UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 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, 2012

OR

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

Commission File Number 1-35442

SELECT INCOME REIT

(Exact Name of Registrant as Specified in Its Charter)

617-796-8303

(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 o  No x

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 (§232.405 of this chapter) 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 6, 2012:  31,200,000

SELECT INCOME REIT

FORM 10-Q

June 30, 2012

INDEX

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

PART I          Financial Information

Item 1.  Financial Statements

SELECT INCOME REIT

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except share data)

(unaudited)

See accompanying notes

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SELECT INCOME REIT

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(amounts in thousands, except per share data)

(unaudited)

See accompanying notes

2

SELECT INCOME REIT

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in thousands)

(unaudited)

See accompanying notes

3

SELECT INCOME REIT

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(amounts in thousands)

(unaudited)

See accompanying notes

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SELECT INCOME REIT

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 Select Income REIT and its subsidiaries, or SIR, we, us or our, have been prepared without audit.  Certain information and footnote 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 Combined Financial Statements of Selected Properties of CommonWealth REIT as of December 31, 2011 and 2010 and for the three years in the period ending December 31, 2011 and notes thereto contained in our Prospectus, dated March 6, 2012, or our Prospectus, filed with Securities and Exchange Commission, or the SEC, in accordance with Rule 424(b) of the Securities Act of 1933, as amended, which is accessible on the SEC’s website at www.sec.gov.  Those combined financial statements include 251 properties with a total of approximately 21.4 million rentable square feet, or the Properties, that were owned by CommonWealth REIT and its subsidiaries, or CWH, until they were contributed to us by CWH on February 16, 2012.  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 with or among our subsidiaries have been eliminated.  Operating results for interim periods are not necessarily indicative of the results that may be expected for the full year.  Because of the significant changes resulting from our initial public offering, or IPO, in March 2012, the financial results reported are not indicative of our expected future results. Reclassifications have been made to the prior years’ financial statements to conform to the current year’s presentation.

These condensed consolidated financial statements are presented as if we were a legal entity separate from CWH at all times for the periods presented, despite our not being in existence until December 19, 2011, and the fact that thereafter we were a wholly owned consolidated subsidiary of CWH until March 12, 2012.

Note 2.  Organization

SIR, a Maryland real estate investment trust, or REIT, was organized on December 19, 2011 as a wholly owned subsidiary of CWH.

On February 16, 2012, CWH contributed the Properties to us. In return, we issued to CWH: (i) 22,000,000 common shares (including 1,000 common shares initially issued to CWH on December 21, 2011 in connection with our formation) and (ii) a $400,000 demand promissory note, or the CWH Note.

On March 6, 2012, we priced our IPO of 8,000,000 common shares. The sale of these shares and an additional 1,200,000 of our common shares pursuant to the exercise in full of our IPO underwriters’ over allotment option closed on March 12, 2012, or the Closing Date, and we became a public company. We used the net proceeds from the IPO and borrowings under our revolving credit facility to repay in full the CWH Note.

Note 3.  Summary of Significant Accounting Policies

Basis of Presentation.  Prior to our IPO, CWH owned us, and we have presented certain historical transactions at CWH’s historical basis.  Historically, substantially all of the rental income received by CWH from the tenants of our Properties were deposited in and commingled with CWH’s general funds. Certain capital investments and other cash requirements of our Properties were paid by CWH and were charged directly to our Properties. General and administrative costs of CWH were allocated to our Properties based on the historical costs of the real estate investments for our Properties as a percentage of CWH’s historical cost of all of CWH’s real estate investments until the Closing Date. In our opinion, and in accordance with applicable accounting guidance, this method for allocating general and administrative expenses is reasonable. However, actual expenses may have been different from allocated expenses if our Properties had operated as a standalone entity, and those differences might be material.  Since the Closing Date, we have recorded general and administrative expenses at our direct cost.  The preparation of 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 the allowance for doubtful accounts, purchase price allocations and useful lives of fixed assets.

Real Estate Properties.  As required by GAAP, we have generally adopted the accounting treatment and policies for our properties and business which were previously employed by CWH.

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Note 4.  Real Estate Properties

On February 16, 2012, CWH contributed the Properties to us. In return, we issued to CWH: (i) 22,000,000 common shares (including 1,000 common shares initially issued to CWH on December 21, 2011 in connection with our formation) and (ii) the CWH Note.

During the three month period ending June 30, 2012, we acquired two properties with a combined 545,861 square feet for an aggregate purchase price of $104,400, excluding closing costs:

(1)          Purchase price excludes closing costs.

Since June 30, 2012, we have acquired three properties with a combined 412,271 square feet for an aggregate purchase price of $46,575, excluding closing costs:

·            In July 2012, we acquired two net leased, single tenant office buildings located in Windsor, CT with a combined 268,328 square feet.  The aggregate purchase price was $27,175, excluding closing costs.

·            Also in July 2012, we acquired a net leased, single tenant office building located in Topeka, KS with 143,943 square feet.  The purchase price was $19,400, excluding closing costs.

As of August 6, 2012, we have entered agreements to acquire four properties with a combined 1,576,856 rentable square feet for an aggregate purchase price of $109,700, including the assumption of $26,000 of mortgage debt and excluding closing costs:

·            In May 2012, we entered an agreement to acquire a net leased, single tenant office building located in Chelmsford, MA with 110,882 square feet.  The purchase price is $12,200, including the assumption of $7,500 of mortgage debt and excluding closing 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 May 2012, we entered an agreement to acquire two net leased, single tenant office buildings located in Carlsbad, CA with a combined 95,000 square feet.  The aggregate purchase price is $24,700, including the assumption of $18,500 of mortgage debt and excluding closing 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 these properties.

·            In July 2012, we entered an agreement to acquire a net leased, single tenant industrial building located in Huntsville, AL with 1,370,974 square feet.  The purchase price is $72,800, excluding closing 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.

A “net leased property” or a property being “net leased” means that the property’s lease requires the tenant to pay rent and also pay or reimburse us for all, or substantially all, property level operating expenses and capital expenditures, such as real estate taxes, insurance, utilities, maintenance and repairs, other than, in certain circumstances, roof and structural element related expenditures or in some instances to reimburse all expenses in excess of certain amounts included in the stated rent.

Note 5.  Tenant Concentration and Segment Information

We operate in one business segment: ownership of properties that are primarily net leased to single tenants.  No single tenant currently accounts for more than 10% of our total revenues.  We define a single tenant leased property as a property which is at least 90% leased to one tenant; however, we also own a few multi tenant buildings in Hawaii.

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Note 6.  Indebtedness

On February 16, 2012, we issued the CWH Note as part of the consideration for the Properties contributed to us by CWH.  Simultaneous with closing of our IPO on March 12, 2012, we repaid the CWH Note in full using net proceeds from our IPO and borrowings under our revolving credit facility.

Simultaneous with the closing of our IPO, we entered a $500,000 revolving credit facility that is available for general business purposes, including acquisitions.  The revolving credit facility is scheduled to mature on March 11, 2016, and subject to the payment of an extension fee and meeting certain other conditions, we have an option to extend the stated maturity date by one year.

Interest under the revolving credit facility is calculated at floating rates based upon LIBOR plus premiums that vary depending upon our debt leverage or credit ratings.  The weighted average annual interest rate for the revolving credit facility was 1.54% for the three months ended June 30, 2012 and 1.55% for the period of March 12, 2012 to June 30, 2012.  As of June 30, 2012, we had $321,000 of borrowings and $179,000 available for additional borrowings under the revolving credit facility.

On July 12, 2012, we amended the revolving credit facility.  As a result of this amendment, the pledge agreement that we and certain of our subsidiaries had entered into was terminated, and the equity of our subsidiaries that had been pledged pursuant to that pledge agreement as collateral for our and our subsidiary guarantors’ obligations under the revolving credit facility was released.

Simultaneous with amending the revolving credit agreement, we entered into a five year $350,000 unsecured term loan with a group of institutional lenders.  The term loan matures on July 11, 2017 and is prepayable by us without penalty at any time.  In addition, the term loan includes a feature under which maximum borrowings may be increased to up to $700,000 in certain circumstances.  Interest is calculated at floating rates based upon LIBOR plus premiums that vary depending upon our debt leverage or credit ratings.  We used the net proceeds of our term loan to repay amounts outstanding under our revolving credit facility and deposited excess proceeds into interest bearing cash accounts to fund general business activities, including acquisitions.

Our revolving credit facility agreement and our term loan agreement include various financial and other covenants that generally restrict our ability to incur debts in excess of calculated amounts, restrict our ability to make distributions under certain circumstances and require us to maintain certain financial ratios.  We believe we were in compliance with the terms of our revolving credit facility covenants at June 30, 2012.

Note 7. Fair Value of Financial Instruments

Our financial instruments at June 30, 2012 include cash and cash equivalents, rents receivable, accounts payable, our revolving credit facility, amounts due to related persons, other accrued expenses and security deposits.  At June 30, 2012, the fair value of our financial instruments approximated their carrying values in our condensed consolidated financial statements.

Note 8.  Shareholders’ Equity

We were formed on December 19, 2011 as a wholly owned subsidiary of CWH.  On December 21, 2011, we issued 1,000 common shares to CWH in connection with our formation.  On February 16, 2012, we issued 22,000,000 common shares (including the 1,000 common shares issued to CWH on December 21, 2011 in connection with our formation) to CWH as part of the consideration for the Properties contributed to us by CWH.

In March 2012, we issued 9,200,000 of our common shares in our IPO, including 1,200,000 common shares issued when the underwriters exercised in full their over allotment option, at a price of $21.50 per share, raising net proceeds of approximately $180,814.  We used the net proceeds from this offering to repay part of the CWH Note.

In July 2012, we declared a distribution of $0.49 per common share, or $15,288, to be paid on or about August 20, 2012 to shareholders of record on July 24, 2012.  This distribution includes a regular quarterly dividend of $0.40 per common share with respect to the quarter ended June 30, 2012, plus an additional $0.09 per common share reflecting our first 20 days as a public company during the prior quarter.

Note 9.  Income Taxes

Through the Closing Date, while we were 100% owned by CWH, our operations were included in CWH’s income tax returns.  CWH is a real estate investment trust under the Internal Revenue Code of 1986, as amended, or the Code.  Accordingly, CWH is not subject to federal and most state income taxes provided it distributes its taxable income and meets certain other requirements to qualify as a real estate investment trust.  However, CWH is subject to certain state and local taxes.

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From and after the Closing Date, we intend to qualify for taxation as a real estate investment trust under the Code.  As such, we expect to generally not be subject to federal and most state income taxation on our operating income provided we distribute our taxable income to our shareholders and meet certain requirements to qualify as a real estate investment trust. However, we expect to be subject to income tax in certain states and local jurisdictions despite our real estate investment trust status.

Note 10.  Related Person Transactions

We have no employees.  Personnel and various services we require to operate our business are provided to us by Reit Management & Research LLC, or RMR.  We have two agreements with RMR to provide management and administrative services to us: (1) a business management agreement and (2) a property management agreement.  Under our business management agreement with RMR, we acknowledge that RMR also provides management services to other companies, including CWH.  One of our Managing Trustees, Mr. Barry Portnoy, is Chairman, majority owner and an employee of RMR.  Our other Managing Trustee, Mr. Adam Portnoy, is the son of Mr. Barry Portnoy and an owner, President, Chief Executive Officer and a director of RMR.  Each of our other executive officers is also an officer of RMR.  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.  Mr. Barry Portnoy serves as a managing director or managing trustee of those companies and Mr. Adam Portnoy serves as a managing trustee of a majority of those companies.

Pursuant to our business management agreement with RMR, we incurred expenses of $1,252 for the three months ended June 30, 2012, and $1,500 for the period beginning on March 12, 2012, the date on which we entered into the agreement, through June 30, 2012.  These amounts are included in general and administrative expenses in our condensed consolidated financial statements.  In connection with our property management agreement with RMR, we incurred property management and construction supervision fees of $807 for the three months ended June 30, 2012, and $965 for the period beginning on March 12, 2012, the date on which we entered into the agreement, through June 30, 2012.  These amounts are included in operating expenses or have been capitalized, as appropriate, in our condensed consolidated financial statements.

We were formerly a 100% owned subsidiary of CWH.  CWH is our largest shareholder and, as of the date of this report, CWH owned 22,000,000 of our common shares, or approximately 70.5% of our outstanding common shares.  One of our Managing Trustees, Mr. Barry Portnoy, is a managing trustee of CWH.  Our other Managing Trustee, Mr. Adam Portnoy, is a managing trustee and President of CWH.  In addition, Mr. John Popeo, our Treasurer and Chief Financial Officer, also serves as the Treasurer and Chief Financial Officer of CWH, and one of our Independent Trustees, Mr. William Lamkin, is also an independent trustee of CWH.  RMR provides management services to both us and CWH.

In March 2012, we completed our IPO of 9,200,000 of our common shares (including 1,200,000 common shares sold pursuant to the full exercise of the underwriters’ over allotment option), for net proceeds (after deducting underwriters’ discounts and commissions and estimated expenses) of $180,814.  We applied those net proceeds, along with proceeds of our initial borrowings under our $500,000 revolving credit facility, to repay in full the CWH Note and to reimburse CWH for costs that CWH incurred in connection with our organization and preparation for our IPO.  In connection with our IPO, we and CWH entered into a transaction agreement that governs our relationship with CWH.  The transaction agreement provides that, among other things, (1) the current assets and liabilities of the Properties, as of the time of closing of the IPO, were settled between us and CWH so that CWH will retain all pre-closing current assets and liabilities and we will assume all post-closing current assets and liabilities and (2) we will indemnify CWH with respect to any liability relating to any property transferred by CWH to us, including any liability which relates to periods prior to our formation, other than the pre-closing current assets and current liabilities that CWH retained with respect to the Properties.

On May 21, 2012, we entered into a subscription agreement, or the Subscription Agreement, with the Affiliates Insurance Company, or AIC, an Indiana insurance company.  Pursuant to the Subscription Agreement, we purchased from AIC 20,000 shares of its common stock, par value $10.00 per share, or the Shares, at an aggregate purchase price of approximately $5,335.  Concurrently with the execution and delivery of the Subscription Agreement, in May 2012, we entered into an amended and restated shareholders agreement, or the Shareholders Agreement, with AIC, RMR, CWH and five other companies to which RMR provides management services, which Shareholders Agreement includes arbitration provisions for the resolution of certain disputes, claims and controversies.  We, RMR, CWH and five other companies to which RMR provides management services each currently own 12.5% of AIC.  All of our Trustees and nearly all of the trustees and directors of the other AIC shareholders currently serve on the board of directors of AIC.  RMR 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 also directors of AIC.  Our investment in AIC had a carrying value of $5,408 as of June 30, 2012.  During the period from May 21, 2012, to June 30, 2012, we recognized income of $74 related to this investment.  We and the other shareholders of AIC have purchased property insurance providing $500,000 of coverage pursuant to an insurance program arranged by AIC and with respect to which AIC is a reinsurer of certain coverage amounts.  The current program was entered into in June 2012 and has a one year period.  We paid a premium, including taxes and fees, of $324 for this program, which amount may be adjusted from time to time in response to our acquisition and

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disposition of properties that are included in this program.  We are also currently investigating the possibilities to expand our insurance relationships with AIC to include other types of insurance.  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.  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 further information about these and other such relationships and related person transactions, 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 our Prospectus, including the sections captioned “Business,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Related Person Transactions,” “Certain Relationships and Related Person Transactions” and “Cautionary Statement Regarding Forward Looking Statements”.  In addition, please see the section captioned “Risk Factors” in our Prospectus for a description of risks that may arise from these transactions and relationships.  Our filings with the SEC, including our Prospectus, are available at the SEC’s website at www.sec.gov.  In addition, copies of certain of our agreements with these parties, including our business management agreement and property management agreement with RMR, various agreements we have with CWH and our Shareholders Agreement with AIC and its shareholders, are also publicly available as exhibits to our public filings with the SEC and accessible at the SEC’s website.

Note 11.  Subsequent Events

Subsequent events have been disclosed within other notes to these condensed consolidated financial statements.

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

The following discussion of our financial condition and results of operations should be read together with our condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q and with the Combined Financial Statements of Selected Properties of CommonWealth REIT as of December 31, 2011 and 2010 and for the three years in the period ended December 31, 2011 and notes thereto contained in our Prospectus.

OVERVIEW

As of June 30, 2012, we owned 253 properties, located in 16 states, that contain approximately 22.0 million rentable square feet and were approximately 95.6% leased (based upon rentable square feet).  For the three months ended June 30, 2012, approximately 66.4% of our total revenue was from 228 properties with 17.8 million rentable square feet we own on Oahu, Hawaii.  The remainder of our total revenue for the three months ended June 30, 2012 was from 25 properties located throughout the mainland United States.

Property Operations

As of June 30, 2012, 95.6% of our rentable square feet was leased, compared to 95.5% of our rentable square feet as of June 30, 2011.  Occupancy data for 2012 and 2011 is as follows (square feet and dollars in thousands):

(1)          Includes properties owned continuously since January 1, 2011 by us or, prior to the completion of our IPO on March 12, 2012, with respect to the Properties, by CWH.

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

The average annualized effective rental rate per square foot, as defined below, for our properties for the periods ended June 30, 2012 and 2011 are as follows:

(1)          Average annualized effective rental rate per square foot represents annualized total revenue during the period specified adjusted for tenant concessions, including free rent and tenant reimbursements, divided by the average rentable square feet occupied during the period specified.

During the three months ended June 30, 2012, we entered lease renewals for approximately 38,000 square feet and new leases for approximately 147,000 square feet, which had combined weighted average rental rates that were 52.0% higher than prior rents for the same space.  The weighted average lease term for new leases and lease renewals entered into during the second quarter of 2012 was 10.3 years.  Commitments for tenant improvement, leasing commission costs and concessions for leases entered during the quarter ended June 30, 2012 totaled $3.29 per square foot on average, or approximately $0.32 per square foot per year of the lease term.  All new and renewal leasing activity during the quarter ended June 30, 2012 occurred at our properties located in Hawaii.

We executed rent resets at properties located in Hawaii for approximately 30,000 square feet of land during the quarter ended June 30, 2012, which had combined weighted average reset rates that were 34.2% higher than prior rates.

The U.S. economy has recently experienced a recession, and the recovery to date has been slow, unsteady and incomplete. We believe that the high current unemployment rate and weak national office and industrial leasing market conditions may lead to a continued decrease in national office and industrial occupancy and effective rental rates through the end of 2012. However, because our weighted average remaining lease term (based on annualized rental revenue, as defined below) was approximately 11.8 years as of June 30, 2012, we do not expect our occupancy rate to materially change through the end of 2012. In addition, despite the recent

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recession and incomplete recovery of the U.S. economy, revenues from our properties located in Hawaii, which represented approximately 66.4% of our total rental revenue for the three months ended June 30, 2012, have generally increased under CWH’s prior ownership as leases for those properties have reset or renewed. Nevertheless, because of the current U.S. and global economic uncertainty, there are too many variables for us to reasonably project what the financial impact of changing market conditions will be on our occupancy or financial results.

As shown in the table below, approximately 4.0% of our rented square feet and approximately 2.7% of total annualized rental revenue are included in leases scheduled to expire by December 31, 2012. Lease renewals and rental rates for which available space may be relet in the future will depend on prevailing market conditions at the times these renewals, new leases and rent reset rates are negotiated. However, all of our leases scheduled to expire through December 31, 2014 relate to properties located in Oahu, Hawaii, and, as stated above, revenues from our properties in Hawaii have generally increased during our and CWH’s prior ownership as the leases for those properties have been reset or renewed. As of June 30, 2012, lease expirations by year are as follows (square feet and dollars in thousands):

(1)          Rented square feet is pursuant to existing leases as of June 30, 2012, and includes (i) space being fitted out for occupancy pursuant to existing leases and (ii) space which is leased but is not occupied or is being offered for sublease by tenants.

(2)         Annualized rental revenue is the annualized contractual rents from our tenants pursuant to existing leases as of June 30, 2012, plus straight line rent adjustments and estimated recurring expense reimbursements.

A majority of our Hawaii properties are lands leased for rents that are periodically reset based on fair market values, generally every five to ten years.  The following chart shows the annualized rental revenue as of June 30, 2012 scheduled to reset at our Hawaii lands.

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Scheduled Rent Resets At Hawaii Lands

(dollars in thousands)

(1)          Annualized rental revenue is the annualized contractual rents from our tenants pursuant to existing leases as of June 30, 2012, plus straight line rent adjustments and estimated recurring expense reimbursements.

We intend to continue to seek to negotiate with our tenants as rents under their leases are scheduled to reset in order to achieve new rents based on the then current fair market values. Despite CWH’s and our prior experience with rent resets in Hawaii, our ability to increase rents when rent resets occur depends upon market conditions which are beyond our control. Accordingly, we can provide no assurance that the historical increases in rents which we and CWH have achieved in the past pursuant to contractual rent resets will be repeated in the future, and it is possible that rents could reset to a lower level if fair market values decrease.

We intend to seek to renew or extend the terms of leases relating to our mainland properties when they expire. Because these properties are each leased to a single tenant, because of the capital many of these tenants have invested into the improvements and because our properties may be of strategic importance to the each tenant’s business, we believe that there is a greater likelihood that these tenants will renew or extend their leases when they expire as compared to tenants in a property with multiple tenants.  However, we also believe that if a building previously occupied by a single tenant becomes vacant, it may take longer and cost more to locate a new tenant than when space becomes vacant in a multi-tenant property. Whenever we extend, renew or enter into new leases for our properties, we intend to seek rents which are equal to or higher than our historical rents for the same properties; however, our ability to maintain or increase the rents for our current properties will depend in large part upon market conditions which are beyond our control.

Our manager, RMR, employs a tenant review process for us. RMR assesses tenants on an individual basis and does not employ a uniform set of credit criteria. In general, depending on facts and circumstances, RMR evaluates the creditworthiness of a tenant based on information concerning the tenant that is provided by the tenant and, in some cases, information that is publicly available or obtained from third party sources. RMR also often uses a third party service to monitor the credit ratings of debt securities of our existing tenants whose debt securities are rated by a nationally recognized statistical rating organization.

Our principal source of funds for our operations to pay our debt service and our distributions to shareholders is rents from tenants at our properties.  Rents are generally received from our tenants monthly in advance.  As of June 30, 2012, tenants representing 1% or more of our total annualized rental revenues were as follows (square feet in thousands):

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Tenants Representing 1% or More of Our Total Annualized Rental Revenues:

(1)             Square feet is pursuant to existing leases as of June 30, 2012, and includes (i) space being fitted out for occupancy and (ii) space which is leased but is not occupied or is being offered for sublease.

(2)             Annualized rental revenue is the annualized contractual rents from our tenants pursuant to existing leases as of June 30, 2012, plus straight line rent adjustments and estimated recurring expense reimbursements.

Investment Activities

On February 16, 2012, CWH contributed the Properties to us. In return, we issued to CWH: (i) 22,000,000 common shares (including 1,000 common shares initially issued to CWH on December 21, 2011 in connection with our formation) and (ii) the CWH Note.

Since February 16, 2012, we have acquired five properties with a combined 958,132 square feet for an aggregate purchase price of $151.0 million, excluding closing costs.  As of August 6, 2012, we have entered into existing agreements to acquire four properties with a combined 1,576,856 rentable square feet for an aggregate purchase price of $109.7 million, including the assumption of $26.0 million of mortgage debt and excluding closing costs.  For more information regarding properties that we have acquired and properties that we have agreed to acquire pursuant to existing agreements we have entered, see Note 4 to our Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, which is incorporated herein by reference.

Our strategy related to property acquisitions and dispositions is materially unchanged from that disclosed in our Prospectus.  We anticipate seeking to negotiate with tenants at our Hawaii properties as rents under their leases are scheduled to reset. We may explore redevelopment opportunities at some of our Hawaii properties as leases expire. We will also seek to expand our portfolio by acquiring additional single tenant properties. We expect that most of our acquisition efforts will focus on office and industrial properties; however, we may consider acquiring other types of properties, including properties which are net leased to single tenants for retail uses and properties specifically suited to particular tenants’ requirements.

Financing Activities

On February 16, 2012, CWH contributed the Properties to us. In return, we issued to CWH: (i) 22,000,000 common shares (including 1,000 common shares initially issued to CWH on December 21, 2011 in connection with our formation) and (ii) the CWH Note.

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On March 12, 2012, we issued 9,200,000 common shares in connection with our IPO, including 1,200,000 shares issued when the underwriters exercised in full their over allotment option, at a price of $21.50 per share, raising net proceeds of approximately $180.8 million.  We used the net proceeds from our IPO and drawings under our revolving credit facility to repay the CWH Note.

Simultaneous with the closing of our IPO, we entered into a $500.0 million revolving credit facility that is available for general business purposes, including acquisitions.  The revolving credit facility is scheduled to mature on March 11, 2016, and subject to the payment of an extension fee and meeting certain other conditions, we have an option to extend the stated maturity date by one year.

Interest under the revolving credit facility is calculated at floating rates based upon LIBOR plus premiums that vary depending upon our debt leverage or credit ratings.  The weighted average annual interest rate for the revolving credit facility was 1.54% for the three months ended June 30, 2012 and 1.55% for the period of March 12, 2012 to June 30, 2012.  As of June 30, 2012, we had $321.0 million of borrowings and $179.0 million available for additional borrowings under the revolving credit facility.

On July 12, 2012, we amended the revolving credit facility.  As a result of this amendment, the pledge agreement that we and certain of our subsidiaries had entered into was terminated, and the equity of our subsidiaries that had been pledged pursuant to that pledge agreement as collateral for our and our subsidiary guarantors’ obligations under the revolving credit facility was released.

Simultaneous with amending the revolving credit agreement, we entered into a five year $350.0 million unsecured term loan with a group of institutional lenders.  The term loan matures on July 11, 2017 and is prepayable without penalty at any time.  In addition, the term loan includes a feature under which maximum borrowings may be increased to up to $700.0 million in certain circumstances.  Interest is calculated at floating rates based upon LIBOR plus premiums that vary depending upon our debt leverage or credit ratings.  We used the net proceeds of our term loan to repay amounts outstanding under our revolving credit facility and deposited excess proceeds into interest bearing cash accounts to fund general business activities, including acquisitions.

Our revolving credit facility agreement and our term loan agreement include various financial and other covenants that generally restrict our ability to incur debts in excess of calculated amounts, restrict our ability to make distributions under certain circumstances and require us to maintain certain financial ratios.  We believe we were in compliance with the terms of our revolving credit facility covenants at June 30, 2012.

14

RESULTS OF OPERATIONS

Three Months Ended June 30, 2012, Compared to Three Months Ended June 30, 2011 (dollars in thousands, except per share data)