Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

COMMONWEALTH REIT

(Exact Name of Registrant as Specified in Its Charter)

Two Newton Place, 255 Washington Street, Suite 300, Newton, Massachusetts 02458-1634

 (Address of Principal Executive Offices)  (Zip Code)

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 May 4, 2011: 72,138,686

Table of Contents

COMMONWEALTH REIT

FORM 10-Q

March 31, 2011

INDEX

References in this Form 10-Q to “we”, “us” and “our” refers to CommonWealth REIT and its consolidated subsidiaries, unless otherwise noted.  All share amounts in this Form 10-Q give effect to the reverse stock split that resulted in a one for four combination of our common shares effective July 1, 2010.

Table of Contents

PART I          Financial Information

Item 1.  Financial Statements

COMMONWEALTH REIT

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except share data)

(unaudited)

See accompanying notes

1

Table of Contents

COMMONWEALTH REIT

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(amounts in thousands, except per share data)

(unaudited)

See accompanying notes

2

Table of Contents

COMMONWEALTH REIT

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in thousands)

(unaudited)

See accompanying notes

3

Table of Contents

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, or CWH, we or us, and its subsidiaries 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, 2010, 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 intercompany transactions and balances with 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.

Note 2.  Real Estate Properties

Since January 1, 2011, we acquired ten properties with approximately 2,035,000 square feet for an aggregate purchase price of $350,125, excluding closing costs, and sold seven properties with approximately 838,000 square feet for an aggregate sale price of $98,145, excluding closing costs.  We also funded $12,737 of improvements to our owned properties during the three months ended March 31, 2011.  In addition, we have entered into agreements to acquire 11 properties with approximately 3,060,000 square feet for an aggregate purchase price of $624,227, including the assumption of approximately $321,600 of mortgage debt and excluding closing costs.  Details of our completed and pending acquisitions and sales during 2011 are as follows:

In January 2011, we acquired three office properties located in Boca Raton, FL with a combined 639,830 square feet.  The aggregate purchase price was $171,000, excluding closing costs.  We allocated $15,900 to land, $129,790 to buildings and improvements and $25,310 to acquired real estate leases.

In January 2011, we acquired an office property located in Columbia, SC with 115,028 square feet.  The purchase price was $12,025, excluding closing costs.  We allocated $1,180 to land, $8,886 to buildings and improvements, $2,072 to acquired real estate leases and $113 to acquired real estate lease obligations.

In January 2011, we acquired an office property located in Chelmsford, MA with 98,048 square feet.  The purchase price was $10,000, excluding closing costs.  We allocated $1,410 to land, $7,322 to buildings and improvements, $1,711 to acquired real estate leases and $443 to acquired real estate lease obligations.

In February 2011, we acquired an office property located in Montvale, NJ with 119,089 square feet.  The purchase price was $20,600, excluding closing costs.  We allocated $3,650 to land, $13,726 to buildings and improvements, $3,954 to acquired real estate leases and $730 to acquired real estate lease obligations.

In March 2011, we acquired four properties located in Phoenix, AZ with a combined 1,063,364 square feet.  The aggregate purchase price was $136,500, excluding closing costs.  We allocated $30,985 to land, $55,733 to buildings and improvements, $38,635 to investment in direct financing lease, $15,706 to acquired real estate leases, $500 to acquired real estate lease obligations and $4,059 to notes payable based on currently available information.  These preliminary allocations are subject to change pending an evaluation by an independent real estate appraisal firm that is expected to be completed during the second quarter of 2011.

In November 2010, we entered an agreement to acquire four office properties located in Stafford, VA with a combined 149,023 square feet.  The aggregate purchase price is $25,725, including the assumption of approximately $15,300 of mortgage debt and excluding closing costs.  We expect to acquire these properties during the second quarter of 2011; however, this acquisition is subject to customary closing conditions and no assurance can be given that this acquisition will be consummated in that time period or at all.

In March 2011, we entered an agreement to acquire four office properties located in Folsom, CA with a combined 269,254 square feet.  The aggregate purchase price is $46,300, including the assumption of approximately $41,300 of mortgage debt and excluding closing costs.  We expect to acquire these properties during the second quarter of 2011; however, this acquisition is subject to customary closing conditions and no assurance can be given that this acquisition will be consummated in that time period or at all.

4

Table of Contents

COMMONWEALTH REIT

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

In May 2011, we entered an agreement to acquire an office property located in Chicago, IL with 1,070,388 square feet.  The purchase price is $162,202, excluding closing costs.  We expect to acquire this property during the second quarter of 2011; however, this acquisition is subject to customary closing conditions and no assurance can be given that this acquisition will be consummated in that time period or at all.

In May 2011, we entered an agreement to acquire two office properties located in Chicago, IL with a combined 1,571,386 square feet.  The aggregate purchase price is $390,000, including the assumption of approximately $265,000 of mortgage debt and excluding closing costs.  We expect to acquire these properties during the second or third quarter of 2011; however, this acquisition is subject to customary closing conditions and no assurance can be given that this acquisition will be consummated in that time period or at all.

In November 2010, we entered into various agreements to sell 27 properties which are majority leased as medical office, clinic and biotech laboratory buildings to Senior Housing Properties Trust, or SNH, for an aggregate sale price of $470,000, excluding closing costs.  In 2010, we sold 21 of these properties containing approximately 2,066,000 square feet for $374,130, excluding closing costs, and recognized net gains totaling $133,272.  In January 2011, we sold the remaining six properties containing approximately 737,000 square feet for aggregate sales prices of $95,870, excluding closing costs, and recognized gains totaling $34,666.  SNH has continuing rights of first refusal to purchase from us any of 19 additional buildings that are leased to tenants in medical related businesses which we continue to own.

In February 2011, we sold an industrial property located in Adairsville, GA with 101,400 square feet for $2,275, excluding closing costs, and recognized a loss of $94.

As of March 31, 2011, we had seven office properties with a combined 1,054,000 square feet and 20 industrial & other properties with a combined 1,835,000 square feet classified as held for sale in our consolidated balance sheet.  We are actively marketing these properties for sale and expect to sell them within the next year.

We classify all properties actively marketed, under contract, in active negotiations or otherwise probable for sale within one year as held for sale in our consolidated balance sheets.  Results of operations for properties sold or held for sale are included in discontinued operations in our consolidated statements of income, except for properties sold during 2010 to Government Properties Income Trust, or GOV.  Properties that we sold to GOV are not considered discontinued operations under GAAP because of our retained equity interest in this former subsidiary.  Summarized balance sheet information for all properties classified as held for sale and income statement information for properties sold or held for sale, other than properties sold to GOV, is as follows:

Balance Sheets:

5

Table of Contents

COMMONWEALTH REIT

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

Income Statements:

Note 3.  Investment in Direct Financing Lease

Our investment in a direct financing lease relates to the triple net lease with a term that exceeds 75% of the useful life of one office tower located within a mixed use property in Phoenix, AZ that we acquired in March 2011. We recognize direct financing lease 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 following table summarizes the carrying amount of our net investment in the direct financing lease as of March 31, 2011. The carrying amount of our net investment is included in other assets in our condensed consolidated balance sheet.

Additionally, we have determined that no allowance for losses was necessary at March 31, 2011.

Our direct financing lease has an expiration date in 2045.  Future minimum rentals receivable on this direct financing lease as of March 31, 2011 are $6,073 in 2011, $8,098 in 2012, $8,098 in 2013, $8,098 in 2014, $8,098 in 2015 and $6,791 thereafter.

Note 4.  Equity Investments

At March 31, 2011 and December 31, 2010, we had the following equity investments in GOV and Affiliates Insurance Company, or AIC:

At March 31, 2011, we owned 9,950,000, or approximately 24.6%, of the common shares of beneficial interest of GOV, with a carrying value of $164,983 and a market value, based on quoted market prices, of $267,257 ($26.86 per share).  GOV is a REIT which primarily owns properties that are majority leased to government tenants and was our wholly owned subsidiary until its IPO in June 2009 when it became a separate public entity.

6

Table of Contents

COMMONWEALTH REIT

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

Since GOV’s IPO, we have accounted for our investment in it using the equity method.  Under the equity method, we record our percentage share of net earnings of GOV in our consolidated statements of income.  Prior to GOV’s IPO, the operating results and investments of GOV were included in our results of operations and financial position.  The market value of our GOV common shares on the date of the GOV IPO exceeded our carrying value by $13,824.  We are amortizing the difference between our carrying value of GOV and our share of the underlying equity of GOV over a 30 year period, which approximates the remaining useful lives of the properties that we initially contributed to GOV.  If we determine there is an “other than temporary” decline in the fair value of this investment, we would record a charge to earnings.

During the three months ended March 31, 2011 and 2010, we received cash distributions from GOV totaling $4,080 and $3,980, respectively.

The following summarized financial data of GOV is as reported in GOV’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2011.  References in our financial statements to the Quarterly Report on Form 10-Q for GOV are included as textual references only, and the information in GOV’s Quarterly Report is not incorporated by reference into our financial statements.

7

Table of Contents

COMMONWEALTH REIT

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

As of March 31, 2011, we have invested $5,209 in AIC, an insurance company organized by Reit Management & Research LLC, or RMR, and companies to which RMR provides management services.  We may invest additional amounts in AIC in the future if the expansion of this insurance business requires additional capital, but we are not obligated to do so.  At March 31, 2011, we owned approximately 14.3% of AIC with a current carrying value of $5,117.  Although we own less than 20% of AIC, we use the equity method to account for this investment because we believe that we have significant influence over AIC because each of our Trustees is a director of AIC.  Under the equity method, we record our percentage share of net earnings from AIC in our consolidated statements of income.  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.

In 2010, AIC designed a combination property insurance program for us and other AIC shareholders in which AIC participated as a reinsurer.  Our total premiums paid under this program in 2010 were approximately $5,328.  We are currently investigating the possibilities to expand our insurance relationships with AIC to include other types of insurance. By participating in this insurance business with RMR and the other companies to which RMR provides management services, we expect that we may benefit financially by possibly reducing our insurance expenses or by realizing our pro-rata share of any profits of this insurance business.

Note 5.  Real Estate Mortgage Receivable

We provided mortgage financing totaling $8,288 at 4.75% per annum in connection with an office property sold in September 2010.  This real estate mortgage requires monthly principal and interest payments and matures on September 30, 2020.  As of March 31, 2011 and December 31, 2010, this mortgage had a carrying value of $8,113 and $8,183, respectively, and was included in other assets in our condensed consolidated balance sheets.

Note 6.  Indebtedness

We have a $750,000 unsecured revolving credit facility that we use for acquisitions, working capital and general business purposes.  The credit facility matures on August 8, 2013 and includes a conditional option for us to extend the facility for one year to August 8, 2014.  Interest paid under our credit facility is set at LIBOR plus a spread, subject to adjustments based on our credit ratings.  The interest rate on our revolving credit facility averaged 2.3% and 0.8% per annum for the three months ended March 31, 2011 and 2010, respectively.  As of March 31, 2011, we had $270,000 outstanding and $480,000 available under our revolving credit facility.

In March 2011, we repaid at maturity, all $168,219 of our floating rate senior notes due in 2011 using borrowings under our revolving credit facility.

Our public debt indentures, our credit facility agreement and our term loan agreement contain a number of financial and other covenants, including a credit facility and term loan covenant which restricts our ability to make distributions under certain circumstances.  At March 31, 2011, we believe we were in compliance with all of our covenants under our public debt indentures, our revolving credit facility and term loan agreements.

At March 31, 2011, 15 properties costing $599,890 with an aggregate net book value of $487,096 were secured by mortgage notes totaling $350,462 (net of discounts) maturing from 2011 through 2027.

8

Table of Contents

COMMONWEALTH REIT

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

Note 7.  Shareholders’ Equity

Other comprehensive income includes unrealized gains or losses on the fair value of our interest rate swap agreements, other investments, and foreign currency translation adjustments.  Our interest rate swap agreements qualify as cash flow hedges and convert the floating interest rate on a $175,000 mortgage note payable to a fixed interest rate.  The following is a reconciliation of net income to total comprehensive income for the three months ended March 31, 2011 and 2010:

Note 8.  Income Taxes

We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, and as such, are generally not subject to federal and most state income taxation on our operating income provided we distribute our taxable income to our shareholders and meet certain organization and operating requirements.  We are subject to income tax in Australia and certain states despite our REIT status.  During the three months ended March 31, 2011, we recognized current tax expense of $266, which includes $164 of foreign taxes and $102 of certain state taxes.  In addition, we recognized a deferred tax provision of $80 related to basis differences in our Australian properties.

9

Table of Contents

COMMONWEALTH REIT

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

Note 9.  Fair Value of Assets and Liabilities

The table below presents certain of our assets and liabilities measured at fair value during 2011, categorized by the level of inputs used in the valuation of each asset and liability:

We are exposed to certain risks relating to our ongoing business operations, including the effect of changes in foreign currency exchange rates and interest rates.  The only risk currently managed by using our derivative instruments is interest rate risk.  Although we have not done so as of March 31, 2011 and have no present intention to do so, we may manage our Australian currency exchange exposure by borrowing in Australian dollars or using derivative instruments in the future, depending on the relative significance of our business activities in Australia at that time.  We enter into interest rate swaps to manage interest rate risk associated with our floating rate borrowings.  We have interest rate swap agreements to manage our interest rate risk exposure on $175,000 of mortgage notes due 2019, which require interest at a spread over LIBOR.  The interest rate swap agreements utilized by us qualify as cash flow hedges and effectively modify our exposure to interest rate risk by converting our floating interest rate debt to a fixed interest rate basis for this loan through December 1, 2016, thus reducing the impact of interest rate changes on future interest expense.  These agreements involve the receipt of floating interest rate amounts in exchange for fixed rate interest payments over the life of the agreements without an exchange of the underlying principal amount.  The fair value of our derivative instruments increased by $2,045 during the three months ended March 31, 2011, based primarily on changes in market interest rates.  As of March 31, 2011, the fair value of these derivative instruments included in accounts payable and accrued expenses and cumulative other comprehensive income in our consolidated balance sheet totaled ($4,911).  As of December 31, 2010, the fair value of these derivative instruments included in accounts payable and accrued expenses and cumulative other comprehensive income in our consolidated balance sheet totaled ($6,956).

10

Table of Contents

COMMONWEALTH REIT

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

In addition to the assets and liabilities described in the above table, our financial instruments include our cash and cash equivalents, rents receivable, equity investments, investment in direct financing lease receivable, real estate mortgage receivable, marketable pass through certificates, restricted cash, revolving credit facility, senior notes and mortgage notes payable, accounts payable and other accrued expenses, rent collected in advance, security deposits and amounts due to affiliates.  At March 31, 2011 and December 31, 2010, the fair values of these additional financial instruments were not materially different from their carrying values, except as follows:

At March 31, 2011 and December 31, 2010, the fair values of our equity investment in GOV are based on quoted market prices of $26.86 and $26.79, respectively.  The fair values of our senior notes and mortgage notes payable are based on estimates using discounted cash flow analyses and currently prevailing interest rates adjusted by credit risk spreads.

Other financial instruments that potentially subject us to concentrations of credit risk consist principally of rents receivable; however, none of our tenants are responsible for more than 3% of our total rents.

We maintain derivative financial instruments, including interest rate swaps, with major financial institutions and monitor the amount of credit exposure to any one issuer.

Note 10.  Earnings Per Common Share

The effect of our convertible preferred shares on income from continuing operations available for common shareholders per share is anti-dilutive for the periods presented.

11

Table of Contents

COMMONWEALTH REIT

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

Note 11.  Segment Information

As of March 31, 2011, we owned 271 suburban office properties, 39 Central Business District, or CBD, office properties and 180 industrial & other properties, excluding properties held for sale. We account for all of these properties in geographic operating segments for financial reporting purposes based on our method of internal reporting. We account for our properties by property type (i.e. suburban office, CBD office and industrial & other) and by geographic regions. We define these individual geographic segments as those which currently, or during either of the last two quarters, represent or generate 5% or more of our total square feet, annualized revenues or property net operating income, or NOI, which we define as rental income less operating expenses. Our geographic segments include Metro Philadelphia, PA, Oahu, HI, Metro Denver, CO, Australia, Metro Washington, DC, Metro Boston, MA and Other Markets, which includes properties located elsewhere throughout the United States. Prior periods have been restated to reflect one office property reclassified to discontinued operations during the third quarter of 2010 and 31 office properties and 25 industrial & other properties reclassified to discontinued operations during the fourth quarter of 2010. Property level information by geographic segment and property type as of and for the three months ended March 31, 2011 and 2010 is as follows:

12

Table of Contents

COMMONWEALTH REIT

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

The following table reconciles our calculation of NOI to net income, the most directly comparable financial measure under GAAP reported in our consolidated financial statements. We consider NOI to be appropriate supplemental information to net income because it helps both investors and management to understand the operations of our properties. We use NOI internally as a performance measure and believe NOI provides useful information to investors regarding our results of operations because it reflects only those income and expense items that are incurred at the property level and may facilitate comparisons of our operating performance between periods. Our management also uses NOI to evaluate individual, regional and company wide property level performance. NOI excludes certain components from net income in order to provide results that are more closely related to our properties’ results of operations. NOI does not represent cash generated by operating activities in accordance with GAAP and should not be considered an alternative to net income, net income available for common shareholders or cash flow from operating activities as a measure of financial performance. A reconciliation of NOI to net income for the three months ended March 31, 2011 and 2010, is as follows: