OFFICE PROPERTIES INCOME TRUST - FORM 10-Q - October 27, 2016

Attached files

file filename
EX-31.1 - EXHIBIT 31.1 - OFFICE PROPERTIES INCOME TRUSTgov_093016xexhibitx311.htm
EX-32.1 - EXHIBIT 32.1 - OFFICE PROPERTIES INCOME TRUSTgov_093016xexhibitx321.htm
EX-31.4 - EXHIBIT 31.4 - OFFICE PROPERTIES INCOME TRUSTgov_093016xexhibitx314.htm
EX-31.3 - EXHIBIT 31.3 - OFFICE PROPERTIES INCOME TRUSTgov_093016xexhibitx313.htm
EX-31.2 - EXHIBIT 31.2 - OFFICE PROPERTIES INCOME TRUSTgov_093016xexhibitx312.htm
EX-12.1 - EXHIBIT 12.1 - OFFICE PROPERTIES INCOME TRUSTgov_093016xexhibitx121.htm
EX-10.1 - EXHIBIT 10.1 - OFFICE PROPERTIES INCOME TRUSTgov_093016xexhibitx101.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2016
 
OR
 
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission File Number 1-34364
 
GOVERNMENT PROPERTIES INCOME TRUST
(Exact Name of Registrant as Specified in Its Charter)
 
Maryland
 
26-4273474
(State or Other Jurisdiction of Incorporation or
Organization)
 
(IRS Employer Identification No.)
 
Two Newton Place, 255 Washington Street, Suite 300, Newton, Massachusetts 02458-1634
(Address of Principal Executive Offices)  (Zip Code)
 
617-219-1440
(Registrant’s Telephone Number, Including Area Code)
 
Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒  No ☐
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☒  No ☐
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
 
Large accelerated filer ☒
 
Accelerated filer ☐
 
 
 
Non-accelerated filer ☐
 
Smaller reporting company ☐
(Do not check if a smaller reporting company)
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐  No ☒
 
Number of registrant’s common shares of beneficial interest, $.01 par value per share, outstanding as of October 25, 2016: 71,178,999


GOVERNMENT PROPERTIES INCOME TRUST
 
FORM 10-Q
 
September 30, 2016
 
INDEX
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
References in this Quarterly Report on Form 10-Q to “the Company”, “GOV”, ”we”, “us” or “our” include Government Properties Income Trust and its consolidated subsidiaries unless otherwise expressly stated or the context indicates otherwise.


1

PART I.       Financial Information
 
Item 1.  Financial Statements
 
GOVERNMENT PROPERTIES INCOME TRUST
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in thousands, except share data)
(unaudited) 
 
 
September 30,
 
December 31,
 
 
2016
 
2015
ASSETS
 
 

 
 

Real estate properties:
 
 

 
 

Land
 
$
259,416

 
$
253,058

Buildings and improvements
 
1,528,585

 
1,443,074

Total real estate properties, gross
 
1,788,001

 
1,696,132

Accumulated depreciation
 
(285,974
)
 
(255,879
)
Total real estate properties, net
 
1,502,027

 
1,440,253

 
 
 
 
 
Equity investment in Select Income REIT
 
491,973

 
491,369

Assets of discontinued operations
 
12,490

 
12,468

Assets of property held for sale
 
—

 
3,098

Acquired real estate leases, net
 
105,499

 
118,267

Cash and cash equivalents
 
13,749

 
8,785

Restricted cash
 
514

 
1,022

Rents receivable, net
 
49,350

 
45,269

Deferred leasing costs, net
 
20,012

 
14,299

Other assets, net
 
69,456

 
33,680

Total assets
 
$
2,265,070

 
$
2,168,510

 
 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 

 
 

Unsecured revolving credit facility
 
$
25,000

 
$
117,000

Unsecured term loans, net
 
547,000

 
546,490

Senior unsecured notes, net
 
646,551

 
345,809

Mortgage notes payable, net
 
28,250

 
136,299

Liabilities of discontinued operations
 
61

 
54

Liabilities of property held for sale
 
—

 
43

Accounts payable and other liabilities
 
52,237

 
50,543

Due to related persons
 
3,974

 
2,886

Assumed real estate lease obligations, net
 
11,257

 
12,735

Total liabilities
 
1,314,330

 
1,211,859

 
 
 
 
 
Commitments and contingencies
 


 


 
 
 
 
 
Shareholders’ equity:
 
 

 
 

     Common shares of beneficial interest, $.01 par value: 100,000,000 shares
authorized, 71,178,999 and 71,126,308 shares issued and outstanding, respectively
 
712

 
711

Additional paid in capital
 
1,473,557

 
1,472,482

Cumulative net income
 
84,264

 
38,486

Cumulative other comprehensive income (loss)
 
24,127

 
(14,867
)
Cumulative common distributions
 
(631,920
)
 
(540,161
)
Total shareholders’ equity
 
950,740

 
956,651

Total liabilities and shareholders’ equity
 
$
2,265,070

 
$
2,168,510

 
See accompanying notes.

2

GOVERNMENT PROPERTIES INCOME TRUST
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(amounts in thousands, except per share data)
(unaudited)
 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
 
Rental income
 
$
64,478

 
$
62,092

 
$
192,150

 
$
186,864

 
 
 
 
 
 
 
 
 
Expenses:
 
 

 
 

 
 

 
 

Real estate taxes
 
7,591

 
7,735

 
22,810

 
22,819

Utility expenses
 
5,483

 
5,194

 
13,330

 
13,788

Other operating expenses
 
13,854

 
12,281

 
40,031

 
36,659

Depreciation and amortization
 
18,404

 
17,161

 
54,713

 
51,675

Acquisition related costs
 
147

 
270

 
363

 
459

General and administrative
 
3,816

 
3,714

 
11,350

 
11,431

Total expenses
 
49,295

 
46,355

 
142,597

 
136,831

 
 
 
 
 
 
 
 
 
Operating income
 
15,183

 
15,737

 
49,553

 
50,033

Dividend income
 
304

 
—

 
667

 
—

Interest income
 
47

 
2

 
63

 
14

Interest expense (including net amortization of debt premium and discounts and debt issuance costs of $805, $360, $2,024 and $1,020, respectively)
 
(12,608
)
 
(9,137
)
 
(32,286
)
 
(27,894
)
Gain on early extinguishment of debt
 
—

 
34

 
104

 
34

Gain (loss) on issuance of shares by Select Income REIT
 
72

 
(21
)
 
88

 
(42,145
)
Loss on impairment of Select Income REIT investment
 
—

 
—

 
—

 
(203,297
)
Income (loss) from continuing operations before income taxes
 
 

 
 

 
 

 
 

and equity in earnings of investees
 
2,998

 
6,615

 
18,189

 
(223,255
)
Income tax (expense) benefit
 
(13
)
 
13

 
(63
)
 
(49
)
Equity in earnings of investees
 
8,668

 
10,294

 
28,002

 
16,072

Income (loss) from continuing operations
 
11,653

 
16,922

 
46,128

 
(207,232
)
Loss from discontinued operations
 
(154
)
 
(11
)
 
(429
)
 
(390
)
Income (loss) before gain on sale of property
 
11,499

 
16,911

 
45,699

 
(207,622
)
Gain on sale of property
 
79

 
—

 
79

 
—

Net income (loss)
 
11,578

 
16,911

 
45,778

 
(207,622
)
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss)
 
 

 
 

 
 

 
 

Unrealized gain on investment in available for sale securities
 
8,463

 
—

 
28,571

 
—

Equity in unrealized gain (loss) of investees
 
3,273

 
(355
)
 
10,423

 
(166
)
Other comprehensive income (loss)
 
11,736

 
(355
)
 
38,994

 
(166
)
Comprehensive income (loss)
 
$
23,314

 
$
16,556

 
$
84,772

 
$
(207,788
)
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding (basic)
 
71,054

 
71,004

 
71,041

 
70,589

Weighted average common shares outstanding (diluted)
 
71,084

 
71,021

 
71,064

 
70,589

 
 
 
 
 
 
 
 
 
Per common share amounts (basic and diluted):
 
 

 
 

 
 

 
 

Income (loss) from continuing operations
 
$
0.16

 
$
0.24

 
$
0.65

 
$
(2.94
)
Loss from discontinued operations
 
$
—

 
$
—

 
$
(0.01
)
 
$
(0.01
)
Net income (loss)
 
$
0.16

 
$
0.24

 
$
0.64

 
$
(2.94
)
 
See accompanying notes.


3

GOVERNMENT PROPERTIES INCOME TRUST
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
(unaudited)
 
 
 
Nine Months Ended September 30,
 
 
2016
 
2015
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 

 
 

Net income (loss)
 
$
45,778

 
$
(207,622
)
Adjustments to reconcile net income (loss) to cash provided by operating activities:
 
 

 
 

Depreciation
 
31,611

 
29,115

Net amortization of debt premiums and discounts and debt issuance costs
 
2,024

 
1,020

Gain on sale of property
 
(79
)
 
—

Gain on early extinguishment of debt
 
(104
)
 
(34
)
Straight line rental income
 
(1,789
)
 
(2,820
)
Amortization of acquired real estate leases
 
21,948

 
21,771

Amortization of deferred leasing costs
 
2,343

 
1,387

Other non-cash (income) expense, net
 
500

 
1,288

Equity in earnings of investees
 
(28,002
)
 
(16,072
)
(Gain) loss on issuance of shares by Select Income REIT
 
(88
)
 
42,145

Loss on impairment of Select Income REIT investment
 
—

 
203,297

Distributions of earnings from Select Income REIT
 
25,676

 
18,850

Change in assets and liabilities:
 
 

 
 

Restricted cash
 
508

 
950

Deferred leasing costs
 
(7,998
)
 
(2,408
)
Rents receivable
 
(126
)
 
456

Other assets
 
(1,466
)
 
(865
)
Accounts payable and accrued expenses
 
(150
)
 
(1,037
)
Due to related persons
 
1,088

 
(368
)
Net cash provided by operating activities
 
91,674

 
89,053

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 

 
 

Real estate acquisitions and deposits
 
(83,705
)
 
—

Real estate improvements
 
(23,357
)
 
(9,746
)
Investment in Select Income REIT
 
—

 
(95,821
)
Investment in The RMR Group Inc.
 
—

 
(6,467
)
Distributions in excess of earnings from Select Income REIT
 
11,951

 
15,721

Proceeds from sale of properties, net
 
263

 
30,520

Net cash used in investing activities
 
(94,848
)
 
(65,793
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 

 
 

Repayment of mortgage notes payable
 
(107,562
)
 
(48,476
)
Proceeds from issuance of senior unsecured notes
 
310,000

 
—

Borrowings on unsecured revolving credit facility
 
254,000

 
165,000

Repayments on unsecured revolving credit facility
 
(346,000
)
 
(51,000
)
Payment of debt issuance costs
 
(10,229
)
 
(21
)
Repurchase of common shares
 
(312
)
 
(174
)
Distributions to common shareholders
 
(91,759
)
 
(91,074
)
Net cash provided by (used in) financing activities
 
8,138

 
(25,745
)
Increase (decrease) in cash and cash equivalents
 
4,964

 
(2,485
)
Cash and cash equivalents at beginning of period
 
8,785

 
13,791

Cash and cash equivalents at end of period
 
$
13,749

 
$
11,306

 
Supplemental cash flow information:
 
 
 
 
Interest paid
 
$
32,599

 
$
30,107

Income taxes paid
 
$
94

 
$
143

Non-cash investing activities:
 
 

 
 

Investment in The RMR Group Inc. paid in common shares
 
$
—

 
$
13,545

Sale of property
 
$
3,600

 
$
—

Mortgage note receivable related to sale of property
 
$
(3,600
)
 
$
—

See accompanying notes.

4
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
(unaudited)


Note 1.    Basis of Presentation
 
The accompanying condensed consolidated financial statements of Government Properties Income Trust and its subsidiaries, or GOV, we, us or our, are unaudited. Certain information and disclosures required by U.S. generally accepted accounting principles, or GAAP, for complete financial statements have been condensed or omitted.  We believe the disclosures made are adequate to make the information presented not misleading.  However, the accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes contained in our Annual Report on Form 10-K for the year ended December 31, 2015, or our Annual Report.  In the opinion of our management, all adjustments, which include only normal recurring adjustments considered necessary for a fair presentation, have been included.  All intercompany transactions and balances with or among our consolidated subsidiaries have been eliminated.  Our operating results for interim periods are not necessarily indicative of the results that may be expected for the full year. Reclassifications have been made to the prior years’ condensed consolidated financial statements to conform to the current year’s presentation.
 
The preparation of these financial statements in conformity with GAAP requires us to make estimates and assumptions that affect reported amounts. Actual results could differ from those estimates.  Significant estimates in the condensed consolidated financial statements include purchase price allocations, useful lives of fixed assets, impairment of real estate and equity method investments and the valuation of intangible assets.
 
Note 2.    Recent Accounting Pronouncements
 
On January 1, 2016, we adopted the Financial Accounting Standards Board, or FASB, Accounting Standards Update, or ASU, No. 2015-02, Consolidation. Among other things, this update changes how an entity determines the primary beneficiary of a variable interest entity. The implementation of this update did not have an impact in our condensed consolidated financial statements.
 
On January 1, 2016, we adopted FASB ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs, which requires debt issuance costs to be presented in the balance sheet as a direct deduction from the associated debt liability, and FASB ASU No. 2015-15, Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements – Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting, which addresses the presentation of debt issuance costs related to line of credit arrangements. The implementation of these updates resulted in the reclassification of certain of our capitalized debt issuance costs as an offset to the associated debt liability in our condensed consolidated balance sheets. The classification of capitalized debt issuance costs related to our unsecured revolving credit facility remains unchanged in accordance with ASU No. 2015-15. As of December 31, 2015, debt issuance costs related to our unsecured term loans, senior unsecured notes and mortgage notes payable of $3,510, $2,172 and $344, respectively, were reclassified from assets to the associated debt liability in our condensed consolidated balance sheets.
 
On January 1, 2016, we adopted FASB ASU No. 2015-16, Simplifying the Accounting for Measurement-Period Adjustments, which eliminates the requirement for an acquirer in a business combination to account for measurement period adjustments retrospectively. Instead, acquirers must recognize measurement period adjustments during the period in which they determine the amounts, including the effect on earnings of any amounts they would have recorded in previous periods if the accounting had been completed at the acquisition date. The implementation of this update did not have an impact in our condensed consolidated financial statements.
 
In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which changes how entities measure certain equity investments and present changes in the fair value of financial liabilities measured under the fair value option that are attributable to their own credit. This update is effective for interim and annual periods beginning after December 15, 2017, with early adoption permitted subject to certain conditions. Currently, changes in fair value of these investments are recorded through other comprehensive income. Under this ASU, these changes will be recorded through earnings. We are continuing to evaluate this guidance, but we expect the implementation of this guidance will affect how changes in the fair value of available for sale equity investments we hold are presented in our condensed consolidated financial statements.
 
In February 2016, the FASB issued ASU No. 2016-02, Leases, which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e., lessees and lessors). ASU No. 2016-02

5
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
(unaudited)

requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase of the leased asset by the lessee. This classification will determine whether the lease expense is recognized based on an effective interest method or on a straight line basis over the term of the lease. A lessee is also required to record a right of use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales type leases, direct financing leases and operating leases. ASU No. 2016-02 is effective for reporting periods beginning after December 15, 2018, with early adoption permitted. We are currently assessing the potential impact the adoption of ASU No. 2016-02 will have in our condensed consolidated financial statements.
 
In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation, which identifies areas for simplification involving several aspects of accounting for share based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, an option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows. ASU No. 2016-09 is effective for reporting periods beginning after December 15, 2016.  We are currently assessing the potential impact that the adoption of ASU No. 2016-09 will have in our condensed consolidated financial statements.   
 
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which requires that entities use a new forward looking “expected loss” model that generally will result in the earlier recognition of allowance for credit losses. The measurement of expected credit losses is based upon historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. ASU No. 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. We are currently assessing the potential impact that adoption of ASU No. 2016-13 will have in our condensed consolidated financial statements.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which clarifies how companies present and classify certain cash receipts and cash payments in the statement of cash flows. ASU No. 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We are currently assessing the potential impact that adoption of ASU No. 2016-15 will have in our condensed consolidated financial statements.
 
Note 3.    Weighted Average Common Shares
 
The following table provides a reconciliation of the weighted average number of common shares used in the calculation of basic and diluted earnings per share (in thousands): 
 
 
For the Three Months
 
For the Nine Months
 
 
Ended September 30,
 
Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
Weighted average common shares for basic earnings per share
 
71,054

 
71,004

 
71,041

 
70,589

Effect of dilutive securities: unvested share awards
 
30

 
17

 
23

 
—

Weighted average common shares for diluted earnings per share
 
71,084

 
71,021

 
71,064

 
70,589


Note 4.   Real Estate Properties
 
As of September 30, 2016, we owned 71 properties (91 buildings), with an undepreciated carrying value of $1,788,001, excluding one property (one building) classified as discontinued operations with an undepreciated carrying value of $12,260. We generally lease space at our properties on a gross lease or modified gross lease basis pursuant to fixed term contracts expiring between 2016 and 2032.  Our leases generally require us to pay all or some property operating expenses and to provide all or most property management services.  During the three months ended September 30, 2016, we entered into 17 leases for 136,466 rentable square feet, for a weighted (by rentable square feet) average lease term of 6.8 years and we made commitments for approximately $3,428 of leasing related costs. During the nine months ended September 30, 2016, we entered into 51 leases for 1,226,068 rentable square feet, including a 25,579 square foot expansion to be constructed at an existing property, for a weighted (by rentable square feet) average lease term of 10.3 years and we made commitments for approximately $35,033 of leasing related costs. As of September 30, 2016, we have estimated unspent leasing related

6
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
(unaudited)

obligations of $21,580 and have committed to redevelop and expand an existing property at an estimated cost to complete of approximately $17,990.
 
Acquisition Activities
 
During the nine months ended September 30, 2016, we acquired an office property (one building) located in Sacramento, CA with 337,811 rentable square feet.  This property was 86% leased, of which 71% was leased to the State of California and occupied by three separate agencies, on the date of acquisition.  The purchase price was $79,235, excluding acquisition costs.  Our allocation of the purchase price of this acquisition based on the estimated fair values of the acquired assets and assumed liabilities is presented in the table below. 
 
 
 
    
 
    
 
Number
 
    
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
of
 
 
 
 
 
 
 
Buildings
 
Other
 
 
 
Acquired
Acquisition
 
 
 
 
 
Properties/
 
Square
 
Purchase
 
 
 
and
 
Assumed
 
Acquired
 
Lease
Date
 
Location
 
Type
 
Buildings
 
Feet
 
Price
 
Land
 
Improvements
 
Assets
 
Leases
 
Obligations
January 2016
 
Sacramento, CA
 
Office
 
1 / 1
 
337,811

 
$
79,235

 
$
4,688

 
$
61,722

 
$
2,167

 
$
11,245

 
$
(587
)
 
In July 2016, we acquired certain land we leased from a third party at one of our properties in Atlanta, GA for $1,623, excluding acquisition costs.

Also in July 2016, we entered an agreement to acquire an office property (one building) located in Manassas, VA with 69,374 rentable square feet for a purchase price of $13,200, excluding acquisition costs. This property is 100% leased to Prince William County.

In August 2016, we entered an agreement to acquire transferable development rights that would allow us to expand a property we own in Washington, D.C. for a purchase price of $2,030, excluding acquisition costs.

Our pending acquisitions are subject to conditions; accordingly, we cannot be sure that we will complete these acquisitions or that these acquisitions will not be delayed or the terms of these acquisitions will not change.

We regularly evaluate whether events or changes in circumstances have occurred that could indicate an impairment in the value of our long lived assets. If there is an indication that the carrying value of an asset is not recoverable, we estimate the projected undiscounted cash flows to determine if an impairment loss should be recognized. We determine the amount of any impairment loss by comparing the historical carrying value to estimated fair value. We estimate fair value through an evaluation of recent financial performance and projected discounted cash flows using standard industry valuation techniques. In addition to consideration of impairment upon the events or changes in circumstances described above, we regularly evaluate the remaining lives of our long lived assets. If we change our estimate of the remaining lives, we allocate the carrying value of the affected assets over their revised remaining lives.
 
Disposition Activities – Continuing Operations
 
In July 2016, we sold an office property (one 1 building ) in Savannah, GA with 35,228 rentable square feet that had a net book value of $2,986 for $4,000, excluding closing costs. In connection with this sale, we provided $3,600 of mortgage financing to the buyer. The mortgage note requires interest to be paid at an annual rate of LIBOR plus 4.0%, subject to a minimum annual interest rate of 5.0%, and requires monthly payments of interest only until maturity on June 30, 2021. This sales transaction did not qualify for full gain recognition under GAAP and is being accounted for under the installment method. Accordingly, we recognized a gain on sale of real estate of $79 during the three months ended September 30, 2016 and recorded a deferred gain of $712, which we currently expect to recognize when the mortgage note is repaid. The mortgage note receivable of $3,600, net of the $712 deferred gain, is included in other assets on our condensed consolidated balance sheet at September 30, 2016.

We classified this property as held for sale as of June 30, 2016. The results of operations for this property were included in continuing operations in our condensed consolidated financial statements up to the date of sale.  Summarized balance sheet information for the property as of December 31, 2015 is as follows: 

7
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
(unaudited)

 
 
December 31,
 
 
2015
Real estate properties, net
 
$
3,071

Rents receivable
 
1

Other assets
 
26

Assets of property held for sale
 
$
3,098

 
 
 
Other liabilities
 
$
43

Liabilities of property held for sale
 
$
43


Disposition Activities – Discontinued Operations
 
In March 2016, we entered an agreement to sell an office property (one building) in Falls Church, VA with 164,746 rentable square feet and a net book value of $12,282 at September 30, 2016.  The contract sales price is $13,000, excluding closing costs.  This sale is subject to conditions, including the purchaser obtaining certain zoning entitlements, and is currently expected to occur in the first quarter of 2017.  We cannot be sure that the sale of this property will occur, that the sale will not be delayed or that its terms will not change. We have classified this property, which was held for sale prior to our adoption of FASB ASU No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, as a discontinued operation in our condensed consolidated financial statements. Summarized balance sheet and income statement information for the property is as follows:
 
Balance Sheets 
 
 
September 30,
 
December 31,
 
 
2016
 
2015
Real estate properties, net
 
$
12,260

 
$
12,260

Other assets
 
230

 
208

Assets of discontinued operations
 
$
12,490

 
$
12,468

 
 
 
 
 
Other liabilities
 
$
61

 
$
54

Liabilities of discontinued operations
 
$
61

 
$
54

 
Statements of Operations
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
Rental income
 
$
6

 
$
28

 
$
62

 
$
86

Real estate taxes
 
(27
)
 
71

 
(73
)
 
(69
)
Utility expenses
 
(34
)
 
(46
)
 
(113
)
 
(124
)
Other operating expenses
 
(70
)
 
(35
)
 
(219
)
 
(197
)
General and administrative
 
(29
)
 
(29
)
 
(86
)
 
(86
)
Loss from discontinued operations
 
$
(154
)
 
$
(11
)
 
$
(429
)
 
$
(390
)

Note 5.   Revenue Recognition
 
We recognize rental income from operating leases that contain fixed contractual rent changes on a straight line basis over the term of the lease agreements.  Certain of our leases with government tenants provide the tenant the right to terminate before the lease expiration date if the legislature or other funding authority does not appropriate the funding necessary for the government tenant to meet its lease obligations; we have determined the fixed non-cancelable lease term of these leases to be the fully executed term of the lease because we believe the occurrence of early terminations to be remote contingencies based on both our historical experience and our assessments of the likelihood of lease cancellation on a separate lease basis.
 
We increased rental income to record revenue on a straight line basis by $1,205 and $613 for the three months ended September 30, 2016 and 2015, respectively, and $1,789 and $2,820 for the nine months ended September 30, 2016 and 2015,

8
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
(unaudited)

respectively.  Rents receivable include $20,784 and $18,995 of straight line rent receivables at September 30, 2016 and December 31, 2015, respectively.

Note 6.   Concentration
 
Tenant and Credit Concentration
 
We define annualized rental income as the annualized contractual base rents from our tenants pursuant to our lease agreements as of the measurement date, plus straight line rent adjustments and estimated recurring expense reimbursements to be paid to us, and excluding lease value amortization. The U.S. Government, 13 state governments, and three other government tenants combined were responsible for approximately 92.4% and 92.8% of our annualized rental income, excluding one property (one building) classified as discontinued operations, as of September 30, 2016 and 2015, respectively. The U.S. Government is our largest tenant by annualized rental income and was responsible for approximately 63.9% and 67.5% of our annualized rental income, excluding one property classified as discontinued operations, as of September 30, 2016 and 2015, respectively.
 
Geographic Concentration
 
At September 30, 2016, our 71 properties (91 buildings), excluding one property (one building) classified as discontinued operations, were located in 31 states and the District of Columbia.  Properties located in California, Virginia, the District of Columbia, Georgia, New York, Maryland and Massachusetts were responsible for approximately 14.6%, 10.0%, 9.9%, 9.2%, 8.1%, 7.6% and 5.3% of our annualized rental income as of September 30, 2016, respectively.
 
Note 7.   Indebtedness
 
Our principal debt obligations at September 30, 2016 were: (1) $25,000 of outstanding borrowings under our $750,000 unsecured revolving credit facility; (2) $550,000 aggregate outstanding principal amount of term loans; (3) an aggregate outstanding principal amount of $660,000 of public issuances of senior unsecured notes; and (4) $27,877 aggregate principal amount of mortgage notes. 
 
Our $750,000 unsecured revolving credit facility is available for general business purposes, including acquisitions. The maturity date of our revolving credit facility is January 31, 2019 and, subject to the payment of an extension fee and meeting other conditions, we have an option to extend the stated maturity date of our revolving credit facility by one year to January 31, 2020.  We can borrow, repay and reborrow funds available under our revolving credit facility until maturity and no principal repayment is due until maturity. We are required to pay interest at a rate of LIBOR plus a premium, which was 125 basis points per annum at September 30, 2016, on borrowings under our revolving credit facility.  We also pay a facility fee on the total amount of lending commitments under our revolving credit facility, which was 25 basis points per annum at September 30, 2016.  Both the interest rate premium and the facility fee are subject to adjustment based upon changes to our credit ratings.  As of September 30, 2016, the annual interest rate payable on borrowings under our revolving credit facility was 1.7% and the weighted average annual interest rate for borrowings under our revolving credit facility was 1.7% for both the three and nine months ended September 30, 2016 and 1.4% and 1.5%, respectively, for the three and nine months ended September 30, 2015.  As of September 30, 2016 and October 25, 2016, we had $25,000 and $15,000 outstanding under our revolving credit facility, respectively.
 
Our $300,000 unsecured term loan, which matures on March 31, 2020, is prepayable without penalty at any time. We are required to pay interest at a rate of LIBOR plus a premium, which was 140 basis points per annum at September 30, 2016, on the amount outstanding under our $300,000 term loan. The interest rate premium is subject to adjustment based upon changes to our credit ratings.  As of September 30, 2016, the annual interest rate for the amount outstanding under our $300,000 term loan was 1.9%. The weighted average annual interest rate under our $300,000 term loan was 1.9% for both the three and nine months ended September 30, 2016 and 1.6% for both the three and nine months ended September 30, 2015.
 
Our $250,000 unsecured term loan, which matures on March 31, 2022, is prepayable at any time. If our $250,000 term loan is repaid on or prior to November 21, 2016, a prepayment premium of 1.0% of the amount repaid will be payable. Subsequent to November 21, 2016, no prepayment premium will be payable. We are required to pay interest at a rate of LIBOR plus a premium, which was 180 basis points per annum as of September 30, 2016, on the amount outstanding under our $250,000

9
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
(unaudited)

term loan.  The interest rate premium is subject to adjustment based upon changes to our credit ratings. As of September 30, 2016, the annual interest rate for the amount outstanding under our $250,000 term loan was 2.3%.  The weighted average annual interest rate under our $250,000 term loan was 2.3% for both the three and nine months ended September 30, 2016 and 2.0% for both the three and nine months ended September 30, 2015.
 
Our $750,000 revolving credit facility, our $300,000 term loan and our $250,000 term loan are governed by a credit agreement with a syndicate of institutional lenders that includes a number of features common to all of these credit arrangements. This credit agreement also includes a feature under which the maximum aggregate borrowing availability may be increased to up to $2,500,000 on a combined basis in certain circumstances.
 
In May 2016, we issued $300,000 of 5.875% senior unsecured notes due 2046 in an underwritten public offering. In June 2016, the underwriters exercised an option to purchase an additional $10,000 of these notes. The net proceeds from this offering of $299,771, after offering expenses, were used to repay all amounts then outstanding under our revolving credit facility and for general business purposes. These notes require quarterly payments of interest only through maturity and may be repaid at par (plus accrued and unpaid interest) on or after May 26, 2021. Our $350,000 of 3.75% senior unsecured notes due 2019 require semi-annual payments of interest only through maturity and may be repaid at par (plus accrued and unpaid interest) on or after July 15, 2019 or before that date together with a make whole premium. Both issuances of our senior notes are governed by an indenture and its supplements.
 
Our credit agreement and senior notes indenture and its supplements provide for acceleration of payment of all amounts due thereunder upon the occurrence and continuation of certain events of default, such as, in the case of our credit agreement, a change of control of us, which includes The RMR Group LLC, or RMR LLC, ceasing to act as our business manager and property manager.  Our credit agreement and our senior notes indenture and its supplements also contain a number of covenants, including covenants that restrict our ability to incur debts, require us to maintain certain financial ratios and, in the case of our credit agreement, restrict our ability to make distributions under certain circumstances.  We believe we were in compliance with the terms and conditions of the respective covenants under our credit agreement and senior notes indenture and its supplements at September 30, 2016.
 
In February 2016, we repaid, at par, a $23,473 mortgage note requiring annual interest of 6.21% which was secured by one office property (one building) located in Landover, MD. This mortgage note was scheduled to mature in August 2016.  We recorded a loss on extinguishment of debt of $21 in the nine months ended September 30, 2016, which represented unamortized debt issuance costs related to this note.
 
In March 2016, we repaid, at par, an $83,000 mortgage note requiring annual interest of 5.55% which was secured by one office property (two buildings) located in Reston, VA.  This mortgage note was scheduled to mature in April 2016.  We recorded a gain on extinguishment of debt of $125 in the nine months ended September 30, 2016, which represented the net unamortized debt premium and debt issuance costs related to this note.
 
At September 30, 2016, three of our properties (three buildings) with an aggregate net book value of $53,150 are encumbered by three mortgages for an aggregate principal amount of $27,877. Our mortgage notes are non-recourse, subject to certain limited exceptions and do not contain any material financial covenants.

10
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
(unaudited)


Note 8.   Fair Value of Assets and Liabilities
 
The table below presents certain of our assets measured at fair value at September 30, 2016, categorized by the level of inputs, as defined in the fair value hierarchy under GAAP, used in the valuation of each asset:
 
 
 
 
 
Fair Value at Reporting Date Using    
 
 
 
 
Quoted Prices in
 
 
 
Significant
 
 
Estimated
 
Active Markets for
 
Significant Other
 
Unobservable
 
 
Fair
 
Identical Assets
 
Observable Inputs
 
Inputs
Description
 
Value
 
(Level 1)
 
(Level 2)
 
(Level 3)
Recurring Fair Value Measurements Assets:
 
 
 
 
 
 
 
 
Investment in RMR Inc. (1)
 
$
46,068

 
$
46,068

 
$
—

 
$
—

Non-Recurring Fair Value Measurements Assets:
 
 

 
 
 
 
 
 
Property held for sale and classified as discontinued operations (2)
 
$
12,260

 
$
—

 
$
—

 
$
12,260


(1)
Our 1,214,225 shares of class A common stock of The RMR Group Inc., or RMR Inc., which are included in other assets in our condensed consolidated balance sheets, are reported at fair value which is based on quoted market prices (Level 1 inputs).  Our historical cost basis for these shares is $26,888 as of September 30, 2016.  The net unrealized gain of $19,180 for these shares as of September 30, 2016 is included in cumulative other comprehensive income (loss) in our condensed consolidated balance sheets.
(2)
We estimated the fair value of this property at September 30, 2016 based upon broker estimates of value less estimated sale costs (Level 3 inputs as defined in the fair value hierarchy under GAAP).
    
In addition to the assets described in the table above, our financial instruments include cash and cash equivalents, restricted cash, rents receivable, mortgage note receivable, accounts payable, a revolving credit facility, term loans, senior unsecured notes, mortgage notes payable, amounts due to related persons, other accrued expenses and security deposits.  At September 30, 2016 and December 31, 2015, the fair values of our financial instruments approximated their carrying values in our condensed consolidated financial statements due to their short term nature or variable interest rates, except as follows:
 
 
 
As of September 30, 2016
 
As of December 31, 2015
 
 
Carrying  Amount (1) 
 
Fair Value
 
Carrying  Amount (1) 
 
Fair Value
Senior unsecured notes, 3.75% interest rate, due in 2019
 
$
346,667

 
$
358,384

 
$
345,809

 
$
351,692

Senior unsecured notes, 5.875% interest rate, due in 2046
 
299,884

 
320,664

 
—

 
—

Mortgage note payable, 6.21% interest rate, due in 2016 (2) (3)   
 
—

 
—

 
23,476

 
24,038

Mortgage note payable, 5.55% interest rate, due in 2016 (2) (4)          
 
—

 
—

 
83,375

 
83,457

Mortgage note payable, 5.88% interest rate, due in 2021 (2)       
 
13,894

 
15,008

 
14,045

 
14,678

Mortgage note payable, 7.00% interest rate, due in 2019 (2)        
 
8,872

 
9,409

 
9,145

 
9,645

Mortgage note payable, 8.15% interest rate, due in 2021 (2)    
 
5,484

 
5,964

 
6,258

 
6,711

 
 
$
674,801

 
$
709,429

 
$
482,108

 
$
490,221


(1)
Carrying amount includes certain unamortized debt issuance costs and unamortized premiums and discounts.
(2)
We assumed these mortgages in connection with our acquisitions of the encumbered properties.  The stated interest rates for these mortgage debts are the contractually stated rates.  We recorded the assumed mortgages at estimated fair value on the date of acquisition and we are amortizing the fair value premiums, if any, to interest expense over the respective terms of the mortgages to reduce interest expense to the estimated market interest rates as of the date of acquisition.
(3)
This mortgage note was repaid, at par, in February 2016.
(4)
This mortgage note was repaid, at par, in March 2016.
 
We estimate the fair value of our senior unsecured notes using an average of the bid and ask price of the notes as of the measurement date (Level 2 inputs as defined in the fair value hierarchy under GAAP). We estimate the fair values of our mortgage notes payable by using discounted cash flow analyses and currently prevailing market terms as of the measurement date (Level 3 inputs as defined in the fair value hierarchy under GAAP).  Because Level 3 inputs are unobservable, our estimated fair value may differ materially from the actual fair value.

11
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
(unaudited)


Note 9.   Shareholders’ Equity
 
Distributions
 
On February 25, 2016, we paid a regular quarterly distribution to common shareholders of record on January 22, 2016 of $0.43 per share, or $30,584. On May 23, 2016, we paid a regular quarterly distribution to common shareholders of record on April 25, 2016 of $0.43 per share, or $30,585. On August 22, 2016, we paid a regular quarterly distribution to common shareholders of record on July 22, 2016 of $0.43 per share, or $30,590. On October 11, 2016, we declared a regular quarterly distribution payable to common shareholders of record on October 21, 2016 of $0.43 per share, or $30,607. We expect to pay this amount on or about November 21, 2016 using cash on hand and borrowings under our revolving credit facility.
 
Share Issuances and Purchases
On May 17, 2016, we granted 2,500 of our common shares, valued at $19.52 per share, the closing price of our common shares on the New York Stock Exchange on that day, to each of our five Trustees as part of their annual compensation.

On September 15, 2016, pursuant to our 2009 Incentive Share Award Plan, we granted an aggregate of 53,400 of our common shares to our officers and certain other employees of our manager, RMR LLC, valued at $22.16 per share, the closing price of our common shares on The NASDAQ Stock Market LLC, or Nasdaq, on that day.

On September 26, 2016, we purchased an aggregate of 13,209 of our common shares valued at $23.63 per common share, the closing price of our common shares on the Nasdaq on that day, from our officers and other employees of RMR LLC in satisfaction of tax withholding and payment obligations in connection with the vesting of awards of restricted common shares.

Cumulative Other Comprehensive Income (Loss)
    
Cumulative other comprehensive income (loss) represents the unrealized gain on the RMR Inc. shares we own and our share of the comprehensive income (loss) of our equity method investees, Select Income REIT, or SIR, and Affiliates Insurance Company, or AIC. The following table presents changes in the amounts we recognized in cumulative other comprehensive income (loss) by component for the three and nine months ended September 30, 2016: 
 
 
 
Three Months Ended September 30, 2016
 
 
Unrealized Gain
 
Equity in
 
 
 
 
(Loss) on Investment
 
Unrealized Gain
 
 
 
 
in Available for
 
(Loss) of
 
 
 
 
Sale Securities
 
Investees
 
Total
Balance at June 30, 2016
 
$
10,717

 
$
1,674

 
$
12,391

Other comprehensive income before reclassifications
 
8,463

 
3,235

 
11,698

Amounts reclassified from cumulative other comprehensive income (loss) to net income (1) 
 
—

 
38

 
38

Net current period other comprehensive income
 
8,463

 
3,273

 
11,736

Balance at September 30, 2016
 
$
19,180

 
$
4,947

 
$
24,127

 
 
 
Nine Months Ended September 30, 2016
 
 
Unrealized Gain
 
Equity in
 
 
 
 
(Loss) on Investment
 
Unrealized Gain
 
 
 
 
in Available for
 
(Loss) of
 
 
 
 
Sale Securities
 
Investees
 
Total
Balance at December 31, 2015
 
$
(9,391
)
 
$
(5,476
)
 
$
(14,867
)
Other comprehensive income before reclassifications
 
28,571

 
10,382

 
38,953

Amounts reclassified from cumulative other comprehensive income (loss) to net income (1)
 
—

 
41

 
41

Net current period other comprehensive income
 
28,571

 
10,423

 
38,994

Balance at September 30, 2016
 
$
19,180

 
$
4,947

 
$
24,127

(1)
Amounts reclassified from cumulative other comprehensive income (loss) are included in equity in earnings (losses) of investees in our condensed consolidated statements of comprehensive income (loss).

12
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
(unaudited)

 
Note 10.   Related Person Transactions
 
We have relationships and historical and continuing transactions with RMR LLC, SIR and others related to them, including other companies to which RMR LLC provides management services and which have trustees, directors and officers who are also our Trustees or officers.  For further information about these and other such relationships and certain other related person transactions, please refer to our Annual Report.
RMR LLC:  Pursuant to our business management agreement with RMR LLC, we recognized net business management fees of $2,572 and $2,438 for the three months ended September 30, 2016 and 2015, respectively, and $7,614 and $7,482 for the nine months ended September 30, 2016 and 2015, respectively.  The net business management fees we recognized for the 2016 and 2015 periods are included in general and administrative expenses in our condensed consolidated statements of comprehensive income (loss).
In accordance with the terms of our business management agreement, we issued 23,222 of our common shares to RMR LLC for the period from January 1, 2015 through May 31, 2015 as payment for a part of the business management fee we recognized for that period.  Beginning June 1, 2015, all management fees under our business management agreement are paid in cash.
Pursuant to our property management agreement with RMR LLC, we recognized aggregate net property management and construction supervision fees of $2,249 and $1,930 for the three months ended September 30, 2016 and 2015, respectively, and $6,636 and $5,861 for the nine months ended September 30, 2016 and 2015, respectively.  These amounts are included in other operating expenses or have been capitalized, as appropriate, in our condensed consolidated financial statements.
We are generally responsible for all of our operating expenses, including certain expenses incurred by RMR LLC on our behalf.  Our property level operating expenses are generally incorporated into rents charged to our tenants, including certain payroll and related costs incurred by RMR LLC.  We reimbursed RMR LLC $3,221 and $3,011 for property management related expenses for the three months ended September 30, 2016 and 2015, respectively, and $9,132 and $8,478 for the nine months ended September 30, 2016 and 2015, respectively. These amounts are included in other operating expenses in our condensed consolidated statements of comprehensive income (loss).
We have historically awarded share grants to certain RMR LLC employees under our equity compensation plan. In September 2016 and 2015, we awarded annual share grants of 53,400 and 53,100 of our common shares, respectively, to our officers and to other employees of RMR LLC. In September 2016, we purchased 13,209 of our common shares, at the closing price of our common shares on the Nasdaq on the date of purchase, from our officers and certain other employees of RMR LLC in satisfaction of tax withholding and payment obligations in connection with the vesting of awards of our common shares. In addition, under our business management agreement we reimburse RMR LLC for our allocable costs for internal audit services.  The amounts recognized as expense for share grants to RMR LLC employees and internal audit costs were $504 and $292 for the three months ended September 30, 2016 and 2015, respectively, and $1,239 and $725 for the nine months ended September 30, 2016 and 2015, respectively. These amounts are included in general and administrative expenses in our condensed consolidated statements of comprehensive income (loss).
We lease office space to RMR LLC in certain of our properties for its property management offices.  Pursuant to our lease agreements with RMR LLC, we recognized rental income from RMR LLC for leased office space of $90 and $111 for the three months ended September 30, 2016 and 2015, respectively, and $277 and $278 for the nine months ended September 30, 2016 and 2015, respectively.
RMR Inc.:  In connection with our June 2015 acquisition of shares of class A common stock of RMR Inc., we recorded a liability for the amount by which the estimated fair value of these shares exceeded the price we paid for these shares. This liability is included in accounts payable and other liabilities in our condensed consolidated balance sheets.  This liability is being amortized on a straight line basis through December 31, 2035 as an allocated reduction to our business management and property management fee expense.  We amortized $272 and $281 of this liability for the three months ended September 30, 2016 and 2015, respectively, and $815 and $346 of this liability for the nine months ended September 30, 2016 and 2015, respectively. These amounts are included in the net business management and property management fee amounts for such periods.  As of September 30, 2016, the remaining unamortized amount of this liability was $20,938.

13
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
(unaudited)

As of September 30, 2016, we owned 1,214,225 shares of class A common stock of RMR Inc.  We receive dividends on our RMR Inc. class A common shares as declared and paid by RMR Inc. to all holders of its class A common shares.  We received a dividend of $363 on our RMR Inc. class A common shares during the three months ended June 30, 2016, which was for the period from December 14, 2015 through March 31, 2016.  We received a dividend of $304 on our RMR Inc. class A common shares during the three months ended September 30, 2016 which was for the period from April 1, 2016 through June 30, 2016. On October 11, 2016, RMR Inc. declared a regular quarterly dividend of $0.25 per class A common share payable to shareholders of record on October 21, 2016.  RMR Inc. has stated that it expects to pay this dividend on or about November 17, 2016.
Our investment in RMR Inc. class A common shares is included in other assets in our condensed consolidated balance sheets and is recorded at fair value with the related unrealized gain (loss) included in cumulative other comprehensive income (loss) in our condensed consolidated balance sheets. We recognize the increase or decrease in the fair value of our RMR Inc. class A common shares each reporting period as unrealized gain or loss on investment in available for sale securities which is a component of other comprehensive income in our condensed consolidated statements of comprehensive income (loss). For further information, see Notes 8 and 9.
SIR:  As of September 30, 2016, we owned 24,918,421 common shares of SIR, or 27.9% of SIR's outstanding common shares.  We receive distributions on our SIR common shares as declared and paid by SIR to all holders of its common shares.  We received distributions of $12,708 and $12,459 on our SIR common shares during the three months ended September 30, 2016 and 2015, respectively, and $37,627 and $34,571 during the nine months ended September 30, 2016 and 2015, respectively.  On October 11, 2016, SIR declared a regular quarterly distribution of $0.51 per common share payable to shareholders of record on October 21, 2016.  SIR has stated that it expects to pay this distribution on or about November 17, 2016.  We account for our investment in SIR common shares under the equity method. For additional information about our ownership of SIR common shares and how we account for this investment, see Note 11.
AIC:  We and six other companies to which RMR LLC provides management services each own AIC in equal amounts.  We and the other AIC shareholders participate in a combined property insurance program arranged and reinsured in part by AIC.  We paid aggregate annual premiums, including taxes and fees, of approximately $1,032 in connection with this insurance program for the policy year ending June 30, 2017, which amount may be adjusted from time to time as we acquire and dispose of properties that are included in this insurance program.
As of September 30, 2016 and December 31, 2015, our investment in AIC had a carrying value of $7,229 and $6,946, respectively.  These amounts are included in other assets in our condensed consolidated balance sheets.  We recognized income (loss) of $13 and ($24) related to our investment in AIC for the three months ended September 30, 2016 and 2015, respectively, and $107 and $70 for the nine months ended September 30, 2016 and 2015, respectively.  Our other comprehensive income (loss) includes our proportionate part of unrealized gains (losses) on securities which are owned by AIC of $81 and ($72) for the three months ended September 30, 2016 and 2015, respectively, and $175 and ($91) for the nine months ended September 30, 2016 and 2015, respectively.
Directors’ and Officers’ Liability Insurance: We, RMR Inc., RMR LLC and certain companies to which RMR LLC provides management services participate in a combined directors’ and officers’ liability insurance policy. In September 2016, we participated in a one year extension of this combined directors’ and officers’ insurance policy through September 2018. Our premium for this policy extension was approximately $106.

Note 11.   Equity Investment in Select Income REIT
 
As of September 30, 2016, we owned 24,918,421, or approximately 27.9%, of the then outstanding SIR common shares.  SIR is a real estate investment trust that is primarily focused on owning and investing in net leased, single tenant properties. 
 
We account for our investment in SIR under the equity method.  Under the equity method, we record our proportionate share of SIR’s net income as equity in earnings of an investee in our condensed consolidated statements of comprehensive income (loss).  We recorded $8,655 and $10,318 of equity in the earnings of SIR for the three months ended September 30, 2016 and 2015, respectively, and $27,895 and $16,002 for the nine months ended September 30, 2016 and 2015, respectively. Our other comprehensive income (loss) includes our proportionate share of SIR’s unrealized gains (losses) of $3,192 and

14
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
(unaudited)

($283) for the three months ended September 30, 2016 and 2015, respectively, and $10,248 and ($75) for the nine months ended September 30, 2016 and 2015, respectively.
 
As of September 30, 2016, our investment in SIR had a carrying value of $491,973 and a market value, based on the closing price of SIR common shares on the Nasdaq on September 30, 2016, of $670,306. We periodically evaluate our equity investment in SIR for possible indicators of other than temporary impairment whenever events or changes in circumstances indicate the carrying amount of the investment might not be recoverable.  These indicators may include the length of time the market value of our investment is below our cost basis, the financial condition of SIR, our intent and ability to be a long term holder of the investment and other considerations.  If the decline in fair value is judged to be other than temporary, we may record an impairment charge to adjust the basis of the investment to its fair value.
 
During the three and nine months ended September 30, 2016, SIR issued 53,400 and 65,900 common shares, respectively. During the three and nine months ended September 30, 2015, SIR issued 45,389 and 29,414,279 common shares, respectively.  We recognized a gain (loss) on issuance of shares by SIR of $72 and ($21) during the three months ended September 30, 2016 and 2015, respectively, and a gain (loss) of $88 and ($42,145) during the nine months ended September 30, 2016 and 2015, respectively, as a result of the per share issuance price of these SIR common shares being above (below) the then average per share carrying value of our SIR common shares.
 
The cost of our investments in SIR exceeded our proportionate share of SIR’s total shareholders’ equity book value on their dates of acquisition by an aggregate of $166,272. As required under GAAP, we were amortizing this difference to equity in earnings of investees over the average remaining useful lives of the real estate assets and intangible assets and liabilities owned by SIR as of the respective dates of our acquisitions.  This amortization decreased our equity in the earnings of SIR by zero and $4,742 for the three and nine months ended September 30, 2015, respectively.  We recorded a loss on impairment of our SIR investment during the three months ended June 30, 2015 resulting in the carrying value of our SIR investment being less than our proportionate share of SIR’s total shareholders’ equity book value as of June 30, 2015.  As a result, the previous basis difference was eliminated and we are currently accreting a basis difference of ($95,089) to earnings over the estimated remaining useful lives of the real estate assets and intangible assets and liabilities owned by SIR as of June 30, 2015.  This accretion increased our equity in the earnings of SIR by $740 and $2,219 for the three and nine months ended September 30, 2016, respectively, and by $1,893 for the three and nine months ended September 30, 2015.
 
We received cash distributions from SIR totaling $12,708 and $12,459 during the three months ended September 30, 2016 and 2015, respectively, and $37,627 and $34,571 during the nine months ended September 30, 2016 and 2015, respectively.
 
The following are summarized financial data of SIR as reported in SIR’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2016, or the SIR Quarterly Report. References in our financial statements to the SIR Quarterly Report are included as references to the source of the data only, and the information in the SIR Quarterly Report is not incorporated by reference into our financial statements.
 

15
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
(unaudited)


Condensed Consolidated Balance Sheets
 
 
 
September 30,
 
December 31,
 
 
2016
 
2015
Real estate properties, net
 
$
3,913,589

 
$
3,954,889

Acquired real estate leases, net
 
519,952

 
566,195

Cash and cash equivalents
 
16,697

 
17,876

Rents receivable, net
 
117,163

 
99,307

Other assets, net
 
89,855

 
46,078

Total assets
 
$
4,657,256

 
$
4,684,345

 
 
 
 
 
Unsecured revolving credit facility
 
$
297,000

 
$
303,000

Unsecured term loan, net
 
348,249

 
347,876

Senior unsecured notes, net
 
1,429,247

 
1,426,025

Mortgage notes payable, net
 
286,102

 
286,706

Assumed real estate lease obligations, net
 
79,833

 
86,495

Other liabilities
 
124,891

 
137,283

Shareholders' equity
 
2,091,934

 
2,096,960

Total liabilities and shareholders' equity
 
$
4,657,256

 
$
4,684,345


Condensed Consolidated Statements of Income
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
Rental income
 
$
96,037

 
$
94,745

 
$
290,512

 
$
267,389

Tenant reimbursements and other income
 
18,999

 
17,197

 
56,660

 
46,182

Total revenues
 
115,036

 
111,942

 
347,172

 
313,571

 
 
 
 
 
 
 
 
 
Real estate taxes
 
10,755

 
9,871

 
31,565

 
27,247

Other operating expenses
 
14,394

 
11,313

 
39,987

 
30,121

Depreciation and amortization
 
33,366

 
33,070

 
100,240

 
90,179

Acquisition related costs
 
13

 
402

 
71

 
21,720

General and administrative
 
7,553

 
6,328

 
21,903

 
19,488

Total expenses
 
66,081

 
60,984

 
193,766

 
188,755

Operating income
 
48,955

 
50,958

 
153,406

 
124,816

 
 
 
 
 
 
 
 
 
Dividend income
 
397

 
—

 
872

 
—

Interest expense
 
(20,690
)
 
(20,034
)
 
(61,883
)
 
(53,710
)
Loss on early extinguishment of debt
 
—

 
—

 
—

 
(6,845
)
Income before income tax expense and equity in earnings (loss) of an investee
 
28,662

 
30,924

 
92,395

 
64,261

Income tax expense
 
(107
)
 
(98
)
 
(370
)
 
(324
)
Equity in earnings (loss) of an investee
 
13

 
(25
)
 
107

 
70

Net income
 
28,568

 
30,801

 
92,132

 
64,007

Net income allocated to noncontrolling interest
 
—

 
(46
)
 
(33
)
 
(135
)
Net income attributed to SIR
 
$
28,568

 
$
30,755

 
$
92,099

 
$
63,872

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding (basic)
 
89,308

 
89,267

 
89,295

 
85,827

Weighted average common shares outstanding (diluted)
 
89,334

 
89,274

 
89,318

 
85,837

Net income attributed to SIR per common share (basic and diluted)
 
$
0.32

 
$
0.34

 
$
1.03

 
$
0.74

 

16
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
(unaudited)

Note 12.   Segment Information
 
We operate in two separate reportable business segments: ownership of properties that are primarily leased to government tenants and our equity method investment in SIR.
 
 
Three Months Ended September 30, 2016
 
 
Investment
 
Investment
 
 
 
 
 
 
in Real Estate
 
in SIR
 
Corporate
 
Consolidated
Rental income
 
$
64,478

 
$
—

 
$
—

 
$
64,478

 
 
 
 
 
 
 
 
 
Expenses:
 
 

 
 

 
 

 
 

Real estate taxes
 
7,591

 
—

 
—

 
7,591

Utility expenses
 
5,483

 
—

 
—

 
5,483

Other operating expenses
 
13,854

 
—

 
—

 
13,854

Depreciation and amortization
 
18,404

 
—

 
—

 
18,404

Acquisition related costs
 
147

 
—

 
—

 
147

General and administrative
 
—

 
—

 
3,816

 
3,816

Total expenses
 
45,479

 
—

 
3,816

 
49,295

 
 
 
 
 
 
 
 
 
Operating income (loss)
 
18,999

 
—

 
(3,816
)
 
15,183

Dividend income
 
—

 
—

 
304

 
304

Interest income
 
—

 
—

 
47

 
47

Interest expense
 
(429
)
 
—

 
(12,179
)
 
(12,608
)
Gain on issuance of shares by Select Income REIT
 
—

 
72

 
—

 
72

Income (loss) from continuing operations before
 
 

 
 

 
 

 
 

income taxes and equity in earnings of investees
 
18,570

 
72

 
(15,644
)
 
2,998

Income tax expense
 
—

 
—

 
(13
)
 
(13
)
Equity in earnings of investees
 
—

 
8,655

 
13

 
8,668

Income (loss) from continuing operations
 
18,570

 
8,727

 
(15,644
)
 
11,653

Loss from discontinued operations
 
(154
)
 
—

 
—

 
(154
)
Income (loss) before gain on sale of property
 
18,416

 
8,727

 
(15,644
)
 
11,499

Gain on sale of property
 
79

 
—

 
—

 
79

Net income (loss)
 
$
18,495

 
$
8,727

 
$
(15,644
)
 
$
11,578

 
 


17
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
(unaudited)

 
 
Nine Months Ended September 30, 2016
 
 
Investment
 
Investment
 
 
 
 
 
 
in Real Estate
 
in SIR
 
Corporate
 
Consolidated
Rental income 
 
$
192,150

 
$
—

 
$
—

 
$
192,150

 
 
 
 
 
 
 
 
 
Expenses:
 
 

 
 

 
 

 
 

Real estate taxes
 
22,810

 
—

 
—

 
22,810

Utility expenses
 
13,330

 
—

 
—

 
13,330

Other operating expenses
 
40,031

 
—

 
—

 
40,031

Depreciation and amortization
 
54,713

 
—

 
—

 
54,713

Acquisition related costs
 
363

 
—

 
—

 
363

General and administrative
 
—

 
—

 
11,350

 
11,350

Total expenses
 
131,247

 
—

 
11,350

 
142,597

 
 
 
 
 
 
 
 
 
Operating income (loss)
 
60,903

 
—

 
(11,350
)
 
49,553

Dividend income
 
—

 
—

 
667

 
667

Interest income
 
—

 
—

 
63

 
63

Interest expense
 
(1,953
)
 
—

 
(30,333
)
 
(32,286
)
Gain on early extinguishment of debt
 
104

 
—

 
—

 
104

Gain on issuance of shares by Select Income REIT
 
—

 
88

 
—

 
88

Income (loss) from continuing operations before
 
 

 
 

 
 

 
 

income taxes and equity in earnings of investees
 
59,054

 
88

 
(40,953
)
 
18,189

Income tax expense
 
—

 
—

 
(63
)
 
(63
)
Equity in earnings of investees
 
—

 
27,895

 
107

 
28,002

Income (loss) from continuing operations
 
59,054

 
27,983

 
(40,909
)
 
46,128

Loss from discontinued operations
 
(429
)
 
—

 
—

 
(429
)
Income (loss) before gain on sale of property
 
58,625

 
27,983

 
(40,909
)
 
45,699

Gain on sale of property
 
79

 
—

 
—

 
79

Net income (loss)
 
$
58,704

 
$
27,983

 
$
(40,909
)
 
$
45,778

 
 
 
As of September 30, 2016
 
 
Investment
 
Investment
 
 
 
 
 
 
in Real Estate
 
in SIR
 
Corporate
 
Consolidated
Total Assets
 
$
1,699,658

 
$
491,973

 
$
73,439

 
$
2,265,070



18
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
(unaudited)

 
 
Three Months Ended September 30, 2015
 
 
Investment
 
Investment
 
 
 
 
 
 
in Real Estate
 
in SIR
 
Corporate
 
Consolidated
Rental income 
 
$
62,092

 
$
—

 
$
—

 
$
62,092

 
 
 
 
 
 
 
 
 
Expenses:
 
 

 
 

 
 

 
 

Real estate taxes
 
7,735

 
—

 
—

 
7,735

Utility expenses
 
5,194

 
—

 
—

 
5,194

Other operating expenses
 
12,281

 
—

 
—

 
12,281

Depreciation and amortization
 
17,161

 
—

 
—

 
17,161

Acquisition related costs
 
270

 
—

 
—

 
270

General and administrative
 
—

 
—

 
3,714

 
3,714

Total expenses
 
42,641

 
—

 
3,714

 
46,355

 
 
 
 
 
 
 
 
 
Operating income (loss)
 
19,451

 
—

 
(3,714
)
 
15,737

Interest income
 


 
—

 
2

 
2

Interest expense
 
(1,727
)
 
—

 
(7,410
)
 
(9,137
)
Gain on early extinguishment of debt
 
34

 
—

 
—

 
34

Loss on issuance of shares by Select Income REIT
 
—

 
(21
)
 
—

 
(21
)
Income (loss) from continuing operations before
 
 

 
 

 
 

 
 

income taxes and equity in earnings (losses) of investees
 
17,758

 
(21
)
 
(11,122
)
 
6,615

Income tax benefit
 
—

 
—

 
13

 
13

Equity in earnings (losses) of investees
 
—

 
10,318

 
(24
)
 
10,294

Income (loss) from continuing operations
 
17,758

 
10,297

 
(11,133
)
 
16,922

Loss from discontinued operations
 
(11
)
 
—

 
—

 
(11
)
Net income (loss)
 
$
17,747

 
$
10,297

 
$
(11,133
)
 
$
16,911


 

19
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
(unaudited)

 
 
Nine Months Ended September 30, 2015
 
 
Investment
 
Investment
 
 
 
 
 
 
in Real Estate
 
in SIR
 
Corporate
 
Consolidated
Rental income 
 
$
186,864

 
$
—

 
$
—

 
$
186,864

 
 
 
 
 
 
 
 
 
Expenses:
 
 

 
 

 
 

 
 

Real estate taxes
 
22,819

 
—

 
—

 
22,819

Utility expenses
 
13,788

 
—

 
—

 
13,788

Other operating expenses
 
36,659

 
—

 
—

 
36,659

Depreciation and amortization
 
51,675

 
—

 
—

 
51,675

Acquisition related costs
 
459

 
—

 
—

 
459

General and administrative
 
—

 
—

 
11,431

 
11,431

Total expenses
 
125,400

 
—

 
11,431

 
136,831

 
 
 
 
 
 
 
 
 
Operating income (loss)
 
61,464

 
—

 
(11,431
)
 
50,033

Interest income
 
—

 
—

 
14

 
14

Interest expense
 
(21,618
)
 
—

 
(6,276
)
 
(27,894
)
Gain on early extinguishment of debt
 
34

 
—

 
—

 
34

Loss on issuance of shares by Select Income REIT
 
—

 
(42,145
)
 
—

 
(42,145
)
Loss on impairment of Select Income REIT investment
 
—

 
(203,297
)
 
—

 
(203,297
)
Income (loss) from continuing operations before income
 
 

 
 

 
 

 
 

income taxes and equity in earnings of investees
 
39,880

 
(245,442
)
 
(17,693
)
 
(223,255
)
Income tax expense
 
—

 
—

 
(49
)
 
(49
)
Equity in earnings of investees
 
—

 
16,002

 
70

 
16,072

Income (loss) from continuing operations
 
39,880

 
(229,440
)
 
(17,672
)
 
(207,232
)
Loss from discontinued operations
 
(390
)
 
—

 
—

 
(390
)
Net income (loss)
 
$
39,490

 
$
(229,440
)
 
$
(17,672
)
 
$
(207,622
)
 
 
As of December 31, 2015
 
 
Investment
 
Investment
 
 
 
 
 
 
in Real Estate
 
in SIR
 
Corporate
 
Consolidated
Total Assets
 
$
1,639,462

 
$
491,369

 
$
37,679

 
$
2,168,510



20

Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following information should be read in conjunction with our condensed consolidated financial statements and accompanying notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q and with our Annual Report on Form 10-K for the year ended December 31, 2015, or our Annual Report.
 
OVERVIEW
 
We are a real estate investment trust, or REIT, organized under Maryland law. As of September 30, 2016, we owned 71 properties (91 buildings), excluding one property (one building) classified as discontinued operations.  Our properties are located in 31 states and the District of Columbia and contain approximately 11 million rentable square feet, of which 61.1% was leased to the U.S. Government, 22.3% was leased to 13 state governments, 2.8% was leased to three other government tenants, 8.8% was leased to various non-governmental organizations and 5.0% was available for lease as of September 30, 2016. The U.S. Government, 13 state governments and three other government tenants combined were responsible for 92.4% and 92.8% of our annualized rental income as of September 30, 2016 and 2015, respectively. The term annualized rental income as used in this section is defined as the annualized contractual base rents from our tenants pursuant to our lease agreements as of the measurement date, plus straight line rent adjustments and estimated recurring expense reimbursements to be paid to us, and excluding lease value amortization.
 
As of September 30, 2016, we also owned 24,918,421 common shares, or approximately 27.9% of the then outstanding common shares, of Select Income REIT, or SIR. SIR is a REIT that is primarily focused on owning and investing in net leased, single tenant properties.  See Notes 10 and 11 to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information regarding our investment in SIR. We account for our investment in SIR under the equity method.
 
Property Operations
 
As of September 30, 2016, excluding one property (one building) classified as discontinued operations, 95.0% of our rentable square feet was leased, compared to 93.5% of our rentable square feet as of September 30, 2015.  Occupancy data for our properties as of September 30, 2016 and 2015 is as follows (square feet in thousands):
 
 
 
 
 
 
Comparable
 
 
All Properties (1)
 
Properties (2)
 
 
September 30,
 
September 30,
 
 
2016
 
2015
 
2016
 
2015
Total properties
 
71

 
71

 
70

 
70

Total buildings
 
91

 
91

 
90

 
90

Total square feet (3)
 
10,950

 
10,701

 
10,612

 
10,666

Percent leased  (3)(4)     
 
95.0
%
 
93.5
%
 
95.2
%
 
93.8
%

(1)
Based on properties we owned on September 30, 2016 and 2015, respectively, and excludes one property (one building) classified as discontinued operations.
(2)
Based on properties we owned on September 30, 2016 and which we owned continuously since January 1, 2015, and excludes one property (one building) classified as discontinued operations.  Our comparable properties increased from 67 properties (86 buildings) at September 30, 2015 as a result of our acquisition of four properties (five buildings) during the year ended December 31, 2014, offset by the sale of one property (one building) during the nine months ended September 30, 2016.
(3)
Subject to changes when space is re-measured or re-configured for tenants.
(4)
Percent leased includes (i) space being fitted out for tenant occupancy pursuant to our lease agreements, if any, and (ii) space which is leased, but is not occupied or is being offered for sublease by tenants, if any, as of the measurement date.
 
The average annualized effective rental rate per square foot for our properties for the three and nine months ended September 30, 2016 and 2015 are as follows:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
Average annualized effective rental rate per square foot (1):
 
 
 
 
 
 
 
 
  All properties (2)
 
$
25.31

 
$
24.97

 
$
25.15

 
$
24.72

  Comparable properties (3)
 
$
25.09

 
$
24.98

 
$
24.94

 
$
24.70


21


(1)
Average annualized effective rental rate per square foot represents annualized total rental income during the period specified divided by the average rentable square feet leased during the period specified. Excludes one property (one building) classified as discontinued operations.
(2)
Based on properties we owned on September 30, 2016 and excludes one property (one building) classified as discontinued operations.
(3)
Based on properties we owned on September 30, 2016 and which we owned continuously since July 1, 2015 and January 1, 2015, respectively, and excludes one property (one building) classified as discontinued operations.

During the three and nine months ended September 30, 2016, changes in rentable square feet leased and available for lease at our properties, excluding one property (one building) classified as discontinued operations, were as follows:
 
 
 
Three Months Ended September 30, 2016
 
Nine Months Ended September 30, 2016
 
 
 
 
Available
 
 
 
 
 
Available
 
 
 
 
Leased
 
for Lease
 
Total
 
Leased
 
for Lease
 
Total
Beginning of period
 
10,347,357

 
638,010

 
10,985,367

 
10,115,001

 
585,963

 
10,700,964

Changes resulting from:
 
 

 
 

 
 
 
 

 
 

 
 

Acquisition of properties
 
—

 
—

 
—

 
290,878

 
46,933

 
337,811

Disposition of properties
 
—

 
(35,228
)
 
(35,228
)
 
—

 
(35,228
)
 
(35,228
)
Lease expirations
 
(82,030
)
 
82,030

 
—

 
(1,204,575
)
 
1,204,575

 
—

Lease renewals (1)
 
75,895

 
(75,895
)
 
—

 
1,017,982

 
(1,017,982
)
 
—

New leases (1)(2)
 
60,571

 
(60,571
)
 
—

 
182,507

 
(182,507
)
 
—

Re-measurements (3)
 
—

 
—

 
—

 
—

 
(53,408
)
 
(53,408
)
End of period
 
10,401,793

 
548,346

 
10,950,139

 
10,401,793

 
548,346

 
10,950,139


(1)
Based on leases entered into during the three and nine months ended September 30, 2016.
(2)
Rentable square footage of new leases for the nine months ended September 30, 2016 excludes a 25,579 square foot expansion to be constructed at an existing property prior to the commencement of the lease.
(3)
Rentable square footage is subject to changes when space is re-measured or re-configured for tenants.
 
Leases at our properties totaling 82,030 and 1,204,575 rentable square feet expired during the three and nine months ended September 30, 2016, respectively. During the three and nine months ended September 30, 2016, we entered into leases totaling 136,466 and 1,226,068 rentable square feet, including a 25,579 square foot expansion to be constructed at an existing property, and lease renewals of 75,895 and 1,017,982 rentable square feet, respectively.  The weighted (by rentable square feet) average rental rates for leases of 62,552 and 1,038,052 rentable square feet entered into with government tenants (which includes the 25,579 square foot expansion referenced above) during the three and nine months ended September 30, 2016 increased by 10.5% and 9.6%, respectively, when compared to the weighted (by rentable square feet) average prior rents for the same space. The weighted (by rentable square feet) average rental rates for leases of 73,914 and 188,016 rentable square feet entered into with non-government tenants during the three and nine months ended September 30, 2016 decreased by 3.8% and 2.0%, respectively, when compared to the weighted (by rentable square feet) average rental rates previously charged for the same space.
 
During the three and nine months ended September 30, 2016, changes in effective rental rates per square foot achieved for new leases and lease renewals that commenced during the three and nine months ended September 30, 2016, when compared to prior effective rental rates per square foot in effect for the same space (and excluding space acquired vacant), were as follows: 
 
 
Three Months Ended September 30, 2016
 
Nine Months Ended September 30, 2016
 
 
Old Effective
 
New Effective
 
    
 
Old Effective
 
New Effective
 
    
 
 
Rent Per
 
Rent Per
 
Rentable
 
Rent Per
 
Rent Per
 
Rentable
 
 
Square Foot (1)
 
Square Foot (1)
 
Square Feet
 
Square Foot (1)
 
Square Foot (1)
 
Square Feet
New leases
 
$
32.58

 
$
22.48

 
$
89,116

 
$
29.02

 
$
22.93

 
$
159,851

Lease renewals
 
$
26.83

 
$
26.27

 
$
72,504

 
$
25.05

 
$
26.37

 
$
991,120

Total leasing activity
 
$
30.00

 
$
24.18

 
$
161,620

 
$
25.60

 
$
25.90

 
$
1,150,971

(1)
Effective rental rate includes contractual base rents from our tenants pursuant to our lease agreements, plus straight line rent adjustments and estimated expense reimbursements to be paid to us, and excluding lease value amortization.


22

During the three and nine months ended September 30, 2016, commitments made for expenditures, such as tenant improvements and leasing costs, in connection with leasing space at our properties were as follows:
 
 
Government
 
Non-Government
 
 
Three Months Ended September 30, 2016
 
Leases
 
Leases
 
Total
Rentable square feet leased during the period
 
62,552

 
73,914

 
136,466

Tenant leasing costs and concession commitments (1) (in thousands)
 
$
1,087

 
$
2,341

 
$
3,428

Tenant leasing costs and concession commitments per rentable square foot (1)
 
$
17.38

 
$
31.67

 
$
25.12

Weighted (by square feet) average lease term (years)
 
6.9

 
6.6

 
6.8

Total leasing costs and concession commitments per rentable square foot per year (1)
 
$
2.50

 
$
4.77

 
$
3.71

 
 
 
 
 
 
 
 
 
Government
 
Non-Government
 
    
Nine Months Ended September 30, 2016
 
Leases
 
Leases
 
Total
Rentable square feet leased during the period (2)
 
1,038,052

 
188,016

 
1,226,068

Tenant leasing costs and concession commitments (1)(3) (in thousands)
 
30,100

 
4,933

 
35,033

Tenant leasing costs and concession commitments per rentable square foot (1)(3)
 
$
29.00

 
$
26.24

 
$
28.57

Weighted (by square feet) average lease term (years)
 
11.1

 
6.3

 
10.3

Total leasing costs and concession commitments per rentable square foot per year (1)(3)
 
$
2.62

 
$
4.15

 
$
2.76


(1)
Includes commitments made for leasing expenditures and concessions, such as tenant improvements, leasing commissions, tenant reimbursements and free rent.
(2)
Rentable square footage includes a 25,579 square foot expansion to be constructed at an existing property prior to the commencement of the lease.
(3)
Excludes the estimated cost to complete of $17,990 to redevelop and expand an existing property prior to the commencement of the lease.
 
During the three and nine months ended September 30, 2016 and 2015, amounts capitalized at our properties, excluding one property (one building) classified as discontinued operations, for tenant improvements, leasing costs, building improvements and development and redevelopment activities were as follows (dollars in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2016
 
2015
 
2016
 
2015
Tenant improvements (1)
 
$
5,636

 
$
2,213

 
$
12,306

 
$
5,039

Leasing costs (2)
 
$
655

 
$
439

 
$
8,002

 
$
2,876

Building improvements (3)
 
$
3,009

 
$
2,210

 
$
8,691

 
$
4,151

Development, redevelopment and other activities (4)
 
$
1,292

 
$
946

 
$
4,221

 
$
1,167


(1)
Tenant improvements include capital expenditures used to improve tenants’ space or amounts paid directly to tenants to improve their space.
(2)
Leasing costs include leasing related costs, such as brokerage commissions and other tenant inducements.
(3)
Building improvements generally include expenditures to replace obsolete building components and expenditures that extend the useful life of existing assets.
(4)
Development, redevelopment and other activities generally include (i) capital expenditures that are identified at the time of a property acquisition and incurred within a short time period after acquiring the property, and (ii) capital expenditure projects that reposition a property or result in new sources of revenue.
 
As of September 30, 2016, we have estimated unspent leasing related obligations of $21,580 and have committed to redevelop and expand an existing property at an estimated cost to complete of approximately $17,990.
 
We believe that current government budgetary pressures have resulted in a decrease in government employment, government tenants reducing their space utilization per employee and consolidation into existing government owned properties, thereby reducing the demand for government leased space. Our historical experience with respect to properties of the type we own that are majority leased to government tenants has been that government tenants frequently renew leases to avoid the costs and disruptions that may result from relocating their operations. However, relocation has become more prevalent in instances where efforts by government tenants to reduce their space utilization requires a significant reconfiguration of currently leased space. Accordingly, we are unable to reasonably project what the financial impact of market conditions or changing government financial circumstances will be on our financial results for future periods.

The Internal Revenue Service, or IRS, has publicly stated that it plans to discontinue its tax return processing operations at our property located in Fresno, CA in 2021. The IRS lease for this property, which accounted for approximately 3.3% of our annualized rental income as of September 30, 2016, expires in 2021. The IRS has also publicly stated that it plans to

23

discontinue its tax return processing operations in Covington, KY in 2019. Our property located in Florence, KY is leased to the IRS and we believe it is used to support these operations. This lease, which accounted for approximately 1.0% of our annualized rental income as of September 30, 2016, expires in 2022 but is subject to early termination rights beginning in 2017. The IRS has not notified us of its intentions regarding these properties.
    
As of September 30, 2016, we had leases totaling 970,781 rentable square feet that were scheduled to expire through September 30, 2017. As of October 25, 2016, tenants with leases totaling 138,936 rentable square feet that are scheduled to expire through September 30, 2017, have notified us that they do not plan to renew their leases upon expiration and we can provide no assurance as to whether additional tenants may or may not renew their leases upon expiration.  Based upon current market conditions and tenant negotiations for leases scheduled to expire through September 30, 2017, we expect that the rental rates we are likely to achieve on new or renewed leases for space under expiring leases through September 30, 2017 will, in the aggregate and on a weighted (by annualized revenues) average basis, be modestly higher than the rates currently being paid, thereby generally resulting in higher revenue from the same space. We can provide no assurance regarding the rental rates which will result from our ongoing negotiations regarding lease renewals or any new leases we may enter into; also, we may experience material declines in our rental income due to vacancies upon lease expirations.  Prevailing market conditions and government tenants' needs at the time we negotiate and enter leases will generally determine rental rates and demand for leased space in our properties, and market conditions and government tenants' needs are beyond our control.
 
As of September 30, 2016, lease expirations at our properties, excluding one property (one building) classified as discontinued operations, by year are as follows (dollars in thousands):
 
 
 
Number
 
Expirations
 
 
 
 
 
 
 
Annualized
 
 
 
 
 
 
of
 
of Leased
 
 
 
 
 
Cumulative
 
Rental
 
 
 
Cumulative
 
 
Tenants
 
Square
 
 
 
Percent
 
Percent
 
Income
 
Percent
 
Percent
Year (1)
 
Expiring
 
Feet (2)
 
 
 
of Total
 
of Total
 
Expiring
 
of Total
 
of Total
2016
 
20

 
494,157

 
 
 
4.8
%
 
4.8
%
 
$
21,738

 
8.5
%
 
8.5
%
2017
 
36

 
796,454

 
 
 
7.7
%
 
12.5
%
 
16,755

 
6.5
%
 
15.0
%
2018
 
39

 
1,067,705

 
 
 
10.3
%
 
22.8
%
 
29,612

 
11.6
%
 
26.6
%
2019
 
38

 
1,644,650

 
 
 
15.8
%
 
38.6
%
 
43,215

 
16.9
%
 
43.5
%
2020
 
33

 
1,307,618

 
 
 
12.6
%
 
51.2
%
 
31,072

 
12.1
%
 
55.6
%
2021
 
37

 
1,058,636

 
 
 
10.2
%
 
61.4
%
 
20,759

 
8.1
%
 
63.7
%
2022
 
16

 
710,006

 
 
 
6.8
%
 
68.2
%
 
15,414

 
6.0
%
 
69.7
%
2023
 
14

 
536,625

 
 
 
5.2
%
 
73.4
%
 
12,326

 
4.8
%
 
74.5
%
2024
 
13

 
960,838

 
 
 
9.2
%
 
82.6
%
 
21,841

 
8.5
%
 
83.0
%
2025 and thereafter
 
33

 
1,825,104

 
(3) 
 
17.4
%
 
100.0
%
 
43,349

 
17.0
%
 
100.0
%
Total
 
279

 
10,401,793

 
 
 
100.0
%
 
 
 
$
256,081

 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average remaining lease term (in years)
 
5.0
 
 
 
 
 
 
 
4.8
 
 
 
 

(1)
The year of lease expiration is pursuant to current contract terms. Some government tenants have the right to vacate their space before the stated expirations of their leases. As of September 30, 2016, government tenants occupying approximately 11.1% of our rentable square feet and responsible for approximately 8.6% of our annualized rental income as of September 30, 2016 have currently exercisable rights to terminate their leases before the stated terms of their leases expire. Also, in 2016, 2017, 2018, 2019, 2020, 2021, 2022, 2023, 2026 and 2027, early termination rights become exercisable by other tenants who currently occupy an additional approximately 1.6%, 2.5%, 1.6%, 4.5%, 6.3%, 0.7%, 2.5%, 2.0%, 0.9% and 0.6% of our rentable square feet, respectively, and contribute an additional approximately 1.8%, 1.9%, 1.6%, 4.8%, 6.9%, 0.7%, 1.7%, 1.8%, 1.2% and 0.7% of our annualized rental income, respectively, as of September 30, 2016. In addition, as of September 30, 2016, 15 of our government tenants have currently exercisable rights to terminate their leases if the legislature or other funding authority does not appropriate rent amounts in their respective annual budgets. These 15 tenants occupy approximately 18.1% of our rentable square feet and contribute approximately 17.9% of our annualized rental income as of September 30, 2016.

(2)
Leased square feet is pursuant to leases existing as of September 30, 2016, and includes (i) space being fitted out for tenant occupancy pursuant to our lease agreements, if any, and (ii) space which is leased, but is not occupied or is being offered for sublease by tenants, if any.  Square feet measurements are subject to changes when space is re-measured or re-configured for new tenants.

(3)
Leased square footage excludes a 25,579 square foot expansion to be constructed at an existing property prior to the commencement of the lease.



24

Acquisition and Disposition Activities (dollar amounts in thousands)
 
On January 29, 2016, we acquired an office property (one building) located in Sacramento, CA with 337,811 rentable square feet for a purchase price of $79,235, excluding acquisition costs, using cash on hand and borrowings under our revolving credit facility.  We acquired this property at a capitalization rate of 7.2%.  We calculate the capitalization rate for property acquisitions as the ratio of (x) annual straight line rental income, excluding the impact of above and below market lease amortization, based on leases in effect on the acquisition date, less estimated annual property operating expenses as of the acquisition date, excluding depreciation and amortization expense, to (y) the acquisition purchase price, including the principal amount of assumed debt, if any, and excluding acquisition costs.
 
In March 2016, we entered an agreement to sell an office property ( one building) in Falls Church, VA with 164,746 rentable square feet and a net book value of $12,282 at September 30, 2016.  The contract sales price is $13,000, excluding closing costs.  This sale is subject to conditions, including the purchaser obtaining certain zoning entitlements, and is currently expected to occur in the first quarter of 2017. 

In July 2016, we acquired certain land we leased from a third party at one of our properties in Atlanta, GA for $1,623, excluding acquisition costs.

Also in July 2016, we sold an office property (one building) in Savannah, GA with 35,228 rentable square feet and a net book value of $2,986 at September 30, 2016 for $4,000, excluding closing costs. In connection with this sale, we provided $3,600 of mortgage financing to the buyer.

Also in July 2016, we entered an agreement to acquire an office property (one building) located in Manassas, VA with 69,374 rentable square feet for a purchase price of $13,200, excluding acquisition costs. This property is 100% leased to Prince William County.

In August 2016, we entered an agreement to acquire transferable development rights that would allow us to expand a property we own in Washington, D.C. for a purchase price of $2,030, excluding acquisition costs.

Our pending acquisitions and dispositions are subject to conditions; accordingly, we cannot be sure that we will complete these acquisitions and dispositions or that these acquisitions and dispositions will not be delayed or the terms of these acquisitions and dispositions will not change.    
 
Our strategy related to property acquisitions and dispositions is materially unchanged from that disclosed in our Annual Report. We continue to explore and evaluate for possible acquisition additional properties that are majority leased to government tenants; however, we cannot be sure that we will reach any agreement to acquire such properties, or that if we do reach any such agreement, that we will complete any acquisitions. Although we have not identified properties for disposition other than the property described above, we expect to periodically identify properties for sale based on future changes in market conditions, changes in property performance, our expectation regarding lease renewals, our plans with regard to particular properties or alternative opportunities we may wish to pursue. Our plans for particular properties and other strategic considerations may cause us to change our acquisition and disposition strategies, and we may do so at any time and without shareholder approval.

25


RESULTS OF OPERATIONS (amounts in thousands, except per share amounts)
 
Three Months Ended September 30, 2016, Compared to Three Months Ended September 30, 2015
 
 
 
 
 
 
 
 
 
 
Acquired  Property
 
Disposed Property
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Results (2)
 
Results (3) 
 
 
 
 
 
 
 
 
 
 
Comparable Properties Results (1)
 
Three Months Ended
 
Three Months Ended
 
Consolidated Results
 
 
Three Months Ended September 30,
 
September 30,
 
September 30,
 
Three Months Ended September 30,
 
 

 

 
$
 
%
 

 

 

 

 

 

 
$
 
%
 
 
2016
 
2015
 
Change
 
Change
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
 
Change
 
Change
Rental income
 
$
62,298

 
$
62,072

 
$
226

 
0.4
%
 
$
2,180

 
$
—

 
$
—

 
$
20

 
$
64,478

 
$
62,092

 
$
2,386

 
3.8
%
Operating expenses:
 
 

 
 

 
 
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Real estate taxes
 
7,391

 
7,722

 
(331
)
 
(4.3
%)
 
205

 
—

 
(5
)
 
13

 
7,591

 
7,735

 
(144
)
 
(1.9
%)
Utility expenses
 
5,268

 
5,178

 
90

 
1.7
%
 
213

 
—

 
2

 
16

 
5,483

 
5,194

 
289

 
5.6
%
Other operating expenses
 
13,271

 
12,252

 
1,019

 
8.3
%
 
579

 
—

 
4

 
29

 
13,854

 
12,281

 
1,573

 
12.8
%
Total operating expenses
 
25,930

 
25,152

 
778

 
3.1
%
 
997

 
—

 
1

 
58

 
26,928

 
25,210

 
1,718

 
6.8
%
Net operating income (4)
 
$
36,368

 
$
36,920

 
$
(552
)
 
(1.5
%)
 
$
1,183

 
$
—

 
$
(1
)
 
$
(38
)
 
37,550

 
36,882

 
668

 
1.8
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other expenses:
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 
 
 

 
 

 
 
 
 

Depreciation and amortization
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 
 
18,404

 
17,161

 
1,243

 
7.2
%
Acquisition related costs
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 
 
147

 
270

 
(123
)
 
(45.6
%)
General and administrative
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 
 
3,816

 
3,714

 
102

 
2.7
%
Total other expenses
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 
 
22,367

 
21,145

 
1,222

 
5.8
%
Operating income
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 
 
15,183

 
15,737

 
(554
)
 
(3.5
%)
Dividend income
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 
 
304

 
—

 
304

 
nm

Interest income
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 
 
47

 
2

 
45

 
nm

Interest expense (including net amortization of debt premium and discounts and debt issuance costs of $805 and $360, respectively)
 
(12,608
)
 
(9,137
)
 
(3,471
)
 
38.0
%
Gain on early extinguishment of debt
 
—

 
34

 
(34
)
 
nm

Gain (loss) on issuance of shares by Select Income REIT
 
72

 
(21
)
 
93

 
nm

Income from continuing operations before income taxes and equity in earnings of investees
 
2,998

 
6,615

 
(3,617
)
 
(54.7
%)
Income tax (expense) benefit
 
(13
)
 
13

 
(26
)
 
 nm

Equity in earnings of investees
 
8,668

 
10,294

 
(1,626
)
 
(15.8
%)
Income from continuing operations
 
11,653

 
16,922

 
(5,269
)
 
(31.1
%)
Loss from discontinued operations
 
(154
)
 
(11
)
 
(143
)
 
nm

Income before gain on sale of property
 
11,499

 
16,911

 
(5,412
)
 
(32.0
%)
Gain on sale of property
 
79

 
—

 
79

 
nm

Net income
 
$
11,578

 
$
16,911

 
$
(5,333
)
 
(31.5
%)
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding (basic)
 
71,054

 
71,004

 
50

 
0.1
%
Weighted average common shares outstanding (diluted)
 
71,084

 
71,021

 
63

 
0.1
%
 
 
 
 
 
 
 
 
 
Per common share amounts (basic and diluted):
 
 

 
 

 
 
 
 

Income from continuing operations
 
$
0.16

 
$
0.24

 
$
(0.08
)
 
(33.3
%)
Loss from discontinued operations
 
$
—

 
$
—

 
$
—

 
—%

Net income
 
$
0.16

 
$
0.24

 
$
(0.08
)
 
(33.3
%)
 
 
 
 
 
 
 
 
 
Calculation of Funds From Operations and Normalized Funds From Operations (5)
 
 

 
 

 
 
 
 


 
 
 
 
 
 
 
 
Net income
 
$
11,578

 
$
16,911

 
 
 
 

Plus: Depreciation and amortization
 
18,404

 
17,161

 
 
 
 

Plus: FFO attributable to Select Income REIT investment
 
17,264

 
17,780

 
 
 
 

Less: Equity in earnings from Select Income REIT
 
(8,655
)
 
(10,318
)
 
 
 
 

Less: Gain on sale of property
 
(79
)
 
—

 
 
 
 
Funds from operations
 
38,512

 
41,534

 
 
 
 

Plus: Acquisition related costs
 
147

 
270

 
 
 
 

Plus: Loss on issuance of shares by Select Income REIT
 
—

 
21

 
 
 
 

Plus: Loss on impairment of Select Income REIT investment
 
—

 
—

 
 
 
 

Plus: Normalized FFO attributable to Select Income REIT investment
 
17,267

 
17,892

 
 
 
 

Less: FFO attributable to Select Income REIT investment
 
(17,264
)
 
(17,780
)
 
 
 
 

Less: Gain on early extinguishment of debt
 
—

 
(34
)
 
 
 
 

Less: Gain on issuance of shares by Select Income REIT
 
(72
)
 
—

 
 
 
 

Normalized funds from operations
 
$
38,590

 
$
41,903

 
 
 
 
 
 
 
 
 
 
 
 
 

Funds from operations per common share (basic and diluted)
 
$
0.54

 
$
0.58

 
 
 
 

Normalized funds from operations per common share (basic and diluted)
 
$
0.54

 
$
0.59

 
 
 
 
(1)
Comparable properties consist of 70 properties (90 buildings) we owned on September 30, 2016 and which we owned continuously since July 1, 2015, and excludes one property (one building) classified as discontinued operations.
(2)
Acquired property consists of one property (one building) we acquired during the three months ended March 31, 2016.

26

(3)
Disposed property consists of one property (one building) we sold during the three months ended September 30, 2016.
(4)
The calculation of net operating income, or NOI, excludes certain components of net income (loss) in order to provide results that are more closely related to our property level results of operations. We define NOI as income from our rental of real estate less our property operating expenses. NOI excludes amortization of capitalized tenant improvement costs and leasing commissions because we record those amounts as depreciation and amortization. We consider NOI to be an appropriate supplemental measure to net income (loss) because it may help both investors and management to understand the operations of our properties. We use NOI to evaluate individual and company wide property level performance, and we believe that NOI provides useful information to investors regarding our results of operations because it reflects only those income and expense items that are generated and incurred at the property level and may facilitate comparisons of our operating performance between periods and with other REITs. NOI does not represent cash generated by operating activities in accordance with U.S. generally accepted accounting principles, or GAAP, and should not be considered as an alternative to net income (loss) or operating income as an indicator of our operating performance or as a measure of our liquidity. This measure should be considered in conjunction with net income (loss) and operating income as presented in our Condensed Consolidated Statements of Comprehensive Income (Loss). Other REITs and real estate companies may calculate NOI differently than we do.
(5)
We calculate funds from operations, or FFO, and normalized funds from operations, or Normalized FFO, as shown above. FFO is calculated on the basis defined by The National Association of Real Estate Investment Trusts, or NAREIT, which is net income (loss), calculated in accordance with GAAP, plus real estate depreciation and amortization and the difference between FFO attributable to an equity investment and equity in earnings of an equity investee but excluding impairment charges on real estate assets, any gain or loss on sale of properties, as well as certain other adjustments currently not applicable to us. Our calculation of Normalized FFO differs from NAREIT's definition of FFO because we include the difference between FFO and Normalized FFO attributable to our equity investment in SIR, we include business management incentive fees, if any, only in the fourth quarter versus the quarter when they are recognized as expense in accordance with GAAP due to their quarterly volatility not necessarily being indicative of our core operating performance and the uncertainty as to whether any such business management incentive fees will ultimately be payable when all contingencies for determining any such fees are determined at the end of the calendar year and we exclude acquisition related costs, gains or losses on early extinguishment of debt, loss on impairment of SIR investment and gains or losses on issuance of shares by SIR. We consider FFO and Normalized FFO to be appropriate supplemental measures of operating performance for a REIT, along with net income (loss) and operating income. We believe that FFO and Normalized FFO provide useful information to investors because by excluding the effects of certain historical amounts, such as depreciation expense, FFO and Normalized FFO may facilitate a comparison of our operating performance between periods and with other REITs. FFO and Normalized FFO are among the factors considered by our Board of Trustees when determining the amount of distributions to our shareholders. Other factors include, but are not limited to, requirements to maintain our qualification for taxation as a REIT, limitations in our credit agreement and public debt covenants, the availability to us of debt and equity capital, our expectation of our future capital requirements and operating performance, our receipt of distributions from SIR and our expected needs and availability of cash to pay our obligations. FFO and Normalized FFO do not represent cash generated by operating activities in accordance with GAAP and should not be considered as alternatives to net income (loss) or operating income as an indicator of our operating performance or as a measure of our liquidity. These measures should be considered in conjunction with net income (loss) and operating income as presented in our Condensed Consolidated Statements of Comprehensive Income (Loss). Other REITs and real estate companies may calculate FFO and Normalized FFO differently than we do.
 
We refer to the 70 properties (90 buildings) we owned on September 30, 2016 and which we have owned continuously since July 1, 2015, excluding one property (one building) classified as discontinued operations, as comparable properties. We refer to the one property (one building) we acquired during the three months ended March 31, 2016 as the acquired property. We refer to the one property (one building) we sold during the three months ended September 30, 2016 as the disposed property.
 
Our condensed consolidated statements of comprehensive income for the three months ended September 30, 2016 include the operating results of the acquired property for the entire period, as we acquired this property prior to July 1, 2016, and include the operating results of the disposed property for less than the entire period, as that property was sold during the period.  Our condensed consolidated statements of comprehensive income for the three months ended September 30, 2015 exclude the operating results of the acquired property for the entire period, as we acquired that property after September 30, 2015, and include the operating results of the disposed property for the entire period, as we sold that property after September 30, 2015.
 
References to changes in the income and expense categories below relate to the comparison of consolidated results for the three month period ended September 30, 2016, compared to the three month period ended September 30, 2015.
 
Rental income. The increase in rental income reflects an increase in rental income for comparable properties and the effect of the acquired property partially offset by the effect of the disposed property. Rental income increased $2,180 as a result of the acquired property.  Rental income decreased $20 as a result of the disposed property. Rental income for comparable properties increased $226 due primarily to an increase in occupied space at certain of our properties in the 2016 period.  Rental income includes non-cash straight line rent adjustments totaling $1,205 in the 2016 period and $613 in the 2015 period, and amortization of acquired leases and assumed lease obligations totaling ($370) in the 2016 period and ($298) in the 2015 period.
 
Real estate taxes. The decrease in real estate taxes reflects a decrease in real estate taxes for comparable properties partially offset by the net effect of the acquired property and the disposed property. Real estate taxes increased $205 as a result of the acquired property.  Real estate taxes decreased $18 as a result of the disposed property. Real estate taxes for comparable properties decreased $331 due primarily to the effect of lower real estate tax valuation assessments at certain of our properties in the 2016 period.
 

27

Utility expenses. The increase in utility expenses reflects an increase in utility expenses for comparable properties and the net effect of the acquired property and the disposed property. Utility expenses increased $213 as a result of the acquired property.  Utility expenses declined $14 as a result of the disposed property.  Utility expenses at comparable properties increased $90 primarily due to an increase in electricity usage at certain of our buildings during the 2016 period compared to the 2015 period.
 
Other operating expenses. Other operating expenses consist of salaries and benefit costs of property level personnel, repairs and maintenance expense, cleaning expense, other direct costs of operating our properties and property management fees, net of amortization of the liability we recorded in connection with our June 2015 acquisition of shares of Class A common stock of The RMR Group Inc., or RMR Inc. (see Note 10 to our condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q). The increase in other operating expenses reflects an increase in expenses for comparable properties and the net effect of the acquired property and the disposed property. Other operating expenses increased $579 as a result of the acquired property. Other operating expenses declined $25 as a result of the disposed property. Other operating expenses at comparable properties increased $1,019 primarily as a result of higher salaries, cleaning and repairs and maintenance costs at certain of our properties during the 2016 period.
 
Depreciation and amortization. The increase in depreciation and amortization reflects the effect of the property acquisition and improvements made to certain of our properties, partially offset by the effect of certain assets becoming fully depreciated. Depreciation and amortization increased $1,255 as a result of the acquired property. Depreciation and amortization at comparable properties declined $12 due primarily to certain depreciable leasing related assets becoming fully depreciated after July 1, 2015, partially offset by depreciation and amortization of improvements made to certain of our properties after July 1, 2015.
 
Acquisition related costs. Acquisition related costs in both the 2016 and 2015 periods include legal and due diligence costs incurred in connection with our property acquisition activity.
 
General and administrative. General and administrative expenses consist of fees pursuant to our business management agreement, net of amortization of the liability we recorded in connection with our June 2015 acquisition of RMR Inc. shares (see Note 10 to our condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q), equity compensation expense, legal and accounting fees, Trustees’ fees and expenses, securities listing and transfer agency fees and other costs relating to our status as a publicly traded company. The increase in general and administrative expenses is primarily as a result of an increase in stock compensation expense partially offset by a decrease in other professional fees during the 2016 period.
 
Dividend income. Dividend income consists of dividends received from our investment in RMR Inc. during the 2016 period.
 
Interest income. The increase in interest income is primarily the result of interest earned from the mortgage financing we provided to the purchaser of one of our properties during the 2016 period. For more information, see Note 4 to our condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q.
 
Interest expense. The increase in interest expense reflects higher average outstanding debt balances and higher weighted average interest rates on borrowings during the 2016 period compared to the 2015 period.
 
Gain on early extinguishment of debt.  We recorded a $34 gain on early extinguishment of debt in the 2015 period in connection with the repayment of a mortgage note.

Gain (loss) on issuance of shares by Select Income REIT. Gain (loss) on issuance of shares by SIR is a result of the issuance of common shares by SIR at prices above or (below) our then per share carrying value of our SIR common shares.
  
Income tax (expense) benefit. The change in income tax (expense) benefit reflects higher operating income in certain jurisdictions in the 2016 period that is subject to state income taxes, compared to a decrease in our accrued state income tax liability in the 2015 period due to lower estimated operating income in certain jurisdictions.
 
Equity in earnings of investees. Equity in earnings of investees represents our proportionate share of earnings from our investments in SIR and Affiliates Insurance Company, or AIC.
 
Loss from discontinued operations. Loss from discontinued operations reflects operating results for one property (one building) included in discontinued operations during the 2016 and 2015 periods.  

28

 
Gain on sale of property. Gain on sale of property represents the portion of the gain recognized from the sale of a property accounted for under the installment method during the 2016 period. For more information, see Note 4 to our condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q.

Net income. Our net income decreased in the 2016 period compared to the 2015 period as a result of the changes noted above.

29

RESULTS OF OPERATIONS (amounts in thousands, except per share amounts)
 
Nine Months Ended September 30, 2016, Compared to Nine Months Ended September 30, 2015 
 
 
 
 
 
 
 
 
 
 
Acquired Property
 
Disposed Properties
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Results (2)
 
Results (3)
 
 
 
 
 
 
 
 
 
 
Comparable Properties Results (1)
 
Nine Months Ended
 
Nine Months Ended
 
Consolidated Results
 
 
Nine Months Ended September 30,
 
September 30,
 
September 30,
 
Nine Months Ended September 30,
 
 
 
 
 
 
$
 
%
 
 
 
 
 
 
 
 
 
 
 
 
 
$
 
%
 
 
2016
 
2015
 
Change
 
Change
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
 
Change
 
Change
Rental income
 
$
186,297

 
$
185,062

 
$
1,235

 
0.7
%
 
$
5,852

 
$
—

 
$
1

 
$
1,802

 
$
192,150

 
$
186,864

 
$
5,286

 
2.8
%
Operating expenses:
 
 

 
 

 
 
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Real estate taxes
 
22,259

 
22,575

 
(316
)
 
(1.4
%)
 
524

 
—

 
27

 
244

 
22,810

 
22,819

 
(9
)
 
(0.0
%)
Utility expenses
 
12,889

 
13,635

 
(746
)
 
(5.5
%)
 
417

 
—

 
24

 
153

 
13,330

 
13,788

 
(458
)
 
(3.3
%)
Other operating expenses
 
38,534

 
36,224

 
2,310

 
6.4
%
 
1,438

 
—

 
59

 
435

 
40,031

 
36,659

 
3,372

 
9.2
%
Total operating expenses
 
73,682

 
72,434

 
1,248

 
1.7
%
 
2,379

 
—

 
110

 
832

 
76,171

 
73,266

 
2,905

 
4.0
%
Net operating income (4)
 
$
112,615

 
$
112,628

 
$
(13
)
 
(0.0
%)
 
$
3,473

 
$
—

 
$
(109
)
 
$
970

 
115,979

 
113,598

 
2,381

 
2.1
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other expenses:
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 
 
 

 
 

 
 
 
 

Depreciation and amortization
 
 
 
 
 
54,713

 
51,675

 
3,038

 
5.9
%
Acquisition related costs
 
 
 
 
 
363

 
459

 
(96
)
 
(20.9
%)
General and administrative
 
 
 
 
 
11,350

 
11,431

 
(81
)
 
(0.7
%)
Total other expenses
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 
 
66,426

 
63,565

 
2,861

 
4.5
%
Operating income
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 
 
49,553

 
50,033

 
(480
)
 
(1.0
%)
Dividend income
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 
 
667

 
—

 
667

 
 nm

Interest income
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 
 
63

 
14

 
49

 
350.0
%
Interest expense (including net amortization of debt premium and discounts and debt issuance costs of $2,024 and $1,020, respectively)
 
(32,286
)
 
(27,894
)
 
(4,392
)
 
15.7
%
Gain on early extinguishment of debt
 
 
 
 
 
104

 
34

 
70

 
205.9
%
Gain (loss) on issuance of shares by Select Income REIT
 
88

 
(42,145
)
 
42,233

 
 nm

Loss on impairment of Select Income REIT investment
 
—

 
(203,297
)
 
203,297

 
 nm

Income (loss) from continuing operations before income taxes and equity in earnings of investees
 
18,189

 
(223,255
)
 
241,444

 
(108.1
%)
Income tax expense
 
(63
)
 
(49
)
 
(14
)
 
28.6
%
Equity in earnings of investees
 
28,002

 
16,072

 
11,930

 
74.2
%
Income (loss) from continuing operations
 
46,128

 
(207,232
)
 
253,360

 
 nm

Loss from discontinued operations
 
(429
)
 
(390
)
 
(39
)
 
10.0
%
Income (loss) before gain on sale of property
 
45,699

 
(207,622
)
 
253,321

 
 nm

Gain on sale of property
 
79

 
—

 
79

 
 nm

Net income (loss)
 
$
45,778

 
$
(207,622
)
 
$
253,400

 
 nm


 
 
 
 
 
 
 
 
Weighted average common shares outstanding (basic)
 
71,041

 
70,589

 
452

 
0.6
%
Weighted average common shares outstanding (diluted)
 
71,064

 
70,589

 
475

 
0.7
%

 
 
 
 
 
 
 
 
Per common share amounts (basic and diluted):
 
 

 
 

 
 
 
 

Income (loss) from continuing operations
 
$
0.65

 
$
(2.94
)
 
$
3.59

 
 nm

Loss from discontinued operations
 
$
(0.01
)
 
$
(0.01
)
 
$
—

 
 nm

Net income (loss)
 
$
0.64

 
$
(2.94
)
 
$
3.58

 
 nm

 
 
 
 
 
 
 
 
 
 
 
 
 
Calculation of Funds From Operations and Normalized Funds From Operations (5)
 
 
 
 
 
 

 
 

 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income (loss)
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 
 
$
45,778

 
$
(207,622
)
 
 
 
 

Plus: Depreciation and amortization
 
 
 
 
 
54,713

 
51,675

 
 
 
 

Plus: FFO attributable to Select Income REIT investment
 
 
 
 
 
53,609

 
43,961

 
 
 
 

Less: Equity in earnings from Select Income REIT
 
 
 
 
 
(27,895
)
 
(16,002
)
 
 
 
 

Less: Gain on sale of property
 
 
 
 
 
(79
)
 
—

 
 
 
 
Funds from operations
 
 
 
 
 
126,126

 
(127,988
)
 
 
 
 

Plus: Acquisition related costs
 
 
 
 
 
363

 
459

 
 
 
 

Plus: Loss on issuance of shares by Select Income REIT
 
 
 
 
 
—

 
42,145

 
 
 
 

Plus: Loss on impairment of Select Income REIT investment
 
 
 
 
 
—

 
203,297

 
 
 
 

Plus: Normalized FFO attributable to Select Income REIT investment
 
 
 
 
 
53,629

 
51,177

 
 
 
 

Less: FFO attributable to Select Income REIT investment
 
 
 
 
 
(53,609
)
 
(43,961
)
 
 
 
 

Less: Gain on early extinguishment of debt
 
 
 
 
 
(104
)
 
(34
)
 
 
 
 

Less: Gain on issuance of shares by Select Income REIT
 
 
 
 
 
(88
)
 
—

 
 
 
 

Normalized funds from operations
 
 
 
 
 
$
126,317

 
$
125,095

 
 
 
 


 
 
 
 
 
 
 
 
 
 
 
 
Funds from operations per common share (basic and diluted)
 
 
 
 
 
$
1.78

 
$
(1.81
)
 
 
 
 

Normalized funds from operations per common share (basic and diluted)
 
 
 
 
 
$
1.78

 
$
1.77

 
 
 
 

 
(1)
Comparable properties consist of 70 properties (90 buildings) we owned on September 30, 2016 and which we owned continuously since January 1, 2015, and excludes one property (one building) classified as discontinued operations.
(2)
Acquired property consists of one property (one building) we acquired during the nine months ended September 30, 2016.

30

(3)
Disposed properties consist of one property (one building) we sold during the nine months ended September 30, 2015 and one property (one building) we sold during the nine months ended September 30, 2016.
(4)
See footnote (4) on page 27 for a definition of NOI.
(5)
See footnote (5) on page 27 for a definition of FFO and Normalized FFO.
 
We refer to the 70 properties (90 buildings) we owned on September 30, 2016 and which we have owned continuously since January 1, 2015, excluding one property (one building) classified as discontinued operations, as comparable properties. We refer to the one property (one building) we acquired during the nine months ended September 30, 2016 as the acquired property. We refer to the one property (one building) we sold during the nine months ended September 30, 2015 and the one property (one building) we sold during the nine months ended September 30, 2016 as the disposed properties.

Our condensed consolidated statements of comprehensive income (loss) for the nine months ended September 30, 2016 include the operating results of the acquired property for less than the entire period, as we acquired this property during the 2016 period, include the operating results of one disposed property for less than the entire period, as we sold that property during the period, and exclude the operating results of one disposed property for the entire period, as we sold that property prior to January 1, 2016.  Our condensed consolidated statements of comprehensive income (loss) for the nine months ended September 30, 2015 exclude the operating results of the acquired property for the entire period, as we acquired that property after September 30, 2015, include the operating results of one disposed property for the entire period, as we sold that property after September 30, 2015, and include the operating results of one disposed property for less than the entire period, as we sold that property during the 2015 period.
 
References to changes in the income and expense categories below relate to the comparison of consolidated results for the nine month period ended September 30, 2016, compared to the nine month period ended September 30, 2015.
 
Rental income. The increase in rental income reflects an increase in rental income for comparable properties and the net effect of the acquired property and the disposed properties.  Rental income increased $5,852 as a result of the acquired property.  Rental income declined $1,801 as a result of the disposed properties.  Rental income for comparable properties increased $1,235 due primarily to an increase in occupied space at certain of our properties in the 2016 period.  Rental income includes non-cash straight line rent adjustments totaling $1,789 in the 2016 period and $2,820 in the 2015 period, and amortization of acquired leases and assumed lease obligations totaling ($1,103) in the 2016 period and ($862) in the 2015 period.
 
Real estate taxes. The decrease in real estate taxes reflects the decrease in real estate taxes for comparable properties partially offset by the net effect of the acquired property and the disposed properties. Real estate taxes increased $524 as a result of the acquired property.  Real estate taxes declined $217 as a result of the disposed properties.  Real estate taxes for comparable properties declined $316 due primarily to the effect of lower real estate tax valuation assessments at certain of our properties in the 2016 period.
 
Utility expenses. The decrease in utility expenses reflects a decrease in utility expenses for comparable properties partially offset by the net effect of the acquired property and the disposed properties. Utility expenses increased $417 as a result of the acquired property.  Utility expenses declined $129 as a result of the disposed properties.  Utility expenses at comparable properties declined $746 primarily due to milder temperatures experienced in certain parts of the United States during the 2016 period compared to the 2015 period.
 
Other operating expenses. The increase in other operating expenses reflects an increase in expenses for comparable properties and the net effect of the acquired property and the disposed properties. Other operating expenses increased $1,438 as a result of the acquired property.  Other operating expenses declined $376 as a result of the disposed properties.  Other operating expenses at comparable properties increased $2,310 primarily as a result of higher salaries, cleaning and insurance costs at certain of our properties partially offset by lower snow removal costs at certain of our properties during the 2016 period.
 
Depreciation and amortization. The increase in depreciation and amortization reflects the effect of the property acquisition and improvements made to certain of our properties, partially offset by the effect of certain assets becoming fully depreciated. Depreciation and amortization increased $3,343 as a result of the acquired property. Depreciation and amortization at comparable properties declined $305 due primarily to certain depreciable leasing related assets becoming fully depreciated after January 1, 2015, partially offset by depreciation and amortization of improvements made to certain of our properties after January 1, 2015.
 

31

Acquisition related costs. Acquisition related costs in both the 2016 and 2015 periods include legal and due diligence costs incurred in connection with our property acquisition activity.
 
General and administrative. The decrease in general and administrative expenses primarily reflects a decrease in other professional fees and services partially offset by an increase in stock compensation expense during the 2016 period.
 
Dividend income. Dividend income consists of dividends received from our investment in RMR Inc. during the 2016 period.
 
Interest income. The increase in interest income is primarily the result of interest earned from the mortgage financing we provided to the purchaser of one of our properties during the 2016 period. For more information, see Note 4 to our condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q.

Interest expense. The increase in interest expense reflects higher average outstanding debt balances and higher weighted average interest rates on borrowings during the 2016 period compared to the 2015 period.
 
Gain on early extinguishment of debt.  We recorded a net $104 gain on early extinguishment of debt in the 2016 period in connection with the prepayment of two mortgage notes. We recorded a $34 gain on early extinguishment of debt in the 2015 period in connection with the repayment of a mortgage note.
 
Gain (loss) on issuance of shares by Select Income REIT. Gain (loss) on issuance of shares by SIR is a result of the issuance of common shares by SIR at prices above or (below) our then per share carrying value of our SIR common shares.
 
Loss on impairment of Select Income REIT investment. We recorded a $203,297 loss on impairment in the 2015 period to reduce the carrying value of our SIR investment to its estimated fair value.
 
Income tax expense. The increase in income tax expense reflects higher operating income in certain jurisdictions in the 2016 period that is subject to state income taxes.
 
Equity in earnings of investees. Equity in earnings of investees represents our proportionate share of earnings from our investments in SIR and AIC.
 
Loss from discontinued operations. Loss from discontinued operations reflects operating results for one property (one building) included in discontinued operations during the 2016 and 2015 periods.  

Gain on sale of property. Gain on sale of property represents the portion of the gain recognized from the sale of a property accounted for under the installment method during the 2016 period. For more information, see Note 4 to our condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q.
 
Net income (loss). We recognized net income in the 2016 period compared to a net loss in the 2015 period as a result of the changes noted above.
 
LIQUIDITY AND CAPITAL RESOURCES
 
Our Operating Liquidity and Resources (dollar amounts in thousands)
 
Our principal sources of funds to meet operating and capital expenses, debt service obligations and pay distributions on our common shares are the operating cash flows we generate as rental income from our properties, the distributions we receive from our investment in SIR and borrowings under our revolving credit facility. We believe that these sources of funds will be sufficient to meet our operating and capital expenses and debt service obligations and pay distributions on our common shares for the next 12 months and for the foreseeable future thereafter. Our future cash flows from operating activities will depend primarily upon: 
•
our ability to maintain or increase the occupancy of, and the rental rates at, our properties;
•
our ability to control operating expenses at our properties;
•
our ability to purchase additional properties which produce cash flows from operations in excess of our cost of acquisition capital and property operating expenses; and

32

•
our receipt of distributions from our investment in SIR.
 
Our future purchases of properties cannot be accurately projected because such purchases depend upon purchase opportunities which come to our attention and our ability to successfully conclude the acquisitions. We generally do not intend to purchase “turn around” properties, or properties which do not generate positive cash flows.
 
Our changes in cash flows for the nine months ended September 30, 2016 compared to the same period in 2015 were as follows: (i) cash provided by operating activities increased from $89,053 in 2015 to $91,674 in 2016; (ii) cash used in investing activities increased from $65,793 in 2015 to $94,848 in 2016; and (iii) cash flows from financing activities changed from $25,745 of cash used in financing activities in 2015 to $8,138 of cash provided by financing activities in 2016.
 
The increase in cash provided by operating activities for the nine month period ended September 30, 2016 as compared to the corresponding prior year period primarily reflects an increase in property net operating income and an increase in distributions of earnings received from our investment in SIR common shares, partially offset by changes in working capital in the 2016 period. The increase in cash used in investing activities for the nine month period ended September 30, 2016 as compared to the corresponding prior year period was due primarily to our real estate acquisition activity in the 2016 period versus disposition activity in the 2015 period, partially offset by our investment in SIR in the 2015 period. The change in cash provided by (used in) financing activities for the nine month period ended September 30, 2016 as compared to the corresponding prior year period was due primarily to an increase in net borrowings in the 2016 period, including our issuance of senior unsecured notes.
 
Our Investment and Financing Liquidity and Resources (dollar amounts in thousands, except per share and per square foot amounts)
 
In order to fund acquisitions and to meet cash needs that may result from our desire or need to make distributions or pay operating or capital expenses, we maintain a $750,000 unsecured revolving credit facility. The maturity date of our revolving credit facility is January 31, 2019 and, subject to our payment of an extension fee and meeting other conditions, we have an option to extend the stated maturity date of our revolving credit facility by one year to January 31, 2020. We are required to pay interest at a rate of LIBOR plus a premium, which was 125 basis points per annum at September 30, 2016, on the amount outstanding under our revolving credit facility. We also pay a facility fee on the total amount of lending commitments under our revolving credit facility, which was 25 basis points per annum at September 30, 2016. Both the interest rate premium and the facility fee are subject to adjustment based upon changes to our credit ratings. We can borrow, repay and reborrow funds available under our revolving credit facility until maturity, and no principal repayment is due until maturity. As of September 30, 2016, the annual interest rate payable on borrowings under our revolving credit facility was 1.7%. As of September 30, 2016 and October 25, 2016, we had $25,000 and $15,000, respectively, outstanding under our revolving credit facility.
 
Our revolving credit facility is governed by a credit agreement with a syndicate of institutional lenders, which also governs our two unsecured term loans:
 
•
Our $300,000 term loan, which matures on March 31, 2020, is prepayable without penalty at any time. We are required to pay interest at LIBOR plus a premium, which was 140 basis points per annum at September 30, 2016, on the amount outstanding under our $300,000 term loan.  The interest rate premium is subject to adjustment based upon changes to our credit ratings.  As of September 30, 2016, the annual interest rate for the amount outstanding under our $300,000 term loan was 1.9%.
•
Our $250,000 term loan, which matures on March 31, 2022, is prepayable at any time. If our $250,000 term loan is repaid on or prior to November 21, 2016, a prepayment premium of 1.0% of the amount repaid would be payable. Subsequent to November 21, 2016, no prepayment premium would be payable. We are required to pay interest at LIBOR plus a premium, which was 180 basis points per annum at September 30, 2016, on the amount outstanding under our $250,000 term loan.  The interest rate premium is subject to adjustment based upon changes to our credit ratings.  As of September 30, 2016, the annual interest rate for the amount outstanding under our $250,000 term loan was 2.3%.

Our credit agreement also includes a feature under which the maximum borrowing availability may be increased to up to $2,500,000 on a combined basis in certain circumstances.
 
Our credit agreement for our revolving credit facility and term loans provides that, with certain exceptions, a subsidiary of ours is required to guaranty our obligations under the revolving credit facility and term loans only if that subsidiary has

33

separately incurred debt (other than nonrecourse debt), within the meaning specified in the credit agreement, or provided a guarantee of debt incurred by us or any of our other subsidiaries.
 
Our $350,000 of 3.75% senior unsecured notes require semi-annual payments of interest only through maturity in August 2019 and may be repaid at par (plus accrued and unpaid interest) on or after July 15, 2019 or before that date together with a make whole premium.
    
In May 2016, we issued $300,000 of 5.875% senior unsecured notes due 2046 in an underwritten public offering. In June 2016, the underwriters exercised an option to purchase an additional $10,000 of these notes. The net proceeds from this offering of $299,771, after offering expenses, were used to repay all amounts then outstanding under our revolving credit facility and for general business purposes.

Our debt maturities (other than our revolving credit facility) are as follows: $369 in 2016, $1,549 in 2017, $1,671 in 2018, $359,439 in 2019, $301,619 in 2020 and $573,230 thereafter. 
 
None of our debt obligations require sinking fund payments prior to their maturity dates.  Our $27,877 in mortgage debts generally require monthly payments of principal and interest through maturity.
In addition to our debt obligations, as of September 30, 2016, we have estimated unspent leasing related obligations of $21,580 and have committed to redevelop and expand an existing property at an estimated cost to complete of approximately $17,990.
 
We currently expect to use cash balances, borrowings under our revolving credit facility, net proceeds from our property sales, distributions received from our investment in SIR, assumption of mortgage debt and net proceeds from offerings of equity or debt securities to fund our future operations, capital expenditures, distributions to our shareholders and property acquisitions. When significant amounts are outstanding under our revolving credit facility or the maturity date of our revolving credit facility, term loans, senior notes, mortgage notes or our other debts approach, we intend to explore alternatives for repaying or refinancing such amounts. Such alternatives may include incurring additional term debt, issuing equity or debt securities, extending the maturity date of our revolving credit facility and entering into a new revolving credit facility. We may assume additional mortgage debt in connection with our acquisition of properties or elect to place new mortgages on properties we own as a source of financing. Although we cannot be sure that we will be successful in consummating any particular type of financing, we believe that we will have access to financing, such as debt and equity offerings, to fund future acquisitions and capital expenditures and to pay our obligations. We currently have an effective shelf registration statement that allows us to issue public securities on an expedited basis, but it does not assure that there will be buyers for such securities.
Our ability to obtain, and the costs of, our future financings will depend primarily on market conditions and our creditworthiness. We have no control over market conditions. Potential investors and lenders likely will evaluate our ability to pay distributions to shareholders, fund required debt service and repay debts when they become due by reviewing our business practices and plans to balance our use of debt and equity capital so that our financial profile and leverage ratios afford us flexibility to withstand any reasonably anticipated adverse changes. We intend to conduct our business in a manner which will afford us reasonable access to capital for investment and financing activities, but we cannot be sure that we will be able to successfully carry out this intention.
 
On February 25, 2016, we paid a regular quarterly distribution to common shareholders of $0.43 per share, or approximately $30,584. On May 23, 2016, we paid a regular quarterly distribution to common shareholders of $0.43 per share, or approximately $30,585. On August 22, 2016, we paid a regular quarterly distribution to common shareholders of record on July 22, 2016 of $0.43 per share, or $30,590. On October 11, 2016, we declared a regular quarterly distribution payable to common shareholders of record on October 21, 2016 of $0.43 per share, or approximately $30,607. We expect to pay this amount on or about November 21, 2016 using cash on hand and borrowings under our revolving credit facility.
 
In February 2016, we repaid, at par, a $23,473 mortgage note requiring annual interest at 6.21% which was secured by one office property (one building) located in Landover, MD using cash on hand and borrowings under our revolving credit facility. This mortgage note was scheduled to mature in August 2016.
 
In March 2016, we repaid, at par, an $83,000 mortgage note requiring annual interest at 5.55% which was secured by one office property (two buildings) located in Reston, VA using cash on hand and borrowings under our revolving credit facility.  This mortgage note was scheduled to mature in April 2016.


34

Off Balance Sheet Arrangements
    
As of September 30, 2016, we had no off balance sheet arrangements that have had or that we expect would be reasonably likely to have a material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
 
Debt Covenants (dollars in thousands)
 
Our principal debt obligations at September 30, 2016 consisted of borrowings under our $750,000 unsecured revolving credit facility, our $300,000 term loan, our $250,000 term loan, an aggregate outstanding principal amount of $660,000 of public issuances of senior unsecured notes and three secured mortgage notes that were assumed in connection with certain of our acquisitions. Our publicly issued senior unsecured notes are governed by an indenture.  Our senior unsecured notes indenture and its supplements and the credit agreement for our revolving credit facility and our two term loans provide for acceleration of payment of all amounts outstanding upon the occurrence and continuation of certain events of default, such as, in the case of our credit agreement, a change of control of us, which includes The RMR Group LLC, or RMR LLC, ceasing to act as our business manager and property manager. Our senior unsecured notes indenture and its supplements and our credit agreement also contain a number of covenants which generally restrict our ability to incur debts, including debts secured by mortgages on our properties, in excess of calculated amounts, require us to maintain various financial ratios, and, in the case of our credit agreement, restrict our ability to make distributions under certain circumstances. Our mortgage notes are non-recourse, subject to certain limited exceptions, and do not contain any material financial covenants.  As of September 30, 2016, we believe we were in compliance with the terms and conditions of our respective covenants under our senior unsecured notes indenture and its supplements and our credit agreement.
Neither our credit agreement nor our senior unsecured notes indenture and its supplements contain provisions for acceleration which could be triggered by our debt ratings. However, under our credit agreement our highest senior debt rating is used to determine the fees and interest rates we pay. Accordingly, if that debt rating is downgraded by certain credit rating agencies, our interest expense and related costs under our credit agreement would increase.
Our credit agreement has cross default provisions to other indebtedness that is recourse of $25,000 or more and indebtedness that is non-recourse of $50,000 or more. Similarly, our senior unsecured notes indenture and its supplements contain cross default provisions to any other debts of more than $25,000 (or up to $50,000 in certain circumstances).
Related Person Transactions
 
We have relationships and historical and continuing transactions with RMR LLC, SIR and others related to them.  For example, we have no employees and the personnel and various services we require to operate our business are provided to us by RMR LLC pursuant to management agreements; RMR Inc. is the managing member of RMR LLC and we own shares of class A common stock of RMR Inc.; and the controlling shareholder of RMR Inc., ABP Trust, is owned by our Managing Trustees and ABP Trust also owns an equity interest in RMR LLC. Also, we own common shares of SIR; and we and six other companies to which RMR LLC provides management services own in equal amounts AIC, an insurance company, and we participate in a combined property insurance program arranged and reinsured in part by AIC. For further information about these and other such relationships and related person transactions, please see Notes 10 and 11 to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, our Annual Report, our definitive Proxy Statement for our 2016 Annual Meeting of Shareholders and our other filings with the Securities and Exchange Commission, or SEC.  In addition, please see the section captioned “Risk Factors” of our Annual Report for a description of risks that may arise as a result of these and other related person transactions and relationships.  Our filings with the SEC and copies of certain of our agreements with these related parties are publicly available as exhibits to our public filings with the SEC and accessible at the SEC’s website, www.sec.gov.  We may engage in additional transactions with related persons, including RMR LLC and companies to which RMR LLC or its affiliates provide management services.


35

Item 3. Quantitative and Qualitative Disclosures About Market Risk (dollar amounts in thousands)
 
We are exposed to risks associated with market changes in interest rates. We manage our exposure to this market risk by monitoring available financing alternatives. Our strategy to manage exposure to changes in interest rates has not materially changed since December 31, 2015. Other than as described below, we do not currently foresee any significant changes in our exposure to fluctuations in interest rates or in how we manage this exposure in the near future.
 
Fixed Rate Debt
 
At September 30, 2016, our outstanding fixed rate debt consisted of the following:
 
 
 
 
Annual
 
Annual
 
    
 
Interest
 
 
Principal
 
Interest
 
Interest
 
 
 
Payments
Debt
 
Balance (1)
 
Rate (1)
 
Expense (1)
 
Maturity
 
Due
Senior unsecured notes
 
$
350,000

 
3.750
%
 
$
13,125

 
2019
 
Semi-annually
Senior unsecured notes
 
310,000

 
5.875
%
 
18,213

 
2046
 
Quarterly
Mortgage note
 
13,993

 
5.877
%
 
834

 
2021
 
Monthly
Mortgage note
 
8,546

 
7.000
%
 
607

 
2019
 
Monthly
Mortgage note
 
5,338

 
8.150
%
 
441

 
2021
 
Monthly
 
 
$
687,877

 
 

 
$
33,220

 
 
 
 
(1)
The principal balances and interest rates are the amounts determined pursuant to the contracts. In accordance with GAAP, our carrying values and recorded interest expense may differ from these amounts because of market conditions at the time we issued or assumed these debts.  For more information, see Notes 7 and 8 to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
 
Our $350,000 senior unsecured notes require semi-annual interest payments through maturity and our $310,000 senior unsecured notes require quarterly interest payments through maturity.  Our mortgages generally require principal and interest payments through maturity pursuant to amortization schedules.  Because these debts require interest at a fixed rate, changes in market interest rates during the term of these debts will not affect our interest obligations.  If these debts were refinanced at interest rates which are 100 basis points higher or lower than shown above, our per annum interest cost would increase or decrease, respectively, by approximately $7,097.
 
Changes in market interest rates would affect the fair value of our fixed rate debt obligations; increases in market interest rates decrease the fair value of our fixed rate debt, while decreases in market interest rates increase the fair value of our fixed rate debt.  Based on the balances outstanding at September 30, 2016, and discounted cash flow analyses through the respective maturity dates, and assuming no other changes in factors that may affect the fair value of our fixed rate debt obligations, a hypothetical immediate 100 basis point increase in interest rates would change the fair value of those obligations by approximately $50,096.
 
Some of our fixed rate secured debt arrangements allow us to make repayments earlier than the stated maturity date. In some cases, we are not allowed to make early repayment prior to a cutoff date and we are generally allowed to make prepayments only at a premium equal to a make whole amount, as defined, which is generally designed to preserve a stated yield to the note holder. These prepayment rights may afford us opportunities to mitigate the risk of refinancing our debts at maturity at higher rates by refinancing prior to maturity.
 
Floating Rate Debt
 
At September 30, 2016, our floating rate debt consisted of $25,000 of borrowings under our $750,000 revolving credit facility, our $300,000 term loan and our $250,000 term loan. Our revolving credit facility matures in January 2019 and, subject to the payment of an extension fee and our meeting other conditions, we have the option to extend the stated maturity by one year to January 2020. No principal repayments are required under our revolving credit facility or our term loans prior to maturity, and we can borrow, repay and reborrow funds available under our revolving credit facility, subject to conditions, at any time without penalty. Our $300,000 term loan matures on March 31, 2020. Our $250,000 term loan matures on March 31, 2022. Amounts outstanding under our term loans may be repaid at any time, but after they are repaid amounts may not be redrawn. Our $300,000 term loan may be repaid without penalty at any time. If our $250,000 term loan is repaid on or prior to November 21, 2016, a prepayment premium of 1.0% of the amount repaid would be incurred.  Subsequent to November 21, 2016, no prepayment premium would be incurred.


36

Borrowings under our $750,000 revolving credit facility and term loans are in U.S. dollars and require interest at a rate of LIBOR plus premiums that are subject to adjustment based upon changes to our credit ratings. Accordingly, we are vulnerable to changes in U.S. dollar based short term rates, specifically LIBOR. In addition, upon renewal or refinancing of our revolving credit facility or term loans, we are vulnerable to increases in interest rate premiums due to market conditions or our perceived credit characteristics. Generally, a change in interest rates would not affect the value of our floating rate debt but would affect our operating results.
 
The following table presents the impact a 100 basis point increase in interest rates would have on our annual floating rate interest expense as of September 30, 2016:
 
 
Impact of Changes in Interest Rates
 
 
Annual
 
Outstanding
 
Total Interest
 
Annual Earnings
 
 
Interest Rate (1)
 
Debt
 
Expense Per Year
 
Per Share Impact (2)
At September 30, 2016
 
2.1
%
 
$
575,000

 
$
12,243

 
$
0.17

100 bps increase
 
3.1
%
 
$
575,000

 
$
18,073

 
$
0.25


(1)
Weighted based on the respective interest rates and outstanding borrowings under our revolving credit facility and term loans as of September 30, 2016.
(2)
Based on the weighted average shares outstanding (diluted) for the nine months ended September 30, 2016.
 
The following table presents the impact a 100 basis point increase in interest rates would have on our annual floating rate interest expense as of September 30, 2016 if we were fully drawn on our revolving credit facility and our term loans remained outstanding:
 
 
Impact of Changes in Interest Rates
 
 
Annual
 
Outstanding
 
Total Interest
 
Annual Earnings
 
 
Interest Rate (1)
 
Debt
 
Expense Per Year
 
Per Share Impact (2)
At September 30, 2016
 
1.9
%
 
$
1,300,000

 
$
25,043

 
$
0.35

100 bps increase
 
2.9
%
 
$
1,300,000

 
$
38,224

 
$
0.54


(1)
Weighted based on the respective interest rates and outstanding borrowings under our revolving credit facility (assuming fully drawn) and our term loans as of September 30, 2016. 
(2)
Based on the weighted average shares outstanding (diluted) for the nine months ended September 30, 2016.
 
The foregoing tables show the impact of an immediate change in floating interest rates as of September 30, 2016.  If interest rates were to change gradually over time, the impact would be spread over time. Our exposure to fluctuations in floating interest rates will increase or decrease in the future with increases or decreases in the outstanding amount under our revolving credit facility, our term loans or our other floating rate debt, if any. Although we have no present plans to do so, we may in the future enter into hedge arrangements from time to time to mitigate our exposure to changes in interest rates.
 
Item 4.  Controls and Procedures
 
As of the end of the period covered by this report, our management carried out an evaluation, under the supervision and with the participation of our Managing Trustees, our President and Chief Operating Officer and our Chief Financial Officer and Treasurer, of the effectiveness of our disclosure controls and procedures pursuant to Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, as amended. Based upon that evaluation, our Managing Trustees, our President and Chief Operating Officer and our Chief Financial Officer and Treasurer concluded that our disclosure controls and procedures are effective.
 
There have been no changes in our internal control over financial reporting during the quarter ended September 30, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


37

WARNING CONCERNING FORWARD LOOKING STATEMENTS
 
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS STATEMENTS THAT CONSTITUTE FORWARD LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 AND OTHER SECURITIES LAWS.  ALSO, WHENEVER WE USE WORDS SUCH AS “BELIEVE”, “EXPECT”, “ANTICIPATE”, “INTEND”, “PLAN”, “ESTIMATE”, “WILL”, “MAY” AND NEGATIVES OR DERIVATIVES OF THESE OR SIMILAR EXPRESSIONS, WE ARE MAKING FORWARD LOOKING STATEMENTS.  THESE FORWARD LOOKING STATEMENTS ARE BASED UPON OUR PRESENT INTENT, BELIEFS OR EXPECTATIONS, BUT FORWARD LOOKING STATEMENTS ARE NOT GUARANTEED TO OCCUR AND MAY NOT OCCUR.  FORWARD LOOKING STATEMENTS IN THIS REPORT RELATE TO VARIOUS ASPECTS OF OUR BUSINESS, INCLUDING: 
•
OUR ACQUISITIONS AND SALES OF PROPERTIES, 
•
OUR ABILITY TO COMPETE FOR ACQUISITIONS AND TENANCIES EFFECTIVELY, 
•
THE LIKELIHOOD THAT OUR TENANTS WILL PAY RENT OR BE NEGATIVELY AFFECTED BY CYCLICAL ECONOMIC CONDITIONS OR GOVERNMENT BUDGET CONSTRAINTS,
•
THE LIKELIHOOD THAT OUR TENANTS WILL RENEW OR EXTEND THEIR LEASES AND NOT EXERCISE EARLY TERMINATION OPTIONS PURSUANT TO THEIR LEASES OR THAT WE WILL OBTAIN REPLACEMENT TENANTS,
•
OUR ABILITY TO PAY DISTRIBUTIONS TO OUR SHAREHOLDERS AND THE AMOUNT OF SUCH DISTRIBUTIONS,
•
OUR EXPECTATION THAT WE BENEFIT FINANCIALLY FROM OUR OWNERSHIP INTEREST IN SIR,
•
OUR POLICIES AND PLANS REGARDING INVESTMENTS, FINANCINGS AND DISPOSITIONS, 
•
THE FUTURE AVAILABILITY OF BORROWINGS UNDER OUR REVOLVING CREDIT FACILITY,
•
OUR EXPECTATION THAT THERE WILL BE OPPORTUNITIES FOR US TO ACQUIRE, AND THAT WE WILL ACQUIRE, ADDITIONAL PROPERTIES THAT ARE MAJORITY LEASED TO GOVERNMENT TENANTS,
•
OUR EXPECTATIONS REGARDING DEMAND FOR LEASED SPACE BY THE U.S. GOVERNMENT AND STATE AND LOCAL GOVERNMENTS,
•
OUR ABILITY TO RAISE EQUITY OR DEBT CAPITAL, 
•
OUR ABILITY TO PAY INTEREST ON AND PRINCIPAL OF OUR DEBT,
•
OUR ABILITY TO APPROPRIATELY BALANCE OUR DEBT AND EQUITY CAPITAL,
•
OUR CREDIT RATINGS,
•
OUR EXPECTATION THAT WE BENEFIT FROM OUR OWNERSHIP OF RMR INC.,
•
OUR EXPECTATION THAT WE BENEFIT FROM OUR OWNERSHIP OF AIC AND FROM OUR PARTICIPATION IN INSURANCE PROGRAMS ARRANGED BY AIC,
•
THE CREDIT QUALITIES OF OUR TENANTS,
•
OUR QUALIFICATION FOR TAXATION AS A REIT, AND
•
OTHER MATTERS.

OUR ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CONTAINED IN OR IMPLIED BY OUR FORWARD LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS.  FACTORS THAT COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR FORWARD LOOKING STATEMENTS AND UPON OUR BUSINESS, RESULTS OF OPERATIONS, FINANCIAL CONDITION, FFO, NORMALIZED FFO, NOI, CASH FLOWS, LIQUIDITY AND PROSPECTS INCLUDE, BUT ARE NOT LIMITED TO: 

38

•
THE IMPACT OF CHANGES IN THE ECONOMY AND THE CAPITAL MARKETS ON US AND OUR TENANTS,
•
COMPETITION WITHIN THE REAL ESTATE INDUSTRY, PARTICULARLY WITH RESPECT TO THOSE MARKETS IN WHICH OUR PROPERTIES ARE LOCATED AND WITH RESPECT TO GOVERNMENT TENANCIES,
•
THE IMPACT OF CHANGES IN THE REAL ESTATE NEEDS AND FINANCIAL CONDITIONS OF THE U.S. GOVERNMENT AND STATE AND LOCAL GOVERNMENTS,
•
COMPLIANCE WITH, AND CHANGES TO, FEDERAL, STATE AND LOCAL LAWS AND REGULATIONS, ACCOUNTING RULES, TAX LAWS AND SIMILAR MATTERS,
•
ACTUAL AND POTENTIAL CONFLICTS OF INTEREST WITH OUR RELATED PARTIES, INCLUDING OUR MANAGING TRUSTEES, RMR LLC, RMR INC., SIR, AIC AND OTHERS AFFILIATED WITH THEM,
•
LIMITATIONS IMPOSED ON OUR BUSINESS AND OUR ABILITY TO SATISFY COMPLEX RULES IN ORDER FOR US TO QUALIFY FOR TAXATION AS A REIT FOR U.S. FEDERAL INCOME TAX PURPOSES, AND
•
ACTS OF TERRORISM, OUTBREAKS OF SO CALLED PANDEMICS OR OTHER MANMADE OR NATURAL DISASTERS BEYOND OUR CONTROL.
 
FOR EXAMPLE:
 
•
OUR ABILITY TO MAKE PAYMENTS OF PRINCIPAL AND INTEREST ON OUR INDEBTEDNESS AND TO MAKE FUTURE DISTRIBUTIONS TO OUR SHAREHOLDERS DEPENDS UPON A NUMBER OF FACTORS, INCLUDING OUR FUTURE EARNINGS, THE CAPITAL COSTS WE INCUR TO LEASE OUR PROPERTIES AND OUR RECEIPT OF DISTRIBUTIONS FROM SIR, 
•
WE MAY BE UNABLE TO PAY OUR DEBT OBLIGATIONS OR TO MAINTAIN OUR CURRENT RATE OF DISTRIBUTIONS ON OUR COMMON SHARES AND FUTURE DISTRIBUTIONS MAY BE REDUCED OR ELIMINATED,
•
OUR ABILITY TO GROW OUR BUSINESS AND INCREASE DISTRIBUTIONS TO OUR SHAREHOLDERS DEPENDS IN LARGE PART UPON OUR ABILITY TO BUY PROPERTIES AND LEASE THEM FOR RENTS, LESS PROPERTY OPERATING EXPENSES, THAT EXCEED OUR CAPITAL COSTS. WE MAY BE UNABLE TO IDENTIFY PROPERTIES THAT WE WANT TO ACQUIRE OR TO NEGOTIATE ACCEPTABLE PURCHASE PRICES, ACQUISITION FINANCING OR LEASE TERMS FOR NEW PROPERTIES,
•
SOME OF OUR TENANTS MAY NOT RENEW EXPIRING LEASES, AND WE MAY BE UNABLE TO OBTAIN NEW TENANTS TO MAINTAIN OR INCREASE THE HISTORICAL OCCUPANCY RATES OF, OR RENTS FROM, OUR PROPERTIES,
•
SOME GOVERNMENT TENANTS MAY EXERCISE THEIR RIGHTS TO VACATE THEIR SPACE BEFORE THE STATED EXPIRATION OF THEIR LEASES, AND WE MAY BE UNABLE TO OBTAIN NEW TENANTS TO MAINTAIN THE HISTORICAL OCCUPANCY RATES OF, OR RENTS FROM, OUR PROPERTIES,
•
RENTS THAT WE CAN CHARGE AT OUR PROPERTIES MAY DECLINE BECAUSE OF CHANGING MARKET CONDITIONS OR OTHERWISE,
•
CONTINGENCIES IN OUR ACQUISITION AND SALE AGREEMENTS MAY NOT BE SATISFIED AND OUR PENDING ACQUISITIONS AND SALES MAY NOT OCCUR, MAY BE DELAYED OR THE TERMS OF SUCH TRANSACTIONS MAY CHANGE,
•
CONTINUED AVAILABILITY OF BORROWINGS UNDER OUR REVOLVING CREDIT FACILITY IS SUBJECT TO OUR SATISFYING CERTAIN FINANCIAL COVENANTS AND OTHER CONDITIONS THAT WE MAY BE UNABLE TO SATISFY,

39

•
ACTUAL COSTS UNDER OUR REVOLVING CREDIT FACILITY AND OTHER FLOATING RATE CREDIT FACILITIES WILL BE HIGHER THAN LIBOR PLUS A PREMIUM BECAUSE OF OTHER FEES AND EXPENSES ASSOCIATED WITH SUCH FACILITIES,
•
WE MAY BE UNABLE TO REPAY OUR DEBT OBLIGATIONS WHEN THEY BECOME DUE,
 
•
THE MAXIMUM BORROWING AVAILABILITY UNDER OUR REVOLVING CREDIT FACILITY AND TERM LOANS MAY BE INCREASED TO UP TO $2.5 BILLION ON A COMBINED BASIS IN CERTAIN CIRCUMSTANCES; HOWEVER, INCREASING THE MAXIMUM BORROWING AVAILABILITY UNDER OUR REVOLVING CREDIT FACILITY AND TERM LOANS IS SUBJECT TO OUR OBTAINING ADDITIONAL COMMITMENTS FROM LENDERS, WHICH MAY NOT OCCUR,

•
WE HAVE THE OPTION TO EXTEND THE MATURITY DATE OF OUR REVOLVING CREDIT FACILITY UPON PAYMENT OF A FEE AND MEETING OTHER CONDITIONS.  HOWEVER, THE APPLICABLE CONDITIONS MAY NOT BE MET,
•
THE BUSINESS MANAGEMENT AND PROPERTY MANAGEMENT AGREEMENTS BETWEEN US AND RMR LLC HAVE CONTINUING 20 YEAR TERMS.  HOWEVER, THOSE AGREEMENTS INCLUDE TERMS WHICH PERMIT EARLY TERMINATION IN CERTAIN CIRCUMSTANCES.  ACCORDINGLY, WE CANNOT BE SURE THAT THESE AGREEMENTS WILL REMAIN IN EFFECT FOR CONTINUING 20 YEAR TERMS OR FOR SHORTER TERMS,
•
WE BELIEVE THAT OUR RELATIONSHIPS WITH OUR RELATED PARTIES, INCLUDING RMR LLC, RMR INC., SIR, AIC AND OTHERS AFFILIATED WITH THEM MAY BENEFIT US AND PROVIDE US WITH COMPETITIVE ADVANTAGES IN OPERATING AND GROWING OUR BUSINESS. HOWEVER, THE ADVANTAGES WE BELIEVE WE MAY REALIZE FROM THESE RELATIONSHIPS MAY NOT MATERIALIZE,

•
THE PREMIUMS USED TO DETERMINE THE INTEREST RATE PAYABLE ON OUR REVOLVING CREDIT FACILITY AND TERM LOANS AND THE FACILITY FEE PAYABLE ON OUR REVOLVING CREDIT FACILITY ARE BASED ON OUR CREDIT RATINGS.  FUTURE CHANGES IN OUR CREDIT RATINGS MAY CAUSE THE INTEREST AND FEES WE PAY TO INCREASE,
•
SIR MAY REDUCE THE AMOUNT OF ITS DISTRIBUTIONS TO ITS SHAREHOLDERS, INCLUDING US,
•
WE MAY BE UNABLE TO SELL OUR SIR COMMON SHARES FOR AN AMOUNT EQUAL TO OUR CARRYING VALUE OF THOSE SHARES AND ANY SUCH SALE MAY BE AT A DISCOUNT TO MARKET PRICE BECAUSE OF THE LARGE SIZE OF OUR SIR HOLDINGS OR OTHERWISE; WE MAY REALIZE A LOSS ON OUR INVESTMENT IN OUR SIR SHARES, AND
•
WE CURRENTLY EXPECT TO SPEND APPROXIMATELY $18.0 MILLION TO COMPLETE OUR REDEVELOPMENT AND EXPANSION OF AN EXISTING PROPERTY IN CONNECTION WITH A NEW LEASE AGREEMENT.  IN ADDITION, AS OF SEPTEMBER 30, 2016, WE HAVE ESTIMATED UNSPENT LEASING RELATED OBLIGATIONS OF $21.6 MILLION, WHICH EXCLUDES THE ESTIMATED DEVELOPMENT COSTS NOTED IN THE PRECEDING SENTENCE. IT IS DIFFICULT TO ACCURATELY ESTIMATE DEVELOPMENT COSTS.  THIS DEVELOPMENT PROJECT AND OUR UNSPENT LEASING RELATED OBLIGATIONS MAY COST MORE OR LESS AND MAY TAKE LONGER TO COMPLETE THAN WE CURRENTLY EXPECT, AND WE MAY INCUR INCREASING AMOUNTS FOR THESE AND SIMILAR PURPOSES IN THE FUTURE.
 
CURRENTLY UNEXPECTED RESULTS COULD OCCUR DUE TO MANY DIFFERENT CIRCUMSTANCES, SOME OF WHICH ARE BEYOND OUR CONTROL, SUCH AS CHANGES IN GOVERNMENT TENANTS’ NEEDS FOR LEASED SPACE, ACTS OF TERRORISM, NATURAL DISASTERS OR CHANGES IN CAPITAL MARKETS OR THE ECONOMY GENERALLY.
 
THE INFORMATION CONTAINED ELSEWHERE IN THIS QUARTERLY REPORT ON FORM 10-Q AND IN OUR ANNUAL REPORT OR IN OUR OTHER FILINGS WITH THE SEC, INCLUDING UNDER THE CAPTION “RISK FACTORS”, OR INCORPORATED HEREIN OR THEREIN, IDENTIFIES OTHER IMPORTANT FACTORS THAT COULD CAUSE DIFFERENCES FROM OUR FORWARD LOOKING STATEMENTS.  OUR FILINGS WITH THE SEC ARE AVAILABLE ON THE SEC’S WEBSITE AT WWW.SEC.GOV.

40

 
YOU SHOULD NOT PLACE UNDUE RELIANCE UPON OUR FORWARD LOOKING STATEMENTS.
 
EXCEPT AS REQUIRED BY LAW, WE DO NOT INTEND TO UPDATE OR CHANGE ANY FORWARD LOOKING STATEMENTS AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE.

 
 
STATEMENT CONCERNING LIMITED LIABILITY
 
THE AMENDED AND RESTATED DECLARATION OF TRUST ESTABLISHING GOVERNMENT PROPERTIES INCOME TRUST, DATED JUNE 8, 2009, AS AMENDED, AS FILED WITH THE STATE DEPARTMENT OF ASSESSMENTS AND TAXATION OF MARYLAND, PROVIDES THAT NO TRUSTEE, OFFICER, SHAREHOLDER, EMPLOYEE OR AGENT OF GOVERNMENT PROPERTIES INCOME TRUST SHALL BE HELD TO ANY PERSONAL LIABILITY, JOINTLY OR SEVERALLY, FOR ANY OBLIGATION OF, OR CLAIM AGAINST, GOVERNMENT PROPERTIES INCOME TRUST.  ALL PERSONS DEALING WITH GOVERNMENT PROPERTIES INCOME TRUST IN ANY WAY SHALL LOOK ONLY TO THE ASSETS OF GOVERNMENT PROPERTIES INCOME TRUST FOR THE PAYMENT OF ANY SUM OR THE PERFORMANCE OF ANY OBLIGATION.

41

Part II.   Other Information
 
Item 1A.  Risk Factors
 
There have been no material changes to risk factors from those we previously disclosed in our Annual Report.


Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer purchases of equity securities. The following table provides information about our purchases of our equity securities during the quarter ended September 30, 2016:

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Maximum
 
 
 
 
 
 
 
 
Total Number of
 
 
Approximate Dollar
 
 
 
 
 
 
 
 
Shares Purchased
 
 
Value of Shares that
 
 
Number of
 
 
 
 
 
as Part of Publicly
 
 
May Yet Be Purchased
 
 
Shares
 
Average Price
 
 
Announced Plans
 
 
Under the Plans or
Calendar Month
 
Purchased (1)
 
Paid per Share
 
or Programs
 
Programs
September 2016
 
13,209
 
$
23.63
 
$
—
 
$
—
Total
 
13,209
 
$
23.63
 
$
—
 
$
—

(1)
During September 2016, all common share purchases were made to satisfy our officers’ and other RMR LLC employees’ tax withholding and payment obligations in connection with the vesting of awards of our common shares. We repurchased these shares at their fair market value based upon the trading price of our common shares on the repurchase date.


42

Item 6. Exhibits
 
Exhibit
Number
Description
 
 
3.1
Composite Copy of Amended and Restated Declaration of Trust, dated June 8, 2009, as amended to date. (Incorporated by reference to the Company’s Current Report on Form 8-K dated July 28, 2014.)
 
 
3.2
Composite Copy of Amended and Restated Bylaws of the Company, adopted September 7, 2016. (Incorporated by reference to the Company’s Current Report on Form 8-K dated September 7, 2016.)
 
 
4.1
Form of Common Share Certificate. (Incorporated by reference to Amendment No. 2 to the Company’s Registration Statement on Form S-11/A, File No. 333-157455.)
 
 
4.2
Indenture, dated as of August 18, 2014, between the Company and U.S. Bank National Association. (Incorporated by reference to the Company’s Current Report on Form 8-K dated August 18, 2014.)
 
 
4.3
Supplemental Indenture No. 1, dated as of August 18, 2014, between the Company and U.S. Bank National Association, relating to the Company’s 3.75% Senior Notes due 2019, including form thereof. (Incorporated by reference to the Company’s Current Report on Form 8-K dated August 18, 2014.)
 
 
4.4
Supplemental Indenture No. 2, dated as of May 26, 2016, between the Company and U.S. Bank National Association, relating to the Company’s 5.875% Senior Notes due 2046, including form thereof. (Incorporated by reference to the Company’s Current Report on Form 8-K dated May 26, 2016.)
 
 
4.5
Authentication Order, dated June 22, 2016, from the Company to U.S. Bank National Association, relating to the Company's 5.875% Senior Notes due 2046. (Incorporated by reference to the Company’s Registration Statement on Form 8-A dated June 30, 2016.)
 
 
4.6
Registration Rights and Lock-Up Agreement, dated June 5, 2015, among the Company, ABP Trust, Barry M. Portnoy and Adam D. Portnoy. (Incorporated by reference to the Company’s Current Report on Form 8-K dated June 5, 2015.)
 
 
10.1
Form of Share Award Agreement. (Filed herewith.)
 
 
12.1
Computation of Ratio of Earnings to Fixed Charges. (Filed herewith.)
 
 
31.1
Rule 13a-14(a) Certification. (Filed herewith.)
 
 
31.2
Rule 13a-14(a) Certification. (Filed herewith.)
 
 
31.3
Rule 13a-14(a) Certification. (Filed herewith.)
 
 
31.4
Rule 13a-14(a) Certification. (Filed herewith.)
 
 
32.1
Section 1350 Certification. (Furnished herewith.)
 
 
101.1
The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2016 formatted in XBRL (eXtensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Comprehensive Income (Loss), (iii) the Condensed Consolidated Statements of Cash Flows, and (iv) related notes to these financial statements, tagged as blocks of text and in detail. (Filed herewith.)

43

 
SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
GOVERNMENT PROPERTIES INCOME TRUST
 
 
 
 
 
 
 
By:
/s/ David M. Blackman
 
 
David M. Blackman 
President and Chief Operating Officer 
 
 
Dated: October 27, 2016
 
 
 
 
By:
/s/ Mark L. Kleifges
 
 
Mark L. Kleifges 
Chief Financial Officer and Treasurer
(principal financial and accounting officer) 
 
 
Dated: October 27, 2016

















44

Stock widget

Investing forum

OFFICE PROPERTIES INCOME TRUST Reports