| GOVERNMENT PROPERTIES TRUST INC Item 1A Risk Factors Risks Related to Our Business and Properties The pace of our property acquisitions to date has resulted in cash flow that is insufficient to cover dividends at their current level |
| We acquired seven properties for dlra215dtta9 million in 2005 and eight properties for dlra123dtta2 million in 2004 |
| Cash from operations for the properties we own has been significantly less than the dividends we have paid to date |
| To continue to pay dividends at their current level, the Company will be required to use some of the equity capital it raised in its initial public offering |
| We may not be able to generate sufficient cash to pay dividends in the future |
| The closings of our property acquisitions are subject to conditions that may prevent us from acquiring such properties |
| Our ability to complete acquisitions depends upon many factors, such as the negotiation of definitive purchase agreements, the satisfactory results from the due diligence work, completion of construction, and satisfaction of customary closing conditions |
| We have abandoned several prospective purchases due to the failure of one or more of these circumstances |
| The inability to complete future acquisitions within our anticipated time frames may harm our financial results and undercut our ability to pay dividends at their current level |
| Higher asking prices for potential property acquisitions may limit our ability to complete our business plan |
| During this period of increased prices for properties and increased interest rates, we may not be able to acquire additional properties accretively and may elect not to do so |
| To the extent that we do not acquire properties accretively, we will not be able to grow as contemplated in our business plan |
| Our use of debt financing could decrease our cash flow and expose us to risk of default under our debt documents |
| Our policy is to use debt to finance, on average, approximately 75prca of the acquisition cost of the properties that we buy |
| As of December 31, 2005, we had approximately dlra242dtta5 million of outstanding indebtedness representing 62prca of the acquisition cost of properties we owned as of that date |
| 11 _________________________________________________________________ [64]Table of Contents Since we anticipate that our cash flow from operations will be insufficient to repay all of our indebtedness prior to maturity, we expect that we will have to extinguish remaining debt through refinancing, sale of properties or sale of additional equity |
| If we are unable to refinance our indebtedness on acceptable terms, or at all, we might be forced to dispose of one or more of our properties on unfavorable terms, which might result in losses to us and which might adversely affect our cash available for distribution to our stockholders |
| If prevailing interest rates or other factors at the time of a refinancing result in higher interest rates on such refinancing, our interest expense would increase, which could seriously harm our operating results and financial condition and our ability to pay dividends |
| Our debt and any increase in our debt may be detrimental to our business and financial results by: • requiring us to use a substantial portion of our cash flow from operations to pay interest, which reduces the amount available for the operation of our properties or the payment of dividends; • imposing restrictive covenants in our loan documents, which would entitle the lenders to accelerate our debt obligations and foreclose on our properties, if materially violated; • placing us at a competitive disadvantage compared to our competitors who may have less debt; • making us more vulnerable to economic and industry downturns and reducing our flexibility in responding to changing business and economic conditions; • requiring us to sell one or more properties, possibly on unfavorable terms; and • limiting our ability in the future to borrow funds for operations and to finance property acquisitions and to refinance our indebtedness at maturity on acceptable terms |
| Our ability to obtain debt financing could be impaired or delayed due to underwriting restrictions applicable to the type of properties we acquire |
| Our policy is to obtain debt financing related to properties we buy |
| Because of the single tenant nature of the properties we acquire, mortgage underwriters take certain additional precautions intended to assure that the remaining mortgage balance is paid at the end of the loan term |
| Also, for mortgages that have an amortization schedule longer than the lease term, due to the high initial per square foot cost of the property being acquired, mortgage lenders consider the high per square foot remaining principal balance at the end of the mortgage term as a negative with regard to the potential approval of the loan |
| These and other similar negative factors associated with our properties may make it more difficult and more expensive for us to finance or refinance our properties compared to other types of commercial real estate |
| Because our principal tenant is the US government, our properties may have a higher risk of terrorist attack than similar properties leased to non-governmental tenants |
| Because our principal tenant is the US government, our properties may have a higher risk of terrorist attack than similar properties that are leased to non-governmental tenants |
| Some of our properties could be considered “high profile” targets because of the particular government tenant (eg, the FBI) |
| Certain losses resulting from terrorist attacks may be uninsurable |
| Additional terrorism insurance may not be available at a reasonable price or at all |
| We depend on the US government for most of our revenues |
| Any failure by the US government to perform its obligations or renew its leases upon expiration may harm our cash flow and ability to pay dividends |
| In addition, the US government leased 95prca of our total leased square feet of property at December 31, 2005 |
| Any default by the US government, or its failure to renew its leases with us upon their expiration, could cause interruptions in the receipt of lease revenue or result in vacancies, or both, which would reduce our revenue until the affected property is leased, and could decrease the ultimate value of the affected property upon sale |
| Further, failure on the part of a tenant to comply with the terms of a lease may cause us to find another tenant |
| We cannot assure you that we would be able to find another tenant without incurring substantial costs, or that if another tenant were found we would be able to enter into a new lease on favorable terms |
| 12 _________________________________________________________________ [65]Table of Contents An increase in the operating costs of our government-leased properties would harm our cash flow and ability to pay dividends |
| Leased properties in which the tenant is wholly responsible for any increases in operating costs that apply to the property are not typical of the leases entered into through the GSA, the principal leasing agency of the federal government |
| Under present practice, most GSA leases only cover increases in real estate taxes above a base amount and these GSA leases also increase that portion of the rent applicable to other operating expenses by an agreed upon percentage based upon the Consumer Price Index |
| Typically, operating expenses in these leases do not include insurance cost |
| If we are unable to lease properties that are partially or completely vacant, we may be required to recognize an impairment loss with respect to the carrying values of these properties, which may seriously harm our operating results and financial condition |
| Any of our properties could become partially or completely vacant in the future |
| If we are unable to re-lease these properties and generate sufficient cash flow to replace or exceed that amount lost due to the vacancy, we will be required to recognize a financial loss as to that property, which could reduce our operating results and our ability to pay dividends |
| Restrictive covenants in our loan documents may restrict our operating or acquisition activities, which may harm our financial condition and operating results |
| The mortgages on our properties contain customary restrictive covenants, including provisions that may limit the borrowing subsidiary’s ability, without the prior consent of the lender, to incur additional indebtedness, further mortgage or transfer the applicable property, purchase or acquire additional property, discontinue insurance coverage, change the conduct of its business or make loans or advances to, enter into any transaction of merger or consolidation with, or acquire the business, assets or equity of, any third party |
| In addition, our lines of credit or loans contain financial covenants, further restrictive covenants and other obligations |
| If we materially breach such covenants or obligations in our debt agreements, the lender could declare a default, may require us to repay the debt immediately and can foreclose on the property securing the loan |
| We may then have to sell properties either at a loss or at a time that prevents us from achieving a higher price |
| Any failure to pay our indebtedness when due or failure to prevent or cure events of default could result in higher interest rates during the period of the loan default and could ultimately result in the loss of properties through foreclosure |
| Increasing competition for the acquisition of government-leased properties may impede our ability to make future acquisitions or may increase the cost of these acquisitions |
| We compete with many other entities for the acquisition of government-leased properties |
| Our competitors include financial institutions, institutional pension funds, other REITs, other public and private real estate companies and private real estate investors both foreign and domestic |
| These competitors may prevent us from acquiring desirable properties or increase the price we must pay for properties |
| Our competitors, both foreign and domestic, may have greater resources than we do and may be willing to pay more for similar property |
| In addition, the number of entities and the amount of capital competing for government-leased properties may increase in the future, resulting in increased demand and increased prices paid for these properties |
| If we are forced to pay higher prices for properties, our profitability may decrease and our stockholders may experience a lower return on their investment |
| We may have limited time to perform due diligence on many potential property acquisitions, which could result in the loss of acquisition opportunities |
| When we enter into an agreement to acquire a property we often have limited time to complete our due diligence prior to purchase |
| Pursuant to Company policy, if we cannot complete our full due diligence review process within the time allotted, we will not proceed with an acquisition |
| Accordingly, we may lose property acquisitions due to lack of sufficient time to complete our due diligence and therefore limit our future growth |
| 13 _________________________________________________________________ [66]Table of Contents Our cash flow is not assured |
| We may not pay dividends in the future |
| Our ability to pay dividends may be adversely affected by the risks described herein |
| We cannot assure you that we will be able to pay dividends in the future |
| We also cannot assure you that the level of our dividends will increase over time or the receipt of income from additional property acquisitions will necessarily increase our cash available for distribution to stockholders |
| Any failure to make expected cash dividend distributions will likely result in a decrease in the market price of our stock |
| Our board of directors may alter our investment policies at any time without stockholder approval |
| Changes to these policies may adversely affect our financial performance and our ability to maintain or pay dividends |
| We have incurred historical losses and may incur future losses |
| We have had historical losses of dlra2dtta4 million and dlra2dtta7 million for the years ended December 31, 2005 and 2004, respectively |
| As of December 31, 2005, we had an accumulated deficit of dlra30dtta9 million, of which dlra5dtta5 million was due to accumulated losses and dlra25dtta4 million was due to the payment of cash dividends |
| We cannot assure you that we will not have similar losses in the future |
| Risks Related to Our Organization and Structure We depend on key personnel with long-standing business relationships, the loss of whom could threaten our ability to operate our business successfully |
| Our future success depends, to a significant extent, upon the continued services of Thomas D Peschio, our president and chief executive officer, and of the other members of our management team |
| In particular, the relationships that Mr |
| Peschio and the other members of our management team have developed with owners and developers of government-leased properties are critically important to the success of our business |
| Although we have an employment agreement with Mr |
| Peschio, we cannot assure you that he and the other key acquisition personnel will remain employed with us |
| We do not maintain key person life insurance on any of our officers |
| The loss of our management team could adversely impact our operations |
| A majority of the voting power over our shares is currently concentrated in a relatively small number of unrelated investment managers Our stockholder records show that less than 10 investment managers, who have been granted the right by their respective clients to vote our shares, control a majority of our stock |
| Accordingly, this relatively small number of unrelated investment managers could, if acting in concert based on a common interest or concern, vote a majority of the Company’s shares to achieve a common objective |
| This result could be harmful to us and our stockholders |
| Our board of directors may authorize the issuance of additional shares that may cause dilution |
| In connection with future equity offerings, as well as stock grants pursuant to the Company’s 2003 Equity Incentive Plan, the board of directors may authorize the issuance of additional shares of common stock |
| The issuance of additional shares could dilute our existing stockholders |
| Our board of directors may authorize the issuance of shares with differing dividend rights that could harm our stockholders’ right to receive dividends |
| Our board of directors has the power to issue preferred stock or other securities that have distribution rights senior to that of the common stock |
| Any superior dividend rights could prevent us from paying dividends to the holders of our common stock |
| 14 _________________________________________________________________ [67]Table of Contents Our rights and the rights of our stockholders to take action against directors and officers are limited |
| Maryland law provides that a director has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances |
| Our governing documents obligate us to indemnify our directors and permit us to indemnify our officers for actions taken by them in those capacities to the extent permitted by Maryland law which applies broadly |
| Additionally, we may be obligated to fund the defense costs incurred by our directors and officers |
| Finally, our governing documents limit the liability of our directors and officers for money damages, except for liability resulting from: • actual receipt of an improper benefit or profit in money, property or services; or • a final judgment based upon a finding of active and deliberate dishonesty by the director, trustee or officer that was material to the cause of action adjudicated |
| As a result, we and our stockholders have more limited rights against our directors and officers than might otherwise exist without these conditions |
| Our ownership limitations may restrict business combination opportunities |
| To preserve our REIT status, our charter generally prohibits direct or indirect ownership through affiliates by any person of more than 9dtta8prca of the number or value of outstanding shares of any class of our securities, including our common stock |
| Any transfer of our common stock that would disqualify our REIT status will be null and void, and the intended transferee will acquire no rights in such stock |
| These ownership limitations could have the effect of delaying, deterring or preventing a change in control or other transaction in which holders of common stock might receive a premium for their common stock over the then current market price or which such holders might believe to be otherwise in their best interest |
| Further, shares that are transferred in excess of the 9dtta8prca ownership limit will be designated as “excess shares” subject to redemption |
| The ownership limitation provisions also may make our common stock an unsuitable investment vehicle for any person seeking to obtain, either alone or with others as a group, ownership of more than 9dtta8prca of the number or value of outstanding shares of any class of our securities |
| Maryland law grants broad authority to our board to reject any outside proposal involving a change in control |
| Maryland law provides broad discretion to our board of directors with respect to its duties in considering a change in control of our company, including that a board is subject to no greater level of scrutiny in considering a change in control transaction than with respect to any other action within its authority that it considers |
| Accordingly, we may not pursue a change in control which might otherwise be in our stockholders’ best interests |
| Our chief executive officer and chief financial officer have employment agreements that provide them with benefits in the event their employment is terminated, which could prevent or deter a potential acquirer from pursuing a change of control of our company |
| We have entered into employment agreements with Thomas D Peschio, our president and chief executive officer, and Nancy D Olson, our treasurer and chief financial officer, which provide them with severance benefits if their employment ends due to a termination by us without cause |
| In the case of such termination, we would have to pay severance and the vesting of their restricted stock will accelerate |
| Peschio also has the right to terminate his employment agreement upon a change of control of our Company and receive severance benefits |
| These agreements could prevent or deter a change of control of our Company that might involve a premium price for our common stock or otherwise be in the best interests of our stockholders |
| 15 _________________________________________________________________ [68]Table of Contents Risks Related to the Real Estate Industry Mortgage debt obligations expose us to increased risk of property losses, which could harm our financial condition, cash flow and ability to satisfy our other debt obligations and pay dividends |
| Incurring mortgage debt increases our risk of property losses because defaults on indebtedness secured by properties may result in our loss of the property securing any loan for which we are in default |
| For tax purposes, a foreclosure is treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage |
| The outstanding balance of the debt secured by the mortgage could exceed our tax basis in the property, which would cause us to recognize taxable income on foreclosure, without receiving corresponding cash proceeds |
| As a result, we may be required to utilize other sources of cash to pay our taxes, which may result in a decrease in cash available for distribution to our stockholders |
| In addition, our default under any one of our mortgage debt obligations may increase the risk of our default on our other indebtedness |
| If this occurs, our financial condition, cash flow and ability to satisfy our other debt obligations or ability to pay dividends may be harmed |
| Illiquidity of real estate investments could significantly impede our ability to respond to adverse changes in the performance of our properties and harm our financial condition |
| Because real estate investments are relatively illiquid, our ability to promptly sell one or more properties in our portfolio in response to changing economic, financial and investment conditions is limited |
| The real estate market is affected by many factors that are beyond our control, including: • adverse changes in national and local economic and market conditions; • changes in interest rates and in the availability, cost and terms of debt financing; • changes in governmental laws and regulations, fiscal policies and zoning ordinances and costs of compliance with laws and regulations, fiscal policies and ordinances; • the ongoing need for capital improvements, particularly in older structures; • changes in operating expenses; and • civil unrest, acts of war and natural disasters, including earthquakes and floods, which may result in uninsured and underinsured losses |
| We cannot predict whether we will be able to sell any property for the price or on the terms set by us, or whether any price or other terms offered by a prospective purchaser would be acceptable to us |
| We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a property |
| These factors and any others that would impede our ability to respond to adverse changes in the performance of our properties could harm our operating results and financial condition, as well as our ability to pay dividends to stockholders |
| Compliance with environmental laws could materially increase our operating expenses |
| There may be environmental problems associated with our properties of which we are unaware |
| If environmental contamination exists on our properties, we could become subject to strict liability for the contamination |
| The presence of hazardous substances on a property may adversely affect our ability to sell the property and we may incur substantial remediation costs |
| In addition, although we may require in our leases that tenants operate in compliance with all applicable laws and to indemnify us against any environmental liabilities arising from a tenant’s activities on the property, we could nonetheless be subject to strict liability by virtue of our ownership interest, and we cannot be sure that our tenants would satisfy their indemnification obligations |
| Such environmental liability exposure associated with our properties could harm our results of operations and financial condition and our ability to pay dividends to stockholders |
| Our properties may contain or develop harmful mold, which could lead to liability for adverse health effects and costs of remediating the problem |
| The presence of significant mold at any of our properties could require us to undertake a costly remediation program to contain or remove the mold from the affected property |
| In addition, the presence of significant mold 16 _________________________________________________________________ [69]Table of Contents could expose us to liability from our tenants, employees of our tenants and others if property damage for health concerns arise |
| Compliance with the ADA and fire, safety and other regulations may require us to make unexpected expenditures that adversely impact our ability to pay dividends |
| Our properties may be required to comply with the Americans with Disabilities Act, or the ADA Compliance with the ADA requirements could necessitate removal of access barriers and non-compliance could result in imposition of fines by the US government or an award of damages to private litigants, or both |
| We could be required to expend our funds to comply with the provisions of the ADA, which could adversely affect our results of operations and financial condition and our ability to make distributions to stockholders |
| In addition, we are required to operate our properties in compliance with fire and safety regulations, building codes and other land use regulations, as they may be adopted and become applicable to our properties |
| We may be required to make substantial capital expenditures to comply with those requirements and which could harm our ability to pay dividends |
| An uninsured loss or a loss that exceeds the insurance policy limits on our properties could subject us to lost capital or revenue on those properties |
| Our comprehensive loss insurance policies may involve substantial deductibles and certain exclusions and may not be fully in place to cover all conditions when a property is acquired |
| In certain areas, we may have to obtain earthquake insurance on specific properties as required by our lenders or by law |
| We have also obtained terrorism insurance on all of our GSA-leased properties, but this insurance is subject to exclusions for loss or damage caused by nuclear substances, pollutants, contaminants and biological and chemical weapons |
| Should a loss occur that is uninsured or in an amount exceeding the combined aggregate limits for the policies noted above, or in the event of a loss that is subject to a substantial deductible under an insurance policy, we could lose all or part of our capital invested in, and anticipated revenue from, one or more of our properties, which could harm our operations results and financial condition as well as our ability to pay dividends |
| Tax Risks of Our Business and Structure An investment in our common stock has various tax risks that could affect the value of our stockholders’ investment |
| Special tax risks associated with owning stock in our Company include those associated with the treatment of distributions in excess of current and accumulated earnings and profits to the extent that they exceed the adjusted basis of an investor’s common stock, as long-term capital gain (or short-term capital gain if the shares have been held for less than one year); the treatment of any dividend declared by us in October, November or December of any year payable to a stockholder of record on a specific date in any such month as being paid by us and received by the stockholder on December 31 of such year; the treatment of any gain or loss realized upon a taxable disposition of shares by a stockholder who is not a dealer in securities as a long-term capital gain or loss if the shares have been held for more than one year, otherwise as short-term capital gain or loss; the treatment of distributions that we designate as capital gain dividends taxable to stockholders as gains (to the extent that they do not exceed our actual net capital gain for the taxable year) from the sale or disposition of a capital asset held for greater than one year; and distributions we make and gains arising from the sale or exchange by a stockholder of shares of our stock not qualifying to be offset by passive losses |
| Distribution requirements imposed by law limit our flexibility in executing our business plan |
| As a REIT, we generally are required to distribute to our stockholders at least 90prca of our taxable REIT income each year to maintain our status as a REIT for federal income tax purposes |
| Taxable REIT income is determined without regard to the deduction for dividends paid and by excluding net capital gains |
| We are also required to pay tax at regular corporate rates to the extent that we distribute less than 100prca of our taxable income (including net capital gains) each year |
| In addition, we are required to pay 4prca nondeductible excise tax on the amount, if any, by which certain distributions we pay with respect to any calendar year are less than the sum of 85prca of our ordinary 17 _________________________________________________________________ [70]Table of Contents income for that calendar year, 95prca of our capital gain net income for the calendar year and any amount of our income that was not distributed in prior years |
| We may incur additional indebtedness to meet our distribution requirements |
| While we have not borrowed for the specific purpose of paying distributions, our prior borrowings allowed us to pay distributions from our cash flow from operations |
| It is possible that the differences between the time we actually receive revenue or pay expenses and the period we report those items for distribution purposes could result in our having to borrow funds on a short-term basis to meet the 90prca distribution requirement to qualify for REIT tax status |
| While we have not borrowed for the specific purpose of paying distributions, our prior borrowings allowed us to pay distributions from our operations |
| Our disposal of properties may have negative implications, including unfavorable tax consequences |
| If we sell a property directly, and it is deemed to be a sale of dealer property or inventory, the sale may be deemed to be a “prohibited transaction” under the provisions of the federal tax laws applicable to REITs, in which case our gain from the sale would be subject to a 100prca penalty tax |
| If we believe that a sale of a property might be treated as a prohibited transaction, we will attempt to structure a sale through a taxable REIT subsidiary, in which case the gain from the sale would be subject to corporate income tax but not the 100prca prohibited transaction tax |
| We cannot assure you, however, that the Internal Revenue Service (“IRS”) would not assert successfully that sales of properties that we make directly, rather than through a taxable REIT subsidiary, were sales of dealer property or inventory, in which case the 100prca penalty tax would apply |
| If we fail to remain qualified as a REIT, our dividends will not be deductible by us, and our income will be subject to taxation |
| If we fail to remain qualified as a REIT, our dividends will not be deductible by us for federal income tax purposes and we will be subject to a corporate level tax on our taxable income |
| This would substantially reduce our cash available to pay dividends and the yield on your investment |
| Incurring corporate income tax liability might cause us to borrow funds, liquidate some of our investments or take other steps which could negatively affect our operating results |
| If our REIT status is terminated because of our failure to meet a REIT qualification requirement or if we voluntarily revoke our election, we would be disqualified from electing treatment as a REIT for the four taxable years following the year in which REIT status is lost |
| We cannot assure you that we will be able to maintain REIT status, or that it will be in our best interests to continue to do so |
| We may be subject to federal income tax, state income, franchise and other local taxes that would harm our financial condition |
| Even if we maintain our status as a REIT, we may become subject to federal income taxes |
| For example, if we have net income from a sale of dealer property or inventory, that income will be subject to a 100prca penalty tax |
| In addition, we may not be able to pay sufficient distributions to avoid corporate income tax and the 4prca excise tax on undistributed income |
| We may also be subject to state and local taxes on our income or property, either directly or at the level of our operating entities through which we indirectly own our properties that would aversely affect our operating results |
| We may be subject to adverse legislative or regulatory tax changes that could reduce the market price of our common stock |
| The federal tax laws governing REITs and the administrative interpretations of those laws may be amended at any time |
| Any of those new laws or interpretations may take effect retroactively |
| For example, on May 28, 2003, President Bush signed into law legislation that could cause shares in non-REIT corporations to be a more attractive investment to individual investors than they had been, because of lower tax rates on their dividends as compared to the tax rate paid by stockholders receiving REIT distributions |
| This and other tax legislation in the future could harm the market price of our common stock |