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, 2017March 31, 2018
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, 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.
|
| | |
Large accelerated filer ☒ | | Accelerated filer ☐ |
| | |
Non-accelerated filer ☐ | | Smaller reporting company ☐ |
(Do not check if a smaller reporting company) | | |
Emerging growth company ☐ | | |
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
September 30, 2017March 31, 2018
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.
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, | | March 31, | | December 31, |
| | 2017 | | 2016 | | 2018 | | 2017 |
ASSETS | | |
| | |
| | |
| | |
|
Real estate properties: | | |
| | |
| | |
| | |
|
Land | | $ | 269,332 |
| | $ | 267,855 |
| | $ | 623,610 |
| | $ | 627,108 |
|
Buildings and improvements | | 1,660,379 |
| | 1,620,905 |
| | 2,313,123 |
| | 2,348,613 |
|
Total real estate properties, gross | | 1,929,711 |
| | 1,888,760 |
| | 2,936,733 |
| | 2,975,721 |
|
Accumulated depreciation | | (331,069 | ) | | (296,804 | ) | | (353,329 | ) | | (341,848 | ) |
Total real estate properties, net | | 1,598,642 |
| | 1,591,956 |
| | 2,583,404 |
| | 2,633,873 |
|
| | | | | | | | |
Equity investment in Select Income REIT | | 475,265 |
| | 487,708 |
| | 465,131 |
| | 467,499 |
|
Assets of discontinued operations | | — |
| | 12,541 |
| |
Investment in unconsolidated joint ventures | | | 48,758 |
| | 50,202 |
|
Assets of properties held for sale | | | 18,080 |
| | — |
|
Acquired real estate leases, net | | 99,953 |
| | 124,848 |
| | 323,710 |
| | 351,872 |
|
Deposit escrow for FPO acquisition | | 651,696 |
| | — |
| |
Cash and cash equivalents | | 551,707 |
| | 29,941 |
| | 17,380 |
| | 16,569 |
|
Restricted cash | | 509 |
| | 530 |
| | 4,766 |
| | 3,111 |
|
Rents receivable, net | | 47,461 |
| | 48,458 |
| | 65,539 |
| | 61,429 |
|
Deferred leasing costs, net | | 22,250 |
| | 21,079 |
| | 22,622 |
| | 22,977 |
|
Other assets, net | | 89,484 |
| | 68,005 |
| | 106,234 |
| | 96,033 |
|
Total assets | | $ | 3,536,967 |
| | $ | 2,385,066 |
| | $ | 3,655,624 |
| | $ | 3,703,565 |
|
| | | | | | | | |
LIABILITIES AND SHAREHOLDERS’ EQUITY | | |
| | |
| | |
| | |
|
Unsecured revolving credit facility | | $ | 565,000 |
| | $ | 160,000 |
| | $ | 570,000 |
| | $ | 570,000 |
|
Unsecured term loans, net | | 547,682 |
| | 547,171 |
| | 548,022 |
| | 547,852 |
|
Senior unsecured notes, net | | 943,543 |
| | 646,844 |
| | 944,743 |
| | 944,140 |
|
Mortgage notes payable, net | | 26,561 |
| | 27,837 |
| | 182,083 |
| | 183,100 |
|
Liabilities of discontinued operations | | — |
| | 45 |
| |
Liabilities of properties held for sale | | | 275 |
| | — |
|
Accounts payable and other liabilities | | 63,525 |
| | 54,019 |
| | 74,623 |
| | 89,440 |
|
Due to related persons | | 4,297 |
| | 3,520 |
| | 8,544 |
| | 4,859 |
|
Assumed real estate lease obligations, net | | 8,832 |
| | 10,626 |
| | 12,480 |
| | 13,635 |
|
Total liabilities | | 2,159,440 |
| | 1,450,062 |
| | 2,340,770 |
| | 2,353,026 |
|
| | | | | | | | |
Commitments and contingencies | |
|
| |
|
| |
|
| |
|
|
| | | | | | | | |
Preferred units of limited partnership | | | 20,496 |
| | 20,496 |
|
| | | | | |
Shareholders’ equity: | | |
| | |
| | |
| | |
|
Common shares of beneficial interest, $.01 par value: 150,000,000 and 100,000,000 shares | | | | | |
authorized, respectively, 99,145,921 and 71,177,906 shares issued and outstanding, respectively | | 991 |
| | 712 |
| |
Common shares of beneficial interest, $.01 par value: 150,000,000 shares authorized, | | | | | |
99,145,304 and 99,145,921 shares issued and outstanding, respectively | | | 991 |
| | 991 |
|
Additional paid in capital | | 1,968,249 |
| | 1,473,533 |
| | 1,968,205 |
| | 1,968,217 |
|
Cumulative net income | | 126,410 |
| | 96,329 |
| | 174,585 |
| | 108,144 |
|
Cumulative other comprehensive income | | 46,980 |
| | 26,957 |
| | 945 |
| | 60,427 |
|
Cumulative common distributions | | (765,103 | ) | | (662,527 | ) | | (850,368 | ) | | (807,736 | ) |
Total shareholders’ equity | | 1,377,527 |
| | 935,004 |
| | 1,294,358 |
| | 1,330,043 |
|
Total liabilities and shareholders’ equity | | $ | 3,536,967 |
| | $ | 2,385,066 |
| | $ | 3,655,624 |
| | $ | 3,703,565 |
|
See accompanying notes.
GOVERNMENT PROPERTIES INCOME TRUST
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(amounts in thousands, except per share data)
(unaudited)
| | | | Three Months Ended September 30, | | Nine Months Ended September 30, | | Three Months Ended March 31, |
| | 2017 | | 2016 | | 2017 | | 2016 | | 2018 | | 2017 |
| | | | | | | | | | | | |
Rental income | | $ | 70,179 |
| | $ | 64,478 |
| | $ | 209,362 |
| | $ | 192,150 |
| | $ | 108,717 |
| | $ | 69,296 |
|
| | | | | | | | | | | | |
Expenses: | | |
| | |
| | |
| | |
| | |
| | |
|
Real estate taxes | | 8,862 |
| | 7,591 |
| | 24,980 |
| | 22,810 |
| | 12,964 |
| | 8,177 |
|
Utility expenses | | 5,408 |
| | 5,483 |
| | 14,186 |
| | 13,330 |
| | 6,690 |
| | 4,606 |
|
Other operating expenses | | 14,867 |
| | 13,854 |
| | 44,046 |
| | 40,031 |
| | 22,837 |
| | 13,992 |
|
Depreciation and amortization | | 20,781 |
| | 18,404 |
| | 61,949 |
| | 54,713 |
| | 44,204 |
| | 20,505 |
|
Loss on impairment of real estate | | 230 |
| | — |
| | 230 |
| | — |
| | 6,116 |
| | — |
|
Acquisition related costs | | — |
| | 147 |
| | — |
| | 363 |
| |
General and administrative | | 3,266 |
| | 3,816 |
| | 12,314 |
| | 11,350 |
| | 9,606 |
| | 3,962 |
|
Total expenses | | 53,414 |
| | 49,295 |
| | 157,705 |
| | 142,597 |
| | 102,417 |
| | 51,242 |
|
| | | | | | | | | | | | |
Operating income | | 16,765 |
| | 15,183 |
| | 51,657 |
| | 49,553 |
| | 6,300 |
| | 18,054 |
|
Dividend income | | 304 |
| | 304 |
| | 911 |
| | 667 |
| | 304 |
| | 304 |
|
Unrealized gain on equity securities | | | 12,931 |
| | — |
|
Interest income | | 1,715 |
| | 47 |
| | 1,843 |
| | 63 |
| | 116 |
| | 61 |
|
Interest expense (including net amortization of debt premiums and discounts | | | | | | | | | | | | |
and debt issuance costs of $990, $805, $2,605 and $2,024, respectively) | | (16,055 | ) | | (12,608 | ) | | (43,599 | ) | | (32,286 | ) | |
(Loss) gain on early extinguishment of debt | | (1,715 | ) | | — |
| | (1,715 | ) | | 104 |
| |
Gain on issuance of shares by Select Income REIT | | 51 |
| | 72 |
| | 72 |
| | 88 |
| |
Income from continuing operations before income taxes | | |
| | |
| | |
| | |
| |
and equity in earnings of investees | | 1,065 |
| | 2,998 |
| | 9,169 |
| | 18,189 |
| |
and debt issuance costs of $965 and $807, respectively) | | | (22,766 | ) | | (13,581 | ) |
Income (loss) from continuing operations before income taxes and | | | |
| | |
|
equity in earnings of investees | | | (3,115 | ) | | 4,838 |
|
Income tax expense | | (22 | ) | | (13 | ) | | (65 | ) | | (63 | ) | | (32 | ) | | (18 | ) |
Equity in earnings of investees | | 9,484 |
| | 8,668 |
| | 20,804 |
| | 28,002 |
| | 9,712 |
| | 2,739 |
|
Income from continuing operations | | 10,527 |
| | 11,653 |
| | 29,908 |
| | 46,128 |
| | 6,565 |
| | 7,559 |
|
Income (loss) from discontinued operations | | 462 |
| | (154 | ) | | 173 |
| | (429 | ) | |
Income before gain on sale of property | | 10,989 |
| | 11,499 |
| | 30,081 |
| | 45,699 |
| |
Gain on sale of property | | — |
| | 79 |
| | — |
| | 79 |
| |
Loss from discontinued operations | | | — |
| | (144 | ) |
Net income | | 10,989 |
| | 11,578 |
| | 30,081 |
| | 45,778 |
| | 6,565 |
| | 7,415 |
|
Other comprehensive income (loss): | | | |
| | |
|
Unrealized gain on investment in equity securities | | | — |
| | 12,142 |
|
Equity in unrealized gain (loss) of investees | | | (41 | ) | | 4,615 |
|
Other comprehensive income (loss) | | | (41 | ) | | 16,757 |
|
Comprehensive income | | | $ | 6,524 |
| | $ | 24,172 |
|
| | | | | | | | | | | | |
Other comprehensive income: | | |
| | |
| | |
| | |
| |
Unrealized gain on investment in available for sale securities | | 3,279 |
| | 8,463 |
| | 14,389 |
| | 28,571 |
| |
Equity in unrealized gain of investees | | 1,351 |
| | 3,273 |
| | 5,634 |
| | 10,423 |
| |
Other comprehensive income | | 4,630 |
| | 11,736 |
| | 20,023 |
| | 38,994 |
| |
Comprehensive income | | $ | 15,619 |
| | $ | 23,314 |
| | $ | 50,104 |
| | $ | 84,772 |
| |
Net income | | | $ | 6,565 |
| | $ | 7,415 |
|
Preferred units of limited partnership distributions | | | (278 | ) | | — |
|
Net income available for common shareholders | | | $ | 6,287 |
| | $ | 7,415 |
|
| | | | | | | | | | | | |
Weighted average common shares outstanding (basic) | | 96,883 |
| | 71,054 |
| | 79,778 |
| | 71,041 |
| | 99,041 |
| | 71,079 |
|
Weighted average common shares outstanding (diluted) | | 96,958 |
| | 71,084 |
| | 79,852 |
| | 71,064 |
| | 99,049 |
| | 71,094 |
|
| | | | | | | | | | | | |
Per common share amounts (basic and diluted): | | |
| | |
| | |
| | |
| | |
| | |
|
Income from continuing operations | | $ | 0.11 |
| | $ | 0.16 |
| | $ | 0.37 |
| | $ | 0.65 |
| | $ | 0.07 |
| | $ | 0.11 |
|
Income (loss) from discontinued operations | | $ | — |
| | $ | — |
| | $ | — |
| | $ | (0.01 | ) | |
Net income | | $ | 0.11 |
| | $ | 0.16 |
| | $ | 0.38 |
| | $ | 0.64 |
| |
Loss from discontinued operations | | | $ | — |
| | $ | — |
|
Net income available for common shareholders | | | $ | 0.06 |
| | $ | 0.10 |
|
See accompanying notes.
GOVERNMENT PROPERTIES INCOME TRUST
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
(unaudited)
| | | | Nine Months Ended September 30, | | Three Months Ended March 31, |
| | 2017 | | 2016 | | 2018 | | 2017 |
CASH FLOWS FROM OPERATING ACTIVITIES: | | |
| | |
| | |
| | |
|
Net income | | $ | 30,081 |
| | $ | 45,778 |
| | $ | 6,565 |
| | $ | 7,415 |
|
Adjustments to reconcile net income to cash provided by operating activities: | | |
| | |
| | |
| | |
|
Depreciation | | 35,460 |
| | 31,611 |
| | 17,172 |
| | 11,576 |
|
Net amortization of debt premiums and discounts and debt issuance costs | | 2,605 |
| | 2,024 |
| | 965 |
| | 807 |
|
Gain on sale of property | | — |
| | (79 | ) | |
Loss (gain) on early extinguishment of debt | | 1,715 |
| | (104 | ) | |
Straight line rental income | | (3,115 | ) | | (1,789 | ) | | (3,091 | ) | | (1,300 | ) |
Amortization of acquired real estate leases | | 25,592 |
| | 21,948 |
| | 26,790 |
| | 8,672 |
|
Amortization of deferred leasing costs | | 2,790 |
| | 2,343 |
| | 1,120 |
| | 849 |
|
Other non-cash expenses, net | | 352 |
| | 500 |
| |
Other non-cash (income) expenses, net | | | (334 | ) | | 5 |
|
Loss on impairment of real estate | | 230 |
| | — |
| | 6,116 |
| | — |
|
Increase in carrying value of property included in discontinued operations | | (619 | ) | | — |
| |
Equity in earnings of investees | | (20,804 | ) | | (28,002 | ) | |
Gain on issuance of shares by Select Income REIT | | (72 | ) | | (88 | ) | |
Unrealized gain on equity securities | | | (12,931 | ) | | — |
|
Equity in earnings (losses) of investees, net | | | (9,712 | ) | | (2,739 | ) |
Distributions of earnings from Select Income REIT | | 18,062 |
| | 25,676 |
| | 10,289 |
| | 2,611 |
|
Change in assets and liabilities: | | |
| | |
| | |
| | |
|
Restricted cash | | 21 |
| | 508 |
| |
Deferred leasing costs | | (2,846 | ) | | (7,998 | ) | | (2,091 | ) | | (1,075 | ) |
Rents receivable | | 3,839 |
| | (126 | ) | | (1,893 | ) | | (974 | ) |
Other assets | | (7,045 | ) | | (1,466 | ) | | 2,296 |
| | 2,215 |
|
Accounts payable and accrued expenses | | 6,703 |
| | (150 | ) | | (9,679 | ) | | (1,989 | ) |
Due to related persons | | 777 |
| | 1,088 |
| | 3,685 |
| | 152 |
|
Net cash provided by operating activities | | 93,726 |
| | 91,674 |
| | 35,267 |
| | 26,225 |
|
| | | | | | | | |
CASH FLOWS FROM INVESTING ACTIVITIES: | | |
| | |
| | |
| | |
|
Real estate acquisitions and deposits | | (666,202 | ) | | (83,705 | ) | | — |
| | (12,641 | ) |
Real estate improvements | | (29,377 | ) | | (23,357 | ) | | (11,020 | ) | | (9,656 | ) |
Distributions in excess of earnings from Select Income REIT | | 20,063 |
| | 11,951 |
| | 2,419 |
| | 10,097 |
|
Distributions in excess of earnings from unconsolidated joint ventures | | | 823 |
| | — |
|
Proceeds from sale of properties, net | | 13,198 |
| | 263 |
| | 18,797 |
| | — |
|
Net cash used in investing activities | | (662,318 | ) | | (94,848 | ) | |
Net cash provided by (used in) investing activities | | | 11,019 |
| | (12,200 | ) |
| | | | | | | | |
CASH FLOWS FROM FINANCING ACTIVITIES: | | |
| | |
| | |
| | |
|
Repayment of mortgage notes payable | | (1,150 | ) | | (107,562 | ) | | (899 | ) | | (379 | ) |
Proceeds from issuance of senior notes, after discounts | | 297,954 |
| | 300,235 |
| |
Proceeds from issuance of common shares, net | | 493,936 |
| | — |
| |
Borrowings on unsecured revolving credit facility | | 610,000 |
| | 254,000 |
| | 25,000 |
| | 30,000 |
|
Repayments on unsecured revolving credit facility | | (205,000 | ) | | (346,000 | ) | | (25,000 | ) | | (30,000 | ) |
Payment of debt issuance costs | | (2,551 | ) | | (464 | ) | |
Repurchase of common shares | | (255 | ) | | (312 | ) | | (11 | ) | | — |
|
Preferred units of limited partnership distributions | | | (278 | ) | | — |
|
Distributions to common shareholders | | (102,576 | ) | | (91,759 | ) | | (42,632 | ) | | (30,606 | ) |
Net cash provided by financing activities | | 1,090,358 |
| | 8,138 |
| |
Net cash used in financing activities | | | (43,820 | ) | | (30,985 | ) |
| | | | | | | | |
Increase in cash and cash equivalents | | 521,766 |
| | 4,964 |
| |
Cash and cash equivalents at beginning of period | | 29,941 |
| | 8,785 |
| |
Cash and cash equivalents at end of period | | $ | 551,707 |
| | $ | 13,749 |
| |
Increase (decrease) in cash and cash equivalents and restricted cash | | | 2,466 |
| | (16,960 | ) |
Cash and cash equivalents and restricted cash at beginning of period | | | 19,680 |
| | 30,471 |
|
Cash and cash equivalents and restricted cash at end of period | | | $ | 22,146 |
| | $ | 13,511 |
|
Supplemental cash flow information
|
| | | | | | | | |
Supplemental cash flow information: | | | | |
Interest paid | | $ | 42,019 |
| | $ | 32,599 |
|
Income taxes paid | | $ | 100 |
| | $ | 94 |
|
Non-cash investing activities: | | |
| |
|
|
Sale of property | | $ | — |
| | $ | 3,600 |
|
Mortgage note receivable related to sale of property | | $ | — |
| | $ | (3,600 | ) |
|
| | | | | | | | |
Interest paid | | $ | 27,733 |
| | $ | 15,854 |
|
Income taxes paid | | $ | — |
| | $ | — |
|
Supplemental disclosure of cash and cash equivalents and restricted cash
The following table provides a reconciliation of cash and cash equivalents and restricted cash amounts reported within the condensed consolidated balance sheets to the total amount reported in the condensed consolidated statements of cash flows:
|
| | | | | | | | |
| | March 31, 2018 |
| | March 31, 2017 |
|
Cash and cash equivalents | | $ | 17,380 |
| | $ | 12,808 |
|
Restricted cash | | 4,766 |
| | 703 |
|
Total cash and cash equivalents and restricted cash reported in the statements of cash flows | | $ | 22,146 |
| | $ | 13,511 |
|
See accompanying notes.
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
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
On January 1, 2017,2018, we adopted the Financial Accounting Standards Board, or FASB, Accounting Standards Update, or ASU, No. 2017-01, Clarifying2014-09 (and related clarifying guidance issued by the Definition of a BusinessFASB), which provides additional guidance on evaluating whetheratransaction should be accounted for as an acquisition (or disposal) of assets or of a business. This update defines three requirements for a set of assets andactivities (collectively referred to as a “set”) to be considered a business: inputs, processes and outputs. As a result of the implementation of this update, certain property acquisitions, which under previous guidance were accounted foras business combinations, are now accounted for as acquisitions of assets. In an acquisition of assets, certain acquisition costs are capitalized as opposed to expensedunder the previous guidance.
On January 1, 2017, we adopted FASB 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 condensed statement of cash flows. The adoption of ASU No. 2016-09 did not have a material impact in our condensed consolidated financial statements.
In May 2014, the FASB issued ASU No. 2014-09, Revenue From Contracts With Customers, which outlines a comprehensive model forentities to use in accounting for revenue arising from contracts with customers. ASU No. 2014-09 states that “an entity recognizes revenue to depict the transfer ofpromised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods orservices.” While ASU No. 2014-09 specifically references contracts with customers, it may apply to certain other transactions such as the sale of real estate orequipment. In August 2015, the FASB provided for a one-year deferral of the effective date for ASU No. 2014-09, which is now effective for us beginning January 1,2018. A substantial portion of our revenue consists of rental income from leasing arrangements, which is specifically excluded from ASU No. 2014-09. We arecontinuing to evaluatehave adopted ASU No. 2014-09 (and related clarifying guidance issued byusing the FASB); however, we domodified retrospective approach, which resulted in an adjustment to reclassify a previous deferred gain on sale of real estate of $712 from accounts payable and other liabilities to cumulative net income. The adoption of ASU No. 2014-09 did not expect its adoption to have a significantmaterial impact on the amount or timing of our revenue recognition in our consolidated financial statements with the exception ofexcept for profit recognition on real estate sales. We
currently have recorded a deferred gain on sale of real estate of $712 that under current guidance would be recognized upon repayment of a promissory noteOn January 1, 2018, we received in connection with the sale but will be recognized in its entirety upon adoption of ASU No. 2014-09. We currently expect to adopt the standard using the modified retrospective approach.
In January 2016, theadopted FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which changes howentities 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,The implementation of ASU No. 2016-01 resulted in the reclassification of historical changes in the fair value of these investmentsour available for sale equity securities of $45,116 from cumulative other comprehensive income to cumulative net income. We also reclassified $14,325 from cumulative other comprehensive income to cumulative net income for our share of cumulative other comprehensive income of our equity method investee, Select Income REIT, or SIR. Effective January 1, 2018, changes in the fair value of our equity securities are recorded through other comprehensive income.earnings in accordance with ASU No. 2016-01 states that these changes will be recorded through earnings. We are continuing to evaluate this guidance, but2016-01.
On January 1, 2018, we expectadopted FASB 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 statements of cash flows. The implementation of this guidanceupdate resulted in the reclassification of $736 of accretion recorded in our equity in the earnings of SIR, from cash flow from investing activities to cash flow from operating activities for the three months ended March 31, 2017. See Note 12 for further information regarding our investment in SIR.
On January 1, 2018, we adopted FASB ASU No. 2016-18, Restricted Cash, which requires companies to show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. The implementation of ASU 2016-18 resulted in a decrease of $173 of net cash provided by operating activities for the three months ended March 31, 2017. This update also requires a reconciliation of the totals in the statement of cash flows to the related captions in the balance sheets. As a result, amounts included in restricted cash on our condensed consolidated balance sheets are included with cash and cash equivalents on the condensed consolidated statements of cash flows. Restricted cash, which
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
will affect how changes in the fair valueconsists of availableamounts escrowed for sale securities we hold are presented infuture real estate taxes, insurance, leasing costs, capital expenditures and debt service, as required by certain of our condensed consolidated financial statements.
mortgage debts, totaled $4,766 and $703 as of March 31, 2018 and 2017, respectively. The adoption of this update did not change our balance sheet presentation.
In February 2016, the FASB issued ASU No. 2016-02, Leases, which sets out the principles for the recognition, measurement, presentation anddisclosure of leases for both parties to a contract (i.e., lessees and lessors). ASU No. 2016-02 requires lessees to apply a dual approach, classifying leases as eitherfinance 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 classificationwill 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 alsorequired 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 termof 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 anapproach that is substantially equivalent to existing guidance for sales type leases, direct financing leases and operating leases. ASU No. 2016-02 is effective forreporting 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 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 the adoption of ASU No. 2016-13 will have in our condensed consolidated financial statements. We currently expect to adopt the standard using the modified retrospective approach.
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 do not expect this guidance to have a material impact in our condensed consolidated financial statements and related disclosures.
In November 2016, the FASB issued ASU No. 2016-18, Restricted Cash, which clarifies how companies should present restricted cash and restricted cash equivalents. Companies will show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. The new standard requires a reconciliation of the totals in the statement of cash flows to the related captions in the balance sheets. ASU No. 2016-18 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Upon the adoption of ASU No. 2016-18, we will reconcile both cash and cash equivalents and restricted cash and restricted cash equivalents, whereas under the current guidance we explain the changes during the period for cash and cash equivalents only.
In May 2017, the FASB issued ASU No. 2017-09, Scope of Modification Accounting, which clarifies which changes to the terms or conditions of a share based payment award are subject to the guidance on modification accounting under ASC 718. Entities would apply the modification accounting guidance unless the value, vesting requirements and classification of a share based payment award are the same immediately before and after a change to the terms or conditions of the award. ASU No. 2017-09 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We are continuing to evaluate ASU No. 2017-09; however, we do not expect its adoption to have a material impact in our condensed consolidated financial statements.
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
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 | | For the Three Months |
| | Ended September 30, | | Ended September 30, | | Ended March 31, |
| | 2017 | | 2016 | | 2017 | | 2016 | | 2018 | | 2017 |
Weighted average common shares for basic earnings per share | | 96,883 |
| | 71,054 |
| | 79,778 |
| | 71,041 |
| | 99,041 |
| | 71,079 |
|
Effect of dilutive securities: unvested share awards | | 75 |
| | 30 |
| | 74 |
| | 23 |
| | 8 |
| | 15 |
|
Weighted average common shares for diluted earnings per share | | 96,958 |
| | 71,084 |
| | 79,852 |
| | 71,064 |
| | 99,049 |
| | 71,094 |
|
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.
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
During the nine months ended September 30, 2017,Disposition Activities
In March 2018, we acquiredsold an office property (one building) located in Manassas, VAMinneapolis, MN with 69,374193,594 rentable square feet.feet for $20,000, excluding closing costs. During the three months ended March 31, 2018, we recorded a $640 loss on impairment of real estate to reduce the carrying value of this property to its estimated fair value less costs to sell.
As of March 31, 2018, we had two properties (two buildings) with an aggregate carrying value of $18,080 classified as held for sale in our condensed consolidated balance sheets and included in continuing operations in our condensed consolidated statements of comprehensive income. In February 2018, we entered an agreement to sell one of these office properties (one building) located in Sacramento, CA with 110,500 rentable square feet for $10,755, excluding closing costs. This sale is expected to occur in the second quarter of 2018. During the three months ended March 31, 2018, we recorded a $3,023 loss on impairment of real estate to reduce the carrying value of this property to its estimated fair value less costs to sell. In February 2018, we entered an agreement to sell the second of these office properties (one building) located in Safford, AZ with 36,139 rentable square feet for $8,250, excluding closing costs. During the three months ended March 31, 2018, we recorded a $2,453 loss on impairment of real estate to reduce the carrying value of this property to its estimated fair value less costs to sell. In April 2018, the agreement to sell this property was terminated.
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.
|
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | Number | | | | | | | | | | |
| | | | | | of | | | | | | | | Buildings | | Other |
Acquisition | | | | | | Properties/ | | Square | | Purchase | | | | and | | Assumed |
Date | | Location | | Type | | Buildings | | Feet | | Price | | Land | | Improvements | | Assets |
Jan-17 | | Manassas, VA | | Office | | 1/1 | | 69,374 |
| | $ | 12,657 |
| | $ | 1,562 |
| | $ | 8,253 |
| | $ | 2,842 |
|
In September 2017, we acquired transferable development rights that will allow us to expand a property we own in Washington, D.C. for a purchase pricesecond quarter of $2,030, excluding acquisition costs.2018.
FPO AcquisitionAs part of our long term plans to reduce our leverage, we expect to sell additional properties. We are marketing or plan to market for sale 23 properties (55 buildings) with an aggregate carrying value of $467,677 as of March 31, 2018. These properties did not meet the held for sale criteria as of March 31, 2018.
We cannot be sure we will sell our properties under agreement or any of our properties that we are marketing or plan to market for sale or sell them for prices in excess of our carrying values or that we will not recognize impairment losses with respect to these properties. In addition, our pending sales are subject to conditions; accordingly, we cannot be sure that we will complete these sales or that these sales will not be delayed or their terms will not change.
Pro Forma Financial Information
On October 2, 2017, we acquired First Potomac Realty Trust, or FPO, a Maryland REIT, pursuant to a merger transactions, or collectively, the FPO Transaction,transaction, as a result of which we acquired 3935 office properties (74(72 buildings) with 6,454,3826,028,072 rentable square feet and FPO's 50% and 51% interests in two joint ventures that own two properties (three buildings) with 443,867 rentable square feet, or collectively, the FPO Transaction. The aggregate value we paid at the closing of the FPO Transaction was $1,370,888. We financed the FPO Transaction with the assumption of certain FPO mortgage debt, borrowings under our revolving credit facility and cash on hand, including net proceeds from our public offerings of common shares and senior unsecured notes.
The following table presents our pro forma results of operations for the three months ended March 31, 2017 as if the FPO Transaction and related financing activities had occurred on January 1, 2017. The historical FPO results of operations included in this pro forma financial information have been adjusted to eliminate the results of operations of FPO properties and joint venture interests that were sold from January 1, 2017 to October 2, 2017, the closing date of the FPO Transaction. The effect of these adjustments was a decrease in pro forma rental income of $804 and a decrease in net income of $46,905 for the three months ended March 31, 2017.
This pro forma financial information is not necessarily indicative of what our actual financial position or results of operations would have been for the periods presented or for any future period. Differences could result from numerous factors, including future changes in our portfolio of investments, capital structure, property level operating expenses and revenues, including rents expected to be received on our existing leases or leases we may enter during and after 2018, changes in interest rates and other reasons. Actual future results are likely to be different from amounts presented in this pro forma financial information and such differences could be significant.
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
|
| | | |
| Three Months Ended March 31, |
| 2017 |
Rental income | $ | 110,305 |
|
Net loss | (4,687 | ) |
Net loss per share | $ | 0.05 |
|
Unconsolidated Joint Ventures
We own noncontrolling interests in two joint ventures that own two properties (three buildings). We account for these investments under the equity method of accounting. As of March 31, 2018, our investment in unconsolidated joint ventures consisted of the following:
|
| | | | | | | | | | | | | | | |
Joint Venture | | GOV Ownership | | GOV Carrying Value of Investment at March 31, 2018 | | Property Type | | Number of Buildings | | Location | | Square Feet |
Prosperity Metro Plaza | | 51% | | $ | 27,086 |
| | Office | | 2 | | Fairfax, VA | | 328,456 |
|
1750 H Street, NW | | 50% | | 21,672 |
| | Office | | 1 | | Washington, DC | | 115,411 |
|
Total | | | | $ | 48,758 |
| | | | 3 | | | | 443,867 |
|
The following table provides a summary of the mortgage debt of our unconsolidated joint ventures: |
| | | | | | | | |
Joint Venture | | Interest Rate (1) | | Maturity Date | | Principal Balance at March 31, 2018 (2) |
Prosperity Metro Plaza | | 4.09% | | 12/1/2029 | | $ | 50,000 |
|
1750 H Street, NW | | 3.69% | | 8/1/2024 | | 32,000 |
|
Weighted Average/Total | | 3.93% | | | | $ | 82,000 |
|
| |
(1) | Includes the effect of mark to market purchase accounting. |
| |
(2) | Reflects the entire balance of the debt secured by the properties and is not adjusted to reflect the interests in the joint venture we do not own. None of the debt is recourse to us. |
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.
We financed the cash payments for the FPO Transaction with borrowings under our revolving credit facility and with cash on hand, including net proceeds from our public offerings of common shares and senior unsecured notes, as described further in Notes 7 and 9.
The following table presents our pro forma results of operations for each of the nine months ended September 30, 2017 and 2016 as if the FPO Transaction and related financing activities had occurred on January 1, 2016. The historical FPO results of operationsresulting amortization expense is included in this pro forma financial information have been adjusted to remove the resultsequity in earnings of operations of properties and joint venture interests FPO sold since January 1, 2016. The effect of these adjustments was to decrease pro forma rental income $804 and $8,330 for the nine months ended September 30, 2017 and 2016, respectively, and to decrease (increase) net income (loss) $47,019 and ($2,458) for the nine months ended September 30, 2017 and 2016, respectively. This pro forma financial information is not necessarily indicative of what our actual results of operations would have been for the periods presented, nor does it represent the results of operations for any future period. Differences could result from numerous factors, including changes to our preliminary purchase price allocation for the FPO Transaction, future changes in our portfolio of investments, changes in interest rates, changes in our capital structure, changes in net property level operating expenses, changes in property level revenues, including rents expected to be received on our existing leases or leases we may enter into during and after 2017, and other reasons.
|
| | | | | | | |
| Nine Months Ended September 30, |
| 2017 | | 2016 |
Rental income | $ | 328,255 |
| | $ | 311,167 |
|
Net income (loss) | (4,733 | ) | | 19,411 |
|
Net income (loss) per share | $ | (0.05 | ) | | $ | 0.20 |
|
Disposition Activities – Continuing Operations
On October 5, 2017, we sold one vacant office property (one building) located in Albuquerque, NM with 29,045 rentable square feet and a net book value of $1,885 as of September 30, 2017 for $2,000, excluding closing costs. During the three months ended September 30, 2017, we recorded a $230 loss on impairment of real estate to reduce the carrying value of this property to its estimated fair value.
Disposition Activities – Discontinued Operations
In August 2017, we sold one vacant office property (one building) in Falls Church, VA with 164,746 rentable square feet and a net book value of $12,901 as of the date of sale for $13,523, excluding closing costs. Results of operations for this property, which qualified as held for sale prior to our adoption in 2014 of ASU No. 2014-8, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, are classified as discontinued operationsinvestees in our condensed consolidated financial statements. During the three months ended September 30, 2017, we recorded an adjustmentstatements of $619 to increase the carrying value of this property to its estimated fair value less costs to sell.
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
Summarized balance sheet and income statement information for this property is as follows:
Balance Sheets
|
| | | | | | | | |
| | September 30, | | December 31, |
| | 2017 | | 2016 |
Real estate properties, net | | $ | — |
| | $ | 12,260 |
|
Other assets | | — |
| | 281 |
|
Assets of discontinued operations | | $ | — |
| | $ | 12,541 |
|
| | | | |
Other liabilities | | $ | — |
| | $ | 45 |
|
Liabilities of discontinued operations | | $ | — |
| | $ | 45 |
|
Statements of Operations
|
| | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | 2017 | | 2016 | | 2017 | | 2016 |
Rental income | | $ | 4 |
| | $ | 6 |
| | $ | 17 |
| | $ | 62 |
|
Real estate taxes | | (40 | ) | | (27 | ) | | (88 | ) | | (73 | ) |
Utility expenses | | (17 | ) | | (34 | ) | | (97 | ) | | (113 | ) |
Other operating expenses | | (87 | ) | | (70 | ) | | (202 | ) | | (219 | ) |
General and administrative | | (17 | ) | | (29 | ) | | (76 | ) | | (86 | ) |
Increase in carrying value of property | | 619 |
| | — |
| | 619 |
| | — |
|
Income (loss) from discontinued operations | | $ | 462 |
| | $ | (154 | ) | | $ | 173 |
| | $ | (429 | ) |
comprehensive income.
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.
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
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.
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
our annualized rental income as of March 31, 2018.
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
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
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.
On July 20, 2017, we issued $300,000 of 4.000% senior unsecured notes due 2022 in an underwritten public offering. The net proceeds from this offering of $295,403, after payment of the underwriters' discount and other offering expenses, were used to finance, in part, the FPO Transaction.
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
Concurrently with our entering into the FPO merger agreement, we entered a commitment letter with a group of institutional lenders for a 364-day senior unsecured bridge loan facility in an initial aggregate principal amount of up to $750,000. On July 20, 2017, we and the lenders terminated this commitment letter and bridge loan facility as a result of our issuance of the senior unsecured notes described above and the proceeds from the sale of our common shares in July 2017 (see Note 9 for more information regarding this sale), and we recognized a loss on extinguishment of debt of $1,715.March 31, 2018.
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.
As described in Note 4, in connection with the FPO Transaction we assumed five mortgage notes with an aggregate principal balance of $167,549. These mortgage notes are secured by five properties (five buildings). In connection with the FPO Transaction we also assumed two mortgage notes with an aggregate principal balance of $82,000, which are secured by two properties owned by joint ventures in which we acquired FPO's 50% and 51% interests.
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:
| | | | | | Fair Value at Reporting Date Using | | | | Fair Value at Reporting Date Using |
| | | | Quoted Prices in | | | | Significant | | | | Quoted Prices in | | | | Significant |
| | Estimated | | Active Markets for | | Significant Other | | Unobservable | |
| | Active Markets for | | Significant Other | | Unobservable |
| | Fair | | Identical Assets | | Observable Inputs | | Inputs | |
| | Identical Assets | | Observable Inputs | | Inputs |
Description | | Value | | (Level 1) | | (Level 2) | | (Level 3) | | Total | | (Level 1) | | (Level 2) | | (Level 3) |
Recurring Fair Value Measurements Assets: | | | | | | | | | | | | | | | | |
Investment in RMR Inc. (1) | | $ | 62,351 |
| | $ | 62,351 |
| | $ | — |
| | $ | — |
| | $ | 84,935 |
| | $ | 84,935 |
| | $ | — |
| | $ | — |
|
Non-Recurring Fair Value Measurements Assets: | | |
| | | | | | | | |
| | | | | | |
One property (2) | | $ | 1,885 |
| | $ | — |
| | $ | 1,885 |
| | $ | — |
| |
Properties held for sale (2) | | | $ | 18,080 |
| | $ | — |
| | $ | 18,080 |
| | $ | — |
|
| |
(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 as defined in the fair value hierarchy under GAAP). Our historical cost basis for these shares is $26,888 as of September 30, 2017. The netMarch 31, 2018. During the three months ended March 31, 2018, we recorded an unrealized gain of $35,463 for these$12,931 to adjust the carrying value of our investment in RMR Inc. shares as of September 30, 2017 is included in cumulative other comprehensive income in our condensed consolidated balance sheets.to their fair value. |
| |
(2) | We estimated the fair value of this propertytwo properties (two buildings) held for sale at September 30, 2017March 31, 2018 based upon the selling price agreed tonegotiated sale agreements with a third partyparties less estimated sale costs (Level 2 inputs as defined in the fair value hierarchy under GAAP). See Note 4 for further details. |
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
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:
| | | | As of September 30, 2017 | | As of December 31, 2016 | | As of March 31, 2018 | | As of December 31, 2017 |
| | Carrying Amount (1) | | Fair Value | | Carrying Amount (1) | | Fair Value | | Carrying Amount (1) | | Fair Value | | Carrying Amount (1) | | Fair Value |
Senior unsecured notes, 3.75% interest rate, due in 2019 | | $ | 347,810 |
| | $ | 357,625 |
| | $ | 346,952 |
| | $ | 354,078 |
| | $ | 348,381 |
| | $ | 351,673 |
| | $ | 348,096 |
| | $ | 354,993 |
|
Senior unsecured notes, 5.875% interest rate, due in 2046 | | | 300,318 |
| | 314,464 |
| | 300,232 |
| | 320,416 |
|
Senior unsecured notes, 4.000% interest rate, due in 2022 | | 295,587 |
| | 302,655 |
| | — |
| | — |
| | 296,044 |
| | 301,044 |
| | 295,812 |
| | 302,655 |
|
Senior unsecured notes, 5.875% interest rate, due in 2046 | | 300,146 |
| | 325,500 |
| | 299,892 |
| | 292,268 |
| |
Mortgage note payable, 5.88% interest rate, due in 2021 (2) | | 13,677 |
| | 14,388 |
| | 13,841 |
| | 14,492 |
| |
Mortgage note payable, 7.00% interest rate, due in 2019 (2) | | 8,490 |
| | 8,739 |
| | 8,778 |
| | 9,188 |
| |
Mortgage note payable, 8.15% interest rate, due in 2021 (2) | | 4,394 |
| | 4,665 |
| | 5,218 |
| | 5,575 |
| |
Mortgage note payable, 4.050% interest rate, due in 2030 (2) | | | 64,343 |
| | 63,918 |
| | 64,293 |
| | 65,198 |
|
Mortgage note payable, 5.720% interest rate, due in 2020 (2) | | | 35,786 |
| | 35,812 |
| | 36,085 |
| | 36,332 |
|
Mortgage note payable, 4.220% interest rate, due in 2022 (2) | | | 27,742 |
| | 28,081 |
| | 27,906 |
| | 28,432 |
|
Mortgage note payable, 4.800% interest rate, due in 2023 (2) | | | 25,394 |
| | 25,488 |
| | 25,501 |
| | 25,904 |
|
Mortgage note payable, 5.877% interest rate, due in 2021 (2) | | | 13,560 |
| | 14,345 |
| | 13,620 |
| | 14,565 |
|
Mortgage note payable, 7.000% interest rate, due in 2019 (2) | | | 8,291 |
| | 8,410 |
| | 8,391 |
| | 8,555 |
|
Mortgage note payable, 8.150% interest rate, due in 2021 (2) | | | 3,823 |
| | 4,014 |
| | 4,111 |
| | 4,340 |
|
Mortgage note payable, 4.260% interest rate, due in 2020 (2) | | | 3,144 |
| | 3,151 |
| | 3,193 |
| | 3,216 |
|
| | $ | 970,104 |
| | $ | 1,013,572 |
| | $ | 674,681 |
| | $ | 675,601 |
| | $ | 1,126,826 |
| | $ | 1,150,400 |
| | $ | 1,127,240 |
| | $ | 1,164,606 |
|
| |
(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. |
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
Distributions
On February 23, 2017, we paid a regular quarterly distribution to common shareholders of record on January 23, 2017 of $0.43 per share, or $30,606. On May 22, 2017, we paid a regular quarterly distribution to common shareholders of record on April 21, 2017 of $0.43 per share, or $30,606. On August 21, 2017, we paid a regular quarterly distribution to common shareholders of record on July 24, 2017 of $0.43 per share, or $41,364. On October 12, 2017, we declared a regular quarterly distribution payable to common shareholders of record on October 23, 2017 of $0.43 per share, or $42,633. We expect to pay this distribution on or about November 20, 2017 using cash on hand and borrowings under our revolving credit facility.
Sale of SharesShare Awards
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.
Share Grants and Purchases
On May 17, 2017,Trustee compensation arrangements, we granted 3,000 of our common shares, valued at $21.75$13.59 per share, the closing price of our common shares on the Nasdaq on that day, to eachour Managing Trustee, who was elected as a Managing Trustee that day.
Share Purchases
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.
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
On May 17, 2017, we withheld 450 of our common shares awarded to one of our Trustees to fund that Trustee's resulting minimum required tax withholding obligation. The aggregate value of the withheld shares was $10, which is reflected as a decrease to shareholders' equity in our condensed consolidated balance sheets.Distributions
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.
On September 14, 2017, we granted an aggregate of 57,350 of our common shares to our officers and certain other employees of RMR LLC, valued at $18.61$0.43 per share, the closing price ofor $42,634. We expect to pay this distribution on or about May 21, 2018 using cash on hand and borrowings under our common shares on the Nasdaq on that day.
On September 19, 2017, we purchased an aggregate of 13,636 of our common shares valued at $18.30 per share, the closing price of our common shares on the Nasdaq on that day, 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.revolving credit facility.
Cumulative Other Comprehensive Income
Cumulative other comprehensive income represents the unrealized gain on the RMR Inc. shares we own and our share of the comprehensive income of our equity method investees, Select Income REIT, or SIR and Affiliates Insurance Company, or AIC. See Notes 11 and 12 for further information regarding these investments. The following table presents changes in the amounts we recognized in cumulative other comprehensive income by component for the three and nine months ended September 30, 2017: March 31, 2018:
|
| | | | | | | | | | | | |
| | Three Months Ended September 30, 2017 |
| | Unrealized Gain | | Equity in | | |
| | on Investment | | Unrealized Gain | | |
| | in Available for | | of | | |
| | Sale Securities | | Investees | | Total |
Balance at June 30, 2017 | | $ | 32,184 |
| | $ | 10,166 |
| | $ | 42,350 |
|
Other comprehensive income before reclassifications | | 3,279 |
| | 1,355 |
| | 4,634 |
|
Amounts reclassified from cumulative other comprehensive loss to net income (1) | | — |
| | (4 | ) | | (4 | ) |
Net current period other comprehensive income | | 3,279 |
| | 1,351 |
| | 4,630 |
|
Balance at September 30, 2017 | | $ | 35,463 |
| | $ | 11,517 |
| | $ | 46,980 |
|
|
| | | | | | | | | | | | |
| | Nine Months Ended September 30, 2017 |
| | Unrealized Gain | | Equity in | | |
| | on Investment | | Unrealized Gain | | |
| | in Available for | | of | | |
| | Sale Securities | | Investees | | Total |
December 31, 2016 | | $ | 21,074 |
| | $ | 5,883 |
| | $ | 26,957 |
|
Other comprehensive income before reclassifications | | 14,389 |
| | 5,626 |
| | 20,015 |
|
Amounts reclassified from cumulative other comprehensive income to net income (1) | | — |
| | 8 |
| | 8 |
|
Net current period other comprehensive income | | 14,389 |
| | 5,634 |
| | 20,023 |
|
Balance at September 30, 2017 | | $ | 35,463 |
| | $ | 11,517 |
| | $ | 46,980 |
|
|
| | | | | | | | | | | | |
| | Three Months Ended March 31, 2018 |
| | Unrealized Gain | | Equity in | | |
| | on Investment | | Unrealized | | |
| | in Equity | | Gain (Loss)
| | |
| | Securities | | of Investees | | Total |
Balance at December 31, 2017 | | $ | 45,116 |
| | $ | 15,311 |
| | $ | 60,427 |
|
Amounts reclassified from cumulative other comprehensive income to cumulative net income | | (45,116 | ) | | (14,325 | ) | | (59,441 | ) |
| | | | | | |
Other comprehensive loss before reclassifications | | — |
| | (22 | ) | | (22 | ) |
Amounts reclassified from cumulative other comprehensive income to net income (1) | | — |
| | (19 | ) | | (19 | ) |
Net current period other comprehensive loss | | — |
| | (41 | ) | | (41 | ) |
Balance at March 31, 2018 | | $ | — |
| | $ | 945 |
| | $ | 945 |
|
| |
(1) | Amounts reclassified from cumulative other comprehensive loss to net income (loss) are included in equity in earnings of investees in our condensed consolidated statements of comprehensive income. |
Temporary Equity
As of March 31, 2018 and December 31, 2017, one of our subsidiaries had 1,813,504 of 5.5% Series A Cumulative Preferred Units, or Preferred Units, outstanding. The $20,496 carrying value of these Preferred Units is recorded as temporary equity on our condensed consolidated balance sheets. On May 1, 2018, our subsidiary redeemed all of the outstanding Preferred Units for $11.15 per unit plus accrued and unpaid distributions (an aggregate of $20,310), using cash on hand and borrowings under our revolving credit facility.
13
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
Note 10. Business and Property Management Agreements with RMR LLC
We have no employees. The personnel and various services we require to operate our business are provided to us by RMR LLC. We have two agreements with RMR LLC to provide management services to us: (1) a business management agreement, which relates to our business generally; and (2) a property management agreement, which relates to our property level operations.
Pursuant to our business management agreement with RMR LLC, we recognized net business management fees of $1,891$7,309 and $2,572$2,704 for the three months ended September 30,March 31, 2018 and 2017, and 2016, respectively, and $8,241 and $7,614respectively. The net business management fees payable to RMR LLC for the ninethree months ended September 30, 2017 and 2016, respectively. As of September 30, 2017, no annualMarch 31, 2018 include estimated 2018 incentive fees were estimated,of $2,887 based on our common share total return, as defined, as of September 30, 2017, to be payable to RMR LLC for 2017. The business management fee for the three months ended September 30, 2017 includes the reversal of $893 ofMarch 31, 2018. Although we recognized estimated incentive fees accrued as of June 30, 2017. Thein accordance with GAAP, the actual amount of annual incentive fees payable to RMR LLC for 2017,2018, if any, will be based on our common share total return, as defined, for the three year period ending December 31, 2017,2018, and will be payable in 2018. The net business2019. No incentive management fees we recognizedfee was payable for the year ended December 31, 2017. These amounts are included in general and administrative expenses in our condensed consolidated statements of comprehensive income.
Pursuant to our property management agreement with RMR LLC, we recognized aggregate net property management and construction supervision fees of $2,338$3,349 and $2,249$2,466 for the three months ended September 30,March 31, 2018 and 2017, and 2016, respectively, and $7,371 and $6,636 for the nine months ended September 30, 2017 and 2016, respectively. These
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
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, including certain payroll and related costs incurred by RMR LLC, are generally incorporated into rents charged to our tenants. We reimbursed RMR LLC $3,436$4,969 and $3,221$3,391 for property management related expenses for the three months ended September 30,March 31, 2018 and 2017, and 2016, respectively, and $10,482 and $9,132 for the nine months ended September 30, 2017 and 2016, respectively, which amounts are included in other operating expenses in our condensed consolidated statements of comprehensive income. In addition, we are responsible for our share of RMR LLC’s costs for providing our internal audit function. The amount recognized as expense for internal audit costs was $67$69 and $34$67 for the three months ended September 30,March 31, 2018 and 2017, and 2016, respectively, and $202 and $168 for the nine months ended September 30, 2017 and 2016, respectively. We include thesewhich amounts are included in general and administrative expenses in our condensed consolidated statements of comprehensive income.
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.
Our Manager, RMR LLC. We have two agreements with RMR LLC to provide management services to us. See Note 10 for further information regarding our management agreements with RMR LLC.
We have historically granted share awards to certain RMR LLC employees under our equity compensation plans. In September 2017 and 2016, we granted annual share awards of 57,350 and 53,400 of our common shares, respectively, to our officers and to other employees of
Leases with RMR LLC. In September 2017 and 2016, we purchased 13,636 and 13,209 of our common shares, respectively, at the closing price of our common shares on the Nasdaq on the date of purchase from our officers and other employees ofWe lease office space to RMR LLC in satisfaction of tax withholding and payment obligations in connection with the vesting of awardscertain of our common shares.properties for RMR LLC's property management offices. We include amounts recognized as expense for share awards torental income from RMR LLC employees in generalfor leased office space of $218 and administrative expenses in$92 for the three months ended March 31, 2018 and 2017, respectively. Our office space leases with RMR LLC are terminable by RMR LLC if our condensed consolidated statements of comprehensive income.management agreements with RMR LLC are terminated.
RMR Inc. RMR LLC is a majority owned subsidiary of RMR Inc. and RMR Inc. is the managing member of RMR LLC. TheAdam D. Portnoy, one of our Managing Trustees, is the sole trustee of ABP Trust, the controlling shareholder of RMR Inc., and is a managing director, president and chief executive officer of RMR Inc., an officer of ABP Trust is owned byand RMR LLC and a managing trustee or managing director of all of the public companies to which RMR LLC or its subsidiaries provide management services. Mark L. Kleifges, our other Managing Trustees.Trustee, also serves as an executive officer of RMR LLC. As of September 30, 2017,March 31, 2018, we owned 1,214,225 shares of class A common stock of RMR Inc. See Note 8 for further information regarding our investment in RMR Inc.
SIR. We are SIR’s largest shareholder. As of September 30, 2017,March 31, 2018, we owned 24,918,421 of SIR's common shares, or approximately 27.8% of its outstanding common shares. OurAdam D. Portnoy, one of our Managing Trustees, also serveserves as a managing trusteestrustee of SIR, and our President and Chief Operating Officer and
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
one of our Independent Trustees also serves as a managing trustee and the president and chief operating officer and an independent trustee of SIR, respectively.SIR. RMR LLC provides management services to SIR and us. See Note 12 for further information regarding our investment in SIR.
AIC. We, SIR, ABP Trust, SIR and four other companies to which RMR LLC provides management services currently own AIC an Indiana insurance company, 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 $757 in connection with this insurance program for the policy year ending June 30, 2018, 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, 2017March 31, 2018 and December 31, 2016,2017, our investment in AIC had a carrying value of $8,064$8,255 and $7,235,$8,304, respectively. These amounts are included in other assets in our condensed consolidated balance sheets. We recognized income related to our investment in AIC, which amounts areis presented as equity in earnings of investees in our condensed consolidated statements of comprehensive income. Our other comprehensive income includes our proportionate part of unrealized gains on securities which are owned and held for sale by AIC related to our investment in AIC.
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
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
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.
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
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
| | | | September 30, | | December 31, | | March 31, | | December 31, |
| | 2017 | | 2016 | | 2018 | | 2017 |
Real estate properties, net | | $ | 3,922,568 |
| | $ | 3,899,792 |
| | $ | 3,888,100 |
| | $ | 3,905,616 |
|
Acquired real estate leases, net | | 493,780 |
| | 506,298 |
| | 461,577 |
| | 477,577 |
|
Properties held for sale | | 5,829 |
| | — |
| | 5,829 |
| | 5,829 |
|
Cash and cash equivalents | | 18,155 |
| | 22,127 |
| | 30,884 |
| | 658,719 |
|
Rents receivable, net | | 122,292 |
| | 124,089 |
| | 131,445 |
| | 127,672 |
|
Other assets, net | | 114,771 |
| | 87,376 |
| | 151,174 |
| | 127,617 |
|
Total assets | | $ | 4,677,395 |
| | $ | 4,639,682 |
| | $ | 4,669,009 |
| | $ | 5,303,030 |
|
| | | | | | | | |
Unsecured revolving credit facility | | $ | 102,000 |
| | $ | 327,000 |
| | $ | 107,000 |
| | $ | — |
|
Industrial Logistics Properties Trust revolving credit facility | | | 302,000 |
| | 750,000 |
|
Unsecured term loan, net | | 348,746 |
| | 348,373 |
| | — |
| | 348,870 |
|
Senior unsecured notes, net | | 1,776,087 |
| | 1,430,300 |
| | 1,428,571 |
| | 1,777,425 |
|
Mortgage notes payable, net | | 227,772 |
| | 245,643 |
| | 210,749 |
| | 210,785 |
|
Assumed real estate lease obligations, net | | 70,989 |
| | 77,622 |
| | 66,577 |
| | 68,783 |
|
Other liabilities | | 129,502 |
| | 136,782 |
| | 125,668 |
| | 155,348 |
|
Shareholders' equity | | 2,022,299 |
| | 2,073,962 |
| |
Total shareholders' equity attributable to SIR | | | 2,110,595 |
| | 1,991,819 |
|
Noncontrolling interest in consolidated subsidiary | | | 317,849 |
| | — |
|
Total liabilities and shareholders' equity | | $ | 4,677,395 |
| | $ | 4,639,682 |
| | $ | 4,669,009 |
| | $ | 5,303,030 |
|
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
Condensed Consolidated Statements of Income
| | | | Three Months Ended September 30, | | Nine Months Ended September 30, | | Three Months Ended March 31, |
| | 2017 | | 2016 | | 2017 | | 2016 | | 2018 | | 2017 |
Rental income | | $ | 98,635 |
| | $ | 96,037 |
| | $ | 293,020 |
| | $ | 290,512 |
| | $ | 99,755 |
| | $ | 97,344 |
|
Tenant reimbursements and other income | | 19,379 |
| | 18,999 |
| | 57,158 |
| | 56,660 |
| | 20,874 |
| | 18,950 |
|
Total revenues | | 118,014 |
| | 115,036 |
| | 350,178 |
| | 347,172 |
| | 120,629 |
| | 116,294 |
|
| | | | | | | | | | | | |
Real estate taxes | | 11,489 |
| | 10,755 |
| | 33,168 |
| | 31,565 |
| | 11,788 |
| | 10,843 |
|
Other operating expenses | | 14,649 |
| | 14,394 |
| | 41,039 |
| | 39,987 |
| | 15,282 |
| | 12,867 |
|
Depreciation and amortization | | 34,713 |
| | 33,366 |
| | 102,770 |
| | 100,240 |
| | 34,946 |
| | 33,740 |
|
Acquisition related costs | | — |
| | 13 |
| | — |
| | 71 |
| |
General and administrative | | 1,589 |
| | 7,553 |
| | 24,658 |
| | 21,903 |
| | 13,941 |
| | 14,901 |
|
Write-off of straight line rents receivable, net | | — |
| | — |
| | 12,517 |
| | — |
| | — |
| | 12,517 |
|
Loss on asset impairment | | — |
| | — |
| | 4,047 |
| | — |
| | — |
| | 4,047 |
|
Loss on impairment of real estate assets | | — |
| | — |
| | 229 |
| | — |
| |
Total expenses | | 62,440 |
| | 66,081 |
| | 218,428 |
| | 193,766 |
| | 75,957 |
| | 88,915 |
|
Operating income | | 55,574 |
| | 48,955 |
| | 131,750 |
| | 153,406 |
| | 44,672 |
| | 27,379 |
|
| | | | | | | | | | | | |
Dividend income | | 397 |
| | 397 |
| | 1,190 |
| | 872 |
| | 397 |
| | 397 |
|
Unrealized gain on equity securities | | | 16,900 |
| | — |
|
Interest income | | | 510 |
| | 13 |
|
Interest expense | | (24,383 | ) | | (20,690 | ) | | (68,278 | ) | | (61,883 | ) | | (23,492 | ) | | (21,087 | ) |
Loss on early extinguishment of debt | | | (1,192 | ) | | — |
|
Income before income tax expense and equity in earnings of an investee | | 31,588 |
| | 28,662 |
| | 64,662 |
| | 92,395 |
| | 37,795 |
| | 6,702 |
|
Income tax expense | | (177 | ) | | (107 | ) | | (364 | ) | | (370 | ) | | (160 | ) | | (102 | ) |
Equity in earnings of an investee | | 31 |
| | 13 |
| | 533 |
| | 107 |
| | 44 |
| | 128 |
|
Net income | | 31,442 |
| | 28,568 |
| | 64,831 |
| | 92,132 |
| | 37,679 |
| | 6,728 |
|
Net income allocated to noncontrolling interest | | — |
| | — |
| | — |
| | (33 | ) | | (4,479 | ) | | — |
|
Net income attributed to SIR | | $ | 31,442 |
| | $ | 28,568 |
| | $ | 64,831 |
| | $ | 92,099 |
| | $ | 33,200 |
| | $ | 6,728 |
|
| | | | | | | | | | | | |
Weighted average common shares outstanding (basic) | | 89,355 |
| | 89,308 |
| | 89,341 |
| | 89,295 |
| | 89,382 |
| | 89,331 |
|
Weighted average common shares outstanding (diluted) | | $ | 89,379 |
| | $ | 89,334 |
| | $ | 89,364 |
| | $ | 89,318 |
| | $ | 89,390 |
| | $ | 89,348 |
|
Net income attributed to SIR per common share (basic and diluted) | | $ | 0.35 |
| | $ | 0.32 |
| | $ | 0.73 |
| | $ | 1.03 |
| | $ | 0.37 |
| | $ | 0.08 |
|
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
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.
|
| | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, 2018 |
| | Investment | | Investment | | | | |
| | in Real Estate | | in SIR | | Corporate | | Consolidated |
Rental income | | $ | 108,717 |
| | $ | — |
| | $ | — |
| | $ | 108,717 |
|
| | | | | | | | |
Expenses: | | |
| | |
| | |
| | |
|
Real estate taxes | | 12,964 |
| | — |
| | — |
| | 12,964 |
|
Utility expenses | | 6,690 |
| | — |
| | — |
| | 6,690 |
|
Other operating expenses | | 22,837 |
| | — |
| | — |
| | 22,837 |
|
Depreciation and amortization | | 44,204 |
| | — |
| | — |
| | 44,204 |
|
Loss on impairment of real estate | | 6,116 |
| | — |
| | — |
| | 6,116 |
|
General and administrative | | — |
| | — |
| | 9,606 |
| | 9,606 |
|
Total expenses | | 92,811 |
| | — |
| | 9,606 |
| | 102,417 |
|
| | | | | | | | |
Operating income (loss) | | 15,906 |
| | — |
| | (9,606 | ) | | 6,300 |
|
Dividend income | | — |
| | — |
| | 304 |
| | 304 |
|
Unrealized gain on equity securities | | — |
| | | | 12,931 |
| | 12,931 |
|
Interest income | | 57 |
| | — |
| | 59 |
| | 116 |
|
Interest expense | | (2,096 | ) | | — |
| | (20,670 | ) | | (22,766 | ) |
Income (loss) from continuing operations before | | |
| | |
| | |
| | |
|
income taxes and equity in earnings (losses) of investees | | 13,867 |
| | — |
| | (16,982 | ) | | (3,115 | ) |
Income tax expense | | — |
| | — |
| | (32 | ) | | (32 | ) |
Equity in earnings (losses) of investees | | (621 | ) | | 10,289 |
| | 44 |
| | 9,712 |
|
Net income (loss) | | $ | 13,246 |
| | $ | 10,289 |
| | $ | (16,970 | ) | | $ | 6,565 |
|
Preferred units of limited partnership distributions | | — |
| | — |
| | (278 | ) | | (278 | ) |
Net income (loss) available for common shareholders | | $ | 13,246 |
| | $ | 10,289 |
| | $ | (17,248 | ) | | $ | 6,287 |
|
|
| | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, 2017 |
| | Investment | | Investment | | | | |
| | in Real Estate | | in SIR | | Corporate | | Consolidated |
Rental income | | $ | 70,179 |
| | $ | — |
| | $ | — |
| | $ | 70,179 |
|
| | | | | | | | |
Expenses: | | |
| | |
| | |
| | |
|
Real estate taxes | | 8,862 |
| | — |
| | — |
| | 8,862 |
|
Utility expenses | | 5,408 |
| | — |
| | — |
| | 5,408 |
|
Other operating expenses | | 14,867 |
| | — |
| | — |
| | 14,867 |
|
Depreciation and amortization | | 20,781 |
| | — |
| | — |
| | 20,781 |
|
Loss on impairment of real estate | | 230 |
| | — |
| | — |
| | 230 |
|
General and administrative | | — |
| | — |
| | 3,266 |
| | 3,266 |
|
Total expenses | | 50,148 |
| | — |
| | 3,266 |
| | 53,414 |
|
| | | | | | | | |
Operating income (loss) | | 20,031 |
| | — |
| | (3,266 | ) | | 16,765 |
|
Dividend income | | — |
| | — |
| | 304 |
| | 304 |
|
Interest income | | 54 |
| | — |
| | 1,661 |
| | 1,715 |
|
Interest expense | | (401 | ) | | — |
| | (15,654 | ) | | (16,055 | ) |
Loss on early extinguishment of debt | | — |
| | | | (1,715 | ) | | (1,715 | ) |
Gain on issuance of shares by Select Income REIT | | — |
| | 51 |
| | — |
| | 51 |
|
Income (loss) from continuing operations before | | |
| | |
| | |
| | |
|
income taxes and equity in earnings of investees | | 19,684 |
| | 51 |
| | (18,670 | ) | | 1,065 |
|
Income tax expense | | — |
| | — |
| | (22 | ) | | (22 | ) |
Equity in earnings of investees | | — |
| | 9,453 |
| | 31 |
| | 9,484 |
|
Income (loss) from continuing operations | | 19,684 |
| | 9,504 |
| | (18,661 | ) | | 10,527 |
|
Income from discontinued operations | | 462 |
| | — |
| | — |
| | 462 |
|
Net income (loss) | | $ | 20,146 |
| | $ | 9,504 |
| | $ | (18,661 | ) | | $ | 10,989 |
|
|
| | | | | | | | | | | | | | | | |
| | As of March 31, 2018 |
| | Investment | | Investment | | | | |
| | in Real Estate | | in SIR | | Corporate | | Consolidated |
Total Assets | | $ | 3,078,889 |
| | $ | 465,131 |
| | $ | 111,604 |
| | $ | 3,655,624 |
|
18
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
|
| | | | | | | | | | | | | | | | |
| | Nine Months Ended September 30, 2017 |
| | Investment | | Investment | | | | |
| | in Real Estate | | in SIR | | Corporate | | Consolidated |
Rental income | | $ | 209,362 |
| | $ | — |
| | $ | — |
| | $ | 209,362 |
|
| | | | | | | | |
Expenses: | | | | | | | | |
Real estate taxes | | 24,980 |
| | — |
| | — |
| | 24,980 |
|
Utility expenses | | 14,186 |
| | — |
| | — |
| | 14,186 |
|
Other operating expenses | | 44,046 |
| | — |
| | — |
| | 44,046 |
|
Depreciation and amortization | | 61,949 |
| | — |
| | — |
| | 61,949 |
|
Loss on impairment of real estate | | 230 |
| | — |
| | — |
| | 230 |
|
General and administrative | | — |
| | — |
| | 12,314 |
| | 12,314 |
|
Total expenses | | 145,391 |
| | — |
| | 12,314 |
| | 157,705 |
|
| | | | | | | | |
Operating income (loss) | | 63,971 |
| | — |
| | (12,314 | ) | | 51,657 |
|
Dividend income | | — |
| | — |
| | 911 |
| | 911 |
|
Interest income | | 148 |
| | — |
| | 1,695 |
| | 1,843 |
|
Interest expense | | (1,238 | ) | | — |
| | (42,361 | ) | | (43,599 | ) |
Loss on early extinguishment of debt | | (1,715 | ) | | — |
| | — |
| | (1,715 | ) |
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 | | 61,166 |
| | 72 |
| | (52,069 | ) | | 9,169 |
|
Income tax expense | | — |
| | — |
| | (65 | ) | | (65 | ) |
Equity in earnings of investees | | — |
| | 20,271 |
| | 533 |
| | 20,804 |
|
Income (loss) from continuing operations | | 61,166 |
| | 20,343 |
| | (51,601 | ) | | 29,908 |
|
Income from discontinued operations | | 173 |
| | — |
| | — |
| | 173 |
|
Net income (loss) | | $ | 61,339 |
| | $ | 20,343 |
| | $ | (51,601 | ) | | $ | 30,081 |
|
|
| | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, 2017 |
| | Investment | | Investment | | | | |
| | in Real Estate | | in SIR | | Corporate | | Consolidated |
Rental income | | $ | 69,296 |
| | $ | — |
| | $ | — |
| | $ | 69,296 |
|
| | | | | | | | |
Expenses: | | |
| | |
| | |
| | |
|
Real estate taxes | | 8,177 |
| | — |
| | — |
| | 8,177 |
|
Utility expenses | | 4,606 |
| | — |
| | — |
| | 4,606 |
|
Other operating expenses | | 13,992 |
| | — |
| | — |
| | 13,992 |
|
Depreciation and amortization | | 20,505 |
| | — |
| | — |
| | 20,505 |
|
General and administrative | | — |
| | — |
| | 3,962 |
| | 3,962 |
|
Total expenses | | 47,280 |
| | — |
| | 3,962 |
| | 51,242 |
|
| | | | | | | | |
Operating income (loss) | | 22,016 |
| | — |
| | (3,962 | ) | | 18,054 |
|
Dividend income | | — |
| | — |
| | 304 |
| | 304 |
|
Interest income | | 46 |
| | — |
| | 15 |
| | 61 |
|
Interest expense | | (432 | ) | | — |
| | (13,149 | ) | | (13,581 | ) |
Income (loss) from continuing operations before income taxes and | | |
| | |
| | |
| | |
|
equity in earnings of investees | | 21,630 |
| | — |
| | (16,792 | ) | | 4,838 |
|
Income tax expense | | — |
| | — |
| | (18 | ) | | (18 | ) |
Equity in earnings of investees | | — |
| | 2,611 |
| | 128 |
| | 2,739 |
|
Income (loss) from continuing operations | | 21,630 |
| | 2,611 |
| | (16,682 | ) | | 7,559 |
|
Loss from discontinued operations | | (144 | ) | | — |
| | — |
| | (144 | ) |
Net income (loss) available for common shareholders | | $ | 21,486 |
| | $ | 2,611 |
| | $ | (16,682 | ) | | $ | 7,415 |
|
|
| | | | | | | | | | | | | | | | |
| | As of September 30, 2017 |
| | Investment | | Investment | | | | |
| | in Real Estate | | in SIR | | Corporate | | Consolidated |
Total Assets | | $ | 1,780,753 |
| | $ | 475,265 |
| | $ | 1,280,949 |
| | $ | 3,536,967 |
|
|
| | | | | | | | | | | | | | | | |
| | As of December 31, 2017 |
| | Investment | | Investment | | | | |
| | in Real Estate | | in SIR | | Corporate | | Consolidated |
Total Assets | | $ | 3,138,764 |
| | $ | 467,499 |
| | $ | 97,302 |
| | $ | 3,703,565 |
|
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
|
| | | | | | | | | | | | | | | | |
| | 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 |
|
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
|
| | | | | | | | | | | | | | | | |
| | 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 December 31, 2016 |
| | Investment | | Investment | | | | |
| | in Real Estate | | in SIR | | Corporate | | Consolidated |
Total Assets | | $ | 1,807,560 |
| | $ | 487,708 |
| | $ | 89,798 |
| | $ | 2,385,066 |
|
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, 2016,2017, or our Annual Report.
OVERVIEW (dollars in thousands, except per share data)
We are a real estate investment trust, or REIT, organized under Maryland law. As of September 30, 2017,March 31, 2018, we wholly owned 107 properties (166 buildings) and had a noncontrolling ownership interest in two properties (three buildings) totaling 443,867 rentable square feet through two unconsolidated joint ventures in which we owned 7450% and 51% interests. As of March 31, 2018, our consolidated properties (96 buildings)are located in 3130 states and the District of Columbia thatand contain approximately 11.5 million17,332,180 rentable square feet, of which 57.8%41.6% was leased to the U.S. Government, 21.8%15.1% was leased to 13 state governments, 3.2%2.5% was leased to four other government tenants, 3.6%5.9% was leased to government contractor tenants, 8.6%29.2% was leased to various other non-governmental organizations and 5.0%5.6% was available for lease as of September 30, 2017. The U.S. Government, 13 state governments and four otherlease. In aggregate, government tenants combined were responsible for 87.5%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 term annualized rental income as used herein 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.
On October 2, 2017, we completed our acquisition ofacquired First Potomac Realty Trust, or FPO, a Maryland REIT, pursuant to a definitive Agreement and Planmerger transaction, as a result of Merger, by and among us and certain of our subsidiaries and FPO and its operating partnership, or the FPO Transaction, pursuant to which we acquired 3935 office properties (74(72 buildings) with 6,454,3826,028,072 rentable square feet including two properties owned by joint ventures in which we acquiredand FPO's 50% and 51% interests. The estimated aggregate transaction value ofinterests in two joint ventures that owned two properties (three buildings) with 443,867 rentable square feet, or collectively, the FPO Transaction was approximately $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 encumbers the two joint ventureTransaction. The properties which are 50% and 51% owned by FPO, as well as 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 ofwe acquired in place leases and building valuations.
We financed the cash portion of the FPO Transaction consideration with borrowings under our revolving credit facility and with cash on hand, which included net proceeds from our public offerings of common shares and notes, as described further in Notes 7 and 9 to our condensed consolidated financial statements.
The FPO Transaction significantly increased our property portfolio. Giving effect toportfolio and the completionproportion of our total annualized revenues that we earn from properties located in the FPO Transaction, we owned113 properties (170 buildings) that contain approximately 18.0 million square feet, including two properties owned by joint ventures inmetropolitan Washington, D.C. market area, which we acquired FPO's 50%includes Washington, D.C., Northern Virginia and 51% interests. Because the FPO Transaction was completed after the end of the 2017 third fiscal quarter, our results of operations for the three and nine months ending September 30, 2017 and 2016 do not include the properties and joint venture interests we acquired as part of the FPO Transaction. See "Acquisition and Disposition Activities" below for additional information related to the FPO Transaction.suburban Maryland.
As of September 30, 2017,March 31, 2018, we owned 24,918,421 common shares, or approximately 27.8% of the then outstanding common shares, of Select Income REIT, or SIR. SIR is a REIT whichthat owns properties that are primarily net leased to single tenants. See Notes 11 and 12 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.
Consolidated Property Operations
As of September 30, 2017, 95.0%March 31, 2018, 94.4% of our consolidated rentable square feet was leased, compared to 95.0%95.1% of our consolidated rentable square feet as of September 30, 2016,March 31, 2017, which excludes one property (one building) classified as discontinued operations which was sold onin August 31, 2017. Occupancy data for our consolidated properties as of September 30,March 31, 2018 and 2017 and 2016 is as follows (square feet in thousands):
| | | | | | | | Comparable | | | | | | Comparable |
| | All Properties (1) | | Properties (2) | | All Consolidated Properties (1) | | Consolidated Properties (2) |
| | September 30, | | September 30, | | March 31, | | March 31, |
| | 2017 | | 2016 | | 2017 | | 2016 | | 2018 | | 2017 | | 2018 | | 2017 |
Total properties | | 74 |
| | 71 |
| | 70 |
| | 70 |
| | 107 |
| | 74 |
| | 71 |
| | 71 |
|
Total buildings | | 96 |
| | 91 |
| | 90 |
| | 90 |
| | 166 |
| | 96 |
| | 93 |
| | 93 |
|
Total square feet (3) | | 11,517 |
| | 10,950 |
| | 10,617 |
| | 10,612 |
| | 17,332 |
| | 11,512 |
| | 11,234 |
| | 11,220 |
|
Percent leased (4) | | 95.0 | % | | 95.0 | % | | 95.0 | % | | 95.2 | % | | 94.4 | % | | 95.1 | % | | 95.3 | % | | 95.7 | % |
| |
(1) | Based on consolidated properties we owned on September 30,March 31, 2018 and 2017, and 2016, respectively, and excludes one property (one building) classified as discontinued operations which was sold onin August 31, 2017. |
| |
(2) | Based on consolidated properties we owned on September 30, 2017March 31, 2018 and which we owned continuously since January 1, 2016.2017. Our comparable properties decreasedincreased from 7170 properties (91(90 buildings) at September 30, 2016March 31, 2017 as a result of our acquisition of three properties (five buildings) during 2016, partially offset by the sale of one property (one building) in July 2016.two properties (two buildings) since January 1, 2017. |
| |
(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 consolidated properties for the three and nine months ended September 30,March 31, 2018 and 2017 and 2016 are as follows:
| | | | Three Months Ended September 30, | | Nine Months Ended September 30, | | Three Months Ended March 31, |
| | 2017 | | 2016 | | 2017 | | 2016 | | 2018 | | 2017 |
Average annualized effective rental rate per square foot (1): | | | | | | | | | | | | |
All properties (2) | | $ | 25.89 |
| | $ | 25.31 |
| | $ | 25.74 |
| | $ | 25.15 |
| | $ | 26.77 |
| | $ | 25.55 |
|
Comparable properties (3) | | $ | 25.68 |
| | $ | 25.32 |
| | $ | 25.30 |
| | $ | 24.95 |
| | $ | 26.34 |
| | $ | 25.69 |
|
| |
(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 which was sold onin August 31, 2017. |
| |
(2) | Based on consolidated properties we owned on September 30,March 31, 2018 and 2017, and 2016, respectively, and excludes one property (one building) classified as discontinued operations which was sold onin August 31, 2017. |
| |
(3) | Based on consolidated properties we owned on September 30, 2017March 31, 2018 and which we owned continuously since July 1, 2016 and January 1, 2016, respectively.2017. |
During the three and nine months ended September 30, 2017,March 31, 2018, changes in rentable square feet leased and available for lease at our consolidated properties excluding one property (one building) classified as discontinued operations which was sold on August 31, 2017, were as follows:
| | | | Three Months Ended September 30, 2017 | | Nine Months Ended September 30, 2017 | | Three Months Ended March 31, 2018 |
| | | | Available | | | | | | Available | | | | | | Available | | |
| | Leased (1) | | for Lease | | Total | | Leased (1) | | for Lease | | Total | | Leased | | for Lease | | Total |
Beginning of period | | 10,937,046 |
| | 578,941 |
| | 11,515,987 |
| | 10,881,289 |
| | 561,224 |
| | 11,442,513 |
| | 16,477,339 |
| | 1,021,999 |
| | 17,499,338 |
|
Changes resulting from: | | |
| | |
| | | | |
| | |
| | |
| | |
| | |
| | |
Acquisition of properties | | — |
| | — |
| | — |
| | 69,374 |
| | — |
| | 69,374 |
| |
Disposition of properties | | | (169,176 | ) | | (24,418 | ) | | (193,594 | ) |
Lease expirations | | (426,847 | ) | | 426,847 |
| | — |
| | (1,088,995 | ) | | 1,088,995 |
| | — |
| | (256,269 | ) | | 256,269 |
| | — |
|
Lease renewals (2)(1) | | 416,660 |
| | (416,660 | ) | | — |
| | 1,000,878 |
| | (1,000,878 | ) | | — |
| | 196,586 |
| | (196,586 | ) | | — |
|
New leases (2)(1) | | 19,442 |
| | (19,442 | ) | | — |
| | 83,755 |
| | (83,755 | ) | | — |
| | 109,412 |
| | (83,833 | ) | | 25,579 |
|
Re-measurements (3)(2) | | — |
| | 864 |
| | 864 |
| | — |
| | 4,964 |
| | 4,964 |
| | — |
| | 857 |
| | 857 |
|
End of period | | 10,946,301 |
| | 570,550 |
| | 11,516,851 |
| | 10,946,301 |
| | 570,550 |
| | 11,516,851 |
| | 16,357,892 |
| | 974,288 |
| | 17,332,180 |
|
| |
(1) | Rentable square footage excludesBased on leases entered during the three months ended March 31, 2018 and an expansion being constructedof 25,579 rentable square feet completed at an existing property we own prior to the commencement of the lease.property. |
| |
(2) | Based on leases entered into during the three and nine months ended September 30, 2017. |
| |
(3) | Rentable square feet is subject to changes when space is re-measured or re-configured for tenants. |
Leases at our consolidated properties totaling 426,847 and 1,088,995256,269 rentable square feet expired during the three and nine months ended September 30, 2017, respectively.March 31, 2018. During the three and nine months ended September 30, 2017,March 31, 2018, we entered into leases totaling 436,102 and 1,084,633280,419 rentable square feet, including lease renewals of 416,660 and 1,000,878196,586 rentable square feet, respectively.feet. The weighted (by rentable square feet) average rental rates for leases of 393,158 and 953,44472,006 rentable square feet entered into with government tenants during the three and nine months ended September 30, 2017March 31, 2018 increased by 0.2% and 4.0%, respectively,20.2% 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 42,944 and 131,189208,413 rentable square feet entered into with non-government tenants during the three and nine months ended September 30, 2017 decreased by 11.1% andMarch 31, 2018 increased by 0.7%, respectively,1.2% 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, 2017,March 31, 2018, changes in effective rental rates per square foot achieved for new leases and lease renewals at our consolidated properties that commenced during the three and nine months ended September 30, 2017,March 31, 2018, 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, 2017 | | Nine Months Ended September 30, 2017 | | Three Months Ended March 31, 2018 |
| | Old Effective | | New Effective | | | | Old Effective | | New Effective | | | | Old Effective | | New Effective | | |
| | Rent Per | | Rent Per | | Rentable | | 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 | | Square Foot (1) | | Square Foot (1) | | Square Feet |
New leases | | $ | — |
| | $ | — |
| | — |
| | $ | 22.67 |
| | $ | 22.98 |
| | 97,797 |
| | $ | 20.69 |
| | $ | 28.28 |
| | 148,399 |
|
Lease renewals | | $ | 22.74 |
| | $ | 23.25 |
| | 17,442 |
| | $ | 13.65 |
| | $ | 15.25 |
| | 578,330 |
| | $ | 25.95 |
| | $ | 26.59 |
| | 200,488 |
|
Total leasing activity | | $ | 22.74 |
| | $ | 23.25 |
| | 17,442 |
| | $ | 14.95 |
| | $ | 16.36 |
| | 676,127 |
| | $ | 23.71 |
| | $ | 27.31 |
| | 348,887 |
|
| |
(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. |
During the three and nine months ended September 30, 2017,March 31, 2018, commitments made for expenditures, such as tenant improvements and leasing costs, in connection with leasing space at our consolidated properties were as follows:
|
| | | | | | | | | | | | |
| | Government | | Non-Government | | |
Three Months Ended September 30, 2017 | | Leases | | Leases | | Total |
Rentable square feet leased during the period | | 393,158 |
| | 42,944 |
| | 436,102 |
|
Tenant leasing costs and concession commitments (1) (in thousands) | | $ | 6,629 |
| | $ | 1,273 |
| | $ | 7,902 |
|
Tenant leasing costs and concession commitments per rentable square foot (1) | | $ | 16.86 |
| | $ | 29.64 |
| | $ | 18.12 |
|
Weighted (by square feet) average lease term (years) | | 8.5 |
| | 7.2 |
| | 8.4 |
|
Total leasing costs and concession commitments per rentable square foot per year (1) | | $ | 1.98 |
| | $ | 4.10 |
| | $ | 2.16 |
|
| | | | Government | | Non-Government | | | | Three Months Ended March 31, 2018
|
Nine Months Ended September 30,2017 | | Leases | | Leases | | Total | |
| | | Government | | Non-Government | | |
| | | Leases | | Leases | | Total |
Rentable square feet leased during the period | | 953,444 |
| | 131,189 |
| | 1,084,633 |
| | 72,006 |
| | 208,413 |
| | 280,419 |
|
Tenant leasing costs and concession commitments (1) (in thousands) | | $ | 9,120 |
| | $ | 3,489 |
| | $ | 12,609 |
| | $ | 3,682 |
| | $ | 4,316 |
| | $ | 7,998 |
|
Tenant leasing costs and concession commitments per rentable square foot (1) | | $ | 9.57 |
| | $ | 26.59 |
| | $ | 11.62 |
| | $ | 51.13 |
| | $ | 20.71 |
| | $ | 28.52 |
|
Weighted (by square feet) average lease term (years) | | 9.2 |
| | 5.6 |
| | 8.8 |
| | 8.2 |
| | 4.6 |
| | 5.6 |
|
Total leasing costs and concession commitments per rentable square foot per year (1) | | $ | 1.04 |
| | $ | 4.77 |
| | $ | 1.32 |
| | $ | 6.20 |
| | $ | 4.47 |
| | $ | 5.13 |
|
| |
(1) | Includes commitments made for leasing expenditures and concessions, such as tenant improvements, leasing commissions, tenant reimbursements and free rent. |
During the three and nine months ended September 30,March 31, 2018 and 2017, and 2016, amounts capitalized at our consolidated properties, excluding one property (one building) classified as discontinued operations which was sold in August 2017, for tenant improvements, leasing costs, building improvements and development and redevelopment activities were as follows (dollars in thousands):
| | | | Three Months Ended | | Nine Months Ended | | Three Months Ended |
| | September 30, | | September 30, | | March 31, |
| | 2017 | | 2016 | | 2017 | | 2016 | | 2018 | | 2017 |
Tenant improvements (1) | | $ | 3,213 |
| | $ | 5,636 |
| | $ | 6,692 |
| | $ | 12,306 |
| | $ | 2,843 |
| | $ | 2,403 |
|
Leasing costs (2) | | $ | 1,993 |
| | $ | 655 |
| | $ | 4,051 |
| | $ | 8,002 |
| | $ | 1,986 |
| | $ | 1,087 |
|
Building improvements (3) | | $ | 2,640 |
| | $ | 3,009 |
| | $ | 8,883 |
| | $ | 8,691 |
| | $ | 2,707 |
| | $ | 1,778 |
|
Development, redevelopment and other activities (4) | | $ | 3,132 |
| | $ | 1,292 |
| | $ | 16,362 |
| | $ | 4,221 |
| | $ | 1,416 |
| | $ | 6,281 |
|
| |
(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, 2017,March 31, 2018, we have estimated unspent leasing related obligations of $26,631 and 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.$32,762.
We believe that current government budgetary pressuresmethodology, spending priorities and the current U.S. presidential administration's views on the size and scope of government employment have resulted in a decrease in government employment, government tenants reducing their space utilization per employee and consolidation of government tenants 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, efforts to
reduce space utilization rates may result in our tenants exercising early termination rights under our leases, vacating our properties upon expiration of our leases in order to relocate, or in renewing their leases for less space than they currently occupy. Also, our government tenants' desiredesires to reconfigure leased office space to reduce utilization per employee may require us to spend significant amounts for tenant improvements, and tenant relocations have become more prevalent than our past experiences in instances where efforts by government tenants to reduce their space utilization require a significant reconfiguration of currently leased space. Increasing uncertainty with respect to government agency budgets and funding to implement relocations, consolidations and reconfigurations recently has resulted in delayed decisions by some of our
government tenants and their reliance on short term lease renewals. At present, 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.
As of March 31, 2018, we derived 43.3% of our annualized revenues from our consolidated properties located in the metropolitan Washington, D.C. market area. A downturn in economic conditions in this area could result in reduced demand from tenants for our properties in this area or reduce the rents that our tenants in this area are willing to pay when our leases expire or terminate and when renewal or new terms are negotiated. Additionally, in recent years there has been a decrease in demand for new leased space by the U.S. Government in the metropolitan Washington, D.C. market area, and that could increase competition for government tenants and adversely affect our ability to retain U.S. Government tenants when our leases expire.
The U.S. Internal Revenue Service, or the IRS, has publicly stated that it plans to discontinue its paper tax return processing operations at our property located in Fresno, CA in 2021. The IRS lease for this property, which accounted for approximately 3.0%2.0% of our annualized rental income as of September 30, 2017,March 31, 2018, expires in the fourth quarter of 2021. The IRS has also publicly stated that it plans to discontinue its paper 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 the Covington, KY operations. This IRS lease, which accounted for approximately 0.9%0.6% of our annualized rental income as of September 30, 2017,March 31, 2018, expires in the second quarter of 2022, but is subject to possible early termination by our tenant. Despite its public announcements, the IRS has not sentprovided us any official notices of its intentions regarding the Fresno, CA or Covington, KYthese properties.
As of September 30, 2017,March 31, 2018, we had leases at our consolidated properties totaling 787,2711,565,295 rentable square feet that were scheduled to expire through September 30, 2018.March 31, 2019. As of October 30, 2017,May 1, 2018, tenants with leases totaling 196,753703,886 rentable square feet that are scheduled to expire through September 30, 2018,March 31, 2019, have notified us that they do not plan to renew their leases upon expiration and we cannot be sure as to whether other 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, 2018,March 31, 2019, we expect that the rental rates we are likely to achieve on new or renewed leases for space under leases expiring through September 30, 2018March 31, 2019 will, in the aggregate and on a weighted (by annualized revenues) average basis, be lower than the rates currently being paid, thereby generally resulting in lower revenue from the same space. We cannot be sure of the rental rates which will result from our ongoing negotiations regarding lease renewals or any new leases we may enter into;enter; also, we may experience material declines in our rental income due to vacancies upon lease expirations or early terminations. Prevailing market conditions and government and other tenants' needs at the time we negotiate and enter leases or lease renewals will generally determine rental rates and demand for leased space at our properties, and market conditions and government and other tenants' needs are beyond our control.
As of September 30, 2017,March 31, 2018, lease expirations at our consolidated properties by year are as follows (dollars in thousands):
| | | | Number | | Expirations | | | | | | | | Annualized | | | | | | Number | | Expirations | | | | | | Annualized | | | | |
| | of | | of Leased | | | | | | Cumulative | | Rental | | | | Cumulative | | of | | of Leased | | | | Cumulative | | Rental | | | | Cumulative |
| | Tenants | | Square | | | | Percent | | Percent | | Income | | Percent | | Percent | | Tenants | | Square | | Percent | | Percent | | Income | | Percent | | Percent |
Year (1) | | Expiring | | Feet (2) | | | | of Total | | of Total | | Expiring | | of Total | | of Total | | Expiring | | Feet (2) | | of Total | | of Total | | Expiring | | of Total | | of Total |
2017 | | 20 |
| | 434,049 |
| | | | 4.0 | % | | 4.0 | % | | $ | 10,004 |
| | 3.6 | % | | 3.6 | % | |
2018 | | 37 |
| | 704,708 |
| | | | 6.4 | % | | 10.4 | % | | 22,913 |
| | 8.3 | % | | 11.9 | % | | 96 |
| | 1,411,398 |
| | 8.6 | % | | 8.6 | % | | $ | 40,692 |
| | 9.6 | % | | 9.6 | % |
2019 | | 45 |
| | 1,940,016 |
| | | | 17.7 | % | | 28.1 | % | | 59,116 |
| | 21.5 | % | | 33.4 | % | | 92 |
| | 2,559,522 |
| | 15.6 | % | | 24.2 | % | | 73,394 |
| | 17.3 | % | | 26.9 | % |
2020 | | 39 |
| | 1,447,413 |
| | | | 13.2 | % | | 41.3 | % | | 40,155 |
| | 14.6 | % | | 48.0 | % | | 101 |
| | 2,390,456 |
| | 14.6 | % | | 38.8 | % | | 63,234 |
| | 14.9 | % | | 41.8 | % |
2021 | | 37 |
| | 1,061,519 |
| | | | 9.7 | % | | 51.0 | % | | 20,732 |
| | 7.5 | % | | 55.5 | % | | 83 |
| | 1,762,246 |
| | 10.8 | % | | 49.6 | % | | 36,619 |
| | 8.6 | % | | 50.4 | % |
2022 | | 31 |
| | 940,554 |
| | | | 8.6 | % | | 59.6 | % | | 22,505 |
| | 8.2 | % | | 63.7 | % | | 94 |
| | 1,670,331 |
| | 10.2 | % | | 59.8 | % | | 37,039 |
| | 8.7 | % | | 59.1 | % |
2023 | | 18 |
| | 595,662 |
| | | | 5.4 | % | | 65.0 | % | | 13,685 |
| | 5.0 | % | | 68.7 | % | | 56 |
| | 1,247,556 |
| | 7.6 | % | | 67.4 | % | | 36,534 |
| | 8.6 | % | | 67.7 | % |
2024 | | 16 |
| | 993,635 |
| | | | 9.1 | % | | 74.1 | % | | 22,696 |
| | 8.2 | % | | 76.9 | % | | 41 |
| | 1,402,556 |
| | 8.6 | % | | 76.0 | % | | 35,443 |
| | 8.4 | % | | 76.1 | % |
2025 | | 15 |
| | 801,648 |
| | | | 7.3 | % | | 81.4 | % | | 16,572 |
| | 6.0 | % | | 82.9 | % | | 32 |
| | 1,074,820 |
| | 6.6 | % | | 82.6 | % | | 24,770 |
| | 5.8 | % | | 81.9 | % |
2026 and thereafter | | 32 |
| | 2,027,097 |
| | (3) | | 18.6 | % | | 100.0 | % | | 47,042 |
| | 17.1 | % | | 100.0 | % | |
2026 | | | 23 |
| | 780,921 |
| | 4.8 | % | | 87.4 | % | | 22,945 |
| | 5.4 | % | | 87.3 | % |
2027 and thereafter | | | 50 |
| | 2,058,086 |
| | 12.6 | % | | 100.0 | % | | 53,510 |
| | 12.7 | % | | 100.0 | % |
Total | | 290 |
| | 10,946,301 |
| | | | 100.0 | % | | | | $ | 275,420 |
| | 100.0 | % | | | | 668 |
| | 16,357,892 |
| | 100.0 | % | | | | $ | 424,180 |
| | 100.0 | % | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Weighted average remaining lease term (in years) | Weighted average remaining lease term (in years) | | 5.1 | | | | | | | | 4.7 | | | | | Weighted average remaining lease term (in years) | | 4.6 | | | | | | 4.6 | | | | |
| |
(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, 2017,March 31, 2018, government tenants occupying approximately 13.2%9.0% of our consolidated rentable square feet and responsible for approximately 10.2%7.7% of our annualized rental income as of September 30, 2017March 31, 2018 have currently exercisable rights to terminate their leases before the stated terms of their leases expire. Also, in 2017, 2018, 2019, 2020, 2021, 2022, 2023, 2024, 2025, 2026, 2027 and 2027,2028 early termination rights become exercisable by other tenants who currently occupy an additional approximately 0.1%0.7%, 5.2%, 7.1%, 1.6%, 4.9%3.4%, 8.0%0.5%, 1.5%0.3%, 3.6%0.1%, 0.6%, 0.9%0.0% and 0.6% of our consolidated rentable square feet, respectively, and contribute an additional approximately 0.0%0.6%, 2.2%4.9%, 5.1%, 8.3%7.0%, 1.5%, 2.9%, 0.7%0.6%, 1.2%0.5%, 0.4%, 0.8%, 0.1% and 0.6%0.5% of our annualized rental income, respectively, as of September 30, 2017.March 31, 2018. In addition, as of September 30, 2017, 15March 31, 2018, 26 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 1526 tenants occupy approximately 17.3%13.0% of our consolidated rentable square feet and contribute approximately 16.8%12.3% of our annualized rental income as of September 30, 2017.March 31, 2018. |
| |
(2) | Leased square feet is pursuant to leases existing as of September 30, 2017,March 31, 2018, 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 an expansion being constructed at an existing property we own prior to the commencement of the lease. |
Acquisition and Disposition Activities (dollar amounts in thousands)
In January 2017,March 2018, we acquiredsold an office property (one building) located in Manassas, VAMinneapolis, MN with 69,374193,594 rentable square feet for $20,000, excluding closing costs.
As of March 31, 2018, we had two properties (two buildings) with an aggregate carrying value of $18,080 classified as held for sale in our condensed consolidated balance sheets and included in continuing operations in our condensed consolidated statements of comprehensive income. In February 2018, we entered an agreement to sell one of these office properties (one building) located in Sacramento, CA with 110,500 rentable square feet for $10,755, excluding closing costs. This sale is expected to occur in the second quarter of 2018. In February 2018, we entered an agreement to sell the second of these office properties (one building) located in Safford, AZ with 36,139 rentable square feet for $8,250, excluding closing costs. In April 2018, the agreement to sell this property was terminated.
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 purchase pricenet book value of $12,620,$96,633 at March 31, 2018 for $118,500, excluding capitalized acquisition costsclosing costs. This property did not meet the held for sale criteria as of $37,March 31, 2018. This sale is expected to occur in the second quarter of 2018.
As part of our long term plans to reduce our leverage, we expect to sell additional properties. We are marketing or plan to market for sale 23 properties (55 buildings) with an aggregate carrying value of $467,677 as of March 31, 2018. These properties did not meet held for sale criteria as of March 31, 2018.
We cannot be sure we will sell our properties under agreement or any of our properties that we are marketing or plan to market for sale or sell them for prices in excess of our carrying values. In addition, our pending sales are subject to conditions; accordingly, we cannot be sure that we will complete these sales or that these sales will not be delayed or their terms will not change.
Financing Activities (dollar amounts in thousands)
As of March 31, 2018 and December 31, 2017, one of our subsidiaries had 1,813,504 of 5.5% Series A Cumulative Preferred Units, or Preferred Units, outstanding. The $20,496 carrying value of these Preferred Units is recorded as temporary equity on our condensed consolidated balance sheets. On May 1, 2018, our subsidiary redeemed all of the outstanding Preferred Units for $11.15 per unit plus accrued and unpaid distributions (an aggregate of $20,310), using cash on hand and borrowings under our revolving credit facility. We acquired this property at a capitalization rate of 8.6%. 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 that we expected to pay 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 September 2017, we acquired 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.Segment Information
As described above, we completed the FPO Transaction on October 2, 2017. Pursuant to that transaction, we acquired 39 officeWe operate in two separate reportable business segments: ownership of real estate properties (74 buildings) with 6,454,382 rentable square feet, including two properties owned by joint venturesand our equity method investment in which we acquired FPO's 50% and 51% interests. The estimated aggregate transaction value of the FPO Transaction was $1,374,624.SIR.
Our ownership and operation of office properties in the metropolitan Washington, D.C. market area increased significantly as a result of the FPO Transaction and we may acquire additional properties in this area in the future. Outside of the metropolitan Washington, D.C. market area, our strategy related to property acquisitions is materially unchanged from that disclosed in our Annual Report and we will continue to explore and evaluate for possible acquisition additional properties that are majority leased to government tenants and government contractor tenants. Until we have fully integrated the FPO properties into our business we expect that our acquisition activities may be reduced. Also, as part of the long term financing plan for the FPO Transaction, we expect to identify properties within our portfolio for disposition. Generally, we identify properties for sale based on market conditions in the area where the property is located, our expectations regarding property future financial 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.
In August 2017, we sold a vacant office property (one building) located in Falls Church, VA with 164,746 rentable square feet and a net book value of $12,901 as of the sale date for $13,523, excluding closing costs.
In October 2017, we sold a vacant office property (one building) located in Albuquerque, NM with 29,045 rentable square feet and a net book value of $1,885, as of September 30, 2017 for $2,000, excluding closing costs.
Financing Activities (dollar amounts in thousands except per share amounts)
On July 5, 2017, we sold 25,000,000 of 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 was $493,936, after payment of the underwriters' discount and other offering expenses. We used part of the proceeds from these sales to repay amounts outstanding under our revolving credit facility and used the remaining proceeds to finance, in part, the FPO Transaction.
In July 2017, we issued $300,000 of 4.000% senior unsecured notes due 2022 in an underwritten public offering. The net proceeds from this offering of $295,403, after payment of the underwriters' discount and other offering expenses, were used to finance, in part, the FPO Transaction.
Concurrently with our entering into the FPO merger agreement, we entered a commitment letter with a group of institutional lenders for a 364-day senior unsecured bridge loan facility in an initial aggregate principal amount of $750,000. On July 20, 2017, we and the lenders terminated this commitment letter and bridge loan facility as a result of our issuance of the senior unsecured notes and the proceeds from the sale of our common shares in July 2017, each as described above, and we recognized a loss on extinguishment of debt of $1,715.
RESULTS OF OPERATIONS (amounts in thousands, except per share amounts)
Three Months Ended September 30, 2017,March 31, 2018, Compared to Three Months Ended September 30, 2016March 31, 2017
| | | | | | | | | | | | Acquired Properties | | Disposed Property | | | | | | | | | | | | | | | | | | Acquired Properties | | Disposed Properties | | | | | | | | |
| | | | | | | | | | Results (2) | | Results (3) | | | | | | | | | | | | | | | | | | Results (2) | | Results (3) | | | | | | | | |
| | Comparable Properties Results (1) | | Three Months Ended | | Three Months Ended | | Consolidated Results | | 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, | | Three Months Ended March 31 | | March 31, | | March 31, | | Three Months Ended March 31, |
| | | | | | $ | | % | | | | | | | | | | | | | | $ | | % | | | | | | $ | | % | | | | | | | | | | | | | | $ | | % |
| | 2017 | | 2016 | | Change | | Change | | 2017 | | 2016 | | 2017 | | 2016 | | 2017 | | 2016 | | Change | | Change | | 2018 | | 2017 | | Change | | Change | | 2018 | | 2017 | | 2018 | | 2017 | | 2018 | | 2017 | | Change | | Change |
Rental income | | $ | 66,038 |
| | $ | 64,478 |
| | $ | 1,560 |
| | 2.4 | % | | $ | 4,141 |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | 70,179 |
| | $ | 64,478 |
| | $ | 5,701 |
| | 8.8 | % | | $ | 69,589 |
| | $ | 68,143 |
| | $ | 1,446 |
| | 2.1 | % | | $ | 38,503 |
| | $ | 405 |
| | $ | 625 |
| | $ | 748 |
| | $ | 108,717 |
| | $ | 69,296 |
| | $ | 39,421 |
| | 56.9 | % |
Operating expenses: | | |
| | |
| | | | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | | | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
|
Real estate taxes | | 8,354 |
| | 7,591 |
| | 763 |
| | 10.1 | % | | 507 |
| | — |
| | 1 |
| | — |
| | 8,862 |
| | 7,591 |
| | 1,271 |
| | 16.7 | % | | 8,645 |
| | 8,048 |
| | 597 |
| | 7.4 | % | | 4,255 |
| | 26 |
| | 64 |
| | 103 |
| | 12,964 |
| | 8,177 |
| | 4,787 |
| | 58.5 | % |
Utility expenses | | 5,092 |
| | 5,483 |
| | (391 | ) | | (7.1 | %) | | 316 |
| | — |
| | — |
| | — |
| | 5,408 |
| | 5,483 |
| | (75 | ) | | (1.4 | %) | | 4,685 |
| | 4,453 |
| | 232 |
| | 5.2 | % | | 1,870 |
| | 7 |
| | 135 |
| | 146 |
| | 6,690 |
| | 4,606 |
| | 2,084 |
| | 45.2 | % |
Other operating expenses | | 14,079 |
| | 13,854 |
| | 225 |
| | 1.6 | % | | 746 |
| | — |
| | 42 |
| | — |
| | 14,867 |
| | 13,854 |
| | 1,013 |
| | 7.3 | % | | 14,712 |
| | 13,591 |
| | 1,121 |
| | 8.2 | % | | 7,825 |
| | 60 |
| | 300 |
| | 341 |
| | 22,837 |
| | 13,992 |
| | 8,845 |
| | 63.2 | % |
Total operating expenses | | 27,525 |
| | 26,928 |
| | 597 |
| | 2.2 | % | | 1,569 |
| | — |
| | 43 |
| | — |
| | 29,137 |
| | 26,928 |
| | 2,209 |
| | 8.2 | % | | 28,042 |
| | 26,092 |
| | 1,950 |
| | 7.5 | % | | 13,950 |
| | 93 |
| | 499 |
| | 590 |
| | 42,491 |
| | 26,775 |
| | 15,716 |
| | 58.7 | % |
Net operating income (4) | | $ | 38,513 |
| | $ | 37,550 |
| | $ | 963 |
| | 2.6 | % | | $ | 2,572 |
| | $ | — |
| | $ | (43 | ) | | $ | — |
| | 41,042 |
| | 37,550 |
| | 3,492 |
| | 9.3 | % | | $ | 41,547 |
| | $ | 42,051 |
| | $ | (504 | ) | | (1.2 | %) | | $ | 24,553 |
| | $ | 312 |
| | $ | 126 |
| | $ | 158 |
| | 66,226 |
| | 42,521 |
| | 23,705 |
| | 55.7 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Other expenses: | | |
| | |
| | | | |
| | |
| | |
| | | | | | |
| | |
| | | | |
| | |
| | |
| | | | |
| | |
| | |
| | | | | | |
| | |
| | | | |
|
Depreciation and amortization | | |
| | |
| | | | |
| | |
| | |
| | | | | | 20,781 |
| | 18,404 |
| | 2,377 |
| | 12.9 | % | Depreciation and amortization | | 44,204 |
| | 20,505 |
| | 23,699 |
| | 115.6 | % |
Loss on impairment of real estate | | |
| | |
| | | | |
| | |
| | |
| | | | | | 230 |
| | — |
| | 230 |
| | nm |
| Loss on impairment of real estate | | 6,116 |
| | — |
| | 6,116 |
| | nm |
|
Acquisition related costs | | |
| | |
| | | | |
| | |
| | |
| | | | | | — |
| | 147 |
| | (147 | ) | | nm |
| |
General and administrative | | |
| | |
| | | | |
| | |
| | |
| | | | | | 3,266 |
| | 3,816 |
| | (550 | ) | | (14.4 | %) | General and administrative | | 9,606 |
| | 3,962 |
| | 5,644 |
| | 142.5 | % |
Total other expenses | | |
| | |
| | | | |
| | |
| | |
| | | | | | 24,277 |
| | 22,367 |
| | 1,910 |
| | 8.5 | % | Total other expenses | | 59,926 |
| | 24,467 |
| | 35,459 |
| | 144.9 | % |
Operating income | | |
| | |
| | | | |
| | |
| | |
| | | | | | 16,765 |
| | 15,183 |
| | 1,582 |
| | 10.4 | % | Operating income | | 6,300 |
| | 18,054 |
| | (11,754 | ) | | (65.1 | %) |
Dividend income | | |
| | |
| | | | |
| | |
| | |
| | | | | | 304 |
| | 304 |
| | — |
| | — | % | Dividend income | | 304 |
| | 304 |
| | — |
| | — | % |
Unrealized gain on equity securities | | Unrealized gain on equity securities | — |
| 12,931 |
| — |
| — |
| — |
| 12,931 |
| | nm |
|
Interest income | | |
| | |
| | | | |
| | |
| | |
| | | | | | 1,715 |
| | 47 |
| | 1,668 |
| | nm |
| Interest income | | 116 |
| | 61 |
| | 55 |
| | 90.2 | % |
Interest expense (including net amortization of debt premiums and discounts and debt issuance costs of $990 and $805, respectively) | | (16,055 | ) | | (12,608 | ) | | (3,447 | ) | | 27.3 | % | |
Loss on early extinguishment of debt | | (1,715 | ) | | — |
| | (1,715 | ) | | nm |
| |
Gain on issuance of shares by Select Income REIT | | 51 |
| | 72 |
| | (21 | ) | | (29.2 | %) | |
Income from continuing operations before income taxes and equity in earnings of investees | | 1,065 |
| | 2,998 |
| | (1,933 | ) | | (64.5 | %) | |
Interest expense (including net amortization of debt premiums and discounts and debt issuance costs of $965 and $807, respectively) | | Interest expense (including net amortization of debt premiums and discounts and debt issuance costs of $965 and $807, respectively) | | (22,766 | ) | | (13,581 | ) | | (9,185 | ) | | 67.6 | % |
Income (loss) from continuing operations before income taxes and equity in earnings of investees | | Income (loss) from continuing operations before income taxes and equity in earnings of investees | | (3,115 | ) | | 4,838 |
| | (7,953 | ) | | (164.4 | %) |
Income tax expense | Income tax expense | | (22 | ) | | (13 | ) | | (9 | ) | | 69.2 | % | Income tax expense | | (32 | ) | | (18 | ) | | (14 | ) | | 77.8 | % |
Equity in earnings of investees | Equity in earnings of investees | | 9,484 |
| | 8,668 |
| | 816 |
| | 9.4 | % | Equity in earnings of investees | | 9,712 |
| | 2,739 |
| | 6,973 |
| | 254.6 | % |
Income from continuing operations | Income from continuing operations | | 10,527 |
| | 11,653 |
| | (1,126 | ) | | (9.7 | %) | Income from continuing operations | | 6,565 |
| | 7,559 |
| | (994 | ) | | (13.1 | %) |
Income (loss) from discontinued operations | | 462 |
| | (154 | ) | | 616 |
| | nm |
| |
Income before gain on sale of property | | 10,989 |
| | 11,499 |
| | (510 | ) | | (4.4 | %) | |
Gain on sale of property | | — |
| | 79 |
| | (79 | ) | | nm |
| |
Loss from discontinued operations | | Loss from discontinued operations | | — |
| | (144 | ) | | 144 |
| | (100.0 | %) |
Net income | Net income | | $ | 10,989 |
| | $ | 11,578 |
| | $ | (589 | ) | | (5.1 | %) | Net income | | 6,565 |
| | 7,415 |
| | (850 | ) | | (11.5 | %) |
Preferred units of limited partnership distributions | | Preferred units of limited partnership distributions | | (278 | ) | | — |
| | (278 | ) | | nm |
|
Net income available for common shareholders | | Net income available for common shareholders | | $ | 6,287 |
| | $ | 7,415 |
| | $ | (1,128 | ) | | (15.2 | %) |
| | | | | | | | | | | | | | | | | | |
Weighted average common shares outstanding (basic) | Weighted average common shares outstanding (basic) | | 96,883 |
| | 71,054 |
| | 25,829 |
| | 36.4 | % | Weighted average common shares outstanding (basic) | | 99,041 |
| | 71,079 |
| | 27,962 |
| | 39.3 | % |
Weighted average common shares outstanding (diluted) | Weighted average common shares outstanding (diluted) | | 96,958 |
| | 71,084 |
| | 25,874 |
| | 36.4 | % | Weighted average common shares outstanding (diluted) | | 99,049 |
| | 71,094 |
| | 27,955 |
| | 39.3 | % |
| | | | | | | | | | | | | | | | | | |
Per common share amounts (basic and diluted): | Per common share amounts (basic and diluted): | | |
| | |
| | | | |
| Per common share amounts (basic and diluted): | | |
| | |
| | | | |
|
Income from continuing operations | Income from continuing operations | | $ | 0.11 |
| | $ | 0.16 |
| | $ | (0.05 | ) | | (31.3 | %) | Income from continuing operations | | $ | 0.07 |
| | $ | 0.11 |
| | $ | (0.04 | ) | | (36.4 | %) |
Income (loss) from discontinued operations | | $ | — |
| | $ | — |
| | $ | — |
| | — | % | |
Loss from discontinued operations | | Loss from discontinued operations | | $ | — |
| | $ | — |
| | $ | — |
| | — | % |
Net income available for common shareholders | | Net income available for common shareholders | | $ | 0.06 |
| | $ | 0.10 |
| | $ | (0.04 | ) | | (40.0 | %) |
| | | | | | | | | | |
Reconciliation of Net Income Available for Common Shareholders to Consolidated Property NOI: (4) | | Reconciliation of Net Income Available for Common Shareholders to Consolidated Property NOI: (4) | | | | | | | | |
Net income available for common shareholders | | Net income available for common shareholders | | $ | 6,287 |
| | $ | 7,415 |
| | | | |
Preferred units of limited partnership distributions | | Preferred units of limited partnership distributions | | 278 |
| | — |
| | | | |
Net income | Net income | | $ | 0.11 |
| | $ | 0.16 |
| | $ | (0.05 | ) | | (31.3 | %) | Net income | | 6,565 |
| | 7,415 |
| | | | |
| | | | | | | | | |
Reconciliation of Net Income to NOI: (4) | | | | | | | | | |
Net income | | $ | 10,989 |
| | $ | 11,578 |
| | | | | |
Gain on sale of property | | — |
| | (79 | ) | | | | | |
Income before gain on sale of property | | 10,989 |
| | 11,499 |
| | | | | |
(Income) loss from discontinued operations | | (462 | ) | | 154 |
| | | | | |
Loss from discontinued operations | | Loss from discontinued operations | | — |
| | 144 |
| | | | |
Income from continuing operations | Income from continuing operations | | 10,527 |
| | 11,653 |
| | | | | Income from continuing operations | | 6,565 |
| | 7,559 |
| | | | |
Equity in earnings of investees | Equity in earnings of investees | | (9,484 | ) | | (8,668 | ) | | | | | Equity in earnings of investees | | (9,712 | ) | | (2,739 | ) | | | | |
Income tax expense | Income tax expense | | 22 |
| | 13 |
| | | | | Income tax expense | | 32 |
| | 18 |
| | | | |
Gain on issuance of shares by Select Income REIT | | (51 | ) | | (72 | ) | | | | | |
Loss on early extinguishment of debt | | 1,715 |
| | — |
| | | | | |
Interest expense | Interest expense | | 16,055 |
| | 12,608 |
| | | | | Interest expense | | 22,766 |
| | 13,581 |
| | | | |
Interest income | Interest income | | (1,715 | ) | | (47 | ) | | | | | Interest income | | (116 | ) | | (61 | ) | | | | |
Unrealized gain on equity securities | | Unrealized gain on equity securities | | (12,931 | ) | | — |
| | | | |
Dividend income | Dividend income | | (304 | ) | | (304 | ) | | | | | Dividend income | | (304 | ) | | (304 | ) | | | | |
Operating income | Operating income | | 16,765 |
| | 15,183 |
| | | | | Operating income | | 6,300 |
| | 18,054 |
| | | | |
General and administrative | General and administrative | | 3,266 |
| | 3,816 |
| | | | | General and administrative | | 9,606 |
| | 3,962 |
| | | | |
Acquisition related costs | | — |
| | 147 |
| | | | | |
Loss on impairment of real estate | Loss on impairment of real estate | | 230 |
| | — |
| | | | | Loss on impairment of real estate | | 6,116 |
| | — |
| | | | |
Depreciation and amortization | Depreciation and amortization | | 20,781 |
| | 18,404 |
| | | | | Depreciation and amortization | | 44,204 |
| | 20,505 |
| | | | |
Net operating income | Net operating income | | $ | 41,042 |
| | $ | 37,550 |
| | | | | Net operating income | | $ | 66,226 |
| | $ | 42,521 |
| | | | |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Reconciliation of Net Income to Funds From Operations and Normalized Funds From Operations (5) | | |
| | |
| | | | |
| | 2017 | | 2016 | | | | |
Net income | | $ | 10,989 |
| | $ | 11,578 |
| | | | |
Plus: Depreciation and amortization | | 20,781 |
| | 18,404 |
| | | | |
Plus: FFO attributable to Select Income REIT investment | | 18,429 |
| | 17,264 |
| | | | |
Plus: Loss on impairment of real estate | | 230 |
| | — |
| | | | |
Less: Equity in earnings from Select Income REIT | | (9,453 | ) | | (8,655 | ) | | | | |
Less: Increase in carrying value of property included in discontinued operations | | (619 | ) | | — |
| | | | |
Less: Gain on sale of property | | — |
| | (79 | ) | | | | |
Funds from operations | | 40,357 |
| | 38,512 |
| | | | |
Plus: Acquisition related costs | | — |
| | 147 |
| | | | |
Plus: Loss on early extinguishment of debt | | 1,715 |
| | — |
| | | | |
Plus: Normalized FFO attributable to Select Income REIT investment | | 16,903 |
| | 17,267 |
| | | | |
Less: FFO attributable to Select Income REIT investment | | (18,429 | ) | | (17,264 | ) | | | | |
Less: Gain on issuance of shares by Select Income REIT | | (51 | ) | | (72 | ) | | | | |
Less: Estimated business management incentive fee (6) | | (893 | ) | | — |
| | | | |
Normalized funds from operations | | $ | 39,602 |
| | $ | 38,590 |
| | | | |
| | | | | | | | |
Funds from operations per common share (basic and diluted) | | $ | 0.42 |
| | $ | 0.54 |
| | | | |
Normalized funds from operations per common share (basic and diluted) | | $ | 0.41 |
| | $ | 0.54 |
| | | | |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Calculation of Funds From Operations Available for Common Shareholders and Normalized Funds From Operations Available for Common Shareholders (5) | | | | |
| | 2018 | | 2017 | | | | |
Net income available for common shareholders | | $ | 6,287 |
| | $ | 7,415 |
| | | | |
Plus: Depreciation and amortization | | | | | | | | |
Consolidated properties | | 44,204 |
| | 20,505 |
| | | | |
Unconsolidated joint venture properties | | 2,185 |
| | — |
| | | | |
Plus: FFO attributable to Select Income REIT investment | | 18,488 |
| | 12,404 |
| | | | |
Plus: Loss on impairment of real estate | | 6,116 |
| | — |
| | | | |
Less: Equity in earnings from Select Income REIT | | (10,289 | ) | | (2,611 | ) | | | | |
Funds from operations available for common shareholders | | 66,991 |
| | 37,713 |
| | | | |
Plus: Normalized FFO attributable to Select Income REIT investment | | 15,606 |
| | 14,590 |
| | | | |
Less: FFO attributable to Select Income REIT investment | | (18,488 | ) | | (12,404 | ) | | | | |
Less: Estimated business management incentive fees (6) | | 2,887 |
| | — |
| | | | |
Less: Unrealized gain on equity securities | | (12,931 | ) | | — |
| | | | |
Normalized funds from operations available for common shareholders | | $ | 54,065 |
| | $ | 39,899 |
| | | | |
| | | | | | | | |
Funds from operations per common share available for common shareholders (basic and diluted) | | $ | 0.68 |
| | $ | 0.53 |
| | | | |
Normalized funds from operations per common share available for common shareholders (basic and diluted) | | $ | 0.55 |
| | $ | 0.56 |
| | | | |
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(1) | Comparable properties consist of 71 consolidated properties (91(93 buildings) we owned on September 30, 2017March 31, 2018 and which we owned continuously since JulyJanuary 1, 2016.2017. |
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(2) | Acquired properties consist of three36 consolidated properties (five(73 buildings) we acquired since JulyJanuary 1, 2016.2017. In October 2017, we acquired 35 of these properties (72 buildings) in connection with the FPO Transaction and acquired one property (one building) in a separate transaction in January 2017. |
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(3) | Disposed property consistsproperties consist of one consolidated property (one building) which we sold in July 2016October 2017 and one consolidated property (one building) we sold during the three months ended March 31, 2018 and excludes one property (one building) classified as discontinued operations which was sold in August 2017. |
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(4) | The calculation of net operating income,Consolidated Property Net Operating Income, or NOI, excludes certain components of net income available for common shareholders in order to provide results that are more closely related to our consolidated property level results of operations. We define Consolidated Property NOI as consolidated income from our rental of real estate less our consolidated property operating expenses. Consolidated Property NOI excludes amortization of capitalized tenant improvement costs and leasing commissions that we record as depreciation and amortization. We consider Consolidated Property NOI to be an appropriate supplemental measure to net income available for common shareholders because it may help both investors and management to understand the operations of our consolidated properties. We use Consolidated Property NOI to evaluate individual and company wide consolidated property level performance, and we believe that Consolidated Property 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. Consolidated Property 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 an alternative to net income, net income available for common shareholders 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, net income available for common shareholders and operating income as presented in our condensed consolidated statements of comprehensive income.income (loss). Other REITs and real estate companies and REITs may calculate Consolidated Property NOI differently than we do. |
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(5) | We calculate funds from operations, or FFO, available for common shareholders and normalized funds from operations, or Normalized FFO, available for common shareholders as shown above. FFO available for common shareholders is calculated on the basis defined by The National Association of Real Estate Investment Trusts, or NAREIT,Nareit, which is net income available for common shareholders calculated in accordance with GAAP, plus real estate depreciation and amortization of consolidated properties and our proportionate share of the real estate depreciation and amortization of unconsolidated joint venture properties and the difference between FFO attributable to an equity investment and equity in earnings of an equity investee but excluding impairment charges on and increases in the carrying value of real estate assets, any gain or loss on sale of properties,real estate, as well as certain other adjustments currently not applicable to us. Our calculation of Normalized FFO available for common shareholders differs from NAREIT'sNareit's definition of FFO available for common shareholders because we include SIR's Normalized FFO attributable to our equity investment in SIR net(net of FFO attributable to our equity investment in SIR,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 be payable when all contingencies for determining such fees are known at the end of the calendar year and we exclude acquisition related costs expensed under GAAP,unrealized gains and losses on issuance of shares by SIR and gains and losses on early extinguishment of debt.equity securities. We consider FFO available for common shareholders and Normalized FFO available for common shareholders to be appropriate supplemental measures of operating performance for a REIT, along with net income, net income available for our common shareholders and operating income. We believe that FFO available for common shareholders and Normalized FFO available for common shareholders provide useful information to investors because by excluding the effects of certain historical amounts, such as depreciation expense, FFO available for common shareholders and Normalized FFO available for common shareholders may facilitate a comparison of our operating performance between periods and with other REITs. FFO available for common shareholders and Normalized FFO available for common shareholders 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 for and availability of cash to pay our obligations. FFO available for common shareholders and Normalized FFO available for common shareholders do not represent cash generated by operating activities in accordance with GAAP and should not be considered alternatives to net income, net income available for common shareholders or operating income as indicators of our operating performance or as measures of our liquidity. These measures should be considered in conjunction with net income, net income available for common shareholders and operating income as presented in our condensed consolidated statements of comprehensive income. Other REITs and real estate companies and REITs may calculate FFO available for common shareholders and Normalized FFO available for common shareholders differently than we do. |
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(6) | Incentive fees under our business management agreement with The RMR Group LLC, or RMR LLC, are payable after the end of each calendar year, are calculated based on common share total return, as defined, and are included in general and administrative expensesexpense in our condensed consolidated statements of comprehensive income. In calculating net income available for common shareholders in accordance with GAAP, we recognize estimated business management incentive fee expense, if any, in the first, second and third quarters. Although we recognize this expense, if any, in the first, second and third quarters for purposes of calculating net income available for common shareholders, we do not include such expense in the calculation of Normalized FFO available for common shareholders until the fourth quarter, when the amount of the business management incentive fee expense for the calendar year, if any, is determined. General and administrative expenses for the three months ended September 30, 2017 includes the reversal of $893 of previously accrued estimated business management fees. |
We refer to the 71 consolidated properties (91(93 buildings) we owned on September 30, 2017March 31, 2018 and which we have owned continuously since JulyJanuary 1, 20162017 as comparable properties. We refer to the three36 consolidated properties (five(73 buildings) whichthat we acquired since Julyduring the period from January 1, 20162017 to March 31, 2018 as the acquired properties. We refer to the one property (one building)two properties (two buildings) we sold in July 2016during the period from January 1, 2017 to March 31, 2018 as the disposed property.properties.
Our condensed consolidated statements of comprehensive income for the three months ended September 30, 2017March 31, 2018 include the operating results of three36 acquired properties (five(73 buildings) for the entire period, as we acquired those properties prior to July 1,during 2017, and exclude the operating results of the one disposed property (one building) for the entire period, as we sold that property prior to July 1, 2017. Our condensed consolidated statements of comprehensive income for the three months ended September 30, 2016during 2017, and exclude the operating results of three acquired properties (five buildings) for the entire period, as we acquired those properties after September 30, 2016 and include the operating results of the one disposed property (one building) for less than the entire period, as we sold thatthe property during the 2018 period. Our condensed consolidated statements of comprehensive income for the three months ended September 30, 2016.March 31, 2017 exclude the operating results of 35 acquired properties (72 buildings) for the entire period, as we acquired those properties after March 31, 2017, include the operating results of one acquired property (one building) for less than the entire period, as we acquired the property during the 2017 period and include the operating results of two disposed properties (two buildings) for the entire period as we sold those properties after March 31, 2017.
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, 2017,March 31, 2018, compared to the three month period ended September 30, 2016.March 31, 2017.
Rental income. The increase in rental income reflects an increase in rental income for comparable properties and the rental income from the acquired properties, partially offset by a decrease in rental income from the disposed properties. Rental income fromfor comparable properties increased $1,560$1,446 primarily due to increases in rental rates and in occupied space at certain of our properties in the 20172018 period. Rental income increased $4,141$38,098 as a result of the acquired properties. Rental income declined $123 as a result of the disposed properties. Rental income includes non-cash straight line rent adjustments totaling $711$3,091 in the 20172018 period and $1,205$1,300 in the 20162017 period, and amortization of acquired leases and assumed lease obligations totaling ($619)835) in the 20172018 period and ($370)627) in the 20162017 period.
Real estate taxes. The increase in real estate taxes reflects an increase in real estate taxes for comparable properties and the real estate taxes for the acquired properties, partially offset by a decrease in real estate taxes for the disposed properties. Real estate taxes for comparable properties increased $763$597 due primarily to the effect of higher real estate tax valuation assessments at certain of our properties in the 20172018 period. Real estate taxes increased $507$4,229 as a result of the acquired properties. Real estate taxes declined $39 as a result of the disposed properties.
Utility expenses. The decreaseincrease in utility expenses reflects a declinean increase in utility expenses for the comparable properties and utility expenses for the acquired properties, partially offset by a decrease in utility expenses for the net effect of the acquired and disposed properties. Utility expenses at comparable properties decreased $391increased $232 primarily due to a decreasean increase in electricity usage and rates at certain of our buildings during the 20172018 period. Utility expenses increased $316$1,863 as a result of the acquired properties. Utility expenses declined $11 as a result of the disposed properties.
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. The increase in other operating expenses reflects an increase in expenses for the comparable properties and the net effect ofother operating expenses for the acquired andproperties, partially offset by a decrease in other operating expenses for the disposed properties. Other operating expenses at the comparable properties increased $225$1,121 primarily as a result of higher repairs and maintenance costs during the 20172018 period. Other operating expenses increased $746$7,765 as a result of the acquired properties and increased $42properties. Other operating expenses declined $41 as a result of the disposed property.properties.
Depreciation and amortization. The increase in depreciation and amortization reflects the depreciation and amortization fromeffect of the acquired properties and the effect of improvements made to certain of our comparable properties, partially offset by the effect of certain assets becoming fully depreciated.depreciated and property dispositions. Depreciation and amortization increased $1,921$23,442 as a result of the acquired properties. Depreciation and amortization at comparable properties increased $456$399 due primarily to depreciation and amortization of improvements made to certain of our properties after JulyJanuary 1, 2016,2017, partially offset by certain leasing related
assets becoming fully depreciated after JulyJanuary 1, 2016.2017. Depreciation and amortization declined $142 as a result of the disposed properties.
Loss on impairment of real estate. We recorded a $230$6,116 loss on impairment of real estate in the 20172018 period to reduce the carrying value of one property (one building)three properties (three buildings) to itstheir estimated fair value.
Acquisition related costs. Acquisition relatedvalue less costs include legal and diligence costs incurred in connection with our 2016 property acquisition activities that were expensed in accordance with GAAP. Pursuant to changes in GAAP, beginning in 2017, we generally capitalize our asset acquisition related costs.sell.
General and administrative. General and administrative expenses consist of fees pursuant to our business management agreement, 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 decreaseincrease in general and administrative expenses is primarily as a result of the reversal in the 2017 period of $893 of previously accrued estimated business management incentive fee expense, partially offset by an increase in other business management fee expensefees as a result of our acquisition activity and the estimated incentive fees accrued in the 20172018 period.
Dividend income. Dividend income consists of dividends received from our investment in The RMR Group Inc., or RMR Inc.
Unrealized gain on equity securities. Unrealized gain on equity securities represents the adjustment required to adjust the carrying value of our investment in RMR Inc. common shares to its fair value as of March 31, 2018 in accordance with new GAAP standards effective January 1, 2018.
Interest income. The increase in interest income is primarily the result of higher cash balances in the 2017 period due to our financing activities related to the FPO Transaction.2018 period.
Interest expense. The increase in interest expense reflects higher average outstanding debt balances and higher weighted average interest rates on borrowings during the 20172018 period compared to the 20162017 period.
Loss on early extinguishment of debt. We recorded a loss on early extinguishment of debt of $1,715 in the 2017 period in connection with the termination of the bridge loan facility described in Note 7 to our condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q.
Gain on issuance of shares by Select Income REIT. Gain on issuance of shares by SIR is a result of the issuance of common shares by SIR at prices above our then per share carrying value of our SIR common shares.
Income tax expense. The increase in income tax expense reflects higher operating income in certain jurisdictions in the 20172018 period that isare 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 Affiliates Insurance Company, or AIC. The increase in the 2017 period is primarily the result of an increase in SIR's net income for the 2017 period.AIC, and two unconsolidated joint ventures.
Income (loss)Loss from discontinued operations. Income (loss)Loss from discontinued operations reflects operating results for one property (one building) included in discontinued operations. Duringoperations during the 2017 period, we recorded an adjustment of $619 to increase the carrying value of this property to its estimated fair value less costs to sell.period. We sold this property onin August 31, 2017.
Gain on salePreferred units of property.limited partnership distributions. Gain on salePreferred units of property representslimited partnership distributions represent distributions to the portionholders of the gain recognized from the sale of a property accounted for under the installment method during the 2016 period.Preferred Units.
Net income.income and net income available for common shareholders. Our net income, net income available for common shareholders and net income available for common shareholders per basic and diluted common share decreased in the 20172018 period compared to the 20162017 period primarily as a result of the changes noted above. The percentage decrease in net income available for common shareholders per common share (basic and diluted) is higher primarily as a result of the higher number of weighted average common shares outstanding as result of our issuance of common shares in an underwritten public offering during the 2017 period.
RESULTS OF OPERATIONS(amounts in thousands, except per share amounts)
Nine Months Ended September 30, 2017, Compared to Nine Months Ended September 30, 2016
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| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | Acquired Properties | | Disposed Property | | | | | | | | |
| | | | | | | | | | 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, |
| | | | | | $ | | % | | | | | | | | | | | | | | $ | | % |
| | 2017 | | 2016 | | Change | | Change | | 2017 | | 2016 | | 2017 | | 2016 | | 2017 | | 2016 | | Change | | Change |
Rental income | | $ | 189,558 |
| | $ | 186,298 |
| | $ | 3,260 |
| | 1.7 | % | | $ | 19,804 |
| | $ | 5,852 |
| | $ | — |
| | $ | — |
| | $ | 209,362 |
| | $ | 192,150 |
| | $ | 17,212 |
| | 9.0 | % |
Operating expenses: | | | | | | | | | | | | | | | | | | | | | | | | |
Real estate taxes | | 22,916 |
| | 22,259 |
| | 657 |
| | 3.0 | % | | 2,064 |
| | 524 |
| | — |
| | 27 |
| | 24,980 |
| | 22,810 |
| | 2,170 |
| | 9.5 | % |
Utility expenses | | 12,788 |
| | 12,889 |
| | (101 | ) | | (0.8 | %) | | 1,398 |
| | 417 |
| | — |
| | 24 |
| | 14,186 |
| | 13,330 |
| | 856 |
| | 6.4 | % |
Other operating expenses | | 40,424 |
| | 38,535 |
| | 1,889 |
| | 4.9 | % | | 3,587 |
| | 1,438 |
| | 35 |
| | 58 |
| | 44,046 |
| | 40,031 |
| | 4,015 |
| | 10.0 | % |
Total operating expenses | | 76,128 |
| | 73,683 |
| | 2,445 |
| | 3.3 | % | | 7,049 |
| | 2,379 |
| | 35 |
| | 109 |
| | 83,212 |
| | 76,171 |
| | 7,041 |
| | 9.2 | % |
Net operating income (4) | | $ | 113,430 |
| | $ | 112,615 |
| | $ | 815 |
| | 0.7 | % | | $ | 12,755 |
| | $ | 3,473 |
| | $ | (35 | ) | | $ | (109 | ) | | 126,150 |
| | 115,979 |
| | 10,171 |
| | 8.8 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Other expenses: | | | | | | | | | | | | | | | | | | | | | | | | |
Depreciation and amortization | | | | | | | | | | | | | | | | | | 61,949 |
| | 54,713 |
| | 7,236 |
| | 13.2 | % |
Loss on impairment of real estate | | | | | | | | | | | | | | | | | | 230 |
| | — |
| | 230 |
| | nm |
|
Acquisition related costs | | | | | | | | | | | | | | | | | | — |
| | 363 |
| | (363 | ) | | nm |
|
General and administrative | | | | | | | | | | | | | | | | | | 12,314 |
| | 11,350 |
| | 964 |
| | 8.5 | % |
Total other expenses | | | | | | | | | | | | | | | | | | 74,493 |
| | 66,426 |
| | 8,067 |
| | 12.1 | % |
Operating income | | | | | | | | | | | | | | | | | | 51,657 |
| | 49,553 |
| | 2,104 |
| | 4.2 | % |
Dividend income | | | | | | | | | | | | | | | | | | 911 |
| | 667 |
| | 244 |
| | 36.6 | % |
Interest income | | | | | | | | | | | | | | | | | | 1,843 |
| | 63 |
| | 1,780 |
| | nm |
|
Interest expense (including net amortization of debt premium and discounts and debt issuance costs of $2,605 and $2,024, respectively) | | (43,599 | ) | | (32,286 | ) | | (11,313 | ) | | 35.0 | % |
(Loss) gain on early extinguishment of debt | | (1,715 | ) | | 104 |
| | (1,819 | ) | | nm |
|
Gain on issuance of shares by Select Income REIT | | 72 |
| | 88 |
| | (16 | ) | | (18.2 | %) |
Income from continuing operations before income taxes and equity in earnings of investees | | 9,169 |
| | 18,189 |
| | (9,020 | ) | | (49.6 | %) |
Income tax expense | | (65 | ) | | (63 | ) | | (2 | ) | | 3.2 | % |
Equity in earnings of investees | | 20,804 |
| | 28,002 |
| | (7,198 | ) | | (25.7 | %) |
Income from continuing operations | | 29,908 |
| | 46,128 |
| | (16,220 | ) | | (35.2 | %) |
Income (loss) from discontinued operations | | 173 |
| | (429 | ) | | 602 |
| | nm |
|
Income before gain on sale of property | | 30,081 |
| | 45,699 |
| | (15,618 | ) | | (34.2 | %) |
Gain on sale of property | | — |
| | 79 |
| | (79 | ) | | nm |
|
Net income | | $ | 30,081 |
| | $ | 45,778 |
| | $ | (15,697 | ) | | (34.3 | %) |
| | | | | | | | |
Weighted average common shares outstanding (basic) | | 79,778 |
| | 71,041 |
| | 8,737 |
| | 12.3 | % |
Weighted average common shares outstanding (diluted) | | 79,852 |
| | 71,064 |
| | 8,788 |
| | 12.4 | % |
| | | | | | | | |
Per common share amounts (basic and diluted): | | | | | | | | |
Income from continuing operations | | $ | 0.37 |
| | $ | 0.65 |
| | $ | (0.28 | ) | | (43.1 | %) |
Income (loss) from discontinued operations | | $ | — |
| | $ | (0.01 | ) | | $ | 0.01 |
| | — | % |
Net income | | $ | 0.38 |
| | $ | 0.64 |
| | $ | (0.26 | ) | | (40.6 | %) |
| | | | | | | | |
Reconciliation of Net Income to NOI: (4) | | | | | | | | |
Net income | | $ | 30,081 |
| | $ | 45,778 |
| | | | |
Gain on sale of property | | — |
| | (79 | ) | | | | |
Income before gain on sale of property | | 30,081 |
| | 45,699 |
| | | | |
(Income) loss from discontinued operations | | (173 | ) | | 429 |
| | | | |
Income from continuing operations | | 29,908 |
| | 46,128 |
| | | | |
Equity in earnings of investees | | (20,804 | ) | | (28,002 | ) | | | | |
Income tax expense | | 65 |
| | 63 |
| | | | |
Gain on issuance of shares by Select Income REIT | | (72 | ) | | (88 | ) | | | | |
Loss (gain) on early extinguishment of debt | | 1,715 |
| | (104 | ) | | | | |
Interest expense | | 43,599 |
| | 32,286 |
| | | | |
Interest income | | (1,843 | ) | | (63 | ) | | | | |
Dividend income | | (911 | ) | | (667 | ) | | | | |
Operating income | | 51,657 |
| | 49,553 |
| | | | |
General and administrative | | 12,314 |
| | 11,350 |
| | | | |
Acquisition related costs | | — |
| | 363 |
| | | | |
Loss on impairment of real estate | | 230 |
| | — |
| | | | |
Depreciation and amortization | | 61,949 |
| | 54,713 |
| | | | |
Net operating income | | $ | 126,150 |
| | $ | 115,979 |
| | | | |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Calculation of Funds From Operations and Normalized Funds From Operations (5) | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | 2017 | | 2016 | | | | |
Net income | | | | | | | | | | | | | | | | | | $ | 30,081 |
| | $ | 45,778 |
| | | | |
Plus: Depreciation and amortization | | | | | | 61,949 |
| | 54,713 |
| | | | |
Plus: FFO attributable to Select Income REIT investment | | | | | | 47,982 |
| | 53,609 |
| | | | |
Plus: Loss on impairment of real estate | | | | | | 230 |
| | — |
| | | | |
Less: Equity in earnings from Select Income REIT | | | | | | (20,271 | ) | | (27,895 | ) | | | | |
Less: Gain on sale of property | | | | | | — |
| | (79 | ) | | | | |
Less: Increase in carrying value of property included in discontinued operations | | | | | | (619 | ) | | — |
| | | | |
Funds from operations | | | | | | 119,352 |
| | 126,126 |
| | | | |
Plus: Acquisition related costs | | | | | | — |
| | 363 |
| | | | |
Plus: Normalized FFO attributable to Select Income REIT investment | | | | | | 48,900 |
| | 53,629 |
| | | | |
Less: FFO attributable to Select Income REIT investment | | | | | | (47,982 | ) | | (53,609 | ) | | | | |
Less: Loss (gain) on early extinguishment of debt | | | | | | 1,715 |
| | (104 | ) | | | | |
Less: Gain on issuance of shares by Select Income REIT | | | | | | (72 | ) | | (88 | ) | | | | |
Normalized funds from operations | | | | | | $ | 121,913 |
| | $ | 126,317 |
| | | | |
| | | | | | | | | | | | |
Funds from operations per common share (basic) | | | | | | $ | 1.50 |
| | $ | 1.78 |
| | | | |
Funds from operations per common share (diluted) | | | | | | $ | 1.49 |
| | $ | 1.77 |
| | | | |
Normalized funds from operations per common share (basic and diluted) | | | | | | $ | 1.53 |
| | $ | 1.78 |
| | | | |
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(1) | Comparable properties consist of 70 properties (90 buildings) we owned on September 30, 2017 and which we owned continuously since January 1, 2016. |
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(2) | Acquired properties consist of four properties (six buildings) we acquired since January 1, 2016. |
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(3) | Disposed property consists of one property (one building) which we sold in July 2016 and excludes one property (one building) classified as discontinued operations which was sold in August 2017. |
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(4) | See footnote (4) on page 29 for a definition of NOI. |
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(5) | See footnote (5) on page 29 for a definition of FFO and Normalized FFO. |
We refer to the 70 properties (90 buildings) we owned on September 30, 2017 and which we have owned continuously since January 1, 2016 as comparable properties. We refer to the four properties (six buildings) which we acquired since January 1, 2016 as the acquired properties. We refer to one property (one building) we sold in July 2016 as the disposed property.
Our condensed consolidated statements of comprehensive income for the nine months ended September 30, 2017 include the operating results of three acquired properties (five buildings) for the entire period, as we acquired those properties prior to January 1, 2017, one property (one building) for less than the entire period, as we acquired the property after January 1, 2017, and exclude the operating results of the disposed property for the entire period, as we sold that property prior to January 1, 2017. Our condensed consolidated statements of comprehensive income for the nine months ended September 30, 2016 exclude the operating results of three acquired properties (five buildings) for the entire period, as we acquired these properties after September 30, 2016, one property (one building) for less than the entire period, as we acquired that property after January 1, 2016 and include the operating results of the disposed property for less than the entire period, as we sold that property prior to September 30, 2016.
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, 2017, compared to the nine month period ended September 30, 2016.
Rental income. The increase in rental income reflects an increase in rental income for comparable properties and the rental income from the acquired properties. Rental income from comparable properties increased $3,260 primarily due to increases in rental rates and in occupied space at certain of our properties in the 2017 period. Rental income increased $13,952 as a result of the acquired properties. Rental income includes non-cash straight line rent adjustments totaling $3,115 in the 2017 period and $1,789 in the 2016 period, and amortization of acquired leases and assumed lease obligations totaling ($1,863) in the 2017 period and ($1,103) in the 2016 period.
Real estate taxes. The increase in real estate taxes reflects an increase in real estate taxes for the comparable properties and the net effect of the acquired properties and the disposed property. Real estate taxes for the comparable properties increased $657 due primarily to the effect of higher real estate tax valuation assessments at certain of our properties in the 2017 period. Real estate taxes increased $1,540 as a result of the acquired properties. We also realized a decrease of $27 in real estate taxes as a result of the disposed property.
Utility expenses. The increase in utility expenses reflects an increase in utility expenses for the acquired properties partially offset by the combined impact of utility expense decreases at the comparable properties and the disposed property. Utility expenses at the comparable properties decreased $101 primarily due to a decrease in electricity usage at certain of our
properties during the 2017 period. Utility expenses increased $981 as a result of the acquired properties. We also realized a decrease of $24 in utility expenses as a result of the disposed property.
Other operating expenses. The increase in other operating expenses reflects an increase in expenses for the comparable properties and the acquired properties partially offset by a decrease as a result of the disposed property. Other operating expenses at comparable properties increased $1,889 primarily as a result of higher repairs and maintenance costs during the 2017 period. Other operating expenses increased $2,149 as a result of the acquired properties. We also realized a decrease of $23 in other operating expenses as a result of the disposed property.
Depreciation and amortization. The increase in depreciation and amortization reflects the depreciation and amortization from the acquired properties and the effect of improvements made to certain of our properties since January 1, 2016, partially offset by the effect of certain assets becoming fully depreciated. Depreciation and amortization increased $5,974 as a result of the acquired properties. Depreciation and amortization at comparable properties increased $1,262 due primarily to depreciation and amortization of improvements made to certain of our properties after January 1, 2016, partially offset by certain leasing related assets becoming fully depreciated in 2016 and 2017.
Loss on impairment of real estate. We recorded a $230 loss on impairment of real estate in the 2017 period to reduce the carrying value of one property (one building) to its estimated fair value.
Acquisition related costs. Acquisition related costs include legal and diligence costs incurred in connection with our 2016 property acquisition activities that were expensed in accordance with GAAP. Pursuant to changes in GAAP, beginning in 2017, we generally capitalize our asset acquisitions related costs.
General and administrative. The increase in general and administrative expenses is primarily as a result of an increase in business management fees in the 2017 period.
Dividend income. Dividend income consists of dividends received from our investment in RMR Inc.
Interest income. The increase in interest income is primarily the result of higher cash balances in the 2017 period due to our financing activities related to the FPO Transaction.
Interest expense. The increase in interest expense reflects higher average outstanding debt balances and higher weighted average interest rates on borrowings during the 2017 period compared to the 2016 period.
Loss (gain) on early extinguishment of debt. We recorded a loss on early extinguishment of debt of $1,715 in the 2017 period in connection with the termination of the bridge loan facility. For more information, see Note 7 to our condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q. We recorded a net gain on early extinguishment of debt of $104 in the 2016 period in connection with the prepayment of two mortgage notes.
Gain on issuance of shares by Select Income REIT. Gain on issuance of shares by SIR is a result of the issuance of common shares by SIR at prices above our then per share carrying value of our SIR common shares.
Income tax expense. The increase in income tax expense reflects lower operating income in certain jurisdictions in the 2017 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. The decrease in the 2017 period is the result of a decline in SIR's net income for the 2017 period.
Income (loss) from discontinued operations. Income (loss) from discontinued operations reflects operating results for one property (one building) included in discontinued operations. During the 2017 period, we recorded an adjustment of $619 to increase the carrying value of this property to its estimated fair value less costs to sell. We sold this property on August 31, 2017.
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.
Net income. Our net income decreased in the 2017 period compared to the 2016 period as a result of the changes noted above. The percentage decrease in net income per common share (basic and diluted) is higher primarily as a result of the higher
number of weighted average common shares outstanding for the 2017 period as result of our issuance of common shares in an underwritten public offering during the 2017 period.
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 investments in SIR and RMR Inc. 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 and capital 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 capital expenses; and
our receipt of distributions from our investments in SIR and RMR Inc.
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 complete 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 ninethree months ended September 30, 2017March 31, 2018 compared to the same period in 20162017 were as follows: (i) cash provided by operating activities increased from $91,674$26,225 in 20162017 period to $93,726$35,267 in the 20172018 period; (ii) cash flows from investing activities changed from $12,200 of cash used in investing activities increased from $94,848 in the 2016 period to $662,318 in the 2017 period to $11,019 of cash provided by investing activities in the 2018 period; and (iii) cash provided byused in financing activities increased from $8,138$30,985 in the 20162017 period to $1,090,358$43,820 in the 20172018 period.
The increase in cash provided by operating activities for the ninethree month period ended September 30, 2017March 31, 2018 as compared to the corresponding prior year period was due primarily to an increase in propertyConsolidated Property NOI from our acquisition activities and favorable changes in working capital partially offset by a decreasean increase in distributions we received from our investment in SIR classified as an operating activity in our condensed consolidated statement of cash flows as a result of a decreasean increase in ourthe equity in earnings of SIR and an increasewe recognized in interest paidthe 2018 period, partially offset by unfavorable changes in working capital. The change from cash used in investing activities in the 2017 period to cash provided by investing activities in the 2018 period is primarily due to our receipt of cash proceeds from the sale of one of our properties (one building) in the 2018 period, compared to our use of cash to acquire one of our properties (one building) in the 2017 period. The increase in cash used in investingfinancing activities for the ninethree month period ended September 30, 2017March 31, 2018 as compared to the corresponding prior year period was due primarily to our deposit in escrow of some of the FPO Transaction cash consideration. Thean increase in cash provided by financing activities forour distributions to common shareholders in the nine month2018 period ended September 30, 2017 as compared to the corresponding prior year period was due primarily toa result of our FPO Transaction related financing activities during the 2017 period, including issuancesissuance of common shares and senior unsecured notes and borrowings under our revolving credit facility.in July 2017.
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, 2017,March 31, 2018, 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, 2017.March 31, 2018. 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, 2017,March 31, 2018, the annual interest rate payable on borrowings under our revolving credit facility was 2.4%3.0%. 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, respectively, outstanding under our revolving credit facility.
Our revolving credit facility is governed by a credit agreement, or our 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 a 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%.
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 a rate of LIBOR plus a premium, which was 180 basis points per annum at 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%.
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 separately incurred debt (other than nonrecourse debt), within the meaning specified in theour 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 due 2019 are governed by an indenture and a supplement to that indenture and 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.
Our $310,000 of 5.875% senior unsecured notes due 2046 are governed by an indenture and a supplement to that indenture and 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 $300,000 of 4.000% senior unsecured notes due 2022 are governed by an indenture and a supplement to that indenture and require semi-annual payments of interest only through maturity in July 2022 and may be repaid at par (plus accrued and unpaid interest) on or after June 15, 2022.2022 or before that date together with a make whole premium.
Our $310,000 of 5.875% senior unsecured notes due 2046 are governed by an indenture and a supplement to that indenture and require quarterly payments of interest only through maturity in May 2046 and may be repaid at par (plus accrued and unpaid interest) on or after May 26, 2021.
As of September 30, 2017,March 31, 2018, our debt maturities (other than our revolving credit facility) are as follows: $399 in 2017, $1,671$2,772 in 2018, $359,439$361,541 in 2019, $301,619$338,433 in 2020, $13,230$14,420 in 2021, $575,518 in 2022 and $860,000$399,564 thereafter.
None of our unsecured debt obligations require sinking fund payments prior to their maturity dates. Our $26,358$182,248 in mortgage debts generally require monthly payments of principal and interest through maturity.
In addition to our debt obligations, as of September 30, 2017,March 31, 2018, we have estimated unspent leasing related obligations of $26,631 and have committed to redevelop and expand an existing property prior to the commencement of the lease with an estimated remaining cost to complete of approximately $3,302.$32,762.
As of September 30,March 31, 2018 and December 31, 2017, we had $551,707there was an aggregate of cash1,813,504 Preferred Units outstanding. The $20,496 carrying value of the Preferred Units is recorded as temporary equity on our condensed consolidated balance sheets. On May 1, 2018, our subsidiary redeemed all of the outstanding Preferred Units for $11.15 per unit plus accrued and cash equivalents. On October 2, 2017, we used our availableunpaid distributions (an aggregate of $20,310), using cash on hand to fund some of the FPO Transaction cash consideration.
In connection with the FPO Transaction, we assumed five mortgage notes with an aggregate principal balance of $167,549. These mortgage notes are secured by five properties (five buildings). In connection with the FPO Transaction, we also assumed two mortgage notes with an aggregate principal balance of $82,000, which are secured by two properties owned by joint ventures in which we acquired FPO's 50% and 51%interests.borrowings under our revolving credit facility.
We currently expect to use cash balances, borrowings under our revolving credit facility, net proceeds from our property sales, distributions received from our investments in SIR and RMR Inc., assumptionassumptions 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 maturities of our indebtedness approach, we expect to explore refinancing alternatives. 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 acquisitions or elect to place new mortgages on properties we own as a source of financing. We may also seek to participate in additional joint venture or other arrangements that may provide us with additional sources 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.
To partially finance the FPO Transaction, we entered into a commitment letter with Citigroup Global Markets Inc., or Citigroup, pursuant to which, on and subject to the terms and conditions of the commitment letter, Citigroup and a group of institutional lenders committed to provide us a bridge loan facility. On July 20, 2017, we and the lenders terminated this commitment letter and bridge loan facility after we raised the necessary funding for the FPO Transaction by our issuance of senior unsecured notes and the proceeds from the sale of our common shares in July 2017. As a result of the termination of this bridge loan facility we recognized a loss on extinguishment of debt of $1,715.
Our ability to obtain, and the costs of, our future debt financings will depend primarily on credit 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. Similarly, our ability to raise equity capital in the future will depend primarily upon equity capital market conditions and our ability to conduct our business to maintain and grow our operating cash flows. We intend to conduct our business in a manner whichthat 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.
In June 2017, both Moody's Investors Service, or Moody's, and Standard & Poor's Ratings Services, or S&P, updated our debt ratings outlook to negative during 2017 as a result of uncertainties arising fromrelated to the FPO Transaction. Negative debt ratings outlooks may imply that our debt ratings may be downgraded unless we are successful in reorganizing our financial profile.
On February 23, 2017 and May 22, 2017,26, 2018, we paid a regular quarterly distribution to common shareholders of record on January 23, 2017 and April 21, 2017,29, 2018 of $0.43 per share, or $30,606 on each of those dates. On August 21, 2017, we paid a regular distribution to common shareholders of record on July 24, 2017, of $0.43 per share, or $41,364.$42,632. We funded these distributionsthis distribution using cash on hand and borrowings under our revolving credit facility. On October 12, 2017,April 19, 2018, we declared a regular quarterly distribution payable to common shareholders of record on October 23, 2017April 30, 2018 of $0.43 per share, or $42,633.$42,634. We expect to pay this distribution on or about November 20, 2017May 21, 2018 using cash on hand and borrowings under our revolving credit facility.
Off Balance Sheet Arrangements
AsWe own 50% and 51% interests in two unconsolidated joint ventures which own two properties (three buildings). The properties owned by these joint ventures are encumbered by an aggregate $82,000 principal amount of September 30, 2017,mortgage indebtedness. We do not control the activities that are most significant to these joint ventures and, as a result, we account for our investment in these joint ventures under the equity method of accounting. See Note 4 to the Notes to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information on the financial condition and results of operations of these joint ventures. Other than these joint ventures, as of March 31, 2018, 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, 2017March 31, 2018 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 $960,000 of public issuances of senior unsecured notes and threeeight secured mortgage notes with an aggregate outstanding principal balance of $182,248 that were assumed in connection with certain of our acquisitions. Also, two properties (three buildings) which are owned by joint ventures secure two additional mortgage notes. Our publicly issued senior unsecured notes are governed by indentures and their supplements. In addition, as noted elsewhere in this Quarterly Report on Form 10-Q, on October 2, 2017, we assumed five secured mortgage notes in connection with the FPO Transaction. Also, the two joint venture properties acquired in the FPO Transaction secure two additional mortgage notes. Our senior unsecured notes indentures and their supplements and theour 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 and property manager. Our senior unsecured notes indentures and their 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 to our shareholders in 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, 2017,March 31, 2018, we believe we were in compliance with the terms and conditions of our respective covenants under our credit agreement and senior unsecured notes indentures and their supplements.
Neither our credit agreement nor our senior unsecured notes indentures and their 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, our interest expense and related costs under our credit agreement would increase. As noted above, in June 2017, both Moody's and S&P updated our rating outlook to negative during 2017, which may imply that downgrades to our credit rating will occurdebt ratings may be downgraded unless we are successful in reorganizing our financial profile.
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 indentures and their 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, RMR Inc., SIR, AIC 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 our business and property management agreements with RMR LLC; RMR Inc. is the managing member of RMR LLC; Adam D. Portnoy, one of our Managing Trustees, is the sole trustee of ABP Trust, which is owned by our Managing Trustees, is the controlling shareholder of RMR Inc.; and we own shares of class A common stock of RMR Inc. We also have relationships and historical and continuing transactions with other companies to which RMR LLC providesor its subsidiaries provide management services and which may have trustees, directors and officers who are also trustees, directors or officers of us, RMR LLC or RMR Inc., including: SIR, of which we are the largest shareholder owning,and at September 30, 2017,March 31, 2018, owned approximately 27.8% of the outstanding SIR common shares; and AIC, of which we, SIR, ABP Trust, SIR and four other companies to which RMR LLC provides management services each own 14.3% and which arranges and reinsures in part a combined property insurance program for us and its six other shareholders. For further information about these and other such relationships and related
person transactions, see Notes 10, 11 and 12 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 20172018 Annual Meeting of Shareholders and our other filings with the Securities and Exchange Commission, or SEC. In addition, 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 persons, including our business and property management agreements with RMR LLC and our shareholders agreement with AIC and its six other shareholders, are available as exhibits to our filings with the SEC and accessible at the SEC’s website, www.sec.gov.www.sec.gov. We may engage in additional transactions with related persons, including businesses to which RMR LLC or its affiliatessubsidiaries provide management services.
Item 3. Quantitative and Qualitative Disclosures About Market Risk (dollar amounts in thousands, except per share data)
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, 2016.2017. 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, 2017,March 31, 2018, our outstanding fixed rate debt consisted of the following:
| | | | | | Annual | | Annual | | | | Interest | | | | Annual | | Annual | | | | Interest |
| | Principal | | Interest | | Interest | | | | Payments | | Principal | | Interest | | Interest | | | | Payments |
Debt | | Balance (1) | | Rate (1) | | Expense (1) | | Maturity | | Due | | Balance (1) | | Rate (1) | | Expense (1) | | Maturity | | Due |
Senior unsecured notes | | $ | 350,000 |
| | 3.750 | % | | $ | 13,125 |
| | 2019 | | Semi-annually | | $ | 350,000 |
| | 3.750 | % | | $ | 13,125 |
| | 2019 | | Semi-annually |
Senior unsecured notes | | 310,000 |
| | 5.875 | % | | 18,213 |
| | 2046 | | Quarterly | | 310,000 |
| | 5.875 | % | | 18,213 |
| | 2046 | | Quarterly |
Senior unsecured notes | | 300,000 |
| | 4.000 | % | | 12,000 |
| | 2022 | | Semi-annually | | 300,000 |
| | 4.000 | % | | 12,000 |
| | 2022 | | Semi-annually |
Mortgage note | | 13,756 |
| | 5.877 | % | | 820 |
| | 2021 | | Monthly | |
Mortgage note | | 8,288 |
| | 7.000 | % | | 588 |
| | 2019 | | Monthly | |
Mortgage note | | 4,314 |
| | 8.150 | % | | 356 |
| | 2021 | | Monthly | |
Mortgage note (one property (one building) in Tampa, FL) | | | 8,152 |
| | 7.000 | % | | 579 |
| | 2019 | | Monthly |
Mortgage note (one property (one building) in Washington, DC) | | | 34,285 |
| | 5.720 | % | | 1,988 |
| | 2020 | | Monthly |
Mortgage note (one property (one building) in Chesapeake, VA) | | | 3,126 |
| | 4.260 | % | | 135 |
| | 2020 | | Monthly |
Mortgage note (one property (one building) in Lakewood, CO) | | | 3,771 |
| | 8.150 | % | | 312 |
| | 2021 | | Monthly |
Mortgage note (one property (one building) in Fairfax, VA) | | | 13,628 |
| | 5.877 | % | | 812 |
| | 2021 | | Monthly |
Mortgage note (one property (one building) in Washington, DC) | | | 27,708 |
| | 4.220 | % | | 1,186 |
| | 2022 | | Monthly |
Mortgage note (one property (one building) in Washington, DC) | | | 24,798 |
| | 4.800 | % | | 1,207 |
| | 2023 | | Monthly |
Mortgage note (one property (one building) in Washington, DC) | | | 66,780 |
| | 4.050 | % | | 2,742 |
| | 2030 | | Monthly |
| | $ | 986,358 |
| | |
| | $ | 45,102 |
| | | | | | $ | 1,142,248 |
| | |
| | $ | 52,299 |
| | | | |
| |
(1) | The principal balances and interest rates are the amounts stated in 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 and $300,000 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 to be paid 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 pointsone percentage point higher or lower than shown above, our per annumannual interest cost would increase or decrease respectively, by approximately $10,098.$11,446.
Changes in market interest rates also 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, 2017,March 31, 2018, 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 basisone percentage point increase in interest rates would change the fair value of those obligations by approximately $59,302.$53,694.
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.
On October 2, 2017,At March 31, 2018, we owned 50% and 51% interests in connection with the FPO Transaction, we assumedtwo joint venture arrangements which owned two properties (three buildings) that are secured by fixed rate debt consisting of the following mortgage notes:
|
| | | | | | | | | | | | | | | |
| | | | Annual | | Annual | | | | Interest |
| | Principal | | Interest | | Interest | | | | Payments |
Debt | | Balance (1) | | Rate (1) | | Expense (1) | | Maturity | | Due |
Mortgage note (one property (one building) in Washington, DC) | | $ | 66,780 |
| | 4.050 | % | | $ | 2,705 |
| | 2030 | | Monthly |
Mortgage note (one property (one building) in Washington, DC) | | 34,974 |
| | 4.800 | % | | 1,679 |
| | 2023 | | Monthly |
Mortgage note (one property (one building) in Washington, DC) | | 34,598 |
| �� | 5.720 | % | | 1,979 |
| | 2020 | | Monthly |
Mortgage note (one property (one building) in Washington, DC) | | 27,978 |
| | 4.220 | % | | 1,181 |
| | 2022 | | Monthly |
Mortgage note (one property (one building) in Chesapeake, VA) | | 3,219 |
| | 4.260 | % | | 137 |
| | 2020 | | Monthly |
| | $ | 167,549 |
| | | | $ | 7,681 |
| | | | |
|
| | | | | | | | | | | | | | | | | |
| | Our JV | | | | Annual | | Annual | | | | Interest |
| | Ownership | | Principal | | Interest | | Interest | | | | Payments |
Debt | | Interest | | Balance (1)(2) | | Rate (1) | | Expense (1) | | Maturity | | Due |
Mortgage note one property (one building) in Washington, DC | | 50% | | $ | 32,000 |
| | 3.920 | % | | $ | 1,254 |
| | 2024 | | Monthly |
Mortgage note one property (two buildings) in Fairfax, VA | | 51% | | 50,000 |
| | 3.910 | % | | 1,955 |
| | 2029 | | Monthly |
| | | | $ | 82,000 |
| | | | $ | 3,209 |
| | | | |
| |
(1) | The principal balance, annual interest rate and annual interest expense are the amounts stated in the applicable contract. In accordance with GAAP, our carrying value andthe joint ventures' recorded interest expense may differ from these amounts because of market conditions at the time we assumed thisthey incurred the debt. |
Also, in connection with the FPO Transaction, we acquired FPO's 50% and 51% interests in two joint venture arrangements which own properties that are secured by fixed rate debt consisting of the following mortgage notes, which we assumed:
|
| | | | | | | | | | | | | | | | | |
| | Our JV | | | | Annual | | Annual | | | | Interest |
| | Ownership | | Principal | | Interest | | Interest | | | | Payments |
Debt | | Interest | | Balance (1)(2) | | Rate (1) | | Expense (1) | | Maturity | | Due |
Mortgage note (one property) one building in Washington, DC | | 50% | | $ | 32,000 |
| | 3.920 | % | | $ | 1,254 |
| | 2024 | | Monthly |
Mortgage note (one property) one building in Fairfax, VA | | 51% | | 50,000 |
| | 3.910 | % | | 1,955 |
| | 2029 | | Monthly |
| | | | $ | 82,000 |
| | | | $ | 3,209 |
| | | | |
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(1) | The principal balance, annual interest rate and annual interest expense are the amounts stated in the applicable contract. In accordance with GAAP, our recorded interest expense may differ from these amounts because of market conditions at the time we acquired the joint venture interests. |
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(2) | Reflects the entire balance of the debt secured by the properties and is not adjusted to reflect the part of the joint venture arrangement interests we do not own. |
Floating Rate Debt
At September 30, 2017,March 31, 2018, our floating rate debt consisted of $565,000$570,000 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 theour meeting certain conditions, including our 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 without penalty at any time, but after they are repaid amounts may not be redrawn.
Borrowings under our $750,000 revolving credit facility and term loans are in U.S. dollars and require interest to be paid 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 basisone percentage point increase in interest rates would have on our annual floating rate interest expense as of September 30, 2017:March 31, 2018:
|
| | | | | | | | | | | | | | | |
| | 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, 2017 | | 2.6 | % | | $ | 1,115,000 |
| | $ | 29,393 |
| | $ | 0.37 |
|
100 bps increase | | 3.6 | % | | $ | 1,115,000 |
| | $ | 40,698 |
| | $ | 0.51 |
|
|
| | | | | | | | | | | | | | | |
| | Impact of Changes in Interest Rates |
| | Annual | | Outstanding | | Total Interest | | Annual Earnings |
| | Interest Rate (1) | | Debt | | Expense Per Year | | Per Share Impact (2) |
At March 31, 2018 | | 3.2 | % | | $ | 1,120,000 |
| | $ | 36,338 |
| | $ | 0.37 |
|
One percentage point | | 4.2 | % | | $ | 1,120,000 |
| | $ | 47,693 |
| | $ | 0.48 |
|
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(1) | Weighted based on the respective interest rates and outstanding borrowings under our revolving credit facility and our term loans as of September 30, 2017.March 31, 2018. |
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(2) | Based on the weighted average shares outstanding (diluted) for the ninethree months ended September 30, 2017.March 31, 2018. |
The following table presents the impact a 100 basisone percentage point increase in interest rates would have on our annual floating rate interest expense as of September 30, 2017March 31, 2018 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, 2017 | | 2.6 | % | | $ | 1,300,000 |
| | $ | 34,269 |
| | $ | 0.43 |
|
100 bps increase | | 3.6 | % | | $ | 1,300,000 |
| | $ | 47,450 |
| | $ | 0.59 |
|
|
| | | | | | | | | | | | | | | |
| | Impact of an Increase in Interest Rates |
| | Annual | | Outstanding | | Total Interest | | Annual Earnings |
| | Interest Rate (1) | | Debt | | Expense Per Year | | Per Share Impact (2) |
At March 31, 2018 | | 3.2 | % | | $ | 1,300,000 |
| | $ | 42,178 |
| | $ | 0.43 |
|
One percentage point | | 4.2 | % | | $ | 1,300,000 |
| | $ | 55,358 |
| | $ | 0.56 |
|
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(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, 2017.March 31, 2018. |
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(2) | Based on the weighted average shares outstanding (diluted) for the ninethree months ended September 30, 2017.March 31, 2018. |
The foregoing tables show the impact of an immediate changeincrease in floating interest rates as of September 30, 2017.March 31, 2018. If interest rates were to changeincrease 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,Quarterly Report on Form 10-Q, 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, 2017March 31, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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 ACQUISITIONSSALES AND SALESACQUISITIONS 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,
THE LIKELIHOOD THAT OUR RENTS WILL INCREASE WHEN WE RENEW OR EXTEND OUR LEASES OR ENTER NEW LEASES,
OUR ABILITY TO PAY DISTRIBUTIONS TO OUR SHAREHOLDERS AND TO SUSTAIN 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 IN THE METROPOLITAN WASHINGTON, D.C. MARKET AREA OR ELSEWHERE, INCLUDING PROPERTIES THAT ARE MAJORITY LEASED TO GOVERNMENT TENANTS, OR GOVERNMENT CONTRACTOR TENANTS OR OTHER PRIVATE TENANTS,
OUR EXPECTATIONS REGARDING DEMAND FOR LEASED SPACE BY THE U.S. GOVERNMENT AND STATE AND LOCAL GOVERNMENTS,TENANTS,
OUR ABILITY TO RAISE EQUITYDEBT OR DEBTEQUITY CAPITAL,
OUR ABILITY TO PAY INTEREST ON AND PRINCIPAL OF OUR DEBT,
OUR ABILITY TO APPROPRIATELY BALANCE OUR USE OF DEBT AND EQUITY CAPITAL,
OUR CREDIT RATINGS,
OUR EXPECTED BENEFITS FROM THE FPO TRANSACTION,
OUR EXPECTATION THAT WE BENEFIT FROM OUR OWNERSHIP OFINTEREST IN AND OTHER RELATIONSHIPS WITH RMR INC.,
OUR EXPECTATION THAT WE BENEFIT FROM OUR OWNERSHIP OFINTEREST IN AND OTHER RELATIONSHIPS WITH 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 AVAILABLE FOR COMMON SHAREHOLDERS, NORMALIZED FFO AVAILABLE FOR COMMON SHAREHOLDERS, NOI, CASH FLOWS, LIQUIDITY AND PROSPECTS INCLUDE, BUT ARE NOT LIMITED TO:
THE IMPACT OF CONDITIONS AND CHANGES IN THE ECONOMY AND THE CAPITAL MARKETS ON US AND OUR TENANTS,
COMPETITION WITHIN THE REAL ESTATE INDUSTRY, PARTICULARLY WITH RESPECT TOIN 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,TENANTS,
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 FUTURE DISTRIBUTIONS TO OUR SHAREHOLDERS AND TO MAKE PAYMENTS OF PRINCIPAL AND INTEREST ON OUR INDEBTEDNESS DEPENDS UPON A NUMBER OF FACTORS, INCLUDING OUR FUTURE EARNINGS, THE CAPITAL COSTS WE INCUR TO LEASE OUR PROPERTIES, OUR WORKING CAPITAL REQUIREMENTS 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 SHAREHOLDERSDISTRIBUTIONS DEPENDS IN LARGE PART UPON OUR ABILITY TO BUY PROPERTIES AND LEASE THEM FOR RENTS, LESS THEIR PROPERTY OPERATING EXPENSES,COSTS, 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,
AS PART OF OUR LONG TERM FINANCING PLANS TO REDUCE OUR LEVERAGE, WE EXPECT TO DISPOSE OF CERTAIN OF OUR PROPERTIES. CURRENTLY, WE ARE MARKETING OR PLAN TO MARKET FOR SALE 24 PROPERTIES. WE CANNOT BE SURE WE WILL SELL ANY OF THESE PROPERTIES OR WHAT THE TERMS OF ANY SALE MAY BE. WE MAY SELL SOME OR ALL OF THESE PROPERTIES AT PRICES THAT ARE LESS THAN OUR CARRYING VALUES AND WE MAY OTHERWISE INCUR LOSSES AS A RESULT OF CONSIDERING AND PURSUING THESE SALES. FURTHER, WE MAY ELECT TO CHANGE WHICH PROPERTIES WE MAY TO SEEK TO SELL, WHICH COULD RESULT IN DIFFERENT PROPERTIES AND FEWER OR GREATER NUMBER OF PROPERTIES BEING SOLD OR MARKETED FOR SALE,
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 EXPIRATIONS 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,
WE INTEND TO CONDUCT OUR BUSINESS ACTIVITIES IN A MANNER THAT WILL AFFORD US REASONABLE ACCESS TO CAPITAL FOR INVESTMENT AND FINANCING ACTIVITIES. HOWEVER, WE MAY NOT SUCCEED IN THIS REGARD AND WE MAY NOT HAVE REASONABLE ACCESS TO CAPITAL,
CONTINUED AVAILABILITY OF BORROWINGS UNDER OUR REVOLVING CREDIT FACILITY IS SUBJECT TO OUR SATISFYING CERTAIN FINANCIAL COVENANTS AND OTHER CREDIT FACILITY CONDITIONS THAT WE MAY BE UNABLE TO SATISFY,
ACTUAL COSTS UNDER OUR REVOLVING CREDIT FACILITY OR OTHER FLOATING RATE CREDIT FACILITIESDEBT WILL BE HIGHER THAN LIBOR PLUS A PREMIUM BECAUSE OF FEES AND EXPENSES ASSOCIATED WITH SUCH FACILITIES,DEBT,
THE INTEREST RATES PAYABLE UNDER OUR FLOATING RATE DEBT OBLIGATIONS DEPEND UPON OUR CREDIT RATINGS. WE CURRENTLY HAVE A NEGATIVE DEBT RATINGS OUTLOOK BY BOTH MOODY'S AND S&P HAVE RECENTLY UPDATED OUR RATING OUTLOOK TO NEGATIVE WHICH MAY IMPLY THAT OUR CREDIT RATINGS MAY BE DOWNGRADED. IF OUR CREDIT RATINGS ARE DOWNGRADED, OUR BORROWING COSTS WILL INCREASE,
OUR ABILITY TO ACCESS DEBT CAPITAL AND THE COST OF OUR DEBT CAPITAL WILL DEPEND IN PART ON OUR CREDIT RATINGS. BOTH MOODY'S AND S&P HAVE RECENTLY UPDATED OUR RATING OUTLOOK TO NEGATIVE, WHICH MAY IMPLY THAT OUR CREDIT RATINGS MAY BE DOWNGRADED. IF OUR CREDIT RATINGS ARE DOWNGRADED, WE MAY NOT BE ABLE TO ACCESS DEBT CAPITAL OR THE DEBT CAPITAL WE CAN ACCESS MAY BE EXPENSIVE,
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 AND PROPERTY MANAGEMENT AGREEMENTS BETWEEN US AND RMR LLC HAVE CONTINUING 20 YEAR TERMS. HOWEVER, THOSE AGREEMENTS PERMIT EARLY TERMINATION IN CERTAIN CIRCUMSTANCES. ACCORDINGLY, WE CANNOT BE SURE THAT THESE AGREEMENTS WILL REMAIN IN EFFECT FOR CONTINUING 20 YEAR 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,
WE MAY FAIL TO EXECUTE SUCCESSFULLY ON OUR EXPANDED BUSINESS STRATEGY OR INCREASED SCALE OF OUR BUSINESS RESULTING FROM THE FPO TRANSACTION AND THEREFORE MAY NOT REALIZE THE BENEFITS WE EXPECT FROM THE FPO TRANSACTION,
SIR MAY REDUCE THE AMOUNT OF ITS DISTRIBUTIONS TO ITS SHAREHOLDERS, INCLUDING US,
RMR INC. MAY REDUCE THE AMOUNT OF ITS DISTRIBUTIONDISTRIBUTIONS 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 EXPECT TO SPEND, AS OF SEPTEMBER 30, 2017, AN ADDITIONAL $3.3 MILLION TO COMPLETE THE REDEVELOPMENT AND EXPANSION OF A PROPERTYMARCH 31, 2018, WE OWN PRIOR TO THE COMMENCEMENT OF THE LEASE FOR THAT PROPERTY. IN ADDITION, AS OF SEPTEMBER 30 2017, WE HAVEHAD ESTIMATED UNSPENT LEASING RELATED OBLIGATIONS OF $26.6 MILLION, EXCLUDING THE ESTIMATED
DEVELOPMENT COSTS NOTED IN THE PRECEDING SENTENCE. IT IS DIFFICULT TO ACCURATELY ESTIMATE DEVELOPMENT AND TENANT SPACE PREPARATION COSTS. THIS DEVELOPMENT PROJECT AND$32.8 MILLION. OUR UNSPENT LEASING RELATED OBLIGATIONS MAY COST MORE OR LESS AND MAY TAKE LONGER TO COMPLETE THAN WE CURRENTLY EXPECT, AND WE MAY INCUR INCREASINGINCREASED 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 OUR 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.
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.
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 and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2017. As described above, the FPO Transaction was completed on October 2, 2017.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, 2017:March 31, 2018:
| | | | |
| | Maximum | | Maximum |
| | Total Number of | | Approximate Dollar | | Total Number of | | Approximate Dollar |
| | Shares Purchased | | Value of Shares that | | Shares Purchased | | Value of Shares that |
| | Number of | | Average | | as Part of Publicly | | May Yet Be Purchased | | Number of | | as Part of Publicly | | May Yet Be Purchased |
| | Shares | | Price | | Announced Plans | | Under the Plans or | | Shares | | Average Price | | Announced Plans | | Under the Plans or |
Calendar Month | | Purchased (1) | | Paid per Share | | or Programs | | Programs | | Purchased (1) | | Paid per Share | | or Programs | | Programs |
September 2017 | | 13,636 | | $ | 18.30 | | $ | — | | $ | — | |
January 2018 | | | 617 | | $ | 18.54 | | $ | — | | $ | — |
Total | | 13,636 | | $ | 18.30 | | $ | — | | $ | — | | 617 | | $ | 18.54 | | $ | — | | $ | — |
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(1) | TheseThis common share withholdings and purchases werepurchase was made to satisfy employee tax withholding and payment obligations of our officers and certain othera former RMR LLC employeesemployee in connection with the vesting of awards of our common shares. We withheld and purchased these shares at their fair market value based upon the trading price of our common shares at the close of trading on the Nasdaq on the purchase date.December 29, 2017. |
Item 6. Exhibits
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Exhibit Number | Description |
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3.1 | |
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3.2 | |
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4.1 | |
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4.2 | |
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4.3 | |
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4.4 | |
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4.5 | |
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4.6 | |
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4.7 | |
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4.8 | |
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10.1 | |
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12.1 | |
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31.1 | |
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31.2 | |
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31.3 | |
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31.4 | |
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32.1 | |
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99.1 | |
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101.1 | The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2017March 31, 2018 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.) |
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.
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| GOVERNMENT PROPERTIES INCOME TRUST |
| | |
| | |
| By: | /s/ David M. Blackman |
| | David M. Blackman President and Chief Operating Officer |
| | Dated: October 31, 2017May 3, 2018 |
| | |
| By: | /s/ Mark L. Kleifges |
| | Mark L. Kleifges Chief Financial Officer and Treasurer (principal financial and accounting officer) |
| | Dated: October 31, 2017May 3, 2018 |