Office Properties Income Trust (OPI) 10-Q2024 Q2 Quarterly report

Item 1.    Financial Statements

Note 1. Basis of Presentation

The accompanying condensed consolidated financial statements of Office Properties Income Trust and its subsidiaries, or OPI, 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 consolidated financial statements and notes contained in our Annual Report on Form 10-K for the year ended December 31, 2023, or our 2023 Annual Report. In the opinion of management, all adjustments, consisting of normal recurring accruals considered necessary for a fair statement of results for the interim period have been included. All 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 these 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 purchase price allocations, useful lives of fixed assets and assessment of impairment of real estate and the related intangibles.

Note 2. Recent Accounting Pronouncements

Note 3. Per Common Share Amounts

We calculate basic earnings per common share using the two class method. We calculate diluted earnings per common share using the more dilutive of the two class method or the treasury stock method. Unvested share awards and other potentially dilutive common shares, together with the related impact on earnings, are considered when calculating diluted earnings per common share. The calculation of basic and diluted earnings per common share is as follows (amounts in thousands, except per share data):

Note 4. Real Estate Properties

As of June 30, 2024, our wholly owned properties were comprised of 151 properties containing approximately 20,293,000 rentable square feet, with an undepreciated carrying value of $3,989,206, including $207,146 classified as held for sale. We also had a noncontrolling ownership interest of 51% in an unconsolidated joint venture that owned two properties containing approximately 346,000 rentable square feet. We generally lease space at our properties on a gross lease, modified gross lease or net lease basis pursuant to fixed term contracts expiring between 2024 and 2053. Some of our leases generally require us to pay all or some property operating expenses and to provide all or most property management services. During the three months ended June 30, 2024, we entered into 12 leases for approximately 208,000 rentable square feet for a weighted (by rentable square feet) average lease term of 4.0 years, and we made commitments of $3,982 for leasing related costs. During the six months ended June 30, 2024, we entered into 25 leases for approximately 696,000 rentable square feet for a weighted (by rentable square feet) average lease term of 7.7 years and we made commitments for approximately $14,959 of leasing related costs. As of June 30, 2024, we had estimated unspent leasing related obligations of $80,649.

We regularly evaluate whether events or changes in circumstances have occurred that could indicate an impairment in the value of long lived assets. Impairment indicators may include declining tenant occupancy, lack of progress re-leasing vacant space, tenant bankruptcies, low long term prospects for improvement in property performance, weak or declining tenant profitability, cash flow or liquidity, our decision to dispose of an asset before the end of its estimated useful life and legislative, market or industry changes that could permanently reduce the value of a property. If there is an indication that the carrying value of an asset is not recoverable, we estimate the projected undiscounted cash flows to determine if an impairment loss should be recognized. The future net undiscounted cash flows are subjective and are based in part on assumptions regarding hold periods, market rents and terminal capitalization rates. We determine the amount of any impairment loss by comparing the historical carrying value to estimated fair value. We estimate fair value through an evaluation of recent financial performance and projected discounted cash flows using standard industry valuation techniques. In addition to consideration of impairment upon the events or changes in circumstances described above, we regularly evaluate the remaining useful lives of our long lived assets. If we change our estimate of the remaining useful lives, we allocate the carrying value of the affected assets over their revised remaining useful lives.

During the six months ended June 30, 2024, we sold one property containing approximately 248,000 rentable square feet for a sales price of $38,500, excluding closing costs, and recognized a $2,448 loss on sale of real estate. The sale of this property does not represent a strategic shift in our business. As a result, the results of operations of this property are included in continuing operations through the date of sale in our condensed consolidated statements of comprehensive income (loss).

As of June 30, 2024, we had 12 properties classified as held for sale in our condensed consolidated balance sheet that are under agreement to sell for an aggregate sales price of $93,539 as summarized below:

We also had three additional properties held for sale in our condensed consolidated balance sheet as of June 30, 2024 and we recorded a $42,227 loss on impairment to adjust the carrying values of these properties to their estimated fair values, less costs to sell, during the six months ended June 30, 2024. The pending sales in the preceding table are subject to conditions; accordingly, we cannot be sure that we will complete these sales or that these sales will not be delayed or the terms will not change. See Note 8 for more information regarding our properties held for sale.

As of June 30, 2024, we owned an interest in one joint venture that owned two properties. We accounted for this investment under the equity method of accounting. In March 2024, our 1750 H Street, NW joint venture did not have sufficient cash flow to pay its monthly debt service, resulting in an event of default. In June 2024, the non-recourse mortgage lender to this joint venture completed a foreclosure of the property and the joint venture no longer has an economic interest in the property. We wrote off our full investment in this joint venture as of December 31, 2023 and did not make capital contributions to this joint venture during the six months ended June 30, 2024. Accordingly, we did not record our proportionate share of operating results of the joint venture for the six months ended June 30, 2024. As of June 30, 2024 and December 31, 2023, our investments in our unconsolidated joint ventures consisted of the following:

As of June 30, 2024, the unamortized basis difference of our Prosperity Metro Plaza joint venture of $687 was primarily attributable to the difference between the amount we paid to purchase our interest in this joint venture, including transaction costs, and the historical carrying value of the net assets of this joint venture. This difference is being amortized over the remaining useful life of the related property and the resulting amortization expense is included in equity in net losses of investees in our condensed consolidated statements of comprehensive income (loss).

Note 5. Leases

Our leases provide for base rent payments and, in addition, may include variable payments. Rental income from operating leases, including any payments derived by index or market-based indices, is recognized on a straight line basis over the lease term when we have determined that the collectability of substantially all of the lease payments is probable. Some of our leases have options to extend or terminate the lease exercisable at the option of our tenants, which are considered when determining the lease term. Allowances for bad debts are recognized as a direct reduction of rental income. In certain circumstances, some leases provide the tenant with the right to terminate if the legislature or other funding authority does not appropriate the funding necessary for the tenant to meet its lease obligations; we have determined the fixed non-cancelable lease term of these leases to be the full term of the lease because we believe the occurrence of early terminations to be a remote contingency based on both our historical experience and our assessments of the likelihood of lease cancellation on a separate lease basis.

We increased rental income to record revenue on a straight line basis by $7,563 and $4,256 for the three months ended June 30, 2024 and 2023, respectively, and $14,942 and $8,429 for the six months ended June 30, 2024 and 2023, respectively. Rents receivable, excluding properties classified as held for sale, included $126,665 and $112,440 of straight line rent receivables at June 30, 2024 and December 31, 2023, respectively.

We do not include in our measurement of our lease receivables certain variable payments, including payments determined by changes in the index or market-based indices after the inception of the lease, certain tenant reimbursements and other income until the specific events that trigger the variable payments have occurred. Such payments totaled $20,271 and $42,829 for the three and six months ended June 30, 2024, respectively, of which tenant reimbursements totaled $19,067 and $40,396, respectively. For the three and six months ended June 30, 2023, such payments totaled $22,190 and $43,560, respectively, of which tenant reimbursements totaled $20,853 and $40,919, respectively.

As of June 30, 2024 and 2023, the U.S. government and certain state and other government tenants combined were responsible for approximately 27.0% and 28.5%, respectively, of our annualized rental income. The U.S. government is our largest tenant by annualized rental income and represented approximately 19.3% and 19.6% of our annualized rental income as of June 30, 2024 and 2023, respectively. We define annualized rental income as the annualized contractual base rents from our tenants pursuant to our lease agreements as of the measurement date, plus straight line rent adjustments and estimated recurring expense reimbursements to be paid to us, and excluding lease value amortization.

As of June 30, 2024, our 151 wholly owned properties were located in 30 states and the District of Columbia. Properties located in Virginia, California, District of Columbia, Georgia and Illinois were responsible for approximately 12.5%, 10.7%, 10.1%, 9.4% and 9.1% of our annualized rental income as of June 30, 2024, respectively.

Note 7. Indebtedness

Our principal debt obligations as of June 30, 2024 were: (1) $178,000 of outstanding borrowings under our $325,000 secured revolving credit facility; (2) $100,000 outstanding principal amount under our secured term loan; (3) $1,864,210 aggregate outstanding principal amount of senior notes and (4) $177,320 aggregate outstanding principal amount of mortgage notes.

In January 2024, we entered into an amended and restated credit agreement, or our credit agreement, governing a new $325,000 secured revolving credit facility and a $100,000 secured term loan. Our credit agreement replaced our prior revolving credit facility, which had a maturity date of January 31, 2024. As collateral for all loans and other obligations under our credit

Interest payable on borrowings under our credit agreement is at a rate of the secured overnight financing rate, or SOFR, plus a margin of 350 basis points. We are also required to pay an unused facility fee on the amount of total lending commitments, which was 25 basis points per annum at June 30, 2024. As of June 30, 2024 and July 30, 2024, we had $178,000 and $190,000, respectively, outstanding under our revolving credit facility, $100,000 outstanding under our term loan and $147,000 and $135,000, respectively, available for borrowing under our revolving credit facility. As of June 30, 2024, the annual interest rate payable on borrowings under our credit agreement was 8.9%. The weighted average annual interest rate for borrowings under our credit agreement for the three and six months ended June 30, 2024 was 8.9% and 8.7%.

We were required to pay interest at a rate of SOFR plus a premium, which was 145 basis points per annum as of June 30, 2023, on the amount outstanding under our prior revolving credit facility, as well as a facility fee on the total amount of lending commitments, which was 30 basis points per annum. The weighted average annual interest rate for borrowings under our prior revolving credit facility for the three and six months ended June 30, 2023 was 6.5% and 6.2%, respectively.

Our revolving credit facility is governed by a credit agreement with a syndicate of institutional lenders. Our credit agreement and senior notes indentures and their supplements provide for acceleration of payment of all amounts due thereunder upon the occurrence and continuation of certain events of default, such as, in the case of our credit agreement, a change of control of us, which includes The RMR Group LLC, or RMR, ceasing to act as our business and property manager. Our credit agreement and senior notes indentures and their supplements also contain covenants, including covenants that restrict our ability to incur debts, require us to comply with certain financial covenants and, in the case of our credit agreement, restrict our ability to increase our distribution rate above the current level of $0.01 per common share per quarter. We believe we were in compliance with the terms and conditions of the respective covenants under our credit agreement and senior notes indentures and their supplements at June 30, 2024.

In February 2024, we issued $300,000 of 9.000% senior secured notes due 2029, or the 2029 Notes. The aggregate net proceeds from the offering of the 2029 Notes were $270,712, after initial purchaser discounts and other offering expenses. The 2029 Notes are fully and unconditionally guaranteed on a joint, several and senior secured basis by certain of our subsidiaries and secured by a pledge of all of the respective equity interests of the subsidiary guarantors and first mortgage liens on 17 properties with a gross book value of real estate assets of $618,644 as of June 30, 2024. The 2029 Notes require semi-annual payments of interest only and are prepayable, at par plus accrued interest, after March 31, 2028.

In March 2024, we redeemed, at par plus accrued interest, all $350,000 of our 4.25% senior unsecured notes due 2024. As a result of this redemption, we recorded a loss on early extinguishment of debt of $425 during the six months ended June 30, 2024, which represented the unamortized discounts related to these notes.

In June 2024, we exchanged $567,429 of new 9.000% senior secured notes, or the New 2029 Notes, for an aggregate $865,219 of our outstanding unsecured senior notes, or the Existing Notes, and such transaction, the Senior Note Exchange, as follows:

The New 2029 Notes are fully and unconditionally guaranteed on a joint, several and senior secured basis by certain of our subsidiaries and are secured by first mortgage liens on 19 properties with a gross book value of real estate assets of $715,986 as of June 30, 2024 and second mortgage liens on the 19 properties securing our credit agreement. The New 2029 Notes require semi-annual payments of interest only and are prepayable, at par plus accrued interest, after June 3, 2028. During the six months ended June 30, 2024, we recorded a gain on early extinguishment of debt of $225,798 as a result of the Senior Note Exchange. The extinguishment of debt is considered cancellation of debt income, or CODI, for income tax purposes and part of our REIT taxable income. We currently do not expect that any special distribution will be required to maintain our qualification for taxation as a REIT as a result of generating CODI in 2024. However, we will be taxed at regular corporate income tax rates on any undistributed REIT taxable income.

As of June 30, 2024, seven of our properties with an aggregate gross book value of real estate assets of $303,643 were encumbered by mortgage notes with an aggregate principal amount of $177,320. Our mortgage notes are non-recourse, subject to certain limited exceptions and do not contain any material financial covenants.

We currently do not have sufficient sources of liquidity to repay our $499,154 senior unsecured notes due 2025 and are evaluating market-based alternatives to obtain debt or equity financing. Based on the significant number of unencumbered properties in our portfolio, our successful history of obtaining debt financings and our current financing metrics, we believe it is probable that we can obtain new debt financing that will allow us to satisfy the 2025 senior unsecured notes as they become due. Additionally, as we have evaluated our financing options, we have determined that certain assets in our portfolio may not be suitable for secured financing. We are considering whether to sell those assets to raise cash and are at various stages of the sales process for those properties. We also continue to engage with Moelis & Company LLC as our financial advisor to assist in evaluating our options to address our upcoming debt maturities.

Note 8. Fair Value of Assets and Liabilities

The following table presents certain of our assets measured at fair value at June 30, 2024, categorized by level of inputs as defined in the fair value hierarchy under GAAP, used in the valuation of each asset:

Our financial instruments include our cash and cash equivalents, restricted cash, rents receivable, accounts payable, a revolving credit facility, a term loan, senior notes, mortgage notes payable, amounts due to related persons, other accrued expenses and security deposits. At June 30, 2024 and December 31, 2023, the fair values of our financial instruments approximated their carrying values in our condensed consolidated financial statements, due to their short term nature or floating interest rates, except as follows:

We estimated the fair values of our senior notes (except for our senior unsecured notes due 2050) using an average of the bid and ask price of the notes (Level 2 inputs as defined in the fair value hierarchy under GAAP) as of the measurement date. We estimated the fair value of our senior unsecured notes due 2050 based on the closing price on The Nasdaq Stock Market LLC, or Nasdaq, (Level 1 inputs as defined in the fair value hierarchy under GAAP) as of the measurement date. We estimated the fair values of our mortgage notes payable using discounted cash flow analyses and currently prevailing market rates (Level 3 inputs as defined in the fair value hierarchy under GAAP) as of the measurement date. Because Level 3 inputs are unobservable, our estimated fair values may differ materially from the actual fair values.

Note 9. Shareholders’ Equity

In connection with the Senior Note Exchange, we entered into a support agreement with certain holders of our Existing Notes, or the Supporting Noteholders, pursuant to which, on June 21, 2024, in exchange for the Supporting Noteholders tendering their Existing Notes, we issued 1,406,952 of our common shares, valued at $2.26 per share, the closing price of our common shares on Nasdaq on that day, to the Supporting Noteholders.

On June 13, 2024, in accordance with our Trustee compensation agreements, we awarded to each of our nine Trustees 11,627 of our common shares, valued at $2.15 per share, the closing price of our common shares on Nasdaq on that day.

During the three and six months ended June 30, 2024, we purchased an aggregate 7,505 and 8,374 of our common shares, respectively, valued at a weighted average share price of $2.02 and $2.55, respectively, from one of our Trustees and certain former officers and employees of RMR in satisfaction of tax withholding and payment obligations in connection with the vesting of awards of our common shares. We withheld and purchased these common shares at their fair market value based upon the trading price of our common shares at the close of trading on Nasdaq on the purchase date.

On July 11, 2024, we declared a regular quarterly distribution payable to common shareholders of record on July 22, 2024 in the amount of $0.01 per share, or approximately $503. We expect to pay this distribution on or about August 15, 2024.

Note 10. Business and Property Management Agreements with RMR

We have no employees. The 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 services to us: (1) a business management agreement, which relates to our business generally; and (2) a property management agreement, which relates to our property level operations.

Pursuant to our business management agreement with RMR, we recognized net business management fees of $3,309 and $6,867 for the three and six months ended June 30, 2024, respectively, and $3,592 and $7,543 for the three and six months ended June 30, 2023, respectively. Based on our common share total return, as defined in our business management agreement, as of June 30, 2024, no estimated incentive fees are included in the net business management fees we recognized for the three and six months ended June 30, 2024. The actual amount of annual incentive fees for 2024, if any, will be based on our common share total return for the three year period ending December 31, 2024, and will be payable in January 2025. We did not incur an incentive fee payable to RMR for the year ended December 31, 2023. We include business management fees in general and administrative expenses in our condensed consolidated statements of comprehensive income (loss).

Pursuant to our property management agreement with RMR, we recognized aggregate net property management and construction supervision fees of $4,413 and $8,963 for the three and six months ended June 30, 2024, respectively, and $6,163 and $12,482 for the three and six months ended June 30, 2023, respectively. Of these amounts, for the three and six months ended June 30, 2024, $3,339 and $7,157, respectively, were expensed to other operating expenses in our condensed consolidated statements of comprehensive income (loss) and $1,074 and $1,806, respectively, were capitalized as building improvements in our condensed consolidated balance sheets. For the three and six months ended June 30, 2023, $3,801 and $7,534, respectively, were expensed to other operating expenses in our condensed consolidated statements of comprehensive income (loss) and $2,362 and $4,948, respectively, were capitalized as building improvements in our condensed consolidated balance sheet. The amounts capitalized are being depreciated over the estimated useful lives of the related capital assets.

We are generally responsible for all of our operating expenses, including certain expenses incurred or arranged by RMR on our behalf. We are generally not responsible for payment of RMR’s employment, office or administrative expenses incurred to provide management services to us, except for the employment and related expenses of RMR’s employees assigned to work exclusively or partly at our properties, our share of the wages, benefits and other related costs of RMR’s centralized accounting personnel, our share of RMR’s costs for providing our internal audit function and as otherwise agreed. Our property level operating expenses are generally incorporated into the rents charged to our tenants, including certain payroll and related costs incurred by RMR. We reimbursed RMR $6,382 and $12,969 for these expenses and costs for the three and six months ended June 30, 2024, respectively, and $6,617 and $12,964 for the three and six months ended June 30, 2023, respectively. We included these amounts in other operating expenses and general and administrative expenses, as applicable, in our condensed consolidated statements of comprehensive income (loss).

Note 11. Related Person Transactions

We have relationships and historical and continuing transactions with RMR, The RMR Group Inc., or RMR Inc., and others related to them, including other companies to which RMR or its subsidiaries provide management services and some of which have trustees, directors or officers who are also our Trustees or officers. RMR is a majority owned subsidiary of RMR Inc. The Chair of our Board of Trustees and one of our Managing Trustees, Adam D. Portnoy, is the sole trustee, an officer and the controlling shareholder of ABP Trust, which is the controlling shareholder of RMR Inc., the chair of the board of directors, a managing director, the president and chief executive officer of RMR Inc. and an officer and employee of RMR. Jennifer Clark, our other Managing Trustee, is a managing director and the executive vice president, general counsel and secretary of RMR Inc., an officer and employee of RMR and an officer of ABP Trust. Each of our officers is also an officer and employee of RMR. Some of our Independent Trustees also serve as independent trustees of other public companies to which RMR or its subsidiaries provide management services. Mr. Portnoy serves as chair of the boards and as a managing trustee of these public companies. Other officers of RMR, including Ms. Clark, serve as managing trustees or officers of certain of these companies.

For more information about these and other such relationships and certain other related person transactions, refer to our 2023 Annual Report.

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

The following information should be read in conjunction with our Condensed Consolidated Financial Statements and accompanying notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q and with our 2023 Annual Report.

OVERVIEW (dollars in thousands, except per share and per square foot data)

We are a real estate investment trust, or REIT, organized under Maryland law. As of June 30, 2024, our wholly owned properties were comprised of 151 properties and we had a noncontrolling ownership interest of 51% in one unconsolidated joint venture that owned two properties containing approximately 346,000 rentable square feet. As of June 30, 2024, our properties are located in 30 states and the District of Columbia and contain approximately 20,293,000 rentable square feet. As of June 30, 2024, our properties were leased to 260 different tenants with a weighted average remaining lease term (based on annualized rental income) of approximately 6.6 years. The U.S. government is our largest tenant, representing approximately 19.3% of our annualized rental income as of June 30, 2024. The term annualized rental income as used herein is defined as the annualized contractual base rents from our tenants pursuant to our lease agreements as of June 30, 2024, plus straight line rent adjustments and estimated recurring expense reimbursements to be paid to us, and excluding lease value amortization.

Leases representing approximately 9.3% and 9.7% of our annualized rental income are scheduled to expire during the remainder of 2024 and 2025, respectively, and we may be unable to renew leases or find replacement tenants. Certain changes in office space utilization, including increased remote work arrangements and tenants consolidating their real estate footprint, continue to impact the market. The utilization and demand for office space continues to face headwinds and the duration and ultimate impact of current trends on the demand for office space at our properties remains uncertain and subject to change. Accordingly, we do not yet know what the full extent of the impacts will be on our or our tenants’ businesses and operations nor the long-term outlook for leasing our properties. Higher interest rates, inflationary pressures, geopolitical hostilities and tensions, and concerns that the U.S. economy may enter an economic recession have caused disruptions in the financial markets and these factors could adversely affect our and our tenants’ financial condition and the ability or willingness of our tenants to renew our leases or pay rent to us. We also have a significant amount of debt maturing in the next 12 months. Deteriorating office fundamentals, high interest rates and market sentiment towards the office sector will likely restrict our access to, and increase our cost of, capital as we seek to refinance our debts.

For more information about the risks relating to these dynamics and conditions and their impacts on us and our business, see Part I, Item IA, “Risk Factors”, of our 2023 Annual Report.

Unless otherwise noted, the data presented in this section includes properties classified as held for sale as of June 30, 2024 and excludes two properties owned by an unconsolidated joint venture in which we owned a 51% interest. For more information regarding our properties classified as held for sale and our unconsolidated joint venture, see Note 4 to our Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

Occupancy data for our properties as of June 30, 2024 and 2023 was as follows (square feet in thousands):

The average effective rental rate per square foot for our properties for the three and six months ended June 30, 2024 and 2023 were as follows:

During the three and six months ended June 30, 2024, we entered into new and renewal leases as summarized in the following table (square feet in thousands):

During the three and six months ended June 30, 2024, changes in effective rental rates per square foot achieved for new leases and lease renewals at our properties that commenced during the three and six months ended June 30, 2024, when compared to prior effective rental rates per square foot in effect for the same space (and excluding space acquired vacant), were as follows (square feet in thousands): 

During the three and six months ended June 30, 2024 and 2023, amounts capitalized at our properties for lease related costs, building improvements and development, redevelopment and other activities were as follows:

As of June 30, 2024, we had estimated unspent leasing related obligations of $80,649, of which we expect to spend $40,947 over the next 12 months.

As of June 30, 2024, we had leases at our properties totaling approximately 3,763,000 rentable square feet that were scheduled to expire through December 31, 2025. As of July 30, 2024, we expect tenants with leases totaling approximately 2,968,000 rentable square feet that are scheduled to expire through December 31, 2025, excluding space that has been re-leased and space for which we are in advanced negotiations to re-lease, not to renew or to downsize their leased space upon expiration, and we cannot be sure as to whether other tenants will renew their leases upon expiration. Of the 2,968,000 rentable square feet leased to tenants known to be vacating, 2,130,000 rentable square feet relate to properties, excluding properties classified as held for sale, not encumbered by debt. We continue to proactively engage with our existing tenants and are focused on overall tenant retention. Prevailing market conditions and our tenants’ needs at the time we negotiate and enter leases or lease renewals will generally determine rental rates and demand for leased space at our properties, all of which factors are beyond our control. Whenever we 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. We cannot be sure of the rental rates that will result from our ongoing negotiations regarding lease renewals or any new or renewed leases we may enter. Also, we may experience material declines in our rental income due to vacancies upon lease expirations or early terminations or lower rents upon lease renewal or reletting. Additionally, we may incur significant costs and make significant concessions to renew our leases with current tenants or lease our properties to new tenants.

As of June 30, 2024, our lease expirations by year were as follows (square feet in thousands):

We generally will seek to renew or extend the terms of leases at properties with tenants when they expire. However, market and economic factors, along with increases in remote work, changes in space utilization and government spending and budget priorities, may cause our tenants not to renew or extend their leases when they expire, or to seek to renew their leases for less space than they currently occupy. If we are unable to extend or renew our leases, or we renew leases for reduced space, it may be time consuming and expensive to relet some of these properties.

As of June 30, 2024, we derived 23.7% of our annualized rental income from our properties located in the metropolitan Washington, D.C. market area, which includes Washington, D.C., Northern Virginia and suburban Maryland. Current economic conditions in this area or a possible recession, including as a result of current inflationary conditions or otherwise, could reduce demand from tenants for our properties, reduce rents that our tenants in this area are willing to pay when our leases expire and increase lease concessions for new leases and renewals. Additionally, there has been a decrease in demand for new leased office space by the U.S. government, including in the metropolitan Washington, D.C. market area, and that could increase competition for government tenants and adversely affect our ability to retain government tenants or maintain or increase our rents when our leases expire.

Our manager, RMR, employs a tenant review process for us. RMR assesses tenants on an individual basis based on various applicable 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. We consider investment grade tenants to include: (a) investment grade rated tenants; (b) tenants with investment grade rated parent entities that guarantee the tenant’s lease obligations; and/or (c) tenants with investment grade rated parent entities that do not guarantee the tenant’s lease obligations. As of June 30, 2024, tenants contributing 52.3% of annualized rental income were investment grade rated (or their payment obligations were guaranteed by an investment grade rated parent) and tenants contributing an additional 8.5% of annualized rental income were subsidiaries of an investment grade rated parent (although these parent entities were not liable for the payment of rents).