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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 September 30, 2013

OR

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

Commission File Number 1-9317

COMMONWEALTH REIT

(Exact Name of Registrant as Specified in Its Charter)

617-332-3990

(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, $0.01 par value per share, outstanding as of November 4, 2013: 118,387,518.

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COMMONWEALTH REIT

FORM 10-Q

September 30, 2013

INDEX

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References in this Quarterly Report on Form 10-Q to the “Company”, “CWH”, “we”, “us” or “our” refer to CommonWealth REIT and its consolidated subsidiaries, as of September 30, 2013, unless the context indicates otherwise.  On July 2, 2013, Select Income REIT, or SIR, completed an underwritten public offering of its common shares, at which time CWH ceased to own a majority of SIR’s common shares.  Accordingly, following July 2, 2013, CWH no longer consolidates its investment in SIR, but instead accounts for such investment under the equity method.

The financial information presented in this Quarterly Report on Form 10-Q includes SIR’s financial position and results of operations for periods prior to July 2, 2013 when SIR was CWH’s consolidated subsidiary, unless the context indicates otherwise.  SIR is itself a public company that has common shares registered under the Securities Exchange Act of 1934, as amended.  For further information about SIR, please see SIR’s periodic reports and other filings with the Securities and Exchange Commission, or the SEC, which are available at the SEC’s website at www.sec.gov.  References in this Quarterly Report on Form 10-Q to SIR’s filings with the SEC are included as textual references only, and the information in SIR’s filings with the SEC is not incorporated by reference into this Quarterly Report on Form 10-Q unless otherwise expressly stated herein.

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PART I.          Financial Information

Item 1.                 Financial Statements.

COMMONWEALTH REIT

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except share data)

(unaudited)

See accompanying notes.

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COMMONWEALTH REIT

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(amounts in thousands, except per share data)

(unaudited)

See accompanying notes.

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COMMONWEALTH REIT

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(amounts in thousands)

(unaudited)

See accompanying notes.

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COMMONWEALTH REIT

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in thousands)

(unaudited)

See accompanying notes.

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COMMONWEALTH REIT

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(amounts in thousands)

(unaudited)

See accompanying notes.

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COMMONWEALTH 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 CommonWealth REIT and its subsidiaries, or the Company, CWH, we, us or our, have been prepared without audit.  Certain information and footnote disclosures required by U.S. generally accepted accounting principles, or GAAP, for complete financial statements have been condensed or omitted.  We believe the disclosures made are adequate to make the information presented not misleading.  However, the accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes contained in our Annual Report on Form 10-K for the year ended December 31, 2012, 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 subsidiaries have been eliminated.  Operating results for interim periods are not necessarily indicative of the results that may be expected for the full year.  Reclassifications have been made to the prior years’ financial statements to conform to the current year’s presentation.

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, useful lives of fixed assets and impairment of real estate and intangible assets.

On March 12, 2012, our then wholly owned subsidiary, Select Income REIT, completed an initial public offering of 9,200,000 of its common shares, or the SIR IPO.  We refer to Select Income REIT and its consolidated subsidiaries as SIR.  SIR is a real estate investment trust, or REIT.  On July 2, 2013, SIR issued and sold to the public 10,500,000 of its common shares of beneficial interest in an underwritten public offering.  Before this offering, our 22,000,000 common shares of SIR represented approximately 56.0% of SIR’s outstanding common shares and SIR was one of our consolidated subsidiaries.  As of September 30, 2013, we owned 22,000,000 SIR common shares, or approximately 44.2% of SIR’s outstanding common shares.  Since our investment in SIR is below 50% after this offering, effective July 2, 2013, we no longer consolidate our investment in SIR, but instead account for such investment under the equity method.   See Note 6 and Note 15 for additional information regarding SIR.

Note 2.  Recent Accounting Pronouncements

Effective January 2013, we adopted Financial Accounting Standards Board, or FASB, Accounting Standards Update No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.  This update is the culmination of the FASB’s deliberation on reporting reclassification adjustments from accumulated other comprehensive income, or AOCI.  This standard does not change the current requirements for reporting net income or other comprehensive income.  However, it requires disclosure of amounts reclassified out of AOCI in their entirety, by component, on the face of the statement of operations or in the notes thereto.  Amounts that are not required to be reclassified in their entirety to net income must be cross referenced to other disclosures that provide additional detail.  This standard was effective prospectively for interim and annual reporting periods beginning after December 15, 2012.  The implementation of this update did not cause any material changes to the presentation of our condensed consolidated financial statements.

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COMMONWEALTH REIT

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

Note 3.  Board of Trustees

On February 26, 2013, Corvex Management LP, or Corvex, Related Fund Management, LLC and certain of their affiliates, or together with Corvex, Corvex/Related, publicly disclosed their accumulation of the Company’s common shares.  Corvex/Related have since undertaken a series of actions in an effort to influence and control the Company, including publishing “open” letters to our Board of Trustees, announcing conditional, unfinanced purported offers to acquire all the common shares of the Company and running a purported consent solicitation seeking to remove, without cause, all of the members of our Board of Trustees.  Corvex/Related unilaterally, publicly stated that they believed the record date for their purported consent solicitation was April 22, 2013 and solicited consents from our shareholders as of that date to their removal proposal.  On June 21, 2013, Corvex delivered to the Company a letter and enclosed materials that it claimed were written consents from the Company’s shareholders that effectuated the immediate removal of the Company’s entire Board of Trustees.

The legal effectiveness of the Corvex/Related purported consent solicitation is the subject of legal proceedings before an arbitration panel.  We believe that the Corvex/Related consent solicitation has no legal effect because, among other things, under our declaration of trust and bylaws, the power to set a record date for a consent solicitation rests with the Company’s Board of Trustees and our Board of Trustees did not set such a record date for the Corvex/Related purported consent solicitation as the Corvex/Related request for a record date did not comply with requirements in our governing documents.  Moreover, our Board of Trustees believes that the removal of all of our Trustees without cause and in one removal action conflicts with our Board of Trustee’s election to be subject to certain provisions of the Maryland Unsolicited Takeovers Act.  On June 24, 2013, the Company responded to the June 21, 2013 letter from Corvex/Related pointing out that the legal effectiveness of the Corvex/Related consent solicitation is currently the subject of proceedings before an arbitration panel and that the Board of Trustees would continue to manage the Company unless and until the arbitration panel directs otherwise.  An evidentiary hearing on the legal effectiveness of the Corvex/Related consent solicitation was held before the arbitration panel from October 7, 2013 through October 17, 2013, and the parties submitted post-hearing briefs on October 30, 2013.  Our current expectation is that the arbitration panel will issue a ruling regarding these matters on or before November 29, 2013.

We believe that the Corvex/Related purported consent solicitation has no legal effect and to date, no court or arbitration panel has ruled that it is legally effective.  However, if the arbitration panel determines that the Corvex/Related consent solicitation is legally effective and the entire Board of Trustees has been removed as a result of the Corvex/Related consent solicitation, such removal may, among other things, disrupt the Company’s business and operations, give rise to preferred shareholder conversion rights and events of default under certain material agreements, affect our ability to pay dividends, borrow money and implement our business plan, and have other effects which may adversely affect us.

Note 4.  Real Estate Properties

The information presented in this Note 4 excludes information related to SIR and its consolidated subsidiaries, unless the context indicates otherwise.

We did not make any acquisitions during the nine months ended September 30, 2013.

During the nine months ended September 30, 2013, we made improvements totaling $75,431 to our properties, including improvements made by SIR to its properties for the period that SIR was our consolidated subsidiary, which was until July 2, 2013.

Property Sales:

During the nine months ended September 30, 2013, we sold nine properties (27 buildings) with a combined 2,394,680 square feet and two land parcels for an aggregate sale price of $46,712, excluding closing costs.  Details of these completed sales are as follows:

·                  In January 2013, we sold three suburban office and industrial properties (18 buildings) in suburbs of Detroit, MI with a combined 1,060,026 square feet for $10,250, excluding closing costs.  In connection with the sale of these properties, we

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COMMONWEALTH REIT

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

provided mortgage financing to the buyer, an unrelated third party, totaling $7,688 at 6.0% per annum and recognized a gain on sale of $1,277.

·                  As a result of an eminent domain taking in March 2013, we sold a land parcel adjacent to one of our central business district, or CBD, properties located in Boston, MA for $1,806, excluding closing costs, and recognized a gain on sale of $1,596.

·                  In April 2013, we sold a suburban property (one building) with 618,000 square feet for $830, excluding closing costs.

·                  In May 2013, we sold a suburban property (one building) with 57,250 square feet for $4,025, excluding closing costs.

·                  In June 2013, we sold a suburban property (two buildings) with a combined 356,045 square feet for an aggregate sale price of $16,300, excluding closing costs.

·                  Also in June 2013, we sold a suburban property (one building) with 30,105 square feet for $1,600, excluding closing costs, and recognized a gain on sale of $317.

·                  Also in June 2013, we sold a suburban property (one building) with 143,802 square feet for $5,250, excluding closing costs.

·                  Also in June 2013, we sold a parcel of land in Tukwila, WA for $2,551, excluding closing costs, and recognized a gain on sale of $1,765.

·                  In August 2013, we sold a suburban property (three buildings) with a combined 129,452 square feet for $4,100, excluding closing costs.

We classify all properties that meet the criteria outlined in the Property, Plant and Equipment Topic of the FASB Accounting Standards CodificationTM, or the Codification, as held for sale as such on our condensed consolidated balance sheets.  As of December 31, 2012, we had one CBD property (one building) and 39 suburban properties (93 buildings) with a combined 6,673,851 square feet held for sale.  As of September 30, 2013, we had four CBD properties (five buildings) and 72 suburban properties (172 buildings) with a combined 12,704,719 square feet held for sale.  As of November 4, 2013, we have sold 29 of these properties (65 buildings) with a combined 4,201,777 square feet for an aggregate sale price of $111,400, excluding closing costs.  In addition, as of November 4, 2013, we have two of these properties (two buildings) with a combined 77,394 square feet under agreement to sell for an aggregate sale price of $2,050, excluding closing costs.  We expect to complete the sale of these two properties currently under agreement for sale by year end 2013 and the remaining 45 properties listed for sale by mid-year 2014; however, no assurance can be given that these properties will be sold in those time periods or at all, or what the ultimate terms of those sales may be.  Results of operations for properties sold or held for sale are included in discontinued operations in our condensed consolidated statements of operations once the criteria for discontinued operations in the Presentation of Financial Statements Topic of the Codification are met.  Summarized balance sheet information for all properties classified as held for sale and income statement information for properties held for sale or sold is as follows:

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COMMONWEALTH REIT

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

Balance Sheets:

Statements of Operations:

Note 5.  Investment in Direct Financing Lease

We have an investment in a direct financing lease that relates to a lease with a term that exceeds 75% of the useful life of an office tower located within a mixed use property in Phoenix, AZ.  We recognize income using the effective interest method to produce a level yield on funds not yet recovered.  Estimated unguaranteed residual values at the date of lease inception represent our initial estimates of the fair value of the leased assets at the expiration of the lease, which do not exceed their original cost.  Significant assumptions used in estimating residual values include estimated net cash flows over the remaining lease term and expected future real estate values.  The carrying amount of our net investment is included in other assets in our condensed consolidated balance sheets.  The following table summarizes the carrying amount of our net investment in this direct financing lease:

We monitor the payment history and credit profile of the tenant and have determined that no allowance for losses related to our direct financing lease was necessary at September 30, 2013 and December 31, 2012.  Our direct financing lease has an expiration date in 2045.

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COMMONWEALTH REIT

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

Note 6.  Equity Investments

At September 30, 2013 and December 31, 2012, we had the following equity investments in SIR, Government Properties Income Trust, or GOV, and Affiliates Insurance Company, or AIC:

At September 30, 2013, we owned 22,000,000, or approximately 44.2%, of the common shares of beneficial interest of SIR, with a carrying value of $511,473 and a market value, based on quoted market prices, of $567,600 ($25.80 per share).  SIR is a REIT that is primarily focused on owning and investing in net leased, single tenant properties and was one of our consolidated subsidiaries until July 2, 2013.  On July 2, 2013, SIR issued and sold to the public 10,500,000 of its common shares for $28.25 per common share.  Prior to the completion of this offering, our 22,000,000 common shares of SIR represented approximately 56.0% of SIR’s outstanding common shares, and SIR was one of our consolidated subsidiaries.  Following the completion of this offering, our 22,000,000 common shares of SIR represented approximately 44.2% of SIR’s outstanding common shares and SIR ceased to be our consolidated subsidiary.  Accordingly, since the completion of this offering on July 2, 2013, we no longer consolidate our investment in SIR, but instead account for such investment under the equity method.  Under the equity method, we record our percentage share of net earnings of SIR in our condensed consolidated statements of operations.  Prior to July 2, 2013, the operating results and investments of SIR were included in our consolidated results of operations and financial position.  On July 2, 2013, our share of the underlying equity of SIR exceeded our carrying value by $17,590.  As required under GAAP, we are amortizing this difference to equity in earnings of investees over a 27 year period, which approximates the average remaining useful lives of the buildings owned by SIR as of July 2, 2013.  If we determine there is an “other than temporary” decline in the fair value of this investment, we would record a charge to earnings.  See Note 1 and Note 15 for additional information regarding SIR.

Since July 2, 2013, we received cash distributions from SIR totaling $9,680.

The following summarized financial data of SIR is as reported in SIR’s Quarterly Report on Form 10-Q for the period ended September 30, 2013, or the SIR Quarterly Report.  References in our financial statements to the SIR Quarterly Report are included as references to the source of the data only, and the information in the SIR Quarterly Report is not incorporated by reference into our financial statements.

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COMMONWEALTH REIT

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

Condensed Consolidated Balance Sheets:

Condensed Consolidated Statements of Income:

On March 15, 2013, we sold all 9,950,000 common shares that we owned of GOV in a public offering for $25.20 per common share, raising gross proceeds of $250,740 ($239,576 after deducting underwriters’ discounts and commissions and expenses).  We recognized a gain on this sale of an equity investment of $66,293 as a result of the per share sales price of this transaction being above our per share carrying value.  GOV is a REIT which primarily owns properties that are majority leased to government tenants and was our wholly owned subsidiary until its initial public offering in June 2009 when it became a separate public entity.

During the nine months ended September 30, 2013 and 2012, we received cash distributions from GOV totaling $4,279 and $12,537, respectively.

As of September 30, 2013, we have invested $5,209 in AIC, an insurance company owned in equal proportion by us, Reit Management & Research LLC, our business and property manager, or RMR, GOV, SIR and four other companies to which RMR provides management services.  At September 30, 2013, we owned 12.5% of AIC with a carrying value of $5,781.  For the period that

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COMMONWEALTH REIT

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

SIR was both a shareholder of AIC and our consolidated subsidiary, from May 2012 until July 2, 2013, our condensed consolidated financial statements also include SIR’s equity investment in AIC.  We and SIR use the equity method to account for our and SIR’s investment in AIC because we and SIR believe that we each have significant influence over AIC because all of our Trustees and all of SIR’s trustees are also directors of AIC.  Following our deconsolidating SIR, we continue to account for our investment in AIC under the equity method, as we continue to believe we have significant influence over AIC for the same reason.  Under the equity method, we record our and our percentage share of SIR’s percentage share of net earnings from AIC in our condensed consolidated statements of operations.  If we determine there is an “other than temporary” decline in the fair value of this investment, we would record a charge to earnings.  In evaluating the fair value of this investment, we have considered, among other things, the assets and liabilities held by AIC, AIC’s overall financial condition and the financial condition and prospects for AIC’s insurance business.  See Note 15 for additional information about our investment in AIC.

Note 7.  Real Estate Mortgages Receivable

We provided mortgage financing totaling $7,688 at 6.0% per annum in connection with three suburban office and industrial properties (18 buildings) sold in January 2013.  This real estate mortgage requires monthly interest payments and matures on January 24, 2023.  In addition, in September 2013, another borrower prepaid to us in full a $1,000 real estate mortgage that was scheduled to mature on July 1, 2017.  As of September 30, 2013 and December 31, 2012, we had total real estate mortgages receivable with an aggregate carrying value of $8,107 and $1,419, respectively, included in other assets in our condensed consolidated balance sheets.

Note 8.  Shareholders’ Equity

The following is a reconciliation of changes in shareholders’ equity for the nine months ended September 30, 2013: