Item 1. Financial Statements
GOVERNMENT PROPERTIES INCOME TRUST
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in thousands, except share data)
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
December 31,
|
|
|
2018
|
|
2017
|
ASSETS
|
|
|
|
|
|
|
Real estate properties:
|
|
|
|
|
|
|
Land
|
|
$
|
448,714
|
|
|
$
|
627,108
|
|
Buildings and improvements
|
|
2,050,365
|
|
|
2,348,613
|
|
Total real estate properties, gross
|
|
2,499,079
|
|
|
2,975,721
|
|
Accumulated depreciation
|
|
(363,490
|
)
|
|
(341,848
|
)
|
Total real estate properties, net
|
|
2,135,589
|
|
|
2,633,873
|
|
|
|
|
|
|
Assets of discontinued operations - Equity investment in Select Income REIT
|
|
453,275
|
|
|
467,499
|
|
Assets of properties held for sale
|
|
408,626
|
|
|
—
|
|
Investment in unconsolidated joint ventures
|
|
45,161
|
|
|
50,202
|
|
Acquired real estate leases, net
|
|
215,938
|
|
|
351,872
|
|
Cash and cash equivalents
|
|
9,644
|
|
|
16,569
|
|
Restricted cash
|
|
2,354
|
|
|
3,111
|
|
Rents receivable, net
|
|
55,297
|
|
|
61,429
|
|
Deferred leasing costs, net
|
|
22,181
|
|
|
22,977
|
|
Other assets, net
|
|
136,360
|
|
|
96,033
|
|
Total assets
|
|
$
|
3,484,425
|
|
|
$
|
3,703,565
|
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
Unsecured revolving credit facility
|
|
$
|
467,000
|
|
|
$
|
570,000
|
|
Unsecured term loans, net
|
|
548,363
|
|
|
547,852
|
|
Senior unsecured notes, net
|
|
945,948
|
|
|
944,140
|
|
Mortgage notes payable, net
|
|
176,828
|
|
|
183,100
|
|
Liabilities of properties held for sale
|
|
9,998
|
|
|
—
|
|
Accounts payable and other liabilities
|
|
64,868
|
|
|
89,440
|
|
Due to related persons
|
|
23,300
|
|
|
4,859
|
|
Assumed real estate lease obligations, net
|
|
8,759
|
|
|
13,635
|
|
Total liabilities
|
|
2,245,064
|
|
|
2,353,026
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
Preferred units of limited partnership
|
|
—
|
|
|
20,496
|
|
|
|
|
|
|
Shareholders’ equity:
|
|
|
|
|
|
|
Common shares of beneficial interest, $.01 par value: 150,000,000 shares authorized,
|
|
|
|
|
99,205,199 and 99,145,921 shares issued and outstanding, respectively
|
|
992
|
|
|
991
|
|
Additional paid in capital
|
|
1,969,168
|
|
|
1,968,217
|
|
Cumulative net income
|
|
204,579
|
|
|
108,144
|
|
Cumulative other comprehensive income
|
|
265
|
|
|
60,427
|
|
Cumulative common distributions
|
|
(935,643
|
)
|
|
(807,736
|
)
|
Total shareholders’ equity
|
|
1,239,361
|
|
|
1,330,043
|
|
Total liabilities and shareholders’ equity
|
|
$
|
3,484,425
|
|
|
$
|
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,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
|
|
|
|
|
|
|
|
Rental income
|
$
|
106,102
|
|
|
$
|
70,179
|
|
|
$
|
322,904
|
|
|
$
|
209,362
|
|
|
|
|
|
|
|
|
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
Real estate taxes
|
12,072
|
|
|
8,862
|
|
|
37,402
|
|
|
24,980
|
|
Utility expenses
|
7,783
|
|
|
5,408
|
|
|
20,490
|
|
|
14,186
|
|
Other operating expenses
|
21,785
|
|
|
14,867
|
|
|
66,221
|
|
|
44,046
|
|
Depreciation and amortization
|
42,569
|
|
|
20,781
|
|
|
129,444
|
|
|
61,949
|
|
Loss on impairment of real estate
|
—
|
|
|
230
|
|
|
5,800
|
|
|
230
|
|
Acquisition and transaction related costs
|
3,813
|
|
|
—
|
|
|
3,813
|
|
|
—
|
|
General and administrative
|
22,383
|
|
|
3,266
|
|
|
36,438
|
|
|
12,314
|
|
Total expenses
|
110,405
|
|
|
53,414
|
|
|
299,608
|
|
|
157,705
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
(4,303
|
)
|
|
16,765
|
|
|
23,296
|
|
|
51,657
|
|
Dividend income
|
304
|
|
|
304
|
|
|
912
|
|
|
911
|
|
Unrealized gain on equity securities
|
17,425
|
|
|
—
|
|
|
40,677
|
|
|
—
|
|
Interest income
|
140
|
|
|
1,715
|
|
|
405
|
|
|
1,843
|
|
Interest expense (including net amortization of debt premiums and discounts
|
|
|
|
|
|
|
|
and debt issuance costs of $893, $990, $2,749 and $2,605, respectively)
|
(23,374
|
)
|
|
(16,055
|
)
|
|
(69,444
|
)
|
|
(43,599
|
)
|
Loss on early extinguishment of debt
|
—
|
|
|
(1,715
|
)
|
|
—
|
|
|
(1,715
|
)
|
Income (loss) from continuing operations before income taxes,
|
|
|
|
|
|
|
|
|
|
|
|
equity in net earnings (losses) of investees and gain on sale of real estate
|
(9,808
|
)
|
|
1,014
|
|
|
(4,154
|
)
|
|
9,097
|
|
Income tax expense
|
(9
|
)
|
|
(22
|
)
|
|
(124
|
)
|
|
(65
|
)
|
Equity in net earnings (losses) of investees
|
94
|
|
|
31
|
|
|
(1,112
|
)
|
|
533
|
|
Income (loss) from continuing operations
|
(9,723
|
)
|
|
1,023
|
|
|
(5,390
|
)
|
|
9,565
|
|
Income from discontinued operations
|
9,274
|
|
|
9,966
|
|
|
23,872
|
|
|
20,516
|
|
Income (loss) before gain on sale of real estate
|
(449
|
)
|
|
10,989
|
|
|
18,482
|
|
|
30,081
|
|
Gain on sale of real estate
|
—
|
|
|
—
|
|
|
17,329
|
|
|
—
|
|
Net income (loss)
|
(449
|
)
|
|
10,989
|
|
|
35,811
|
|
|
30,081
|
|
Other comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized gain on investment in equity securities
|
—
|
|
|
3,279
|
|
|
—
|
|
|
14,389
|
|
Equity in unrealized gain of investees
|
126
|
|
|
1,351
|
|
|
119
|
|
|
5,634
|
|
Other comprehensive income
|
126
|
|
|
4,630
|
|
|
119
|
|
|
20,023
|
|
Comprehensive income
|
$
|
(323
|
)
|
|
$
|
15,619
|
|
|
$
|
35,930
|
|
|
$
|
50,104
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
$
|
(449
|
)
|
|
$
|
10,989
|
|
|
$
|
35,811
|
|
|
$
|
30,081
|
|
Preferred units of limited partnership distributions
|
—
|
|
|
—
|
|
|
(371
|
)
|
|
—
|
|
Net income (loss) available for common shareholders
|
$
|
(449
|
)
|
|
$
|
10,989
|
|
|
$
|
35,440
|
|
|
$
|
30,081
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding (basic)
|
99,071
|
|
|
$
|
96,883
|
|
|
$
|
99,055
|
|
|
$
|
79,778
|
|
Weighted average common shares outstanding (diluted)
|
99,071
|
|
|
$
|
96,958
|
|
|
$
|
99,075
|
|
|
$
|
79,852
|
|
|
|
|
|
|
|
|
|
Per common share amounts (basic and diluted):
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations
|
$
|
(0.10
|
)
|
|
$
|
0.01
|
|
|
$
|
0.12
|
|
|
$
|
0.12
|
|
Income from discontinued operations
|
$
|
0.09
|
|
|
$
|
0.10
|
|
|
$
|
0.24
|
|
|
$
|
0.26
|
|
Net income (loss) available for common shareholders
|
$
|
0.00
|
|
|
$
|
0.11
|
|
|
$
|
0.36
|
|
|
$
|
0.38
|
|
See accompanying notes.
GOVERNMENT PROPERTIES INCOME TRUST
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
2018
|
|
2017
|
CASH FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
Net income
|
|
$
|
35,811
|
|
|
$
|
30,081
|
|
Adjustments to reconcile net income to cash provided by operating activities:
|
|
|
|
|
|
|
Depreciation
|
|
51,121
|
|
|
35,460
|
|
Net amortization of debt premiums and discounts and debt issuance costs
|
|
2,749
|
|
|
2,605
|
|
Gain on sale of real estate
|
|
(17,329
|
)
|
|
—
|
|
Loss on early extinguishment of debt
|
|
—
|
|
|
1,715
|
|
Straight line rental income
|
|
(7,825
|
)
|
|
(3,115
|
)
|
Amortization of acquired real estate leases
|
|
77,434
|
|
|
25,592
|
|
Amortization of deferred leasing costs
|
|
3,524
|
|
|
2,790
|
|
Other non-cash expenses, net
|
|
189
|
|
|
352
|
|
Loss on impairment of real estate
|
|
5,800
|
|
|
230
|
|
Unrealized gain on equity securities
|
|
(40,677
|
)
|
|
—
|
|
Increase in carrying value of asset held for sale
|
|
—
|
|
|
(619
|
)
|
Equity in net (earnings) losses of investees
|
|
1,112
|
|
|
(533
|
)
|
Equity in earnings of Select Income REIT included in discontinued operations
|
|
(23,843
|
)
|
|
(20,271
|
)
|
Net gain on issuance of shares by Select Income REIT included in discontinued operations
|
|
(29
|
)
|
|
(72
|
)
|
Distributions of earnings from Select Income REIT
|
|
23,843
|
|
|
20,271
|
|
Change in assets and liabilities:
|
|
|
|
|
|
|
Deferred leasing costs
|
|
(5,937
|
)
|
|
(2,846
|
)
|
Rents receivable
|
|
7,535
|
|
|
3,839
|
|
Other assets
|
|
(1,393
|
)
|
|
(7,045
|
)
|
Accounts payable and other liabilities
|
|
(10,361
|
)
|
|
6,703
|
|
Due to related persons
|
|
18,441
|
|
|
777
|
|
Net cash provided by operating activities
|
|
120,165
|
|
|
95,914
|
|
CASH FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
Real estate acquisitions and deposits
|
|
—
|
|
|
(666,202
|
)
|
Real estate improvements
|
|
(32,625
|
)
|
|
(29,377
|
)
|
Distributions in excess of earnings from Select Income REIT
|
|
14,281
|
|
|
17,854
|
|
Distributions in excess of earnings from unconsolidated joint ventures
|
|
3,046
|
|
|
—
|
|
Proceeds from sale of properties, net
|
|
142,189
|
|
|
13,198
|
|
Net cash provided by (used in) investing activities
|
|
126,891
|
|
|
(664,527
|
)
|
CASH FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
Repayment of mortgage notes payable
|
|
(2,732
|
)
|
|
(1,150
|
)
|
Proceeds from issuance of senior notes, after discounts
|
|
—
|
|
|
297,954
|
|
Proceeds from issuance of common shares, net
|
|
—
|
|
|
493,936
|
|
Borrowings on unsecured revolving credit facility
|
|
95,000
|
|
|
610,000
|
|
Repayments on unsecured revolving credit facility
|
|
(198,000
|
)
|
|
(205,000
|
)
|
Payment of debt issuance costs
|
|
—
|
|
|
(2,551
|
)
|
Repurchase of common shares
|
|
(232
|
)
|
|
(255
|
)
|
Redemption of preferred units of limited partnership
|
|
(20,221
|
)
|
|
—
|
|
Preferred units of limited partnership distributions
|
|
(646
|
)
|
|
—
|
|
Distributions to common shareholders
|
|
(127,907
|
)
|
|
(102,576
|
)
|
Net cash (used in) provided by financing activities
|
|
(254,738
|
)
|
|
1,090,358
|
|
|
|
|
|
|
Increase (decrease) in cash and cash equivalents and restricted cash
|
|
(7,682
|
)
|
|
521,745
|
|
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
|
|
$
|
11,998
|
|
|
$
|
552,216
|
|
Supplemental cash flow information
|
|
|
|
|
|
|
|
|
|
Interest paid
|
|
$
|
72,651
|
|
|
$
|
42,019
|
|
Income taxes paid
|
|
$
|
44
|
|
|
$
|
100
|
|
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:
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
|
September 30, 2017
|
|
Cash and cash equivalents
|
|
$
|
9,644
|
|
|
$
|
551,707
|
|
Restricted cash
|
|
2,354
|
|
|
509
|
|
Total cash and cash equivalents and restricted cash reported in the statements of cash flows
|
|
$
|
11,998
|
|
|
$
|
552,216
|
|
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, 2017
, or our Annual Report. In the opinion of management, all adjustments, consisting of normal recurring accruals considered necessary for a fair 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' 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, assessment of impairment of real estate and equity method investments and the valuation of intangible assets.
Segment Information
We operate in
one
business segment: direct ownership of real estate properties. Our equity method investment in Select Income REIT, or SIR, has been reclassified as a discontinued operation and is no longer a separate business segment. See below for further information about our equity method investment in SIR.
Merger with Select Income REIT
On September 14, 2018, we and our wholly owned subsidiary, GOV MS REIT, or Merger Sub, entered into an Agreement and Plan of Merger, or the Merger Agreement, with SIR, pursuant to which SIR has agreed to merge with and into Merger Sub, with Merger Sub continuing as the surviving entity in the merger, or the Merger. Pursuant to the terms and subject to the conditions set forth in the Merger Agreement, at the effective time of the Merger, or the Effective Time, each common share of SIR issued and outstanding immediately prior to the Effective Time will be converted into the right to receive
1.04
, or the Exchange Ratio, of our newly issued common shares, subject to adjustment as described in the Merger Agreement, with cash paid in lieu of fractional shares. The Exchange Ratio is fixed and will not be adjusted to reflect changes in the market price of our common shares or SIR common shares prior to the Effective Time. At the Effective Time, any outstanding unvested SIR common share awards under SIR’s equity compensation plan will be converted into an award under our equity compensation plan, subject to substantially similar vesting requirements and other terms and conditions, of a number of our common shares determined by multiplying the number of unvested SIR common shares subject to such award by the Exchange Ratio (rounded down to the nearest whole number). Also pursuant to the Merger Agreement, we and SIR agreed that, prior to the Effective Time, we would sell, for cash consideration, all
24,918,421
SIR common shares owned by us, or the Secondary Sale, which Secondary Sale was completed on October 9, 2018 as further described below, and further that, subject to the satisfaction of certain conditions, SIR will declare and, at least one business day prior to the closing date of the Merger, pay a
pro rata
distribution to its shareholders of all
45,000,000
common shares of its majority owned subsidiary, Industrial Logistics Properties Trust that SIR owns, or the ILPT Distribution. Following the ILPT Distribution and upon the closing of the Merger, we will acquire SIR's remaining property portfolio of
99
properties with approximately
16,538,462
rentable square feet. The aggregate transaction value, based on the closing price of our common shares on
September 30, 2018
of
$11.29
per share, is approximately
$2,738,488
, excluding estimated closing costs of
$40,000
and including the repayment or assumption of
$1,720,000
of SIR debt. The Merger and the other transactions contemplated by the Merger Agreement, including the Secondary Sale and the ILPT Distribution, are collectively referred to herein as the Transactions.
We expect that immediately after the Merger is effective, Merger Sub will then merge with and into us, with us as the surviving entity, and we will change our name to “Office Properties Income Trust,” following which our ticker symbol on The Nasdaq Stock Market LLC, or Nasdaq, will be changed to “OPI”. We also expect that immediately following that second merger, the combined company will effect a reverse stock split of its common shares pursuant to which every
four
common
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
shares of the combined company will be converted into one common share of the combined company. The combined company will continue to be managed by The RMR Group LLC, or RMR LLC, pursuant to our existing business and property management agreements with RMR LLC.
The completion of the Merger is subject to the satisfaction or waiver of various conditions, including, among other things, approval by our shareholders of the issuance of our common shares in the Merger and by SIR’s shareholders of the Merger and the other Transactions to which SIR is a party, the absence of any law or order by any governmental authority prohibiting, making illegal, enjoining or otherwise restricting, preventing or prohibiting the consummation of the Merger and the other Transactions, the effectiveness of the registration statement on Form S-4, as amended, or the Form S-4, filed by us with the Securities and Exchange Commission, or SEC, to register our common shares to be issued in the Merger and the approval of Nasdaq for the listing of such shares on Nasdaq, subject to official notice of issuance, and, subject to the satisfaction of certain other conditions, the payment of the ILPT Distribution at least one business day before the completion of the Merger. We and SIR expect to consummate the Merger by December 31, 2018. The Merger Agreement provides that either party may terminate the Merger Agreement if the Merger is not consummated by the outside closing date of June 30, 2019.
The Merger Agreement contains certain customary representations, warranties and covenants, including, among others, covenants with respect to the conduct of our and SIR’s respective businesses prior to closing, subject to certain consent rights by SIR and us, respectively, and covenants prohibiting us and SIR from soliciting, providing information or entering into discussions concerning competing proposals (generally defined as proposals for
20%
or more of the assets, revenues or earnings or equity of the applicable party), subject to certain exceptions. In addition, because we owned the SIR common shares we sold pursuant to the Secondary Sale as of October 1, 2018, the record date set by SIR's board of trustees for shareholders eligible to vote at SIR’s special meeting of shareholders to approve the Merger and the other Transactions to which SIR is a party, or the Record Date, we are entitled to vote those shares at that meeting, unless the Record Date is changed pursuant to the Merger Agreement, we have agreed to vote those shares at that meeting in favor of approval of the Merger and the other Transactions to which SIR is a party.
The Merger Agreement contains certain termination rights for both us and SIR, including that under specified circumstances, either party is entitled to terminate the Merger Agreement to accept a superior proposal (generally defined as proposals for
75%
or more of the assets, revenues or earnings or equity of such party, which proposal such party’s board of trustees (or an authorized committee thereof) has determined in good faith, after consultation with outside financial advisors and outside legal counsel, (1) would, if consummated, result in a transaction that is more favorable to the shareholders of such party from a financial point of view than the Merger and the other Transactions, (2) for which the third party has demonstrated that the financing for such offer is fully committed or is reasonably likely to be obtained and (3) which is reasonably likely to receive all required approvals from any governmental authority and otherwise reasonably likely to be consummated on the terms proposed). Neither we nor SIR is entitled to any termination fee under the Merger Agreement. All fees and expenses incurred in connection with the Merger and the other Transactions will be paid by the party incurring those expenses, except that we and SIR will share equally any filing fees incurred in connection with the filing of the Form S-4 and related joint proxy statement/prospectus and, as explained below, we are responsible for all of the costs and expenses incurred in connection with the Secondary Sale, including the costs and expenses of SIR and its affiliates.
Contemporaneously with the execution of the Merger Agreement, and in connection with the Secondary Sale, we entered into a registration agreement with SIR, or the Registration Agreement, pursuant to which we received demand registration rights, subject to certain limitations, with respect to the Secondary Sale. The Registration Agreement provides that we will pay all the costs and expenses incurred in connection with the Secondary Sale, including costs and expenses incurred by SIR and its affiliates. On October 9, 2018, pursuant to the terms of the Registration Agreement, we sold all
24,918,421
SIR common shares in the Secondary Sale that we then owned in an underwritten public offering at a price of
$18.25
per share, raising net proceeds of approximately
$434,700
after deducting underwriting discounts and estimated offering expenses. We used the net proceeds from the Secondary Sale to repay amounts outstanding under our revolving credit facility.
The transactions contemplated by the Merger Agreement and the terms thereof were evaluated, negotiated and recommended to each of our and SIR’s board of trustees by a special committee of our and SIR’s board of trustees, respectively, each comprised solely of our and SIR’s disinterested, independent trustees, respectively, and were separately approved and adopted by our and SIR’s independent trustees and by our and SIR’s board of trustees. Citigroup Global Markets Inc. acted as financial advisor to the special committee of our board of trustees, and UBS Securities LLC acted as financial advisor to the special committee of SIR’s board of trustees.
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
Note 2.
Recent Accounting Pronouncements
On January 1, 2018, we adopted the Financial Accounting Standards Board, or FASB, Accounting Standards Update, or ASU, No. 2014-09 (and related clarifying guidance issued by the FASB),
Revenue From Contracts With Customers
, which outlines a comprehensive model for entities 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 of promised 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 or services.” While ASU No. 2014-09 specifically references contracts with customers, it may apply to certain other transactions such as the sale of real estate or equipment. A substantial portion of our revenue consists of rental income from leasing arrangements, which is specifically excluded from ASU No. 2014-09. We have adopted ASU No. 2014-09 using the modified 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 have a material impact on the amount or timing of our revenue recognition in our condensed consolidated financial statements except for profit recognition on real estate sales.
On January 1, 2018, we adopted FASB ASU No. 2016-01,
Recognition and Measurement of Financial Assets and Financial Liabilities
, which changes how entities measure certain equity investments and present changes in the fair value of financial liabilities measured under the fair value option that are attributable to their own credit. The implementation of ASU No. 2016-01 resulted in the reclassification of historical changes in the fair value of our available for sale equity securities of
$45,116
from cumulative other comprehensive income to cumulative net income. We also reclassified
$15,165
from cumulative other comprehensive income to cumulative net income for our share of cumulative other comprehensive income of certain of our equity method investees. Effective January 1, 2018, changes in the fair value of our equity securities are recorded through earnings in accordance with ASU No. 2016-01.
On January 1, 2018, we adopted 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 update resulted in the reclassification of
$2,209
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
nine months ended
September 30, 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 an increase of
$21
of net cash provided by operating activities for the
nine months ended
September 30, 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 consists of amounts escrowed for future real estate taxes, insurance, leasing costs, capital expenditures and debt service, as required by certain of our mortgage debts, totaled
$2,354
and
$509
as of September 30, 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 and disclosure 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 either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase of the leased asset by the lessee. This classification will determine whether the lease expense is recognized based on an effective interest method or on a straight line basis over the term of the lease. A lessee is also required to record a right of use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales type leases, direct financing leases and operating leases. ASU No. 2016-02 is effective for reporting periods beginning after December 15, 2018, with early adoption permitted. We are currently assessing the potential impact the adoption of ASU No. 2016-02 will have in our condensed consolidated financial statements.
In 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
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
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 June 2018, the FASB issued ASU No. 2018-07,
Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting
, which aligns the measurement and classification guidance for share based payments to nonemployees with the guidance for share based payments to employees, with certain exceptions. ASU No. 2018-07 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We are currently assessing the potential impact the adoption of ASU No. 2018-07 will have in our condensed consolidated financial statements.
Note 3.
Weighted Average Common Shares
The following table provides a reconciliation of the weighted average number of common shares used in the calculation of basic and diluted earnings per share (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months
|
|
For the Nine Months
|
|
|
Ended September 30,
|
|
Ended September 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Weighted average common shares for basic earnings per share
|
|
99,071
|
|
|
96,883
|
|
|
99,055
|
|
|
79,778
|
|
Effect of dilutive securities: unvested share awards
|
|
—
|
|
|
75
|
|
|
20
|
|
|
74
|
|
Weighted average common shares for diluted earnings per share
(1)
|
|
99,071
|
|
|
96,958
|
|
|
99,075
|
|
|
79,852
|
|
(1) For the three months ended
September 30, 2018
,
35
unvested common shares were not included in the calculation of diluted earnings per share because to do so would have been antidilutive.
Note 4. Real Estate Properties
As of
September 30, 2018
, we wholly owned
105
properties (
164
buildings), with an aggregate undepreciated carrying value of
$2,854,937
, 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 2018 and 2038. 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, 2018
, we entered into
24
leases for
182,220
rentable square feet, for a weighted (by rentable square feet) average lease term of
8.1
years and we made commitments for
$6,479
of leasing related costs. During the
nine months ended September 30, 2018
, we entered into
94
leases for
858,998
rentable square feet, for a weighted (by rentable square feet) average lease term of
6.4
years and we made commitments for
$21,287
of leasing related costs. As of
September 30, 2018
, we have estimated unspent leasing related obligations of
$34,048
.
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 evaluating for impairment upon the events or changes in circumstances described above, we regularly evaluate the remaining lives of our long lived assets. If we change our estimate of the remaining lives, we allocate the carrying value of the affected assets over their revised remaining lives.
Disposition Activities
In March 2018, we sold an office property (
one
building) located in Minneapolis, MN with
193,594
rentable square feet for
$20,000
, excluding closing costs. 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 during the three months ended March 31, 2018.
In February 2018, we entered an agreement to sell an office property (
one
building) located in Safford, AZ with
36,139
rentable square feet for
$8,250
. We recorded a
$2,453
loss on impairment of real estate to reduce the carrying value of the
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
property to its estimated fair value less costs to sell in the three months ended March 31, 2018. In April 2018, we terminated the sales agreement and removed this property from held for sale status. We recorded a
$322
adjustment to impairment of real estate to increase the carrying value of the property to its estimated fair value during the three months ended June 30, 2018.
In May 2018, we sold an office property (
one
building) located in New York, NY with
187,060
rentable square feet for
$118,500
, excluding closing costs. We recorded a
$17,329
gain on sale of real estate during the three months ended June 30, 2018 as a result of this sale.
In May 2018, we sold an office property (
one
building) located in Sacramento, CA with
110,500
rentable square feet for
$10,755
, excluding closing costs. We recorded a loss on impairment of real estate of
$3,023
and
$6
to reduce the carrying value of this property to its estimated fair value less costs to sell during the three months ended March 31, 2018 and June 30, 2018, respectively.
The sales of these properties do not represent significant dispositions individually or in the aggregate. The results of operations of these properties are included in continuing operations through the date of sale in our condensed consolidated statements of comprehensive income.
As of
September 30, 2018
, we had
20
properties (
50
buildings) with an aggregate undepreciated carrying value of
$355,858
under agreement to sell in three separate transactions, as presented in the table below. We have classified these properties as held for sale in our condensed consolidated balance sheet at
September 30, 2018
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Date of Agreement
(1)
|
|
Number of Properties
|
|
|
Number of Buildings
|
|
|
Location
|
|
Square Footage
|
|
|
Gross Sale Price
(2)
|
|
August 2018
|
|
1
|
|
|
1
|
|
|
Washington D.C.
|
|
129,035
|
|
|
$
|
70,000
|
|
September 2018
|
|
8
|
|
|
34
|
|
|
Northern Virginia and Maryland
|
|
1,635,868
|
|
|
201,500
|
|
October 2018
|
|
11
|
|
|
15
|
|
|
Southern Virginia
|
|
1,641,109
|
|
|
167,000
|
|
|
|
20
|
|
|
50
|
|
|
|
|
3,406,012
|
|
|
$
|
438,500
|
|
|
|
(1)
|
These 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.
|
|
|
(2)
|
Gross sale price excludes closing costs.
|
As part of our long term plans to reduce our leverage, we expect to sell additional properties. We are currently marketing or plan to market for sale
three
properties (
three
buildings) with an aggregate carrying value of
$24,566
as of
September 30, 2018
. We have determined that these properties did not meet the held for sale criteria as of
September 30, 2018
. We cannot be sure we will sell any of our properties that we are currently 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.
Pro Forma Financial Information
On October 2, 2017, we acquired First Potomac Realty Trust, or FPO, pursuant to a merger transaction, as a result of which we acquired
35
office properties (
72
buildings) with
6,028,072
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
nine months ended
September 30, 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
$47,019
for the
nine months ended
September 30, 2017
.
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
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 pursuant to our existing leases or leases we may enter during the remainder of 2018 and thereafter, 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.
|
|
|
|
|
|
Nine Months Ended September 30, 2017
|
Rental income
|
$
|
328,255
|
|
Net loss
|
$
|
(4,733
|
)
|
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
September 30, 2018
, our investment in unconsolidated joint ventures consisted of the following:
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|
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|
|
|
|
|
|
|
|
|
|
Joint Venture
|
|
GOV Ownership
|
|
GOV Carrying Value of Investment at September 30, 2018
|
|
Property Type
|
|
Number of Buildings
|
|
Location
|
|
Square Feet
|
Prosperity Metro Plaza
|
|
51%
|
|
$
|
24,821
|
|
|
Office
|
|
2
|
|
Fairfax, VA
|
|
328,456
|
|
1750 H Street, NW
|
|
50%
|
|
20,340
|
|
|
Office
|
|
1
|
|
Washington, DC
|
|
115,411
|
|
Total
|
|
|
|
$
|
45,161
|
|
|
|
|
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 September 30, 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
September 30, 2018
, the aggregate
$8,565
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 transaction 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 and the resulting amortization expense is included in equity in net earnings of investees in our condensed consolidated statements of comprehensive income.
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
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
$1,990
and
$711
for the three months ended
September 30, 2018
and
2017
, respectively, and
$7,825
and
$3,115
for the
nine months ended September 30, 2018
and
2017
, respectively. Rents receivable include
$33,978
(including
$1,819
related to properties held for sale) and
$27,267
of straight line rent receivables, net of allowance for doubtful accounts of
$1,755
(including
$976
related to properties held for sale) and
$1,503
at
September 30, 2018
and
December 31, 2017
, respectively.
Note 6. Concentration
Tenant and Credit Concentration
We define annualized rental income as the annualized contractual base rents from our tenants pursuant to our lease agreements as of the measurement date, plus straight line rent adjustments and estimated recurring expense reimbursements to be paid to us, and excluding lease value amortization. The U.S. Government,
13
state governments and
three
other government tenants combined were responsible for approximately
62.5%
and
87.5%
of our annualized rental income as of
September 30, 2018
and
2017
, respectively. The U.S. Government is our largest tenant by annualized rental income and was responsible for approximately
45.6%
and
59.8%
of our annualized rental income as of
September 30, 2018
and
2017
, respectively.
Geographic Concentration
At
September 30, 2018
, our
105
consolidated properties (
164
buildings) were located in
30
states and the District of Columbia. Consolidated properties located in Virginia, the District of Columbia, Maryland, California and Georgia were responsible for
23.7%
,
18.1%
,
15.3%
,
9.4%
and
6.1%
of our annualized rental income as of
September 30, 2018
, respectively. Consolidated properties located in the metropolitan Washington, D.C. market area were responsible for approximately
44.1%
of our annualized rental income as of
September 30, 2018
.
Note 7. Indebtedness
Our principal debt obligations at
September 30, 2018
were: (1)
$467,000
of outstanding borrowings under our
$750,000
unsecured revolving credit facility; (2)
$550,000
aggregate outstanding principal amount of unsecured term loans; (3)
$960,000
aggregate outstanding principal amount of senior unsecured notes; and (4)
$180,416
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. Our 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 a rate of LIBOR plus a premium, which was 125 basis points per annum at
September 30, 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, 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, 2018
, the annual interest rate payable on borrowings under our revolving credit facility was
3.4%
and the
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
weighted average annual interest rate for borrowings under our revolving credit facility was
3.2%
and
2.4%
for the
three months ended September 30, 2018
and
2017
, respectively, and
3.0%
and
2.2%
for the
nine months ended September 30, 2018
and
2017
, respectively. As of
September 30, 2018
and
October 30, 2018
, we had
$467,000
and
$32,000
outstanding under our revolving credit facility.
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, 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, 2018
, the annual interest rate for the amount outstanding under our
$300,000
term loan was
3.6%
. The weighted average annual interest rate under our
$300,000
term loan was
3.5%
and
2.6%
for the
three months ended September 30, 2018
and
2017
, respectively, and
3.3%
and
2.4%
for the
nine months ended September 30, 2018
and
2017
, 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 a rate of LIBOR plus a premium, which was 180 basis points per annum as of
September 30, 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, 2018
, the annual interest rate for the amount outstanding under our
$250,000
term loan was
4.0%
. The weighted average annual interest rate under our
$250,000
term loan was
3.9%
and
3.0%
for the
three months ended September 30, 2018
and
2017
, respectively, and
3.7%
and
2.8%
for the
nine months ended September 30, 2018
and
2017
, 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 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, 2018
.
At
September 30, 2018
,
eight
of our consolidated properties (
eight
buildings) with an aggregate net book value of
$417,842
were encumbered by
eight
mortgages for an aggregate principal amount of
$180,416
. Our mortgage notes are non-recourse, subject to certain limited exceptions and do not contain any material financial covenants.
Note 8. Fair Value of Assets and Liabilities
The table below presents certain of our assets measured at fair value at
September 30, 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
|
|
|
|
|
Quoted Prices in
|
|
|
|
Significant
|
|
|
|
|
Active Markets for
|
|
Significant Other
|
|
Unobservable
|
|
|
|
|
Identical Assets
|
|
Observable Inputs
|
|
Inputs
|
Description
|
|
Total
|
|
(Level 1)
|
|
(Level 2)
|
|
(Level 3)
|
Recurring Fair Value Measurements Assets:
|
|
|
|
|
|
|
|
|
Investment in RMR Inc.
(1)
|
|
$
|
112,680
|
|
|
$
|
112,680
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
(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, 2018
. During the three and nine months ended
September 30, 2018
, we recorded an unrealized gain of
$17,425
and
$40,677
, respectively, to adjust our investment in RMR Inc. to its fair value.
|
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, revolving credit facility, term loans, senior
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
unsecured notes, mortgage notes payable, amounts due to related persons, other accrued expenses and security deposits. At
September 30, 2018
and
December 31, 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, 2018
|
|
As of December 31, 2017
|
|
|
Carrying Amount
(1)
|
|
Fair Value
|
|
Carrying Amount
(1)
|
|
Fair Value
|
Senior unsecured notes, 3.75% interest rate, due in 2019
|
|
$
|
348,953
|
|
|
$
|
351,468
|
|
|
$
|
348,096
|
|
|
$
|
354,993
|
|
Senior unsecured notes, 5.875% interest rate, due in 2046
|
|
300,490
|
|
|
309,380
|
|
|
300,232
|
|
|
320,416
|
|
Senior unsecured notes, 4.000% interest rate, due in 2022
|
|
296,505
|
|
|
296,609
|
|
|
295,812
|
|
|
302,655
|
|
Mortgage note payable, 4.050% interest rate, due in 2030
(2)
|
|
64,441
|
|
|
62,363
|
|
|
64,293
|
|
|
65,198
|
|
Mortgage note payable, 5.720% interest rate, due in 2020
(2)
|
|
35,067
|
|
|
34,877
|
|
|
36,085
|
|
|
36,332
|
|
Mortgage note payable, 4.220% interest rate, due in 2022
(2)
|
|
27,408
|
|
|
27,422
|
|
|
27,906
|
|
|
28,432
|
|
Mortgage note payable, 4.800% interest rate, due in 2023
(2)
|
|
25,145
|
|
|
25,220
|
|
|
25,501
|
|
|
25,904
|
|
Mortgage note payable, 5.877% interest rate, due in 2021
(2)
|
|
13,445
|
|
|
13,978
|
|
|
13,620
|
|
|
14,565
|
|
Mortgage note payable, 7.000% interest rate, due in 2019
(2)
|
|
8,087
|
|
|
8,129
|
|
|
8,391
|
|
|
8,555
|
|
Mortgage note payable, 8.150% interest rate, due in 2021
(2)
|
|
3,235
|
|
|
3,360
|
|
|
4,111
|
|
|
4,340
|
|
Mortgage note payable, 4.260% interest rate, due in 2020
(2) (3)
|
|
3,047
|
|
|
3,028
|
|
|
3,193
|
|
|
3,216
|
|
|
|
$
|
1,125,823
|
|
|
$
|
1,135,834
|
|
|
$
|
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.
|
|
|
(3)
|
Secured by one property (one building) that is held for sale at September 30, 2018.
|
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 Nasdaq as of the measurement date (Level 1 inputs as defined in the fair value hierarchy under GAAP). 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
Share Awards
On April 3, 2018, in accordance with our Trustee compensation arrangements, and in connection with the election of one of our Managing Trustees, we granted
3,000
of our common shares, valued at
$13.59
per share, the closing price of our common shares on Nasdaq on that day, to the Managing Trustee who was elected as a Managing Trustee that day.
On May 24, 2018, in accordance with our Trustee compensation arrangements, we granted
3,000
of our common shares, valued at
$14.10
per share, the closing price of our common shares on Nasdaq on that day, to each of our
six
Trustees as part of their annual compensation.
On September 13, 2018, we granted an aggregate of
58,700
of our common shares, valued at
$16.95
per share, the closing price of our common shares on Nasdaq on that day, to our officers and certain other employees of RMR LLC under our equity compensation plan.
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
Share Purchases
On January 1, 2018, we purchased
617
of our common shares valued at
$18.54
per share, the closing price of our common shares on Nasdaq on December 29, 2017, from a former employee of RMR LLC in satisfaction of tax withholding and payment obligations in connection with the vesting of awards of our common shares.
On May 24, 2018, we purchased
450
of our common shares valued at
$14.10
per share, the closing price of our common shares on Nasdaq on that day, from
one
of our Trustees in satisfaction of tax withholding and payment obligations in connection with the vesting of an award of our common shares.
On September 24, 2018, we purchased an aggregate of
18,875
of our common shares, valued at
$11.35
per share, the closing price of our common shares on 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.
Distributions
On February 26, 2018, we paid a regular quarterly distribution to common shareholders of record on January 29, 2018 of
$0.43
per share, or
$42,632
. On May 21, 2018, we paid a regular quarterly distribution to common shareholders of record on April 30, 2018 of
$0.43
per share, or
$42,634
. On August 20, 2018, we paid a regular quarterly distribution to common shareholders of record on July 30, 2018 of
$0.43
per share, or
$42,641
. On October 18, 2018, we declared a regular quarterly distribution payable to common shareholders of record on October 29, 2018 of
$0.43
per share, or
$42,658
. We expect to pay this distribution on or about November 19, 2018.
Cumulative Other Comprehensive Income
Cumulative other comprehensive income represents our share of the comprehensive income of our equity method investees, 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, 2018
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2018
|
|
|
Unrealized Gain
|
|
Equity in
|
|
|
|
|
on Investment
|
|
Unrealized
|
|
|
|
|
in Equity
|
|
Gain
|
|
|
|
|
Securities
|
|
of Investees
|
|
Total
|
Balance at June 30, 2018
|
|
$
|
—
|
|
|
$
|
139
|
|
|
$
|
139
|
|
Other comprehensive income before reclassifications
|
|
—
|
|
|
143
|
|
|
143
|
|
Amounts reclassified from cumulative other comprehensive income to net income
(1)
|
|
—
|
|
|
(17
|
)
|
|
(17
|
)
|
Net current period other comprehensive income
|
|
—
|
|
|
126
|
|
|
126
|
|
Balance at September 30, 2018
|
|
$
|
—
|
|
|
$
|
265
|
|
|
$
|
265
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 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
|
)
|
|
(15,165
|
)
|
|
(60,281
|
)
|
|
|
|
|
|
|
|
Other comprehensive income before reclassifications
|
|
—
|
|
|
155
|
|
|
155
|
|
Amounts reclassified from cumulative other comprehensive income to net income
(1)
|
|
—
|
|
|
(36
|
)
|
|
(36
|
)
|
Net current period other comprehensive income
|
|
—
|
|
|
119
|
|
|
119
|
|
Balance at September 30, 2018
|
|
$
|
—
|
|
|
$
|
265
|
|
|
$
|
265
|
|
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
|
|
(1)
|
Amounts reclassified from cumulative other comprehensive income to net income (loss) are included in equity in net earnings of investees in our condensed consolidated statements of comprehensive income.
|
Preferred Units of Limited Partnership
On May 1, 2018, one of our subsidiaries redeemed all
1,813,504
of its outstanding
5.5%
Series A Cumulative Preferred Units for
$11.15
per unit plus accrued and unpaid distributions (an aggregate of
$20,310
).
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
$20,575
and
$1,891
for the
three months ended September 30, 2018
and
2017
, respectively, and
$30,059
and
$8,241
for the
nine months ended September 30, 2018
and
2017
, respectively. The net business management fees payable to RMR LLC include
$16,236
and
$16,973
of estimated business management incentive fees for the three and
nine months ended September 30, 2018
, respectively, based on our common share total return, as defined, as of
September 30, 2018
. Although we recognized estimated business management incentive fees in accordance with GAAP, the actual amount of business management incentive fees payable by us to RMR LLC for 2018, if any, will be based on our common share total return, as defined, for the
three
year period ending December 31, 2018, and will be payable in 2019. The net business management fees recognized for the three months ended September 30, 2017 included the reversal of
$893
of previously accrued estimated business management incentive fees as of June 30, 2017. As of September 30, 2017, based on our common share total return, as defined, as of such date, no annual business management incentive fees were estimated to be payable by us to RMR LLC for 2017. No incentive management fee was payable by us to RMR LLC for the year ended December 31, 2017. The net business management fees we recognize 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
$3,415
and
$2,338
for the
three months ended September 30, 2018
and
2017
, respectively, and
$10,201
and
$7,371
for the
nine months ended September 30, 2018
and
2017
, respectively. These amounts are included in other operating expenses or have been capitalized, as appropriate, in our condensed consolidated financial statements.
We are generally responsible for all 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
$5,100
and
$3,436
for property management related expenses for the
three months ended September 30, 2018
and
2017
, respectively, and
$15,121
and
$10,482
for property management related expenses for the
nine months ended September 30, 2018
and
2017
, 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 amounts we recognized as expense for internal audit costs were
$50
and
$67
for the
three months ended September 30, 2018
and
2017
, respectively, and
$173
and
$202
for the
nine months ended September 30, 2018
and
2017
, respectively. These 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 or 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.
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
We lease office space to RMR LLC in certain of our properties for RMR LLC's property management offices. We recognized rental income from RMR LLC for leased office space of
$263
and
$90
for the three months ended
September 30, 2018
and 2017, respectively, and
$763
and
$272
for the
nine months ended September 30, 2018
and 2017, respectively. Our office space leases with RMR LLC are terminable by RMR LLC if our management agreements with RMR LLC are terminated.
We have historically granted share awards to our officers and other RMR LLC employees under our equity compensation plans. In September 2018 and 2017, we granted annual awards of
58,700
and
57,350
of our common shares, respectively, to our officers and other employees of RMR LLC. In September 2018 and 2017, we purchased
18,875
and
13,636
of our common shares, respectively, valued at the closing price of our common shares on Nasdaq on the applicable date of purchase, in satisfaction of tax withholding and payment obligations in connection with the vesting of awards of our common shares to our officers and other employees of RMR LLC. We include amounts recognized as expense for share awards to RMR LLC employees in general and administrative expenses in our condensed consolidated statements of comprehensive income.
RMR Inc.
RMR LLC is a majority owned subsidiary of RMR Inc. and RMR Inc. is the managing member of RMR LLC. Adam D. Portnoy, one of our Managing Trustees, is the sole trustee, an officer and the controlling shareholder of ABP Trust, which is the controlling shareholder of RMR Inc., a managing director, president and chief executive officer of RMR Inc. and an officer of RMR LLC. Mark L. Kleifges, our other Managing Trustee and our Chief Financial Officer and Treasurer, and David M. Blackman, our President and Chief Executive Officer, also serve as executive officers of RMR LLC. Mr. Kleifges has announced his retirement from his position with us, effective December 31, 2018, and Mr. Blackman has been elected to be our other Managing Trustee, effective January 1, 2019. RMR LLC provides management services to us. As of
September 30, 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
. As of
September 30, 2018
, we owned
24,918,421
SIR common shares, or approximately
27.8%
of its outstanding common shares. As described further in Note 1, on September 14, 2018, we and SIR entered into the Merger Agreement, and on October 9, 2018, we completed the Secondary Sale. Adam D. Portnoy, one of our Managing Trustees, also serves as a managing trustee of SIR, and our President and Chief Executive Officer also serves as a managing trustee and the president and chief executive officer of SIR. RMR LLC provides management services to SIR and us. See Note 1 for further information regarding the Merger Agreement and the Secondary Sale and Notes 12 and 13 for further information regarding our investment in SIR.
AIC
. We, ABP Trust, SIR and
four
other companies to which RMR LLC provides management services currently own AIC in equal amounts. We and the other AIC shareholders participate in a combined property insurance program arranged and reinsured in part by AIC. We paid aggregate annual premiums, including taxes and fees, of approximately
$1,211
in connection with the renewal of this insurance program for the policy year ending June 30, 2019, 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, 2018
and December 31, 2017, our investment in AIC had a carrying value of
$9,276
and
$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 is 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 that are owned by AIC related to our investment in AIC.
For further information about these and other such relationships and certain other related person transactions, refer to our Annual Report.
Note 12. Equity Investment in Select Income REIT
As described in Note 11, as of
September 30, 2018
, we owned
24,918,421
, or approximately
27.8%
, of the then outstanding SIR common shares. SIR is a REIT that primarily owns single tenant, net leased properties. As described in Note 1, we completed the Secondary Sale on October 9, 2018. We expect to record a loss on the Secondary Sale of approximately
$19,372
in the fourth quarter of 2018.
We accounted for our investment in SIR under the equity method. As a result of the Secondary Sale, our equity method investment in SIR has been reclassified to discontinued operations in our condensed consolidated financial statements as of
September 30, 2018
. See Note 13 for further information regarding discontinued operations.
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
Under the equity method, we recorded our proportionate share of SIR’s net income as equity in earnings of SIR included in discontinued operations in our condensed consolidated statements of comprehensive income. We recorded
$9,253
and
$9,453
of equity in the earnings of SIR for the
three months ended September 30, 2018
and
2017
, respectively, and
$23,843
and
$20,271
of equity in the earnings of SIR for the
nine months ended September 30, 2018
and
2017
, respectively. Our other comprehensive income includes our proportionate share of SIR’s unrealized gains (losses) of
($47)
and
$1,236
for the
three months ended September 30, 2018
and
2017
, respectively, and
$28
and
$5,339
for the
nine months ended September 30, 2018
and
2017
, respectively.
The adjusted GAAP cost basis of our investment 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, 2018
and December 31, 2017, our basis difference was
$120,492
and
$87,137
, respectively, and as required under GAAP, we were 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 related to SIR's capital finance activities and changes in its net equity during the
nine months ended September 30, 2018
. This accretion increased our equity in the earnings of SIR by
$1,044
and
$736
for the
three months ended September 30, 2018
and
2017
, respectively, and
$3,131
and
$2,209
for the
nine months ended September 30, 2018
and
2017
, respectively.
As of
September 30, 2018
, our investment in SIR had a carrying value of
$453,275
and a market value, based on the closing price of SIR common shares on Nasdaq on
September 30, 2018
, of
$546,710
.
We received aggregate cash distributions from SIR of
$12,708
during both the
three months ended September 30, 2018
and
2017
, and
$38,124
and
$38,125
during the
nine months ended September 30, 2018
and
2017
, respectively.
During the
three months ended September 30, 2018
and
2017
, SIR issued a net amount of
45,774
and
44,724
common shares, respectively. During the
nine months ended September 30, 2018
and
2017
, SIR issued a net amount of
63,157
and
59,502
common shares, respectively. We recognized a gain on issuance of shares by SIR of
$21
and
$51
for the
three months ended September 30, 2018
and
2017
, respectively, and a gain on issuance of shares by SIR of
$29
and
$72
for the
nine months ended September 30, 2018
and
2017
, respectively, as a result of the per share issuance price of these SIR common shares being above the then average per share carrying value of our SIR common shares.
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
The following presents summarized financial data of SIR as reported in SIR’s Quarterly Report on Form 10-Q for the quarter ended
September 30, 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,
|
|
|
2018
|
|
2017
|
Real estate properties, net
|
|
$
|
3,926,606
|
|
|
$
|
3,905,616
|
|
Acquired real estate leases, net
|
|
433,947
|
|
|
477,577
|
|
Properties held for sale
|
|
15,289
|
|
|
5,829
|
|
Cash and cash equivalents
|
|
25,982
|
|
|
658,719
|
|
Rents receivable, net
|
|
131,642
|
|
|
127,672
|
|
Other assets, net
|
|
188,033
|
|
|
127,617
|
|
Total assets
|
|
$
|
4,721,499
|
|
|
$
|
5,303,030
|
|
|
|
|
|
|
Unsecured revolving credit facility
|
|
$
|
108,000
|
|
|
$
|
—
|
|
Industrial Logistics Properties Trust revolving credit facility
|
|
380,000
|
|
|
750,000
|
|
Unsecured term loan, net
|
|
—
|
|
|
348,870
|
|
Senior unsecured notes, net
|
|
1,430,688
|
|
|
1,777,425
|
|
Mortgage notes payable, net
|
|
210,624
|
|
|
210,785
|
|
Assumed real estate lease obligations, net
|
|
62,176
|
|
|
68,783
|
|
Other liabilities
|
|
150,371
|
|
|
155,348
|
|
Total shareholders' equity attributable to SIR
|
|
2,061,556
|
|
|
1,991,819
|
|
Noncontrolling interest in consolidated subsidiary
|
|
318,084
|
|
|
—
|
|
Total liabilities and shareholders' equity
|
|
$
|
4,721,499
|
|
|
$
|
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,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Rental income
|
|
$
|
101,833
|
|
|
$
|
98,635
|
|
|
$
|
298,003
|
|
|
$
|
293,020
|
|
Tenant reimbursements and other income
|
|
20,048
|
|
|
19,379
|
|
|
60,514
|
|
|
57,158
|
|
Total revenues
|
|
121,881
|
|
|
118,014
|
|
|
358,517
|
|
|
350,178
|
|
|
|
|
|
|
|
|
|
|
Real estate taxes
|
|
12,518
|
|
|
11,489
|
|
|
36,748
|
|
|
33,168
|
|
Other operating expenses
|
|
14,814
|
|
|
14,649
|
|
|
43,714
|
|
|
41,039
|
|
Depreciation and amortization
|
|
35,371
|
|
|
34,713
|
|
|
105,326
|
|
|
102,770
|
|
Acquisition and transaction related costs
|
|
3,796
|
|
|
—
|
|
|
3,796
|
|
|
—
|
|
General and administrative
|
|
15,331
|
|
|
1,608
|
|
|
47,353
|
|
|
24,697
|
|
Write-off of straight line rents, net
|
|
—
|
|
|
—
|
|
|
10,626
|
|
|
12,517
|
|
Loss on asset impairment
|
|
—
|
|
|
—
|
|
|
—
|
|
|
4,047
|
|
Loss on impairment of real estate assets
|
|
9,706
|
|
|
—
|
|
|
9,706
|
|
|
229
|
|
Total expenses
|
|
91,536
|
|
|
62,459
|
|
|
257,269
|
|
|
218,467
|
|
Operating income
|
|
30,345
|
|
|
55,555
|
|
|
101,248
|
|
|
131,711
|
|
|
|
|
|
|
|
|
|
|
Dividend income
|
|
397
|
|
|
397
|
|
|
1,190
|
|
|
1,190
|
|
Unrealized gain on equity securities
|
|
22,771
|
|
|
—
|
|
|
53,159
|
|
|
—
|
|
Interest income
|
|
133
|
|
|
19
|
|
|
753
|
|
|
39
|
|
Interest expense
|
|
(23,287
|
)
|
|
(24,383
|
)
|
|
(69,446
|
)
|
|
(68,278
|
)
|
Loss on early extinguishment of debt
|
|
—
|
|
|
—
|
|
|
(1,192
|
)
|
|
—
|
|
Income before income tax expense, equity in earnings of an investee
|
|
|
|
|
|
|
|
|
|
|
|
and gain on of real estate
|
|
30,359
|
|
|
31,588
|
|
|
85,712
|
|
|
64,662
|
|
Income tax expense
|
|
(185
|
)
|
|
(177
|
)
|
|
(446
|
)
|
|
(364
|
)
|
Equity in earnings of an investee
|
|
831
|
|
|
31
|
|
|
882
|
|
|
533
|
|
Net income before gain on sale of real estate
|
|
31,005
|
|
|
31,442
|
|
|
86,148
|
|
|
64,831
|
|
Gain on sale of real estate
|
|
4,075
|
|
|
—
|
|
|
4,075
|
|
|
—
|
|
Net income
|
|
35,080
|
|
|
31,442
|
|
|
90,223
|
|
|
64,831
|
|
Net income allocated to noncontrolling interest
|
|
(5,597
|
)
|
|
—
|
|
|
(15,841
|
)
|
|
—
|
|
Net income attributed to SIR
|
|
$
|
29,483
|
|
|
$
|
31,442
|
|
|
$
|
74,382
|
|
|
$
|
64,831
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding (basic)
|
|
89,410
|
|
|
89,355
|
|
|
89,395
|
|
|
89,341
|
|
Weighted average common shares outstanding (diluted)
|
|
89,437
|
|
|
89,379
|
|
|
89,411
|
|
|
89,364
|
|
Net income attributed to SIR per common share (basic and diluted)
|
|
$
|
0.33
|
|
|
$
|
0.35
|
|
|
$
|
0.83
|
|
|
$
|
0.73
|
|
Note 13. Discontinued Operations
Our equity method investment in SIR has been reclassified to discontinued operations in our condensed consolidated financial statements as of
September 30, 2018
. See Notes 1 and 12 for further information regarding our equity method investment in SIR and the Secondary Sale.
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 operations in our condensed consolidated financial statements.
GOVERNMENT PROPERTIES INCOME TRUST
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
Below are the components of our income from discontinued operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Equity in earnings of Select Income REIT
|
|
$
|
9,253
|
|
|
$
|
9,453
|
|
|
$
|
23,843
|
|
|
$
|
20,271
|
|
Net gain on issuance of shares by Select Income REIT
|
|
21
|
|
|
51
|
|
|
29
|
|
|
72
|
|
Income from property classified as discontinued operations
|
|
—
|
|
|
462
|
|
|
—
|
|
|
173
|
|
Income from discontinued operations
|
|
$
|
9,274
|
|
|
$
|
9,966
|
|
|
$
|
23,872
|
|
|
$
|
20,516
|
|
Consolidated Property Operations
As of
September 30, 2018
,
93.3%
of our consolidated rentable square feet was leased, compared to
95.0%
of our consolidated rentable square feet as of
September 30, 2017
. Occupancy data for our consolidated properties as of
September 30, 2018
and
2017
is as follows (square feet in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comparable
|
|
|
All Consolidated Properties
(1)
|
|
Consolidated Properties
(2)
|
|
|
September 30,
|
|
September 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Total properties
|
|
105
|
|
|
74
|
|
|
69
|
|
|
69
|
|
Total buildings
|
|
164
|
|
|
96
|
|
|
91
|
|
|
91
|
|
Total square feet
(3)
|
|
17,046
|
|
|
11,517
|
|
|
10,948
|
|
|
10,927
|
|
Percent leased
(4)
|
|
93.3
|
%
|
|
95.0
|
%
|
|
94.6
|
%
|
|
95.3
|
%
|
|
|
(1)
|
Based on consolidated properties we owned on
September 30, 2018
and
2017
, respectively.
|
|
|
(2)
|
Based on consolidated properties we owned on
September 30, 2018
and which we owned continuously since January 1, 2017. Our comparable properties decreased from 70 properties (90 buildings) at
September 30, 2017
as a result of our sale of four properties (four buildings) since January 1, 2017, partially offset by our acquisition of three properties (five buildings) during 2016.
|
|
|
(3)
|
Subject to changes when space is re-measured or re-configured for tenants.
|
|
|
(4)
|
Percent leased includes (i) space being fitted out for tenant occupancy pursuant to our lease agreements, if any, and (ii) space which is leased, but is not occupied or is being offered for sublease by tenants, if any, as of the measurement date.
|
The average annualized effective rental rate per square foot for our consolidated properties for the
three and nine
months ended
September 30, 2018
and
2017
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Average annualized effective rental rate per square foot
(1)
:
|
|
|
|
|
|
|
|
|
All properties
(2)
|
|
$
|
26.86
|
|
|
$
|
25.89
|
|
|
$
|
26.81
|
|
|
$
|
25.74
|
|
Comparable properties
(3)
|
|
$
|
25.70
|
|
|
$
|
25.42
|
|
|
$
|
25.92
|
|
|
$
|
25.43
|
|
|
|
(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.
|
|
|
(2)
|
Based on consolidated properties we owned on
September 30, 2018
and
2017
, respectively.
|
|
|
(3)
|
Based on consolidated properties we owned on
September 30, 2018
and which we owned continuously since July 1, 2017 and January 1, 2017, respectively.
|
During the
three and nine
months ended
September 30, 2018
, changes in rentable square feet leased and available for lease at our consolidated properties were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2018
|
|
Nine Months Ended September 30, 2018
|
|
|
|
|
Available
|
|
|
|
|
|
Available
|
|
|
|
|
Leased
|
|
for Lease
|
|
Total
|
|
Leased
|
|
for Lease
|
|
Total
|
Beginning of period
|
|
16,021,566
|
|
|
1,024,385
|
|
|
17,045,951
|
|
|
16,477,339
|
|
|
1,021,999
|
|
|
17,499,338
|
|
Changes resulting from:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Disposition of properties
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(466,736
|
)
|
|
(24,418
|
)
|
|
(491,154
|
)
|
Lease expirations
|
|
(306,677
|
)
|
|
306,677
|
|
|
—
|
|
|
(998,071
|
)
|
|
998,071
|
|
|
—
|
|
Lease renewals
(1)
|
|
97,670
|
|
|
(97,670
|
)
|
|
—
|
|
|
573,583
|
|
|
(573,583
|
)
|
|
—
|
|
New leases
(1)
|
|
84,550
|
|
|
(84,550
|
)
|
|
—
|
|
|
310,994
|
|
|
(285,415
|
)
|
|
25,579
|
|
Re-measurements
(2)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
12,188
|
|
|
12,188
|
|
End of period
|
|
15,897,109
|
|
|
1,148,842
|
|
|
17,045,951
|
|
|
15,897,109
|
|
|
1,148,842
|
|
|
17,045,951
|
|
|
|
(1)
|
Based on leases entered into during the
three and nine
months ended
September 30, 2018
and an expansion of 25,579 rentable square feet completed at an existing property during the first quarter of 2018.
|
|
|
(2)
|
Rentable square feet is subject to changes when space is re-measured or re-configured for tenants.
|
Leases at our consolidated properties totaling
306,677
and
998,071
rentable square feet expired during the
three and nine
months ended
September 30, 2018
, respectively. During the
three and nine
months ended
September 30, 2018
, we entered leases totaling
182,220
and
858,998
rentable square feet, including lease renewals of
97,670
and
573,583
rentable square feet, respectively. The weighted (by rentable square feet) average rental rates for leases of
18,110
and
274,860
rentable square feet entered with government tenants during the
three and nine
months ended
September 30, 2018
decreased by
8.0%
and increased by
6.6%
, respectively, when compared to the weighted (by rentable square feet) average prior rents for the same space. The weighted (by rentable square feet) average rental rates for leases of
164,110
and
584,138
rentable square feet entered with non-government tenants during the
three and nine
months ended
September 30, 2018
increased by
0.3%
and decreased by
0.7%
, respectively, when compared to the weighted (by rentable square feet) average rental rates previously charged for the same space.
During the
three and nine
months ended
September 30, 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, 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, 2018
|
|
Nine Months Ended September 30, 2018
|
|
|
Old Effective
|
|
New Effective
|
|
|
|
Old Effective
|
|
New Effective
|
|
|
|
|
Rent Per
|
|
Rent Per
|
|
Rentable
|
|
Rent Per
|
|
Rent Per
|
|
Rentable
|
|
|
Square Foot
(1)
|
|
Square Foot
(1)
|
|
Square Feet
|
|
Square Foot
(1)
|
|
Square Foot
(1)
|
|
Square Feet
|
New leases
|
|
$
|
22.64
|
|
|
$
|
21.57
|
|
|
82,079
|
|
|
$
|
20.82
|
|
|
$
|
24.28
|
|
|
290,582
|
|
Lease renewals
|
|
$
|
28.79
|
|
|
$
|
28.75
|
|
|
78,267
|
|
|
$
|
24.47
|
|
|
$
|
25.91
|
|
|
694,069
|
|
Total leasing activity
|
|
$
|
25.64
|
|
|
$
|
25.07
|
|
|
160,346
|
|
|
$
|
23.39
|
|
|
$
|
25.43
|
|
|
984,651
|
|
|
|
(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, 2018
, commitments made for expenditures, such as tenant improvements and leasing costs, in connection with leasing space at our consolidated properties were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2018
|
|
|
Government
|
|
Non-Government
|
|
|
|
|
Leases
|
|
Leases
|
|
Total
|
Rentable square feet leased
|
|
18,110
|
|
|
164,110
|
|
|
182,220
|
|
Tenant leasing costs and concession commitments
(1)
(in thousands)
|
|
$
|
1,181
|
|
|
$
|
5,298
|
|
|
$
|
6,479
|
|
Tenant leasing costs and concession commitments per rentable square foot
(1)
|
|
$
|
65.21
|
|
|
$
|
32.28
|
|
|
$
|
35.56
|
|
Weighted (by square feet) average lease term (years)
|
|
19.7
|
|
|
6.8
|
|
|
8.1
|
|
Total leasing costs and concession commitments per rentable square foot per year
(1)
|
|
$
|
3.32
|
|
|
$
|
4.76
|
|
|
$
|
4.41
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2018
|
|
|
Government
|
|
Non-Government
|
|
|
|
|
Leases
|
|
Leases
|
|
Total
|
Rentable square feet leased
|
|
274,860
|
|
|
584,138
|
|
|
858,998
|
|
Tenant leasing costs and concession commitments
(1)
(in thousands)
|
|
$
|
7,813
|
|
|
$
|
13,474
|
|
|
$
|
21,287
|
|
Tenant leasing costs and concession commitments per rentable square foot
(1)
|
|
$
|
28.43
|
|
|
$
|
23.07
|
|
|
$
|
24.78
|
|
Weighted (by square feet) average lease term (years)
|
|
9.2
|
|
|
5.0
|
|
|
6.4
|
|
Total leasing costs and concession commitments per rentable square foot per year
(1)
|
|
$
|
3.09
|
|
|
$
|
4.58
|
|
|
$
|
3.89
|
|
|
|
(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, 2018
and
2017
, amounts capitalized at our consolidated properties for tenant improvements, leasing costs, building improvements and development and redevelopment activities were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
September 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Tenant improvements
(1)
|
|
$
|
2,293
|
|
|
$
|
3,213
|
|
|
$
|
8,990
|
|
|
$
|
6,692
|
|
Leasing costs
(2)
|
|
$
|
1,831
|
|
|
$
|
1,993
|
|
|
$
|
5,443
|
|
|
$
|
4,051
|
|
Building improvements
(3)
|
|
$
|
6,707
|
|
|
$
|
2,640
|
|
|
$
|
13,462
|
|
|
$
|
8,883
|
|
Development, redevelopment and other activities
(4)
|
|
$
|
664
|
|
|
$
|
3,132
|
|
|
$
|
2,814
|
|
|
$
|
16,362
|
|
|
|
(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, 2018
, we have estimated unspent leasing related obligations of
$34,048
.
We believe that current government budgetary methodology, 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 renewing their leases for less space than they currently occupy. Also, our government tenants' desires 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 circumstances will be on our financial results for future periods.
As of
September 30, 2018
, we derived
44.1%
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
2.1%
of our annualized rental income as of
September 30, 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
0.6%
of our annualized rental income as of
September 30, 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 provided us any official notices of its intentions regarding these properties.
As of
September 30, 2018
, we had leases at our consolidated properties totaling 2,675,810 rentable square feet that were scheduled to expire through
September 30, 2019
. As of
October 30, 2018
, tenants with leases totaling 494,470 rentable square feet that are scheduled to expire through
September 30, 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, 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, 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; 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, 2018
, lease expirations at our consolidated properties by year are as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number
|
|
Expirations
|
|
|
|
|
|
Annualized
|
|
|
|
|
|
|
of
|
|
of Leased
|
|
|
|
Cumulative
|
|
Rental
|
|
|
|
Cumulative
|
|
|
Tenants
|
|
Square
|
|
Percent
|
|
Percent
|
|
Income
|
|
Percent
|
|
Percent
|
Year
(1)
|
|
Expiring
|
|
Feet
(2)
|
|
of Total
|
|
of Total
|
|
Expiring
|
|
of Total
|
|
of Total
|
2018
|
|
52
|
|
|
819,971
|
|
|
5.2
|
%
|
|
5.2
|
%
|
|
$
|
27,402
|
|
|
6.7
|
%
|
|
6.7
|
%
|
2019
|
|
91
|
|
|
2,584,697
|
|
|
16.3
|
%
|
|
21.5
|
%
|
|
74,181
|
|
|
18.1
|
%
|
|
24.8
|
%
|
2020
|
|
99
|
|
|
2,232,317
|
|
|
14.0
|
%
|
|
35.5
|
%
|
|
54,766
|
|
|
13.4
|
%
|
|
38.2
|
%
|
2021
|
|
91
|
|
|
1,814,185
|
|
|
11.4
|
%
|
|
46.9
|
%
|
|
37,653
|
|
|
9.2
|
%
|
|
47.4
|
%
|
2022
|
|
96
|
|
|
1,689,207
|
|
|
10.6
|
%
|
|
57.5
|
%
|
|
38,143
|
|
|
9.3
|
%
|
|
56.7
|
%
|
2023
|
|
70
|
|
|
1,309,371
|
|
|
8.2
|
%
|
|
65.7
|
%
|
|
37,597
|
|
|
9.2
|
%
|
|
65.9
|
%
|
2024
|
|
44
|
|
|
1,424,865
|
|
|
9.0
|
%
|
|
74.7
|
%
|
|
35,906
|
|
|
8.8
|
%
|
|
74.7
|
%
|
2025
|
|
33
|
|
|
995,024
|
|
|
6.3
|
%
|
|
81.0
|
%
|
|
22,776
|
|
|
5.6
|
%
|
|
80.3
|
%
|
2026
|
|
26
|
|
|
832,369
|
|
|
5.2
|
%
|
|
86.2
|
%
|
|
23,677
|
|
|
5.8
|
%
|
|
86.1
|
%
|
2027 and thereafter
|
|
57
|
|
|
2,195,103
|
|
|
13.8
|
%
|
|
100.0
|
%
|
|
56,711
|
|
|
13.9
|
%
|
|
100.0
|
%
|
Total
|
|
659
|
|
|
15,897,109
|
|
|
100.0
|
%
|
|
|
|
$
|
408,812
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average remaining lease term (in years)
|
|
4.4
|
|
|
|
|
|
4.4
|
|
|
|
|
|
|
(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, 2018
, government tenants occupying approximately
10.1%
of our consolidated rentable square feet and responsible for approximately
8.4%
of our annualized rental income as of
September 30, 2018
have currently exercisable rights to terminate their leases before the stated terms of their leases expire. Also, in
2018
,
2019
,
2020
,
2021
,
2022
,
2023
,
2024
,
2025
,
2026
,
2028
and
2033
early termination rights become exercisable by other tenants who currently occupy an additional approximately
0.3%
,
5.0%
,
6.6%
,
1.8%
,
3.1%
,
0.8%
,
0.3%
,
0.4%
,
0.6%
,
1.0%
, and
0.1%
of our consolidated rentable square feet, respectively, and contribute an additional approximately
0.2%
,
4.8%
,
6.6%
,
1.7%
,
2.4%
,
0.8%
,
0.3%
,
0.9%
,
0.9%
,
1.0%
and
0.0%
of our annualized rental income, respectively, as of
September 30, 2018
. In addition, as of
September 30, 2018
,
23
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
23
tenants occupy approximately
12.6%
of our consolidated rentable square feet and contribute approximately
12.5%
of our annualized rental income as of
September 30, 2018
.
|
|
|
(2)
|
Leased square feet is pursuant to leases existing as of
September 30, 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.
|
Disposition Activities (dollar amounts in thousands)
In March 2018, we sold an office property (
one
building) located in Minneapolis, MN with
193,594
rentable square feet for
$20,000
, excluding closing costs.
In February 2018, we entered an agreement to sell an office property (
one
building) located in Safford, AZ with 36,139 rentable square feet for $8,250. In April 2018, we terminated the sales agreement to sell this property.
In May 2018, we sold an office property (one building) located in New York, NY with
187,060
rentable square feet for
$118,500
, excluding closing costs.
In May 2018, we sold an office property (one building) located in Sacramento, CA with
110,500
rentable square feet for
$10,755
, excluding closing costs.
As of
September 30, 2018
, we had
20
properties (
50
buildings) with an aggregate undepreciated carrying value of
$355,858
under agreement to sell in three separate transactions presented in the table below. We have classified these properties as held for sale in our condensed consolidated balance sheet at
September 30, 2018
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Date of Agreement
(1)
|
|
Number of Properties
|
|
|
Number of Buildings
|
|
|
Location
|
|
Square Footage
|
|
|
Gross Sale Price
(2)
|
|
August 2018
|
|
1
|
|
|
1
|
|
|
Washington D.C.
|
|
129,035
|
|
|
$
|
70,000
|
|
September 2018
|
|
8
|
|
|
34
|
|
|
Northern Virginia and Maryland
|
|
1,635,868
|
|
|
201,500
|
|
October 2018
|
|
11
|
|
|
15
|
|
|
Southern Virginia
|
|
1,641,109
|
|
|
167,000
|
|
|
|
20
|
|
|
50
|
|
|
|
|
3,406,012
|
|
|
$
|
438,500
|
|
|
|
(1)
|
These 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.
|
|
|
(2)
|
Gross sale price excludes closing costs.
|
As part of our long term plans to reduce our leverage, we expect to sell additional properties. We are currently marketing or plan to market for sale
three
properties (
three
buildings) with an aggregate carrying value of
$24,566
as of
September 30, 2018
. We cannot be sure we will sell any of our properties that we are currently marketing or plan to market for sale or sell them for prices in excess of our carrying values.
Financing Activities (dollar amounts in thousands)
On May 1, 2018, one of our subsidiaries redeemed all
1,813,504
of its outstanding
5.5%
Series A Cumulative Preferred Units, or the 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.
Segment Information
We operate in one business segment: direct ownership of real estate properties. As a result of the Secondary Sale, our equity method investment in SIR has been reclassified to discontinued operations in our condensed consolidated financial statements as of
September 30, 2018
. See Note 13 to our Condensed Consolidated Financial Statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q for further information regarding discontinued operations.
RESULTS OF OPERATIONS
(amounts in thousands, except per share amounts)
Three Months Ended
September 30, 2018
, Compared to Three Months Ended
September 30, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Acquired Properties
|
|
Disposed Properties
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Results
(2)
|
|
Results
(3)
|
|
|
|
|
|
|
|
|
|
|
Comparable Properties Results
(1)
|
|
Three Months Ended
|
|
Three Months Ended
|
|
Consolidated Results
|
|
|
Three Months Ended September 30
|
|
September 30,
|
|
September 30,
|
|
Three Months Ended September 30,
|
|
|
|
|
|
|
$
|
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
|
%
|
|
|
2018
|
|
2017
|
|
Change
|
|
Change
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
|
Change
|
|
Change
|
Rental income
|
|
$
|
66,559
|
|
|
$
|
66,056
|
|
|
$
|
503
|
|
|
0.8
|
%
|
|
$
|
39,543
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
4,123
|
|
|
$
|
106,102
|
|
|
$
|
70,179
|
|
|
$
|
35,923
|
|
|
51.2
|
%
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate taxes
|
|
7,750
|
|
|
8,000
|
|
|
(250
|
)
|
|
(3.1
|
%)
|
|
4,322
|
|
|
—
|
|
|
—
|
|
|
862
|
|
|
12,072
|
|
|
8,862
|
|
|
3,210
|
|
|
36.2
|
%
|
Utility expenses
|
|
5,597
|
|
|
5,226
|
|
|
371
|
|
|
7.1
|
%
|
|
2,186
|
|
|
—
|
|
|
—
|
|
|
182
|
|
|
7,783
|
|
|
5,408
|
|
|
2,375
|
|
|
43.9
|
%
|
Other operating expenses
|
|
14,287
|
|
|
14,128
|
|
|
159
|
|
|
1.1
|
%
|
|
7,498
|
|
|
—
|
|
|
—
|
|
|
739
|
|
|
21,785
|
|
|
14,867
|
|
|
6,918
|
|
|
46.5
|
%
|
Total operating expenses
|
|
27,634
|
|
|
27,354
|
|
|
280
|
|
|
1.0
|
%
|
|
14,006
|
|
|
—
|
|
|
—
|
|
|
1,783
|
|
|
41,640
|
|
|
29,137
|
|
|
12,503
|
|
|
42.9
|
%
|
Net operating income
(4)
|
|
$
|
38,925
|
|
|
$
|
38,702
|
|
|
$
|
223
|
|
|
0.6
|
%
|
|
$
|
25,537
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
2,340
|
|
|
64,462
|
|
|
41,042
|
|
|
23,420
|
|
|
57.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
42,569
|
|
|
20,781
|
|
|
21,788
|
|
|
104.8
|
%
|
Loss on impairment of real estate
|
|
—
|
|
|
230
|
|
|
(230
|
)
|
|
(100.0
|
%)
|
Acquisition and transaction related costs
|
|
3,813
|
|
|
—
|
|
|
3,813
|
|
|
nm
|
|
General and administrative
|
|
22,383
|
|
|
3,266
|
|
|
19,117
|
|
|
nm
|
|
Total other expenses
|
|
68,765
|
|
|
24,277
|
|
|
44,488
|
|
|
183.3
|
%
|
Operating income (loss)
|
|
(4,303
|
)
|
|
16,765
|
|
|
(21,068
|
)
|
|
(125.7
|
%)
|
Dividend income
|
|
304
|
|
|
304
|
|
|
—
|
|
|
—
|
%
|
Unrealized gain on equity securities
|
|
17,425
|
|
|
—
|
|
|
17,425
|
|
|
nm
|
|
Interest income
|
|
140
|
|
|
1,715
|
|
|
(1,575
|
)
|
|
(91.8
|
%)
|
Interest expense (including net amortization of debt premiums and discounts and debt issuance costs of $893 and $990, respectively)
|
|
(23,374
|
)
|
|
(16,055
|
)
|
|
(7,319
|
)
|
|
45.6
|
%
|
Loss on early extinguishment of debt
|
|
—
|
|
|
(1,715
|
)
|
|
1,715
|
|
|
(100.0
|
%)
|
Income (loss) from continuing operations before income taxes and equity in net earnings of investees
|
|
(9,808
|
)
|
|
1,014
|
|
|
(10,822
|
)
|
|
nm
|
|
Income tax expense
|
|
(9
|
)
|
|
(22
|
)
|
|
13
|
|
|
(59.1
|
%)
|
Equity in net earnings of investees
|
|
94
|
|
|
31
|
|
|
63
|
|
|
203.2
|
%
|
Income (loss) from continuing operations
|
|
(9,723
|
)
|
|
1,023
|
|
|
(10,746
|
)
|
|
nm
|
|
Income from discontinued operations
|
|
9,274
|
|
|
9,966
|
|
|
(692
|
)
|
|
(6.9
|
%)
|
Net income (loss) available for common shareholders
|
|
$
|
(449
|
)
|
|
$
|
10,989
|
|
|
$
|
(11,438
|
)
|
|
(104.1
|
%)
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding (basic)
|
|
99,071
|
|
|
96,883
|
|
|
2,188
|
|
|
2.3
|
%
|
Weighted average common shares outstanding (diluted)
|
|
99,071
|
|
|
96,958
|
|
|
2,113
|
|
|
2.2
|
%
|
|
|
|
|
|
|
|
|
|
Per common share amounts (basic and diluted):
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations
|
|
$
|
(0.10
|
)
|
|
$
|
0.01
|
|
|
$
|
(0.11
|
)
|
|
nm
|
|
Income from discontinued operations
|
|
$
|
0.09
|
|
|
$
|
0.10
|
|
|
$
|
(0.01
|
)
|
|
(10.0
|
%)
|
Net income (loss) available for common shareholders
|
|
$
|
0.00
|
|
|
$
|
0.11
|
|
|
$
|
(0.11
|
)
|
|
(100.0
|
%)
|
|
|
|
|
|
|
|
|
|
Reconciliation of Net Income (Loss) Available for Common Shareholders to Consolidated Property NOI:
(4)
|
|
|
|
|
|
|
|
|
Net income (loss) available for common shareholders
|
|
$
|
(449
|
)
|
|
$
|
10,989
|
|
|
|
|
|
Income from discontinued operations
|
|
(9,274
|
)
|
|
(9,966
|
)
|
|
|
|
|
Income (loss) from continuing operations
|
|
(9,723
|
)
|
|
1,023
|
|
|
|
|
|
Equity in net earnings of investees
|
|
(94
|
)
|
|
(31
|
)
|
|
|
|
|
Income tax expense
|
|
9
|
|
|
22
|
|
|
|
|
|
Loss on early extinguishment of debt
|
|
—
|
|
|
1,715
|
|
|
|
|
|
Interest expense
|
|
23,374
|
|
|
16,055
|
|
|
|
|
|
Interest income
|
|
(140
|
)
|
|
(1,715
|
)
|
|
|
|
|
Unrealized gain on equity securities
|
|
(17,425
|
)
|
|
—
|
|
|
|
|
|
Dividend income
|
|
(304
|
)
|
|
(304
|
)
|
|
|
|
|
Operating income (loss)
|
|
(4,303
|
)
|
|
16,765
|
|
|
|
|
|
General and administrative
|
|
22,383
|
|
|
3,266
|
|
|
|
|
|
Acquisition and transaction related costs
|
|
3,813
|
|
|
—
|
|
|
|
|
|
Loss on impairment of real estate
|
|
—
|
|
|
230
|
|
|
|
|
|
Depreciation and amortization
|
|
42,569
|
|
|
20,781
|
|
|
|
|
|
Net operating income
|
|
$
|
64,462
|
|
|
$
|
41,042
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Calculation of Funds From Operations Available for Common Shareholders and Normalized Funds From Operations Available for Common Shareholders
(5)
|
|
|
|
|
|
|
2018
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) available for common shareholders
|
|
$
|
(449
|
)
|
|
$
|
10,989
|
|
|
|
|
|
Add (less): Depreciation and amortization:
|
|
|
|
|
|
|
|
|
Consolidated properties
|
|
42,569
|
|
|
20,781
|
|
|
|
|
|
Unconsolidated joint venture properties
|
|
1,913
|
|
|
—
|
|
|
|
|
|
FFO attributable to Select Income REIT
|
|
19,012
|
|
|
18,429
|
|
|
|
|
|
Loss on impairment of real estate
|
|
—
|
|
|
230
|
|
|
|
|
|
Equity in earnings from Select Income REIT included in discontinued operations
|
|
(9,253
|
)
|
|
(9,453
|
)
|
|
|
|
|
Increase in carrying value of property included in discontinued operations
|
|
—
|
|
|
(619
|
)
|
|
|
|
|
Funds from operations available for common shareholders
|
|
53,792
|
|
|
40,357
|
|
|
|
|
|
Add (less): Acquisition and transaction related costs
|
|
3,813
|
|
|
—
|
|
|
|
|
|
Loss on early extinguishment of debt
|
|
—
|
|
|
1,715
|
|
|
|
|
|
Normalized FFO attributable to Select Income REIT
|
|
15,584
|
|
|
16,903
|
|
|
|
|
|
FFO attributable to Select Income REIT
|
|
(19,012
|
)
|
|
(18,429
|
)
|
|
|
|
|
Net gain on issuance of shares by Select Income REIT included in discontinued operations
|
|
(21
|
)
|
|
(51
|
)
|
|
|
|
|
Estimated business management incentive fee
(6)
|
|
16,236
|
|
|
(893
|
)
|
|
|
|
|
Unrealized gain on equity securities
|
|
(17,425
|
)
|
|
—
|
|
|
|
|
|
Normalized funds from operations available for common shareholders
|
|
$
|
52,967
|
|
|
$
|
39,602
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Funds from operations per common share available for common shareholders (basic and diluted)
|
|
$
|
0.54
|
|
|
$
|
0.42
|
|
|
|
|
|
Normalized funds from operations per common share available for common shareholders (basic and diluted)
|
|
$
|
0.53
|
|
|
$
|
0.41
|
|
|
|
|
|
|
|
(1)
|
Comparable properties consist of
70
consolidated properties (
92
buildings) we owned on
September 30, 2018
and which we owned continuously since July 1, 2017.
|
|
|
(2)
|
Acquired properties consist of
35
consolidated properties (
72
buildings) we acquired since July 1, 2017. We acquired these 35 properties (72 buildings) in connection with the FPO Transaction in October 2017.
|
|
|
(3)
|
Disposed properties consist of one consolidated property (one building) which we sold in October 2017, one consolidated property (one building) which we sold in March 2018 and two consolidated properties (two buildings) which we sold in May 2018, and excludes one property (one building) classified as discontinued operations which we sold in August 2017.
|
|
|
(4)
|
The calculation of Consolidated Property Net Operating Income, or NOI, excludes certain components of net income (loss) 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 (loss) 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 (loss), net income (loss) 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 (loss), net income (loss) available for common shareholders and operating income as presented in our condensed consolidated statements of comprehensive income. Other real estate companies and REITs may calculate Consolidated Property NOI differently than we do.
|
|
|
(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, which is net income (loss) 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 SIR included in discontinued operations but excluding impairment charges on and increases in the carrying value of real estate assets, any gain or loss on sale of 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's definition of FFO available for common shareholders because we include SIR's Normalized FFO attributable to our equity investment in SIR (net of FFO attributable to our equity investment in SIR) included in discontinued operations, 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 and transaction related costs, loss on early extinguishment of debt, gains on issuance of shares by SIR included in discontinued operations, and unrealized gains and losses on 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 (loss), net income (loss) 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 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 (loss), net income (loss) 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 (loss), net income (loss) available for common shareholders and operating income as presented in our condensed consolidated statements of comprehensive income. Other real estate companies and REITs may calculate FFO available for common shareholders and Normalized FFO available for common shareholders differently than we do.
|
|
(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 expense in our condensed consolidated statements of comprehensive income. In calculating net income (loss) 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 (loss) 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.
|
We refer to the
70
consolidated properties (
92
buildings) we owned on
September 30, 2018
and which we have owned continuously since
July 1, 2017
as comparable properties. We refer to the
35
consolidated properties (
72
buildings) that we acquired during the period from
July 1, 2017
to
September 30, 2018
as the acquired properties. We refer to the four consolidated properties (four buildings) we sold during the period from
July 1, 2017
to
September 30, 2018
as the disposed properties.
Our condensed consolidated statements of comprehensive income for the three months ended
September 30, 2018
include the operating results of
35
acquired properties (
72
buildings) for the entire period, as we acquired those properties in 2017, exclude the operating results of four disposed properties (four buildings) for the entire period, as we sold those properties prior to July 1, 2018. Our condensed consolidated statements of comprehensive income for the three months ended
September 30, 2017
exclude the operating results of
35
acquired properties (
72
buildings) for the entire period, as we acquired those properties after
September 30, 2017
and include the operating results of four disposed properties (four buildings) for the entire period as we sold those properties after
September 30, 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, 2018
, compared to the three month period ended
September 30, 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 for comparable properties
increased
$503
primarily due to increases in rental rates and in occupied space at certain of our properties in the
2018
period. Rental income increased
$39,543
as a result of the acquired properties. Rental income declined
$4,123
as a result of the disposed properties. Rental income includes non-cash straight line rent adjustments totaling
$1,990
in the
2018
period and
$711
in the
2017
period, and amortization of acquired leases and assumed lease obligations totaling
$773
in the
2018
period and
$619
in the
2017
period.
Real estate taxes.
The increase
in real estate taxes reflects an increase in real estate taxes for the acquired properties, partially offset by a decrease in real estate taxes for the comparable properties and the disposed properties. Real estate taxes for comparable properties
declined
$250
due primarily to the effect of lower real estate tax valuation assessments at certain of our properties in the
2018
period. Real estate taxes increased
$4,322
as a result of the acquired properties. Real estate taxes declined
$862
as a result of the disposed properties.
Utility expenses.
The increase
in utility expenses reflects an 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 disposed properties. Utility expenses at comparable properties increased
$371
primarily due to an increase in electricity and gas usage and rates at certain of our properties during the
2018
period. Utility expenses increased
$2,186
as a result of the acquired properties. Utility expenses declined
$182
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 other operating expenses for the comparable properties and other operating expenses for the acquired properties, partially offset by a decrease in other operating expenses for the disposed properties. Other operating expenses at comparable properties
increased
$159
primarily as a result of higher repairs and maintenance costs during the
2018
period. Other operating expenses increased
$7,498
as a result of the acquired properties. Other operating expenses declined
$739
as a result of the disposed properties.
Depreciation and amortization.
The increase
in depreciation and amortization reflects the effect of the acquired properties and of improvements made to certain of our comparable properties, partially offset by the effect of certain assets becoming fully depreciated and property dispositions. Depreciation and amortization increased
$23,133
as a result of the acquired
properties. Depreciation and amortization at comparable properties decreased
$77
due primarily to certain leasing related assets becoming fully depreciated after
July 1, 2017
, partially offset by depreciation and amortization of improvements made to certain of our properties after
July 1, 2017
. Depreciation and amortization declined
$1,268
as a result of the disposed properties.
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 and transaction related costs.
Acquisition and transaction related costs in the 2018 period include costs incurred in connection with our pending Merger with SIR and other related Transactions. For further information regarding the Merger and other related Transactions, see Notes 1, 11, 12 and 13 to the Notes to condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q.
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 increase in general and administrative expenses in the 2018 period primarily reflects an increase in accrued estimated business management incentive fees ($17,129) and an increase in base business management fees as a result of our acquisition activity.
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 unrealized gain to adjust our investment in RMR Inc. to its fair value in accordance with a change in GAAP effective January 1, 2018. For further information, see Notes 2 and 8 to the Notes to condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q.
Interest income.
The decrease in interest income is primarily the result of lower cash balances in the 2018 period compared to the 2017 period.
Interest expense.
The increase in interest expense reflects higher average outstanding debt balances and higher weighted average interest rates on borrowings during the
2018
period compared to the
2017
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 a bridge loan facility that we entered into in connection with the FPO Transaction.
Income tax expense.
The decrease in income tax expense reflects lower operating income in certain jurisdictions in the
2018
period that is subject to state income taxes.
Equity in net earnings of investees.
Equity in net earnings of investees represents our proportionate share of earnings from our investments in Affiliates Insurance Company, or AIC, and two unconsolidated joint ventures.
Income from discontinued operations.
Income from discontinued operations consists of our proportionate share of earnings from our investment in SIR, gain on issuance of shares by SIR as a result of the issuance of common shares by SIR at prices which were in the aggregate above the then per share carrying value of our SIR common shares and the operating results for one property (one building) we sold in 2017. During the 2017 period, we recorded an adjustment of $619 to increase the carrying value of the property we sold during the 2017 period to its estimated fair value less costs to sell. See Notes 1, 11, 12 and 13 to our condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q, for further information about our equity method investment in SIR.
Net income (loss) available for common shareholders.
Our net loss available for common shareholders and net loss available for common shareholders per basic and diluted common share in the 2018 period compared to net income available for common shareholders and net income available for common shareholders per basic and diluted common share in the 2017 period was primarily as a result of the changes noted above.
RESULTS OF OPERATIONS
(amounts in thousands, except per share amounts)
Nine Months Ended September 30, 2018
, Compared to
Nine Months Ended September 30, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Acquired Properties
|
|
Disposed Properties
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Results
(2)
|
|
Results
(3)
|
|
|
|
|
|
|
|
|
|
|
Comparable Properties Results
(1)
|
|
Nine Months Ended
|
|
Nine Months Ended
|
|
Consolidated Results
|
|
|
Nine Months Ended September 30
|
|
September 30,
|
|
September 30,
|
|
Nine Months Ended September 30
|
|
|
|
|
|
|
$
|
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
|
%
|
|
|
2018
|
|
2017
|
|
Change
|
|
Change
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
|
Change
|
|
Change
|
Rental income
|
|
$
|
199,373
|
|
|
$
|
195,817
|
|
|
$
|
3,556
|
|
|
1.8
|
%
|
|
$
|
117,954
|
|
|
$
|
1,233
|
|
|
$
|
5,577
|
|
|
$
|
12,312
|
|
|
$
|
322,904
|
|
|
$
|
209,362
|
|
|
$
|
113,542
|
|
|
54.2
|
%
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate taxes
|
|
23,284
|
|
|
22,482
|
|
|
802
|
|
|
3.6
|
%
|
|
12,907
|
|
|
79
|
|
|
1,211
|
|
|
2,419
|
|
|
37,402
|
|
|
24,980
|
|
|
12,422
|
|
|
49.7
|
%
|
Utility expenses
|
|
14,303
|
|
|
13,659
|
|
|
644
|
|
|
4.7
|
%
|
|
5,965
|
|
|
17
|
|
|
222
|
|
|
510
|
|
|
20,490
|
|
|
14,186
|
|
|
6,304
|
|
|
44.4
|
%
|
Other operating expenses
|
|
42,275
|
|
|
41,650
|
|
|
625
|
|
|
1.5
|
%
|
|
23,086
|
|
|
226
|
|
|
860
|
|
|
2,170
|
|
|
66,221
|
|
|
44,046
|
|
|
22,175
|
|
|
50.3
|
%
|
Total operating expenses
|
|
79,862
|
|
|
77,791
|
|
|
2,071
|
|
|
2.7
|
%
|
|
41,958
|
|
|
322
|
|
|
2,293
|
|
|
5,099
|
|
|
124,113
|
|
|
83,212
|
|
|
40,901
|
|
|
49.2
|
%
|
Net operating income
(4)
|
|
$
|
119,511
|
|
|
$
|
118,026
|
|
|
$
|
1,485
|
|
|
1.3
|
%
|
|
$
|
75,996
|
|
|
$
|
911
|
|
|
$
|
3,284
|
|
|
$
|
7,213
|
|
|
198,791
|
|
|
126,150
|
|
|
72,641
|
|
|
57.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
129,444
|
|
|
61,949
|
|
|
67,495
|
|
|
109.0
|
%
|
Loss on impairment of real estate
|
|
5,800
|
|
|
230
|
|
|
5,570
|
|
|
nm
|
|
Acquisition and transaction related costs
|
|
3,813
|
|
|
—
|
|
|
3,813
|
|
|
nm
|
|
General and administrative
|
|
36,438
|
|
|
12,314
|
|
|
24,124
|
|
|
195.9
|
%
|
Total other expenses
|
|
175,495
|
|
|
74,493
|
|
|
101,002
|
|
|
135.6
|
%
|
Operating income
|
|
23,296
|
|
|
51,657
|
|
|
(28,361
|
)
|
|
(54.9
|
%)
|
Dividend income
|
|
912
|
|
|
911
|
|
|
1
|
|
|
0.1
|
%
|
Unrealized gain on equity securities
|
|
40,677
|
|
|
—
|
|
|
40,677
|
|
|
nm
|
|
Interest income
|
|
405
|
|
|
1,843
|
|
|
(1,438
|
)
|
|
(78.0
|
%)
|
Interest expense (including net amortization of debt premium and discounts and debt issuance costs of $2,749 and $2,605, respectively)
|
|
(69,444
|
)
|
|
(43,599
|
)
|
|
(25,845
|
)
|
|
59.3
|
%
|
Loss on early extinguishment of debt
|
|
—
|
|
|
(1,715
|
)
|
|
1,715
|
|
|
(100.0
|
%)
|
Income (loss) from continuing operations before income taxes, equity in net earnings (losses) of investees and gain on sale of real estate
|
|
(4,154
|
)
|
|
9,097
|
|
|
(13,251
|
)
|
|
(145.7
|
%)
|
Income tax expense
|
|
(124
|
)
|
|
(65
|
)
|
|
(59
|
)
|
|
90.8
|
%
|
Equity in net earnings (losses) of investees
|
|
(1,112
|
)
|
|
533
|
|
|
(1,645
|
)
|
|
nm
|
|
Income (loss) from continuing operations
|
|
(5,390
|
)
|
|
9,565
|
|
|
(14,955
|
)
|
|
(156.4
|
%)
|
Income from discontinued operations
|
|
23,872
|
|
|
20,516
|
|
|
3,356
|
|
|
16.4
|
%
|
Income before gain on sale of real estate
|
|
18,482
|
|
|
30,081
|
|
|
(11,599
|
)
|
|
(38.6
|
%)
|
Gain on sale of real estate
|
|
17,329
|
|
|
—
|
|
|
17,329
|
|
|
nm
|
|
Net income
|
|
35,811
|
|
|
30,081
|
|
|
5,730
|
|
|
19.0
|
%
|
Preferred units of limited partnership distributions
|
|
(371
|
)
|
|
—
|
|
|
(371
|
)
|
|
nm
|
|
Net income available for common shareholders
|
|
$
|
35,440
|
|
|
$
|
30,081
|
|
|
$
|
5,359
|
|
|
17.8
|
%
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding (basic)
|
|
99,055
|
|
|
79,778
|
|
|
19,277
|
|
|
24.2
|
%
|
Weighted average common shares outstanding (diluted)
|
|
99,075
|
|
|
79,852
|
|
|
19,223
|
|
|
24.1
|
%
|
|
|
|
|
|
|
|
|
|
Per common share amounts (basic and diluted):
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations
|
|
$
|
0.12
|
|
|
$
|
0.12
|
|
|
$
|
—
|
|
|
—
|
%
|
Income from discontinued operations
|
|
$
|
0.24
|
|
|
$
|
0.26
|
|
|
$
|
(0.02
|
)
|
|
(7.7
|
%)
|
Net income available for common shareholders
|
|
$
|
0.36
|
|
|
$
|
0.38
|
|
|
$
|
(0.02
|
)
|
|
(5.3
|
%)
|
|
|
|
|
|
|
|
|
|
Reconciliation of Net Income Available for Common Shareholders to Consolidated Property NOI:
(4)
|
|
|
|
|
|
|
|
|
Net income available for common shareholders
|
|
$
|
35,440
|
|
|
$
|
30,081
|
|
|
|
|
|
Preferred units of limited partnership distributions
|
|
371
|
|
|
—
|
|
|
|
|
|
Net income
|
|
35,811
|
|
|
30,081
|
|
|
|
|
|
Gain on sale of real estate
|
|
(17,329
|
)
|
|
—
|
|
|
|
|
|
Income before gain on sale of real estate
|
|
18,482
|
|
|
30,081
|
|
|
|
|
|
Income from discontinued operations
|
|
(23,872
|
)
|
|
(20,516
|
)
|
|
|
|
|
Income (loss) from continuing operations
|
|
(5,390
|
)
|
|
9,565
|
|
|
|
|
|
Equity in net (earnings) losses of investees
|
|
1,112
|
|
|
(533
|
)
|
|
|
|
|
Income tax expense
|
|
124
|
|
|
65
|
|
|
|
|
|
Loss on early extinguishment of debt
|
|
—
|
|
|
1,715
|
|
|
|
|
|
Interest expense
|
|
69,444
|
|
|
43,599
|
|
|
|
|
|
Interest income
|
|
(405
|
)
|
|
(1,843
|
)
|
|
|
|
|
Unrealized gain on equity securities
|
|
(40,677
|
)
|
|
—
|
|
|
|
|
|
Dividend income
|
|
(912
|
)
|
|
(911
|
)
|
|
|
|
|
Operating income
|
|
23,296
|
|
|
51,657
|
|
|
|
|
|
General and administrative
|
|
36,438
|
|
|
12,314
|
|
|
|
|
|
Acquisition and transaction related costs
|
|
3,813
|
|
|
—
|
|
|
|
|
|
Loss on impairment of real estate
|
|
5,800
|
|
|
230
|
|
|
|
|
|
Depreciation and amortization
|
|
129,444
|
|
|
61,949
|
|
|
|
|
|
Net operating income
|
|
$
|
198,791
|
|
|
$
|
126,150
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
|
|
$
|
35,440
|
|
|
$
|
30,081
|
|
|
|
|
|
Add (less): Depreciation and amortization:
|
|
|
|
|
|
|
|
|
Consolidated properties
|
|
129,444
|
|
|
61,949
|
|
|
|
|
|
Unconsolidated joint venture properties
|
|
6,283
|
|
|
—
|
|
|
|
|
|
FFO attributable to Select Income REIT
|
|
49,914
|
|
|
47,982
|
|
|
|
|
|
Loss on impairment of real estate
|
|
5,800
|
|
|
230
|
|
|
|
|
|
Equity in earnings from Select Income REIT included in discontinued operations
|
|
(23,843
|
)
|
|
(20,271
|
)
|
|
|
|
|
Increase in carrying value of property included in discontinued operations
|
|
—
|
|
|
(619
|
)
|
|
|
|
|
Gain on sale of real estate
|
|
(17,329
|
)
|
|
—
|
|
|
|
|
|
Funds from operations available for common shareholders
|
|
185,709
|
|
|
119,352
|
|
|
|
|
|
Add (less): Acquisition and transaction related costs
|
|
3,813
|
|
|
—
|
|
|
|
|
|
Estimated business management incentive fee
(6)
|
|
16,973
|
|
|
—
|
|
|
|
|
|
Loss on early extinguishment of debt
|
|
—
|
|
|
1,715
|
|
|
|
|
|
Normalized FFO attributable to Select Income REIT
|
|
42,482
|
|
|
48,900
|
|
|
|
|
|
FFO attributable to Select Income REIT
|
|
(49,914
|
)
|
|
(47,982
|
)
|
|
|
|
|
Unrealized gain on equity securities
|
|
(40,677
|
)
|
|
—
|
|
|
|
|
|
Net gain on issuance of shares by Select Income REIT included in discontinued operations
|
|
(29
|
)
|
|
(72
|
)
|
|
|
|
|
Normalized funds from operations available for common shareholders
|
|
$
|
158,357
|
|
|
$
|
121,913
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Funds from operations per common share available for common shareholders (basic)
|
|
$
|
1.87
|
|
|
$
|
1.50
|
|
|
|
|
|
Funds from operations per common share available for common shareholders (diluted)
|
|
$
|
1.87
|
|
|
$
|
1.49
|
|
|
|
|
|
Normalized funds from operations per common share available for common shareholders (basic and diluted)
|
|
$
|
1.60
|
|
|
$
|
1.53
|
|
|
|
|
|
|
|
(1)
|
Comparable properties consist of
69
consolidated properties (
91
buildings) we owned on
September 30, 2018
and which we owned continuously since
January 1, 2017
.
|
|
|
(2)
|
Acquired properties consist of
36
consolidated properties (
73
buildings) we acquired since January 1, 2017. We acquired 35 of these properties (72 buildings) in connection with the FPO Transaction in October 2017 and acquired one property (one building) in a separate transaction in January 2017.
|
|
|
(3)
|
Disposed properties consist of one consolidated property (one building) which we sold in October 2017 and three consolidated properties (three buildings) which we sold during the
nine
months
September 30, 2018
and excludes one property (one building) classified as discontinued operations which we sold in August 2017.
|
|
|
(4)
|
See footnote (4) on page 28 for definition of NOI.
|
|
|
(5)
|
See footnote (5) on page 28 for definition of FFO and Normalized FFO available for common shareholders.
|
|
|
(6)
|
See footnote (6) on page 29 for more information on incentive fees under our business management agreements.
|
We refer to the
69
consolidated properties (
91
buildings) we owned on
September 30, 2018
and which we have owned continuously since
January 1, 2017
as comparable properties. We refer to the
36
consolidated properties (
73
buildings) that we acquired during the period from January 1, 2017 to
September 30, 2018
as the acquired properties. We refer to the four consolidated properties (four buildings) we sold during the period from January 1, 2017 to
September 30, 2018
as the disposed properties.
Our condensed consolidated statements of comprehensive income for the
nine months ended September 30, 2018
include the operating results of the acquired properties for the entire period, as we acquired those properties in 2017, exclude the operating results of one disposed property (one building) for the entire period, as we sold that property in 2017, and include the operating results of three disposed properties (three buildings) for less than the entire period, as we sold those properties during the 2018 period. Our condensed consolidated statements of comprehensive income for the
nine
months ended
September 30, 2017
exclude the operating results of 35 acquired properties (72 buildings) for the entire period, as we acquired those properties after
September 30, 2017
, include the operating results of one property (one building) for less than the entire period, as we acquired that property during the 2017 period and include the operating results of the disposed properties for the entire period as we sold those properties after
September 30, 2017
.
References to changes in the income and expense categories below relate to the comparison of consolidated results for the
nine months ended September 30, 2018
, compared to the
nine
month period ended
September 30, 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 for comparable properties
increased
$3,556
primarily due to increases in rental rates and in occupied space at certain of our properties in the
2018
period. Rental income increased
$116,721
as a result of the acquired properties. Rental income declined
$6,735
as a result of the disposed properties. Rental income includes non-cash straight line rent adjustments totaling
$7,825
in the
2018
period and
$3,115
in the
2017
period, and amortization of acquired leases and assumed lease obligations totaling
$7,825
in the
2018
period and
$3,115
in the
2017
period.
Real estate taxes.
The increase
in real estate taxes reflects an increase in real estate taxes for the comparable properties and 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
$802
due primarily to the effect of higher real estate tax valuation assessments at certain of our properties in the
2018
period. Real estate taxes increased
$12,828
as a result of the acquired properties. Real estate taxes declined
$1,208
as a result of the disposed properties.
Utility expenses.
The increase
in utility expenses reflects an 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 disposed properties. Utility expenses at comparable properties increased
$644
primarily due to an increase in electricity and gas usage and rates at certain of our properties during the
2018
period. Utility expenses increased
$5,948
as a result of the acquired properties. Utility expenses declined
$288
as a result of the disposed properties.
Other operating expenses.
The increase
in other operating expenses reflects an increase in other operating expenses for the comparable properties and the other operating expenses for the acquired properties, partially offset by a decrease in other operating expenses for the disposed properties. Other operating expenses at comparable properties
increased
$625
primarily as a result of higher snow removal and repairs and maintenance costs during the
2018
period. Other operating expenses increased
$22,860
as a result of the acquired properties. Other operating expenses declined
$1,310
as a result of the disposed properties.
Depreciation and amortization.
The increase
in depreciation and amortization reflects the effect of the acquired properties and of improvements made to certain of our comparable properties, partially offset by the effect of certain assets becoming fully depreciated and property dispositions. Depreciation and amortization increased
$69,508
as a result of the acquired properties. Depreciation and amortization at comparable properties increased
$753
due primarily to depreciation and amortization of improvements made to certain of our properties after
January 1, 2017
, partially offset by certain leasing related assets becoming fully depreciated after
January 1, 2017
. Depreciation and amortization declined
$2,766
as a result of the disposed properties.
Loss on impairment of real estate.
We recorded a
$5,800
loss on impairment of real estate in the 2018 period to reduce the carrying value of three properties (three buildings) to their estimated fair value less costs to sell.
Acquisition and transaction related costs.
Acquisition and transaction related costs in the 2018 period include costs incurred in connection with our pending Merger with SIR and other related Transactions. For further information regarding the Merger and other related Transactions, see Notes 1, 11, 12 and 13 to the Notes to condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q.
General and administrative.
The increase in general and administrative expenses primarily reflects an increase in accrued estimated business management incentive fees (
$16,973
) and an increase in base business management fees as a result of our acquisition activity.
Dividend income.
Dividend income consists of dividends received from our investment in RMR Inc.
Unrealized gain on equity securities.
Unrealized gain on equity securities represents the unrealized gain to adjust our investment in RMR Inc. to its fair value in accordance with a change in GAAP effective January 1, 2018. For further information, see Notes 2 and 8 to the Notes to condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q.
Interest income.
The decrease in interest income is primarily the result of lower cash balances in the 2018 period compared to the 2017 period.
Interest expense.
The increase in interest expense reflects higher average outstanding debt balances and higher weighted average interest rates on borrowings during the
2018
period compared to the
2017
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 a bridge loan facility that we entered into in connection with the FPO Transaction.
Income tax expense.
The increase in income tax expense reflects higher operating income in certain jurisdictions in the
2018
period that is subject to state income taxes.
Equity in net earnings (losses) of investees.
Equity in net earnings (losses) of investees represents our proportionate share of earnings from our investments in AIC and two unconsolidated joint ventures.
Income from discontinued operations.
Income from discontinued operations consists of our proportionate share of earnings from our investment in SIR, gain on issuance of shares by SIR as a result of the issuance of common shares by SIR at prices which were in the aggregate above the then per share carrying value of our SIR common shares and the operating results for one property (one building) we sold during the 2017 period. During the 2017 period, we recorded an adjustment of $619 to increase the carrying value of the property sold in 2017 to its estimated fair value less costs to sell. See Notes 1, 11, 12 and 13 to our condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q, for further information about our equity method investment in SIR.
Gain on sale of real estate.
We recorded a
$17,329
gain on sale of real estate resulting from the sale of one property (one building) during the 2018 period.
Preferred units of limited partnership distributions.
Preferred units of limited partnership distributions represent distributions to the holders of the Preferred Units. The Preferred Units were redeemed by one of our subsidiaries in May 2018.
Net 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 increased in the 2018 period compared to the 2017 period primarily as a result of the changes noted above. Net income available for common shareholders per common share (basic and diluted) decreased despite the increase in net income available for common shareholders because of the higher number of weighted average common shares outstanding as result of our issuance of common shares in an underwritten public offering in July 2017.
LIQUIDITY AND CAPITAL RESOURCES
Under the Merger Agreement, we have agreed to conduct our business in all material respects in the ordinary course of business consistent with past practice. The Merger Agreement contains certain operating covenants that could affect our liquidity and capital resources, but we do not expect any material changes to our liquidity and capital resources prior to consummation of the Merger or, if applicable, the termination of the Merger Agreement.
Our Operating Liquidity and Resources (dollar amounts in thousands)
On a standalone basis, our principal sources of funds to meet operating and capital expenses, pay debt service obligations and make distributions to our shareholders are the operating cash flows we generate as rental income from our properties, net proceeds from property sales and borrowings under our revolving credit facility. If the Merger is consummated, we and SIR have identified approximately $750,000 of assets to be sold by the combined company following the closing of the Merger. Alternatively, in lieu of selling such properties, the combined company may sell some or all of the approximately 2.8 million shares of class A common stock of RMR Inc. that it will own following completion of the Merger. We believe that these sources of funds will be sufficient to meet our operating and capital expenses, pay debt service obligations and (except as described below) make distributions to our shareholders for the next 12 months and for the foreseeable future thereafter. Our future cash flows from operating activities will depend primarily upon:
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our ability to maintain or increase the occupancy of, and the rental rates at, our properties;
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our ability to control operating expenses and capital expenses at our properties;
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our ability to successfully complete our pending property sales and to sell properties that we market for sale; and
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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.
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Following the Merger, we and SIR expect that the combined company’s annual distribution will range between $0.50 and $0.60 per common share of beneficial interest (before giving effect to the one-for-four reverse stock split described above), based on a target payout ratio of 75% of the combined company's projected cash available for distribution, which is below our current annualized distribution of $1.72 per share. The combined company's expected distribution rate is lower than our and SIR's combined current rates due to various reasons, including that the combined company may not have sufficient cash to pay such distributions at a higher rate due to expected capital expenditures or changes in its cash requirements, cash flow or financial position.
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
nine
months ended
September 30, 2018
compared to the same period in
2017
were as follows: (i) cash provided by operating activities increased from
$95,914
in
2017
period to
$120,165
in the
2018
period; (ii) cash flows from investing activities changed from
$664,527
of cash used in investing activities in the
2017
period to
$126,891
of cash provided by investing activities in the
2018
period; and (iii) cash flows from financing activities changed from
$1,090,358
of cash provided by financing activities in the
2017
period to
$254,738
of cash used in financing activities in the
2018
period.
The increase in cash provided by operating activities for the
nine
month period ended
September 30, 2018
as compared to the corresponding prior year period was due primarily to an increase in Consolidated Property NOI from our acquisition activities and an 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 an increase in the equity in earnings of SIR we recognized in the 2018 period, partially offset by an increase in interest paid due to higher average outstanding debt balances and higher weighed average interest rates on borrowings in the 2018 period and 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 the sale of four of our properties (four buildings) in the 2018 period, compared to our use of cash for a deposit in escrow of a portion of the cash consideration for the FPO Transaction in the 2017 period. The change from cash used in financing activities for the 2018 period to cash provided by financing activities in the 2017 period is primarily due to an increase in net debt repayments and the redemption of the Preferred Units in the 2018 period, compared to our financing activities related to the FPO Transaction during the 2017 period, including issuances of common shares and senior unsecured notes and borrowings under our revolving credit facility.
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, 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, 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, 2018
, the annual interest rate payable on borrowings under our revolving credit facility was
3.4%
. As of
September 30, 2018
and
October 30, 2018
, we had
$467,000
and
$32,000
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:
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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, 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, 2018
, the annual interest rate for the amount outstanding under our $300,000 term loan was
3.6%
.
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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, 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, 2018
, the annual interest rate for the amount outstanding under our $250,000 term loan was
4.0%
.
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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 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 our 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 $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 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, 2018
, our debt maturities (other than our revolving credit facility) are as follows:
$940
in
2018
,
$361,541
in
2019
,
$338,433
in
2020
,
$14,420
in
2021
,
$575,518
in
2022
and
$399,564
thereafter.
None of our unsecured debt obligations require sinking fund payments prior to their maturity dates. Our
$180,416
in mortgage debts generally require monthly payments of principal and interest through maturity.
In addition to our debt obligations, as of
September 30, 2018
, we have estimated unspent leasing related obligations of
$34,048
.
On May 1, 2018, one of our subsidiaries 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.
On October 9, 2018, we completed the Secondary Sale, pursuant to which we sold all 24,918,421 SIR common shares that we then owned in an underwritten public offering at a price of
$18.25
per share, raising net proceeds of approximately
$434,700
after deducting underwriting discounts and estimated offering expenses. We used the net proceeds from the Secondary Sale to repay amounts outstanding under our revolving credit facility. We expect to record a loss on the Secondary Sale of approximately
$19,372
in the fourth quarter of 2018.
We currently expect to use cash balances, borrowings under our revolving credit facility, net proceeds from property sales, assumptions 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. In connection with the pending Merger, we expect to pay off SIR's revolving credit facility and to assume $1,450,000 of principal amount of SIR’s unsecured notes and $162,000 of mortgage indebtedness of SIR. Although we cannot be sure that we will be successful in consummating any particular type of financing, we believe that we will have access to financing, such as debt and equity offerings, to fund future acquisitions and capital expenditures and to pay our obligations. We currently have an effective shelf registration statement that allows us to issue public securities on an expedited basis, but it does not assure that there will be buyers for such securities.
Our ability to obtain, and the costs of, our future 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 that 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 September 2018, as a result of the proposed Merger, Standard & Poor's Ratings Services, or S&P, affirmed our credit ratings and revised its outlook on our debt to stable and Moody's Investor Service, or Moody's, affirmed our credit ratings and maintained its negative outlook on our debt. A negative credit rating outlook may imply that our credit ratings may be downgraded unless we are successful in improving our financial profile.
On February 26, 2018, May 21, 2018 and August 20, 2018, we paid a regular quarterly distribution to common shareholders of record on January 29, 2018, April 30, 2018 and July 30, 2018 of
$0.43
per share, or
$42,632
and
$42,634
,
$42,641
, respectively. We funded these distributions using cash on hand and borrowings under our revolving credit facility. On October 18, 2018, we declared a regular quarterly distribution payable to common shareholders of record on October 29, 2018 of
$0.43
per share, or
$42,658
. We expect to pay this distribution on or about November 19, 2018 using cash on hand and borrowings under our revolving credit facility. Pursuant to the Merger Agreement, we have agreed not to pay any distribution exceeding an annual rate of $1.72 per common share, and we have agreed to certain limitations with respect to our ability to make any other distribution.
Off Balance Sheet Arrangements
We 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 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
September 30, 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, 2018
consisted of borrowings under our $750,000 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 eight secured mortgage notes with an aggregate outstanding principal balance of
$180,416
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. Our credit agreement and our senior unsecured notes indentures and their supplements 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 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 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, 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, although in September 2018 S&P revised its outlook on our debt to stable, Moody's reaffirmed its negative rating, which may imply that our debt 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. 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, an officer and controlling shareholder of ABP Trust, which 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 or 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, as of
September 30, 2018
, we owned 24,918,421 of its common shares, or approximately
27.8%
of its outstanding common shares, all of which we sold on October 9, 2018 pursuant to the Secondary Sale, and further, with which, on September 14, 2018, we entered into the Merger Agreement, all as further described in Note 1 to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q; and AIC, of which we, 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 2018 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 this Quarterly Report and 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, the Merger Agreement, the registration agreement with SIR 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
. We may engage in additional transactions with related persons, including businesses to which RMR LLC or its subsidiaries provide management services.