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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 March 31, 2014

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 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 (§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, $.01 par value per share, outstanding as of April 23, 2014:  49,870,633

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SELECT INCOME REIT

FORM 10-Q

March 31, 2014

INDEX

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

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PART I                             Financial Information

Item 1.  Financial Statements

SELECT INCOME REIT

CONDENSED CONSOLIDATED BALANCE SHEETS

(dollars 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

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SELECT INCOME REIT

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(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, 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, 2013, 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 with or among our consolidated subsidiaries have been eliminated. Our operating results for interim periods are not necessarily indicative of the results that may be expected for the full year.

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.

Note 2.  Recent Accounting Pronouncements

In April 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.  This update amends the criteria for reporting discontinued operations to, among other things, raise the threshold for disposals to qualify as discontinued operations. This update is effective for interim and annual reporting periods, beginning after December 15, 2014, with early adoption permitted.  We currently expect the adoption of this update to reduce the number of future property dispositions we make, if any, to be presented as discontinued operations in our condensed consolidated financial statements.

Note 3.  Real Estate Properties

As of March 31, 2014, we owned 48 properties (278 buildings, leasable land parcels and easements) with approximately 26.1 million rentable square feet.

In April 2014, we acquired a single tenant, net leased office property located in Naperville, IL with approximately 820,000 rentable square feet. This property was acquired and simultaneously leased back to an affiliate of the seller in a sale and leaseback transaction. The purchase price of this property was $187,500, excluding closing costs, and was accounted for as an asset acquisition.

Also in April 2014, we acquired a single tenant, net leased office/warehouse property located in Mahwah, NJ with approximately 167,000 rentable square feet. The purchase price of this property was $20,500, excluding closing costs, and was accounted for as a business combination. As of the date of this filing, the purchase price allocation for this property is pending third party appraisals.

Certain of our real estate assets contain hazardous substances, including asbestos. We believe the asbestos at our properties is contained in accordance with current environmental regulations and we have no current plans to remove it. If these properties were demolished today, certain environmental regulations specify the manner in which the asbestos must be removed and we could incur substantial costs complying with such regulations. Certain of our industrial lands in Hawaii may require environmental remediation, especially if the use of those lands is changed; however, we do not have any present plans to change the use of those land parcels or to undertake this environmental cleanup. In general, we do not have any insurance designated to limit any losses that we may incur as a result of known or unknown environmental conditions which are not caused by an insured event, such as, for example, fire or flood, although some of our tenants may maintain such insurance. However, as of March 31, 2014 and December 31, 2013, accrued environmental remediation costs totaling $8,148 and $8,150, respectively, were included in accounts payable and accrued expenses in our condensed consolidated balance sheets. These accrued environmental remediation costs relate to maintenance of our properties for current uses and, because of the indeterminable timing of the remediation, these amounts have not been discounted to present value. We do not believe that there are environmental conditions at any of our properties that will have a material adverse effect on us. However, no assurances can be given that such conditions are not present in our properties or that other costs we incur to remediate contamination will not have a material adverse effect on our business or financial condition. Charges for environmental remediation costs are included in other operating expenses in our condensed consolidated statements of income and comprehensive income.

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Note 4.  Segment Information and Tenant Concentration

We operate in one business segment: ownership of properties that include buildings and leased industrial lands that are primarily net leased to single tenants, with no one tenant accounting for more than 10% of our total revenues. A “net leased property” or a property being “net leased” means that the building or land lease requires the tenant to pay rent and 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; in some instances, tenants instead reimburse us for all expenses in excess of certain amounts included in the stated rent. We define a single tenant leased building or leased land as a building or land parcel with at least 90% of its rentable square footage leased to one tenant. Our buildings and lands are primarily leased to single tenants; however, we do own some multi tenant buildings on the island of Oahu, HI.

Note 5.  Indebtedness

In January 2014, we repaid, at par, a $7,500 mortgage note which was secured by a building located in Chelmsford, MA. This mortgage was scheduled to mature in 2016.

At March 31, 2014 and December 31, 2013, our outstanding indebtedness consisted of the following:

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

(2)              This mortgage note was repaid, at par, in January 2014.

We have a $750,000 unsecured revolving credit facility that is available for general business purposes, including acquisitions. The maturity date of our revolving credit facility is March 11, 2016 and, subject to the payment of an extension fee and meeting certain other conditions, our revolving credit facility includes an option for us to extend the stated maturity date by one year to March 11, 2017.  In addition, our revolving credit facility includes a feature under which maximum borrowings may be increased to $1,000,000 in certain circumstances. Borrowings under our revolving credit facility bear interest at LIBOR plus a premium.  We also pay a facility fee on the total amount of lending commitments under our revolving credit facility. Both the interest rate premium and the facility fee are subject to adjustment based upon changes to our leverage or credit ratings. As of March 31, 2014, the interest rate premium on our revolving credit facility was 130 basis points and our facility fee was 30 basis points.  As of March 31, 2014, the interest rate payable on borrowings under our revolving credit facility was 1.45% and the weighted average interest rate for borrowings under the revolving credit facility was 1.46% and 1.51% for the three months ended March 31, 2014 and 2013, respectively. We can borrow, repay and reborrow funds available under our revolving credit facility until maturity, and no principal repayment is due until maturity. As of March 31, 2014 and April 23, 2014, we had $345,000 and $357,000, respectively, outstanding under our revolving credit facility.

We also have a $350,000 unsecured term loan that matures on July 11, 2017 and is prepayable without penalty at any time. In addition, our term loan includes a feature under which maximum borrowings may be increased to up to $700,000 in certain circumstances. Our term loan bears interest at a rate of LIBOR plus a premium, which was 155 basis points as of March 31, 2014. The interest rate premium is subject to adjustment based upon changes to our leverage or credit ratings. As of March 31, 2014, the interest rate payable for the amount outstanding under our term loan was 1.70% and the weighted average interest rate for the amount outstanding under our term loan was 1.69% and 1.76% for the three months ended March 31, 2014 and 2013, respectively.

Our revolving credit facility agreement and our term loan agreement provide for acceleration of payment of all amounts due thereunder upon the occurrence and continuation of certain events of default, including a change of control of us, which includes Reit Management & Research LLC, or RMR, ceasing to act as our business manager and property manager. Our revolving credit facility agreement and our term loan agreement also contain a number of financial and other covenants, including covenants that restrict our ability to incur indebtedness or to make distributions under certain circumstances and require us to maintain financial ratios and a

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minimum net worth. We believe we were in compliance with the terms of our revolving credit facility and term loan covenants at March 31, 2014.

At March 31, 2014, one of our properties (two buildings) with an aggregate net book value of $20,626 secured a mortgage note we assumed in connection with our acquisition of the property. The aggregate principal amount outstanding under the mortgage note as of March 31, 2014, was $18,170. This mortgage note is non-recourse, subject to certain limited exceptions, and does not contain any material financial covenants.

Note 6. Fair Value of Financial Instruments

Our financial instruments at March 31, 2014 included cash and cash equivalents, rents receivable, equity investments, a mortgage note payable, our revolving credit facility, our term loan, amounts due to related persons, accounts payable and other accrued expenses. At March 31, 2014, the fair value of our financial instruments approximated their carrying values in our condensed consolidated financial statements due to their short term nature or variable interest rates, except as follows:

We estimate the fair values of our mortgage notes payable by using discounted cash flow analyses and currently prevailing market rates for similar mortgage notes as of March 31, 2014.  These inputs are categorized as level 3 inputs as defined in the fair value hierarchy under the accounting standards for Fair Value Measurements and Disclosures.  Because level 3 inputs are unobservable, our estimated fair value may differ materially from the actual fair value.

Note 7.  Shareholders’ Equity

Share Issuances:

We issued 38,383 common shares to RMR during the three months ended March 31, 2014 and 2,709 shares in April 2014, as part of its compensation under our business management agreement. See Note 8 for further information regarding this agreement.

Distributions:

In February 2014, we paid a distribution of $0.46 per common share, or approximately $22,922, to shareholders of record on January 13, 2014.

In April 2014, we declared a quarterly distribution of $0.48 per common share, or approximately $23,938, to shareholders of record on April 14, 2014. We expect to pay this distribution on or about May 20, 2014 using existing cash balances and borrowings under our revolving credit facility.

Note 8.  Related Person Transactions

RMR:  We have no employees. Personnel and various services we require to operate our business are provided to us by RMR. We have two agreements with RMR to provide management and administrative services to us: (i) a business management agreement, which relates to our business generally, and (ii) a property management agreement, which relates to our property level operations.

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 executive officers is also an officer 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 a majority of those companies and Mr. Adam Portnoy serves as a managing trustee of a majority of those companies. In addition, officers of RMR serve as officers of those companies.

Pursuant to our business management agreement with RMR, we recognized business management fees of $4,371 and $2,167 for the three months ended March 31, 2014 and 2013, respectively.  The fees for the three months ended March 31, 2014, include estimated 2014 incentive fees payable in common shares in 2015 based on our common share total return. These recognized amounts for the 2013 and 2014 periods are included in general and administrative expenses in our condensed consolidated financial statements. In accordance with the terms of our business management agreement, as amended in December 2013, we issued 8,227 of our common

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shares to RMR for the three months ended March 31, 2014 as payment for 10% of the base business management fee we recognized for such period. In March 2014, we also issued 32,865 of our common shares to RMR for the incentive fee for 2013 pursuant to the business management agreement.

In connection with our property management agreement with RMR, the aggregate property management and construction supervision fees we recognized were $1,490 and $1,258 for the three months ended March 31, 2014 and 2013, respectively. These amounts are included in operating expenses or have been capitalized, as appropriate, in our condensed consolidated financial statements.

CWH:  We were formerly a 100% owned subsidiary of CommonWealth REIT, or CWH. CWH is our largest shareholder and, as of March 31, 2014, CWH owned 22,000,000 of our common shares, or approximately 44.1% of our outstanding common shares.  One of our Managing Trustees, Mr. Barry Portnoy, was a managing trustee of CWH until March 25, 2014. Our other Managing Trustee, Mr. Adam Portnoy, is the President of CWH and was a managing trustee of CWH until March 25, 2014. 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, was an independent trustee of CWH until March 25, 2014. RMR provides management services to both us and CWH.

In 2012, we completed our initial public offering, or IPO. To facilitate our IPO, we and CWH entered into a transaction agreement that governs our separation from and relationship with CWH. The transaction agreement provides that, among other things, (i) the current assets and liabilities of the 29 properties (251 buildings, leasable land parcels and easements) contributed to us by CWH, or the Initial Properties, as of the time of closing of the IPO, were settled between us and CWH so that CWH retained all pre-closing current assets and liabilities and we assumed all post-closing current assets and liabilities and (ii) 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 Initial Properties.

In March 2013, we entered into a registration agreement with CWH, pursuant to which we agreed to register for resale by CWH up to 22,000,000 of our common shares owned by CWH, or an Offering, and we filed a registration statement on Form S-3 to permit the resale by CWH of some or all of our common shares owned by CWH. CWH has not sold any of our common shares it owns pursuant to that registration statement.  Under the registration agreement, CWH agreed to pay all expenses incurred by us relating to the registration and sale of the shares in an Offering. On March 31, 2014, we notified CWH that, effective that same day, we had elected to terminate the registration agreement with CWH as a result of the removal, without cause, of all of the trustees of CWH which constituted a change of control of CWH as provided in that agreement.

AIC:  We, RMR and six other companies to which RMR provides management services each currently own approximately 12.5% of Affiliates Insurance Company, or AIC, an Indiana insurance company.  All of our Trustees and most 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.

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. This program currently expires in June 2014, and we may determine to renew our participation in this program at that time. As of March 31, 2014, we had invested $5,335 in AIC since we became an equity owner of AIC in 2012. 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 as all of our Trustees are also directors of AIC. Our investment in AIC had a carrying value of $5,835 and $5,913 as of March 31, 2014 and December 31, 2013, respectively, which amounts are included in other assets on our condensed consolidated balance sheet. We recognized income (loss) of $(97) and $76 related to our investment in AIC for the three months ended March 31, 2014 and 2013, respectively.

On March 25, 2014, as a result of the removal, without cause, of all of the trustees of CWH, CWH underwent a change in control, as defined in the shareholders agreement among us, the other shareholders of AIC and AIC. In April 2014, as a result of the change in control of CWH and in accordance with the terms of the shareholders agreement, we provided notice of exercise of our right to purchase shares of AIC CWH then owned.  We expect that we and the other non-CWH shareholders will purchase pro rata all of the AIC shares CWH owns.  As such, we expect to purchase 2,857 of those shares for $825, and that following these purchases, we and the other remaining six shareholders will then each own approximately 14.3% of AIC.

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

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

OVERVIEW

We are a real estate investment trust, or REIT, organized under Maryland law.  As of March 31, 2014, we owned 48 properties (278 buildings, leasable land parcels and easements), located in 20 states, that contain approximately 26.1 million rentable square feet and were approximately 95.7% leased (based on rentable square feet). For the period ended March 31, 2014, approximately 41.7% of our total revenue was from 11 properties (229 buildings, leasable land parcels and easements) with 17.8 million rentable square feet that we own on the island of Oahu, HI, or our Hawaii Properties.  The remainder of our total revenue for the period ended March 31, 2014 was from 37 properties (49 buildings) located throughout the mainland United States, or our Mainland Properties. As of March 31, 2014, our properties were leased to 263 different tenants, with a weighted average remaining lease term (based on annualized rental revenue) of approximately 10.6 years.

Property Operations

As of March 31, 2014, 95.7% of our rentable square feet were leased, compared to 95.8% of our rentable square feet as of March 31, 2013.  Occupancy data for 2014 and 2013 is as follows (square feet in thousands):

(1)             Consists of 41 properties (267 buildings, leasable land parcels and easements) that we owned continuously since January 1, 2013.

(2)             Subject to modest adjustments when space is re-measured or re-configured for new tenants and when land leases are converted to building leases.

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

The modest occupancy decrease at our comparable properties from March 31 2013 to March 31, 2014 did not materially impact our March 31, 2014 comparable financial results. Our comparable financial results have been primarily impacted by rent increases during the period at some of our comparable leased land properties located in Hawaii, as further described below.

The average annualized effective rental rate per square foot, as defined below, for our properties for the periods ended March 31, 2014 and 2013 are as follows:

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

(2)             Consists of 41 properties (267 buildings, leasable land parcels and easements) that we owned continuously since January 1, 2013.

During the three months ended March 31, 2014, we entered lease renewals and new leases for approximately 206,000 square feet at weighted average rental rates that were approximately 20.0% higher than prior rates for the same space.  The weighted average lease term for new and renewal leases entered during the three months ended March 31, 2014 was 12.4 years.  Commitments for tenant improvements, leasing costs and concessions for leases entered during the three months ended March 31, 2014 totaled approximately $580,000, or approximately $0.23 per square foot per year of the weighted average lease term.  All leasing activity during the three months ended March 31, 2014 occurred at our Hawaii Properties.

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During the three months ended March 31, 2014, we also executed 18 rent resets at our Hawaii Properties for approximately 592,000 square feet of land, at weighted average reset rates that were approximately 50.8% higher than prior rates.

We currently believe that U.S. real estate leasing market conditions are slowly improving, but remain weak in many U.S. markets. However, because our weighted average remaining lease term (based on annualized rental revenue, as defined in footnote (2) of the table below) was approximately 10.6 years as of March 31, 2014, and because only 0.9% of our total rented square feet is subject to leases scheduled to expire during the remainder of 2014, we do not expect our occupancy rate to materially change through the end of 2014. In addition, despite the recent recession and incomplete recovery of the U.S. economy, revenues from our Hawaii Properties, which represented approximately 41.7% of our total rental revenue for the three months ended March 31, 2014, have generally increased under our ownership and CWH’s prior ownership as leases for those properties have reset or renewed to the then current fair market value. 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, rents or financial results.

As shown in the table below, approximately 0.9% of our total rented square feet and approximately 0.6% of our total annualized rental revenue (as defined in footnote (2) of the table below) are included in leases scheduled to expire by December 31, 2014. 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 2014 relate to our Hawaii Properties, and, as stated above, revenues from these properties have generally increased during our and CWH’s prior ownership as the leases for those properties have been reset or renewed. As of March 31, 2014, our lease expirations by year are as follows (square feet and dollars in thousands):

(1)             Rented square feet is pursuant to existing leases as of March 31, 2014, and includes (i) space being fitted out for occupancy pursuant to existing leases, if any, and (ii) space which is leased but is not occupied or is being offered for sublease by tenants, if any.

(2)             Annualized rental revenue is the annualized contractual rents from our tenants pursuant to existing leases as of March 31, 2014, including straight line rent adjustments and estimated recurring expense reimbursements, excluding lease value amortization.

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 March 31, 2014 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 March 31, 2014, including straight line rent adjustments and estimated recurring expense reimbursements, excluding lease value amortization.

(2)             Amount includes rents currently being paid, excluding rent resets not yet established. However, rental income in our condensed consolidated statements of income and comprehensive income includes estimated rental rate adjustments for these rent resets.

With respect to our Hawaiian land leases, we intend 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. If we are unable to reach agreement with a tenant on a rent reset, our Hawaiian land leases typically provide that rent is reset based on an appraisal process. 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 will be repeated in the future, and it is possible that rents could reset to a lower level if fair market values decrease.

We expect to seek to renew or extend the terms of leases relating to our Mainland Properties when they expire. Because of the capital many of these tenants have invested in improvements and because many of our properties may be of strategic importance to the tenants’ business, we believe that there may be a greater likelihood that these tenants may 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 because in place improvements designed specifically for the needs of the prior single tenant may need to be replaced.

During the third quarter of 2013, one of our mainland tenants defaulted on its obligation to pay real estate taxes and rent under its lease with us. As of March 31, 2014, pursuant to the lease, we applied a portion of this tenant’s security deposit to cover all unpaid amounts. While we work with this tenant to resolve the default, we have commenced litigation to pursue our contractual rights under the lease, including reimbursement of amounts drawn on the now underfunded security deposit and payment in full of all past due amounts plus amounts that become due if we elect to accelerate the expiration of the lease. Since March 31, 2014, we have continued to apply portions of this tenant’s security deposit to satisfy its current rent and expense obligations. If this tenant does not begin paying rent and expenses by July 2014, its security deposit is expected to be depleted and we could experience a reduction in annual revenue of approximately $3.4 million, an increase in annual real estate tax expense of approximately $270,000, and increases in other property operating expenses previously paid by this tenant directly, unless and until we are able to collect past due amounts through litigation or otherwise or re-let the property, although the terms of any re-let may not be on as favorable terms for us. In addition, we may, under certain circumstances, be required to expense over $10.5 million of accumulated straight line rent accruals and acquired real estate lease assets, or a significant portion of those amounts, related to this lease on an accelerated basis if the lease is terminated or the terms change.

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 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 March 31, 2014, 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 March 31, 2014, and includes (i) space being fitted out for occupancy pursuant to existing leases, if any, and (ii) space which is leased but is not occupied or is being offered for sublease by tenants, if any.

(2)             Annualized rental revenue is the annualized contractual rents from our tenants pursuant to existing leases as of March 31, 2014, including straight line rent adjustments and estimated recurring expense reimbursements, excluding lease value amortization.

Investment Activities (dollar amounts in thousands)

During April 2014, we acquired two single tenant, net leased properties with approximately 987,000 of combined rentable square feet for an aggregate purchase price of $208,000, excluding closing costs. For more information regarding properties that we have acquired, see Note 3 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 Annual Report. We currently intend to expand our investments by primarily acquiring additional single tenant, net leased properties throughout the mainland United States and we expect to use the extensive nationwide resources of RMR to locate and acquire such properties. However, during most of the past 12 to 15 months property pricing has increased as a result of increased availability of debt and equity capital making it more difficult for us to find appropriately priced properties that meet our investment criteria. We intend to remain selective in the acquisitions we make. One of our goals in acquiring additional properties will be to further diversify our sources of rents with the intention of improving the security of our revenues. Another goal will be to purchase properties that produce rents, less property operating expenses, that are greater than our capital costs to acquire the properties and, accordingly, allow us to increase distributions to our shareholders over time. 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 special purpose properties specifically suited to particular tenants’ requirements.  We also may acquire additional properties in Hawaii, but we currently expect this will not be a significant part of our future acquisitions because there are limited opportunities to acquire properties in Hawaii, especially to acquire lands which are leased to third party tenants.

Financing Activities (dollar amounts in thousands)

In January 2014, we repaid, at par, a $7,500 mortgage note which was secured by a building located in Chelmsford, MA. This mortgage was scheduled to mature in 2016.

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RESULTS OF OPERATIONS

Three Months Ended March 31, 2014, Compared to Three Months Ended March 31, 2013 (dollars in thousands, except per share data)