NOTE 3. — LEASES

As of September 30, 2016, we owned 743 properties and leased 92 properties from third-party landlords. Our 835 properties are located in 23 states across the United States and Washington, D.C. Substantially all of our properties are leased on a triple-net basis primarily to petroleum distributors and, to a lesser extent, to individual operators. Generally, our tenants supply fuel and either operate our properties directly or sublet our properties to operators who operate their convenience stores, gasoline stations, automotive repair service facilities or other businesses at our properties. Our triple-net tenants are responsible for the payment of all taxes, maintenance, repairs, insurance and other operating expenses relating to our properties, and are also responsible for environmental contamination occurring during the terms of their leases and in certain cases also for environmental contamination that existed before their leases commenced. See Note 6 for additional information regarding environmental obligations. Substantially all of our tenants’ financial results depend on the sale of refined petroleum products and, to a lesser extent, convenience store sales or rental income from their subtenants. As a result, our tenants’ financial results are highly dependent on the performance of the petroleum marketing industry, which is highly competitive and subject to volatility. During the terms of our leases, we monitor the credit quality of our triple-net tenants by reviewing their published credit ratings, if available, reviewing publicly available financial statements or reviewing financial or other operating statements which are delivered to us pursuant to applicable lease agreements, monitoring news reports regarding our tenants and their respective businesses, and monitoring the timeliness of lease payments and the performance of other financial covenants under their leases.

Revenues from rental properties included in continuing operations were $24,328,000 and $72,856,000 for the three and nine months ended September 30, 2016, respectively, and $24,840,000 and $67,376,000 for the three and nine months ended September 30, 2015, respectively. Rental income contractually due or received from our tenants in revenues from rental properties included in continuing operations were $23,531,000 and $70,347,000 for the three and nine months ended September 30, 2016, respectively, and $23,513,000 and $64,695,000 for the three and nine months ended September 30, 2015, respectively.

In accordance with GAAP, we recognize rental revenue in amounts which vary from the amount of rent contractually due or received during the periods presented. As a result, revenues from rental properties include non-cash adjustments recorded for deferred rental revenue due to the recognition of rental income on a straight-line basis over the current lease term, the net amortization of above-market and below-market leases, rental income recorded under direct financing leases using the effective interest method which produces a constant periodic rate of return on the net investments in the leased properties and the amortization of deferred lease incentives (the “Revenue Recognition Adjustments”). Revenue Recognition Adjustments included in revenues from rental properties in continuing operations were $797,000 and $2,509,000 for the three and nine months ended September 30, 2016, respectively, and $1,327,000 and $2,681,000 for the three and nine months ended September 30, 2015. We provide reserves for a portion of the recorded deferred rent receivable if circumstances indicate that a tenant will not make all of its contractual lease payments during the current lease term. Our assessments and assumptions regarding the recoverability of the deferred rent receivable are reviewed on an ongoing basis and such assessments and assumptions are subject to change.

Tenant reimbursements, which consist of real estate taxes and other municipal charges paid by us which were reimbursable by our tenants pursuant to the terms of triple-net lease agreements, included in continuing operations were $3,397,000 and $9,921,000 for the three and nine months ended September 30, 2016, respectively, and $4,237,000 and $11,095,000 for the three and nine months ended September 30, 2015.

We incurred $148,000 and $90,000 of lease origination costs for the nine months ended September 30, 2016 and 2015, respectively. This deferred expense is recognized on a straight-line basis as amortization expense in our consolidated statements of operations over the terms of the various leases.

The components of the $92,636,000 investment in direct financing leases as of September 30, 2016, are minimum lease payments receivable of $170,164,000 plus unguaranteed estimated residual value of $13,979,000 less unearned income of $91,507,000. The components of the $94,098,000 investment in direct financing leases as of December 31, 2015, are minimum lease payments receivable of $179,372,000 plus unguaranteed estimated residual value of $13,979,000 less unearned income of $99,253,000.

Major Tenants

As of September 30, 2016, we had three significant tenants by revenue:

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We leased 164 convenience store and gasoline station properties in three separate unitary leases and one stand-alone lease to subsidiaries of Global Partners LP (NYSE: GLP) (“Global Partners”). Two of these leases were assigned to subsidiaries of Global Partners in June 2015 by our former tenants, White Oak Petroleum, LLC and Big Apple Petroleum Realty, LLC (both affiliates of Capitol Petroleum Group, LLC). In the aggregate, our leases with subsidiaries of Global Partners represented 21% of our total revenues for the nine months ended September 30, 2016 and 2015. All three of our leases with subsidiaries of Global Partners are guaranteed by the parent company.

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We leased 79 convenience store and gasoline station properties pursuant to three separate unitary leases to subsidiaries of Chestnut Petroleum Dist., Inc. (“Chestnut Petroleum”). In the aggregate, our leases with subsidiaries of Chestnut Petroleum represented 14% and 17% of our total revenues for the nine months ended September 30, 2016 and 2015, respectively. The largest of these unitary leases, accounting for 57 of our properties, is guaranteed by the parent company, its principals and numerous Chestnut Petroleum affiliates.

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We leased 77 convenience store and gasoline station properties pursuant to three separate unitary leases to Apro, LLC (d/b/a “United Oil”). In the aggregate, our leases with United Oil represented 15% and 7% of our total revenues for the nine months ended September 30, 2016 and 2015, respectively. See Note 10 for additional information regarding the United Oil Transaction.

Month-to-Month License Agreements

As of September 30, 2016, six of our properties are subject to month-to-month license agreements. These month-to-month license agreements are interim occupancy arrangements, which allow the licensees to occupy and use these properties until the properties are sold or leased on a triple-net basis. Our month-to-month license agreements differ from our triple-net lease arrangements in that, among other things, we receive monthly occupancy payments directly from the licensees while we remain responsible for certain operating expenses, certain environmental compliance costs and costs associated with any environmental remediation at the properties. We will continue to be responsible for such operating expenses and environmental compliance costs until these properties are sold or leased on a triple-net basis, and under certain leases and agreements, thereafter.

Marketing and the Master Lease

As of September 30, 2016, 397 of the properties we own or lease, were previously leased to Getty Petroleum Marketing Inc. (“Marketing”) pursuant to a master lease (the “Master Lease”). In December 2011 Marketing filed for Chapter 11 bankruptcy protection in the U.S. Bankruptcy Court. The Master Lease was terminated effective April 30, 2012, and in July 2012 the Bankruptcy Court approved Marketing’s Plan of Liquidation and appointed a trustee (the “Liquidating Trustee”) to oversee liquidation of the Marketing estate (the “Marketing Estate”).

As part of Marketing’s bankruptcy proceedings, we maintained significant pre-petition and post-petition unsecured claims against Marketing. On March 3, 2015, we entered into a settlement agreement with the Liquidating Trustee of the Marketing Estate to resolve claims asserted by us in Marketing’s bankruptcy case (the “Settlement Agreement”). The Settlement Agreement was approved by an order of the U.S. Bankruptcy Court and on April 22, 2015, we received a distribution from the Marketing Estate of $6,800,000 on account of our general unsecured claims. The Settlement Agreement also resolved a dispute relating to the balance of payment due to us pursuant to our agreement to fund a lawsuit that was brought by the Liquidating Trustee against Lukoil Americas Corporation and related entities and individuals for the benefit of Marketing’s creditors. As a result, on April 22, 2015, we also received an additional distribution of $550,000 from the Marketing Estate in full resolution of the funding agreement dispute.

On October 19, 2015, the U.S. Bankruptcy Court entered a final decree closing the bankruptcy case of the Marketing Estate. As a result, on November 3, 2015, we received a final distribution from the Marketing Estate of approximately $10,800,000 on account of our general unsecured claims. We do not expect to receive any further distributions from the Marketing Estate.

As of September 30, 2016, we have entered into long-term triple-net leases with petroleum distributors for 15 separate property portfolios comprising 351 properties in the aggregate and 20 properties leased as single unit triple-net leases, that were previously leased to Marketing. The long-term triple-net leases with petroleum distributors are unitary triple-net lease agreements generally with an initial term of 15 to 20 years and options for successive renewal terms of up to 20 years. Rent is scheduled to increase at varying intervals during both the initial and renewal terms of our leases. Several of the leases provide for additional rent based on the aggregate volume of fuel sold. In addition, the majority of the leases require the tenants to make capital expenditures at our properties substantially all of which are related to the replacement of USTs that are owned by our tenants. As of September 30, 2016, we have a remaining commitment to fund as much as $10,805,000 in the aggregate with our tenants for a portion of such capital expenditures. Our commitment provides us with the option to either reimburse our tenants, or to offset rent when these capital expenditures are made. This deferred expense is recognized on a straight-line basis as a reduction of rental revenue in our consolidated statements of operations over the terms of the various leases.

As part of the triple-net leases for properties previously leased to Marketing, we transferred title of the USTs to our tenants, and the obligation to pay for the retirement and decommissioning or removal of USTs at the end of their useful lives or earlier if circumstances warranted was fully or partially transferred to our new tenants. We remain contingently liable for this obligation in the event that our tenants do not satisfy their responsibilities. Accordingly, through September 30, 2016, we removed $13,769,000 of asset retirement obligations and $10,808,000 of net asset retirement costs related to USTs from our balance sheet. The cumulative net amount of $2,961,000 is recorded as deferred rental revenue and will be recognized on a straight-line basis as additional revenues from rental properties over the terms of the various leases.

NECG Lease Restructuring

On May 1, 2012, we entered into a lease with NECG Holdings Corp (“NECG”) covering 84 properties formerly leased to Marketing in Connecticut, Massachusetts and Rhode Island (the “NECG Lease”). Eviction proceedings against a holdover group of former subtenants who continued to occupy properties subject to the NECG Lease had a material adverse impact on NECG’s operations and profitability. On January 27, 2015, the Connecticut Supreme Court, in a written opinion, affirmed the Superior Court rulings in favor of NECG and us. As a result, we or NECG have regained possession of all of the locations that were still subject to appeal.

We had previously entered into a lease modification agreement with NECG which deferred a portion of NECG’s rent due to us and allowed us to remove properties from the NECG Lease. As a result, as of December 31, 2015, there were eight properties remaining in the NECG Lease. During the nine months ended September 30, 2016, we severed five properties from the NECG Lease. The three remaining properties continue to be leased to NECG with the understanding that the properties will be severed from the NECG Lease when we either re-lease or sell the properties.