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

 

 

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)

 

 

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, smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ☐

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 30, 2017: 99,145,921May 1, 2018: 99,148,304

GOVERNMENT PROPERTIES INCOME TRUST

 

FORM 10-Q

 

 

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.

 

Item 1.  Financial Statements

 

GOVERNMENT PROPERTIES INCOME TRUST

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except share data)

(unaudited) 

See accompanying notes.

GOVERNMENT PROPERTIES INCOME TRUST

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(amounts in thousands, except per share data)

(unaudited)

 

 

See accompanying notes.

 

See accompanying notes.

Note 1.    Basis of Presentation

 

The accompanying condensed consolidated financial statements of Government Properties Income Trust and its subsidiaries, or the Company, 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, 2016,2017, or our Annual Report. In the opinion of our management, all adjustments, which include onlyconsisting of normal recurring adjustmentsaccruals considered necessary for a fair presentation,statement of results for the interim period 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’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

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): 

Note 4.   Real Estate Properties

 

As of September 30, 2017,March 31, 2018, we wholly owned 74107 properties (96(166 buildings), with an aggregate undepreciated carrying value of $1,929,711.$2,953,770, and had a noncontrolling ownership interest in two unconsolidated joint ventures that owned two properties (three buildings). We generally lease space at our properties on a gross lease or modified gross lease basis pursuant to fixed term contracts expiring between 20172018 and 2034.  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, 2017,March 31, 2018, we entered into 1433 leases for 436,102280,419 rentable square feet, for a weighted (by rentable square feet) average lease term of 8.45.6 years and we made commitments for $7,902 of leasing related costs. During the nine months ended September 30, 2017, we entered into 42 leases for 1,084,633 rentable square feet, for a weighted (by rentable square feet) average lease term of 8.8 years and we made commitments for $12,609$7,998 of leasing related costs. As of September 30, 2017,March 31, 2018, we have estimated unspent leasing related obligations of $26,631, and we have committed to redevelop and expand an existing property prior to commencement of the lease with an estimated remaining cost to complete as of September 30, 2017 of $3,302. During the nine months ended September 30, 2017, we capitalized $328 of interest expense related to the redevelopment and expansion of that existing property.$32,762.

 

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.

 

In April 2018, we entered an agreement to sell an office property (one building) located in New York, NY with 187,060 rentable square feet and a net book value of $96,633 at March 31, 2018 for $118,500, excluding closing costs. This property was 100% leaseddid not meet the held for sale criteria as of March 31, 2018. This sale is expected to Prince William County on the date of acquisition.  This transaction was accounted for as an acquisition of assets. The purchase price was $12,657, including capitalized acquisition costs of $37.  Our allocation of the purchase price of this acquisition based on the estimated fair values of the acquired assets and assumed liabilities is presentedoccur in the table below. 

At March 31, 2018, the aggregate $8,811 unamortized basis difference of our unconsolidated joint ventures is primarily attributable to the difference between the amount we paid to purchase our interest in these joint ventures, including twotransaction costs, and the historical carrying value of the net assets of these joint ventures. This difference is being amortized over the remaining useful life of the properties owned by these joint ventures in which we acquired FPO's 50% and 51% interests. The estimated aggregate transaction value of the FPO Transaction was $1,374,624, including $651,696 in cash consideration paid to FPO shareholders, the repayment of $483,000 of FPO debt, the assumption of $167,549 of FPO mortgage debt and an additional $82,000 of mortgage debt that encumber two joint venture properties that are 50% and 51% owned by FPO and the payment of certain transaction fees and expenses, net of FPO cash on hand. We currently expect to complete our purchase price allocation for the FPO Transaction in the fourth quarter of 2017 upon completion of third party appraisals and our analysis of acquired in place leases and building valuations.

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 full 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 $711$3,091 and $1,205$1,300 for the three months ended September 30,March 31, 2018 and 2017, and 2016, respectively, and $3,115 and $1,789 for the nine months ended September 30, 2017 and 2016, respectively. Rents receivable include $24,801$29,613 and $21,686$27,267 of straight line rent receivables, net of allowance for doubtful accounts of $132$1,718 and $155,$1,503 at September 30, 2017March 31, 2018 and December 31, 2016,2017, 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 four other government tenants combined were responsible for 87.5%approximately 63.2% and 92.4%87.9% of our annualized rental income as of September 30,March 31, 2018 and 2017, and 2016, respectively. The U.S. Government is our largest tenant by annualized rental income and was responsible for 59.8%approximately 44.0% and 63.9%60.1% of our annualized rental income as of September 30,March 31, 2018 and 2017, and 2016, respectively.

 

Geographic Concentration

 

At September 30, 2017,March 31, 2018, our 74107 wholly owned properties (96(166 buildings) were located in 3130 states and the District of Columbia. PropertiesConsolidated properties located in Virginia, California, the District of Columbia, Georgia, Maryland, New YorkCalifornia and MassachusettsGeorgia were responsible for 14.8%23.2%, 14.8%17.6%, 9.5%15.0%, 8.6%, 7.0%, 6.9%9.6% and 4.9%5.8% of our annualized rental income as of September 30, 2017,March 31, 2018, respectively.

 

Note 7.   Indebtedness

 

Our principal debt obligations at September 30, 2017March 31, 2018 were: (1) $565,000$570,000 of outstanding borrowings under our $750,000 unsecured revolving credit facility; (2) an$550,000 aggregate outstanding principal amount of $550,000 of unsecured term loans; (3) an$960,000 aggregate outstanding principal amount of $960,000 of public issuances of senior unsecured notes; and (4) $26,358$182,248 aggregate outstanding principal amount of mortgage notes. 

 

Our $750,000 revolving credit facility, our $300,000 term loan and our $250,000 term loan are governed by a credit agreement, or our credit agreement, with a syndicate of institutional lenders that includes a number of features common to all of these credit arrangements. ThisOur 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.

Our $750,000 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 thea rate of LIBOR plus a premium, which was 125 basis points per annum at September 30, 2017,March 31, 2018, 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, 2017.March 31, 2018.  Both the interest rate premium and the facility fee are subject to adjustment based upon changes to our credit ratings.  As of September 30, 2017,March 31, 2018, the annual interest rate payable on borrowings under our revolving credit facility was 2.4%3.0% and the weighted average annual interest rate for borrowings under our revolving credit facility was 2.4%2.8% and 1.7%2.0% for the three months ended September 30,March 31, 2018 and 2017, and 2016, respectively, and 2.2% and 1.7% for the nine months ended September 30, 2017 and 2016, respectively. As of September 30, 2017March 31, 2018 and October 30, 2017,May 1, 2018, we had $565,000$570,000 and $545,000$580,000 outstanding under our revolving credit facility, respectively.

 

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 thea rate of LIBOR plus a premium, which was 140 basis points per annum at September 30, 2017,March 31, 2018, 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, 2017,March 31, 2018, the annual interest rate for the amount outstanding under our $300,000 term loan was 2.6%3.3%. The weighted average annual interest rate under our $300,000 term loan was 2.6%3.0% and 1.9%2.2% for the three months ended September 30,March 31, 2018 and 2017, and 2016, respectively, and 2.4% and 1.9% for the nine months ended September 30, 2017 and 2016, respectively.

 

Our $250,000 term loan, which matures on March 31, 2022, is prepayable without penalty at any time. We are required to pay interest at thea rate of LIBOR plus a premium, which was 180 basis points per annum as of September 30, 2017,March 31, 2018, 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, 2017,March 31, 2018, the annual interest rate for the amount outstanding under our $250,000 term loan was 3.0%3.7%. The weighted average annual interest rate under our $250,000 term loan was 3.0%3.4% and 2.3%, respectively,2.6% for the three months ended September 30,March 31, 2018 and 2017, and 2016 and 2.8% and 2.3% for the nine months ended September 30, 2017 and 2016, respectively.

 

Our credit agreement and senior unsecured notes indentures and their 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 and property manager.  Our credit agreement and our senior unsecured notes indentures and their 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 unsecured notes indentures and their supplements at September 30, 2017.

At September 30, 2017, threeMarch 31, 2018, eight of our consolidated properties (three(eight buildings) with an aggregate net book value of $50,031$426,404 were encumbered by threeeight mortgages withfor an aggregate principal balanceamount of $26,358. These$182,248. Our mortgage notes are non-recourse, subject to certain limited exceptions and do not contain any material financial covenants.

Note 8.   Fair Value of Assets and Liabilities

 

The table below presents certain of our assets measured at fair value at September 30, 2017,March 31, 2018, categorized by the level of inputs, as defined in the fair value hierarchy under GAAP, used in the valuation of each asset:

 

In addition to the assets described in the table above, our financial instruments include our cash and cash equivalents, restricted cash, rents receivable, mortgage notes receivable, accounts payable, our 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, 2017March 31, 2018 and December 31, 2016,2017, 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:

 

 

We estimated the fair value of our senior unsecured notes due 2019 and due 2022 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 estimated the fair value of our senior unsecured notes due 2046 based on the closing price on The Nasdaq Stock Market LLC, or Nasdaq, as of the measurement date (Level 1 inputs as defined in the fair value hierarchy under GAAP) as of the measurement date.. We estimated 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.

Note 9.   Shareholders’ Equity

On July 5, 2017, we sold 25,000,000 ofApril 3, 2018, in accordance with our common shares at a price of $18.50 per share in an underwritten public offering. On August 3, 2017, we sold 2,907,029 of our common shares at a price of $18.50 per share pursuant to an overallotment option granted to the underwriters for the July offering. The aggregate net proceeds from these sales were $493,936, after payment of the underwriters' discount and other offering expenses.

On January 1, 2018, we purchased 617 of our six Trustees as partcommon shares valued at a price per share of their annual compensation.$18.54, the closing price of our common shares on Nasdaq on December 29, 2017, from a former employee of RMR LLC in satisfaction of tax withholding and payment obligations in connection with the vesting of awards of our common shares.

On June 30, 2017,February 26, 2018, we purchased 278paid a regular quarterly distribution to common shareholders of our common shares valued at $18.31record on January 29, 2018 of $0.43 per share, the closing priceor $42,632. On April 19, 2018, we declared a regular quarterly distribution payable to common shareholders of our common sharesrecord on the Nasdaq on that day, from a former employeeApril 30, 2018 of RMR LLC in satisfaction of tax withholding and payment obligations in connection with vesting of awards of our common shares.

Cumulative Other Comprehensive Income

Note 10. Business and Property Management Agreements with RMR LLC

amounts are included in other operating expenses or have been capitalized, as appropriate, in our condensed consolidated financial statements.

Note 11.   Related Person Transactions

We have relationships and historical and continuing transactions with RMR LLC, RMR Inc., SIR, AIC and others related to them, including other companies to which RMR LLC providesor its subsidiaries provide 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.

Note 12.   Equity Investment in Select Income REIT

 

As described in Note 11, as of September 30, 2017,March 31, 2018, we owned 24,918,421, or approximately 27.8%, of the then outstanding SIR common shares. SIR is a REIT whichreal estate investment trust that owns properties that are primarily net leased to single tenants. 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 investeeinvestees in our condensed consolidated statements of comprehensive income.  WeDuring the three months ended March 31, 2018 and 2017, we recorded $9,453$10,289 and $8,655$2,611 of equity in the earnings of SIR, for the three months ended September 30, 2017 and 2016, respectively, and $20,271 and $27,895 of equity in the earnings of SIR for the nine months ended September 30, 2017 and 2016, respectively. Our other comprehensive income includes our proportionate share of SIR’s unrealized gains of $1,236$51 and $3,192$4,492 for the three months ended September 30,March 31, 2018 and 2017, and 2016, respectively, and $5,339 and $10,248 for the nine months ended September 30, 2017 and 2016, respectively.

 

The adjusted GAAP cost basis of our investments in SIR was less than our proportionate share of SIR’s total shareholders’ equity book value on the dates we acquired the shares. As of September 30,March 31, 2018 and December 31, 2017, our remaining basis difference was $87,976$122,579 and $87,137, respectively, and as required under GAAP, we are accreting this basis difference to earnings over the estimated remaining useful lives of certain real estate assets and intangible assets and liabilities owned by SIR. The increase in the basis difference primarily relates to SIR's capital finance activities and changes in its net equity during the three months ended March 31, 2018. This accretion increased our equity in the earnings of SIR by $736$1,044 and $740$736 for the three months ended September 30,March 31, 2018 and 2017, and 2016, respectively, and $2,209 and $2,219 for the nine months ended September 30, 2017 and 2016, respectively.

    

As of September 30, 2017,March 31, 2018, our investment in SIR had a carrying value of $475,265$465,131 and a market value, based on the closing price of SIR common shares on the Nasdaq on September 30, 2017,March 31, 2018, of $583,589.$485,411. 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.

 

We received cash distributions from SIR totaling $12,708 duringDuring each of the three months ended September 30,March 31, 2018 and 2017, and 2016 and $38,125 and $37,627 during the nine months ended September 30, 2017 and 2016, respectively.we received aggregate cash distributions from SIR totaling $12,708.

 

The following arepresents summarized financial data of SIR as reported in SIR’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2017,March 31, 2018, or the SIR Quarterly Report. References in our condensed consolidated 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 condensed consolidated financial statements.

 

Condensed Consolidated Balance Sheets

 

Condensed Consolidated Statements of Income

 

Note 13.   Segment Information

We operate in two separate reportable business segments: direct ownership of real estate properties and our equity method investment in SIR.