurring investment management fees during the year ended December 31, 2022. In our Co-Investment Portfolio, we are also eligible to earn performance allocations (amounts that are allocated to us on co-investments we manage based on the cumulative performance of the underlying investment). During the year ended December 31, 2022, we had a reversal of $21.1 million in performance allocations that we previously recognized based on the fair value of the underlying investment. Please see “Fair Value Investments” below for a discussion of our assets held at estimated fair value and our methodology with respect to the same. We generally invest our own capital alongside our equity partners in these joint ventures and commingled funds that we manage.
As of December 31, 2022, the following key metrics of our Consolidated and Co-Investment Portfolio are as follows:
| | | | | | | | |
| Consolidated | Co-Investments |
Multifamily units - market rate | 11,475 | | 14,780 | |
Multifamily units - affordable | — | | 11,526 | |
Office square feet (millions) | 4.8 | | 6.9 | |
Industrial square feet (millions) | — | | 10.6 | |
Retail square feet (millions) | 2.5 | | 1.4 | |
Hotels | 1 | 1 |
Real estate debt investments - 100% (billions) | $ | — | | $ | 2.4 | |
Real estate debt investments - KW Share (millions) | $ | — | | $ | 155.1 | |
Revenues (millions) | $ | 481.8 | | $ | 276.0 | |
NOI (millions) | $ | 294.2 | | $ | 157.6 | |
AUM (billions) | $ | 9.2 | | $ | 13.8 | |
In our Co-Investment Portfolio, 88% of our carrying value is accounted for at fair value. Our interests in such joint ventures and commingled funds and the fees that we earn from such vehicles make up our Co-Investment Portfolio segment as discussed in detail throughout this report.
In addition to our income-producing real estate, we also engage in development, redevelopment and value add initiatives through which we enhance cash flows or reposition assets to increase value. Our total share of development project costs with respect to these investments are estimated at $379.0 million over the next three years. These costs are generally financed by cash from our balance sheet, capital provided by partners (if applicable), cash flows from investment and construction loans. Cost overrun risks are reduced by detailed architectural plans, guaranteed price contracts and supervision by expert Company executives and personnel. When completed, the construction loans are generally replaced by long-term mortgage financing. See additional detail in the section titled Development and Redevelopment below.
Investment Approach
The following is our investment approach:
•Identify countries and markets with an attractive investment landscape
•Establish operating platforms in our target markets
•Develop local intelligence and create long-lasting relationships, primarily with financial institutions
•Leverage relationships and local knowledge to drive proprietary investment opportunities with a focus on off-market transactions that we expect will result in above average cash flows and returns over the long term
•Acquire high quality assets, either on our own or with strategic partners
•Reposition assets to enhance cash flows post-acquisition
•Explore development opportunities on underutilized portions of assets, or acquire development assets that fit within our overall investment strategy
•Continuously evaluate and selectively harvest asset and entity value through strategic realizations using both the public and private markets
The table below highlights some of the Company's key metrics over the past five years:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
($ in millions, except fee bearing capital which $ in billions) | 2022 | | 2021 | | 2020 | | 2019 | | 2018 |
Revenue | $ | 540.0 | | | $ | 453.6 | | | $ | 454.0 | | | $ | 569.7 | | | $ | 773.5 | |
Net income to Kennedy-Wilson Holdings Inc. common shareholders | 64.8 | | | 313.2 | | | 92.9 | | | 224.1 | | | 150.0 | |
Basic income per share | 0.47 | | | 2.26 | | | 0.66 | | | 1.60 | | | 1.04 | |
Dividends declared per share of common stock | 0.96 | | | 0.90 | | | 0.88 | | | 0.85 | | | 0.78 | |
Adjusted EBITDA(1) | 591.5 | | 927.9 | | 608.0 | | 728.1 | | 712.7 |
% change | (36.3) | % | | 52.6 | % | | (16.5) | % | | 2.2 | % | | — | % |
Adjusted Net Income(1) | 264.9 | | | 509.0 | | | 306.9 | | | 442.5 | | | 397.0 | |
Adjusted Net Income annual increase (decrease) | (48.0) | % | | 65.9 | % | | (31.3) | % | | 11.5 | % | | 63.7 | % |
Consolidated NOI(1) | 294.2 | | 255.8 | | 262.3 | | 305.2 | | 368.3 |
% change | 15.0 | % | | (2.5) | % | | (14.1) | % | | (17.1) | % | | — | % |
JV NOI(1) | 157.6 | | 124.4 | | 102.5 | | 77.8 | | 55.3 |
% change | 26.7 | % | | 21.4 | % | | 31.7 | % | | 40.7 | % | | — | % |
Fee-bearing capital | 5.9 | | | 5.0 | | 3.9 | | 3.0 | | 2.2 |
% change | 18.0 | % | | 28.2 | % | | 30.0 | % | | 36.4 | % | | — | % |
AUM | 23.0 | | | 21.6 | | | 17.6 | | | 18.1 | | | 16.3 | |
% change | 6.5 | % | | 22.7 | % | | (2.8) | % | | 11.0 | % | | — | % |
(1) Please refer to "Certain Non-GAAP Measures and Reconciliations" for a reconciliation of certain non-GAAP items to U.S. GAAP.
The table below highlights some of the Company's balance sheet metrics over the past five years:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(In millions) | As of December 31, |
| 2022 | | 2021 | | 2020 | | 2019 | | 2018 |
Balance sheet data: | | | | | | | | | |
Cash and cash equivalents | $ | 439.3 | | | $ | 524.8 | | | $ | 965.1 | | | $ | 573.9 | | | $ | 488.0 | |
Total assets | 8,271.8 | | | 7,876.5 | | | 7,329.0 | | | 7,304.5 | | | 7,381.8 | |
Mortgage debt | 3,018.0 | | | 2,959.8 | | | 2,589.8 | | | 2,641.0 | | | 2,950.3 | |
KW unsecured debt | 2,062.6 | | | 1,852.3 | | | 1,332.2 | | | 1,131.7 | | | 1,202.0 | |
KWE unsecured bonds | 506.4 | | | 622.8 | | | 1,172.5 | | | 1,274.2 | | | 1,260.5 | |
Kennedy Wilson equity | 1,964.0 | | | 1,777.6 | | | 1,644.5 | | | 1,678.7 | | | 1,246.7 | |
Noncontrolling interests | 46.4 | | | 26.3 | | | 28.2 | | | 40.5 | | | 184.5 | |
Total equity | 2,010.4 | | | 1,803.9 | | | 1,672.7 | | | 1,719.2 | | | 1,431.2 | |
Common shares outstanding | 137.8 | | | 138.0 | | | 141.4 | | | 151.6 | | | 143.2 | |
The following table shows the historical U.S. federal income tax treatment of the Company’s common stock dividend for the years ended December 31, 2022 through 2018:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, |
| 2022 | | 2021 | | 2020 | | 2019 | | 2018 |
Taxable Dividend | 37.81 | % | | — | % | | 27.14 | % | | 10.53 | % | | 23.43 | % |
Non-Taxable Return of Capital | 62.19 | % | | 100.00 | % | | 72.86 | % | | 89.47 | % | | 76.57 | % |
Total | 100.00 | % | | 100.00 | % | | 100.00 | % | | 100.00 | % | | 100.00 | % |
Business Segments
Our operations are defined by two business segments: our consolidated investment portfolio (the "Consolidated Portfolio") and our co-investment portfolio (the "Co-Investment Portfolio")
•Our Consolidated Portfolio consists of the investments in real estate and real estate-related assets that we have made and consolidate on our balance sheet. We typically wholly-own the assets in our Consolidated Portfolio.
•Our Co-Investment Portfolio consists of (i) the co-investments in real estate and real estate-related assets, including loans secured by real estate, that we have made through the commingled funds and joint ventures that we manage; (ii) fees (including, without limitation, asset management fees and construction management fees); and (iii) performance allocations that we earn on our fee bearing capital. We typically have a 5% to 50% ownership interest in the assets in our Co-Investment Portfolio. We have a weighted average ownership of 41% as of December 31, 2022.
In addition to our two primary business segments, our Corporate segment includes, among other things, our corporate overhead and our property services group prior to its sale in October 2020.
Consolidated Portfolio
Our Consolidated Portfolio is a permanent capital vehicle focused on maximizing property cash flow. These assets are primarily wholly-owned and tend to have longer hold periods and we target investments with accretive asset management opportunities. We typically focus on office and multifamily assets in the Western United States and commercial assets in the United Kingdom and Ireland within this segment.
The non-GAAP table below represents a summarized balance sheet of our Consolidated Portfolio which is held at historical depreciated cost as of December 31, 2022 and 2021. This table does not include amounts from our corporate segment such as corporate cash and the KWH Senior Notes.
| | | | | | | | | | | |
($ in millions) | December 31, 2022 | | December 31, 2021 |
Cash and cash equivalents(1) | $ | 316.7 | | | $ | 362.3 | |
Real estate and acquired in place lease values | 5,188.1 | | | 5,059.8 | |
Accounts receivable and other assets, net | 135.1 | | | 111.7 | |
Total Assets | $ | 5,639.9 | | | $ | 5,533.8 | |
| | | |
Accounts payable, accrued expenses and other liabilities | 156.6 | | | 142.1 | |
Mortgage debt | 3,018.0 | | | 2,959.8 | |
KWE unsecured bonds | 506.4 | | | 622.8 | |
Total Liabilities | 3,681.0 | | | 3,724.7 | |
| | | |
Equity | $ | 1,958.9 | | | $ | 1,809.1 | |
(1)Excludes $122.5 million and $162.5 million as of December 31, 2022 and December 31, 2021, respectively, of corporate non-property level cash.
Co-Investment Portfolio
We utilize different platforms in the Co-Investment Portfolio segment depending on the asset and risk return profiles.
The table below represents the carrying value of our Co-Investment Portfolio balance sheet which is primarily at fair value, at our share of the underlying investments as of December 31, 2022 and December 31, 2021. The Co-Investment Portfolio consists of our unconsolidated investments as well as our loan purchases and originations.
| | | | | | | | | | | |
($ in millions) | December 31, 2022 | | December 31, 2021 |
Cash and cash equivalents | $ | 86.9 | | | $ | 103.7 | |
Real estate and acquired in place lease values | 4,319.1 | | | 3,667.9 | |
Loan purchases and originations | 158.7 | | | 143.4 | |
Accounts receivable and other assets, net | 298.0 | | | 311.9 | |
Total Assets | $ | 4,862.7 | | | $ | 4,226.9 | |
| | | |
Accounts payable, accrued expenses and other liabilities | 88.0 | | | 87.1 | |
Mortgage debt | 2,387.2 | | | 2,061.9 | |
Total Liabilities | 2,475.2 | | | 2,149.0 | |
| | | |
Equity | $ | 2,387.5 | | | $ | 2,077.9 | |
Separate accounts
We have several equity partners whereby we act as the general partner and receive investment management fees including acquisition, disposition, financing, construction management and other fees. We also can earn performance allocations if investments exceed certain return hurdles. In addition to acting as the asset manager and general partner of those joint ventures, we are also a co-investor in these investments. Our separate account platforms have defined investment parameters such as asset types, leverage and return profiles and expected hold periods. As of December 31, 2022, our weighted average ownership interest in the various joint ventures that we manage was 45%.
Commingled funds
We currently have four closed-end funds that we manage and through which we receive investment management fees and potentially performance allocations. We focus on sourcing investors in the U.S., Europe and Middle East and target investments in the U.S. and Europe with respect to our commingled funds. Each of our funds have, among other things, defined investment guidelines, investment hold periods and target returns. Currently our U.S.-based funds focus on value-add properties that have an expected hold period of 5 to 7 years. Our European fund focuses on value add commercial properties in the United Kingdom, Ireland and Spain that also have expected hold periods of 5 to 7 years. As of December 31, 2022, our weighted average ownership interest in the commingled funds that we manage was 13%.
VHH
Through our Vintage Housing Holdings ("VHH") partnership, we acquire and develop income and age restricted properties. See a detailed discussion of this business in the Multifamily section below.
Investment Types
The following are the product types we invest in through our Consolidated Portfolio and Co-Investment Portfolio segments:
Multifamily
We pursue multifamily acquisition opportunities where we can unlock value through a myriad of strategies, including institutional management, asset rehabilitation, repositioning and recapitalization. We focus primarily on apartments in supply-constrained, infill markets.
As of December 31, 2022, we held investments in 149 multifamily assets that include 11,475 consolidated market rate multifamily apartment units, 14,780 market rate units within our Co-Investment Portfolio and 11,526 affordable units in our VHH platform. The unit accounts above include units that are unstabilized and undergoing development. Our largest Western United States multifamily regions are the Mountain West region (Idaho, Utah, Montana, Colorado, Arizona, New Mexico and Nevada) and the Pacific Northwest (primarily the greater Seattle area and Portland, Oregon). The remainder of the Western United States portfolio is located in Northern and Southern California. In Ireland we focus on Dublin city center and the suburbs of the city.
Our asset management strategy entails installing strong property management teams to drive leasing activity and upkeep of the properties. We also seek to add amenities designed to promote health and wellness, celebrate local and cultural events and enhance the lives of residents living in our communities. We also incorporate spaces for rest and socialization across
our global multifamily portfolio, including clubhouses, fitness centers, business suites, outdoor play areas, pools and dog parks. Lastly, we utilize real-time market data and artificial intelligence-based applications to ensure we are attaining current market rents.
Multifamily - Affordable Housing
Through our VHH platform we focus on affordable units based on income or age restrictions. With homes reserved for residents that make 50% to 60% of the area’s median income, VHH provides an affordable long-term solution for qualifying working families and active senior citizens, coupled with modern amenities that are a hallmark of our traditional multifamily portfolio. Fundamental to our success is a shared commitment to delivering quality affordable homes and building communities that enrich residents’ lives, including providing programs such as social support groups, after-school programs, transportation assistance, computer training, and wellness classes.
VHH typically utilizes tax-exempt bond financing and the sale of federal tax credits to help finance its investments. We are entitled to 50% of the operating cash flows from the VHH partnership in addition to any investing distributions we receive from federal tax credits or refinancing activity at the property level.
When we acquired VHH in 2015, the portfolio consisted of 5,485 units. As of December 31, 2022, the VHH portfolio includes 9,157 stabilized rental units with another 2,369 units currently under stabilization, development or undergoing entitlements in the Western United States. We acquired our ownership interest in VHH in 2015 for approximately $80.0 million. As of December 31, 2022, we have contributed an additional $121.8 million into VHH and have received $267.9 million in cash distributions. VHH is an unconsolidated investment that we account for using the fair value option, which had a carrying value of $272.3 million as of December 31, 2022. We have recorded $268.5 million worth of fair value gains on our investment in VHH over the life of the investment, including $108.4 million during the year ended December 31, 2022.
Commercial
Our investment approach for office acquisitions differs across our various investment platforms. For our Consolidated Portfolio, we look to invest in large high quality properties with high replacement costs. In our separate account portfolios, our partners have certain characteristics that factor into our investment decision, including, without limitation, location, financing (unencumbered properties) or hold periods. In our commingled funds that we manage, we typically look for opportunities that have a value-add component that can benefit from our asset management expertise. We do not typically own high-rise buildings in city centers and instead look to invest in mid-to-low rise buildings in areas adjacent to city centers and suburban markets. After acquisition, the properties are generally repositioned to enhance market value.
Our industrial portfolio consists mainly of distribution centers located in the United Kingdom, Ireland, Spain and Mountain West regions.
Our retail portfolio has different characteristics based on the geographic markets wherein the properties are located. In Europe, we have a mixture of high street retail, suburban shopping centers and leisure assets which are mainly located in the United Kingdom, as well as in Dublin and Madrid. In our Western United States retail portfolio, we invest in shopping centers that are generally grocery anchored.
As of December 31, 2022, we hold investments in 58 office properties totaling over 11.7 million square feet, 109 industrial properties totaling 10.6 million square feet and 39 retail properties totaling 3.9 million square feet, predominately in the United Kingdom and Ireland with additional investments in the Pacific Northwest, Southern California, Spain and Italy. Our Consolidated Portfolio held over 4.8 million square feet of office space and 2.5 million square feet of retail space. Our Co-Investment Portfolio held 6.9 million square feet of office space, 10.6 million square feet of industrial space and 1.4 million square feet of retail space.
Development and redevelopment
We have a number of development, redevelopment and entitlement projects that are underway or in the planning stages. Unlike the residential projects that are held for sale and described in the Residential and Other section below, these initiatives may ultimately result in income-producing assets. As of December 31, 2022, we are actively developing 2,220 multifamily units, 0.4 million commercial rentable square feet and 150 hotel rooms. If these projects are brought to completion, the Company’s estimated share of the total capitalization of these projects would be approximately $1.1 billion (approximately 70% of which has already been funded), which we expect would be funded through our existing equity, third-party equity, project sales, tax credit financing and secured debt financing. This represents total capital over the life of the projects and is not a representation of peak capital and does not take into account any distributions over the course of the investment. We and our equity partners are under no obligation to complete these projects and may dispose of any such assets after adding value through the entitlement process. Please also see the section titled “Liquidity and Capital Resources - Development and redevelopment” in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this report for additional detail on these investments.
Real Estate Debt Investment
We have a global real estate debt platform with multiple partners. In March 2022, we announced the expansion of our global debt platform to over $6 billion. Our global debt platform, which includes partners across insurance and sovereign wealth, seeks out investment opportunities across the entire real estate debt capital structure in the United States, United Kingdom and Europe and targets loans secured by high-quality real estate located in such jurisdictions. In our role as asset manager, we earn customary fees for managing the platform. Currently, our global debt platform investments have been made without the use of any leverage and are invested through our Co-Investment Portfolio.
As of December 31, 2022, we held interests in 39 loans, 87% of which have floating interest rates, with collateral located in the Western United States and the United Kingdom, with an average interest rate of 10.0% per annum and an unpaid principal balance ("UPB") of $2.4 billion (of which our share was a UPB of $155.1 million). Some of our loans contain additional funding commitments that will increase our loan balances if they are utilized. All of the loans in our global debt platform are performing and making payments as contractually agreed. In addition to interest income (which includes origination, exit and extension fees), we also earn customary asset management fees from our partners for managing these loan investments.
Our current loan portfolio is focused on performing loans. However, if market conditions deteriorate, we expect more opportunities to arise in acquiring loan portfolios at a discount to their contractual balance due as a result of deteriorated credit quality of the borrower. Such loans are underwritten by us based on the value of the underlying real estate collateral. Due to the discounted purchase price for such loans, we seek, and are generally able to, accomplish near term realization of the loan in a cash settlement or by obtaining title to the property. Accordingly, the credit quality of the borrower is not of substantial importance to our evaluation of the risk of recovery from such investments.
Hotel
We originally acquired debt interests in each of the hotels in our Consolidated and Co-Investment portfolios and were able to utilize these debt positions to take ownership of the real estate. These properties are examples of how we are able to leverage different platforms within the Company to add value to properties and shareholders.
As of December 31, 2022, we owned one consolidated operating hotel with 265 hotel rooms located in Dublin, Ireland. Additionally, in our Co-Investment Portfolio, we have a five-star resort development that will consist of 150 rooms in Kona, Hawaii and is currently expected to open in the second half of 2023.
Residential and Other
In certain cases, we may pursue for-sale housing acquisition opportunities, including land for entitlements, finished lots, urban infill housing sites and partially finished and finished housing projects. On certain income-producing acquisitions, there are adjacent land parcels for which we may pursue entitlement activities or, in some cases, development or re-development opportunities.
This group also includes our investment in liquid non-real estate investments which include investment funds that hold marketable securities and private equity investments.
As of December 31, 2022, we held 15 investments primarily comprised of 97 residential units/lots and 3,770 acres of land located in Hawaii and the Western United States. As of December 31, 2022, these investments had a Gross Asset Value of $224.3 million and the Company had a weighted average ownership in such investments of 76%. These investments are in various stages of completion, ranging from securing the proper entitlements on land positions to sales of units/lots.
Fair Value Investments
As of December 31, 2022, $2.1 billion, or 88%, of our investments in unconsolidated investments (25% of total assets) were held at estimated fair value. As of December 31, 2022, there were cumulative fair value gains of $546.1 million which comprises 26% of the $2.1 billion carrying value of fair value unconsolidated investments that are currently held. Our investment in VHH is our largest unconsolidated investment held at estimated fair value and was held at $272.3 million and $157.9 million as of December 31, 2022 and 2021, respectively. Fair value changes consist of changes in the underlying value of properties and associated mortgage debt as well as foreign currency fluctuations (net of any hedges) for non-dollar denominated investments. During the year ended December 31, 2022, we recognized $93.5 million of fair value gains and performance allocations on unconsolidated investments.
In determining estimated fair market values, the Company utilizes two approaches to value real estate, a discounted cash flow analysis and direct capitalization approach.
Discounted cash flow models estimate future cash flows from a buyer's perspective (including terminal values) and compute a present value using a market discount rate. The holding period in the analysis is typically ten years. Although the ten year holding period is consistent with how market participants often estimate values in connection with buying real estate, these holding periods can be shorter depending on the life of the structure an investment is held within. The cash flows include a projection of the net sales proceeds at the end of the holding period, computed using a market reversionary capitalization rate.
Under the direct capitalization approach, the Company applies a market derived capitalization rate to current and future income streams with appropriate adjustments for tenant vacancies or rent-free periods. These capitalization rates and future income streams are derived from comparable property and leasing transactions and are considered to be key inputs in the valuation. Other factors that are taken into consideration include tenancy details, planning, building and environmental factors that might affect the property.
The Company also utilizes valuations from independent real estate appraisal firms on some of its investments ("appraised valuations"), with certain investment structures periodically (typically annually) requiring appraised valuations. All appraised valuations are reviewed and approved by the Company.
The accuracy of estimating fair value for investments cannot be determined with precision and cannot be substantiated by comparison to quoted prices in active markets and may not be realized in a current sale or immediate settlement of the asset or liability. Additionally, there are inherent uncertainties in any fair value measurement technique, and changes in the underlying assumptions used, including capitalization rates, discount rates, liquidity risks, and estimates of future cash flows could significantly affect the fair value measurement amounts. All valuations of real estate involve subjective judgments, and the actual market price of real estate can only be determined by negotiation between independent parties in a sales transaction.
The table below describes the range of inputs used as of December 31, 2022 for real estate assets:
| | | | | | | | | | | | | | | | | |
| | | Estimated Rates Used For |
| | | Capitalization Rates | | Discount Rates |
Multifamily | Income approach - discounted cash flow | | 5.80% — 7.50% | | 8.00% — 9.80% |
| Income approach - direct capitalization | | 3.80% — 5.70% | | N/A |
Office | Income approach - discounted cash flow | | 5.20% — 7.50% | | 7.50% — 9.30% |
| Income approach - direct capitalization | | 4.20% — 8.70% | | N/A |
Industrial | Income approach - discounted cash flow | | 5.00% —6.30% | | 6.30% — 7.80% |
| Income approach - direct capitalization | | 3.80% — 8.30% | | N/A |
Retail | Income approach - discounted cash flow | | 6.50% | | 8.30% |
Hotel | Income approach - discounted cash flow | | 6.00% | | 8.30% |
In valuing indebtedness, Kennedy Wilson considers significant inputs to be the term of the debt, value of collateral, market loan-to-value ratios, market interest rates and spreads, and credit quality of investment entities. The credit spreads used by Kennedy Wilson for these types of investments range from 1.22% to 7.25%.
There is no active secondary market for the Company's development projects and no readily available market value given the uncertainty of the amount and timing of future cash flows. Accordingly, the Company's determination of fair value of the Company's development projects requires judgment and extensive use of estimates. Therefore, the Company typically uses investment cost as the estimated fair value until future cash flows become more predictable. Additionally, the fair value of its development projects may differ significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values that the Company may ultimately realize. If the Company were required to liquidate an investment in a forced or liquidation sale, it could realize significantly less than the value at which the Company have recorded it. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the unrealized gains or losses reflected in the currently assigned valuations.
Ongoing macroeconomic conditions, such as, but not limited to, high inflation, central banks raising interest rates to curtail high inflation, currency fluctuations, the COVID-19 pandemic and the ongoing military conflict between Russia and Ukraine and international sanctions against Russia, continue to fuel recessionary fears and create volatility in our business results and operations. Any prolonged downturn in the financial markets or a recession, either globally or locally in the United States or in other countries in which we conduct business, could impact the fair value of investments held by the Company. As a result of the rapid development, fluidity and uncertainty surrounding these situations, the Company expects that information with respect to fair value measurement may change, potentially significantly, going forward and may not be indicative of the
actual impact on our business, operations, cash flows and financial condition for the year ended December 31, 2022 and future periods.
Value Creation
Our differentiated and unique approach to investing is the cornerstone of how we create value for our shareholders. Our investment philosophy is based on three core fundamentals:
•Leverage our global footprint and complementary investment and investment management businesses to identify attractive investment markets across the world.
•Selectively invest in opportunities across many real estate product types with a goal of maximizing cash flow and risk-adjusted return on capital.
•Actively manage assets and finance our assets in a manner designed to generate stable, predictable and growing cash flows for shareholders and clients.
Kennedy Wilson is able to create value for its shareholders in the following ways:
•We are able to identify and acquire attractive real estate assets across many markets, in part due to the significant proprietary deal flow driven from an established global network of industry relationships, particularly with financial institutions. This can create value by allowing us to maintain and develop a large pipeline of attractive opportunities.
•Our operating expertise allows us to focus on opportunistic investments where we believe we can increase the value of assets and cash flows and include transactions with distressed real estate owners or lenders seeking liquidity, or purchases of under-managed or under-leased assets, and repositioning opportunities.
•We have been able to create place-making areas in our investment locations where we are able to make multiple investments in a particular city either through direct investments or development initiatives that further drives interest in the area.
•Many times, these investments are acquired at a discount to replacement cost or recent comparative sales, thereby offering opportunities to achieve above average total returns. In many cases, this may lead to significant additional returns, such as a carried interest (where we have partners), based on the performance of the assets.
•Our long-lasting and deep relationships with financial institutions allow us to refinance loans (generally after we implement our value-add initiatives) to reduce interest rates and/or increase borrowings due to property appreciation and thereby obtain cash flow to use for new investments.
•We have been able to attract third party capital due to our ability to generate above-market returns for our partners, diversity of geographic markets and investment product types as well as our flexibility in structuring deals through funds, separate accounts and equity partner arrangements.
•We understand that real estate is cyclical. Our management team employs a multi-cyclical approach that has resulted in our AUM being globally diversified across many sectors of real estate while maintaining a healthy liquidity position and adequate access to capital.
Competitive Strengths
We have a unique platform from which to execute our investment and investment management strategy. The combination of an investment and investment management platform provides several competitive strengths when compared to other real estate buyers and asset managers operating stand-alone or investment-focused firms and may allow us to generate superior risk-adjusted returns. Our investment strategy focuses on investments that offer significant appreciation potential through intensive asset management, leasing, repositioning, redevelopment and the opportunistic use of capital. We differentiate ourselves from other firms in the industry with our full service, investment-oriented structure.
Our competitive strengths include:
•Transaction experience: Our senior management team has an average of over 25 years of real estate experience and has been working and investing together on average for almost 20 years. Members of the senior management team have collectively acquired, developed and managed in excess of $30 billion of real estate investments in the United States, the United Kingdom, Ireland, Spain, Italy and Japan throughout various economic cycles, both at our Company and throughout their careers.
•Extensive relationship and sourcing network: We leverage our relationships in order to source attractive on and off-market deals. In addition, the senior management team and our acquisition team have transacted deals in nearly every major metropolitan market on the West Coast of the United States, as well as in the United Kingdom, Ireland, Spain, Italy and Japan. Their local presence and reputation in these markets have enabled them to cultivate key relationships with major holders of property inventory, in particularly financial institutions, throughout the real estate community.
•Structuring expertise and speed of execution: Prior acquisitions completed by us have taken a variety of forms, including direct property investments, joint ventures, exchanges involving stock or operating partnership units, participating loans and investments in performing and non-performing mortgages at various capital stack positions with the objective of long-term ownership. We believe we have developed a reputation of being able to quickly execute, as well as originate and creatively structure acquisitions, dispositions and financing transactions.
•Strategic partnerships: Through our relationships and transaction experience we have been able to establish various strategic partnerships with a variety of different companies and institutions in which we are highly collaborative and aligned with our partners in the deals. Coupled with our ability to structure acquisitions in a variety of ways that fit the needs of our strategic partners, we have been able to access various forms of capital due to our experience and versatility.
•Vertically integrated platform for operational enhancement: We have 230 employees in 12 offices throughout the United States, the United Kingdom, Ireland, Spain and Jersey. We have a hands-on approach to real estate investing and possess the local expertise in property and asset management, leasing, construction management, development and investment sales, which we believe enable us to invest successfully in selected submarkets.
•Calculated risk taking: We underwrite our investments based upon a thorough examination of property economics and a critical understanding of market dynamics and risk management strategies. We conduct an in-depth sensitivity analysis on each of our acquisitions. This analysis applies various economic scenarios that include changes to rental rates, absorption periods, operating expenses, interest rates, exit values and holding periods. We use this analysis to develop our disciplined acquisition strategies.
•Management's alignment with shareholders: As of December 31, 2022, our directors and executive officers and their respective affiliates owned an aggregate of approximately 14% of the outstanding shares of our common stock. Due to our management team's ownership interest in the Company its interests are in alignment with common shareholders of the Company and gives us an owner's mentality on the investments we own and manage.
The real estate business is cyclical. Real estate cycles are generally impacted by many factors, including availability of equity and debt capital, borrowing cost, rent levels, and asset values. Our strategy has resulted in a strong track record of creating both asset and entity value for the benefit of our shareholders and partners over these various real estate cycles.
Industry Overview
Key Investment Markets
Western United States
In 2022, the U.S. economy began to adjust to significant changes in monetary policy. For the first time since 2018, the Federal Reserve began to raise its key federal funds rate in 2022, ending the year by increasing rates 425 basis points, aiming to offset rising inflation. GDP decelerated to a 2.9% annualized pace in the fourth quarter of 2022, even though national unemployment rate improved to 3.5% from 3.9% at the beginning of the year. As a result of rapidly rising interest rates, the real estate transaction market in the U.S. fell sharply in the second half of the year, with transactions in the fourth quarter declining by over 60% according to Real Capital Analytics. The US equity markets, as measured by the S&P 500, experienced its worse year since 2008, driven by the onset of aggressive fed policy and potential risk of the U.S. economy experiencing a recession.
The multifamily sector continued to see strong rental growth in 2022 as overall demand for rental housing remained strong. Rising mortgage rates further drove demand due to the high cost of home ownership, and domestic migration patterns demonstrated that renters continued to move out of high cost cities and into more affordable markets. However, rising interest rates and borrowing costs resulted in declining transaction volumes, with fourth quarter 2022 multifamily volumes declining by an estimated 70% on a year-over-year basis. Investment volumes are expected to rebound when interest rates stabilize, as more debt capital is expected to be available for institutional investors, who remained on the sidelines during the fourth quarter of 2022. While the delivery of new supply is expected to rise in 2023, there continues to be a long-term undersupply of rental housing in the U.S., with CBRE estimating approximately 3.5 million new units that will be needed in the U.S. by 2035 to keep pace with demand. Kennedy Wilson's U.S. multifamily portfolio is largely comprised of garden style communities in suburban markets. In addition to our meaningful portfolio in the surrounding Seattle region, the Company has shifted its market-rate portfolio to the Mountain states, which now is the largest market-rate region by unit count and primarily consists of its assets in Utah, Idaho, and Nevada.
The outlook for office continued to be impacted by COVID-19 variants and the ability for workers to return to the office in 2022. Office investment volumes fell in fourth quarter of 2022 by 66%, compared to fourth quarter of 2021. Occupier demand for office is expected to improve in 2023, although there is a large divide between best-in-class primary office and
secondary space. Hybrid working arrangements continues to see widespread adoption as occupiers focus on energy-efficient workplaces that offer a variety of amenities, new desirable technology, and flexible configurations. Kennedy Wilson's U.S. office portfolio is primarily located in Southern California and the Greater Seattle market. The majority of the U.S. office is owned with partners through the Company’s Co-Investment segment.
Hawaii
The Hawaiian economy was negatively impacted by the COVID-19 pandemic but continues to experience a strong recovery. Travel to the islands has rebounded with 9.3 million visitors traveling to Hawaii in 2022, an increase of 37% from 2021. The luxury real estate market in Hawaii started off on a strong pace in 2022; however, as interest rates began to rise, transaction volumes slowed with total sales and transactions in 2022 decreasing by approximately 22% from 2021. However, property values in Hawaii continued to rise throughout every segment in 2022. The outlook remains positive for Hawaii, with almost 10 million visitors expected in 2023.
Ireland
Ireland’s economy is estimated to have had the strongest GDP growth across the EU at 10.1% in 2022 and the Organization for Economic Co-operation and Development is forecasting Ireland to have the highest GDP growth of any major European economy over the next two years.
Real estate investment volumes reached approximately €6.0 billion for 2022 which is the second strongest year on record. The overall investment volumes recorded in 2022 was up 9% on 2021 and almost 40% up on the 10-year average of €4.3 billion, a strong figure given the uncertain macroeconomic backdrop. Demonstrating Ireland’s position as an attractive global real estate market, 62% of investments were from institutional investors, and foreign investors accounted for 68% of the volume.
Dublin office absorption was more than 2.5 million square feet in 2022 with 60% occurring in the second half of 2022 demonstrating a renewed level of employer confidence in the future of physical offices. Prime headline city center rents increased to €65.00 per square foot up from €57.50 in 2021 and are expected to remain stable over 2023.
The Irish multifamily sector remains the dominant investment sector accounting for 33% of all transactions in 2022. As a result of the persisting supply-demand gap in the Dublin rental market, average rent prices are expected to see further upward pressure in 2023.
United Kingdom
Annual GDP in the UK is estimated to have grown by 4.1% in 2022, following growth of 7.4% in 2021. Similar to trends in the U.S., the UK Consumer price index ("CPI") has continued on an upward trajectory to 10.5% in December. As of the beginning of February 2023 base rates have increased 50 basis points to 4% and headline CPI inflation has begun to edge back and is likely to fall over the rest of the year as a result of past movements in energy and other goods prices. The UK labor market remained strong, with the unemployment rate estimated at 3.7% at December 31, 2022.
Investment in UK commercial property fell by 24.9% to £10.1 billion during the fourth quarter 2022, from £13.4 billion at the end of September 2022, 6% higher than the fourth quarter ten-year quarterly average and 32% lower than the ten-year quarterly average. Capital deployed was split evenly with domestic investment accounting for 49% and international investment accounting for 51%.
In regards to South East London Offices, the 2022 annual transaction volume of £3 billion showed a 14% decrease on the five year annual average of £3.5 billion and a 30% decrease on 2021. Vacancy across the wider M25 market now stands at 11.2%, seeing a marginal decline quarter on quarter.
For the Industrial and Logistics sectors fourth quarter 2022 investment volumes totaled £1.5 billion (down 39% when compared to third quarter 2022), with multi-lets only capturing 26% of investment, down from 41% in third quarter 2022. Take up was 14.7 million square feet in fourth quarter 2022, almost exactly the same as in third quarter 2022 and 5% below the 5-year quarterly average. However, occupier take up for 2022 as a whole was 65.8 million square feet, down 25% on the record high in 2021, but still the second most active year on record.
In the UK Retail sector, economic headwinds proved strong in the second half of 2022, suppressing deal volumes to £2.75 billion (down 33% on the same period for 2021), contrasting against the high deal volumes of first half of 2022 at £3.58 billion (up 11% on the same period for 2021).
Environmental, Social and Governance (ESG)
Kennedy Wilson’s approach to ESG aligns with its business strategy to maximize the inherent value of our assets and by striving to deliver long-term social, environmental, and economic value across our portfolio and to our key stakeholders. We aim to integrate ESG factors into key business processes, underpinned by a measure, manage, and monitor approach framed by our four ESG pillars most relevant to our business: Optimizing Resources, Creating Great Places, Building Communities and Operating Responsibly. Details of this framework can be found on our ESG website (esg.kennedywilson.com) (this website address is not intended to function as a hyperlink, and the information contained in, or accessible from, our website is not intended to be a part of this filing).
The ESG Committee of the Board of Directors (the "ESG Committee") oversees the Company’s ESG program, including opportunities and risk management strategies. The ESG Committee's main areas of focus include:
•Overseeing and reviewing the Company’s ESG strategies, initiatives, and policies, including the Company’s ESG-related reporting and disclosures.
•In conjunction with the Compensation Committee, overseeing and reviewing the Company’s culture and human capital management strategy, initiatives, and policies, including our inclusion, diversity, and equity efforts; and
•In conjunction with the Audit Committee, overseeing risk management and oversight programs and performance-related material to ESG matters affecting Kennedy Wilson.
The ESG Committee is also responsible for overseeing Kennedy Wilson’s management-level Global ESG Committee. The Global ESG Committee, chaired by our President and Board of Directors member Mary Ricks, manages the Company’s ESG responsibilities and commitments and is responsible for formulating and implementing procedures and priorities to deliver the Company’s ESG strategy.
The Global ESG Committee focuses on the following: monitoring compliance with existing and future material ESG-related laws and regulations applicable to the Company and its investments that would have a material impact on business operations; setting appropriate global ESG priorities aim to align across target markets; monitoring delivery progress; and supporting ESG communication to investors and other stakeholders. The Global ESG Committee is supported by two executive level ESG committees in the US and Europe, each of which focus on the implementation of ESG policies and strategies in their respective regions.
It is Kennedy Wilson's intention to manage ESG factors, both opportunities and risks, at the corporate, fund and individual assets level, with the goal of integrating robust procedures across all stages of its investment process. The Company's policies can be reviewed on its corporate website (https://www.kennedywilson.com/corporate-responsibility) (this website address is not intended to function as a hyperlink, and the information contained in, or accessible from, the Company's website is not intended to be a part of this filing) and cover guidelines and rules regarding ESG, anti-discrimination, anti-harassment, non-retaliation, human trafficking and slavery, fraud prevention, data security and data privacy.
Human Capital Management
Company Overview and Values
We operate as a non-bureaucratic, teamwork-oriented, and nimble organization. We promote an entrepreneurial culture, and at our core, we are powered by a team of focused, high-performance people who thrive on excellence in the workplace and a shared desire to make an impact.
Workplace Diversity
We strive to maintain a diverse corporate culture, celebrating and promoting equality across gender, socio-economic backgrounds, education, and ethnicity. This allows for better representation of different viewpoints, historical perspective and can bring fresh ideas to all levels of the Company. Within Kennedy Wilson’s total workforce of approximately 230 employees, 40% are women, with many serving in leadership positions throughout the company. Women also hold 25% of the board of director positions. In 2022, we continued Kennedy Wilson Woman speaker series as part of our efforts to advance women in real estate and finance and deepen our industry’s talent pool.
Training and Development
Kennedy Wilson would not exist without our most important asset: our people. We strive to maintain a culture that fosters collaboration and innovation, and we take great pride in building and maintaining a driven, results-oriented workforce.
Our talent development program includes access to formal and informal mentorships, tuition reimbursement, where we are supporting employees who are seeking advanced certificates in areas of specialty that pertain to their role at Kennedy Wilson, and "Lunch and Learn" sessions. These alongside our regular global senior management calls continue to develop our managers to become more effective leaders. A dynamic internship and internal transfer program also helps promote personal development and improves leadership skills across all departments.
Through our annual summer internship program, we continue to find ways to better support our equality, diversity, and inclusion aspirations by building a diverse pipeline of talented individuals in the real estate industry with the intention to introduce our business to those who may not have considered a career in real estate.
Competition
We compete with a range of global, national and local real estate firms, individual investors and other corporations, both private and public. Our investment business competes with real estate investment partnerships, real estate investments trusts, private equity firms and other investment companies and regional investors and developers. We believe that our relationships with the sellers and our ability to close an investment transaction in a short time period at competitive pricing provide us a competitive advantage.
Foreign Currency
Approximately 37% of our investment account is invested through our foreign platforms in their local currencies. Investment level debt is generally incurred in local currencies and we consider our equity investment as the appropriate exposure to evaluate for balance sheet hedging purposes. We typically do not hedge foreign exchange rates for future operations or cash flows of operations, which may have a significant impact on the results of our operations. In order to manage the effect of fluctuations in foreign exchange rates, we generally hedge our book equity exposure to foreign currencies through currency forward contracts and options.
We wholly-own Kennedy Wilson Europe Real Estate Limited ("KWE"), which is domiciled in the United Kingdom and has GBP as its functional currency. KWE has investments in assets that have functional currencies of GBP and euros. Kennedy-Wilson Holdings, Inc. does not have a direct interest in the euro-denominated investments but has indirect ownership through its interest in KWE. We cannot directly hedge the foreign currency movements in these euro-denominated assets but we do hedge foreign currency movements in euro assets at the KWE level through GBP/EUR hedging instruments. We then are able to hedge the USD/GBP foreign currency exposure through our direct interest in KWE.
Within KWE we have historically utilized three types of contracts to hedge our GBP/EUR exposure: foreign forward currency contracts; a cross currency swap (until its settlement in September 2021) on the 3.95% pound sterling-denominated bonds due 2022 (the "KWE Bonds") (swapped GBP to EUR); and the KWE Euro Medium Term Notes ("KWE Notes"). The KWE Notes were issued in euros and held by KWE but we have elected to treat the foreign currency movements as a net investment hedge on our euro-denominated investments in KWE. The foreign currency movements on these hedge items above are recorded to unrealized foreign currency derivative contract gains/losses within other comprehensive income for GBP/EUR movements. However, when we translate our investment in KWE from USD/GBP, the foreign currency movements on these items go through unrealized foreign currency translation gains/losses within other comprehensive income.
Please refer to Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation for a discussion regarding foreign currency and currency derivative instruments.
Transaction-Based Results
A significant portion of our cash flow is tied to transaction activity which can affect an investor’s ability to compare our financial condition and results of operations on a quarter-by-quarter or year-over-year basis or to easily evaluate the breadth of our operation. Historically, this variability has caused our revenue, net income and cash flows to be tied to transaction activity, which is not necessarily concentrated in any one quarter.
Employees
As of December 31, 2022, we have 230 employees in 12 offices throughout the United States, the United Kingdom, Ireland, Spain and Jersey. We believe that we have been able to attract and maintain high quality employees. There are no employees subject to collective bargaining agreements. In addition, we believe we have a strong relationship with our employees.
Available Information
Information about us is available on our website (http://www.kennedywilson.com) (this website address is not intended to function as a hyperlink, and the information contained in, or accessible from, our website is not intended to be a part of this filing). We make available on our website, free of charge, copies of our Annual Report on Form 10-K, Quarterly Reports
on Form 10-Q, Current Reports on Form 8-K, Proxy Statements on Schedule 14A and amendments to those reports and other statements filed or furnished pursuant to Section 13(a), 14 or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after filing or submitting such material electronically or otherwise furnishing it to the SEC. In addition, we have previously filed registration statements and other documents with the SEC. Any document we file is available at the SEC's internet address at http://www.sec.gov (this website address is not intended to function as a hyperlink, and the information contained in, or accessible from, the SEC's website is not intended to be a part of this filing).
Item 1A.
Risk Factor Summary
Our business is subject to a number of risks and uncertainties. These risks are more fully described in the section titled “Risk Factors” included in Part I, Item 1A of this report. These risks include, among others, the following:
•The success of our business is significantly related to general economic conditions and the real estate industry, and, accordingly, our business could be harmed by an economic slowdown, recession and downturn in real estate asset values, property sales and leasing activities.
•Adverse developments in the credit markets and rising interest rates may harm our business, financial condition and results of operations.
•Inflation may adversely affect our financial condition and results of operations.
•Our business and those of our tenants may be adversely affected by epidemics, pandemics or other outbreaks.
•Our significant operations in the United Kingdom and Ireland and, to a lesser extent, Spain and Italy, expose our business to risks inherent in conducting business in foreign markets.
•Our revenues and earnings may be materially and adversely affected by fluctuations in foreign currency exchange rates due to our international operations.
•Some of our portfolio investments may be recorded at fair value, and, as a result, there will be uncertainty as to the value of these investments.
•Our real estate development and redevelopment strategies may not be successful.
•Poor performance of our commingled funds would cause a decline in our revenue and results of operations and could adversely affect our ability to raise capital for future funds.
•Our joint venture activities subject us to third-party risks, including risks that other participants may become bankrupt or take action contrary to our best interests.
•If we are unable to identify, acquire and integrate suitable investment opportunities and acquisition targets, our future growth will be impeded.
•Our real estate debt investment business operates in a highly competitive market for lending and investment opportunities through our debt platforms.
•Our reliance on third parties to operate certain of our properties may harm our business.
•Our leasing activities depend on various factors, including tenant occupancy and rental rates, which, if adversely affected, could cause our operating results to suffer.
•Increasing scrutiny and changing expectations from stakeholders with respect to our environmental, social and governance practices may impose additional costs on us or expose us to new or additional risks.
•We have in the past incurred and may continue in the future to incur significant amounts of debt and, to a lesser extent, preferred stock, to finance acquisitions, which could negatively affect our cash flows and subject our properties or other assets to the risk of foreclosure.
•Our debt obligations impose significant operating and financial restrictions, which may prevent us from pursuing certain business opportunities and taking certain actions.
•If we are unable to raise additional debt and equity capital, our growth prospects may suffer.
•The loss of one or more key personnel, particularly our CEO, could have a material adverse effect on our operations.
•Our results are subject to significant volatility from quarter to quarter due to the varied timing and magnitude of our strategic acquisitions and dispositions, the incurrence of any impairment losses and other transactions.
•Our directors and officers and their affiliates are significant stockholders, which makes it possible for them to have significant influence over the outcome of all matters submitted to stockholders for approval and which influence may be in conflict with our interests and the interests of our other stockholders.
Risk Factors
Our results of operations and financial condition can be adversely affected by numerous risks. You should carefully consider the risk factors detailed below in conjunction with the other information contained in this report. If any of the following risks actually occur, our business, financial condition, operating results, cash flows and future prospects could be materially adversely affected.
Risks Related to Our Business
The success of our business is significantly related to general economic conditions and the real estate industry, and, accordingly, our business could be harmed by an economic slowdown, recession and downturn in real estate asset values, property sales and leasing activities.
Our business is closely tied to general economic conditions in the real estate industry. As a result, our economic performance, the value of our real estate and our ability to implement our business strategies may be significantly and adversely affected by changes in national and local economic conditions. The condition of the real estate markets in which we operate is cyclical and primarily depends on the condition of the economy in the United States, United Kingdom, Ireland and, to a lesser extent, Spain and Italy, as a whole and on the perceptions of investors on the overall economic outlook. In each of the markets in which we operate, rising interest rates, foreign currency fluctuations, inflation, declining demand for real estate, declining real estate values, potentially declining employment levels, periods of general economic slowdown and recession fears, or the perception that any of these events may continue or worsen, have negatively impacted the real estate market and our operating performance. The economic condition of each local market where we operate may depend on one or more key industries within that market, which, in turn, makes our business sensitive to the performance of those industries. Real estate investments are generally illiquid, which may affect our ability to promptly change our portfolio in response to changes in economic and other conditions. Moreover, we may not be able to unilaterally decide the timing of the disposition of an investment under certain joint venture arrangements, and as a result, we may not control when and whether any gain will be realized, or loss avoided. Certain significant expenditures, such as debt service costs, which have increased with the rapid rise of interest rates in response to high inflation, real estate taxes and operating and maintenance costs, are generally not reduced when market conditions are poor. These factors impede us from responding quickly to changes in the performance of our investments and could adversely impact our business, financial condition and results of operations. Although current general macroeconomic conditions, globally and locally in the United States and in other countries in which we conduct business, remain volatile and uncertain, we continue to evaluate the extent to which each factor may impact our business, financial condition and results of operations.
We are typically active in many real estate transactions. The current high interest rates and inflationary pressures in our markets, however, have led to a general decrease in transactional activity, leading to lower levels of gains recognized and cash generated to reinvest in our business. Previous recessions and downturns in the real estate market have resulted in and may result in:
•a general decline in rents due to defaulting tenants or less favorable terms for renewed or new leases;
•a general decline in demand for new office space and commercial real estate, which in turn led to a general increase in the levels of vacancy across our office and commercial portfolio;
•a decline in actual and projected sale prices of our properties, resulting in lower returns on the properties in which we have invested;
•higher interest rates, higher loan costs, less desirable loan terms and a reduction in the availability of mortgage loans, all of which could increase costs and limit our ability to acquire additional real estate assets; and
•a decrease in the availability of lines of credit and the capital markets and other sources of capital used to grow, operate and maintain our business.
The profitability of our office, industrial and retail portfolio (which makes up 11.7 million square feet, 10.6 million square feet and 3.9 million square feet, respectively, of our total commercial portfolio) depends, in part, on the willingness and ability of customers to visit our tenants' businesses and demand for office space. In addition to economic conditions, the real estate industry is also susceptible to societal trends among certain types of tenants, which may lead to an increase or decrease in demand for certain of our assets. Currently, there is a notable trend among certain influential commercial tenants (including some of our tenants) of maintaining COVID-19 pandemic-driven hybrid work schedules, remote workforces and/or reducing the overall size of their workforce in response to the macroeconomic conditions discussed above, leading to a decrease in demand for office and industrial space. Such large commercial tenants’ policies are generally widely publicized and discussed, potentially influencing other commercial tenants to follow suit. Decreased demand for office space, either due to hybrid or remote workforces or reductions in tenants’ workforces, may impact our prospective or current commercial tenants’ ability or willingness to enter into, maintain or renew their leases for certain office space, which may have an adverse effect on our
business and results of operations. One of the two tenants that make up our entire tenant population at one of our office properties located in Bellevue, Washington (the third largest asset by our share of net operating income), has given us notice of its intent to vacate the property at the end of their current lease (October 2023). The other tenant has a lease termination option in January 2025. While we are working on securing new long-term leases with high-credit tenants at the property, there is no assurance that we will be able to do so at favorable terms or at all.
If our business performance and profitability deteriorate, we could fail to comply with certain financial covenants in our unsecured bond and revolving credit facility, which would force us to seek an amendment with our lenders. We may be unable to obtain any necessary waivers or amendments on satisfactory terms, if at all, which could result in the principal and interest of the debt to become immediately due. Please also see “Our debt obligations impose significant operating and financial restrictions, which may prevent us from pursuing certain business opportunities and taking certain actions.” In addition, due to, among other things, a decrease in transactional activity and the macroeconomic conditions discussed above, we may become more highly leveraged, resulting in an increase in debt service costs that could adversely affect our results of operations or our credit ratings. From time to time, Moody’s Investors Service, Inc. and Standard & Poor’s Ratings Services (“S&P”), a division of The McGraw-Hill Companies, Inc., rate our outstanding debt. These ratings are based on a variety of factors, including our current leverage and transactional activity. In October of 2022, S&P placed us on negative CreditWatch due to a slowdown in investment transaction activity leading to elevated leverage and in February of 2023, S&P downgraded us to ‘BB’ from ‘BB+’. Additionally, in February 2023, S&P downgraded the KWE Notes to ‘BB+’ from ‘BBB-’ and the KWI Notes to ‘BB-’ from ‘BB’. Downgrades in our credit ratings may further limit our ability to access capital markets. Any of these factors could lead to a significant deterioration of our business, and we could have insufficient liquidity to meet our debt service obligations when they come due in future years or maintain our common stock or preferred stock dividends. Please also see “Adverse developments in the credit markets and rising interest rates may harm our business, financial condition and results of operations” below.
Adverse developments in the credit markets and rising interest rates may harm our business, financial condition and results of operations.
The credit markets are experiencing significant price volatility, dislocations and liquidity disruptions. These circumstances have, and may continue to, materially impact liquidity in the financial markets, making terms for certain financings less attractive, and, in some cases, unavailable, even for companies that are otherwise qualified to obtain financing. As of February 2, 2023, the Federal Reserve raised its target range for the federal funds rate to 4.50% to 4.75%, a 425 basis point increase since March 2022, and it has indicated it is likely to continue to raise the rate in 2023 in order to curtail high inflation. Volatility and uncertainty in the credit markets, including increasing interest rates, have increased the cost of borrowing, on both a corporate and property level, and may negatively impact our ability to access future additional financing for our capital needs or refinance or extend our existing debt on favorable terms, if at all. A prolonged downturn in the financial markets or recession, either globally or locally in the United States or in other countries in which we conduct business, may cause us to seek alternative sources of potentially less attractive financing and may require us to adjust our business plan. Disruptions in the credit markets may also adversely affect our business of providing investment management services to our limited partners in our commingled funds and joint venture partners, which would lead to a decrease in the performance allocations we generate.
Additionally, our primary market risk exposure relates to fluctuations in market interest rates on investment mortgages and debt obligations, specifically short-term borrowings. To attempt to minimize our overall cost of debt, we have established an interest rate management policy to maintain a combination of variable and fixed rate debt and as of December 31, 2022, 76% of our consolidated debt is fixed rate, 20% is floating rate with interest caps and 4% is floating rate without interest caps and 55% of our share unconsolidated mortgages was fixed rate, 34% was floating rate with interest caps and 11% was floating rate. We also hold variable rate debt on some of our consolidated and unconsolidated properties that are subject to interest rate fluctuations and we have purchased interest rate caps to limit the amount that interest expense can increase with rate increases. However, some of our debt is uncapped and the mortgages that do have interest caps are subject to increased interest expense until rates hit the level of caps that have been purchased. If there was a 100-basis point increase or decrease, we would have a $6.3 million increase in interest expense or $9.5 million of interest expense savings during 2023 on our current share of indebtedness. The weighted average strike price on caps and maturity of Kennedy Wilson’s variable rate mortgages is 2.32% and approximately 2.1 years, respectively, as of December 31, 2022. If the market interest rates continue to increase, our cash flow and results of operations will be adversely affected and we may need to adjust our interest rate management policy, either or both of which may adversely affect our business, financial condition, liquidity and results of operations.
Our real estate debt investment business primarily originates and invests in floating interest rate instruments. In addition to originating and acquiring senior loans, we also originate and invest in mezzanine loans, B-and C-Notes and preferred equity. These types of investments generally involve a higher degree of risk than long-term senior mortgage lending secured by income-producing real property. For example, if a borrower defaults, there may not be sufficient funds remaining
for a B-Note holder after payment to the A-Note holder. While our income from such variable rate loans and investments has increased as the market interest rates increased, borrowers may be unable to continue to service their debt at the applicable rates. Returns on loan investments depend on the borrower’s ability to make required payments or, in the event of default, our security interest and our ability to foreclose and liquidate whatever property that secures the loans and loan portfolios. We may be unable to collect on a defaulted loan or foreclose on security successfully or in a timely fashion, either of which may adversely affect our business and results of operations. Additionally, potential borrowers may be unable or unwilling to accept variable rate loans, which would result in less transaction activity for our real estate debt investment business and could adversely affect our business, financial condition, liquidity and results of operations. Please also see “Any distressed loans and loan portfolios that we may purchase, or investments that may become "sub-performing" or "non-performing" following our origination or acquisition thereof, may have a higher risk of default and delinquencies than newly originated loans, and, as a result, we may lose part or all of our investment in such loans and loan portfolios.”
Inflation may adversely affect our financial condition and results of operations.
Recently, inflation has increased to its highest level in decades. Over the last twelve months ending December 2022, the consumer price index rose by approximately 6.5%, before seasonal adjustment, in the United States and 9.2% in the United Kingdom, and the annual inflation rate in the euro area was 9.2% in December 2022.
High inflation has led to rapidly rising interest rates, the effects of which are discussed throughout this report. Increasing inflation could, among other things, have an adverse impact on our floating rate mortgages and general and administrative expenses, as these costs could increase at a rate higher than our rental and other revenue. During times when inflation is increasing at a greater rate than the increases in rent provided by our leases, our rent levels will not keep up with the costs associated with rising inflation. Inflation could also have an adverse effect on consumer spending, which could impact our tenants’ revenues and, in turn, our percentage rents, where applicable. Additionally, we may face decreased demand for our office and industrial assets as inflationary pressures continue to rise from certain of our prospective or current retail, ecommerce or manufacturing-based commercial tenants, who are generally more sensitive to inflation and consumer demand. Further, increased inflation, in addition to other geopolitical and related economic factors such as the ongoing military conflict between Russia and Ukraine and international sanctions against Russia, have resulted in energy shortages and a material increase of energy prices in the markets in which we operate, primarily in Europe, which are expected to further drive up inflation. In the United States, the energy index increased 7.3% for the twelve months ending December 31, 2022. Electricity prices in the United Kingdom rose by 59% and gas prices by 95% in the twelve months ending December 31, 2022. Energy shortages and rising energy costs may negatively impact both us and our tenants’ operations and financial condition, especially in Europe. In addition, substantial inflationary pressures could have a negative impact on certain real estate assets, including, without limitation, development projects that do not have guaranteed, or fixed price, contracts and real estate assets with long-term leases that do not provide for short-term rent increases. Although we continue to seek investments in markets where we see opportunities for stronger relative growth, including multifamily assets with leases that have an initial term of 12 months or less, and continue to work to manage cost overrun risks for our development and redevelopment projects with detailed architectural plans, guaranteed, or fixed price, contracts and close supervision by expert Company executives and personnel, if we are unable to execute our business strategy or if there is a substantial increase in inflation, such circumstances could adversely affect our financial condition, liquidity, results of operations and prospects.
Our business and those of our tenants may be adversely affected by epidemics, pandemics or other outbreaks.
Epidemics, pandemics or other outbreaks of an illness, disease or virus (including COVID-19) that affect countries or regions in which our tenants or their parent companies, as applicable, operate or in which our investments or corporate offices are located, and actions taken to contain or prevent their further spread, may have a material and adverse impact on general commercial activity, the financial condition, results of operations, liquidity and creditworthiness of us and our tenants. In addition, numerous state, local, federal and industry-initiated efforts may also affect our ability to collect rents and enforce remedies for the failure to pay rent, including eviction moratoriums.
The risk, public perception of the risk and measures taken to limit the impact of epidemics, pandemics or other outbreaks of an illness, disease or virus, (including COVID-19), including social distancing, travel restrictions and other restrictions, could adversely impact demand for commercial space, demand for hotels and/or cause the temporary closure or slowdown of our tenants' businesses, and severely disrupt their operations. This may impact our ability to lease properties on favorable terms and/or collect owed rents on a timely basis or at all, which could then have a material adverse effect on our business, financial condition and results of operations.
Epidemics, pandemics or other health crisis, including the COVID-19 pandemic and measures to prevent its spread, could adversely affect the businesses and financial condition of our counterparties, including our equity partners, borrowers
under our first-mortgage loans, construction loans and mezzanine loans, companies in which we and our equity partners have invested in, and general contractors and their subcontractors, and their ability to satisfy their obligations to borrowers of our construction loans and to complete transactions or projects with borrowers of our construction loans as intended. In addition, a significant number of retail tenants have been forced to temporarily close or operate on a limited basis as a result of the COVID-19 pandemic and related government actions, which has resulted in, and could continue to result in, delays in rent payments, rent concessions, early lease terminations or tenant bankruptcies, and which in turn could adversely affect our borrowers’ ability to service our loans or a company’s ability to pay us dividends on the preferred stock we hold in such company. All of the above listed risks could adversely affect our business, financial condition, liquidity, results of operations and prospects. See “Our real estate development and redevelopment strategies may not be successful.” below.
Additionally, the financial impact of the COVID-19 pandemic, or any other epidemic, pandemic or other health crisis, could impact our future compliance with operational and financial debt covenants contained in the agreements that govern the Second A&R Facility, our 4.750% Senior Notes due 2029 (the "2029 Notes"), 4.750% Senior Notes due 2030 (the "2030 Notes"), and 5.000% Senior Notes due 2031 (the "2031 Notes"), together with the 2029 Notes, 2030 Notes and the 2031 Notes, the "KWI Notes") and the KWE Notes and certain of our property-level non-recourse financings. Our failure to comply with such covenants could result in an event of default that, if not cured or waived, could result in a foreclosure on the underlying assets. In addition, certain of our debt instruments also contain cross-default and/or cross-acceleration provisions, including, but not limited to, the documents governing our KWI Notes and the KWE Notes. Please also see “We have in the past incurred and may continue in the future to incur significant amounts of debt and, to a lesser extent, preferred stock, to finance acquisitions, which could negatively affect our cash flows and subject our properties or other assets to the risk of foreclosure.”
Our significant operations in the United Kingdom and Ireland and to a lesser extent, Spain and Italy expose our business to risks inherent in conducting business in foreign markets.
As of December 31, 2022, approximately 41% of our revenues were sourced from our foreign operations in the United Kingdom, Ireland, Spain and Italy, 93% of which was sourced from our operations in the United Kingdom and Ireland. Accordingly, our firm-wide results of operations depend significantly on our foreign operations. Conducting a global business carries significant risks, including:
•restrictions and problems relating to the repatriation of capital;
•difficulties and costs of staffing and managing international operations;
•the burden of complying with multiple and potentially conflicting laws, including local laws related to public health;
•laws restricting foreign companies from conducting business;
•political instability, civil unrest, acts of war and terrorism, pandemics, epidemics, acts of God, including earthquakes, hurricanes, volcanic eruptions and other natural disasters (which may result in uninsured or under insured losses);
•greater difficulty in perfecting our security interests, collecting accounts receivable, foreclosing on secured assets and protecting our interests as a creditor in bankruptcies in certain geographic regions;
•potentially adverse tax consequences;
•share ownership restrictions on foreign operations; and
•tariff regimes of the countries in which we do business
Our revenues and earnings may be materially and adversely affected by fluctuations in foreign currency exchange rates due to our international operations.
Our revenues from foreign operations have been primarily denominated in the local currency where the associated revenues were earned. Fluctuations in currency exchange rates create volatility in our reported results as we translate the balance sheets, operational results and cash flows of our subsidiaries into U.S. Dollars for consolidated reporting. To date, our foreign currency exposure has been limited to the GBP and the euro. Recent volatility in currency exchange rates have led to fluctuations in our earnings because of corresponding fluctuations in the GBP and euro currency exchange rates. The GBP dropped to a record low of $1.07 against the U.S. Dollar in September 2022 after the United Kingdom government announced a new economic plan that has since been abandoned. Although the GBP has rallied in recent weeks, it remains historically weak against the U.S. Dollar, primarily due to the recent macroeconomic conditions and lingering effects of Brexit, dropping to $1.21, as of December 31, 2022, as compared to $1.35 as of December 31, 2021. Similarly, the euro hit a two-decade low of $0.99 against the U.S. Dollar in August 2022 and continued to trend down to a low of $0.96 on September 27, 2022. As of December 31, 2022, the euro slightly improved to $1.07 against the U.S. Dollar, but it is still below its rate of $1.14 as of December 31, 2021.
Due to the constantly changing currency exposures to which we will be subject and the volatility of currency exchange rates, we may experience currency losses in the future, and we cannot predict the effect of exchange rate fluctuations on future operating results. Our management uses currency hedging instruments from time to time, including foreign currency forward contracts, purchased currency options (where applicable) and foreign currency borrowings. The economic risks associated with these hedging instruments include unexpected fluctuations in foreign currency rates, which could lead to hedging losses or the requirement to post collateral, along with unexpected changes in our underlying net asset position. Our hedging activities may not be effective.
We may expose ourselves to risks if we engage in hedging transactions.
We have and may in the future enter into hedging transactions, which may expose us to risks associated with such transactions. We may utilize instruments such as forward contracts, currency options and interest rate swaps, caps, collars and floors to seek to hedge against fluctuations in the relative values of our portfolio positions from changes in currency exchange rates and market interest rates. Use of these hedging instruments may include counter-party credit risk.
Hedging against a decline in the values of our portfolio positions does not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the values of such positions decline. However, such hedging can establish other positions designed to gain from those same developments, thereby offsetting the decline in the value of such portfolio positions. Such hedging transactions may also limit the opportunity for gain if the values of the underlying portfolio positions should increase. Moreover, it may not be possible to hedge against an exchange rate or interest rate fluctuation that is so generally anticipated that we are not able to enter into a hedging transaction at an acceptable price.
The success of our hedging transactions will depend on our ability to correctly predict movements in currencies and interest rates. Therefore, while we may enter into such transactions to seek to reduce currency exchange rate and interest rate risks, unanticipated changes in currency exchange rates or interest rates may result in poorer overall investment performance than if we had not engaged in any such hedging transactions. In addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions being hedged may vary. Moreover, for a variety of reasons, we may not seek to (or be able to) establish a perfect correlation between such hedging instruments and the portfolio holdings being hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to risk of loss. In addition, it may not be possible to hedge fully or perfectly against currency fluctuations affecting the value of securities denominated in non-U.S. currencies because the value of those securities is likely to fluctuate as a result of factors not related to currency fluctuations.
Some of our portfolio investments may be recorded at fair value, and, as a result, there will be uncertainty as to the value of these investments.
As of December 31, 2022, $2.1 billion, or approximately 88% of our unconsolidated investments and approximately 25% of our total assets were recorded on our financial statements at estimated fair value. These include our investments in the commingled funds that we manage and unconsolidated investments in which we have elected the fair value option under U.S. generally accepted principles (U.S. GAAP). At the end of each reporting period, the fair value of these investments is recalculated, and any change from the fair value as of the end of the prior reporting period is reflected in our consolidated statement of income as a gain or loss included in income (loss) from unconsolidated investments. Accordingly, fair value accounting could result in significant non-cash volatility in our financial position and our results of operation, which, in turn, could adversely affect the trading price of our common stock and other securities.
In determining estimated fair market values, the Company utilizes two approaches to value real estate, a discounted cash flow analysis and direct capitalization approach.
Discounted cash flow models estimate future cash flows from a buyer's perspective (including terminal values) and compute a present value using a market discount rate. The holding period in the analysis is typically ten years. This is consistent with how market participants often estimate values in connection with buying real estate but these holding periods can be shorter depending on the life of the structure an investment is held within. The cash flows include a projection of the net sales proceeds at the end of the holding period, computed using a market reversionary capitalization rate.
Under the direct capitalization approach, the Company applies a market derived capitalization rate to current and future income streams with appropriate adjustments for tenant vacancies or rent-free periods. These capitalization rates and future income streams are derived from comparable property and leasing transactions and are considered to be key inputs in the valuation. Other factors that are taken into consideration include tenancy details, planning, building and environmental factors that might affect the property.
The Company also utilizes valuations from independent real estate appraisal firms on some of its investments ("appraised valuations"), with certain investment structures requiring appraised valuations periodically (typically annually). All appraised valuations are reviewed and approved by the Company.
Estimating fair values using any valuation methodology is inherently uncertain and involves a significant number of assumptions. Furthermore, any changes in the underlying assumptions, including capitalization rates, discount rates, liquidity risks, and estimates of future cash flows, as a result of, without limitation, economic and market volatility due to recessionary fears and pressures from high levels of inflation, central banks raising interest rates to curtail high inflation, currency fluctuations and the COVID-19 pandemic, could significantly affect the fair value estimates. For example, small changes in the inputs and assumptions that we use from period to period to estimate these fair values may result in large changes in the carrying value of these investments and could materially and adversely impact our reported earnings. Moreover, the estimated fair values used in preparing our financial statements may not represent amounts that could be realized in a current sale or an immediate settlement of the related asset or liability, nor would those estimated fair values necessarily reflect the returns we may actually realize.
Our real estate development and redevelopment strategies may not be successful.
We acquire development assets to the extent attractive projects become available. As part of our investment strategy, we seek to locate and acquire real estate assets that we believe are undervalued and improve them to increase their resale value. When we engage in development activities, we are subject to risks associated with those activities that could adversely affect our financial condition, results of operations, cash flows and the market price of, our common stock, including, but not limited to:
•we may not be able to obtain, or may experience delays in obtaining, all necessary zoning, land-use, building, occupancy and other governmental permits and authorizations;
•we may not be able to obtain financing for development projects, or obtain financing on favorable terms;
•construction costs of a project may exceed the original estimates or construction may not be concluded on schedule, making the project less profitable than originally estimated or not profitable at all (including the possibility of errors or omissions in the project's design, contract default, contractor or subcontractor default, performance bond surety default, the effects of local weather conditions, natural disasters and pandemics, the possibility of local or national strikes and the possibility of shortages in materials, building supplies or energy and fuel for equipment);
•tenants who pre-lease space or contract with us for a build-to-suit project may default prior to occupying the project;
•upon completion of construction, we may not be able to obtain, or obtain on advantageous terms, permanent financing for activities that we financed through construction loans;
•we may not achieve sufficient occupancy levels, sales levels and/or obtain sufficient rents to ensure the profitability of a completed project;
•we may overestimate the value of the property;
•such development activities typically require a significant amount of management's time and attention, diverting their attention from our other operations; and
•development projects in which we have invested may be abandoned and the related investment will be impaired.
Any failure to complete a redevelopment project in a timely manner and within budget or to sell or lease the project after completion could have a material adverse effect upon our business, results of operation and financial condition.
Poor performance of our commingled funds would cause a decline in our revenue and results of operations and could adversely affect our ability to raise capital for future funds.
When any of our commingled closed-end funds perform poorly, our investment record suffers. As a result, our management fees and performance allocations and our ability to raise additional capital from our partners may be adversely affected. If a fund performs poorly, we will receive little or no performance allocations with regard to the fund and little income or possibly losses from our own principal investment in such fund. As the fair value of underlying investments varies between reporting periods, if we were to have negative performance in a period that causes the amount due to us to be less than the amount previously recognized, this could result in a negative adjustment to performance allocations to the general partner or asset manager. Our fund investors and potential fund investors continually assess our funds' performance independently and relative to market benchmarks and our competitors, and our ability to raise capital for existing and future funds depends on our funds' performance. Alternatively, in the face of poor fund performance, investors could demand lower fees or significant fee concessions for existing or future funds which would likewise decrease our revenue or decide not to invest with us.
Our joint venture activities subject us to third-party risks, including risks that other participants may become bankrupt or take action contrary to our best interests.
We have used joint ventures for large real estate investments and developments. We plan to continue to acquire interests in additional joint ventures formed to own or develop real property or interests in real property, however, we cannot be certain that we will continue to identify suitable joint venture partners and form new joint ventures in the future. Although, we generally serve as the general partner or managing member of such joint venture, we have acquired and may acquire non-controlling interests in joint ventures, and we may, from time-to-time, also acquire interests as a passive investor without rights to actively participate in the management of the joint ventures. Investments in joint ventures involve additional risks, including the possibility that the other participants may become bankrupt or have economic or other business interests or goals that are inconsistent with ours, that we will not have the right or power to direct the management and policies of the joint ventures and that other participants may take action contrary to our instructions or requests and against our policies and objectives. Should a participant in a material joint venture investment act contrary to our interests, our business, results of operations and financial condition could significantly suffer.
If we are unable to identify, acquire and integrate suitable investment opportunities and acquisition targets, our future growth will be impeded.
Acquisitions and expansion have been, and will continue to be, a significant component of our growth strategy. While maintaining our existing business lines, we intend to continue to pursue a sustained growth strategy by increasing revenues from seeking selective investment and co-investment opportunities and pursuing strategic acquisitions. Our ability to manage our growth will require us to effectively integrate new acquisitions into our existing operations while managing development of principal properties. We expect that significant growth in several business lines occurring simultaneously will place substantial demands on our managerial, administrative, operational and financial resources. We may be unable to successfully manage all factors necessary for a successful expansion of our business. Moreover, our strategy of growth depends on the existence of and our ability to identify attractive investment opportunities and synergistic acquisition targets. The unavailability of suitable investment opportunities and acquisition targets, or our inability to find or be successful in competing for them, may result in a decline in business, financial condition and results of operations.
We own real estate properties located in Hawaii, which subjects us to unique risks relating to, among other things, Hawaii’s economic dependence on fluctuating tourism, the isolated location of Hawaii and the potential for natural disasters.
We conduct operations and own properties in Hawaii. The gross asset value of our investments in Hawaii is $481.4 million and $386.5 million as of December 31, 2022 and 2021, respectively. The success of our investments in Hawaii depends on and is affected by general trends in Hawaii’s economy and real estate market. Hawaii’s economy largely depends on tourism, which is subject to fluctuation based on a number of factors that we do not control. In addition, Hawaii has historically been vulnerable to certain natural disaster risks, such as tsunamis, volcanoes, hurricanes and earthquakes, which could cause damage to properties owned by us or property values to decline in general. For example, Mauna Loa, on the Big Island of Hawaii, erupted for nearly two weeks in late November into early December of 2022.
Our three largest investments in Hawaii are a hotel development project on the Big Island and two residential assets (one located on the Big Island and the other located on the island of Oahu). In addition to the general risks with respect to development and redevelopment projects as discussed above, Hawaii’s remote and isolated location may create additional operational costs and expenses (general operating and development-related costs), which could have a material adverse impact on our financial results. If any or all of the factors discussed above were to occur and result in our inability or materially limit our ability to sell or lease our residential and commercial properties, a significant delay in or a significant increase costs to complete our development assets, it would likely have a material adverse effect on our business, financial condition and results of operations.
Uncertainty relating to the LIBOR calculation process and phasing out of LIBOR may adversely affect us.
The United Kingdom’s Financial Conduct Authority, which regulates the London Interbank Offered Rate ("LIBOR"), stopped publishing one week and 2-month U.S. Dollar LIBOR rates after 2021 with remaining U.S. Dollar LIBOR rates ceasing to be published on June 30, 2023. In the United States, the Alternative Reference Rates Committee (the “ARCC”) has confirmed that, in its opinion, the March 5, 2021 announcements by the IBA and the FCA on future cessation and loss of representativeness of the LIBOR benchmarks constituted a “Benchmark Transition Event” with respect to all U.S. Dollar LIBOR settings under ARRC-recommended fallback language and has recommended the Secured Overnight Financing Rate (“SOFR”), plus a recommended spread adjustment as LIBOR’s replacement. SOFR is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities. It is impossible to predict whether and to what extent banks will
continue to provide LIBOR submissions to the administrator of LIBOR. Any changes in the method used for determining LIBOR may result in a sudden or prolonged increase or decrease in LIBOR. If a published LIBOR rate is unavailable prior to June 30, 2023, the interest rates on certain of the Company’s debt obligations could change. Any of these proposals or consequences could have a material adverse effect on our financing costs, and as a result, our financial condition and results of operations.
Our real estate debt investment business operates in a highly competitive market for lending and investment opportunities through our debt platforms, including originating and investing in senior loans, mezzanine loans, B- and C-Notes and preferred equity, which may limit our ability to originate or acquire desirable loans and investments in our target assets and are subject to increased risks.
Our real estate debt investment business ("Debt Platform") operates in a highly competitive market for lending and investment opportunities. A number of entities compete with us to make the types of loans and investments that we seek to make, including originating and investing in senior loans, mezzanine loans, B-and C-Notes and preferred equity. The profitability of our debt platform depends, in large part, on our ability to originate or acquire target assets at attractive prices for ourselves and our partners. In addition, some of our competitors may have a lower cost of funds and access to funding sources that may not be available to us. Furthermore, competition for originations of, and investments in, our target assets may lead to the yield of such assets decreasing, which may further limit our ability to generate desired returns for ourselves and our partners. Also, as a result of this competition, desirable loans and investments in specific types of target assets may be limited in the future.
In addition to originating and acquiring senior loans, we also originate and invest in mezzanine loans, B-and C-Notes and preferred equity and these types of investments generally involve a higher degree of risk than long-term senior mortgage lending secured by income-producing real property. For example, if a borrower defaults, there may not be sufficient funds remaining for a B-Note holder after payment to the A-Note holder. Similarly, if a borrower defaults on our mezzanine loan or debt senior to our loan, or in the event of a borrower bankruptcy, our mezzanine loan will be satisfied only after the senior debt and may become unsecured as a result of foreclosure by the senior lender. Further, preferred equity investments involve a higher degree of risk than conventional debt financing due to a variety of factors, including their non-collateralized nature and subordinated ranking to other loans and liabilities of the entity in which such preferred equity is held. As a result, we may not recover some or all of our investment. Significant losses related to our mezzanine loans, B-Notes or preferred equity interests would result in operating losses for us and our partners. In addition, in the event a borrower defaults on a loan, there is no guarantee or assurance that we will be able to successfully foreclose and take control of the underlying collateral (to the extent available).
Any distressed loans and loan portfolios that we may purchase, or investments that may become "sub-performing" or "non-performing" following our origination or acquisition thereof, may have a higher risk of default and delinquencies than newly originated loans, and, as a result, we may lose part or all of our investment in such loans and loan portfolios.
While our loans and investments focus primarily on "performing" real estate-related interests, our loans and investments may also include making distressed investments from time to time (e.g., investments in defaulted, out-of-favor or distressed loans and debt securities) or may involve loans and loan portfolios in some cases that may be non-performing or sub-performing and may be in default at the time of purchase or may become "sub-performing" or "non-performing" following our origination or acquisition thereof. In general, the distressed loans and loan portfolios we may acquire are speculative investments and have a greater than normal risk of future defaults and delinquencies as compared to newly originated loans. Returns on loan investments depend on the borrower’s ability to make required payments or, in the event of default, our security interests and our ability to foreclose and liquidate whatever property that secures the loans and loan portfolios. We may be unable to collect on a defaulted loan or foreclose on security successfully or in a timely fashion. There may also be instances when we are able to acquire title to an underlying property and sell it but not make a profit on its investment.
In addition, in the event of a decline in real estate values, the likelihood that we will incur losses on our loans in the event of default because the value of our collateral may be insufficient to cover our cost on the loan significantly increases.
Our reliance on third-parties to operate certain of our properties may harm our business.
We rely on third party property managers and hotel operators to manage the daily operations of our properties. We are also parties to hotel management agreements under which unaffiliated third-party property managers manage our hotels. These third parties are directly responsible for the day-to-day operation of our properties with limited supervision by us, and they often have potentially significant decision-making authority with respect to those properties. Thus, the success of our business
may depend in large part on the ability of our third-party property managers to manage the day-to-day operations, and any adversity experienced by our property managers could adversely impact the operation and profitability of our properties.
These third parties may fail to manage our properties effectively or in accordance with their agreements with us, may be negligent in their performance and may engage in criminal or fraudulent activity. If any of these events occur, we could incur losses or face liabilities from the loss or injury to our property or to persons at our properties. In addition, disputes may arise between us and these third-party managers and operators, and we may incur significant expenses to resolve those disputes or terminate the relevant agreement with these third parties and locate and engage competent and cost-effective service providers to operate and manage the relevant properties, which in turn could adversely affect us, including damage to our relationships with such franchisers or we may be in breach of our franchise agreement.
Our leasing activities depend on various factors, including tenant occupancy and rental rates, which, if adversely affected, could cause our operating results to suffer.
Our ability to lease properties depends on several factors, including, but not limited to, the attractiveness of our properties to tenants, competition from other available space, our ability to provide adequate maintenance and obtain insurance and to pay increased operating expenses, which may not be passed through to tenants, and the availability of capital to periodically renovate, repair and maintain the properties, as well as for other operating expenses. Our business, financial condition and results of operations may be adversely affected if we fail to promptly find suitable tenants for substantial amounts of vacant space at our properties, if rental rates on new or renewal leases are significantly lower than expected, or if reserves for costs of re-leasing prove inadequate. One of the two tenants that make up our entire tenant population at one of our office properties located in Bellevue, Washington (the third largest asset by our share of net operating income), has given us notice of its intent to vacate the property at the end of their current lease (October 2023). The other tenant has a lease termination option in January 2025.
Increasing scrutiny and changing expectations from stakeholders with respect to our environmental, social and governance practices may impose additional costs on us or expose us to new or additional risks.
Companies across all industries are facing increasing scrutiny from stakeholders related to their environmental, social and governance (“ESG”) practices. Investor advocacy groups, certain institutional investors, investment funds and other influential investors are also increasingly focused on ESG practices and in recent years have placed increasing importance on the implications and social cost of their investments. Regardless of the industry, investors’ increased focus related to ESG and similar matters may hinder access to capital, as investors may decide to reallocate capital or to not commit capital as a result of their assessment of a company’s ESG practices. Companies which do not adapt to or comply with investor or other stakeholder expectations and standards, which are evolving, or which are perceived to have not responded appropriately to the growing concern for ESG issues, regardless of whether there is a legal requirement to do so, may suffer from reputational damage and the business, financial condition, and/or stock price of such a company could be materially and adversely affected.
We have adopted certain practices and policies to align our ESG approach with our business strategy by maximizing the inherent value of our assets and delivering long-term social, environmental and economic values across our portfolio. However, our stakeholders may look to us to implement more or different ESG procedures, standards or goals in order to continue engaging with us, to remain invested in us, or before they make further investments in us. Additionally, we may face reputational challenges in the event our ESG procedures or standards do not meet the standards set by certain constituencies or such constituencies might not be satisfied with our efforts or the speed of adoption of ESG practices or polices. If we do not meet our stakeholders’ expectations or we are not effective in addressing social and environmental responsibility matters or achieving relevant sustainability goals, trust in our brand may suffer and our business and/or our ability to access capital could be harmed.
The occurrence of any of the foregoing could have a material adverse effect on our business and financial condition and expose us to market, operational and execution costs or risks.
Rent control or rent stabilization legislation and other regulatory restrictions may limit our ability to increase rents and pass through new or increased operating costs to our tenants.
We presently expect to continue operating and acquiring properties in areas that have adopted laws and regulations imposing restrictions on the timing or amount of rent increases. Although, we are able to increase rents to market rates once a tenant vacates a rent-controlled or stabilized unit, increases in rental rates for renewing tenants are limited by such regulations. The state of California has implemented a statewide rent control initiative that limits rental increases to 5% + CPI. The state of Oregon has also implemented a statewide rent control program that caps annual increases to 7% + CPI with the city of Portland,
Oregon limiting increases to 9.2%. In addition to the statewide rent control programs, various municipalities, including certain cities where we hold investments, have enacted or are considering rent control or rent stabilization legislation.
Similarly, under current Irish law, for rent controlled properties we are restricted from increasing rents to market rates for renewing tenants or replacement tenants, and any rent increases in these circumstances are generally capped, save in certain limited circumstances. These laws and regulations can (i) limit our ability to charge market rents, increase rents, evict tenants or recover increases in our operating expenses, (ii) negatively impact our ability to attract higher-paying tenants, (iii) require us to increase spend for reporting and compliance, and (iv) make it more difficult for us to dispose of properties in certain circumstances. Any failure to comply with these regulations could result in fines and/or other penalties.
We may be subject to potential environmental liability.
Under various foreign, federal, state and local laws, ordinances and regulations, a current or previous owner or operator of real estate may be liable for the cleanup of hazardous or toxic substances and may be liable to a governmental entity or to third parties for property damage and for investigation and clean-up costs incurred by governmental entities or third parties in connection with the contamination. Such laws typically impose liability without regard to whether the owner or operator knew of, or was responsible for, the presence of the hazardous or toxic substances, even when the contaminants were associated with previous owners or operators. The costs of investigation, remediation or removal of hazardous or toxic substances may be substantial, and the presence of those substances, or the failure to properly remediate those substances, may adversely affect the owner’s or operator’s ability to sell or rent the affected 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. Additionally, the owner of a site may be subject to claims by parties who have no relation to the property based on damages and costs resulting from environmental contamination emanating from the site. In connection with the direct or indirect ownership, operation, management and development of real properties, we may be considered an owner or operator of those properties or as having arranged for the disposal or treatment of hazardous or toxic substances. Therefore, we may be potentially liable for removal or remediation costs.
Before consummating the acquisition of a particular piece of real property, it is our policy to retain independent environmental consultants to conduct an environmental review of the real property, including performing a Phase I environmental review. These assessments have included, among other things, a visual inspection of the real properties and the surrounding area and a review of relevant federal, state and historical documents. It is possible that the assessments we commission do not reveal all environmental liabilities or that there are material environmental liabilities of which we are currently unaware. 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 those properties, or by unrelated third parties. Federal, state, local and foreign agencies or private plaintiffs may bring actions against us in the future, and those actions, if adversely resolved, may have a material adverse effect on our business, financial condition and results of operations.
We may incur significant costs complying with laws, regulations and covenants that are applicable to our properties and operations.
The properties in our portfolio and our operations are subject to various covenants and federal, state, local and foreign laws and regulatory requirements, including permitting and licensing requirements. Such laws and regulations, including municipal or local ordinances, zoning restrictions and restrictive covenants imposed by community developers, may restrict our use of our properties and may require us to obtain approval from local officials or community standards organizations at any time with respect to our properties, including prior to acquiring a property or when undertaking renovations of any of our existing properties. Among other things, these restrictions may relate to fire and safety, seismic, asbestos-cleanup, hazardous material abatement requirements or accessibility of our properties, such as those required by the Americans with Disabilities Act. Existing laws and regulations may adversely affect us, the timing or cost of our future acquisitions or renovations may be uncertain, and additional regulations may be adopted that increase such delays or result in additional costs. Our failure to obtain required permits, licenses and zoning relief or to comply with applicable laws could, among other things, result in monetary fines, private litigation and have a material adverse effect on our business, financial condition and results of operations.
Our property insurance coverage is limited, and any uninsured losses could cause us to lose part or all of our investment in our insured properties.
We carry commercial general liability coverage and umbrella coverage on all of our properties with limits of liability that we deem adequate and appropriate under the circumstances (certain policies subject to deductibles) to insure against liability claims and provide for the cost of legal defense. There are, however, certain types of extraordinary losses that either
may be uninsurable or are not generally insured because it is not economically feasible to insure against those losses. Should any uninsured loss occur, we could lose our investment in, and anticipated revenues from, a property, and these losses could have a material adverse effect on our operations. Currently, we also insure some of our properties for loss caused by earthquakes in levels we deem appropriate and, where we believe necessary, for loss caused by flood. The occurrence of an earthquake, flood or other natural disaster may materially and adversely affect our business, financial condition and results of operations.
Our business could be adversely affected by security breaches through cyber-attacks, cyber intrusions or otherwise.
We face risks associated with security breaches, whether through cyber-attacks or cyber intrusions over the internet, malware, computer viruses, attachments to e-mails, persons inside our organization or persons with access to systems inside our organization, and other significant disruptions of our information technology networks and related systems. These risks include operational interruption, private data exposure and damage to our relationship with our customers, among others. A security breach involving our networks and related systems could disrupt our operations in numerous ways that could ultimately have an adverse effect on our financial condition and results of operations.
It is possible that our business, financial and other systems could be compromised, which might not be noticed for some period of time. Although we utilize various procedures and controls to mitigate our exposure to such risk, cybersecurity attacks are evolving and unpredictable. The occurrence of such an attack could lead to financial losses and have a material adverse effect on our business, financial condition and results of operations.
Economic and social volatility and geopolitical instability outside of the United States due to large-scale conflicts, including warfare among countries, may adversely impact us, the United States, and global economies.
From time to time, tensions between countries may erupt into warfare and may adversely affect neighboring countries and those who conduct trade or foreign relations with those affected regions. Such acts of war may cause widespread and lingering damage on a global scale, including, but not limited to: (i) safety and cyber security, (ii) the economy, and (iii) global relations.
In February 2022, Russia invaded Ukraine following years of strained diplomatic relations between the two countries. In response to the invasion and ongoing war, many countries, including the United States and United Kingdom, imposed significant economic and other sanctions against Russia. In retaliation, Russia has drastically reduced its supply of natural gas to Europe and restricted airspace to these nations and their allies, among other actions. The consequence of these actions may continue to drive inflation upward, creating further economic uncertainty and loss of investor confidence, which may also negatively impact the capital markets, investments and asset prices. Further, Russia has launched an onslaught of cyberwarfare against Ukraine following its invasion, targeting the country’s critical infrastructure, government agencies, media organizations, and related think tanks in the United States and the European Union ("EU"). It is yet unknown whether Russia will be successful in breaching our network defenses, which, if successful, may cause disruptions to critical infrastructure required for our operations and livelihoods, or those of our tenants, communities, and business partners.
The scale and extent of the impact from the Russia-Ukraine war are not yet fully known. Disruption, instability, volatility, and decline in economic activity, both in the affected regions and on a global scale, regardless of where it occurs, whether caused by acts of war, other acts of aggression, or terrorism, could in turn also harm the demand for, the safety of, and the value of our properties and adversely impact the global economy. As a result of the factors discussed above, we may be unable to operate our business as usual, which may adversely affect our cash flows, financial condition, and results of operations.
Risks Related to Our Company
We have in the past incurred and may continue in the future to incur significant amounts of debt and, to a lesser extent, preferred stock, to finance acquisitions, which could negatively affect our cash flows and subject our properties or other assets to the risk of foreclosure.
We have historically financed new acquisitions with cash derived from secured and unsecured loans and lines of credit and, to a lesser extent, preferred stock. We typically purchase real property with loans secured by a mortgage on the property acquired and we anticipate continuing this trend. We may incur additional debt from time to time to finance strategic acquisitions, investments, joint ventures or for other purposes, subject to the restrictions contained in the documents governing our indebtedness. We do not have a policy limiting the amount of debt that we may incur. Accordingly, our management and board of directors have discretion to increase the amount of our outstanding debt at any time. We could become more highly
leveraged, resulting in an increase in debt service costs that could adversely affect our results of operations and increase the risk of default on debt. Our earnings may not be sufficient to allow us to pay principal and interest on our debt and meet our other obligations. If we do not have sufficient earnings, we may be required to seek to refinance all or part of our existing debt, sell assets at terms that are not attractive, borrow more money or sell more securities, which we may be unable to do, and our stock price may be adversely affected. If our business performance and profitability deteriorate, we could fail to comply with certain financial covenants in our unsecured bond and revolving credit facility, which would force us to seek an amendment with our lenders. We may be unable to obtain any necessary waivers or amendments on satisfactory terms, if at all, which could result in the principal and interest of the debt to become immediately due.
Some of our debt bears interest at variable rates. As a result, we are subject to fluctuating interest rates that may impact, adversely or otherwise, results of operations and cash flows. We may be subject to risks normally associated with debt financing, including the risks that:
•a decrease in the availability of lines of credit and the public equity and debt markets and other sources of capital used to operate and maintain our business;
•any downgrade of our credit ratings;
•cash flow may be insufficient to make required payments of principal and interest;
•existing indebtedness on our properties may not be refinanced and our leverage could increase our vulnerability to general economic downturns and adverse competitive and industry conditions, placing us at a disadvantage compared to those of our competitors that are less leveraged;
•our debt service obligations could limit our flexibility in planning for, or reacting to, changes in our business and in the commercial real estate services industry;
•our failure to comply with the financial and other restrictive covenants in the documents governing our indebtedness could result in an event of default that, if not cured or waived, results in foreclosure on substantially all of our assets; and
•the terms of available new financing may not be as favorable as the terms of existing indebtedness.
As previously discussed herein, S&P has recently downgraded us, the KWE Notes and the KWI Notes. Our ratings and any downgrades thereof may impact our ability to borrow under any new agreements in the future, and could increase the interest rates of, and require more onerous terms for, any future borrowings, and could also cause a decline in the market price of our common stock.
If we are unable to satisfy the obligations owed to any lender with a lien on one of our properties, including the compliance with any operational or financial covenants, the lender could foreclose on the real property or other assets securing the loan and we would lose that property or asset. The loss of any property or asset to foreclosure could have a material adverse effect on our business, financial condition and results of operations. In addition, agreements governing certain of our financings contain cross-default and/or cross-acceleration provisions, including, without limitation, the indentures governing our KWI Notes and the documents governing the Second A&R Facility and the KWE Notes. For example, the indentures governing the KWI Notes provide that recourse debt that is not paid within any applicable grace period after final maturity or is accelerated by the applicable lender because of a default and the total amount of such recourse debt unpaid or accelerated exceeds seventy-five million dollars, may constitute a default which could lead to the entire principal amount of the KWI Notes to become immediately due and payable. The documents governing the Second A&R Facility and KWE Notes contain similar provisions.
Our debt obligations impose significant operating and financial restrictions, which may prevent us from pursuing certain business opportunities and taking certain actions.
Our existing debt obligations impose, and future debt obligations may impose, significant operating and financial restrictions on us, including our ability to pursue available business opportunities or finance our future operations. These restrictions limit or prohibit, among other things, our ability to incur additional indebtedness, repay indebtedness (including our KWI Notes) prior to stated maturities, pay dividends on, redeem or repurchase our stock or make other distributions, make acquisitions or investments, create or incur liens, transfer or sell certain assets or merge or consolidate with or into other companies, enter into certain transactions with affiliates, and restrict dividends, distributions or other payments from our subsidiaries. A breach of any of these covenants could result in a default in respect of the related indebtedness. If a default occurs, the relevant lenders could elect to declare the indebtedness, together with accrued interest and other fees, to be
immediately due and payable and proceed against any collateral securing that indebtedness. In addition, a default under one series of our indebtedness may also constitute a default under another series of our indebtedness.
Our unsecured revolving credit facility and the indentures governing our KWI Notes, and the KWE Notes require us to maintain compliance with specified financial covenants, including maximum balance sheet leverage and fixed charge coverage ratios. In addition, loan agreements governing the mortgages that are secured by our properties may contain operational and financial covenants, including but not limited to, debt service coverage ratio covenants and, with respect to mortgages secured by certain properties in Europe, loan-to-value ratio covenants. Mortgages with such loan-to-value covenants require that the underlying properties be valued on a periodic basis (at least annually) and as such, adverse market conditions (which are influenced by factors that are outside of the Company’s control) could result in a reduction in the fair value of the subject properties and a breach of the applicable covenant. Subsequent to the year-ended December 31, 2022, the Company resolved a breach of a loan-to-value covenant in a non-recourse loan agreement secured by retail and commercial assets in the United Kingdom. The Company promptly resolved such breach by paying down the mortgage by $9.1 million, $7.6 million of which was held at the properties that serves as the collateral for the subject mortgage. The loan totals $165.8 million or 5.5% of our consolidated mortgage balance. As of December 31, 2022, the Company was in compliance with all property-level mortgages (other than discussed immediately above) and was current on all payments (principal and interest) with respect to the same.
If we are unable to raise additional debt and equity capital, our growth prospects may suffer.
We depend on the capital markets to grow our balance sheet along with third-party equity and debt financings to acquire properties through our investment business, which is a key driver of future growth. We currently intend to raise a significant amount of third-party equity and debt to acquire assets in the ordinary course of our business. We depend on debt financing from a combination of financial institutions, the assumption of existing loans, government agencies and seller financing. We depend on equity financing from equity partners, which include public companies, pension funds, family offices, financial institutions, endowments, sovereign wealth and money managers. Our access to capital funding is uncertain. Our inability to raise additional capital on terms reasonably acceptable to us could jeopardize the future growth of our business.
The loss of one or more key personnel, particularly our CEO, could have a material adverse effect on our operations.
Our continued success depends to a significant degree on the efforts of our senior executives, particularly our chief executive officer, or CEO, who have each been essential to our business. The departure of all or any of our executives for whatever reason or the inability of all or any of them to continue to serve in their present capacities or our inability to attract and retain other qualified personnel could have a material adverse effect upon our business, financial condition and results of operations. Our executives attract business opportunities and assist both in negotiations with lenders and potential joint venture partners and in the representation of large and institutional clients. If we lost their services, our relationships with lenders, joint venture partners and clients would diminish significantly. Additionally, as we continue to grow, our success will largely depend on our ability to attract and retain qualified personnel in all areas of business. We may be unable to continue to hire and retain a sufficient number of qualified personnel to support or keep pace with our planned growth.
Our results are subject to significant volatility from quarter to quarter due to the varied timing and magnitude of our strategic acquisitions and dispositions, the incurrence of any impairment losses and other transactions.
We have experienced a fluctuation in our financial performance from quarter to quarter and year over year due in part to the significance of revenues from the sales of real estate on overall performance. The timing of purchases and sales of our real estate investments has varied, and will continue to vary, widely from quarter to quarter due to variability in market opportunities, changes in interest rates, and the overall demand for multifamily and commercial real estate, among other things. While these factors have contributed to our increased operating income and earnings in past years, we may be unable to continue to perform well due to the significant variability in these factors.
Additionally, if our future undiscounted net cash flow evaluation indicates that we are 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. 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.
We are subject to certain "non-recourse carve out guarantees" that may be triggered in the future and have guaranteed a number of loans in connection with various real estate investments, which may result in us being obligated to make certain payments.
Most of our real estate properties are encumbered by traditional non-recourse debt obligations. In connection with most of these loans, however, we entered into certain “non-recourse carve out” guarantees, which provide for the loans to become partially or fully recourse against us if certain triggering events occur. Although these events are different for each guarantee, some of the common events include:
•the special purpose property-owning subsidiary’s filing a voluntary petition for bankruptcy;
•the special purpose property-owning subsidiary’s failure to maintain its status as a special purpose entity; and
•subject to certain conditions, the special purpose property-owning subsidiary’s failure to obtain lender’s written consent prior to obtaining any subordinate financing or encumbering the associated property.
In the event that any triggering event occurs and the loans become partially or fully recourse against us, our business, financial condition, results of operations and common stock price could be materially adversely affected.
We have also provided recourse guarantees associated with loans secured by real estate. The maximum potential undiscounted amount of future payments that we could be required to make under these guarantees was approximately $142.9 million at December 31, 2022. The guarantees expire through 2031, and our performance under the guarantees would be required to the extent there is a shortfall upon liquidation between the principal amount of the loan and the net sales proceeds of the property. If we were to become obligated to perform on these guarantees, our financial condition could suffer.
If a transaction intended to qualify as a Section 1031 Exchange is later determined to be taxable or if we are unable to identify and complete the acquisition of a suitable replacement property to effect a Section 1031 Exchange, we may face adverse consequences, and if the laws applicable to such transactions are amended or repealed, we may not be able to dispose of properties on a tax deferred basis.
When possible, we dispose of properties in transactions that are intended to qualify for tax deferral under Section 1031 of the Internal Revenue Code of 1986, as amended (the "Code") (each such transaction, a "Section 1031 Exchange"). It is possible that the qualification of a transaction as a Section 1031 Exchange could be successfully challenged by the U.S. Internal Revenue Service (the "IRS") and determined to be currently taxable or that we may be unable to identify and complete the acquisition of a suitable replacement property to effect a Section 1031 Exchange. In such case, if there are no alternatives available to us (including the use of our net operating loss carryforwards and foreign tax credits), we may have to pay corporate income tax with respect to the disposition of such properties, possibly including interest and penalties. In addition, if a Section 1031 Exchange was later determined to be taxable, we may be required to amend our tax returns for the applicable year in question, including any information reports we sent the Company’s stockholders. Moreover, Section 1031 of the Code permits exchanges of real property only. Legislation that could modify or repeal the laws with respect to Section 1031 Exchanges could be enacted, which could make it more difficult or not possible for us to dispose of properties on a tax-deferred basis. If we are unable to complete transactions as Section 1031 Exchanges, our taxable income and earnings and profits could increase, which would increase the portion of any distribution with respect to our common stock that is treated as dividend income instead of return of capital.
Our ability to use our net operating loss carryforwards and certain other tax attributes may be limited.
As of December 31, 2022, we had approximately $3.4 million and $90.9 million of federal and California net operating loss carryforwards, respectively, as well as approximately $92.0 million of foreign tax credits, which generally can be used to offset future taxable income or taxes, as applicable. However, under Sections 382 and 383 of the Code, if a corporation undergoes an “ownership change," the corporation’s ability to use its pre-change net operating loss carryforwards and foreign tax credits to offset its post-change federal taxable income or taxes, as applicable, may be limited. Generally, a corporation experiences such an ownership change if the percentage of its stock owned by its “5-percent shareholders,” as defined in Section 382 of the Code, increases by more than 50 percentage points (by value) over a rolling three-year period. Based on our analysis, no ownership changes as defined under Section 382 have occurred which would result in limitations on the utilization of our domestic net operating loss and foreign tax credit carryovers. We may experience ownership changes in the future as a result of subsequent shifts in our stock ownership (some of which shifts are outside of our control). Similar provisions of state tax law may also apply. Federal net operating loss carryforwards generated after December 31, 2017 may be carried forward indefinitely, but they may only be used to offset 80% of taxable income in a given year. The entire balance of $3.4 million of federal net operating loss carryforwards was generated after December 31, 2017.
As of December 31, 2022, we also had $175.5 million of foreign net operating loss carryforwards which could be subject to similar limitations in foreign jurisdictions based upon changes in equity ownership.
We may fail to comply with section 404 of the Sarbanes-Oxley Act of 2002.
We are subject to section 404 of The Sarbanes-Oxley Act of 2002 and the related rules of the SEC, which generally require our management and independent registered public accounting firm to report on the effectiveness of our internal control over financial reporting. Although our management has concluded that our internal control over financial reporting was effective as of December 31, 2022 and our independent registered public accounting firm has issued an unqualified report as to the same, our management or our independent registered public accounting firm may not be able to come to the same conclusion in future periods. During the course of the review and testing of our internal controls, we may identify deficiencies and weaknesses and be unable to remediate them before we must provide the required reports. If our management or our independent registered public accounting firm is unable to conclude on an ongoing basis that we have effective internal control over financial reporting, our operating results may suffer, investors may lose confidence in our reported financial information and the trading price of our stock may fall.
Risks Related to Ownership of Our Common Stock
Our directors and officers and their affiliates are significant stockholders, which makes it possible for them to have significant influence over the outcome of all matters submitted to stockholders for approval and which influence may be in conflict with our interests and the interests of our other stockholders.
As of December 31, 2022, our directors and executive officers and their respective affiliates owned an aggregate of approximately 14% of the outstanding shares of our common stock. These stockholders will have significant influence over the outcome of all matters submitted for stockholder approval, including the election of our directors and other corporate actions. In addition, such influence by one or more of these stockholders could discourage others from attempting to purchase or take us over in a transaction that would be favorable to our other stockholders or reduce the market price offered for our common stock in such an event.
Our stockholders may experience dilution upon the conversion of our Series A Cumulative Perpetual Convertible Preferred Stock or warrants, and we may issue additional equity securities, which may also dilute our stockholders’ interest in us.
Our outstanding warrants are convertible into approximately 13 million shares of common stock and our Series A Cumulative Perpetual Convertible Preferred Stock are convertible into approximately 12 million shares of common stock. We also have an at-the-market equity offering program ("ATM program") in place pursuant to which we may issue up to $200 million of shares of common stock. As of December 31, 2022, the exercise price of the warrants was $23.00 per share and the conversion price of the Series A stock was $25.00 per share, in each case subject to further adjustments in certain circumstances. If we elect to deliver shares of common stock upon a conversion at the time our tangible book value per share exceeds the conversion price in effect at such time, our stockholders may incur dilution. In addition, our stockholders will experience dilution in their ownership percentage of common stock upon our issuance of common stock in connection with the conversion of the Series A shares and/or warrants and any dividends paid on our common stock will also be paid on shares issued in connection with such conversion after such issuance.
Additionally, in order to expand our business, we may consider offering and issuing additional equity or equity-based securities. If we issue and sell additional shares of our common stock, or convertible securities, the ownership interests of our existing stockholders will be diluted to the extent they do not participate in the offering. The number of shares that we may issue for cash in non-public offerings without stockholder approval will be limited by the rules of the NYSE or other exchange on which our securities are listed. However, we may issue and sell shares of our common stock in public offerings, and there generally are exceptions that allow companies to issue a limited number of equity securities in private offerings without stockholder approval, which could dilute your ownership.
The price of our common stock may be volatile.
The trading price of our common stock has historically been and may in the future continue to be volatile due to factors such as:
•changes in real estate prices;
•actual or anticipated fluctuations in our quarterly and annual results and those of our publicly held competitors;
•mergers and strategic alliances among any real estate companies;
•market conditions in the industry;
•changes in government regulation and taxes;
•shortfalls in our operating results from levels forecasted by securities analysts;
•investor sentiment toward the stock of real estate companies in general;
•announcements concerning us or our competitors; and
•the general state of the securities markets.
Our common stock may be delisted, which could limit your ability to trade our common stock and subject us to additional trading restrictions.
Our common stock is listed on the NYSE, a national securities exchange. However, our common stock may not continue to be listed on the NYSE in the future. If the NYSE delists our common stock from trading on its exchange, we could face significant material adverse consequences, including:
•a limited availability of market quotations for our common stock;
•a limited amount of news and analyst coverage for our company;
•a decreased ability for us to issue additional securities or obtain additional financing in the future; and
•limited liquidity for our stockholders due to thin trading.
Our staggered board may entrench management and discourage unsolicited stockholder proposals that may be in the best interests of stockholders, and certain anti-takeover provisions in our organizational documents may discourage a change in control.
Our amended and restated certificate of incorporation provides for our board of directors to be divided into three classes, each of which generally serves for a term of three years with only one class of directors being elected in each year. As a result, at any annual meeting only a minority of the board of directors will be considered for election. Since this “staggered board” would prevent our stockholders from replacing a majority of our board of directors at any annual meeting, it may entrench management and discourage unsolicited stockholder proposals that may be in the best interests of stockholders. Additionally, certain provisions of our amended and restated certificate of incorporation and our amended and restated bylaws may have an anti-takeover effect and may delay, defer or prevent a tender offer or takeover attempt that a stockholder might consider in its best interest, including those attempts that might result in the payment of a premium over the market price for the shares held by stockholders.
In addition, Section 203 of the Delaware General Corporation Law may, under certain circumstances, make it more difficult for a person who would be an “interested stockholder” to effect a “business combination” with us for a three-year period. An “interested stockholder” generally is defined as any entity or person that beneficially owns 15% or more of our outstanding voting stock or any entity or person that is an affiliate or associate of such entity or person. A “business combination” generally is defined to include, among other transactions, mergers, consolidations and certain other transactions, including sales, leases or other dispositions of assets with an aggregate market value equal to 10% or more of the aggregate market value of the corporation.
These anti-takeover provisions could make it more difficult for a third party to acquire us, even if the third party’s offer may be considered beneficial by many stockholders. As a result, stockholders may be limited in their ability to obtain a premium for their shares.
We may change our dividend policy.
Future distributions will be declared and paid at the discretion of our board of directors and the amount and timing of distributions will depend upon cash generated by operating activities, our financial condition, capital requirements, restrictions in the agreements governing our indebtedness, the certificate of designations governing our outstanding preferred stock and such other factors as our board of directors deems relevant. Our board of directors may change our dividend policy at any time, and there can be no assurance as to the manner in which future dividends will be paid or that the current dividend level will be maintained in future periods.
Our amended and restated bylaws designate the Court of Chancery within the State of Delaware as the exclusive forum for certain litigation that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a different judicial forum for disputes with us.
Our amended and restated bylaws provide that unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will, to the fullest extent permitted by the law, be the sole and exclusive forum for (1) any derivative action or proceeding brought on our behalf, (2) any action asserting a claim of breach of a fiduciary duty owed by any of our current or former directors, officers, other employees or our stockholders to us or our stockholders, (3) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law, our amended and restated
certificate of incorporation or our amended and restated bylaws or to which the Delaware General Corporation Law confers jurisdiction on the Court of Chancery of the State of Delaware, or (4) any action asserting a claim governed by the internal affairs doctrine. This choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that the stockholder finds favorable for disputes with us or any of our directors, officers, other employees or other stockholders, which may discourage lawsuits against us and our directors, officers, other employees and other stockholders. Additionally, this exclusive forum provision will not apply to claims that are vested in the exclusive or concurrent jurisdiction of a court or forum other than the Court of Chancery of the State of Delaware, or for which the Court of Chancery of the State of Delaware does not have subject matter jurisdiction. For instance, the provision would not preclude the filing of claims brought to enforce any liability or duty created by the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, or the rules and regulations thereunder, in federal court.