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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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, $.01 par value per share, outstanding as of November 1, 2011: 47,051,650.

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GOVERNMENT PROPERTIES INCOME TRUST

FORM 10-Q

September 30, 2011

INDEX

References in this Quarterly Report on 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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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, 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 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 material intercompany transactions and balances between the Company and its subsidiaries have been eliminated.

As of September 30, 2011, we owned 67 properties located in 27 states and the District of Columbia containing approximately 8.3 million rentable square feet.  The U.S. Government, certain state governments and the United Nations 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.  The adoption of this update is not expected to cause any material changes to our 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 September 30, 2011, we executed seven leases for 85,444 rentable square feet and a weighted average lease term of 9.6 years and made commitments for approximately $2,872 of leasing related costs.  During the nine months ended September 30, 2011, we executed 22 leases for 130,882 rentable square feet and a weighted average lease term of 8.6 years and made commitments for approximately $3,688 of leasing related costs.  We have unspent tenancy related obligations of approximately $12,690 as of September 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 estimated 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

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

(unaudited)

real estate leases and $525 to assumed real estate lease obligations based on the estimated fair values of the acquired assets and assumed liabilities.

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 estimated 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 estimated fair values of the acquired assets.

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 estimated 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 estimated 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 estimated fair values of the acquired assets.

In August 2011, we acquired an office property located in Holtsville, NY with 264,482 rentable square feet.  This property is majority leased to the U.S. Government.  The purchase price was $39,250, excluding acquisition costs.  We allocated approximately $6,530 to land, $17,711 to building and improvements and $13,453 to acquired real estate leases based on the estimated fair values of the acquired assets.

In September 2011, we acquired an office property located in Sacramento, CA with 87,863 rentable square feet.  This property is leased to the State of California.  The purchase price was $13,600, excluding acquisition costs.  We allocated approximately $1,450 to land, $9,465 to building and improvements and $2,685 to acquired real estate leases based on the estimated fair values of the acquired assets.

Also in September 2011, we acquired an office property located in Atlanta, GA with 375,805 rentable square feet.  This property is majority leased to the State of Georgia.  The purchase price was $48,600, excluding acquisition costs.  We allocated approximately $10,250 to land, $27,933 to building and improvements, $10,421 to acquired real estate leases and $4 to assumed real estate lease obligations based on the estimated fair values of the acquired assets and assumed liabilities.

In October 2011, we acquired three office properties located in Indianapolis, IN with 433,927 rentable square feet.  These properties are majority leased to the U.S. Government.  The purchase price was $85,000, including the assumption of $49,395 of mortgage debt and excluding acquisition costs.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

(unaudited)

Also in October 2011, we entered into an agreement to acquire an office property located in Salem, OR with 233,358 rentable square feet.  This property is majority leased to the State of Oregon.  The contract purchase price is $32,000, 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.

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 our lease agreements with them as of the measurement date, plus estimated expense reimbursements to be paid to us, and excluding lease value amortization.  The U.S. Government, seven state governments and the United Nations combined were responsible for approximately 93.1% and 93.6% of our annualized rental income as of September 30, 2011 and 2010, respectively.  The U.S. Government is our largest tenant by annualized rental income and was responsible for approximately 71.3% and 81.0% of our annualized rental income as of September 30, 2011 and 2010, respectively.

Note 5.  Indebtedness

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

(1)             On October 18, 2011, we amended our credit agreement as described below.

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

At September 30, 2011, we had a $500,000 unsecured revolving credit facility that was available for acquisitions, working capital and general business purposes.  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.  On October 18, 2011, we amended our revolving credit facility to, among other things, increase maximum borrowings under the facility to $550,000, reduce the interest paid on drawings under the facility and extend the stated maturity date of the facility from October 28, 2013 to October 19, 2015.  Subject to certain conditions and the payment of a fee, we have the option to further extend the stated maturity date by one year to October 19, 2016.  Our revolving credit facility agreement, including as amended on October 18, 2011, 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 of our revolving credit facility agreement at September 30, 2011.  The weighted average annual interest rate for our revolving credit facility was 2.31% and 2.32% for the three and nine months ended September 30, 2011, respectively.  As of September 30, 2011, we had $282,500 outstanding under our revolving credit facility.

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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 September 30, 2011 include cash and cash equivalents, restricted cash, rents receivable, mortgage notes payable, accounts payable, our revolving credit facility, amounts due to related persons, other accrued expenses and deposits. At September 30, 2011, the fair value of our financial instruments approximated their carrying values in our condensed consolidated financial statements, except as follows:

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

Note 7. Shareholders’ Equity

Distributions

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 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 August 24, 2011, we paid a distribution to common shareholders in the amount of $0.42 per share, or $17,015, that was declared on July 1, 2011 and was payable to shareholders of record on July 11, 2011.

On October 6, 2011, we declared a distribution payable to common shareholders of record on October 22, 2011, in the amount of $0.42 per share, or $19,762.  We expect to pay this distribution on or about November 22, 2011.

Share Issuances

On May 17, 2011, pursuant to our equity compensation plan, we granted 2,000 of our common shares of beneficial interest, $.01 par value per share, or our common shares, valued at $25.61 per share, the closing price of our common 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 July 20, 2011, we amended our declaration of trust to increase the number of authorized common shares from 50,000,000 to 70,000,000.

On July 25, 2011, we issued 6,500,000 of our common shares in a public offering at a price of $25.40 per share, raising net proceeds of approximately $157,894.  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.

On September 16, 2011, pursuant to our equity compensation plan, we granted an aggregate of 40,850 of our common shares valued at $22.56 per share, the closing price of our common shares on the NYSE on that day, to our officers and certain employees of our manager, Reit Management & Research LLC, or RMR.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

(unaudited)

We have no dilutive securities.

Note 8.   Related Person Transactions

CommonWealth REIT, or CWH, is our former parent company.  CWH is our largest shareholder and, as of the date of this Quarterly Report on Form 10-Q, owned 9,950,000 of our common shares, or approximately 21.1% of our outstanding common shares.  RMR provides management services to both us and CWH. One of our Managing Trustees, Barry Portnoy, is Chairman and majority owner of RMR and serves as managing trustee of CWH.  Our other Managing Trustee, Adam Portnoy, is Barry Portnoy’s son, and is an owner, President, Chief Executive Officer and a director of RMR and serves as a managing trustee and President of CWH.  Our executive officers and CWH’s executive officers are officers of RMR.  Our Independent Trustees also serve as independent directors or independent trustees of other public companies to which RMR provides management services.   Barry Portnoy serves as a managing director or managing trustee of those companies and Adam Portnoy serves as a managing trustee of a majority of those companies.

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.  There have been no changes in the terms of our management agreements with RMR from those described in our reports with the Securities and Exchange Commission, or the SEC (other than as described in those reports or in this Quarterly Report on Form 10-Q, including in Part II, Item 5).  Pursuant to the business management agreement with RMR, we incurred expenses of $2,015 and $1,204 for the three months ended September 30, 2011, and 2010, respectively, and $5,494 and $3,062 for the nine months ended September 30, 2011 and 2010, respectively.  These amounts are included in general and administrative expenses in our condensed consolidated statements of income.  On October 31, 2011, we and RMR amended our business management agreement to provide that, for purposes of determining the fees we pay to RMR under that agreement, which are based on a percentage of the value of our properties as determined under the agreement, the value of properties we may acquire from certain other companies to which RMR provides management services will be based upon the seller’s historical cost for those properties rather than our acquisition costs and to provide other companies to which RMR provides management services a right of first offer on properties of ours that we determine to sell if such properties are primarily of a type that are within the investment focus of such other companies.  This amendment is further described in Part II, Item 5 of this Quarterly Report on Form 10-Q. In connection with the property management agreement with RMR, we incurred property management fees of $1,352 and $910 for the three months ended September 30, 2011 and 2010, respectively, and $3,716 and $2,378 for the nine months ended September 30, 2011 and 2010, respectively.  We also incurred construction management fees to RMR of $345 and $56 for the three months ended September 30, 2011 and 2010, respectively, and $814 and $264 for the nine months ended September 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 and the other six shareholders currently each own approximately 14.29% of the outstanding equity of Affiliates Insurance Company, or AIC.  The other shareholders of AIC are RMR and five other companies, including CWH, to which RMR provides management services.  All of our Trustees, all of the trustees and directors of the other publicly held AIC shareholders and nearly all of the directors of RMR currently serve on the board of directors of AIC.  RMR provides management and administrative services to 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 also directors of AIC.  As of September 30, 2011, we have invested approximately $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.  Our investment had a carrying value of $5,364 and $5,195 as of September 30, 2011 and December 31, 2010, respectively.  During the three and nine months ended September 30, 2011 and 2010 we recognized income of approximately $28 and $111 and income of $35 and a loss of $17, 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.  This program was modified and extended in June 2011 for a one year term.  Our total premiums under this program for the policy years expiring May 31, 2011 and 2012 were approximately $415 and $1,227, respectively.  The amounts we expensed in relation to those insurance premiums for the nine months ended September 30, 2011 and 2010 were $582 and $138, respectively, and for the three months ended September 30, 2011 and 2010 were $307 and $104, 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

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

(unaudited)

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 these and other relationships among us, our Trustees, our executive officers, CWH, RMR, AIC, other companies to which RMR provides management services, and others affiliated with or related to them and about the risks which may arise as a result of those and other related person transactions and relationships, please see elsewhere in this Quarterly Report on Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Related Person Transactions” in Part I, Item 2 and “Warning Concerning Forward Looking Statements”, and in our Annual Report, in our Proxy Statement for our 2011 Annual Meeting of Shareholders dated February 25, 2011, or our Proxy Statement, and in our other filings with the SEC, including the sections captioned “Business”, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Related Person Transactions” and “Warning Concerning Forward Looking Statements”, in our Annual Report, and the information regarding our Trustees and executive officers and the section captioned “Related Person Transactions and Company Review of Such Transactions” in our Proxy Statement.  In addition, please see the “Risk Factors” section of our Annual Report for a description of risks which may arise from these transactions and relationships.  Our filings with the SEC, including our Annual Report and our Proxy Statement, are available at the SEC’s website at www.sec.gov.  In addition, copies of certain of our agreements with these parties are also publicly available as exhibits to our public filings with the SEC and accessible at the SEC’s website, including our business management agreement and property management agreement with RMR.

Note 9.   Pro Forma Information

During the third quarter of 2011, we purchased three properties for an aggregate purchase price of $101,450, excluding acquisition costs.  During the second quarter of 2011, we purchased six properties for an aggregate purchase price of $184,675, excluding acquisition costs.  During the first quarter of 2011, we purchased three properties for an aggregate purchase price of $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 $44,951of mortgage debt.  Also in 2010, we replaced our $250,000 secured revolving credit facility with our $500,000 unsecured revolving credit facility and issued 18,975,000 of our common 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 various factors, including but 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 nine months ended September 30, 2011, we recognized revenues of $6,569 and $10,580, respectively and operating income of $1,785 and $1,816, 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 September 30, 2011, we owned  67 properties, located in  27 states and the District of Columbia, that contain approximately 8.3 million rentable square feet, of which 70.7% was leased to the U.S. Government, 16.9% was leased to seven state governments and 2.3% was leased to the United Nations, an international intergovernmental organization.  The U.S. Government, seven state governments and the United Nations combined were responsible for 93.1% and 93.6% of our annualized rental income, as defined below, as of September 30, 2011 and 2010, respectively.

Property Operations

As of September 30, 2011, 96.1% of our rentable square feet was leased, compared to 96.0% leased as of September 30, 2010.  Occupancy data as of September 30, 2011 and 2010 is as follows (square feet in thousands):

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

(2)                  Percent leased includes (i) space being fitted out for 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 effective rental rate per square foot, as defined below, for our properties for the periods ended September 30, 2011 and 2010 are as follows:

(1)                   Average annualized 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 currently believe general U.S. leasing market conditions are slowly improving, but remain weak in many U.S. markets.  Our historical experience, including that of our predecessor CWH 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.   We believe that current budgetary pressures may cause increased demand for leased space by government tenants, as opposed to new buildings built on behalf of the government.  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 September 30, 2011, leases totaling 893,871 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, lower than the rates currently being paid, thereby generally resulting in lower revenue from the same space, and the effect of any such decreases may be amplified by declines in rental income due to vacancies upon lease expirations.

Prevailing market conditions at the time our leases expire will generally determine lease renewals and rental rates for space in our properties.  As of September 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 September 30, 2011, government tenants occupying approximately 12.6% of our rentable square feet and representing approximately 8.8% of our rental income have exercisable rights to terminate their leases before the stated expirations.  Also as of September 30, 2011, in 2011, 2012, 2013, 2014, 2015, 2016, 2017, 2018, 2019 and 2020, early termination rights become exercisable by other government tenants who occupy approximately 16.4%, 2.9%, 4.0%, 2.7%, 0.3%, 6.6%, 0.1%, 0.3%, 1.0% and 0.7%, respectively, of our rentable square feet and are responsible for approximately 11.1%, 2.8%, 3.6%, 2.9%, 0.3%, 11.7%, 0.1%, 0.6%, 1.8%, and 0.8%, respectively, of our rental income.  In August 2011 and September 2011, we were notified by two of our tenants representing, as of September 30, 2011, approximately 1.5% and 1.2% of our rentable square feet, respectively, and 1.6% and 1.9% of our rental income, respectively, that they intend to exercise their right to vacate their space in December 2011 and March 2012, respectively, prior to the stated expirations of their leases in April 2015 and March 2013, respectively.  In addition, seven leases with four 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 seven leases represent approximately 5.6% of our rentable square feet, representing approximately 6.1% of our rental income, as of September 30, 2011.

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

(3)      Annualized rental income is the annualized rents from our tenants pursuant to leases existing as of September 30, 2011, plus estimated expense reimbursements to be paid to us, 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.

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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.

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.

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 August 2011, we acquired an office property located in Holtsville, NY with 264,482 rentable square feet.  This property is 82% leased to three tenants, of which 72% is leased to the U.S. Government and occupied by the Internal Revenue Service and U.S. Citizenship and Immigration Services.  The purchase price was $39,250, excluding acquisition costs.

In September 2011, we acquired 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 purchase price was $13,600, excluding acquisition costs.

Also in September 2011, we acquired an office property located in Atlanta, GA with 375,805 rentable square feet.  This property is 97% leased to 19 tenants, of which 78% is leased to the State of Georgia and occupied by the Georgia Department of Transportation.  The purchase price was $48,600, excluding acquisition costs.

In October 2011, we acquired three office properties located in Indianapolis, IN with 433,927 rentable square feet.  These properties are 94% leased to 15 tenants, of which 56% is leased to the U.S. Government and occupied by the U.S. Customs and Border Protection Agency.  The purchase price was $85,000, including the assumption of $49,395 of mortgage debt and excluding acquisition costs.

Also in October 2011, we entered an agreement to acquire an office property located in Salem, OR with 233,358 rentable square feet.  This property is 84% leased to five tenants, of which 70% is leased to the State of Oregon and occupied by the Oregon Department of Human Services, Oregon Department of Justice and the Oregon Employment Department.  The contract purchase price is $32,000, 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 12 properties we acquired during the nine months ended September 30, 2011 were acquired at a range of capitalization rates from 7.1% to 10.2% (weighted average capitalization rate of 8.4%).  We calculate the capitalization rate for property acquisitions as the ratio of (x) annual straight line rental income, excluding the impact of above and below market lease amortization, based on leases then in effect at the acquisition date, less estimated annual property

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operating expenses, excluding depreciation and amortization expense, to (y) the acquisition purchase price, including assumed debt and excluding acquisition costs.

Our strategy related to property acquisitions and dispositions is materially unchanged from that disclosed in our Annual Report.  In addition to the one property with respect to which we entered an agreement in October 2011 to acquire, and which is described above, we continue to explore and evaluate for possible acquisition additional properties that are majority leased to government tenants; however, we can provide no assurance that we will reach agreement to acquire such properties.  Although we may sell properties on occasion, we do not currently plan to dispose of any of our properties.  Future changes in market conditions or property performance may change our disposition strategy.

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

In July 2011, we issued 6,500,000 of our common shares in a public offering at a price of $25.40 per share, raising net proceeds of approximately $157,894.  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.

At September 30, 2011, we had a $500,000 unsecured revolving credit facility that was available for acquisitions, working capital and general business purposes.  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.  On October 18, 2011, we amended our revolving credit facility to, among other things, increase maximum borrowings under the facility to $550,000, reduce the interest rate on drawings under the facility and extend the maturity date of the facility from October 28, 2013 to October 19, 2015.  Subject to certain conditions and the payment of a fee, we have the option to further extend the stated maturity date by one year to October 19, 2016.  Our revolving credit facility agreement, including as amended on October 18, 2011, 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 agreement at September 30, 2011.  The weighted average annual interest rate for our revolving credit facility was 2.31% and 2.32% for the three and nine months ended September 30, 2011, respectively.  As of September 30, 2011, we had $282,500 outstanding under our revolving credit facility.

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

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

(1)             Comparable properties consists of 41 properties we owned on September 30, 2011 and that we owned continuously since July 1, 2010.

(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

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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 Condensed 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 our 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 or 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 Statements 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 July 1, 2010.  Rental income includes non-cash straight line rent adjustments totaling approximately $290 in 2011 and $49 in 2010 and amortization of acquired real estate leases and obligations totaling approximately ($169) in 2011 and ($128) in 2010.  Rental income for the comparable properties increased slightly primarily due to an increase in base rental income and operating expense reimbursement income, partially offset by a decrease in straight line rental income and income related to the amortization of acquired real estate leases and obligations at certain of our properties.

Real estate taxes.  The increase in real estate taxes primarily reflects the effects of property acquisitions since July 1, 2010.  Real estate taxes for the comparable properties were essentially unchanged between 2011 and 2010.

Utility expenses.  The increase in utility expenses primarily reflects the effects of property acquisitions since July 1, 2010.  Utility expenses for the comparable properties decreased modestly due to a decrease in utilities usage at certain of our properties as a result of conservation efforts.

Other operating expenses.  The increase in other operating expenses primarily reflects the increase in property management fees, cleaning expenses and maintenance costs as a result of property acquisitions since July 1, 2010.  Other operating expenses for the comparable properties increased due to increased repair and maintenance 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 July 1, 2010.

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

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

Interest and other income.  The increase in interest and other income is the result of a larger average amount of investable cash in 2011 compared to the same period in 2010.

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Interest expense.  The increase in interest expense reflects a larger average outstanding balance under our revolving credit facility in 2011 compared to the same period in 2010 and interest expense related to the mortgage notes 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.

Equity in earnings of an investee.  Equity in earnings of an investee is the result of earnings from our investment in AIC for the three months ended September 30, 2011.

Income tax benefit (expense).  The decrease in income tax expense is a result of an adjustment to reduce accrued income taxes during the three months ended September 30, 2011, due to a decrease in our estimated 2011 state income tax liability.

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

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Nine Months Ended September 30, 2011, Compared to Nine Months Ended September 30, 2010