I concluded with that statement in last year's shareholder letter. I'm pleased to say that the opportunities did, indeed, emerge in 2011. We took advantage of them last year and are continuing to do so in 2012.
Financial Performance
Funds from operations decreased to $2.61 per share in 2011 from $2.66 per share in 2010. The decrease was primarily due to portfolio repositioning activities discussed later in this letter.
Operating revenue increased to $668 million in 2011 from $657 million in 2010, an increase primarily attributable to a higher average portfolio size. Net income increased to $1.59 per share in 2011 from $1.12 per share in 2010. The increase in net income was primarily due to gains on the sale of properties as a part of the portfolio repositioning.
Operations
2011 was a very solid year for operations, the result of hard work by our leasing and property management teams, the deep relationships we have with our tenants and the brokerage community, and slowly firming markets. Market rents began to move in the right direction, and declines in rental rates for the year were 7.2%, at the low end of our expected decline of 7 – 12%. By year-end, our portfolio occupancy was 91.3%, up from 88.7% at the end of 2010, and the highest level in three years. This occupancy increase contributed to same store operating income growth of 1%. Though modest, this increase was definitely a step in the right direction.
Also moving in the right direction was our portfolio's efficiency and our sustainability practices. A dozen years ago, we began exploring, then designing and developing, office buildings using the standards of the US Green Building Council's Leadership in Energy and Environmental Design (LEED) program. Then we led the way in LEED industrial development. We then turned our attention to our existing portfolio – redeveloping using LEED standards, moving to green cleaning methods and installing building wide area networks in our properties to monitor energy consumption. In 2011 we continued to improve the efficiency of our portfolio by reducing energy consumption 13.8% in our managed portfolio over our original 2008 baseline measurement, which equates to an estimated $3.7 million in savings for our tenants. We have 80 buildings certified under the EPA's Energy Star program. We also launched our "Turning Existing Buildings Into Smart Buildings" project, a research and development initiative in partnership with PECO Energy and partially funded by the Department of Energy's Smart Grid Investment Grant.
Development
We started 2011 with our development pipeline at zero. But that was no surprise, since the recession had shut off new supply across the industry. The good news is 2011 was the year when we began to rebuild Liberty's valuecreating development pipeline.
We began construction of 10 properties totaling 3.1 million square feet. We expect to invest $289 million in these projects, which consist primarily of speculative and build-to-suit industrial buildings and build-to-suit office properties.
We anticipate that these properties will begin to contribute to our results in late 2012. All of these projects will be LEED®, bringing Liberty's LEED development history to more than 50 projects and 10 million square feet.
More than 75% of the square footage of these projects is industrial product in Lehigh Valley/Central Pennsylvania. One of the nation's premier distribution markets, we've been creating value here since 1980. It got a little crowded with developers starting around 2000, but the recession has taken its toll on our competition and we are, once again, the only major industrial developer with a fully-staffed office in this market. Large blocks of prime distribution space in the most sought-after locations are now rare, and we are fortunate to be in the position to enjoy first-mover advantage in this market.
Acquisitions
In 2011, acquisitions also became a major part of our capital activity. This was in contrast to 2010, when a lot of hard work resulted in the acquisition of five properties at a whopping investment of $49 million.
More owners were willing to part with their properties in 2011. We invested approximately $250 million in 21 properties, acquiring 4.2 million square feet. Over 90% of this was industrial. Many of the properties purchased represent value-add opportunities to which we can apply our leasing and/or development skills. All further our market and product strategies.
For instance, on June 20 we purchased a vacant, 535,000 square foot distribution building in the Lehigh Valley. With the exception of one short-term lease that had already terminated, the property had been vacant since it was developed five years earlier. The day after purchase, we signed a long-term lease for 63% of the building. One month later we signed a second lease for the remainder of the building. This type of value creation would be virtually impossible for a company lacking our deep local operating platform.
In North Carolina, we purchased a 179,000 square foot multi-tenant industrial building with an attached 15 acre land parcel in Charlotte. Six months later, we broke ground on a 156,000 square foot, build-to-suit warehouse on that land.
In Washington, DC, we purchased a 146,000 square foot office building in the heart of the central business district. The key to the purchase was our ability to work through a complex existing ownership structure in order to make the deal work for both Liberty and the seller. This property represents an opportunity to add value in the short term by leasing the 18% of the building that was vacant at purchase, while providing an attractive opportunity for long-term value creation through redevelopment.
Dispositions
In 2011 buyer financing became more available. We saw an opportunity to significantly advance our strategic repositioning, and we jumped at it.
We sold 4.2 million square feet, 72% of which was suburban office and high-finish flex properties, for $365 million. The bulk of these sales were in two portfolio transactions and were primarily in the Lehigh Valley and Richmond markets. The sale of our suburban office portfolios will allow us to concentrate on the stronger industrial sector in these markets.
As we print this letter, we are about to close on a third portfolio sale totaling 2.5 million square feet of office and high-finish flex properties for $195 million. Most of this is located in Milwaukee and Greensboro, but it also includes properties in New Jersey, Maryland and Richmond. Once this sale is completed, in five quarters we will have sold 6.7 million square feet of assets for $560 million.
Strategic Portfolio Repositioning
In 2008 we put in place a new five-year strategy. The strategy called for adjusting our product mix in existing markets to increase our exposure to industrial properties while reducing exposure to suburban office and high-finish flex. For a while it looked as if the recession and lack of available buyer financing would make it impossible to accomplish our five-year goals. But in 2011, and continuing in 2012, we have made up for lost time.
To put the execution over the past year into perspective: with the completion of the sale we are executing now, we will have exited the Milwaukee market in its entirety, exited the office markets in Lehigh Valley, Richmond, North Carolina and South Carolina, increased our industrial investment in Chicago, increased our investment in Lehigh Valley big box industrial, increased our investment in multi-tenant industrial in Charlotte and Minneapolis, and increased our investment in metro office in Philadelphia and Washington, DC.
Factoring in no additional transaction activity but taking into account the completion of our existing development pipeline, by the end of this year (or the five-year strategy window) we expect to have increased Liberty's industrial square feet since 2008 from 49% to 62% of our portfolio. We will continue to keep an eye on the transaction markets and will continue to adjust the portfolio to increase our industrial and metro office footprints and maximize long-term value enhancement and rent growth potential.
Capital and Balance Sheet Management
Liberty's capital position is as solid as ever. During the year, we reduced our borrowing cost by replacing our existing $500 million credit facility with a new facility of equal size but with a longer term and a lower spread. As of the date of this letter, we are borrowing at 107.5 basis points over LIBOR. Our cost of capital gives us a terrific advantage when sourcing acquisitions and pricing development.
Liberty's dividend was fully covered by cash flow in 2011. Although in the long term, we expect the property sales completed and anticipated to increase cash flow by reducing exposure to capital-intensive properties, and that our valueadd acquisitions and development pipeline will add revenue, we expect the loss of revenue from these sales will create a modest shortfall between operating cash flow and our dividend. This condition will probably last until the end of 2012.
2012 Outlook
So 2011 proved to be a strong year for Liberty across all of our disciplines. We increased occupancy. We exceeded our investment and disposition projections, and we advanced the execution of our strategy. But the world is still an uncertain place and the economic recovery, while consistent, is slow. Real estate markets are still very competitive, particularly on the office side. However, the opportunities to advance our strategy via acquisitions, dispositions and development appear encouraging. The strengthening demand that we see on the industrial side should begin to allow for rent growth in select transactions, planting the seeds for a more widespread industrial rent recovery in 2013. And we will apply patience, hard work, and discipline to seek out opportunities to grow Liberty into the future. We feel good about where we are and excited about what the future holds.
Sincerely yours,
Chairman and Chief Executive Officer
May 15, 2012