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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2011

OR

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-34364

GOVERNMENT PROPERTIES INCOME TRUST

(Exact Name of Registrant as Specified in Its Charter)

Two Newton Place, 255 Washington Street, Suite 300, Newton, Massachusetts 02458-1634

 (Address of Principal Executive Offices)  (Zip Code)

617-219-1440

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x

Number of registrant’s common shares of beneficial interest, $0.01 par value per share, outstanding as of August 2, 2011:  47,010,800

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GOVERNMENT PROPERTIES INCOME TRUST

FORM 10-Q

JUNE 30, 2011

INDEX

References in this Form 10-Q to “we”, “us” and “our” refer to Government Properties Income Trust and its consolidated subsidiaries, unless otherwise noted.

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PART I          Financial Information

Item 1.  Financial Statements

GOVERNMENT PROPERTIES INCOME TRUST

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except share data)

(unaudited)

See accompanying notes.

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GOVERNMENT PROPERTIES INCOME TRUST

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(amounts in thousands, except per share data)

(unaudited)

See accompanying notes.

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GOVERNMENT PROPERTIES INCOME TRUST

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in thousands)

(unaudited)

See accompanying notes.

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GOVERNMENT PROPERTIES INCOME TRUST

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

(unaudited)

Note 1.  Basis of Presentation

The accompanying condensed consolidated financial statements of Government Properties Income Trust and its subsidiaries, or GOV, the Company, we or us, have been prepared without audit.  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 financial statements and notes contained in our Annual Report on Form 10-K for the year ended December 31, 2010, or our Annual Report.  In the opinion of our management, all adjustments, which include only normal recurring adjustments considered necessary for a fair presentation, have been included.  All intercompany transactions and balances between the Company and its subsidiaries have been eliminated.

As of June 30, 2011, we owned 64 properties located in 27 states and the District of Columbia containing approximately 7.6 million rentable square feet.  The U.S. Government and certain state governments are our primary tenants.

Note 2.  Recent Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board issued Accounting Standards Update No. 2011-05, Presentation of Comprehensive Income.  This standard eliminates the current option to report other comprehensive income and its components in the statement of shareholders’ equity.  This standard is intended to enhance comparability between entities that report under GAAP and to provide a more consistent method of presenting non-owner transactions that affect an entity’s equity.  This standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  We do not expect the adoption of this update to cause any material changes to the disclosures in our condensed consolidated financial statements.

Note 3.  Real Estate Properties

We generally lease space in our properties on a gross lease or modified gross lease basis pursuant to fixed term operating leases expiring between 2011 and 2025.  Certain of our government tenants have the right to cancel their leases before the lease terms expire, although we expect that few will do so.  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 June 30, 2011, we executed eight leases for 24,572 rentable square feet for an average lease term of 5.1 years and made commitments for approximately $356 of leasing related costs.  During the six months ended June 30, 2011, we executed 15 leases for 45,438 rentable square feet for an average lease term of 5.1 years and made commitments for approximately $816 of leasing related costs.  We have unspent tenancy related obligations of approximately $6,130 as of June 30, 2011.

In February 2011, we acquired an office property located in Quincy, MA with 92,549 rentable square feet.  This property is majority leased to the State of Massachusetts.  The purchase price was $14,000, excluding acquisition costs.  We allocated approximately $2,700 to land, $9,200 to building and improvements, $2,113 to acquired real estate leases and $13 to assumed real estate lease obligations based on the fair values of the acquired assets and assumed liabilities.

Also in February 2011, we acquired two office properties located in Woodlawn, MD with 182,561 rentable square feet.  These properties are majority leased to the U.S. Government.  The purchase price was $28,000, excluding acquisition costs.  We allocated approximately $3,735 to land, $21,509 to building and improvements, $3,281 to acquired real estate leases and $525 to assumed real estate lease obligations based on the fair values of the acquired assets and assumed liabilities.

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GOVERNMENT PROPERTIES INCOME TRUST

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

(unaudited)

In May 2011, we acquired an office property located in Plantation, FL with 135,819 rentable square feet.  This property is leased to the U.S. Government.  The purchase price was $40,750, excluding acquisition costs.  We allocated approximately $4,800 to land, $30,592 to building and improvements and $5,358 to acquired real estate leases based on the fair values of the acquired assets.

Also in May 2011, we acquired an office property located in New York, NY with 187,060 rentable square feet.  This property is leased to the United Nations.  The purchase price was $114,050, excluding acquisition costs.  We allocated approximately $36,800 to land, $66,661 to building and improvements and $10,589 to acquired real estate leases based on the fair values of the acquired assets.

Also in May 2011, we entered into a purchase agreement to acquire three office properties located in Indianapolis, IN with 433,927 rentable square feet.  These properties are 97% leased to 18 tenants, of which a majority is leased to the U.S. Government.  The contract purchase price is $88,000, including the assumption of $50,000 of mortgage debt and excluding acquisition costs.  This pending acquisition is subject to our satisfactory completion of diligence and other customary closing conditions, as well as the assumption of mortgage debt; accordingly, we can provide no assurance that we will acquire these properties.

In June 2011, we acquired an office property located in Milwaukee, WI with 29,297 rentable square feet.  This property is leased to the U.S. Government.  The purchase price was $6,775, excluding acquisition costs.  We allocated approximately $945 to land, $4,539 to building and improvements and $1,291 to acquired real estate leases based on the fair values of the acquired assets.

Also in June 2011, we acquired two office properties located in Stafford, VA with 64,488 rentable square feet.  These properties are leased to the U.S. Government.  The purchase price was $11,550, excluding acquisition costs.  We allocated approximately $2,090 to land, $7,465 to building and improvements and $1,995 to acquired real estate leases based on the fair values of the acquired assets.

Also in June 2011, we acquired an office property located in Montgomery, AL with 57,815 rentable square feet.  This property is leased to the U.S. Government.  The purchase price was $11,550, excluding acquisition costs.  We allocated approximately $920 to land, $9,084 to building and improvements and $1,546 to acquired real estate leases based on the fair values of the acquired assets.

In July 2011, we entered into a purchase agreement to acquire an office property located in Holtsville, NY with 264,482 rentable square feet.  This property is 82% leased to three tenants, of which a majority is leased to the U.S. Government.  The contract purchase price is $40,750, excluding acquisition costs.  This pending acquisition is subject to our satisfactory completion of diligence and other customary closing conditions; accordingly, we can provide no assurance that we will acquire this property.

Also in July 2011, we entered into a purchase agreement to acquire an office property located in Sacramento, CA with 87,863 rentable square feet.  This property is leased to the State of California.  The contract purchase price is $13,600, excluding acquisition costs.  This pending acquisition is subject to our satisfactory completion of diligence and other customary closing conditions; accordingly, we can provide no assurance that we will acquire this property.

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GOVERNMENT PROPERTIES INCOME TRUST

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

(unaudited)

Note 4.  Tenant Concentration and Segment Information

We operate in one business segment: ownership of properties that are majority leased to government tenants.  We define annualized rental income as the annualized rents from our tenants pursuant to signed leases as of the measurement date, plus estimated expense reimbursements, and excluding lease value amortization.  The U.S. Government, six state governments and the United Nations, an international intergovernmental organization, combined were responsible for approximately 93.6% and 94.6% of our annualized rental income as of June 30, 2011 and 2010, respectively.  The U.S. Government is our largest tenant and was responsible for approximately 74.2% and 81.6% of our annualized rental income as of June 30, 2011 and 2010, respectively.

Note 5.  Indebtedness

At June 30, 2011 and December 31, 2010, our outstanding indebtedness included the following:

(1)       We assumed these mortgages in connection with our acquisition of certain properties.  The interest amounts for these mortgage debts are the contractually stated amounts; we recorded the assumed mortgages at fair value on the date of acquisition and are amortizing the fair value premiums to interest expense over the terms of the mortgages to reduce interest expense to market rates.

We have a $500,000 unsecured revolving credit facility that is available for acquisitions, working capital and general business purposes.  The revolving credit facility has a maturity date of October 28, 2013 and, subject to meeting certain conditions and the payment of a fee, we may extend the maturity date to October 28, 2014.  Interest under the revolving credit facility is based upon LIBOR plus a spread that is subject to adjustment based upon changes to our senior unsecured debt rating.  Our revolving credit facility agreement contains a number of covenants that restrict our ability to incur debts in excess of calculated amounts, restrict our ability to make distributions under certain circumstances and generally require us to maintain certain financial ratios.  We believe we were in compliance with the terms and conditions of our revolving credit facility at June 30, 2011.  The weighted average annual interest rate for our revolving credit facility was 2.31% and 2.33% for the three and six months ended June 30, 2011, respectively.  As of June 30, 2011, we had $338,000 outstanding and $162,000 available to be drawn under our revolving credit facility.

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GOVERNMENT PROPERTIES INCOME TRUST

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

(unaudited)

Note 6. Fair Value of Financial Instruments

Our financial instruments at June 30, 2011 include cash and cash equivalents, restricted cash, rents receivable, mortgage notes payable, accounts payable, our revolving credit facility, due to affiliates, other accrued expenses and deposits. At June 30, 2011, the fair value of our financial instruments approximated their carrying values, except as follows:

We estimate the fair values of our mortgage notes payable by using discounted cash flow analyses and currently prevailing market terms.

Note 7. Shareholders’ Equity

On February 23, 2011, we paid a distribution to common shareholders in the amount of $0.41 per share, or $16,606, that was declared on January 5, 2011 and was payable to shareholders of record on January 26, 2011.

On May 17, 2011, pursuant to our equity compensation plan, we granted 2,000 of our common shares of beneficial interest, $0.01 par value per share, or our Shares, valued at $25.61 per share, the closing price of our Shares on the New York Stock Exchange, or the NYSE, on that day, to each of our five trustees as part of their annual compensation.

On May 24, 2011, we paid a distribution to common shareholders in the amount of $0.42 per share, or $17,010, that was declared on April 5, 2011 and was payable to shareholders of record on April 26, 2011.

On July 1, 2011, we declared a distribution payable to common shareholders of record on July 11, 2011, in the amount of $0.42 per share, or $17,014.  This distribution will be paid on or about August 24, 2011.

On July 20, 2011, we amended our declaration of trust to increase the number of authorized Shares from 50,000,000 to 70,000,000.

On July 25, 2011, we issued 6,500,000 Shares in a public offering at a price of $25.40 per Share, raising net proceeds of approximately $157,700.  We used the net proceeds from this offering to reduce amounts outstanding under our revolving credit facility and for general business purposes, including funding acquisitions.  We granted the underwriters of the offering a 30-day option to purchase an additional 975,000 Shares to cover overallotments, if any.

We have no dilutive securities.

Note 8.  Related Person Transactions

As described in our Annual Report, we were formerly 100% owned by CommonWealth REIT, or CWH.  On June 30, 2011, CWH owned 24.6% of our outstanding Shares.  REIT Management & Research LLC, or RMR, provides management services to both us and CWH.  RMR is owned by our Managing Trustees, Messrs. Barry and Adam Portnoy.

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GOVERNMENT PROPERTIES INCOME TRUST

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

(unaudited)

We have no employees.  Instead, services that might be provided to us by employees are provided to us by RMR.   RMR provides both business and property management services to us under a business management agreement and a property management agreement.  Pursuant to the business management agreement with RMR, we incurred expenses of $1,805 and $1,005 for the three months ended June 30, 2011 and 2010, respectively, and $3,479 and $1,858 for the six months ended June 30, 2011 and 2010, respectively.  These amounts are included in general and administrative expenses in our condensed consolidated statements of income.  In connection with the property management agreement with RMR, we incurred property management fees of $1,209 and $771 for the three months ended June 30, 2011 and 2010, respectively, and $2,364 and $1,468 for the six months ended June 30, 2011 and 2010, respectively.  We also incurred construction management fees to RMR of $300 and $49 for the three months ended June 30, 2011 and 2010, respectively, and $469 and $208 for the six months ended June 30, 2011 and 2010, respectively.  These amounts are included in other operating expenses or have been capitalized, as appropriate, in our condensed consolidated financial statements.

We, RMR, CWH and other companies to which RMR provides management services each currently owns approximately 14.29% of Affiliates Insurance Company, or AIC.  All of our Trustees and all of the trustees and directors of the other shareholders of AIC currently serve on the board of directors of AIC.  RMR, in addition to being a shareholder, provides management and administrative services to AIC pursuant to a management and administrative services agreement with AIC.  Although we own less than 20% of AIC, we use the equity method to account for this investment because we believe that we have significant influence over AIC because all of our Trustees are directors of AIC.  As of June 30, 2011, we have invested $5,194 in AIC.  We may invest additional amounts in AIC in the future if the expansion of this insurance business requires additional capital, but we are not obligated to do so.  We carried this investment in our condensed consolidated balance sheet in other assets at $5,321 and $5,195 as of June 30, 2011 and December 31, 2010, respectively.  During the three months ended June 30, 2011 and 2010, we recognized earnings (losses) of approximately $46 and $(23), respectively, and $83 and $(52) for the six months ended June 30, 2011 and 2010, respectively, related to this investment.  In 2010, AIC designed a combination property insurance program for us and other AIC shareholders in which AIC participated as a reinsurer.  Our total premiums under this program for the policy years expiring May 31, 2011 and 2012 were $415 and $1,227, respectively.  We are currently investigating the possibilities to expand our insurance relationships with AIC to include other types of insurance. By participating in this insurance business with RMR and the other companies to which RMR provides management services, we expect that we may benefit financially by possibly reducing our insurance expenses or by realizing our pro-rata share of any profits of this insurance business.

For more information about the relationships among us, our Trustees and executive officers, CWH, RMR, AIC and other companies to which RMR provides management services and about the risks which may arise from these relationships, please refer to our Annual Report and our other filings with the Securities and Exchange Commission, or SEC, including the sections captioned “Business”,  “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Related Person Transactions” in our Annual Report and the section captioned “Related Person Transactions and Company Review of Such Transactions” in our Proxy Statement dated February 25, 2011 relating to our 2011 Annual Meeting of Shareholders, or our Proxy Statement.  Our Annual Report and Proxy Statement are available at the SEC website: www.sec.gov.

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GOVERNMENT PROPERTIES INCOME TRUST

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

(unaudited)

Note 9. Pro Forma Information

During the second quarter of 2011, we purchased six properties for $184,675, excluding acquisition costs. During the first quarter of 2011, we purchased three properties for $42,000, excluding acquisition costs. During 2010, we purchased 22 properties for an aggregate purchase price of $434,411, excluding acquisition costs and including the assumption of $44,951 of mortgage debt. Also in 2010, we replaced our $250,000 secured revolving credit facility with a $500,000 unsecured revolving credit facility and issued 18,975,000 of our Shares. The following table presents our pro forma results of operations as if these acquisitions and financing activities were completed on January 1, 2010. This pro forma data is not necessarily indicative of what our actual results of operations would have been for the periods presented, nor does it represent the results of operations for any future period. Differences could result from, but are not limited to, additional property acquisitions, property sales, changes in interest rates and changes in our debt or equity capital structure.

During the three and six months ended June 30, 2011, we recognized revenues of $3,231  and $4,010, respectively, and operating income of $429 and $31, respectively, arising from our acquisitions completed in 2011.

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and tables should be read in conjunction with the financial statements and notes thereto included in this Quarterly Report on Form 10-Q and in our Annual Report.

OVERVIEW

As of June 30, 2011, we owned 64 properties, located in 27 states and the District of Columbia, that contain approximately 7.6 million rentable square feet, of which 75.0% is leased to the U.S. Government, 13.5% to six state governments and 2.5% to the United Nations, an international intergovernmental organization.  The U.S. Government, six state governments and the United Nations combined were responsible for 93.6% and 94.6% of our annualized rental income, as defined below, as of June 30, 2011 and 2010, respectively.

Property Operations

As of June 30, 2011, 96.5% of our rentable square feet was leased, compared to 99.7% leased as of June 30, 2010.  Occupancy data as of June 30, 2011 and 2010 is as follows (square feet in thousands):

(1)       Properties we owned on June 30, 2011 which were owned continuously since January 1, 2010.

(2)       Percent leased includes (i) space being fitted out for occupancy pursuant to signed leases, if any, and (ii) space which is leased, but is not occupied or is being offered for sublease by tenants, if any.

The average effective rental rate per square foot, as defined below, for our properties for the periods ended June 30, 2011 and 2010 are as follows:

(1)   Average effective rental rate per square foot represents total rental income during the period specified divided by the average rentable square feet occupied during the period specified.

We believe general U.S. leasing market conditions are slowly improving, but remain weak in many U.S. markets.  The historical experience of our manager, RMR, has been that government tenants frequently renew leases to avoid the costs and disruptions that may result from relocating their operations.   We believe that budgetary pressures may cause an increased demand for leased space in existing buildings, as opposed to new buildings built on behalf of the government, among government tenants generally. For these and other reasons we believe that occupancy at our government leased properties may outperform national market averages for property occupancies. However, these same increased budgetary pressures faced by the U.S. Government and state governments could also result in a decrease in government sector employment and consolidation of operations into government owned properties thereby reducing their need for leased space.  Accordingly, it is difficult for us to reasonably project what the financial impact of market conditions will be on our financial results for future periods.

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As of June 30, 2011, leases totaling 905,718 rentable square feet are scheduled to expire through December 31, 2011.  Based upon current market conditions and tenant negotiations for leases scheduled to expire through December 31, 2011, we expect that rental rates we are likely to achieve on new or renewed leases will be, on a weighted average basis, greater than the rates currently being paid, thereby generally resulting in greater revenue from the same space.  However, there can be no assurance that such increases will occur, and the effect of any such increases may be offset by declines in rental income due to vacancies upon lease expirations.  Prevailing market conditions at that time will determine lease renewals and rental rates for available space in our properties.  As of June 30, 2011, lease expirations by year at our properties are as follows (square feet and dollars in thousands):

(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 June 30, 2011, government tenants occupying approximately 15.9% of our rentable square feet and representing approximately 12.4% of our rental income have exercisable rights to terminate their leases before the stated expirations.  Also as of June 30, 2011, in 2011, 2012, 2013, 2014, 2015, 2016, 2017 and 2019, early termination rights become exercisable by other government tenants who occupy approximately 17.3%, 3.2%, 0.9%, 3.0%, 0.3%, 5.4%, 0.5% and 1.1%, respectively, of our rentable square feet and are responsible for approximately 13.6%, 3.1%, 1.1%, 3.1%, 0.3%, 11.1%, 0.7% and 2.0%, respectively, of our rental income.  In February 2011, we were notified by one of our tenants representing approximately 0.9% of our rentable square feet and 0.5% of our rental income that they intend to exercise their right to vacate their space in August 2011 prior to the stated expiration of their lease in August 2013.  In addition, five of our state government tenants have exercisable rights to terminate their leases if these states do not annually appropriate rent amounts in their respective annual budgets. These five tenants occupy approximately 6.1% of our rentable square feet, representing approximately 6.4% of our rental income as of June 30, 2011.

(2)       Square feet occupied is pursuant to signed leases as of June 30, 2011, and includes (i) space being fitted out for occupancy and (ii) space, if any, which is leased but is not occupied.

(3)       Rental income is the annualized rents from our tenants pursuant to signed leases as of June 30, 2011, plus estimated expense reimbursements, and excludes lease value amortization.

Investment Activities (dollar amounts in thousands)

In February 2011, we acquired an office property located in Quincy, MA with 92,549 rentable square feet.  This property is 100% leased to four tenants, of which 90% is leased to the Commonwealth of Massachusetts and occupied by the Registry of Motor Vehicles as its headquarters.  The purchase price was $14,000, excluding acquisition costs.

Also in February 2011, we acquired two office properties located in Woodlawn, MD with 182,561 rentable square feet.  These properties are 100% leased to two tenants, of which 94% is leased to the U.S. Government and occupied by the Social Security Administration.  The purchase price was $28,000, excluding acquisition costs.

In May 2011, we acquired an office property located in Plantation, FL with 135,819 rentable square feet.  This property is 100% leased to the U.S. Government and occupied by the Internal Revenue Service.  The purchase price was $40,750, excluding acquisition costs.

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Also in May 2011, we acquired an office property located in New York, NY with 187,060 rentable square feet.  This property is 100% leased to the United Nations.  The purchase price was $114,050, excluding acquisition costs.

Also in May 2011, we entered into a purchase agreement to acquire three office properties located in Indianapolis, IN with 433,927 rentable square feet.  These properties are 97% leased to 18 tenants, of which 58% is leased to the U.S. Government and occupied by the U.S. Customs and Border Protection Agency.  The contract purchase price is $88,000, including the assumption of $50,000 of mortgage debt and excluding acquisition costs.  This pending acquisition is subject to our satisfactory completion of diligence and other customary closing conditions, as well as the assumption of mortgage debt; accordingly, we can provide no assurance that we will acquire these properties.

In June 2011, we acquired an office property located in Milwaukee, WI with 29,297 rentable square feet.  This property is 100% leased to the U.S. Government and occupied by the Military Entrance Processing Station.  The purchase price was $6,775, excluding acquisition costs.

Also in June 2011, we acquired two office properties located in Stafford, VA with 64,488 rentable square feet.  These properties are 100% leased to the U.S. Government and occupied by the Federal Bureau of Investigation.  The purchase price was $11,550, excluding acquisition costs.

Also in June 2011, we acquired an office property located in Montgomery, AL with 57,815 rentable square feet.  This property is 100% leased to the U.S. Government and serves as the office of the U.S. Attorney for the Middle District of Alabama.  The purchase price was $11,550, excluding acquisition costs.

In July 2011, we entered into a purchase agreement to acquire an office property located in Holtsville, NY with 264,482 rentable square feet.  This property is 82% leased to three tenants, of which a majority is leased to the U.S. Government and occupied by the Internal Revenue Service and U.S. Citizenship and Immigration Services.  The contract purchase price is $40,750, excluding acquisition costs.  This pending acquisition is subject to our satisfactory completion of diligence and other customary closing conditions; accordingly, we can provide no assurance that we will acquire this property.

Also in July 2011, we entered into a purchase agreement to acquire an office property located in Sacramento, CA with 87,863 rentable square feet.  This property is 100% leased to the State of California and occupied by the California State Employment Development Department.  The contract purchase price is $13,600, excluding acquisition costs.  This pending acquisition is subject to our satisfactory completion of diligence and other customary closing conditions; accordingly, we can provide no assurance that we will acquire this property.

The nine properties we acquired during the six months ended June 30, 2011 were acquired at a range of capitalization rates from 7.1% to 10.2% (weighted average capitalization rate of 7.9%).  We calculate the capitalization rate for property acquisitions as the ratio of (x) annual straight line rental income, excluding the impact of above and below market lease amortization, based on in place leases at the acquisition date, less estimated annual property operating expenses, excluding depreciation and amortization expense, to (y) the acquisition purchase price, excluding acquisition costs.

Our strategy related to property acquisitions and dispositions is unchanged from that disclosed in our Annual Report.  In addition to the five properties we have agreed to acquire, we continue to evaluate for acquisition a number of additional properties that are majority leased to government tenants; however, we can provide no assurance that we will reach agreement to acquire any of these properties.  We are not currently considering the disposition of any of our properties, although future changes in market conditions or property performance may change our disposition strategy.

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Financing Activities (dollar amounts in thousands, except per share amounts)

We have a $500,000 unsecured revolving credit facility that is available for acquisitions, working capital and general business purposes.  The weighted average annual interest rate for our revolving credit facility was 2.31% and 2.33% for the three and six months ended June 30, 2011, respectively.  As of June 30, 2011 and August 2, 2011, we had $338,000 and $178,000, respectively, outstanding under our revolving credit facility.  The revolving credit facility has a maturity date of October 28, 2013 and, subject to certain conditions and the payment of a fee, we may extend the maturity date to October 28, 2014.  Interest under our revolving credit facility is based upon LIBOR plus a spread that is subject to adjustment based on changes to our senior unsecured debt rating.

On July 25, 2011, we issued 6,500,000 Shares in a public offering at a price of $25.40 per Share, raising net proceeds of approximately $157,700.  We used the net proceeds from this offering to reduce amounts outstanding under our revolving credit facility and for general business purposes, including funding acquisitions.  We also granted the underwriters of the offering a 30-day option to purchase an additional 975,000 Shares to cover overallotments, if any.

RESULTS OF OPERATIONS (dollar amounts in thousands, except per share amounts)

Three Months Ended June 30, 2011, Compared to Three Months Ended June 30, 2010

(1)       Comparable properties consists of 35 properties we owned on June 30, 2011 which were owned continuously since April 1, 2010.

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(2)       We compute Net Operating Income, or NOI, as shown above.  We define NOI as rental income from real estate less our property operating expenses.  We consider NOI to be appropriate supplemental information to net income because it helps both investors and management to understand the operations of our properties.  We use NOI internally to evaluate individual and company wide property level performance and believe NOI provides useful information to investors regarding our results of operations because it reflects only those income and expense items that are incurred at the property level and may facilitate comparisons of our operating performance between periods.  The calculation of NOI excludes depreciation and amortization, acquisition related costs and general and administrative expenses from the calculation of net income in order to provide results that are more closely related to our properties’ results of operations. This measure does not represent cash generated by operating activities in accordance with GAAP and should not be considered as an alternative to net income or cash flow from operating activities, determined in accordance with GAAP, as an indicator of our financial performance or liquidity, nor is this measure necessarily indicative of sufficient cash flow to fund all of our needs.  We believe that this data may facilitate an understanding of our consolidated historical operating results.  This measure should be considered in conjunction with net income and cash flow from operating activities as presented in our Consolidated Statements of Income and Condensed Consolidated Statements of Cash Flows.  Other REITs and real estate companies may calculate NOI differently than we do.

(3)       We compute Funds from Operations, or FFO, and Normalized FFO as shown above.  FFO is computed on the basis defined by The National Association of Real Estate Investment Trusts, or NAREIT, which is net income, computed in accordance with GAAP, plus real estate depreciation and amortization.  Our calculation of Normalized FFO differs from NAREIT’s definition of FFO because we exclude acquisition related costs.  We consider FFO and Normalized FFO to be appropriate measures of performance for a REIT, along with net income and cash flow from operating, investing and financing activities.  We believe that FFO and Normalized FFO provide useful information to investors because by excluding the effects of certain historical amounts, such as depreciation expense, FFO and Normalized FFO can facilitate a comparison of operating performances between periods.  FFO and Normalized FFO are among the factors considered by our Board of Trustees when determining the amount of distributions to shareholders.  Other factors include, but are not limited to, requirements to maintain our status as a REIT, limitations in our revolving credit facility, the availability of debt and equity capital to us and our expectation of our future capital requirements and operating performance.  These measures do not represent cash generated by operating activities in accordance with GAAP and should not be considered as alternatives to net income or cash flow from operating activities, determined in accordance with GAAP, as indicators of our financial performance or liquidity, nor are these measures necessarily indicative of sufficient cash flow to fund all of our needs.  We believe that this data may facilitate an understanding of our consolidated historical operating results.  These measures should be considered in conjunction with net income and cash flow from operating activities as presented in our Condensed Consolidated Statements of Income and Condensed Consolidated Statement of Cash Flows.  Other REITs and real estate companies may calculate FFO and Normalized FFO differently than we do.

Rental income.  The increase in rental income primarily reflects the effects of our property acquisitions since April 1, 2010.  Rental income includes non-cash straight line rent adjustments totaling approximately $43 in 2011 and ($59) in 2010 and amortization of acquired real estate leases and obligations totaling approximately $116 in 2011 and $14 in 2010.  Rental income for the comparable properties decreased slightly primarily due to decreased operating expense and real estate tax reimbursement income partially offset by an increase in base rental income at certain of our properties.

Real estate taxes.  The increase in real estate taxes primarily reflects the effects of property acquisitions since April 1, 2010.  Real estate taxes for the comparable properties decreased due to the effects of lower assessed values from successful property tax appeals at certain of our properties.

Utility expenses.  The increase in utility expenses primarily reflects the effects of property acquisitions since April 1, 2010.  Utility expenses for the comparable properties were substantially unchanged between 2011 and 2010.

Other operating expenses.  The increase in other operating expenses primarily reflects the increase in property management fees, cleaning expenses and security costs as a result of property acquisitions since April 1, 2010.  Other operating expenses for the comparable properties increased due to increased repair and maintenance costs partially offset by a decrease in landscaping related costs at certain of our properties.

Depreciation and amortization.  The increase in depreciation and amortization reflects the effect of our property acquisitions and improvements made to some of our properties since April 1, 2010.

Acquisition related costs.  Acquisition related costs represent costs incurred in connection with our acquisition activity during the three months ended June 30, 2011 and June 30, 2010.

General and administrative.  The increase in general and administrative expense primarily reflects the effect of our property acquisitions since April 1, 2010.

Interest and other income.  The increase in interest and other income is the result of a larger average amount of investable cash compared to the same period in 2010.

Interest expense.  The increase in interest expense reflects a larger average outstanding balance under our revolving credit facility compared to the same period in 2010 and interest expense related to the mortgages we assumed in connection with certain of our 2010 acquisitions, partially offset by a lower weighted average interest rate for borrowings under our revolving credit facility in 2011.

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Equity in earnings (losses) of an investee. The increase in equity in earnings (losses) of an investee is the result of earnings from our investment in AIC for the three months ended June 30, 2011 compared to a loss in the same period in 2010.

Income tax expense.  The increase in income tax expense is a result of our higher operating income in 2011 which is subject to state income taxes in certain jurisdictions.

Net income.  Our net income for the three months ended June 30, 2011 increased as compared to the three months ended June 30, 2010 as a result of the changes noted above.

Six Months Ended June 30, 2011, Compared to Six Months Ended June 30, 2010