We are unable to predict the impact of these or other recent legislative and regulatory actions or proposed actions with respect to state Medicaid rates and federal Medicare rates and federal payments to states for Medicaid programs discussed above on us and those of our tenants and managers that derive a portion of their revenues from Medicare, Medicaid and other government programs. The changes implemented or to be implemented as a result of such actions could result in the failure of Medicare, Medicaid or private payment reimbursement rates to cover increasing costs, in a reduction in payments or other circumstances.
Government authorities are devoting increasing attention and resources to the prevention, detection and prosecution of healthcare fraud and abuse. CMS contractors are also expanding the retroactive audits of Medicare claims submitted by SNFs and other providers, and recouping alleged overpayments for services determined by auditors not to have been medically necessary or not to meet Medicare coverage criteria as billed. State Medicaid programs and other third party payers are conducting similar medical necessity and compliance audits. The ACA facilitates the Department of Justice’s, or the DOJ’s,DOJ's ability to investigate allegations of wrongdoing or fraud at SNFs, in part because of increased cooperation and data sharing among CMS, the Office of the Inspector General, the DOJ and the states. In March 2016, the DOJ also announced the launch of 10 regional intergovernmental task forces across the country to identify and take enforcement action against SNFs that provide substandard care to residents. In
Federal and state laws designed to protect the confidentiality and security of individually identifiable information apply to us, our tenants and our managers. Under the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, and the Health Information Technology for Economic and Clinical Health Act, or the HITECH Act, we, our tenantsmanagers and our managerstenants that are covered entities or business associates within the meaning of HIPAA must comply with rules adopted by HHS governing the privacy, security, use and disclosure of individually identifiable information, including financial information and protected health information, or PHI, and also with security rules for electronic PHI. There may be both civil monetary penalties
and criminal sanctions for noncompliance with such federal laws. In January 2013, HHS released the HIPAA Omnibus Rule, or the Omnibus Rule, which went into effect in March 2013 and required compliance with most provisions by September 2013. The Omnibus Rule modified various requirements, including the standard for providing breach notices, which was previously to perform an analysis of the harm of any disclosure to a more objective analysis relating to whether any PHI was actually acquired or viewed as a result of the breach. In addition to HIPAA, many states have enacted their own security and privacy laws relating to individually identifiable information. In some states, these laws are more stringent than HIPAA, and we, our tenants and our managers must comply with both the applicable federal and state standards. HIPAA enforcement efforts have increased considerably over the past few years, with HHS, through its Office for Civil Rights, entering into several multi-million dollar HIPAA settlements in 20172019 alone. Finally, the Office for Civil Rights and other regulatory bodies have become increasingly focused on cybersecurity risks, including the emerging threat of ransomware and similar cyber attacks. The increasing sophistication of cybersecurity threats presents challenges to the entire healthcare industry.
We require our tenants and managers to comply with all laws that regulate the operation of our senior living communities. Although we do not believe that the costs to comply with these laws will have a material adverse effect on us, those costs may adversely affect the profitability of our managed senior living communities and the ability of our tenants to pay their rent to us. If we, our managers, or any of our tenants or managers were subject to an action alleging violations of such laws or to any adverse determination concerning any of our or our tenants’tenants' or managers’managers' licenses or eligibility for Medicare or Medicaid reimbursement or any substantial penalties, repayments or sanctions, these actions could materially and adversely affect the ability of our tenants to pay rent to us, the profitability of our managed senior living communities and the values of our properties. If our managers or any of our tenants or managers becomes unable to operate our properties, or if any of our tenants becomes unable to pay its rent because it has violated government regulations or payment laws, we may experience difficulty in finding a substitute tenant or managermanagers or selling the affected property at a price that provides us with a desirable return, and the value of the affected property may decline materially.
Healthcare providers and suppliers, including physicians and other licensed medical practitioners, that receive federal or state reimbursement under Medicare, Medicaid or other federal or state programs must comply with the requirements for their participation in those programs. Our tenants that are healthcare providers or suppliers are subject to reimbursement rates that are increasingly subject to cost control pressures and may be reduced or may not be increased sufficiently to cover their increasing costs, including our rents.
The U.S. Food and Drug Administration, or the FDA, and other federal, state and local authorities extensively regulate our biotechnology laboratory tenants that develop, manufacture, market or distribute new drugs, biologicals or medical devices for human use. The FDA and such other authorities regulate the clinical development, testing, manufacture, quality control, safety, effectiveness, labeling, storage, record keeping, advertising and promotion of those products. Before a new pharmaceutical product or medical device may be marketed and distributed in the United States, the FDA must approve it as safe and effective for human use. Preclinical and clinical studies and documentation in connection with FDA approval of new pharmaceuticals or medical devices involve significant time, expense and risks of failure. Once a product is approved, the FDA maintains oversight of the product and its developer and can withdraw its approval, recall products or suspend their production, impose or seek to impose civil or criminal penalties on the developer or take other actions for the developer’sdeveloper's failure to comply with regulatory requirements, including anti-fraud, false claims, anti-kickback or physician referral laws. Other concerns affecting our biotechnology laboratory tenants include the potential for subsequent discovery of safety concerns and related litigation, ensuring that the product qualifies for reimbursement under Medicare, Medicaid or other federal or state programs, cost control initiatives of payment programs, the potential for litigation over the validity or infringement of intellectual property rights related to the product, the eventual expiration
of relevant patents and the need to raise additional capital. The cost of compliance with these regulations and the risks described in this paragraph, among others, could adversely affect the ability of our biotechnology laboratory tenants to pay rent to us. In addition, to the extent the new Trump Administration and the 115th Congress alterif these laws and regulations are altered, additional regulatory risks may arise. Depending upon what aspects of the laws and regulations are altered, the ability of our biotechnology laboratory tenants to pay rent to us could be adversely and materially affected.
Our tenants and managers compete on a local and regional basis with operators of facilities that provide comparable services. Operators compete for residents and patients based on quality of care, reputation, physical appearance of properties, services offered, family preferences, physicians, staff, price and location. We and our tenants and managermanagers also face competition from other healthcare facilities for qualified personnel, such as physicians and other healthcare providers that provide comparable facilities and services.
For additional information on competition and the risks associated with our business, please see “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K.
We or our tenants are generally responsible for the costs of insurance coverage for our properties and the operations conducted on them, including for casualty, liability, fire, and extended coverage and rental or business interruption loss insurance.losses. Either we purchase the insurance ourselves and, except in the case of our managed senior living communities, our tenants are required to reimburse us, or the tenants buy the insurance directly and are required to list us as an insured party. We participatepreviously participated with RMR LLC and other companies to which RMR LLC provides management services in a combined property insurance program through Affiliates Insurance Company, or AIC,AIC. The policies under that program expired on June 30, 2019 and with respectwe and the other companies to which AIC is an insurer or a reinsurer of certain coverage amounts. We also participate with RMR Inc. and other companies managed by RMR LLC in a partial joint program for directors and officers liabilityprovides management services elected not to renew the AIC property insurance as well as purchasing suchprogram; we instead have purchased standalone property insurance for our own account.coverage with unrelated third party insurance providers. For more information, see “Management’s“Management's Discussion and Analysis of Financial Condition and Results of Operations—Related Person Transactions” and Note 7 to our Consolidated Financial Statements included in in Part II,IV, Item 715 of this Annual Report on Form 10-K.
accessible on our website that shareholders can use to report concerns or complaints about accounting, internal accounting controls or auditing matters or violations or possible violations of our Code of Conduct. We make available, free of charge, onthrough the "Investors" section of our website, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, as soon as reasonably practicable after these forms are filed with, or furnished to, the Securities and Exchange Commission, or SEC. Any material we file with or furnish to the SEC is also maintained on the SEC website, www.sec.gov. Securityholders may send communications to our Board of Trustees or individual Trustees by writing to the party for whom the communication is intended at c/o Secretary, Senior Housing PropertiesDiversified Healthcare Trust, Two Newton Place, 255 Washington Street, Suite 300, Newton, Massachusetts 02458-1634 or by email secretary@snhreit.com.at secretary@dhcreit.com. Our website address is included several times in this Annual Report on Form 10-K as a textual reference only and theonly. The information inon or accessible through our website is not incorporated by reference into this Annual Report on Form 10-K.10-K or other documents we file with, or furnish to, the SEC. We intend to use our website as a means of disclosing material non-public information and for complying with our disclosure obligations under Regulation FD. Those disclosures will be included on our website in the “Investors” section. Accordingly, investors should monitor our website, in addition to following our press releases, SEC filings and public conference calls and webcasts.
The following summary of material United States federal income tax considerations is based on existing law, and is limited to investors who own our shares as investment assets rather than as inventory or as property used in a trade or business. The summary does not discuss all of the particular tax considerations that might be relevant to you if you are subject to special rules under federal income tax law, for example if you are:
a person who marks-to-market our shares for U.S. federal income tax purposes;
a U.S. shareholder (as defined below) that has a functional currency other than the U.S. dollar;
a person who acquires or owns our shares in connection with employment or other performance of services;
a person who acquires or owns our shares as part of a straddle, hedging transaction, constructive sale transaction, constructive ownership transaction or conversion transaction, or as part of a “synthetic security” or other integrated financial transaction;
a U.S. expatriate;
a non-U.S. shareholder (as defined below) whose investment in our shares is effectively connected with the conduct of a trade or business in the United States;
a nonresident alien individual present in the United States for 183 days or more during an applicable taxable year;
a “qualified foreign pension fund” (as defined in Section 897(l)(2) of the IRC) or any entity wholly owned by one or more qualified foreign pension funds;
a person subject to special tax accounting rules as a result of their use of applicable financial statements (within the meaning of Section 451(b)(3) of the IRC); or
except as specifically described in the following summary, a trust, estate, tax-exempt entity or foreign person.
Your federal income tax consequences generally will differ depending on whether or not you are a “U.S. shareholder.” For purposes of this summary, a “U.S. shareholder” is a beneficial owner of our shares that is:
an individual who is a citizen or resident of the United States, including an alien individual who is a lawful permanent resident of the United States or meets the substantial presence residency test under the federal income tax laws;
an entity treated as a corporation for federal income tax purposes that is created or organized in or under the laws of the United States, any state thereof or the District of Columbia;
an estate the income of which is subject to federal income taxation regardless of its source; or
a trust if a court within the United States is able to exercise primary supervision over the administration of the trust and one or more U.S. persons have the authority to control all substantial decisions of the trust, or, to the extent provided in Treasury regulations, a trust in existence on August 20, 1996 that has elected to be treated as a domestic trust;
If any entity (or other arrangement) treated as a partnership for federal income tax purposes holds our shares, the tax treatment of a partner in the partnership generally will depend upon the tax status of the partner and the activities of the partnership. Any entity (or other arrangement) treated as a partnership for federal income tax purposes that is a holder of our shares and the partners in such a partnership (as determined for federal income tax purposes) are urged to consult their own tax advisors about the federal income tax consequences and other tax consequences of the acquisition, ownership and disposition of our shares.
Our continued qualification and taxation as a REIT will depend upon our compliance with various qualification tests imposed under the IRC and summarized below. While we believe that we have satisfied and will satisfy these tests, our counsel does not review compliance with these tests on a continuing basis. If we fail to qualify for taxation as a REIT in any year, we will be subject to federal income taxation as if we were a corporation taxed under subchapter C of the IRC, or a C corporation, and our shareholders will be taxed like shareholders of regular C corporations, meaning that federal income tax generally will be
applied at both the corporate and shareholder levels. In this event, we could be subject to significant tax liabilities, and the amount of cash available for distribution to our shareholders could be reduced or eliminated.
We will be taxed at regular corporate income tax rates on any undistributed “real estate investment trust taxable income,” determined by including our undistributed ordinary income and net capital gains, if any.
If we have net income from the disposition of “foreclosure property,” as described in Section 856(e) of the IRC, that is held primarily for sale to customers in the ordinary course of a trade or business or other nonqualifying income from foreclosure property, we will be subject to tax on this income at the highest regular corporate income tax rate.
If we have net income from “prohibited transactions” — that is, dispositions at a gain of inventory or property held primarily for sale to customers in the ordinary course of a trade or business other than dispositions of foreclosure property and other than dispositions excepted by statutory safe harbors — we will be subject to tax on this income at a 100% rate.
If we fail to satisfy the 75% gross income test or the 95% gross income test discussed below, due to reasonable cause and not due to willful neglect, but nonetheless maintain our qualification for taxation as a REIT because of specified cure provisions, we will be subject to tax at a 100% rate on the greater of the amount by which we fail the 75% gross income test or the 95% gross income test, with adjustments, multiplied by a fraction intended to reflect our profitability for the taxable year.
If we fail to satisfy any of the REIT asset tests described below (other than a de minimis failure of the 5% or 10% asset tests) due to reasonable cause and not due to willful neglect, but nonetheless maintain our qualification for taxation as a REIT because of specified cure provisions, we will be subject to a tax equal to the greater of $50,000 or the highest regular corporate income tax rate multiplied by the net income generated by the nonqualifying assets that caused us to fail the test.
If we fail to satisfy any provision of the IRC that would result in our failure to qualify for taxation as a REIT (other than violations of the REIT gross income tests or violations of the REIT asset tests described below) due to reasonable cause and not due to willful neglect, we may retain our qualification for taxation as a REIT but will be subject to a penalty of $50,000 for each failure.
If we fail to distribute for any calendar year at least the sum of 85% of our REIT ordinary income for that year, 95% of our REIT capital gain net income for that year and any undistributed taxable income from prior periods, we will be subject to a 4% nondeductible excise tax on the excess of the required distribution over the amounts actually distributed.
If we acquire a REIT asset where our adjusted tax basis in the asset is determined by reference to the adjusted tax basis of the asset in the hands of a C corporation, under specified circumstances we may be subject to federal income taxation on all or part of the built-in gain (calculated as of the date the property ceased being owned by the C corporation) on such asset. We generally have not sold and do not expect to sell assets if doing so would result in the imposition of a material built-in gains tax liability; but if and when we do sell assets that may have associated built-in gains tax exposure, then we expect to make appropriate provision for the associated tax liabilities on our financial statements.
If we acquire a corporation in a transaction where we succeed to its tax attributes, to preserve our qualification for taxation as a REIT we must generally distribute all of the C corporation earnings and profits inherited in that acquisition, if any, no later than the end of our taxable year in which the acquisition occurs. However, if we fail to do so, relief provisions would allow us to maintain our qualification for taxation as a REIT provided we distribute any subsequently discovered C corporation earnings and profits and pay an interest charge in respect of the period of delayed distribution.
Our subsidiaries that are C corporations, including our TRSs, generally will be required to pay federal corporate income tax on their earnings, and a 100% tax may be imposed on any transaction between us and one of our TRSs that does not reflect arm’s | |
• | Our subsidiaries that are C corporations, includingourTRSs, generally will be required to pay federal corporate income tax on their earnings, and a 100% tax may be imposed on any transaction between us and one of our TRSs that does not reflect arm's length terms. |
As discussed below, we are invested in real estate through a subsidiary that we believe qualifies for taxation as a REIT. If it is determined that this entity failed to qualify for taxation as a REIT, we may fail one or more of the REIT asset tests. In such case, we expect that we would be able to avail ourselves of the relief provisions described below, but would be subject to a tax equal to the greater of $50,000 or the highest regular corporate income tax rate multiplied by the net income we earned from this subsidiary.
If we fail to qualify for taxation as a REIT in any year, then we will be subject to federal income tax in the same manner as a regular C corporation. Further, as a regular C corporation, distributions to our shareholders will not be deductible by us, nor will distributions be required under the IRC. Also, to the extent of our current and accumulated earnings and profits, all distributions to our shareholders will generally be taxable as ordinary dividends potentially eligible for the preferential tax rates discussed below under the heading “Taxation“—Taxation of Taxable U.S. Shareholders” and, subject to limitations in the IRC, will be potentially eligible for the dividends received deduction for corporate shareholders. Finally, we will generally be disqualified from taxation as a REIT for the four taxable years following the taxable year in which the termination of our REIT status is effective. Our failure to qualify for taxation as a REIT for even one year could result in us reducing or eliminating distributions to our shareholders, or in us incurring substantial indebtedness or liquidating substantial investments in order to pay the resulting corporate levelcorporate-level income taxes. Relief provisions under the IRC may allow us to continue to qualify for taxation as a REIT even if we fail to comply with various
REIT requirements, all as discussed in more detail below. However, it is impossible to state whether in any particular circumstance we would be entitled to the benefit of these relief provisions.
REIT Qualification Requirements
General Requirements. Section 856(a) of the IRC defines a REIT as a corporation, trust or association:
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(1) | that is managed by one or more trustees or directors; |
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(2) | the beneficial ownership of which is evidenced by transferable shares or by transferable certificates of beneficial interest; |
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(3) | that would be taxable, but for Sections 856 through 859 of the IRC, as a domestic C corporation; |
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(4) | that is not a financial institution or an insurance company subject to special provisions of the IRC; |
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(5) | the beneficial ownership of which is held by 100 or more persons; |
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(6) | that is not “closely held,” meaning that during the last half of each taxable year, not more than 50% in value of the outstanding shares are owned, directly or indirectly, by five or fewer “individuals” (as defined in the IRC to include specified tax-exempt entities); and |
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(7) | that meets other tests regarding the nature of its income and assets and the amount of its distributions, all as described below. |
Section 856(b) of the IRC provides that conditions (1) through (4) must be met during the entire taxable year and that condition (5) must be met during at least 335 days of a taxable year of 12 months, or during a proportionate part of a taxable year of less than 12 months. Although we cannot be sure, we believe that we have met conditions (1) through (7) during each of the requisite periods ending on or before the close of our most recently completed taxable year, and that we will continue to meet these conditions in our current and future taxable years.
To help comply with condition (6), our declaration of trust restricts transfers of our shares that would otherwise result in concentrated ownership positions. These restrictions, however, do not ensure that we have previously satisfied, and may not ensure that we will in all cases be able to continue to satisfy, the share ownership requirements described in condition (6). If we comply with applicable Treasury regulations to ascertain the ownership of our outstanding shares and do not know, or by exercising reasonable diligence would not have known, that we failed condition (6), then we will be treated as having met condition (6). Accordingly, we have complied and will continue to comply with these regulations, including by requesting annually from holders of significant percentages of our shares information regarding the ownership of our shares. Under our declaration of trust, our shareholders are required to respond to these requests for information. A shareholder that fails or refuses to comply with the request is required by Treasury regulations to submit a statement with its federal income tax return disclosing its actual ownership of our shares and other information.
For purposes of condition (6), an “individual” generally includes a natural person, a supplemental unemployment compensation benefit plan, a private foundation, or a portion of a trust permanently set aside or used exclusively for charitable purposes, but does not include a qualified pension plan or profit-sharing trust. As a result, REIT shares owned by an entity that is not an “individual” are considered to be owned by the direct and indirect owners of the entity that are individuals (as so defined), rather than to be owned by the entity itself. Similarly, REIT shares held by a qualified pension plan or profit-sharing trust are treated as held directly by the individual beneficiaries in proportion to their actuarial interests in such plan or trust. Consequently, five or fewer such trusts could own more than 50% of the interests in an entity without jeopardizing that entity’sentity's qualification for taxation as a REIT.
The IRC provides that we will not automatically fail to qualify for taxation as a REIT if we do not meet conditions (1) through (6), provided we can establish that such failure was due to reasonable cause and not due to willful neglect. Each such excused failure will result in the imposition of a $50,000 penalty instead of REIT disqualification. This relief provision may apply to a failure of the applicable conditions even if the failure first occurred in a year prior to the taxable year in which the failure was discovered.
Our Wholly Owned Subsidiaries and Our Investments Through Partnerships. Except in respect of a TRS as discussed below, Section 856(i) of the IRC provides that any corporation, 100% of whose stock is held by a REIT and its disregarded
subsidiaries, is a qualified REIT subsidiary and shall not be treated as a separate corporation for U.S. federal income tax purposes. The assets, liabilities and items of income, deduction and credit of a qualified REIT subsidiary are treated as the REIT’s.REIT's. We believe that each of our direct and indirect wholly owned subsidiaries, other than the TRSs discussed below (and entities owned in whole or in part by the TRSs), will be either a qualified REIT subsidiary within the meaning of Section 856(i)(2) of the IRC or a noncorporate entity that for federal income tax purposes is not treated as separate from its owner under Treasury regulations issued under Section 7701 of the IRC, each such entity referred to as a QRS. Thus, in applying all of the REIT qualification requirements described in this summary, all assets, liabilities and items of income, deduction and credit of our QRSs are treated as ours, and our investment in the stock and other securities of such QRSs will be disregarded.
We have invested and may in the future invest in real estate through one or more entities that are treated as partnerships for federal income tax purposes. In the case of a REIT that is a partner in a partnership, Treasury regulations under the IRC provide that, for purposes of the REIT qualification requirements regarding income and assets described below, the REIT is generally deemed to own its proportionate share, based on respective capital interests, of the income and assets of the partnership (except that for purposes of the 10% value test, described below, the REIT’sREIT's proportionate share of the partnership’spartnership's assets is based on its proportionate interest in the equity and specified debt securities issued by the partnership). In addition, for these purposes, the character of the assets and items of gross income of the partnership generally remains the same in the hands of the REIT. In contrast, for purposes of the distribution requirements discussed below, we must take into account as a partner our share of the partnership’spartnership's income as determined under the general federal income tax rules governing partners and partnerships under Sections 701 through 777Subchapter K of the IRC.
Subsidiary REITs.REITs. We indirectly own real estate through a subsidiary that we believe has qualified and will remain qualified for taxation as a REIT under the IRC, and we may in the future invest in real estate through one or more other subsidiary entities that are intended to qualify for taxation as REITs. When a subsidiary qualifies for taxation as a REIT separate and apart from its REIT parent, the subsidiary’ssubsidiary's shares are qualifying real estate assets for purposes of the REIT parent’sparent's 75% asset test described below. However, failure of the subsidiary to separately satisfy the various REIT qualification requirements described in this summary or that are otherwise applicable (and failure to qualify for the applicable relief provisions) would generally result in (a) the subsidiary being subject to regular U.S. corporate income tax, as described above, and (b) the REIT parent’sparent's ownership in the subsidiary (i) ceasing to be qualifying real estate assets for purposes of the 75% asset test, (ii) becoming subject to the 5% asset test, the 10% vote test and the 10% value test generally applicable to a REIT’sREIT's ownership in corporations other than REITs and TRSs, and (iii) thereby jeopardizing the REIT parent’sparent's own REIT qualification and taxation on account of the subsidiary’ssubsidiary's failure cascading up to the REIT parent, all as described under “Asset“—Asset Tests” below.
We indirectly own real estate through a subsidiary that we believe has qualified and will remain qualified for taxation as a REIT under the IRC, and we may in the future invest in real estate through one or more other subsidiary entities that are intended to qualify for taxation as REITs. We joined with our subsidiary REIT in filing a protective TRS election, effective for the first quarter of 2017, and we have reaffirmed this protective election with this subsidiary as ofevery January 2018,thereafter, and we may continue to do so every January hereafter unless and until our ownership of this subsidiary falls below 10%. Pursuant to this protective TRS election, we believe that if our subsidiary is not a REIT for some reason, then it would instead be considered one of our TRSs, and as such its value would fit within our REIT gross asset tests described below. ProtectiveWe expect to make similar protective TRS elections willwith respect to any other subsidiary REIT that we form or acquire. We do not expect protective TRS elections to impact our compliance with the 75% and 95% gross income tests described below, because we do not expect our gains and dividends from a subsidiary REIT’sREIT's shares willto jeopardize compliance with these tests even if for some reason the subsidiary is not a REIT.
Taxable REIT Subsidiaries.As a REIT, we are permitted to own any or all of the securities of a TRS, provided that no more than 20% (25% before our 2018 taxable year) of the total value of our assets, at the close of each quarter, is comprised of our investments in the stock or other securities of our TRSs. Very generally, a TRS is a subsidiary corporation other than a REIT in which a REIT directly or indirectly holds stock and that has made a joint election with its affiliated REIT to be treated as a TRS. Our ownership of stock and other securities in our TRSs is exempt from the 5% asset test, the 10% vote test and the 10% value test discussed below. Among other requirements, a TRS of ours must:
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(1) | not directly or indirectly operate or manage a lodging facility or a health care facility; and |
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(2) | not directly or indirectly provide to any person, under a franchise, license or otherwise, rights to any brand name under which any lodging facility or health care facility is operated, except that in limited circumstances a subfranchise, sublicense or similar right can be granted to an independent contractor to operate or manage a lodging facility or a health care facility. |
In addition, any corporation (other than a REIT) in which a TRS directly or indirectly owns more than 35% of the voting power or value of the outstanding securities is automatically a TRS. Subject to the discussion below, we believe that we and each of our TRSs have complied with, and will continue to comply with, the requirements for TRS status at all times during which we intend for the subsidiary’ssubsidiary's TRS election to be in effect, and we believe that the same will be true for any TRS that we later form or acquire.
We acquired in the second quarter of 2015, and continue to own, an ownership position in RMR Inc. that is in excess of 10% of RMR Inc.’s outstanding securities by vote or value. Accordingly, we elected to treat RMR Inc. as a TRS effective as of June 5, 2015. RMR Inc., through its principal subsidiary, RMR LLC, has provided and continues to provide business and property management and other services to us and to other public and private companies, including other public REITs. Among these clients were and are operators of lodging facilities, operators of health care facilities, and owners of such facilities. Our counsel, Sullivan & Worcester LLP, has provided to us an opinion that the activities proscribed to TRSs under Section 856(l)(3) of the IRC relating to operating or managing lodging facilities or health care facilities should include only regular onsite services or day to day operational activities at or for lodging facilities or health care facilities. To the best of our knowledge, neither RMR Inc. nor RMR LLC has been or is involved in proscribed activities at or for lodging facilities or health care facilities. Thus, we do not believe that Section 856(l)(3) of the IRC precluded or precludes RMR Inc. from being treated as our TRS. In addition, because we acquired a significant portion of our investment in RMR Inc. in exchange for our common shares that were newly issued, our counsel, Sullivan & Worcester LLP, is of the opinion that our investment in RMR Inc. should have qualified as a “temporary investment of new capital” under Section 856(c)(5)(B) of the IRC to the extent related to such issuance of our common shares. To the extent our investment in RMR Inc. so qualified, it constituted a “real estate asset” under Section 856(c) of the IRC and did not constitute a security subject to the REIT asset test limitations discussed below for a one year period that ended in June 2016. If the IRS or a court determines, contrary to the opinion of our counsel, that RMR Inc. was or is precluded from being treated as our TRS, then our ownership position in RMR Inc. in excess of 10% of RMR Inc.’s outstanding securities by vote or value, except to the extent and for the period that such ownership qualified as a “temporary investment of new capital,” would have been and would be in violation of the applicable REIT asset tests described below. Under those circumstances, however, we expect that we would qualify for the REIT asset tests’ relief provision described below, and thereby would preserve our qualification for taxation as a REIT. If the relief provision below were to apply to us, we would be subject to tax at the highest regular corporate income tax rate on the net income generated by our investment in RMR Inc. in excess of a 10% ownership position in that company.
In addition, we have elected to treat as a TRS a particular corporate subsidiary of Five Starwith whom we do not have a rental relationship. This intended TRS manages and operates independent living facilities for us, and in the future may operate additional independent living facilities for us. In that role, the intended TRS provides amenities and services to our tenants, the independent living residents; for the duration of our ownership of these independent living facilities, there have not been, and are not expected to be, assisted living or skilled nursing residents at these facilities, and neither we nor the intended TRS have provided or expect to provide health care services at these facilities or elsewhere. Although the law is unclear on this point, and in fact a close read of the statute and legislative history might suggest otherwise, IRS private letter rulings conclude and imply that the management and operation of independent living facilities do not constitute operating or managing a health care facility such that TRS status is precluded, provided that there are no assisted living or skilled nursing residents in the facilities and provided further that neither the REIT nor the intended TRS provide health care services. Although IRS private letter rulings do not generally constitute binding precedent, they do represent the reasoned, considered judgment of the IRS and thus provide insight into how the IRS applies and interprets the federal income tax laws. Based on these IRS private letter rulings, our counsel, Sullivan & Worcester LLP, is of the opinion that it is more likely than not that our intended TRS that manages and operates pure independent living facilities will qualify as a TRS, provided that there are no assisted living or skilled nursing residents in the subject facilities and provided further that neither we nor the intended TRS provide health care services.
As discussed below, TRSs can perform services for our tenants without disqualifying the rents we receive from those tenants under the 75% gross income test or the 95% gross income test discussed below. Moreover, because our TRSs are taxed as C corporations that are separate from us, their assets, liabilities and items of income, deduction and credit generally are not imputed to us for purposes of the REIT qualification requirements described in this summary. Therefore, our TRSs may generally conduct activities that would be treated as prohibited transactions or would give rise to nonqualified income if conducted by us directly. Additionally, while a REIT is generally limited in its ability to earn qualifying rental income from a TRS, a REIT can earn qualifying rental income from the lease of a qualified health care property to a TRS if an eligible independent contractor operates the facility, as discussed more fully below. As regular C corporations, TRSs may generally utilize net operating losses and other tax attribute carryforwards to reduce or otherwise eliminate federal income tax liability in a given taxable year. Net operating losses and other carryforwards are subject to limitations, however, including limitations imposed under Section 382 of the IRC following an “ownership change” (as defined in applicable Treasury regulations) and a limitation stemming from December 2017 amendments to the IRC providing that carryforwards of net operating losses arising in taxable years beginning after 2017 generally cannot offset more than 80% of the current year’syear's taxable income. Moreover, pursuant to the December 2017 amendments to the IRC, net operating losses arising in taxable years beginning after 2017 may not be carried back, but may be carried forward indefinitely. As a result, we cannot be sure that our TRSs will be able to utilize, in full or in part, any net operating losses or other carryforwards that they have generated or may generate in the future.
Restrictions and sanctions are imposed on TRSs and their affiliated REITs to ensure that the TRSs will be subject to an appropriate level of federal income taxation. For example, if a TRS pays interest, rent or other amounts to its affiliated REIT in an amount that exceeds what an unrelated third party would have paid in an arm’sarm's length transaction, then the REIT generally will
be subject to an excise tax equal to 100% of the excessive portion of the payment. Further, if in comparison to an arm’sarm's length transaction, a third party tenant has overpaid rent to the REIT in exchange for underpaying the TRSfor services rendered, and if the REIT has not adequately compensated the TRS for services provided to or on behalf of the third party tenant, then the REIT may be subject to an excise tax equal to 100% of the undercompensation to the TRS. A safe harbor exception to this excise tax applies if the TRS has been compensated at a rate at least equal to 150% of its direct cost in furnishing or rendering the service. Finally, beginning with our 2016 taxable year, the 100% excise tax also applies to the underpricing of services provided by one of our TRSsa TRS to usits affiliated REIT in contexts where the services are unrelated to services for ourREIT tenants. We cannot be sure that arrangements involving our TRSs will not result in the imposition of one or more of these restrictions or sanctions, but we do not believe that we or our TRSs are or will be subject to these impositions.
Income Tests. There areWe must satisfy two gross income requirements fortests annually to maintain our qualification for taxation as a REIT under the IRC:
AtREIT. First, at least 75% of our gross income for each taxable year (excluding: (a) gross income from sales or other dispositions of property subject to the 100% tax on prohibited transactions; (b) any income arising from “clearly identified” hedging transactions that we enter into to manage interest rate or price changes or currency fluctuations with respect to borrowings we incur to acquire or carry real estate assets; (c) any income arising from “clearly identified” hedging transactions that we enter into primarily to manage risk of currency fluctuations relating to any item that qualifies under the 75% gross income test or the 95% gross income test (or any property that generates such income or gain); (d) beginning with our 2016 taxable year, any income from “clearly identified” hedging transactions that we enter into to manage risk associated with extant, qualified hedges of liabilities or properties that have been extinguished or disposed; (e) real estate foreign exchange gain (as defined in Section 856(n)(2) of the IRC); and (f) income from the repurchase or discharge of indebtedness) must be derived from investments relating to real property, including “rents from real property” as defined underwithin the meaning of Section 856856(d) of the IRC, interest and gain from mortgages on real property or on interests in real property, income and gain from foreclosure property, gain from the sale or other disposition of real property (including specified ancillary personal property treated as real property under the IRC), or dividends on and gain from the sale or disposition of shares in other REITs (but excluding in all cases any gains subject to the 100% tax on prohibited transactions). When we receive new capital in exchange for our shares or in a public offering of our five yearfive-year or longer debt instruments, income attributable to the temporary investment of this new capital in stock or a debt instrument, if received or accrued within one year of our receipt of the new capital, is generally also qualifying income under the 75% gross income test.
At Second, at least 95% of our gross income for each taxable year (excluding: (a) grossmust consist of income from sales or other dispositionsthat is qualifying income for purposes of property subject to the 100% tax on prohibited transactions; (b) any income arising from “clearly identified” hedging transactions that we enter into to manage interest rate or price changes or currency fluctuations with respect to borrowings we incur to acquire or carry real estate assets; (c) any income arising from “clearly identified” hedging transactions that we enter into primarily to manage risk of currency fluctuations relating to any item that qualifies under the 75% gross income test,
other types of interest and dividends, gain from the sale or the 95% grossdisposition of stock or securities, or any combination of these. Gross income test (or anyfrom our sale of property that generateswe hold primarily for sale to customers in the ordinary course of business, income and gain from specified “hedging transactions” that are clearly and timely identified as such, income or gain); (d) beginning with our 2016 taxable year, any income from “clearly identified” hedging transactions that we enter into to manage risk associated with extant, qualified hedges of liabilities or properties that have been extinguished or disposed; (e) passive foreign exchange gain (as defined in Section 856(n)(3) of the IRC); and (f) income from the repurchase or discharge of indebtedness) must be derivedindebtedness is excluded from a combination of items of real property income that satisfyboth the 75%numerator and the denominator in both gross income test described above, dividends, interest, ortests. In addition, specified foreign currency gains from the sale or disposition of stock, securities or real property (but excluding in all cases any gains subject to the 100% tax on prohibited transactions).
Although we will use our best efforts to ensure that the income generated by our investments will be of a type that satisfies both the 75% and 95%excluded from gross income tests, there can be no assurance in this regard.for purposes of one or both of the gross income tests.
In order to qualify as “rents from real property” underwithin the meaning of Section 856856(d) of the IRC, several requirements must be met:
The amount of rent received generally must not be based on the income or profits of any person, but may be based on a fixed percentage or percentages of receipts or sales.
Rents generally do not qualify if the REIT owns 10% or more by vote or value of stock of the tenant (or 10% or more of the interests in the assets or net profits of the tenant, if the tenant is not a corporation), whether directly or after application of attribution rules. We generally do not intend to lease property to any party if rents from that property would not qualify as “rents from real property,” but application of the 10% ownership rule is dependent upon complex attribution rules and circumstances that may be beyond our control. In this regard, prior to the termination of our leases with Five Star, we already ownowned close to, but less than, 10% of the outstanding common shares of Five Star, and Five Star has undertaken to limit its redemptions of outstanding common shares so that we do not come to own 10% or more of its outstanding common shares.Star. Our declaration of trust generally disallowstransfers or purported acquisitions, directly or by attribution, of our shares to the extent necessary to maintain our
qualification for taxation as a REIT under the IRC. Nevertheless, we cannot be sure that these restrictions will be effective to prevent our qualification for taxation as a REIT from being jeopardized under the 10% affiliated tenant rule. Furthermore, we cannot be sure that we will be able to monitor and enforce these restrictions, nor will our shareholders necessarily be aware of ownership of our shares attributed to them under the IRC’sIRC's attribution rules.
There is a limited exception to the above prohibition on earning “rents from real property” from a 10% affiliated tenant where the tenant is a TRS. If at least 90% of the leased space of a property is leased to tenants other than TRSs and 10% affiliated tenants, and if the TRS’sTRS's rent to the REIT for space at that property is substantially comparable to the rents paid by nonaffiliated tenants for comparable space at the property, then otherwise qualifying rents paid by the TRS to the REIT will not be disqualified on account of the rule prohibiting 10% affiliated tenants.
There is an additional exception to the above prohibition on earning “rents from real property” from a 10% affiliated tenant. For this additional exception to apply, a real property interest in a “qualified health care property” must be leased by the REIT to its TRS, and the facility must be operated on behalf of the TRS by a person who is an “eligible independent contractor,” all as described in Sections 856(d)(8)-(9) and 856(e)(6)(D) of the IRC. As described below, we believe our leases with our TRSs have satisfied and will continue to satisfy these requirements.
In order for rents to qualify, we generally must not manage the property or furnish or render services to the tenants of the property, except through an independent contractor from whom we derive no income or through one of our TRSs. There is an exception to this rule permitting a REIT to perform customary management and tenant services of the sort that a tax-exempt organization could perform without being considered in receipt of “unrelated business taxable income,” or UBTI, under Section 512(b)(3) of the IRC. In addition, a de minimis amount of noncustomary services provided to tenants will not disqualify income as “rents from real property” as long as the value of the impermissible tenant services does not exceed 1% of the gross income from the property.
If rent attributable to personal property leased in connection with a lease of real property is 15% or less of the total rent received under the lease, then the rent attributable to personal property qualifies as “rents from real property.” None of the rent attributable to personal property received under a lease will qualify if this 15% threshold is exceeded. The portion of rental income treated as attributable to personal property is determined according to the ratio of the fair market value of the personal property to the total fair market value of the real and personal property that is rented. | |
• | In order for rents to qualify, a REIT generally must not manage the property or furnish or render services to the tenants of the property, except through an independent contractor from whom it derives no income or through one of its TRSs. There is an exception to this rule permitting a REIT to perform customary management and tenant services of the sort that a tax-exempt organization could perform without being considered in receipt of “unrelated business taxable income” as defined in Section 512(b)(3) of the IRC, or UBTI. In addition, a de minimis amount of noncustomary services provided to tenants will not disqualify income as “rents from real property” as long as the value of the impermissible tenant services does not exceed 1% of the gross income from the property. |
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• | If rent attributable to personal property leased in connection with a lease of real property is 15% or less of the total rent received under the lease, then the rent attributable to personal property will qualify as “rents from real property”; if this 15% threshold is exceeded, then the rent attributable to personal property will not so qualify. The portion of rental income treated as attributable to personal property is determined according to the ratio of the fair market valueof the personal property to the total fair market value of the real and personal property that is rented. |
In addition, “rents from real property” includes both charges we receive for services customarily rendered in connection with the rental of comparable real property in the same geographic area, even if the charges are separately stated, as well as charges we receive for services provided by our TRSs when the charges are not separately stated. Whether separately stated charges received by a REIT for services that are not geographically customary and provided by a TRS are included in “rents from real property” has not been addressed clearly by the IRS in published authorities; however, our counsel, Sullivan & Worcester LLP, is of the opinion that, although the matter is not free from doubt, “rents from real property” also includes charges we receive for services provided by our TRSs when the charges are separately stated, even if the services are not geographically customary. Accordingly, we believe that our revenues from TRS providedTRS-provided services,
whether the charges are separately stated or not, qualify as “rents from real property” because the services satisfy the geographically customary standard, because the services have been provided by a TRS, or for both reasons.
We believe that all or substantially all of our rents and related service charges have qualified and will continue to qualify as “rents from real property” for purposes of Section 856 of the IRC, subject to the considerations in the following paragraph.
As discussed above, we currently own independent living facilities that we purchased to be managed and operated by a TRS; the TRS provides amenities and services, but not health care services, to the facilities’ residents, who are our tenants. We may from time to time in the future acquire additional properties to be managed and operated in this manner. Our counsel, Sullivan & Worcester LLP, is of the opinion that it is more likely than not that our intended TRS that manages and operates independent living facilities will qualify as a TRS, provided that there are no assisted living or skilled nursing residents in the subject facilities and provided further that neither we nor the intended TRS provide health care services. Accordingly, we expect that the rents we receive from these facilities’ independent living residents will qualify as “rents from real property” because services and amenities to them are provided through a TRS. If the IRS should assert, contrary to its current private letter ruling practice, that our intended TRS does not in fact so qualify, and if a court should agree, then the rental income we receive from the independent living facility residents who are our tenants would be nonqualifying income for purposes of the 75% and 95% gross income tests, possibly jeopardizing our compliance with the 95% gross income test. Under those circumstances, however, we expect that we would qualify for the gross income tests’ relief provision described below, and thereby would preserve our qualification for taxation as a REIT. If the relief provision below were to apply to us, we would be subject to tax at a 100% rate on the amount by which we failed the 95% gross income test, with adjustments, multiplied by a fraction intended to reflect our profitability for the taxable
year; however, in a typical taxable year, we have little or no nonqualifying income from other sources and thus would expect to owe little tax in such circumstances.
In order to qualify as mortgage interest on real property for purposes of the 75% gross income test, interest must derive from a loan secured by a mortgage on real property or on interests in real property (including, in the case of a loan secured by both real property and personal property, such personal property to the extent that it does not exceed 15% of the total fair market value of all of the property securing the loan) with a fair market value at the time the loan is made (reduced by any senior liens on the property) at least equal to the amount of such loan. If the amount of the loan exceeds the fair market value of the real property (as so reduced by senior liens), then a part of the interest income from such loan equal to the percentage amount by which the loan exceeds the value of the real property (as so reduced by senior liens) will not be qualifying income for purposes of the 75% gross income test, but will be qualifying income for purposes of the 95% gross income test.IRC.
Absent the “foreclosure property” rules of Section 856(e) of the IRC, a REIT’sREIT's receipt of active, nonrental gross income from a property would not qualify under the 75% and 95% gross income tests. But as foreclosure property, the active, nonrental gross income from the property would so qualify. Foreclosure property is generally any real property, including interests in real property, and any personal property incident to such real property:
that is acquired by a REIT as a result of the REIT having bid on such property at foreclosure, or having otherwise reduced such property to ownership or possession by agreement or process of law, after there was a default or when default was imminent on a lease of such property or on indebtedness that such property secured;
for which any related loan acquired by the REIT was acquired at a time when the default was not imminent or anticipated; and
for which the REIT makes a proper election to treat the property as foreclosure property.
Any gain that a REIT recognizes on the sale of foreclosure property held as inventory or primarily for sale to customers, plus any income it receives from foreclosure property that would not otherwise qualify under the 75% gross income test in the absence of foreclosure property treatment, reduced by expenses directly connected with the production of those items of income, would be subject to income tax at the highest regular corporate income tax rate under the foreclosure property income tax rules of Section 857(b)(4) of the IRC. Thus, if a REIT should lease foreclosure property in exchange for rent that qualifies as “rents from real property” as described above, then that rental income is not subject to the foreclosure property income tax.
Property generally ceases to be foreclosure property at the end of the third taxable year following the taxable year in which the REIT acquired the property, or longer if an extension is obtained from the IRS. However, this grace period terminates and foreclosure property ceases to be foreclosure property on the first day:
on which a lease is entered into for the property that, by its terms, will give rise to income that does not qualify for purposes of the 75% gross income test (disregarding income from foreclosure property), or any amountnonqualified income under the 75% gross income test is received or accrued by the REIT, directly or indirectly, pursuant to a lease entered into on or after such day that will give rise to income that does not qualify for purposes of the 75% gross income test;day;
on which any construction takes place on the property, other than completion of a building or any other improvement where more than 10% of the construction was completed before default became imminent and other than specifically exempted forms of maintenance or deferred maintenance; or
which is more than 90 days after the day on which the REIT acquired the property and the property is used in a trade or business which is conducted by the REIT, other than through an independent contractor from whom the REIT itself does not derive or receive any income or a TRS.
Other than sales of foreclosure property, any gain that we realize on the sale of property held as inventory or other property held primarily for sale to customers in the ordinary course of a trade or business, together known as dealer gains, may be treated as income from a prohibited transaction that is subject to a penalty tax at a 100% rate. The 100% tax does not apply to gains from the sale of property that is held through a TRS, butalthough such income will be subject to tax in the hands of the TRS at regular corporate income tax rates; we may therefore utilize our TRSs in transactions in which we might otherwise recognize dealer gains. Whether property is held as inventory or primarily for sale to customers in the ordinary course of a trade or business is a question of fact that depends on all the facts and circumstances surrounding each particular transaction. Sections 857(b)(6)(C) and (E) of the IRC provide safe harbors pursuant to which limited sales of real property held for at least two years and meeting specified additional requirements will not be treated as prohibited transactions. However, compliance with the safe harbors is not always achievable
in practice. We attempt to structure our activities to avoid transactions that are prohibited transactions, or otherwise conduct such activities through TRSs. WeTRSs; but, we cannot be sure whether or not the IRS might successfully assert that one or more of our dispositions is subject to the 100% penalty tax. Gains subject to the 100% penalty tax are excluded from the 75% and 95% gross income tests, whereas real property gains that are not dealer gains or that are exempted from the 100% penalty tax on account of the safe harbors are considered qualifying gross income for purposes of the 75% and 95% gross income tests.
We believe that any gain from dispositions of assets that we have made, or that we might make in the future, including through any partnerships, will generally qualify as income that satisfies the 75% and 95% gross income tests, to the extent that such assets qualify as real property, and will not be dealer gains or subject to the 100% penalty tax,tax. This is because our general intent has been and is to:
(a) own our assets for investment with a view to long termlong-term income production and capital appreciation;
(b) engage in the business of developing, owning, leasing and managing our existing properties and acquiring, developing, owning, leasing and managing new properties; and
(c) make occasional dispositions of our assets consistent with our long termlong-term investment objectives.
If we fail to satisfy one or both of the 75% gross income test or the 95% gross income test in any taxable year, we may nevertheless qualify for taxation as a REIT for that year if we satisfy the following requirements:
(a) our failure to meet the test is due to reasonable cause and not due to willful neglect; and
(b) after we identify the failure, we file a schedule describing each item of our gross income included in the 75% gross income test or the 95% gross income test for that taxable year.
Even if this relief provision does apply, a 100% tax is imposed upon the greater of the amount by which we failed the 75% gross income test or the amount by which we failed the 95% gross income test, with adjustments, multiplied by a fraction intended to reflect our profitability for the taxable year. This relief provision may apply to a failure of the applicable income tests even if the failure first occurred in a year prior to the taxable year in which the failure was discovered.
Based on the discussion above, we believe that we have satisfied, and will continue to satisfy, the 75% and 95% gross income tests outlined above on a continuing basis beginning with our first taxable year as a REIT.
Asset Tests.Tests. At the close of each calendar quarter of each taxable year, we must also satisfy the following asset percentage tests in order to qualify for taxation as a REIT for federal income tax purposes:
At least 75% of the value of our total assets must consist of “real estate assets,” defined as real property (including interests in real property and interests in mortgages on real property or on interests in real property), ancillary personal property to the extent that rents attributable to such personal property are treated as rents from real property in accordance with the rules described above, (beginning with our 2016 taxable year), cash and cash items, shares in other REITs, debt instruments issued by “publicly offered REITs” as defined in Section 562(c)(2) of the IRC, (beginning with our 2016 taxable year), government securities and temporary investments of new capital (that is, any stock or debt instrument that we hold that is attributable to any amount received by us (a) in exchange for our stock or (b) in a public offering of our five yearfive-year or longer debt instruments, but in each case only for the one yearone-year period commencing with our receipt of the new capital).
Not more than 25% of the value of our total assets may be represented by securities other than those securities that count favorably toward the preceding 75% asset test.
Of the investments included in the preceding 25% asset class, the value of any one non-REIT issuer’sissuer's securities that we own may not exceed 5% of the value of our total assets. In addition, we may not own more than 10% of the vote or value of any one non-REIT issuer’sissuer's outstanding securities, unless the securities are “straight debt” securities or otherwise excepted as discussed below. Our stock and other securities in a TRS are exempted from these 5% and 10% asset tests.
Not more than 20% (25% before our 2018 taxable year) of the value of our total assets may be represented by stock or other securities of our TRSs.
Beginning with our 2016 taxable year, notNot more than 25% of the value of our total assets may be represented by “nonqualified publicly offered REIT debt instruments” as defined in Section 856(c)(5)(L)(ii) of the IRC.
Our counsel, Sullivan & Worcester LLP, is of the opinion that, although the matter is not free from doubt, our investments in the equity or debt of a TRS of ours, to the extent that and during the period in which theyqualify as temporary investments of new capital, will be treated as real estate assets, and not as securities, for purposes of the above REIT asset tests.
If we own a loan secured by a mortgage on real property or on interests in real property (including, in the case of a loan secured by both real property and personal property, such personal property to the extent that it does not exceed 15% of the total fair market value of all of the property securing the loan) with a fair market value at the time the loan is made (reduced by any senior liens on the property) at least equal to the amount of such loan, the mortgage loan will generally be treated as a real estate asset for purposes of the 75% asset test above. But if the loan is undersecured when made, then the portion adequately secured by the real property (or the interests in real property) will generally be treated as a real estate asset for purposes of the 75% asset test above and the remaining portion will generally be treated as a separate security that must satisfy applicable asset tests.
The above REIT asset tests must be satisfied at the close of each calendar quarter of each taxable year as a REIT. After a REIT meets the asset tests at the close of any quarter, it will not lose its qualification for taxation as a REIT in any subsequent quarter solely because of fluctuations in the values of its assets. This grandfathering rule may be of limited benefit to a REIT such as us that makes periodic acquisitions of both qualifying and nonqualifying REIT assets. When a failure to satisfy the above asset tests results from an acquisition of securities or other property during a quarter, the failure can be cured by disposition of sufficient nonqualifying assets withinthirtydays after the close of that quarter.
In addition, if we fail the 5% asset test, the 10% vote test or the 10% value test at the close of any quarter and we do not cure such failure within thirtydays after the close of that quarter, that failure will nevertheless be excused if (a) the failure is de minimis and (b) within six months after the last day of the quarter in which we identify the failure, we either dispose of the assets
causing the failure or otherwise satisfy the 5% asset test, the 10% vote test and the 10% value test. For purposes of this relief provision, the failure will be de minimis if the value of the assets causing the failure does not exceed $10,000,000. If our failure is not de minimis, or if any of the other REIT asset tests have been violated, we may nevertheless qualify for taxation as a REIT if (a) we provide the IRS with a description of each asset causing the failure, (b) the failure was due to reasonable cause and not willful neglect, (c) we pay a tax equal to the greater of (1) $50,000 or (2) the highest regular corporate income tax rate imposed on the net income generated by the assets causing the failure during the period of the failure, and (d) within six months after the last day of the quarter in which we identify the failure, we either dispose of the assets causing the failure or otherwise satisfy all of the REIT asset tests. These relief provisions may apply to a failure of the applicable asset tests even if the failure first occurred in a year prior to the taxable year in which the failure was discovered.
The IRC also provides an excepted securities safe harbor to the 10% value test that includes among other items (a) “straight debt” securities, (b) specified rental agreements in which payment is to be made in subsequent years, (c) any obligation to pay “rents from real property,” (d) securities issued by governmental entities that are not dependent in whole or in part on the profits of or payments from a nongovernmental entity, and (e) any security issued by another REIT. In addition, any debt instrument issued by an entity classified as a partnership for federal income tax purposes, and not otherwise excepted from the definition of a security for purposes of the above safe harbor, will not be treated as a security for purposes of the 10% value test if at least 75% of the partnership’spartnership's gross income, excluding income from prohibited transactions, is qualifying income for purposes of the 75% gross income test.
We have maintained and will continue to maintain records of the value of our assets to document our compliance with the above asset tests and intend to take actions as may be required to cure any failure to satisfy the tests within thirtydays after the close of any quarter or within the six month periods described above.
Based on the discussion above, we believe that we have satisfied, and will continue to satisfy, the REIT asset tests outlined above on a continuing basis beginning with our first taxable year as a REIT.
Our Relationships with Five Star. As of December 31, 2017,Prior to January 1, 2020, we owned approximately 9%a significant percentage (but less than 10%) of the outstanding common shares of Five Star. Our leases with Five Star, Five Star’s charter, and other agreements collectively contain restrictions upon the ownership of Five Star common shares and require Five Star to refrain from taking any actions that may result in any affiliation with us that would jeopardize our qualification for taxation as a REIT under the IRC. Accordingly, commencingCommencing with our 2002 taxable year and through and including our 2019 taxable year, we expect that the rental income we have received and will receive from Five Star and its subsidiaries has been and will beconstituted “rents from real property” under Section 856(d) of the IRC, and therefore qualifying income under the 75% and 95% gross income tests described above. In addition, as described above,From and after January 1, 2020, we have come to own (directly and indirectly through one of our TRSs) just under 35% of the outstanding common shares of Five Star. We have not elected to treat Five Star as a TRS and it is not otherwise an automatic TRS because no TRS of ours owns more than 35% of Five Star. This structure for our Five Star ownership permits our continued engagement of a particular corporate subsidiary of Five Star with whom we do not have a rental relationship, andto manage health care facilities leased to our counsel, Sullivan & Worcester LLP, is of the opinion that it is more likely
than not that this intended TRS will so qualify. Finally,TRSs, as described below we have engaged as an intended eligible independent contractor another corporate subsidiary of Five Star with whom we do not have a rental relationship.in greater detail.
Our Relationship with Our Taxable REIT Subsidiaries. In addition We currently own properties that we purchased to be leased to our TRSs or which are being leased to our TRSs as a result of modifications to, or expirations of, a prior lease, all as agreed to by applicable parties. For example, in connection with past lease defaults and expirations, we have terminated occupancy of some of our health care properties by the TRS described above that managesdefaulting or expiring tenants and operates independent living facilitiesimmediately leased these properties to our TRSs and entered into new third party management agreements for us, we also have wholly owned TRSs that lease properties from us.these properties. We may from time to time in the future acquirelease additional health care properties to be leased in this manner. In addition, in response to a lease default or expiration, we may choose to lease a reclaimed qualified health care property to a TRS.our TRSs.
In lease transactions involving our TRSs, our general intent is for the rents paid to us by the TRS to qualify as “rents from real property” under the REIT gross income tests summarized above. In order for this to be the case, the manager operating the leased property on behalf of the applicable TRS must be an “eligible independent contractor” within the meaning of Section 856(d)(9)(A) of the IRC, and the properties leased to the TRS must be “qualified health care properties” within the meaning of Section 856(e)(6)(D) of the IRC. Qualified health care properties are defined as health care facilities and other properties necessary or incidental to the use of a health care facility.
For these purposes, a contractor qualifies as an “eligible independent contractor” if it is less than 35% affiliated with the REIT and, at the time the contractor enters into the agreement with the TRS to operate the qualified health care property, that contractor or any person related to that contractor is actively engaged in the trade or business of operating qualified health care properties for persons unrelated to the TRS or its affiliated REIT. For these purposes, an otherwise eligible independent contractor is not disqualified from that status on account of (a) the TRS bearing the expenses of the operation of the qualified health care property, (b) the TRS receiving the revenues from the operation of the qualified health care property, net of expenses for that operation and fees payable to the eligible independent contractor, or (c) the REIT receiving income from the eligible independent contractor pursuant to a preexisting or otherwise grandfathered lease of another property.
We have engaged as an intended eligible independent contractor a particular corporate subsidiary of Five Star with whom we do not have a rental relationship.Star. This contractor and its affiliates at Five Star are actively engaged in the trade or business of operating qualified health care properties for their own accounts, including pursuant to management contracts among themselves and including properties that we do not lease to them;themselves; however, this contractor and its affiliates have few if any management contracts for qualified health care properties with third parties other than us and our TRSs. Based on a plain reading of the statute as well as applicable legislative history, our counsel, Sullivan & Worcester LLP, has opined that this intended eligible independent contractor should in fact so qualify. If the IRS or a court determines that this opinion is incorrect, then the rental income we receive from our TRSs in respect of properties managed by this particular contractor would be nonqualifying income for purposes of the 75% and 95% gross income tests, possibly jeopardizing our compliance with one or both of these gross income tests. Under those circumstances, however, we expect we would qualify for the gross income tests’tests' relief provision described above, and thereby would preserve our qualification for taxation as a REIT. If the relief provision were to apply to us, we would be subject to tax at a 100% rate upon the greater of the amount by which we failed the 75% gross income test or the amount by which we failed the 95% gross income test, with adjustments, multiplied by a fraction intended to reflect our profitability for the taxable year; even though we have little or no nonqualifying income from other sources in a typical taxable year, imposition of this 100% tax in this circumstance could be material because to date allmost of the properties leased to our TRSs are managed for the TRSs by this contractor.
As explained above, we will be subject to a 100% tax on the rents paid to us by any of our TRSs if the IRS successfully asserts that those rents exceed an arm’sarm's length rental rate. Although there is no clear precedent to distinguish for federal income tax purposes among leases, management contracts, partnerships, financings, and other contractual arrangements, we believe that our leases and our TRSs’TRSs' management agreements will be respected for purposes of the requirements of the IRC discussed above. Accordingly, we expect that the rental income from our current and future TRSs will qualify as “rents from real property,” and that the 100% tax on excessive rents from a TRS will not apply.
Annual Distribution Requirements.Requirements. In order to qualify for taxation as a REIT under the IRC, we are required to make annual distributions other than capital gain dividends to our shareholders in an amount at least equal to the excess of:
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(1) | the sum of 90% of our “real estate investment trust taxable income” and 90% of our net income after tax, if any, from property received in foreclosure, over |
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(2) | the amount by which our noncash income (e.g., imputed rental income or income from transactions inadvertently failing to qualify as like-kind exchanges) exceeds 5% of our “real estate investment trust taxable income.” |
For these purposes, our “real estate investment trust taxable income” is as defined under Section 857 of the IRC and is computed without regard to the dividends paid deduction and our net capital gain and will generally be reduced by specified corporate levelcorporate-level income taxes that we pay (e.g., taxes on built-in gains or foreclosure property income).
The December 2017 amendments to the IRC generally limitlimits the deductibility of net interest expense paid or accrued on debt properly allocable to a trade or business to 30% of “adjusted taxable income,” subject to specified exceptions. Any deduction in excess of the limitation is carried forward and may be used in a subsequent year, subject to that year’syear's 30% limitation. Provided a taxpayer makes an election (which is irrevocable), the 30% limitation does not apply to a trade or business involving real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage, within the meaning of Section 469(c)(7)(C) of the IRC. LegislativeWhile legislative history indicatesand proposed Treasury regulations indicate that a real property trade or business includes a trade or business conducted by a corporation or a REIT. We intend to makeREIT, we have not yet made an election to be treated as a real property trade or business and accordingly do not expect the foregoing interest deduction limitations to apply to us or to the calculation of our real estate investment trust taxable income.
For our 2014 and prior taxable years, a distribution of ours that was not pro rata within a class of our beneficial interests entitled to a distribution, or which was not consistent with the rights to distributions among our classes of beneficial interests, would have been a preferential distribution that would not have been taken into consideration for purposes of the distribution requirements, and accordingly the payment of a preferential distribution would have affected our ability to meet the distribution requirements. Taking into account our distribution policies, including any dividend reinvestment plan we adopted, we do not believe that we made any preferential distributions in 2014 or prior taxable years. From and after our 2015 taxable year, the preferential distribution rule has not applied to us because we have been and expect to remain a “publicly offered REIT” (as defined in Section 562(c)(2) of the IRC) that is required to file annual and periodic reports with the SECunder the Exchange Act.business.
Distributions must be paid in the taxable year to which they relate, or in the following taxable year if declared before we timely file our federal income tax return for the earlier taxable year and if paid on or before the first regular distribution payment after that declaration. If a dividend is declared in October, November or December to shareholders of record during one of those months and is paid during the following January, then for federal income tax purposes such dividend will be treated as having been both paid and received on December 31 of the prior taxable year.year to the extent of any undistributed earnings and profits.
The 90% distribution requirements may be waived by the IRS if a REIT establishes that it failed to meet them by reason of distributions previously made to meet the requirements of the 4% excise tax discussed below. To the extent that we do not distribute all of our net capital gain and all of our “real estate investment trust taxable income,” as adjusted, we will be subject to federal income tax at regular corporate income tax rates on undistributed amounts. In addition, we will be subject to a 4% nondeductible excise tax to the extent we fail within a calendar year to make required distributions to our shareholders of 85% of our ordinary income and 95% of our capital gain net income plus the excess, if any, of the “grossed up required distribution” for the preceding calendar year over the amount treated as distributed for that preceding calendar year. For this purpose, the term “grossed up required distribution” for any calendar year is the sum of our taxable income for the calendar year without regard to
the deduction for dividends paid and all amounts from earlier years that are not treated as having been distributed under the provision. We will be treated as having sufficient earnings and profits to treat as a dividend any distribution by us up to the amount required to be distributed in order to avoid imposition of the 4% excise tax.
If we do not have enough cash or other liquid assets to meet the 90% distribution requirements, or if we so choose, we may find it necessary or desirable to arrange for new debt or equity financing to provide funds for required distributions in order to maintain our qualification for taxation as a REIT. We cannot be sure that financing would be available for these purposes on favorable terms, or at all.
We may be able to rectify a failure to pay sufficient dividends for any year by paying “deficiency dividends” to shareholders in a later year. These deficiency dividends may be included in our deduction for dividends paid for the earlier year, but an interest charge would be imposed upon us for the delay in distribution. While the payment of a deficiency dividend will apply to a prior year for purposes of our REIT distribution requirements and our dividends paid deduction, it will be treated as an additional distribution to the shareholders receiving it in the year such dividend is paid.
In addition to the other distribution requirements above, to preserve our qualification for taxation as a REIT we are required to timely distribute all C corporation earnings and profits that we inherit from acquired corporations, as described below.
Acquisitions of C Corporations
Wehave engaged in andmay in the future engage in transactions where we acquire all of the outstanding stock of a C corporation. Upon these acquisitions, except to the extent wehave made or domake an applicable TRS election, each of our acquired entities and their various wholly ownedwholly-owned corporate and noncorporate subsidiaries generally became orwill become our QRSs. Thus, after such acquisitions, all assets, liabilities and items of income, deduction and credit of the acquired and then disregarded entities have been andwill be treated as ours for purposes of the various REIT qualification tests described above. In addition, we generally have been andwill be treated as the successor to the acquired and(and then disregarded entities’disregarded) entities' federal income
tax attributes, such as those entities’entities' (a) adjusted tax bases in their assets and their depreciation schedules; and (b) earnings and profits for federal income tax purposes, if any. The carryover of these attributes creates REIT implications such as built-in gains tax exposure and additional distribution requirements, as described below. However, when wemake an election under Section 338(g) of the IRC with respect to corporations that we acquire, as we have done from time to time in the past,we generally will not be subject to such attribute carryovers in respect of attributes existing prior to such election.
Built-in Gains from C Corporations.Notwithstanding our qualification and taxation as a REIT, under specified circumstances we may be subject to corporate income taxation if we acquire a REIT asset where our adjusted tax basis in the asset is determined by reference to the adjusted tax basis of the asset as owned by a C corporation. For instance, we may be subject to federal income taxation on all or part of the built-in gain that was present on the last date an asset was owned by a C corporation, if we succeed to a carryover tax basis in that asset directly or indirectly from such C corporation and if we sell the asset during the five year period beginning on the day the asset ceased being owned by such C corporation. To the extent of our income and gains in a taxable year that are subject to the built-in gains tax, net of any taxes paid on such income and gains with respect to that taxable year, our taxable dividends paid in the following year will be potentially eligible for taxation to noncorporate U.S. shareholders at the preferential tax rates for “qualified dividends” as described below under the heading “Taxation“—Taxation of Taxable U.S. Shareholders”. We generally have not sold anddo not expect to sell assets if doing so would result in the imposition of a material built-in gains tax liability; but if and when we do sell assets that may have associated built-in gains tax exposure, then we expect to make appropriate provision for the associated tax liabilities on our financial statements.
Earnings and Profits. Following a corporate acquisition, we must generally distribute all of the C corporation earnings and profits inherited in that transaction, if any, no later than the end of our taxable year in which the transaction occurs, in order to preserve our qualification for taxation as a REIT. However, if we fail to do so, relief provisions would allow us to maintain our qualification for taxation as a REIT provided we distribute any subsequently discovered C corporation earnings and profits and pay an interest charge in respect of the period of delayed distribution. C corporation earnings and profits that we inherit are, in general, specially allocated under a priority rule to the earliest possible distributions following the event causing the inheritance, and only then is the balance of our earnings and profits for the taxable year allocated among our distributions to the extent not already treated as a distribution of C corporation earnings and profits under the priority rule. The distribution of these C corporation earnings and profits is potentially eligible for taxation to noncorporate U.S. shareholders at the preferential tax rates for “qualified dividends” as described below under the heading “Taxation“—Taxation of Taxable U.S. Shareholders”.
Depreciation and Federal Income Tax Treatment of Leases
Our initial tax bases in our assets will generally be our acquisition cost. As described above and pursuant to the December 2017 amendments to the IRC, we intend to make an election to be treated as an electing real property trade or business pursuant to Section 163(j)(7)(B) of the IRC; depreciable real property (including specified improvements) held by electing real property trades or businesses must be depreciated under the alternative depreciation system under the IRC, which generally imposes a class life for depreciable real property as long as forty years. We will generally depreciate our depreciable real property on a straight-line basis over forty years and our personal property over the applicable shorter periods. These depreciation schedules, and our initial tax bases, may vary for properties that we acquire through tax-free or carryover basis acquisitions, or that are the subject of cost segregation analyses.
We are entitled to depreciation deductions from our facilities only if we are treated for federal income tax purposes as the owner of the facilities. This means that the leases of our facilities must be classified for U.S. federal income tax purposes as true leases, rather than as sales or financing arrangements, and we believe this to be the case.
Distributions to our Shareholders
General. As described above, we expect to make distributions to our shareholders from time to time. These distributions may include cash distributions, in kind distributions of property (such as our pro rata distribution that we paid on January 1, 2020, to our shareholders of record as of December 13, 2019, of the right to receive an aggregate number of Five Star common shares that equaled approximately 51% of Five Star's outstanding common shares, or the FVE Distribution), and deemed or constructive distributions resulting from capital market activities. The U.S. federal income tax treatment of our distributions will vary based on the status of the recipient shareholder as more fully described below under the headings “Taxation“—Taxation of Taxable U.S. Shareholders,” “Taxation“—Taxation of Tax-Exempt U.S. Shareholders,” and “Taxation“—Taxation of Non-U.S. Shareholders.”
ASection 302 of the IRC treats a redemption of our shares for cash only will be treated as a distribution under Section 302301 of the IRC, and hence taxable as a dividend to the extent of our available current or accumulated earnings and profits, unless the redemption satisfies one of the tests set forth in Section 302(b) of the IRC enabling the redemption to be treated as a sale or exchange of the shares. The redemption for cash only will be treated as a sale or exchange if it (a) is “substantially disproportionate” with respect to the surrendering shareholder’sshareholder's ownership in us, (b) results in a “complete termination” of the surrendering shareholder’sshareholder's entire share interest in us, or (c) is “not essentially equivalent to a dividend” with respect to the surrendering shareholder, all within the meaning of
Section 302(b) of the IRC. In determining whether any of these tests have been met, a shareholder must generally take into account shares considered to be owned by such shareholder by reason of constructive ownership rules set forth in the IRC, as well as shares actually owned by such shareholder. In addition, if a redemption is treated as a distribution under the preceding tests, then a shareholder’sshareholder's tax basis in the redeemed shares generally will be transferred to the shareholder’sshareholder's remaining shares in us, if any, and if such shareholder owns no other shares in us, such basis generally may be transferred to a related person or may be lost entirely. Because the determination as to whether a shareholder will satisfy any of the tests of Section 302(b) of the IRC depends upon the facts and circumstances at the time that our shares are redeemed, we urge you to consult your own tax advisor to determine the particular tax treatment of any redemption.
FVE Distribution. The FVE Distribution is treated as a 2020 distribution by us to our common shareholders in the amount of the fair market value of the Five Star common shares that a shareholder ultimately received (including any fractional shares deemed to have been received, as described in the next sentence). Any cash received by a shareholder in lieu of a fractional Five Star common share is treated as if such fractional Five Star common share had been (i) received by such shareholder and then (ii) sold for the amount of cash received. Because we expect the value of our total 2020 distributions to exceed our 2020 current and accumulated earnings and profits, we expect that a portion of each distribution in 2020 (including the FVE Distribution) will be taxable to each of our common shareholders as a dividend and a portion will be treated as a return of capital that reduces such shareholder's adjusted tax basis in our common shares. A shareholder's tax basis in the Five Star common shares received equals the fair market value of such shares on the issuance date, and the holding period for such Five Star common shares began the day after the issuance date. Because of the factual nature of value determinations, Sullivan & Worcester LLP is unable to render an opinion on the fair market value of the Five Star common shares received by our common shareholders. Nevertheless, we believe that the fair market value of the Five Star common shares may be properly determined for federal income tax purposes as the closing price of the Five Star common shares in the public market on December 31, 2019 (the last trading day before issuance), or $3.71 per share. Accordingly, we will perform all federal income tax reporting, including statements supplied to shareholders and to the IRS, on the basis of this price.
For additional considerations applicable to a shareholder that received the FVE Distribution, see the information set forth below under the headings "—Taxation of Taxable U.S. Shareholders," "—Taxation of Tax-Exempt U.S. Shareholders," and "—Taxation of Non-U.S. Shareholders."
Taxation of Taxable U.S. Shareholders
For noncorporate U.S. shareholders, to the extent that their total adjusted income does not exceed applicable thresholds, the maximum federal income tax rate for long-term capital gains and most corporate dividends is generally 15%. For those noncorporate U.S. shareholders whose total adjusted income exceeds the applicable thresholds, the maximum federal income tax rate for long-term capital gains and most corporate dividends is generally 20%. However, because we are not generally subject to federal income tax on the portion of our “real estate investment trust taxable income” distributed to our shareholders, dividends on our shares generally are not eligible for these preferential tax rates, except that any distribution of C corporation earnings and profits and taxed built-in gain items will potentially be eligible for these preferential tax rates. As a result, our ordinary dividends generally aretaxed at the higher federal income tax rates applicable to ordinary income (subject to the lower effective tax rates applicable to qualified REIT dividends via the deduction-without-outlay mechanism of Section 199A of the IRC, which is generally available to our noncorporate U.S. shareholders for taxable years after 2017 and before 2026). To summarize, the preferential federal income tax rates for long-term capital gains and for qualified dividends generally apply to:
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(1) | long-term capital gains, if any, recognized on the disposition of our shares; |
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(2) | our distributions designated as long-term capital gain dividends (except to the extent attributable to real estate depreciation recapture, in which case the distributions are subject to a maximum 25% federal income tax rate); |
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(3) | our dividends attributable to dividend income, if any, received by us from C corporations such as TRSs; |
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(4) | our dividends attributable to earnings and profits that we inherit from C corporations; and |
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(5) | our dividends to the extent attributable to income upon which we have paid federal corporate income tax (such as taxes on foreclosure property income or on built-in gains), net of the corporate income taxes thereon. |
As long as we qualify for taxation as a REIT, a distribution to our U.S. shareholders that we do not designate as a capital gain dividend generally will be treated as an ordinary income dividend to the extent of our available current or accumulated earnings and profits (subject to the lower effective tax rates applicable to qualified REIT dividends via the deduction-without-outlay mechanism of Section 199A of the IRC, which is available to our noncorporate U.S. shareholders for taxable years after 2017 and before 2026). Distributions made out of our current or accumulated earnings and profits that we properly designate as capital gain dividends generally will be taxed as long-term capital gains, as discussed below, to the extent they do not exceed our actual net capital gain for the taxable year. However, corporate shareholders may be required to treat up to 20% of any capital gain dividend as ordinary income under Section 291 of the IRC.
In addition, we may elect to retain net capital gain income and treat it as constructively distributed. In that case:
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(1) | we will be taxed at regular corporate capital gains tax rates on retained amounts; |
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(2) | each of our U.S. shareholders will be taxed on its designated proportionate share of our retained net capital gains as though that amount were distributed and designated as a capital gain dividend; |
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(3) | each of our U.S. shareholders will receive a credit or refund for its designated proportionate share of the tax that we pay; |
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(4) | each of our U.S. shareholders will increase its adjusted basis in our shares by the excess of the amount of its proportionate share of these retained net capital gains over the U.S. shareholder’sshareholder's proportionate share of the tax that we pay; and |
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(5) | both we and our corporate shareholders will make commensurate adjustments in our respective earnings and profits for federal income tax purposes. |
If we elect to retain our net capital gains in this fashion, we will notify our U.S. shareholders of the relevant tax information within sixtydays after the close of the affected taxable year.
If for any taxable year we designate capital gain dividends for our shareholders, then a portion of the capital gain dividends we designate will be allocated to the holders of a particular class of shares on a percentage basis equal to the ratio of the amount of the total dividends paid or made available for the year to the holders of that class of shares to the total dividends paid or made available for the year to holders of all outstanding classes of our shares. We will similarly designate the portion of any dividend
that is to be taxed to noncorporate U.S. shareholders at preferential maximum rates (including any qualified dividend income and any capital gains attributable to real estate depreciation recapture that are subject to a maximum 25% federal income tax rate) so that the designations will be proportionate among all outstanding classes of our shares.
Distributions in excess of our current or accumulated earnings and profits will not be taxable to a U.S. shareholder to the extent that they do not exceed the shareholder’sshareholder's adjusted tax basis in our shares, but will reduce the shareholder’sshareholder's basis in such shares. To the extent that these excess distributions exceed a U.S. shareholder’sshareholder's adjusted basis in such shares, they will be included in income as capital gain, with long-term gain generally taxed to noncorporate U.S. shareholders at preferential maximum rates. No U.S. shareholder may include on its federal income tax return any of our net operating losses or any of our capital losses. In addition, no portion of any of our dividends is eligible for the dividends received deduction for corporate shareholders.
If a dividend is declared in October, November or December to shareholders of record during one of those months and is paid during the following January, then for federal income tax purposes the dividend will be treated as having been both paid and received on December 31 of the prior taxable year.
A U.S. shareholder will generally recognize gain or loss equal to the difference between the amount realized and the shareholder’sshareholder's adjusted basis in our shares that are sold or exchanged. This gain or loss will be capital gain or loss, and will be long-term capital gain or loss if the shareholder’sshareholder's holding period in our shares exceeds one year. In addition, any loss upon a sale or exchange of our shares held for six months or less will generally be treated as a long-term capital loss to the extent of any long-term capital gain dividends we paid on such shares during the holding period.
U.S. shareholders who are individuals, estates or trusts are generally required to pay a 3.8% Medicare tax on their net investment income (including dividends on our shares (without regard to any deduction allowed by Section 199A of the IRC) and gains from the sale or other disposition of our shares), or in the case of estates and trusts on their net investment income that is not distributed, in each case to the extent that their total adjusted income exceeds applicable thresholds. U.S. shareholders are urged to consult their tax advisors regarding the application of the 3.8% Medicare tax, including the applicability of the deduction-without-outlay mechanism of Section 199A of the IRC to the calculation of their net investment income.tax.
If a U.S. shareholder recognizes a loss upon a disposition of our shares in an amount that exceeds a prescribed threshold, it is possible that the provisions of Treasury regulations involving “reportable transactions” could apply, with a resulting requirement to separately disclose the loss generatingloss-generating transaction to the IRS. These Treasury regulations are written quite broadly, and apply to many routine and simple transactions. A reportable transaction currently includes, among other things, a sale or exchange of our shares resulting in a tax loss in excess of (a) $10$10.0 million in any single year or $20$20.0 million in a prescribed combination of taxable years in the case of our shares held by a C corporation or by a partnership with only C corporation partners or (b) $2$2.0 million in any single year or $4$4.0 million in a prescribed combination of taxable years in the case of our shares held by any other partnership or an S corporation, trust or individual, including losses that flow through pass through entities to individuals. A taxpayer discloses a reportable transaction by filing IRS Form 8886 with its federal income tax return and, in the first year of filing, a copy of Form 8886 must be sent to the IRS’sIRS's Office of Tax Shelter Analysis. The annual maximum penalty for failing to disclose a reportable transaction is generally $10,000 in the case of a natural person and $50,000 in any other case.
Noncorporate U.S. shareholders who borrow funds to finance their acquisition of our shares could be limited in the amount of deductions allowed for the interest paid on the indebtedness incurred. Under Section 163(d) of the IRC, interest paid or accrued on indebtedness incurred or continued to purchase or carry property held for investment is generally deductible only to the extent of the investor’sinvestor's net investment income. A U.S. shareholder’sshareholder's net investment income will include ordinary income dividend distributions received from us and, only if an appropriate election is made by the shareholder, capital gain dividend distributions and qualified dividends received from us. In addition, a U.S. shareholder that utilizes the deduction under Section 199A of the IRC with respect to qualified REIT dividends received from us may also be required to make a similar election in order to include such qualified REIT dividends in the calculation of net investment income. Distributionsus; however, distributions treated as a nontaxable return of the shareholder’sshareholder's basis will not enter into the computation of net investment income.
Taxation of Tax-Exempt U.S. Shareholders
The rules governing the federal income taxation of tax-exempt entities are complex, and the following discussion is intended only as a summary of material considerations of an investment in our shares relevant to such investors. If you are a tax-exempt shareholder, we urge you to consult your own tax advisor to determine the impact of federal, state, local and foreign tax laws, including any tax return filing and other reporting requirements, with respect to your acquisition of or investment in our shares.
Our distributions made to shareholders that are tax-exempt pension plans, individual retirement accounts or other qualifying tax-exempt entities should not constitute UBTI, provided that the shareholder has not financed its acquisition of our shares with “acquisition indebtedness” within the meaning of the IRC, that the shares are not otherwise used in an unrelated trade or business of the tax-exempt entity, and that, consistent with our present intent, we do not hold a residual interest in a real estate
mortgage investment conduit or otherwise hold mortgage assets or conduct mortgage securitization activities that generate “excess inclusion” income.
Taxation of Non-U.S. Shareholders
The rules governing the U.S. federal income taxation of non-U.S. shareholders are complex, and the following discussion is intended only as a summary of material considerations of an investment in our shares relevant to such investors. If you are a non-U.S. shareholder, we urge you to consult your own tax advisor to determine the impact of U.S. federal, state, local and foreign tax laws, including any tax return filing and other reporting requirements, with respect to your acquisition of or investment in our shares.
We expect that a non-U.S. shareholder’sshareholder's receipt of (a) distributions from us, and (b) proceeds from the sale of our shares, will not be treated as income effectively connected with a U.S. trade or business and a non-U.S. shareholder will therefore not be subject to the often higher federal tax and withholding rates, branch profits taxes and increased reporting and filing requirements that apply to income effectively connected with a U.S. trade or business. This expectation and a number of the determinations below are predicated on our shares being listed on a U.S. national securities exchange, such as The Nasdaq Stock Market LLC, or Nasdaq. Although we cannot be sure, we expect that eachEach class of our shares has been and will remain listed on a U.S. national securities exchange; however, we cannot be sure that our shares will continue to be so listed in future taxable years or that any class of our shares that we may issue in the future will be so listed.
Distributions.Distributions. A distribution by us to a non-U.S. shareholder that is not designated as a capital gain dividend will be treated as an ordinary income dividend to the extent that it is made out of our current or accumulated earnings and profits. A distribution of this type will generally be subject to U.S. federal income tax and withholding at the rate of 30%, or at a lower rate if the non-U.S. shareholder has in the manner prescribed by the IRS demonstrated to the applicable withholding agent its entitlement to benefits under a tax treaty. Because we cannot determine our current and accumulated earnings and profits until the end of the taxable year, withholding at the statutory rate of 30% or applicable lower treaty rate will generally be imposed on the gross amount of any distribution to a non-U.S. shareholder that we make and do not designate as a capital gain dividend. Notwithstanding this potential withholding on distributions in excess of our current and accumulated earnings and profits, these excess portions of distributions are a nontaxable return of capital to the extent that they do not exceed the non-U.S. shareholder’sshareholder's adjusted basis in our shares, and the nontaxable return of capital will reduce the adjusted basis in these shares. To the extent that distributions in excess of our current and accumulated earnings and profits exceed the non-U.S. shareholder’sshareholder's adjusted basis in our shares, the distributions will give rise to U.S. federal income tax liability only in the unlikely event that the non-U.S. shareholder would otherwise be subject to tax on any gain from the sale or exchange of these shares, as discussed below under the heading “Dispositions“—Dispositions of Our Shares.” A non-U.S. shareholder may seek a refund from the IRS of amounts withheld on distributions to it in excess of such shareholder’sshareholder's allocable share of our current and accumulated earnings and profits.
For so long as a class of our shares is listed on a U.S. national securities exchange, capital gain dividends that we declare and pay to a non-U.S. shareholder on those shares, as well as dividends to a non-U.S. shareholder on those shares attributable to our sale or exchange of “United States real property interests” within the meaning of Section 897 of the IRC, or USRPIs, will not be subject to withholding as though those amounts were effectively connected with a U.S. trade or business, and non-U.S. shareholders will not be required to file U.S. federal income tax returns or pay branch profits tax in respect of these dividends. Instead, these dividends will generally be treated as ordinary dividends and subject to withholding in the manner described above.
Tax treaties may reduce the withholding obligations on our distributions. Under some treaties, however, rates below 30% that are applicable to ordinary income dividends from U.S. corporations may not apply to ordinary income dividends from a REIT or may apply only if the REIT meets specified additional conditions. A non-U.S. shareholder must generally use an applicable
IRS Form W-8, or substantially similar form, to claim tax treaty benefits. If the amount of tax withheld with respect to a distribution to a non-U.S. shareholder exceeds the shareholder’sshareholder's U.S. federal income tax liability with respect to the distribution, the non-U.S. shareholder may file for a refund of the excess from the IRS. Treasury regulations also provide special rules to determine whether, for purposes of determining the applicability of a tax treaty, our distributions to a non-U.S. shareholder that is an entity should be treated as paid to the entity or to those owning an interest in that entity, and whether the entity or its owners are entitled to benefits under the tax treaty.
If, contrary to our expectation, a class of our shares was not listed on a U.S. national securities exchange and we made a distribution on those shares that was attributable to gain from the sale or exchange of a USRPI, then a non-U.S. shareholder holding those shares would be taxed as if the distribution was gain effectively connected with a trade or business in the United States conducted by the non-U.S.non-U.S. shareholder. In addition, the applicable withholding agent would be required to withhold from a distribution to such a non-U.S.non-U.S. shareholder, and remit to the IRS, up to 21% of the maximum amount of any distribution that was or could have been designated as a capital gain dividend. The non-U.S. shareholder also would generally be subject to the
same treatment as a U.S. shareholder with respect to the distribution (subject to any applicable alternative minimum tax and a special alternative minimum tax in the case of a nonresident alien individual), would be subject to fulsome U.S. federal income tax return reporting requirements, and, in the case of a corporate non-U.S. shareholder, may owe the up to 30% branch profits tax under Section 884 of the IRC (or lower applicable tax treaty rate) in respect of these amounts.
Dispositions of Our Shares. Shares. If as expected our shares are not USRPIs, then a non-U.S. shareholder’sshareholder's gain on the sale of these shares generally will not be subject to U.S. federal income taxation or withholding. We expect that our shares will not be USRPIs because one or both of the following exemptions will be available at all times.
First, for so long as a class of our shares is listed on a U.S. national securities exchange, a non-U.S. shareholder’sshareholder's gain on the sale of those shares will not be subject to U.S. federal income taxation as a sale of a USRPI. Second, our shares will not constitute USRPIs if we are a “domestically controlled” REIT. A domestically controlledWe will be a “domestically controlled” REIT if less than 50% of the value of our shares (including any future class of shares that we may issue) is a REIT in whichheld, directly or indirectly, by non-U.S. shareholders at all times during the preceding five-year period less than 50%five years, after applying specified presumptions regarding the ownership of our shares as described in Section 897(h)(4)(E) of the fair market value of its outstanding shares was directly or indirectly held by foreign persons. From and after December 18, 2015, a person who at all relevant times holds less than 5% of a REIT’s shares that are “regularly traded” on a domestic “established securities market” is deemed to be a U.S. person in making the determination of whether a REIT is domestically controlled, unless the REIT has actual knowledge that the person is not a U.S. person. Other presumptions apply in making the determination with respect to other classes of REIT shareholders. As a result of applicable presumptions, we expect to be able to demonstrate from and after December 18, 2015 that we are less than 50% foreign owned.IRC. For periods prior to December 18, 2015,these purposes, we believe that we were less than 50% foreign owned, but that may not be possiblethe statutory ownership presumptions apply to demonstrate unless and until technical corrections legislation expressly expands application of the ownership presumptions.validate our status as a “domestically controlled” REIT. Accordingly, although we cannot be sure, we believe that we are and will remain a “domestically controlled” REIT.
If, contrary to our expectation, a gain on the sale of our shares is subject to U.S. federal income taxation (for example, because neither of the above exemptions were then available, i.e., that class of our shares were not then listed on a U.S. national securities exchange and we were not a “domestically controlled” REIT), then (a) a non-U.S. shareholder would generally be subject to the same treatment as a U.S. shareholder with respect to its gain (subject to any applicable alternative minimum tax and a special alternative minimum tax in the case of nonresident alien individuals), (b) the non-U.S. shareholder would also be subject to fulsome U.S. federal income tax return reporting requirements, and (c) a purchaser of that class of our shares from the non-U.S. shareholder may be required to withhold 15% of the purchase price paid to the non-U.S. shareholder and to remit the withheld amount to the IRS.
Information Reporting, Backup Withholding, and Foreign Account Withholding
Information reporting, backup withholding, and foreign account withholding may apply to distributions or proceeds paid to our shareholders under the circumstances discussed below. If a shareholder is subject to backup or other U.S. federal income tax withholding, then the applicable withholding agent will be required to withhold the appropriate amount with respect to a deemed or constructive distribution or a distribution in kind even though there is insufficient cash from which to satisfy the withholding obligation. To satisfy this withholding obligation, the applicable withholding agent may collect the amount of U.S. federal income tax required to be withheld by reducing to cash for remittance to the IRS a sufficient portion of the property that the shareholder would otherwise receive or own, and the shareholder may bear brokerage or other costs for this withholding procedure.
Amounts withheld under backup withholding are generally not an additional tax and may be refunded by the IRS or credited against the shareholder’sshareholder's federal income tax liability, provided that such shareholder timely files for a refund or credit with the IRS. A U.S. shareholder may be subject to backup withholding when it receives distributions on our shares or proceeds
upon the sale, exchange, redemption, retirement or other disposition of our shares, unless the U.S. shareholder properly executes, or has previously properly executed, under penalties of perjury an IRS Form W-9 or substantially similar form that:
provides the U.S. shareholder’sshareholder's correct taxpayer identification number;
certifies that the U.S. shareholder is exempt from backup withholding because (a) it comes within an enumerated exempt category, (b) it has not been notified by the IRS that it is subject to backup withholding, or (c) it has been notified by the IRS that it is no longer subject to backup withholding; and
certifies that it is a U.S. citizen or other U.S. person.
If the U.S. shareholder has not provided and does not provide its correct taxpayer identification number and appropriate certifications on an IRS Form W-9 or substantially similar form, it may be subject to penalties imposed by the IRS, and the applicable withholding agent may have to withhold a portion of any distributions or proceeds paid to such U.S. shareholder. Unless the U.S. shareholder has established on a properly executed IRS Form W-9 or substantially similar form that it comes within an enumerated exempt category, distributions or proceeds on our shares paid to it during the calendar year, and the amount of tax withheld, if any, will be reported to it and to the IRS.
Distributions on our shares to a non-U.S. shareholder during each calendar year and the amount of tax withheld, if any, will generally be reported to the non-U.S. shareholder and to the IRS. This information reporting requirement applies regardless of whether the non-U.S. shareholder is subject to withholding on distributions on our shares or whether the withholding was reduced or eliminated by an applicable tax treaty. Also, distributions paid to a non-U.S. shareholder on our shares will generally be subject to backup withholding, unless the non-U.S. shareholder properly certifies to the applicable withholding agent its non-U.S. shareholder status on an applicable IRS Form W-8 or substantially similar form. Information reporting and backup withholding will not apply to proceeds a non-U.S. shareholder receives upon the sale, exchange, redemption, retirement or other disposition of our shares, if the non-U.S. shareholder properly certifies to the applicable withholding agent its non-U.S. shareholder status on an applicable IRS Form W-8 or substantially similar form. Even without having executed an applicable IRS Form W-8 or substantially similar form, however, in some cases information reporting and backup withholding will not apply to proceeds that a non-U.S. shareholder receives upon the sale, exchange, redemption, retirement or other disposition of our shares if the non-U.S. shareholder receives those proceeds through a broker’sbroker's foreign office.
Non-U.S. financial institutions and other non-U.S. entities are subject to diligence and reporting requirements for purposes of identifying accounts and investments held directly or indirectly by U.S. persons. The failure to comply with these additional information reporting, certification and other requirements could result in a 30% U.S. withholding tax on applicable payments to non-U.S. persons, notwithstanding any otherwise applicable provisions of an income tax treaty. In particular, a payee that is a foreign financial institution that is subject to the diligence and reporting requirements described above must enter into an agreement with the U.S. Department of the Treasury requiring, among other things, that it undertake to identify accounts held by “specified United States persons” or “United States owned foreign entities” (each as defined in the IRC)IRC and administrative guidance thereunder), annually report information about such accounts, and withhold 30% on applicable payments to noncompliant foreign financial institutions and account holders. Foreign financial institutions located in jurisdictions that have an intergovernmental agreement with the United States with respect to these requirements may be subject to different rules. The foregoing withholding regime generally applies to payments of dividends on our shares, and is expected to generally apply to other “withholdable payments” (including payments of gross proceeds from a sale, exchange, redemption, retirement or other disposition of our shares) made after December 31, 2018.shares. In general, to avoid withholding, any non-U.S. intermediary through which a shareholder owns our shares must establish its compliance with the foregoing regime, and a non-U.S. shareholder must provide specified documentation (usually an applicable IRS Form W-8) containing information about its identity, its status, and if required, its direct and indirect U.S. owners. Non-U.S. shareholders and shareholders who hold our shares through a non-U.S. intermediary are encouraged to consult their own tax advisors regarding foreign account tax compliance.
Other Tax Considerations
Our tax treatment and that of our shareholders may be modified by legislative, judicial or administrative actions at any time, which actions may have retroactive effect. The rules dealing with federal income taxation are constantly under review by the U.S. Congress, the IRS and the U.S. Department of the Treasury, and statutory changes, new regulations, revisions to existing regulations and revised interpretations of established concepts are issued frequently; in fact, both technical corrections legislation and administrative guidance may someday be enacted or promulgated in response to the substantial December 2017 amendments to the IRC.frequently. Likewise, the rules regarding taxes other than U.S. federal income taxes may also be modified. No prediction can be made as to the likelihood of passage of new tax legislation or other provisions, or the direct or indirect effect on us and our shareholders. Revisions to tax laws and interpretations of these laws could adversely affect our ability to qualify and be taxed as a REIT, as well as the tax or other consequences of an investment in our shares. We and our shareholders may also be subject to taxation by state, local or other jurisdictions, including those in which we or our shareholders transact business or reside. These tax consequences may not be comparable to the U.S. federal income tax consequences discussed above.
ERISA PLANS, KEOGH PLANS AND INDIVIDUAL RETIREMENT ACCOUNTS
General Fiduciary Obligations
The Employee Retirement Income Security Act of 1974, as amended, or ERISA, the IRC and similar provisions to those described below under applicable foreign or state law, individually and collectively, impose certain duties on persons who are fiduciaries of any employee benefit plan subject to Title I of ERISA, or an ERISA Plan, or an individual retirement account or annuity, or an IRA, a Roth IRA, a tax-favored account (such as an Archer MSA, Coverdell education savings account or health savings account), a Keogh plan or other qualified retirement plan not subject to Title I of ERISA, each a Non-ERISA Plan. Under ERISA and the IRC, any person who exercises any discretionary authority or control over the administration of, or the management or disposition of the assets of, an ERISA Plan or Non-ERISA Plan, or who renders investment advice for a fee or other compensation to an ERISA Plan or Non-ERISA Plan, is generally considered to be a fiduciary of the ERISA Plan or Non-ERISA Plan.
Fiduciaries of an ERISA Plan must consider whether:
their investment in our shares or other securities satisfies the diversification requirements of ERISA;
the investment is prudent in light of possible limitations on the marketability of our shares;
they have authority to acquire our shares or other securities under the applicable governing instrument and Title I of ERISA; and
the investment is otherwise consistent with their fiduciary responsibilities.
Fiduciaries of an ERISA Plan may incur personal liability for any loss suffered by the ERISA Plan on account of a violation of their fiduciary responsibilities. In addition, these fiduciaries may be subject to a civil penalty of up to 20% of any amount recovered by the ERISA Plan on account of a violation. Fiduciaries of any Non-ERISA Plan should consider that the Non-ERISA Plan may only make investments that are authorized by the appropriate governing instrument and applicable law.
Fiduciaries considering an investment in our securities should consult their own legal advisors if they have any concern as to whether the investment is consistent with the foregoing criteria or is otherwise appropriate. The sale of our securities to an ERISA Plan or Non-ERISA Plan is in no respect a representation by us or any underwriter of the securities that the investment meets all relevant legal requirements with respect to investments by the arrangements generally or any particular arrangement, or that the investment is appropriate for arrangements generally or any particular arrangement.
Prohibited Transactions
Fiduciaries of ERISA Plans and persons making the investment decision for Non-ERISA Plans should consider the application of the prohibited transaction provisions of ERISA and the IRC in making their investment decision. Sales and other transactions between an ERISA Plan or a Non-ERISA Plan and disqualified persons or parties in interest, as applicable, are prohibited transactions and result in adverse consequences absent an exemption. The particular facts concerning the sponsorship, operations and other investments of an ERISA Plan or Non-ERISA Plan may cause a wide range of persons to be treated as disqualified persons or parties in interest with respect to it. A non-exempt prohibited transaction, in addition to imposing potential personal liability upon ERISA Plan fiduciaries, may also result in the imposition of an excise tax under the IRC or a penalty under ERISA upon the disqualified person or party in interest. If the disqualified person who engages in the transaction is the individual
on behalf of whom an IRA, Roth IRA or other tax-favored account is maintained (or his beneficiary), the IRA, Roth IRA or other tax-favored account may lose its tax-exempt status and its assets may be deemed to have been distributed to the individual in a taxable distribution on account of the non-exempt prohibited transaction, but no excise tax will be imposed. Fiduciaries considering an investment in our securities should consult their own legal advisors as to whether the ownership of our securities involves a non-exempt prohibited transaction.
“Plan Assets” Considerations
The U.S. Department of Labor has issued a regulation defining “plan assets.” The regulation, as subsequently modified by ERISA, generally provides that when an ERISA Plan or a Non-ERISA Plan otherwise subject to Title I of ERISA and/or Section 4975 of the IRC acquires an interest in an entity that is neither a “publicly offered security” nor a security issued by an investment company registered under the Investment Company Act of 1940, as amended, the assets of the ERISA Plan or Non-ERISA Plan include both the equity interest and an undivided interest in each of the underlying assets of the entity, unless it is established
either that the entity is an operating company or that equity participation in the entity by benefit plan investors is not significant. We are not an investment company registered under the Investment Company Act of 1940, as amended.
Each class of our equity (that is, our common shares and any other class of equity that we may issue) must be analyzed separately to ascertain whether it is a publicly offered security. The regulation defines a publicly offered security as a security that is “widely held,” “freely transferable” and either part of a class of securities registered under the Exchange Act,or sold under an effective registration statement under the Securities Act of 1933, as amended, or the Securities Act, provided the securities are registered under the Exchange Act within 120 days after the end of the fiscal year of the issuer during which the offering occurred. Each class of our outstanding shares has been registered under the Exchange Act within the necessary time frame to satisfy the foregoing condition.
The regulation provides that a security is “widely held” only if it is part of a class of securities that is owned by 100 or more investors independent of the issuer and of one another. However, a security will not fail to be “widely held” because the number of independent investors falls below 100 subsequent to the initial public offering as a result of events beyond the issuer’sissuer's control. Although we cannot be sure, we believe our common shares have been and will remain widely held, and we expect the same to be true of any future class of equity that we may issue.
The regulation provides that whether a security is “freely transferable” is a factual question to be determined on the basis of all relevant facts and circumstances. The regulation further provides that, where a security is part of an offering in which the minimum investment is $10,000 or less, some restrictions on transfer ordinarily will not, alone or in combination, affect a finding that these securities are freely transferable. The restrictions on transfer enumerated in the regulation as not affecting that finding include:
any restriction on or prohibition against any transfer or assignment that would result in a termination or reclassification for federal or state tax purposes, or would otherwise violate any state or federal law or court order;
any requirement that advance notice of a transfer or assignment be given to the issuer and any requirement that either the transferor or transferee, or both, execute documentation setting forth representations as to compliance with any restrictions on transfer that are among those enumerated in the regulation as not affecting free transferability, including those described in the preceding clause of this sentence;
any administrative procedure that establishes an effective date, or an event prior to which a transfer or assignment will not be effective; and
any limitation or restriction on transfer or assignment that is not imposed by the issuer or a person acting on behalf of the issuer.
We believe that the restrictions imposed under our declaration of truston the transfer of shares do not result in the failure of our shares to be “freely transferable.” Furthermore, we believe that there exist no other facts or circumstances limiting the transferability of our shares that are not included among those enumerated as not affecting their free transferability under the regulation, and we do not expect or intend to impose in the future, or to permit any person to impose on our behalf, any limitations or restrictions on transfer that would not be among the enumerated permissible limitations or restrictions.
Assuming that each class of our shares will be “widely held” and that no other facts and circumstances exist that restrict transferability of these shares, our counsel, Sullivan & Worcester LLP, is of the opinion that our shares will not fail to be “freely transferable” for purposes of the regulation due to the restrictions on transfer of our shares in our declaration of trust and that under the regulation each class of our currently outstanding shares is publicly offered and our assets will not be deemed to be “plan
assets” of any ERISA Plan or Non-ERISA Plan that acquires our shares in a public offering. This opinion is conditioned upon certain assumptions and representations, as discussed above in “Material United States Federal Income Tax Considerations—Taxation as a REIT.”
Item 1A. Risk Factors.
Our business is subject to a number of risks and uncertainties. Investors and prospective investors should carefully consider the risks described below, together with all of the other information in this Annual Report on Form 10-K. The risks described below may not be the only risks we face but are risks we believe aremay be material at this time. Additional risks that we do not yet know of, or that we currently think are immaterial, also may impair our business operations or financial results. If any of the events or circumstances described below occurs, our business, financial condition, results of operations liquidity, prospects or ability to make or sustain distributions to our shareholders could be adversely affected and the value of our securities could decline.be adversely affected. Investors and prospective investors
should consider the following risks, described below, the information contained under the heading “Warning Concerning Forward LookingForward-Looking Statements” and the risks described elsewhere in this Annual Report on Form 10-K before deciding whether to invest in our securities.
Risks Related to Our Tenants andManagersBusiness
Financial and other difficulties atFollowing the completion of the Restructuring Transaction, the results of operations for our senior living communities that Five Star could adversely affect us.manages for us will be directly reflected and included in our operating results and will represent a significant part of our consolidated operating results and a substantial majority of the operating results of our senior housing operating portfolio.
OurAs of January 1, 2020, we and Five Star completed the Restructuring Transaction, pursuant to which, among other things, our previously existing master leases and management and pooling agreements with Five Star accountedwere terminated and replaced with the New Management Agreements for approximately 31.2%all of our total annualized rental income assenior living communities operated by Five Star. Unlike a lease structure, the operating results of December 31, 2017the managed communities are directly reflected and approximately 19.6%included in our operating results. As a result, our results of operations will be directly impacted by the operating results of our total revenuessenior living communities that Five Star manages. If Five Star does not manage our senior living communities profitably and in accordance with our expectations, our results of operations, financial condition and prospects, and the value of our senior living communities, may be materially adversely affected.
We are dependent on Five Star for the year ended December 31, 2017.operation of most of our senior living communities.
The senior living communities that Five Star also leases 27.6% and manages for our account 19.3%us represent most of our properties, at cost before depreciation and purchase price allocations, less impairments, as of December 31, 2017.senior living communities. Five Star has not been consistently profitable since it becamemanages our senior living communities pursuant to the New Management Agreements. As a public company in 2001. Although Five Star has access to a $100.0 million secured revolving credit facility that matures in 2020, subject to extensionsresult, the success of our senior living communities will depend upon Five Star's payment of extensionability to efficiently and effectively operate them. Our ability to terminate the New Management Agreements is limited to the termination rights provided under such agreements or as may otherwise be recognized under law. As a result, we may be limited in our ability to replace Five Star as a manager if we determine it is in our best interests to do so, and we may be required to pay Five Star a significant termination fee if we terminate the New Management Agreements. In addition, if Five Star were to cease managing our senior living communities, we may not be able to obtain a replacement manager as qualified as Five Star or at all and we may incur significant expenses in connection with any replacement manager, including transitioning operational costs, capital expenditures to renovate our senior living communities to the replacement manager's practices and standards and declines in residents fees and meeting other conditions, it currently has limitedservices revenue. Although we have various rights as owner under the New Management Agreements, we rely on the manager’s personnel, good faith, expertise, performance, technical resources, operating efficiencies, information systems, proprietary information and substantial lease obligationsjudgment to manage our managed senior living communities efficiently and effectively. We also rely on the manager to set resident fees and otherwise operate our managed senior living communities in compliance with the New Management Agreements.
We assume the operational risks and fund the operations and capital and maintenance requirements for all of our senior living communities that Five Star manages, which may require us to fund significant amounts and require us to maintain sufficient funding for those managed senior living communities.
Under the New Management Agreements, we assume the operational risks and fund the operations and capital and maintenance requirements for all those senior living communities that Five Star previously leased from us and others.
Five Star’snow manages for us. As a result, we are required to maintain sufficient funding for these purposes. We cannot be sure that we will be able to maintain sufficient funding for these purposes. Further, any funding we do maintain for these purposes will not be available for other business is subjectpurposes, which may limit our ability to a numberpursue other business opportunities and could limit the amount of risks, including the following:
Five Star has high operating leverage; therefore, a small percentage decline in Five Star’s revenues or increase in its expenses could have a material adverse impact on Five Star’s operating results.distributions we can pay to our shareholders.
The current trend for seniors to delay moving to senior living communities until they require greater care could have a material adverse effect on Five Star’s business, financial condition and results of operations.
Increases in labor costs may have a material adverse effect on Five Star.
Increases in newly developed senior living communities may have a material adverse effect on Five Star.
Circumstances that adversely affect the ability of seniors or their families to pay for Five Star’s services, such as economic downturns, softness in the U.S. housing market, higher levels of unemployment among resident family members, lower levels of consumer confidence, stock market volatility and/or changes in demographics, could cause Five Star’s occupancy rates, revenues and results of operations to decline.
The failure of Medicare and Medicaid rates to match Five Star’s costs would reduce Five Star’s income and may cause Five Star to continue to experience losses.
Private third party payers’, such as insurance companies’, continued efforts to reduce healthcare costs could adversely affect Five Star.
Provisions of the ACA, or the possible future repeal, replacement or modification of the ACA, could reduce Five Star’s income and increase its costs.
Five Star’s business is subject to extensive regulation, which requires Five Star to incur significant costs and may cause Five Star to experience losses.
The nature of Five Star’s business exposes it to litigation and regulatory and government proceedings; Five Star has been, is currently, and expects in the future to be involved in claims, lawsuits and regulatory and government audits,
investigations and proceedings arising in the ordinary course of its business, some of which may involve material amounts.
Five Star’s strategy to continue to grow its business by entering into additional long term lease and management arrangements for, and by acquiring, senior living communities where residents’ private resources account for all or a large majority of revenues, may not succeed and may cause Five Star to continue to experience losses.
If Five Star’s operations continue to be unprofitable, it may default in its rent obligations to us or we may realize reduced income from our managed senior living communities, and, if Five Star fails to provide quality services at the senior living communities we own, our income from these communities may be adversely affected. Furthermore, if we were required to replace Five Star as our majority tenant and manager, we could experience significant disruptions in operations at our applicable senior living communities, which could reduce our income and cash flow from, and the value of, those communities.
The current trend for seniors to delayforgo moving to senior living communities until they require greater carealtogether could have a material adverse effect on our business, financial condition and results of operations.
Seniors have been increasingly delaying their moves to senior living communities, including to our leased and managed senior living communities, until they require greater care.care, and they have been increasingly forgoing moving to senior living communities altogether. Further, rehabilitation therapy and other services are increasingly being provided to seniors on an outpatient basis or in seniors’seniors' personal residences in response to market demand and government regulation, which may increase the trend for seniors to delay moving to senior living communities. Such delays may cause decreases in occupancy rates and increases in resident turnover rates at our senior living communities. Moreover, older aged persons may have greater care needs and require higher acuity services, which may increase our tenants’managers' and managers’tenants' cost of business, expose our tenantsmanagers and managerstenants to additional liability or result in lost business and shorter stays at our leased and managed senior living communities if our tenantsmanagers and managerstenants are not able to provide the requisite care services or fail to adequately provide
those services. These trends may negatively impact the occupancy rates, revenues and cash flows at our leased and managed senior living communities and our tenants' results of operations. Further, if any of our managers or tenants is unable to offset lost revenues from these trends by providing and growing other revenue sources, such as new or increased service offerings to seniors, our senior living communities may be unprofitable and we may receive lower returns and rent and the value of our senior living communities may decline.
Increases in labor costs at our managed senior living communities may have a material adverse effect on us.
Wages and employee benefits associated with the operations of our managed senior living communities represent a significant part of our managed senior living communities’communities' operating expenses. The U.S. labor market has been experiencing an extended period of low unemployment. Further, there has been recent legislation enacted and proposed legislation to increase the minimum wage in certain jurisdictions. This, in turn, has put upward pressure on wages. Our managers compete with other senior living community operators, among others, to attract and retain qualified personnel responsible for the day to day operations of our managed senior living communities. The market for qualified nurses, therapists and other healthcare professionals is highly competitive, and periodic or geographic area shortages of such healthcare professionals may require our managers to increase the wages and benefits they offer to their employees in order to attract and retain such personnel or to utilize temporary personnel at an increased cost. Moreover, the low level of unemployment in the United States currently may result in our managers being unable to fully staff its senior living communities or having to pay overtime to adequately staff its senior living communities. In addition, employee benefit costs, including health insurance and workers’workers' compensation insurance costs, have materially increased in recent years and, as noted above, we cannot predict the future impact of the ACA, or the possible future repeal, replacement or modification of the ACA, on the cost of employee health insurance. Although Five Star determines its employee health insurance and workers’ compensation self insurance reserves with guidance from third party professionals, its reserves may nonetheless be inadequate. Increasing employee health insurance and workers’ compensation insuranceyears.
We have been experiencing increasing labor costs and increasing self insurance reserves for labor related insurance may materially and adversely affect our earnings fromat our managed senior living communities.
We cannot be sure that labor costs at our managed senior living communities will not continue to increase or that any increases will eventually be recovered by corresponding increases in the rates charged to residents or otherwise. Any significant failure by our managers to prudently control labor costs or to pass any increases on to residents through rate increases could have a material adverse effect on our business, financial condition and results of operations. Five Star, like most senor living operators, often experiences staffing turnover, which may increase in the current competitive labor market and the competitive environment in the senior living industry. Heightened levels of staffing turnover for Five Star, particularly for key and skilled positions, such as management, its regional and executive directors and other skilled and qualified personnel who provide services with respect to our senior living communities that Five Star manages for us may disrupt operations, limit or slow Five Star's ability to execute its business strategies, decrease our revenues and increase our costs at our managed senior living communities, which may have a material adverse effect on our business, financial condition, results of operations and prospects.
If we, our managers and our tenants fail to identify and successfully act upon changes and trends in the healthcare industry and seniors' needs and preferences, our business, financial condition, results of operations and prospects will be adversely impacted.
The healthcare industry is a dynamic industry. The needs and preferences of seniors have generally changed over the past several years, including preferences to reside in their homes longer or permanently, as well as changes in services and offerings, including delivery of home healthcare services and for service offerings that address their desire to maintain active lifestyles. If we, our managers and our tenants fail to identify and successfully act upon and address changes and trends in the healthcare industry and seniors' needs and preferences, our business, financial condition, results of operations and prospects will be adversely impacted.
Federal, state and local employment related laws and regulations could increase theour cost of doing business at our managed senior living communities,and our managers may fail to comply with such laws and regulations.
The operations at our managed senior living communities are subject to a variety of federal, state and local employment related laws and regulations, including, but not limited to, the U.S. Fair Labor Standards Act, which governs such matters as minimum wages, the Family and Medical Leave Act, overtime pay, compensable time, recordkeeping and other working conditions, and a variety of similar laws that govern these and other employment related matters. Because labor represents a significant portion of our managed senior living communities’communities' operating expenses, compliance with these evolving laws and regulations could substantially increase the cost of doing business at our managed senior living communities, while failure to do so could subject our managers to significant back pay awards, fines and lawsuits. Our managers’managers' failure to comply with federal, state and local
employment related laws and regulations could have a material adverse effect on our business, financial condition and results of operations.
The nature of our tenants’managers' and managers’tenants' business exposes us and them to litigation and regulatory and government proceedings.
Our tenantsmanagers and managerstenants have been, are currently, and expect in the future to be involved in claims, lawsuits and regulatory and government audits, investigations and proceedings arising in the ordinary course of their and our business, some of which may involve material amounts.amounts, and we may also be involved in such claims, lawsuits and regulatory and government audits, investigations and proceedings at our managed communities. The defense and resolution of such claims, lawsuits and other proceedings may require our managers and tenants and managersor us to incur significant expenses. In several well publicized instances, private litigation by residents of senior living communities for alleged abuses has resulted in large damage awards against senior living companies. Some lawyers and law firms specialize in bringing litigation against senior living community operators. As a result of this litigation and potential litigation, the cost of our tenants’ and managers’ liability insurance continues to increase. Medical liability insurance reform has at times been a topic of political debate, and some states have enacted legislation to limit future liability awards. However, such reforms have not generally been adopted, and we expect our tenants’ and managers’that insurance costs may continue to increase. Further, although Five Star determines its self insurance reserves with guidance from third party professionals, its reserves may nonetheless be inadequate. Insurance costs related to our managed senior living communities are, and the costs, claims, lawsuits and regulatory and government audits, investigations and proceedings related to our managed senior living communities may be, included as operating expenses of those communities, which reduce our returns from those communities. Increasing liability insurance costs and increasingthe need to increase self insurance reserves could have a material adverse effect on our tenants’ and managers’ business,our managers' and tenants' businesses, financial condition and results of operations which could cause them to become unable to pay rents due to us or generate and pay minimum and other returns to us.operations.
Depressed U.S. housing market conditions may reduce the willingness or ability of seniors to relocate to our senior living communities.
Downturns or stagnation in the U.S. housing market could adversely affect the ability, or perceived ability, of seniors to afford our tenants’managers' and managers’tenants' entrance fees and resident fees as prospective residents frequently use the proceeds from the sale of their homes to cover the cost of such fees. If seniors have a difficult time selling their homes, their ability to relocate to our leasedmanaged and managedleased senior living communities or finance their stays at our leasedmanaged and managedleased senior living communities with private resources could be adversely affected. If U.S. housing market conditions reduce seniors’seniors' willingness or ability to relocate to our leasedmanaged and managedleased senior living communities, the occupancy rates, revenues and cash flows at our leasedmanaged and managedleased senior living communities and our results of operations could be negatively impacted.
Our tenantsmanagers or managerstenants may fail to comply with laws relating to the operation of our leasedmanaged and managedleased senior living communities.
We and our tenantsmanagers and managerstenants are subject to, or impacted by, extensive and frequently changing federal, state and local laws and regulations, including: licensure laws; laws protecting consumers against deceptive practices; laws relating to the operation of our properties and how our tenantsmanagers and managerstenants conduct their operations, such as with respect to health and safety, fire and privacy matters; laws affecting communities that participate in Medicaid; laws affecting SNFs, clinics and other healthcare facilities that participate in both Medicare and Medicaid which mandate allowable costs, pricing, reimbursement procedures and limitations, quality of services and care, food service and physical plants; resident rights laws (including abuse and neglect laws) and fraud laws; anti-kickback and physician referral laws; the Americans with Disabilities Act and similar laws; and safety and health standards established by OSHA. We and our tenantsmanagers and managerstenants are also required to comply with federal and state laws governing the privacy, security, use and disclosure of individually identifiable information, including financial information and protected health information. Under HIPAA, we and our tenantsmanagers and managerstenants are required to comply with the HIPAA privacy rule, security standards and standards for electronic healthcare transactions. State laws also govern the privacy of individual health information, and these laws are, in some jurisdictions, more stringent than HIPAA.
We and our tenantsmanagers and managerstenants expend significant resources to maintain compliance with these laws and regulations. However, if we or our tenantsmanagers or managerstenants are alleged to fail, or do fail, to comply with applicable legal requirements, we or they may have to expend significant resources to respond to such allegations, and if we or they are unable to cure deficiencies, certain sanctions may be imposed which may adversely affect the ability of our tenants to pay us rent, the profitability of our managed senior living communities and our ability to obtain, renew or maintain licenses at those communities and the values of our properties. Changes in applicable regulatory frameworks could also have similar adverse effects.
The failure of Medicare and Medicaid rates to match our costs will reduce our income or create losses.
Some of our managed senior living communities, especially those with skilled nursing units, may receive significant revenues from Medicare and Medicaid. Although we have made efforts to increasingly transition our business away from government payer sources, such as Medicare and Medicaid, these programs still comprise part of our business and their direct
impact will likely increase as a result of the Conversion (as defined above in "Business—Senior Housing Operating Portfolio Managements" in Part I, Item 1 of this Annual Report on Form 10-K). Payments under Medicare and Medicaid are set by government policy, laws and regulations. The rates and amounts of these payments are subject to periodic adjustment. Current and projected federal budget deficits, federal spending priorities and challenging state fiscal conditions have resulted in numerous recent legislative and regulatory actions or proposed actions with respect to Medicare and Medicaid payments, insurance and healthcare delivery. For further information regarding these matters and developments, see “Business—Government Regulation and Reimbursement” in Part I, Item 1 of this Annual Report on Form 10-K. These matters could result in the failure of Medicare or Medicaid payment rates to cover our costs of providing required services to residents, or in reductions in payments to us or other circumstances that could have a material adverse effect on our business, results of operations and financial condition. Further, certain tenants of our properties receive some of their revenues from government paying sources. If they were to experience these pressures, their ability to pay rent to us may be adversely impacted.
Private third party payers continue to try to reduce healthcare costs.
Private third party payers such as insurance companies continue their efforts to control healthcare costs through direct contracts with healthcare providers, increased utilization review practices and greater enrollment in managed care programs and preferred provider organizations. These third party payers increasingly demand discounted fee structures and the assumption by healthcare providers of all or a portion of the financial risk. These efforts to limit the amount of payments we receive for healthcare services could adversely affect us. Reimbursement payments under third party payer programs may not remain at levels comparable to present levels or be sufficient to cover the costs allocable to patients participating in such programs. Future changes in, or renegotiations of, the reimbursement rates or methods of third party payers, or the implementation of other measures to reduce payments for our services could result in a substantial reduction in our NOI with respect to our managed senior living communities. At the same time, as a result of competitive pressures, our managers' ability to maintain operating margins at our managed senior living communities through price increases to private pay residents may be limited. Further certain tenants of our properties face similar payment and pricing pressures and their ability to pay rent to us may be adversely impacted as a result.
If Five Star faces financial and other difficulties again in the future, we may be adversely affected.
In the fourth quarter of 2018, Five Star announced that the conditions in the senior living industry, its recurring operating losses, the expected continued industry challenges and the risk that it may not be able to obtain sufficient funding, gave rise to a substantial doubt about its ability to continue as a going concern. In response, in April 2019, we and Five Star entered into the Transaction Agreement, and Five Star has since then determined that a substantial doubt no longer existed about its ability to continue as a going concern. The Restructuring Transaction significantly reduced Five Star's operating leverage and cash and other working capital needs for the senior living communities it operates because under the New Management Arrangements, unlike the prior lease arrangements, we, not Five Star, fund the operations and capital requirements of the senior living communities, and Five Star is no longer obligated to pay us rent. Despite these changes, we cannot be sure that Five Star will not face financial and other difficulties in the future. Although Five Star will be relieved of the obligation to fund the operations and capital for our senior living communities, Five Star owns its own senior living communities and it may purchase additional senior living communities or enter into lease arrangements to operate additional senior living communities in the future. Further, Five Star will still have to fund its other business expenses and commitments. In addition, Five Star could elect to grow or develop its business beyond its management arrangements with us in the future. If Five Star is not profitable, our business may be materially adversely affected.
Termination of assisted living resident agreements and resident attrition could adversely affect revenues and earnings at our leasedmanaged and managedleased senior living communities.
State regulations governing assisted living communities typically require a written resident agreement with each resident. Most of these regulations also require that each resident have the right to terminate these assisted living resident agreements for
any reason on reasonable notice. Consistent with these regulations, most of our tenants’tenants' and managers’managers' resident agreements allow residents to terminate their agreements on 30 days’days' notice. Thus, our tenantsmanagers and managerstenants may be unable to contract with assisted living residents to stay for longer periods of time, unlike typical apartment leasing arrangements that involve lease agreements with terms of up to a year or longer. If a large number of residents elected to terminate their resident agreements at or around the same time, revenues and earnings at our leasedmanaged and managedleased senior living communities could be materially and adversely affected. In addition, the advanced ages of residents at our leasedmanaged and managedleased senior living communities make resident turnover rates difficult to predict.
The operations of some of our communities are dependent upon payments from the Medicare and Medicaid programs.
For the year ended December 31, 2017, approximately 97% of our NOI was generated from properties where a majority of the revenue is derived from private resources, and the remaining 3% of our NOI was generated from properties where a majority of the revenue was derived from Medicare and Medicaid reimbursements. Operations at most of our Medicare and Medicaid dependent properties currently produce sufficient cash flow to pay our allocated rents or our minimum returns, but operations at certain of these properties do not. Even at properties where less than a majority of the NOI comes from Medicare or Medicaid payments, a reduction in such payments could materially adversely affect profits of, or result in losses to, our tenants or managers. With the background of the current and projected federal budget deficit and other federal priorities and continued challenging state fiscal conditions, there have been numerous recent legislative and regulatory actions or proposed actions with respect to federal Medicare and state Medicaid rates and federal payments to states for Medicaid programs. For further information regarding such programs, see elsewhere in this Annual Report on Form 10-K, including under the caption “Business—Government Regulation and Reimbursement” in Part I, Item 1 of this Annual Report on Form 10-K, and under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Impact of Government Reimbursement” in Part II, Item 7 of this Annual Report on Form 10-K. If and to the extent Medicare or Medicaid rates are reduced from current levels, or if rate increases are less than increases in operating costs, such changes could have a material adverse effect on the ability of our tenants to pay us rent, the profitability of our managed senior living communities and the values of our properties. In addition, the revenues that we or our tenants receive from Medicare and Medicaid may be subject to statutory and regulatory changes, retroactive rate adjustments, recovery of program overpayments or set offs, administrative rulings and policy interpretations, and payment delays, any of which could have a material adverse effect on the ability of our tenants to pay us rent, the profitability of our managed senior living communities and the values of our properties.
Provisions of the ACA and efforts to repeal, replace or modify the ACA could adversely affect us or our tenantsmanagers and managers.tenants.
The ACA contains insurance changes, payment changes and healthcare delivery systems changes that have affected, and will continue to affect, us, our tenantsmanagers and managers. Examples of these, and other information regarding such programs, are provided below as well as under the caption “Business—Government Regulation and Reimbursement” in Part I, Item 1 of this Annual Report on Form 10-K and under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Impact of Government Reimbursement” in Part II, Item 7 of this Annual Report on Form 10-K.
Provisions of the ACA include multiple reductions to the annual market basket updates for inflation that may result in SNF Medicare payment rates being less than for the preceding fiscal year. We are unable to predict how potential Medicare rate reductionstenants. Changes implemented under the ACA will affect our tenants’ and our managers’caused or may cause in the future financial results of operations; however, the effect may be adverse and material and hence adverse and material to our future financial condition and results of operations.
Further, the ACA includes other changes that may affect us, our tenants and our managers, suchreduced payments for services, as enforcement reforms and Medicare and Medicaid program integrity control initiatives, new compliance, ethics and public disclosure requirements, initiatives to encourage the development of home and community based long term care services rather than institutional services under Medicaid, value based purchasing plans and a Medicare post acutepost-acute care pilot program to develop and evaluate making a bundled payment for services, including hospital, physician and SNF services, provided during an episode of care. Since enactment in 2011, the ACA has been the subject of partial or complete repeal through legislation, administrative action and judicial opinions. Information regarding the ACA is provided under the caption “Business—Government Regulation and Reimbursement” in Part I, Item 1 of this Annual Report on Form 10-K and under the caption “Management's Discussion and Analysis of Financial Condition and Results of Operations—Impact of Government Reimbursement” in Part II, Item 7 of this Annual Report on Form 10-K.
Changes implementedWe are unable to predict how potential Medicare rate reductions under the ACA resulting in reduced payments for serviceswill affect our managers' and tenants' future financial results of operations; however, the effect may be adverse and material and hence adverse and material to our future financial condition and results of operations. If some or the failureall of Medicare, Medicaid or insurance payment rates to cover increasing costs could adversely and materially affect the ability of our tenants to pay rent to us, the profitability of certain of our managed senior living communities and the values of our properties.
On October 12, 2017, President Trump signed an executive order that modified certain aspects of the ACA by directing federal agencies to reduce limits on association health plans and temporary insurance plans and to permit workers to use funds from tax advantaged accounts to pay for their own coverage. On the same day, the Trump Administration also announced that it would stop paying what are known as cost sharing reduction subsidies to issuers of qualified health plans under the ACA. Further, as a result of a new tax reform law, effective January 1, 2019, the penalty associated with the individual mandate provision of the
ACA was reduced to $0. To the extent the ACA is repealed, replaced or modified, additional risks and regulatory uncertainty may arise. Depending upon what aspects of the ACA are repealed, replaced or modified, our future financial results could be adversely and materially affected.
We may not succeed in selling any properties we identify for sale, the proceeds we may receive for any such sales may be less than we expect and we may incur losses with respect to these sales. Risks RelatedTo reduce our leverage, we have sold properties and other assets and have identified additional properties to sell, with a focus on the sale of underperforming senior living communities and non-core assets. Although we have sold or agreed to sell a significant number of properties in furtherance of this plan, we cannot be sure that we will be able to find attractive sales opportunities for additional properties or that any sale will be completed in a timely manner, if at all. Our Businessability to sell these or any of our other properties, and the prices we receive upon a sale, may be affected by many factors, and we may be unable to execute our strategy. In particular, these factors could arise from weakness in or the lack of an established market for properties, changes in the financial condition or prospects of prospective purchasers and the tenants of the properties, the terms of the leases with tenants at the properties, the characteristics, quality and prospects of the properties, and the availability of financing to potential purchasers on reasonable terms, the number of prospective purchasers, the number of competing properties in the market, unfavorable local, national or international economic conditions, industry trends and changes in laws, regulations or fiscal policies of jurisdictions in which the properties are located. We may not succeed in selling properties that we have identified, or in the future identify, for sale, the terms of any such sales may not meet our expectations, prospective buyers may fail to perform their obligations under the terms of agreements for the sale of our properties, requiring us to find new buyers for such properties, and we may incur losses in connection with these potential sales. In addition, we may elect to change the amount or mix of properties we may seek to sell or to otherwise change or abandon the plan. If we are unable to realize proceeds from the sale of properties sufficient to allow us to reduce our leverage to a level we believe appropriate or which ratings agencies and possible financing sources believe appropriate, our credit ratings may be further lowered, we may reduce our acquisition activity, we may reduce the amount we invest in our properties or pay for expenses and we may reduce the amount of distributions we pay to our shareholders.
REIT distribution requirements and limitations on our ability to access reasonably priced capital may adversely impact our ability to carry out our business plan.
To maintain our qualification for taxation as a REIT under the IRC, we are required to distribute at least 90% of our annual satisfy distribution requirements imposed by the IRC. See "Material United States Federal Income Tax Considerations—REIT taxable income (excluding capital gains).Qualification Requirements—Annual Distribution Requirements." Accordingly, we may not be able to retain sufficient cash to fund our operations, repay our debts, invest in our properties or fund our acquisitions or development or redevelopment efforts. Our business strategies therefore depend, in part, upon our ability to raise additional capital at reasonable costs. The volatility in the availability of capital to businesses on a global basis in most debt and equity markets generally may limit our ability to raise reasonably priced capital. We may also be unable to raise reasonably priced capital because of reasons related to our business, market perceptions of our prospects, the terms of our indebtedness, the extent of our leverage, or for reasons beyond our control, such as market conditions. Because the earnings we are permitted to retain are limited by the rules governing REIT qualification and taxation, if we are unable to raise reasonably priced capital, we may not be able to carry out our business plan.
Increasing
Changes in market interest rates, including changes that may result from the expected phase out of LIBOR, may adversely affect us.
Since the most recent U.S. recession, the Board of Governors of the U.S. Federal Reserve System, or the U.S. Federal Reserve, has taken actions thatwhich have resulted in low interest rates prevailing in the marketplace for a historically long period of time. Since December 2016, theThe U.S. Federal Reserve has raised its benchmark intereststeadily increased the targeted federal funds rate by one percentage point,over the last several years, but recently took action to decrease the federal funds rate and there are some market expectations that market interest rates will rise furthermay continue to make adjustments in the near future. In addition, as noted in Part II, Item 7A of this Annual Report on Form 10-K, LIBOR is expected to intermediate term. Marketbe phased out in 2021. The interest rates under our revolving credit facility and term loans are based on LIBOR and future debt we may continueincur may also be based on LIBOR. We currently expect that the determination of interest under our revolving credit facility and term loan agreements would be based on the alternative rates provided under those agreements or would be revised to increase,provide for an interest rate that approximates the existing interest rate as calculated in accordance with LIBOR. Despite our current expectations, we cannot be sure that, if LIBOR is phased out or transitioned, the changes to the determination of interest under our revolving credit facility and thoseterm loan agreements would approximate the current calculation in accordance with LIBOR. An alternative interest rate index that may replace LIBOR may result in our paying increased interest. Interest rate increases may materially and negatively affect us in several ways, including:
Investors may consider whether to buy or sell our common shares based upon the distribution rate on our common shares relative to the then prevailing market interest rates. If market interest rates go up, investors may expect a higher distribution rate than we are able to pay, which may increase our cost of capital, or they may sell our common shares and seek alternative investments that offer higher distribution rates. Sales of our common shares may cause a decline in the value of our common shares.
Property values are often determined, in part, based upon a capitalization of rental income formula. When market interest rates increase, property investors often demand higher capitalization rates and that causes property values to decline. Increases in interest rates could lower the value of our properties and cause the value of our securities to decline.
Amounts outstanding under our revolving credit facility and term loans require interest to be paid at variablefloating interest rates. When interest rates increase, our interest costs will increase, which could adversely affect our cash flows, our ability to pay principal and interest on our debt, our cost of refinancing our fixed rate debts when they become due and our ability to make or sustain distributions to our shareholders. Additionally, if we choose to hedge our interest rate risk, we cannot be sure that the hedge will be effective or that our hedging counterparty will meet its obligations to us.
Property values are often determined, in part, based upon a capitalization of rental income formula. WhenLow market interest rates, particularly if they remain over a sustained period, may increase our use of debt capital to fund property investors often demand higheracquisitions, lower capitalization rates for property purchases and that causesincreased competition for property valuespurchases, which may reduce our ability to decline. Increases in interest rates could lower the value of our properties and cause the value of our securities to decline.acquire new properties.
We are limited in our ability to operate or manage our properties and are thus dependent on our tenantsmanagers and managers.tenants.
Because federal income tax laws restrict REITs and their subsidiaries from operating or managing health carehealthcare facilities, we do not operate or manage our senior living communities. Instead, we lease nearly all of our senior living communities to operating companies or to our subsidiaries that qualify as TRSs under the IRC. We have retained a third party managersmanager to operate and manage our senior living communities that are leased to our subsidiaries. Our income from our properties may be adversely affected if our tenantsmanagers or managerstenants fail to provide quality services and amenities to residents or if they fail to maintain quality services. While we monitor the performance of our tenantsmanagers and managerstenants and apply asset management strategies and discipline, we have limited recourse under our leases and management agreements if we believe that our tenantsmanagers or managerstenants are not performing adequately. Any failure by our tenantsmanagers or managerstenants to fully perform the duties agreed to in our leases and management agreements could adversely affect our results of operations. In addition, our tenantsmanagers and managerstenants operate, and in some cases own or have invested in, properties that compete with our properties, which may result in conflicts of interest, and fees paid to our managers are often set as a percentage of gross revenues rather than profits.interest. As a result, our tenantsmanagers and managerstenants have made, and may in the future make, decisions regarding competing properties or our properties’properties' operations that may not be in our best interests.
our returns.
Our properties and their operations are subject to extensive regulations.
Various government authorities mandate certain physical characteristics of senior housing properties, clinics, other healthcare communities and biotechnology laboratories. Changes in laws and regulations relating to these matters may require significant expenditures. Our leases, other than our MOBmedical office and life science property leases, and our management agreements generally require our tenants or managers to maintain our properties in compliance with applicable laws and regulations, and we
expend resources to monitor their compliance. However, our tenants or managers may neglect maintenance of our properties if they suffer financial distress. Under some of our leases, we have agreed to fund capital expenditures in return for rent increases and, minimum returns due to us, with respect to our managed senior living communities, increasethe target EBITDA that Five Star must generate in order to earn incentive fees increases by a defined percentage of the amount of capital expenditures we fund at those communities.in excess of target amounts. Our available financial resources or those of our tenants or managers may be insufficient to fund the expenditures required to operate our properties in accordance with applicable laws and regulations. If we fund these expenditures, our tenants’tenants' financial resources may be insufficient to satisfy their increased rental payments to us or our managed senior living communities may fail to generate profits sufficient to fundprovide us with our minimum returns.expected returns on our capital investments at those managed senior living communities.
Licensing, Medicare and Medicaid laws also require our managers and tenants who operate senior living communities, clinics and other healthcare communities to comply with extensive standards governing their operations. In addition, certain laws prohibit fraud by senior living operators, and other healthcare communities, including civil and criminal laws that prohibit false claims in Medicare, Medicaid and other programs and that regulate patient referrals. In recent years, the federal and state governments have devoted increasing resources to monitoring the quality of care at senior living communities and to anti-fraud investigations in healthcare operations generally. The ACA also facilitates the DOJ’sDOJ's ability to investigate allegations of wrongdoing or fraud at SNFs. When violations of anti-fraud, false claims, anti-kickback or physician referral laws are identified, federal or state authorities may impose civil monetary damages, treble damages, repayment requirements and criminal sanctions. Healthcare communities may also be subject to license revocation or conditional licensure and exclusion from Medicare and Medicaid participation or conditional participation. When quality of care deficiencies or improper billing are identified, various laws may authorize civil money penalties or fines; the suspension, modification or revocation of a license or Medicare/Medicaid participation; the suspension or denial of admissions of residents; the denial of payments in full or in part; the implementation of state oversight, temporary management or receivership; and the imposition of criminal penalties. We, our tenants and our managers receive notices of potential sanctions from time to time, and government authorities impose such sanctions from time to time on our communities which our tenantsmanagers and managerstenants operate. If our tenantsmanagers or managerstenants are unable to cure deficiencies which have been identified or which are identified in the future, these sanctions may be imposed, and if imposed, may adversely affect our tenants’tenants' ability to pay rents to us, our returns and our ability to identify substitute tenantsmanagers or managers.tenants. Federal and state requirements for change in control of healthcare communities, including, as applicable, approvals of the proposed operator for licensure, CONs, and Medicare and Medicaid participation, may also limit or delay our ability to find substitute tenantsmanagers or managers.tenants. If any of our tenantsmanagers or managerstenants becomes unable to operate our properties, or if any of our tenants becomes unable to pay its rent or generate and pay our minimumsufficient returns for us because it has violated government regulations or payment laws, such incidents may trigger a default or termination right under their leases and management agreements with us and our or our tenants’managers' or managers’tenants' credit agreements, and we may experience difficulty in finding a substitute tenant or managermanagers or selling the affected property for a fair and commercially reasonable price, and the value of an affected property may decline materially.
Various laws administered by the FDA and other agencies regulate the operations of our tenants that operate biotechnology laboratories that develop, manufacture, market or distribute pharmaceuticals or medical devices. Once a product is approved, the FDA maintains oversight of the product and its developer and can withdraw its approval, recall products or suspend their production, impose or seek to impose civil or criminal penalties on the developer or take other actions for the developer’sdeveloper's failure to comply with regulatory requirements, including anti-fraud, false claims, anti-kickback or physician referral laws. Other concerns affecting our biotechnology laboratory tenants include the potential for subsequent discovery of safety concerns and related litigation, ensuring that the product qualifies for reimbursement under Medicare, Medicaid or other federal or state programs, cost control initiatives of payment programs, the potential for litigation over the validity or infringement of intellectual property rights related to the product, the eventual expiration of relevant patents and the need to raise additional capital. The cost of compliance with these regulations and the risks described in this paragraph, among others, could adversely affect the ability of our biotechnology laboratory tenants to pay rent to us.
We may be unable to grow our business by acquisitions of additional properties.
Our business plans involve the acquisition of additional properties. Our ability to make profitable acquisitions is subject to risks, including, but not limited to, risks associated with:
competition from other investors, including publicly traded and private REITs, numerous financial institutions, individuals, foreign investors and other public and private companies;
our long term cost of capital;
contingencies in our acquisition agreements; and
the availability and terms of financing.
We might encounter unanticipated difficulties and expenditures relating to our acquired properties. For example:
we do not believe that it is possible to understand fully a property before it is owned and operated for a reasonable period of time, and, notwithstanding pre-acquisition due diligence, we could acquire a property that contains undisclosed defects in design or construction;
the market in which an acquired property is located may experience unexpected changes that adversely affect the property’sproperty's value;
the occupancy of and rents from properties that we acquire may decline during our ownership;
property operating costs for our acquired properties may be higher than anticipated, and our acquired properties may not yield expected returns; and
we may acquire properties subject to unknown liabilities and without any recourse, or with limited recourse, such as liability for the cleanup of undisclosed environmental contamination or for claims by residents, tenants, vendors or other persons related to actions taken by former owners of the properties; and
acquired properties might require significant management attention that would otherwise be devoted to our other business activities.properties.
For these reasons, among others, we might not realize the anticipated benefits of our acquisitions, and our business plan to acquire additional properties may not succeed or may cause us to experience losses.
We and our tenantsmanagers and managerstenants face significant competition.
We face significant competition for acquisition opportunities from other investors, including publicly traded and private REITs, numerous financial institutions, individuals, foreign investors and other public and private companies. Because of competition, we may be unable to acquire, or may pay a significantly increased purchase price for, a desired property, which would reduce our expected returns from that property. Some of our competitors may have greater financial and other resources than us. Further, during prior periods of economic recession, some investors have focused on healthcare real estate investments because of a belief that these types of investments may be less affected by general economic circumstances than most other investments. Low historical market interest rates and increased leverage utilized by financial and other buyers have caused purchase prices for healthcare real estate investments to increase, therefore decreasing rates of returns. Such conditions have resulted in increased competition for investments, fewer available investment opportunities and lower spreads over the cost of capital. If such conditions continue for a protracted period, our ability to grow our business and improve our financial results may be materially and adversely affected.
We also face competition for tenants at our properties, particularly at our MOBs.medical office and life science properties. Some competing properties may be newer, better located or more attractive to tenants. Competing properties may have lower rates of occupancy than our properties, which may result in competing owners offering available space at lower rents than we offer at our properties. Development activities may increase the supply of properties of the type we own in the leasing markets in which we own properties and increase the competition we face. Competition may make it difficult for us to attract and retain tenants and may reduce the rents we are able to charge.
Further, our tenantsmanagers and managerstenants compete with numerous other senior living community operators, as well as companies that provide senior living services, such as home healthcare companies and other real estate based service providers. Some of our tenants’managers' and managers’tenants' existing competitors are larger and have greater financial resources than they do and some of their competitors are not for profit entities which have endowment income and may not face the same financial pressures that they do. We cannot be sure that our tenantsmanagers and managerstenants will be able to attract a sufficient number of residents to our leasedmanaged and managedleased senior living communities at rates that will generate acceptable returns or that they will be able to attract employees and keep wages and other employee benefits, insurance costs and other operating expenses at levels which will allow them to compete successfully and operate our senior living communities profitably.
Competition from newly developed senior living communities may adversely affect the profitability of our senior living communities.
In recent years, a significant number of new senior living communities have been developed and continue to be developed. Although there are indications that the rate of newly started developments has recently declined,may be slowing, the increased supply of senior living communities that has resulted from recent development activity has increased competitive pressures on our tenantsmanagers and managers,tenants, particularly in certain geographic markets where we own senior living communities, and we expect these competitive challenges to continue for at least the next few years. These competitive challenges may prevent our tenantsmanagers and managertenants from maintaining
or improving occupancy and rates at our senior living communities, which may increase the risk of default under our leases, reduce the rents and returns we may receive and earn from our leasedmanaged and managedleased senior living communities and adversely affect the profitability of our senior living communities, and may cause the value of our properties to decline.
We may be unable to lease our properties when our leases expire.
Although we typically will seek to renew our leases with current tenants when they expire, we cannot be sure that we will be successful in doing so. If our tenants do not renew their leases, we may be unable to obtain new tenants to maintain or increase the historical occupancy rates of, or rents from, our properties.
We may experience declining rents or incur significant costs to renew our leases with current tenants or to lease our properties to new tenants.
When we renew our leases with current tenants or lease to new tenants, we may experience rent decreases, and we may have to spend substantial amounts for leasing commissions, tenant improvements or other tenant inducements. Moreover, many of our MOBmedical office and life science properties have been specially designed for the particular businesses of our tenants; if the current leases for such properties are terminated or are not renewed, we may be required to renovate such properties at substantial costs, decrease the rents we charge or provide other concessions in order to lease such properties to new tenants.
Current office space utilization trends may adversely impact our business.
There is a general trend in office real estate for companies to decrease the space they occupy per employee. This increase in office utilization rates may result in our MOBmedical office and life science property tenants renewing their leases for less area than they currently occupy, which could increase the vacancy and decrease rental income at our MOBs.medical office and life science properties. The need to reconfigure leased office space to increase utilization also may require us to spend increased amounts for tenant improvements.
Ownership of real estate is subject to environmental risks.risks and liabilities.
Ownership of real estate is subject to risks associated with environmental hazards. WeUnder various laws, owners as well as tenants and operators of real estate may be liable for environmental hazardsrequired to investigate and clean up or remove hazardous substances present at or migrating from our properties including those created by prior ownersthey own, lease or occupants, existing tenantsoperate and may be held liable for property damage or managers, abutters or other persons. Various federal and statepersonal injuries that result from hazardous substances. These laws impose liabilities upon property owners, includingalso expose us for environmental damages arising at, or migrating from, owned properties, andto the possibility that we may bebecome liable for the costs of environmental investigation and clean up at, or near, our properties. As an owner or previous owner of properties, we also may be liable to pay damages to government agencies or third parties for costs and damages they incur arising from environmental hazards at, or migrating from, such properties.in connection with hazardous substances. The costs and damages that may arise from environmental hazards may be substantial and are often difficult to projectassess and estimate for numerous reasons, including uncertainty about the extent of contamination, alternative treatment methods that may be substantial.
In addition, we believe someapplied, the location of our properties may contain asbestos. We believe any asbestos on our properties is contained in accordance with applicablethe property which subjects it to differing local laws and regulations and we have no current planstheir interpretations, as well as the time it may take to remove it. If we removed the asbestos or demolished the affected properties, certain environmental regulations govern the manner in which the asbestos must be handled and removed, and we could incur substantial costs complying with such regulations.
Current government policies regarding interest rates and trade policies may cause a recession.
The U.S. Federal Reserve policyremediate contamination. In addition, these laws also impose various requirements regarding the timingoperation and amountmaintenance of future increases in interest ratesproperties and changing U.S.recordkeeping and other countries’ trade policies may hinderreporting requirements relating to environmental matters that require us or the growth of the U.S. economy. It is unclear whether the U.S. economy will be able to withstand these challenges and continue sustained growth. Economic weakness in the U.S. economy generallymanagers or a new U.S. recession would likely adversely affect our financial condition and that of our tenants and managers, could adversely impact the ability of our tenants and managers to renew our leases or management agreements or pay rents or returns to us, and may cause the values of our properties to incur costs to comply with.
We may incur substantial liabilities and of our securities to decline.costs for environmental matters.
Ownership of real estate is subject to climate change andrisks from adverse weather risks.and climate events.
Some observers believe severe weather in different parts of the world over the last few years is evidence of global climate change. Severe weather may have an adverse effect on certain properties we own. Flooding caused by rising sea levels and severe weather events, including hurricanes, tornadoes and widespread fires, may have an adverse effect on properties we own and result in significant losses to us and interruption of our business. When major weather or climate-related events, such as hurricanes, floods and wildfires, occur near our properties, we, our tenants or our managers may relocate the residents at our senior living properties to alternative locations for their safety and we, our tenants or our managers may close or limit the operations of the impacted senior living community or medical office or life science property until the event has ended and the property is then ready for operation. We or the managers or tenants of our properties may incur significant costs and losses as a result of these activities, both in terms of operating, preparing and repairing our properties in anticipation of, during and after a severe weather or climate-related event and in terms of potential lost business due to the interruption in operating our properties. Our insurance and our managers' and tenants' insurance may not adequately compensate us or them for these costs and losses.
Also, the political debateconcerns about climate change hashave resulted in various treaties, laws and regulations that are intended to limit carbon emissions.emissions and address other environmental concerns. These or futureand other laws may cause operatingenergy or other costs at our properties to increase. Laws enacted to mitigate climate change may make some of our buildings obsolete or requirecause us to make material
investments in our properties which could materially and adversely affect our financial condition or the financial condition of our managers or tenants and results of operationstheir ability to pay rent to, or generate sufficient returns for, us and cause the value of our securities to decline. In addition, concerns about climate change and increasing storm intensities may increase the cost of our insurance for our properties or potentially render it unavailable to obtain.
Real estate ownership creates risks and liabilities.
In addition to the risks discussed above, our business is subject to other risks associated with real estate ownership, including:
the illiquid nature of real estate markets, which limits our ability to sell our assets rapidly to respond to changing market conditions;
the subjectivity of real estate valuations and changes in such valuations over time;
current and future adverse national real estate trends, including increasing vacancy rates, declining rental rates and general deterioration of market conditions;
costs that may be incurred relating to property maintenance and repair, and the need to make expenditures due to changes in government regulations; and
liabilities and litigations arising from injuries on our properties or otherwise incidental to the ownership of our properties.
We have debt and we may incur additional debt.
As of December 31, 2017,2019, our consolidated indebtedness was $3.7$3.5 billion, our consolidated indebtednessnet debt to total gross assets ratio was 42.0%42.5% and we had $404.0$462.5 million available for borrowing under our $1.0 billion revolving credit facility. The agreements governing our $1.0 billion revolving credit facility our $350.0 million term loan and our $200.0 million term loan include a feature under which the maximum aggregate borrowing availability may be increased to up to $2.0 billion $700.0 million and $400.0 million, respectively.
We are subject to numerous risks associated with our debt, including the risk that our cash flows could be insufficient for us to make required payments on our debt. There are no limits in our organizational documents on the amount of debt we may incur, and we may incur substantial debt. Our debt obligations could have important consequences to our securityholders. Our incurring debt may increase our vulnerability to adverse economic, market and industry conditions, limit our flexibility in planning for, or reacting to, changes in our business, and place us at a disadvantage in relation to competitors that have lower debt levels. Our incurrence of debt could also increase the costs to us of incurring additional debt, increase our exposure to floating interest rates or expose us to potential events of default (if not cured or waived) under covenants contained in debt instruments that could have a material adverse effect on our business, financial condition and operating results. Excessive debt could reduce the available cash flow to fund, or limit our ability to obtain financing for, working capital, capital expenditures, acquisitions, construction projects, refinancing, lease obligations or other purposes and hinder our ability to maintain investment grade ratings from nationally recognized credit rating agencies or to make or sustain distributions to our shareholders. Following our announcement of the Restructuring Transaction, in April 2019, Standards and Poor's Global, or S&P, downgraded our issuer credit rating to BB+ and reaffirmed the ratings on our senior notes at BBB-, and in May 2019, Moody's Investors Service downgraded our unsecured credit rating to Ba1. The interest rate premiums on our revolving credit facility and our $200.0 million term loan were not changed by these changes to our ratings, but if our ratings further decline, our interest rates would likely increase.
If we default under any of our debt obligations, we may be in default under the agreements governing other debt obligations of ours which have cross default provisions, including our revolving credit facility and term loan agreements and our senior unsecured notes indentures and their supplements. In such case, our lenders may demand immediate payment of any outstanding indebtedness and we could be forced to liquidate our assets for less than the values we would receive in a more orderly process.
We may fail to comply with the terms of our revolving credit facility and term loan agreements and our senior unsecured notes indentures and their supplements, which could adversely affect our business and may prevent our making distributions to our shareholders.
Our revolving credit facility and term loan agreements and our senior unsecured notes indentures and their supplements include various conditions, covenants and events of default. We may not be able to satisfy all of these conditions or may default on some of these covenants for various reasons, including for reasons beyond our control. For example, our revolving credit facility
and term loan agreements and our senior unsecured notes indentures and their supplements require us to maintain certain debt service ratios. Our ability to comply with such covenants will depend upon the net rental income and returns we receive from our properties. If
the occupancy at our properties declines or if our rents or returns decline, we may be unable to borrow under our revolving credit facility. Complying with these covenants may limit our ability to take actions that may be beneficial to us and our securityholders.
If we are unable to borrow under our revolving credit facility, we may be unable to meet our obligations or grow our business by acquiring additional properties. If we default under our revolving credit facility or term loan agreements, our lenders may demand immediate payment and may elect not to fund future borrowings. During the continuance of any event of default under our revolving credit facility or term loan agreements, we may be limited or in some cases prohibited from making distributions to our shareholders. Any default under our revolving credit facility or term loan agreements that results in acceleration of our obligations to repay outstanding indebtedness or in our no longer being permitted to borrow under our revolving credit facility would likely have serious adverse consequences to us and would likely cause the value of our securities to decline.
In the future, we may obtain additional debt financing, and the covenants and conditions which apply to any such additional debt may be more restrictive than the covenants and conditions that are contained in our revolving credit facility or term loan agreements or our senior unsecured notes indentures and their supplements.
RMR LLC and Five Star rely on information technology and systems in their operations, and any material failure, inadequacy, interruption or security failure of that technology or those systems could materially and adversely affect us.
RMR LLC and Five Star rely on information technology and systems, including the Internet and cloud-based infrastructures, commercially available software and their internally developed applications, to process, transmit, store and safeguard information and to manage or support a variety of their business processes (including managing our building systems), including financial transactions and maintenance of records, which may include personal identifying information of employees, residents and tenants and lease data. If either of RMR LLC or Five Star experiences material security or other failures, inadequacies or interruptions of its information technology, it could incur material costs and losses and our operations could be disrupted as a result. Further, third party vendors could experience similar events with respect to their information technology and systems that impact the products and services they provide to RMR LLC, Five Star or us. RMR LLC and Five Star rely on commercially available systems, software, tools and monitoring, as well as their internally developed applications and internal procedures and personnel, to provide security for processing, transmitting, storing and safeguarding confidential resident, tenant, customer and vendor information, such as personally identifiable information related to their employees and others, including in Five Star’sStar's case, residents, and information regarding their and our financial accounts. Each of RMR LLC and Five Star takes various actions, and incurs significant costs, to maintain and protect the operation and security of its information technology and systems, including the data maintained in those systems. However, it is possible that these measures will not prevent the systems’systems' improper functioning or a compromise in security, such as in the event of a cyberattack or the improper disclosure of personally identifiable information.
Security breaches, computer viruses, attacks by hackers, online fraud schemes and similar breaches can create significant system disruptions, shutdowns, fraudulent transfer of assets or unauthorized disclosure of confidential information. For example, in June 2017, RMR LLC became aware that it had been a victim of criminal fraud in which a person pretending to be a representative of a seller in a property acquisition transaction provided fraudulent money wire instructions that caused money to be wire transferred to an account that was believed to be, but was not, the seller’s account. We were not involved in that transaction and we did not incur any loss from that transaction; however, there may be a risk that similar fraudulent activities could be attempted against us, RMR LLC or others with respect to our assets. The cybersecurity risks to RMR LLC, Five Star, us and third party vendors are heightened by, among other things, the evolving nature of the threats faced, advances in computer capabilities, new discoveries in the field of cryptography and new and increasingly sophisticated methods used to perpetuateperpetrate illegal or fraudulent activities against RMR LLC or Five Star, including cyberattacks, email or wire fraud and other attacks exploiting security vulnerabilities in RMR LLC’s,LLC's, Five Star’sStar's or other third parties’parties' information technology networks and systems or operations. Any failure to maintain the security, proper function and availability of RMR LLC’sLLC's or Five Star’sStar's information technology and systems, or certain third party vendors’vendors' failure to similarly protect their information technology and systems that are relevant to RMR LLC’s,LLC's, Five Star’sStar's or our operations, or to safeguard RMR LLC’s,LLC's, Five Star’sStar's or our business processes, assets and information could result in financial losses, interrupt RMR LLC’sLLC's or Five Star’sStar's operations, damage RMR LLC’sLLC's or Five Star’sStar's reputation, cause RMR LLC or Five Star to be in default of material contracts and subject RMR LLC or Five Star to liability claims or regulatory penalties. Any or allpenalties, any of the foregoingwhich could materially and adversely affect our business and the value of our securities.
Real estate construction and redevelopment creates risks.
Our business plans involve the development of new properties or the redevelopment of some of our existing properties as the existing leases expire, as our tenants’managers' or managers’tenants' needs change or to pursue any other opportunities that we believe are desirable. The development and redevelopment of new and existing buildings involves significant risks in addition to those involved in the ownership and operation of leased properties, including the risks that construction may not be completed on schedule or within budget, resulting in increased construction costs and delays in leasing such properties and generating cash flows. Development activities are also subject to risks relating to the inability to obtain, or delays in obtaining, all necessary zoning, land
use, building, occupancy, and other required government permits and authorizations. Once completed, any new properties may perform below anticipated financial results. The occurrence of one or more of these circumstances in connection with our development or redevelopment activities could have an adverse effect on our financial condition, results of operations and the value of our securities.
Insurance may not adequately cover our losses.losses, and the cost of obtaining such insurance may continue to increase.
We or our tenants are generally responsible for the costs of insurance coverage for our properties and the operations conducted on them, including for casualty, liability, malpractice at managed properties, fire, extended coverage and extended coverage.rental or business interruption loss insurance. Recently, the costs of insurance have increased significantly, and these increased costs have had an adverse effect on us and our managers and tenants. Increased insurance costs may adversely affect our managers' ability to operate our properties profitably and provide us with desirable returns and our tenants' ability to pay us rent or result in downward pressure on rents we can charge under new or renewed leases. In the future, we may acquire additional properties for which we are responsible for the costs of insurance. Losses of a catastrophic nature, such as those caused by hurricanes, flooding, volcanic eruptions and earthquakes, among other things, or losses from terrorism, may be covered by insurance policies with limitations such as large deductibles or co-payments that we or a responsible tenant may not be able to pay. Insurance proceeds may not be adequate to restore an affected property to its condition prior to a loss or to compensate us for our losses, including the loss of future revenues from an affected property. Similarly, our other insurance, including our general liability insurance, may not provide adequate insurance to cover our losses. In addition, we do not have any insurance to limit losses that we may incur as a result of known or unknown environmental conditions. Further, we cannot be sure that certain types of risks that are currently insurable will continue to be insurable on an economically feasible basis, and we may discontinue, or agree to our managers' and tenants' discontinuing, certain insurance coverage on some or all of our properties in the future if the cost of premiums for any of these policies exceeds the value of the coverage. If we determine that an uninsured loss or a loss in excess of insured limits occurs and if we are not able to recover amounts from our applicable managers and tenants from certain losses, we may have to incur uninsured costs to mitigate such losses or lose all or a portion of the capital invested in a property, as well as the anticipated future revenue from the property. We might also remain obligated for any financial obligations related to the property, even if the property is irreparably damaged. In addition, future changes in the insurance industry's risk assessment approach and pricing structure could further increase the cost of insuring our properties or decrease the scope of insurance coverage, either of which could have an adverse effect on our financial condition, results of operations, liquidity and ability to pay distributions to our shareholders.
Our use of joint ventures may limit our flexibility with jointly owned investments.
In March 2017, we enteredWe are party to a joint venture with a sovereign investor for one of our MOBslife science properties located in Boston, Massachusetts, and we may in the future acquire, develop or recapitalize properties in joint ventures with other persons or entities. Our participation in these joint ventures is subject to risks, including the following:
we may share approval rights over major decisions affecting the ownership or operation of the joint venture and any property owned by the joint venture;
we may be required to contribute additional capital if our partners fail to fund their share of any required capital contributions;
our joint venture partners may have economic or other business interests or goals that are inconsistent with our business interests or goals and that could affect our ability to lease or release the property, operate the property or maintain our qualification for taxation as a REIT;
our joint venture partners may be subject to different laws or regulations than us, or may be structured differently than us for tax purposes, which could create conflicts of interest and/or affect our ability to maintain our qualification for taxation as a REIT;
our ability to sell the interest on advantageous terms when we so desire may be limited or restricted under the terms of the applicable joint venture agreements; and
disagreements with our joint venture partners could result in litigation or arbitration that could be expensive and distracting to management and could delay important decisions.
Any of the foregoing risks could have a material adverse effect on our business, financial condition and results of operations.
Bankruptcy law may adversely impact us.
The occurrence of a tenant bankruptcy could reduce the rent we receive from such tenant's lease. If a tenant becomes bankrupt, federal law may prohibit us from evicting such tenant based solely upon its bankruptcy. In addition, a bankrupt tenant may be authorized to reject and terminate its lease with us. Any claims against a bankrupt tenant for unpaid future rent would be subject to statutory limitations that may be substantially less than the contractually specified rent we are owed under the lease, and any claim we have for unpaid past rent may not be paid in full. Further, if a manager files for bankruptcy, we may experience delays in enforcing our rights, may be limited in our ability to replace the manager and may incur substantial costs in protecting our investment and re-leasing or finding a replacement manager for the property.
We may incur significant costs complying with the Americans with Disabilities Act and similar laws.
Under the Americans with Disabilities Act and certain similar state statutes, many commercial properties must meet specified requirements related to access and use by disabled persons. In addition, our properties are subject to various laws and regulations relating to fire, safety and other regulations. We may be required to make substantial capital expenditures at our properties to comply with these laws. In addition, non-compliance could result in the imposition of fines or an award of damages and costs to private litigants. These expenditures may have an adverse impact on our financial results and the value of our securities.
Our business could be adversely impacted if there are deficiencies in our disclosure controls and procedures or our internal control over financial reporting.
The design and effectiveness of our disclosure controls and procedures and our internal control over financial reporting may not prevent all errors, misstatements or misrepresentations. While management will continue to review the effectiveness of our disclosure controls and procedures and our internal control over financial reporting, we cannot assureguarantee that our disclosure controls and procedures and internal control over financial reporting will be effective in accomplishing all control objectives all
of the time. Deficiencies, including any material weaknesses, in our disclosure controls and procedures or internal control over financial reporting could result in misstatements of our results of operations or our financial statements or could otherwise materially and adversely affect our business, reputation, results of operations, financial condition or liquidity.
Changes in lease accountingWe and our managers and tenants may fail to comply with laws governing the privacy and security of personal information, including relating to health.
We and our managers and tenants are required to comply with federal and state laws governing the privacy, security, use and disclosure of personally identifiable information and protected health information. Under HIPAA and the HITECH Act, as updated by the Omnibus Rule, we and our managers and tenants are required to comply with the HIPAA privacy rule, security standards and standards for electronic healthcare transactions. State laws also govern protected health information, and rules regarding state privacy rights may be more stringent than HIPAA. Other federal and state laws govern the privacy of other personally identifiable information. If we or our managers or tenants fail to comply with applicable federal or state standards, we or they could be subject to civil sanctions and criminal penalties, and our and our managers' and tenants' reputations could be adversely impacted, which could materially and adversely affect us.our and their business, financial condition and results of operations and our tenants' ability to pay us rent.
The Financial Accounting Standards Board,A severe cold and flu season, epidemics or FASB, adoptedany other widespread illnesses could adversely affect the occupancy of our senior living communities.
Our revenues and our managers' and tenants' revenues with respect to our senior living communities are dependent on occupancy. If a severe cold and flu season, an epidemic or any other widespread illnesses occurred in locations where our senior living communities are located, our and our applicable managers' and tenants' revenues from those communities would likely be significantly and negatively impacted. During such occasions, we and our managers and tenants may experience a decline in occupancy due to residents leaving our communities and, we, our managers or our tenants may be required, or we, our managers or our tenants may otherwise determine that it would be prudent, to quarantine some or all of the senior living community and not to permit new accounting rules to be effective for fiscal years ending after December 2018, which will require companies to capitalize substantially all leasesresidents during that time. Further, depending on their balance sheets by recognizing a lessee’s rights and obligations. When the final rules are effective, many companies that account for certain leases on an “off balance sheet” basis willseverity of the occurrence, we, our managers or our tenants may be required to account for such leases “on balance sheet.” This change will remove manyincur costs to identify, contain and remedy the impacts of those occurrences at those senior living communities. As a result, these occurrences could significantly and adversely affect our and our managers' and tenants' results of operations and adversely affect the differences in the way companies account for owned property and leased property and could have a material effect on various aspectsability of our tenants’ businesses, includingapplicable tenants to pay us rent.
If our managers and tenants do not achieve and maintain high quality care, payments through pay for performance and value based purchasing programs may be reduced, and the appearanceoverall attractiveness of their creditour senior living communities to potential residents could decrease as more quality and other factors they considerdata becomes publicly available.
CMS is moving towards pay for performance programs, such as value based payment, as an alternative to fee for service reimbursement. In October 2016, CMS issued a final rule to implement the Quality Payment Program. Starting in deciding whether2019, providers may be subject to owneither MIPS payment adjustments or lease properties. WhenAPM incentive payments. Under PAMA, beginning in federal fiscal year 2019, Medicare payment rates are now partially based on SNFs' performance scores on a hospital readmissions measure as part of CMS's new SNF Value Based Purchasing Program. Moreover, under the rulesIMPACT Act, SNFs are effective, or as the effective date approaches, these rules could cause companies that lease properties to prefer shorter lease terms in an effort to reduce the leasing liability required to report certain quality measures, resource use measures and certain patient assessment data in a standardized and interoperable format. SNFs that fail to comply with the reporting requirements are subject to a 2.0% reduction in their Medicare payment rates. Beginning in October 2018, HHS made SNF reported data publicly available on its Nursing Home Compare website. We cannot predict the impact of these quality driven payment reforms, but they may be recorded on their balance sheets or some companies may decidematerial to prefer property ownership to leasing. Such decisions byand adversely affect our current or prospectiveand our managers' and tenants' future results of operations. In addition, we cannot predict the impact of more quality data becoming publicly available, but if we and our managers and tenants may adversely impact our business and the value of our securities.senior living communities do not achieve and maintain high quality of care, the overall attractiveness of our communities to potential residents could decrease.
Risks Related to Our Relationships with RMRInc., RMR LLC andFive Star
We are dependent upon RMR LLC to manage our business and implement our growth strategy.strategy and Five Star to manage our senior living communities.
We have no employees. Personnel and services that we require are provided to us by RMR LLC pursuant to our management agreements with RMR LLC. Our ability to achieve our business objectives depends on RMR LLC and its ability to effectively manage our properties, to appropriately identify and complete our acquisitions and dispositions and to execute our growth strategy. Accordingly, our business is dependent upon RMR LLC’sLLC's business contacts, its ability to successfully hire, train, supervise and manage its personnel and its ability to maintain its operating systems. If we lose the services provided by RMR LLC or its key personnel, our business and growth prospects may decline. We may be unable to duplicate the quality and depth of management available to us by becoming internally managed or by hiring another manager. In the event RMR LLC is unwilling or unable to continue to provide management services to us, our cost of obtaining substitute services may be greater than the fees we pay RMR LLC under our management agreements, and as a result our expenses may increase. In addition, we depend on Five Star to manage our senior living communities. See “—Risks Related to our Business—We are dependent on Five Star for the operation of most of our senior living communities."
Our management structure and agreements and relationships with RMR LLC and RMR LLC’s and its controlling shareholder's relationships with others may create conflicts of interest, or the appearance of such conflicts, and may restricthas broad discretion in operating our investment activities.day to day business.
Our manager, RMR LLC, is authorized to follow broad operating and investment guidelines and, therefore, has discretion in determiningidentifying the properties that will be appropriate investments for us, as well as our individual operating and investment decisions. Our Board of Trustees periodically reviews our operating and investment guidelines and our operating activities and investments but it does not review or approve each decision made by RMR LLC on our behalf. In addition, in conducting periodic reviews, our Board of Trustees relies primarily on information provided to it by RMR LLC. RMR LLC may exercise its discretion in a manner that results in investment returns that are substantially below expectations or that results in losses.
Our management structure and agreements and relationships with RMR LLC and RMR LLC's and its controlling shareholder's relationships with others may create conflicts of interest, or the perception of such conflicts, and may restrict our investment activities.
RMR LLC is a subsidiary of RMR Inc. OurThe Chair of our Board of Trustees and one of our Managing Trustee,Trustees, Adam D. Portnoy, as the current sole trustee of ABP Trust, is the controlling shareholder of RMR Inc. and as the current sole Trustee of ABP Trust beneficially owns all the class A membership units of RMR LLC not owned by RMR Inc. Adam Portnoy is a managing director and the president and chief executive officer of RMR Inc. and an officer and employee of RMR LLC. Barry Portnoy was our other Managing Trustee and a director and an officer of RMR Inc. and an officer of RMR LLC until his death on February 25, 2018. RMR LLC or its subsidiary also acts as the manager for fivefour other Nasdaq listed REITs: GOV,OPI, which primarily owns office properties that are majority leased to governmentsingle tenants and office properties in the metropolitan Washington, D.C. market area that may also be leased to private sectorhigh credit quality tenants, including government tenants; HPT, which owns hotels and travel centers; ILPT, which primarily owns industrial and logistics properties; SIR,SVC, which primarily owns a diverse portfolio of hotels and invests in net leased, single tenantlease service and necessity based retail properties; and Tremont Mortgage Trust, or TRMT, which primarily originates and invests in first mortgage loans secured by middle market and transitional commercial real estate.estate. RMR LLC also provides services to other publicly and privately owned companies, including: Five Star, our largest tenant and the manager of our managed senior living communities;communities and of which we own 33.9% of its outstanding common shares as of January 1, 2020; TA, which operates and franchises travel centers, convenience storestruck repair facilities and restaurants; and Sonesta, which operates, manages and franchises hotels, resorts and cruise ships. An affiliateboats. A subsidiary of RMR LLC is an investment adviser to the RMR Real Estate Income Fund, or RIF, a closed end investment company listed on the NYSE American, which primarily invests in securities of REITsreal estate companies that are not managed by RMR LLC. Mr. Portnoy
Each
serves as chair of our executive officers is also an officerthe board of trustees or board of directors, as applicable, of OPI, ILPT, SVC, Five Star and TA and as managing director, managing trustee, director or trustee, as applicable, of the companies managed by RMR LLC includingor its subsidiaries.
Jennifer F. Francis, our President and Chief Operating Officer, Richard W. Siedel, Jr., our Chief Financial Officer and Treasurer, Richard W.and Jennifer B. Clark, our Secretary and one of our Managing Trustees, are also officers and employees of RMR LLC. Mr. Siedel Jr., who is also the Chief Financial Officerchief financial officer and Treasurertreasurer of ILPT. Because our executive officersMses. Francis and Clark and Mr. Siedel have duties
to RMR LLC, and Mr. Siedel has duties to ILPT, as well as to us, and Richard W. Siedel, Jr. has duties to ILPT, we do not have their undivided attention. They and other RMR LLC personnel may have conflicts in allocating their time and resources between us and RMR LLC and other companies to which RMR LLC providesor its subsidiaries provide services. Our Independent Trustees also serve as independent directors or independent trustees of other public companies to which RMR LLC or its subsidiary providessubsidiaries provide management services.
In addition, we may in the future enter into additional transactions with RMR LLC, its affiliates, or entities managed by it or its subsidiaries. In addition to theirhis investments in RMR Inc. and RMR LLC, our current and former Managing Trustees holdAdam Portnoy holds equity investments in other companies to which RMR LLC providesor its subsidiaries provide management services and some of these companies including us, have significant cross ownership interests, including, for example: as of February 23, 2018, our Managing Trustee and BarryDecember 31, 2019, Adam Portnoy our former Managing Trustee,beneficially owned, directly or indirectly, in aggregate, 1.3%1.1% of our outstanding common shares, 36.4%35.3% of outstanding Five Star’s outstandingStar common stock,1.5%shares (6.3% as of HPT’sJanuary 1, 2020) (including through ABP Trust), 1.2% of ILPT's outstanding common shares, 1.8%1.5% of GOV’sOPI's outstanding common shares, 1.9%2.3% of SIR’sRIF's outstanding common shares; and 9.1%shares, 1.1% of RIF’sSVC's outstanding common shares; we own 8.4%shares, 4.0% of Five Star’sTA's outstanding common stock; GOV owns 27.8%shares (including through RMR LLC) and 19.5% of SIR’sTRMT's outstanding common shares; SIR owns 69.2% of ILPT’s outstanding common shares; HPT owns 8.6% of TA’s outstanding common shares; andshares (including through Tremont Realty Advisors LLC, a whollyLLC); and we owned subsidiary8.2% of RMR LLC, owns 19.2%outstanding Five Star common shares (33.9% as of TRMT’s outstanding common shares.January 1, 2020). Our executive officers may also own equity investments in other companies to which RMR LLC or its subsidiary providessubsidiaries provide management services. These multiple responsibilities, relationships and cross ownerships could create competition for the time and efforts of RMR LLC, Adam Portnoy and other RMR LLC personnel, including our executive officers, and give rise to conflicts of interest or the appearanceperception of such conflicts of interest with respect to matters involving us, RMR Inc., RMR LLC, our Managing Trustee,Trustees, the other companies to which RMR LLC or its subsidiaries provide management services and their related parties. Conflicts of interest or the appearanceperception of conflicts of interest could have a material adverse impact on our reputation, business and the market price of our common shares and other securities and we may be subject to increased risk of litigation as a result.
In our management agreements with RMR LLC, we acknowledge that RMR LLC may engage in other activities or businesses and act as the manager to any other person or entity (including other REITs) even though such person or entity has investment policies and objectives similar to our policies and objectives and we are not entitled to preferential treatment in receiving information, recommendations and other services from RMR LLC. Accordingly, we may lose investment opportunities to, and may compete for tenants with, other businesses managed by RMR LLC or its subsidiary.subsidiaries. We cannot assurebe sure that our Code of Conduct or our Governance Guidelines,governance guidelines, or other procedural protections we adopt will be sufficient to enable us to identify, adequately address or mitigate actual or alleged conflicts of interest or ensure that our transactions with related persons are made on terms that are at least as favorable to us as those that would have been obtained with an unrelated person.
Our management agreements were not negotiated on an arm’sarm's length basis and their fee and expense structure may not create proper incentives for RMR LLC, which may increase the risk of an investment in our common shares.
As a result of our relationships with RMR LLC and its current and former controlling shareholder(s), our management agreements were not negotiated on an arm’sarm's length basis between unrelated parties, and therefore, while such agreements were negotiated with the use of a special committee and disinterested Trustees, the terms, including the fees payable to RMR LLC, may not be as favorable to us as they would have been if they were negotiated on an arm’sarm's length basis between unrelated parties. Our property management fees are calculated based on rents we receive and construction supervision fees for construction at our properties overseen and managed by RMR LLC, and our base business management fee is calculated based upon the lower of the historical costs of our real estate investments and our market capitalization. We pay RMR LLC substantial base management fees regardless of our financial results. These fee arrangements could incentivize RMR LLC to pursue acquisitions, capital transactions, tenancies and construction projects or to avoid disposing of our assets in order to increase or maintain its management fees.fees and might reduce RMR LLC's incentive to devote its time and effort to seeking investments that provide attractive returns for us. If we do not effectively manage our investment, disposition and capital transactions and leasing, construction and other property management activities, we may pay increased management fees without proportional benefits to us. In addition, we payare obligated under our management agreements to reimburse RMR LLC substantial base management fees regardlessfor employment and related expenses of RMR LLC's employees assigned to work exclusively or partly at our financial results.properties, our share of the wages, benefits and other related costs of RMR LLC’s entitlementLLC's centralized accounting personnel and our share of RMR LLC's costs for providing our internal audit function. We are also required to a base management fee mightpay for third party costs incurred with respect to us. Our obligation to reimburse RMR LLC for certain of its costs and to pay third party costs may reduce itsRMR LLC's incentive to devote its time and effort to seeking investments that provide attractive returns for us.efficiently manage those costs, which may increase our costs.
The termination of our management agreements may require us to pay a substantial termination fee, including in the case of a termination for unsatisfactory performance, which may limit our ability to end our relationship with RMR LLC.
The terms of our management agreements with RMR LLC automatically extend on December 31st of each year so that such terms thereafter end on the 20th anniversary of the date of the extension. We have the right to terminate these agreements: (1) at any time on 60 days’days' written notice for convenience, (2) immediately upon written notice for cause, as defined in the agreements, (3) on written notice given within 60 days after the end of any applicable calendar year for a performance reason, as defined in the agreements, and (4) by written notice during the 12 months following a manager change of control, as defined in the agreements. However, if we terminate a management agreement for convenience, or if RMR LLC terminates a management agreement with us for good reason, as defined in such agreement, we are obligated to pay RMR LLC a termination fee in an amount equal to the sum of the present values of the monthly future fees, as defined in the applicable agreement, payable to RMR LLC for the thenterm that was remaining term,before such termination, which, depending on the time of termination, would be between 19 and 20 years. Additionally, if we terminate a management agreement for a performance reason, as defined in the agreement, we are obligated to pay RMR LLC the termination fee calculated as described above, but assuming a remaining term of 10 years. These provisions substantially increase the cost to us of terminating the management agreements without cause, which may limit our ability to end our relationship with
RMR LLC as our manager. The payment of the termination fee could have a material adverse effect on our financial condition, including our ability to pay dividends to our shareholders.
Our management arrangements with RMR LLC may discourage a change of control of us.
Our management agreements with RMR LLC have continuing 20 year terms that renew annually. As noted in the preceding risk factor, if we terminate either of these management agreements other than for cause or upon a change of control of our manager, we are obligated to pay RMR LLC a substantial termination fee. For these reasons, our management agreements with RMR LLC may discourage a change of control of us, including a change of control which might result in payment of a premium for our common shares.
Our business dealings with Five Star comprise a significant part of our business and operations and they may create conflicts of interest or the appearanceperception of such conflicts of interest.
Five Star was originally organized as our subsidiary. We distributed substantially all of our Five Star common shares to our shareholders on December 31, 2001. RMR LLC provides management services to both us and Five Star. Adam Portnoy, the Chair of our Board and one of our Managing Trustee,Trustees, as the current sole trustee of ABP Trust, is Five Star’s largesta significant stockholder controlling, directly or indirectly, in aggregate 36.4% of Five Star’s outstanding common stock. Barry Portnoy served as a managing director of Five Star, until his death on February 25, 2018.beneficially owning 6.3% of outstanding Five Star is our largest tenant and,common shares as of December 31, 2017,January 1, 2020. Five Star leased 185 senior living communities from us and also managed 70manages most of our senior living communities. We recognized total rental income fromIn addition, Mr. Portnoy is the chair of Five StarStar's board of $210.5 million (including percentage rentdirectors and one of $5.5 million)its managing directors and incurred management fees of $14.1 million with respect to the communitiesour other Managing Trustee, Jennifer B. Clark, is Five Star manages for us for the year ended December 31, 2017.Star's other managing director and secretary.
The historical and continuing relationships which we, RMR LLC and our Managing TrusteeAdam Portnoy have with Five Star could create, or appear to create, conflicts of interest with respect to matters involving us, the other companies to which RMR LLC providesor its subsidiaries provide management services and their related parties. As a result of these relationships, our agreements with Five Star were not negotiated on an arm’sarm's length basis between unrelated parties, and therefore the terms may not be as favorable to us as they would have been if they were negotiated on an arm’sarm's length basis between unrelated parties. Conflicts of interest or the appearanceperception of conflicts of interest could have a material adverse impact on our reputation, business and the market price of our common shares and other securities and we may be subject to increased risk of litigation as a result.
We may not realize the expected benefits of our acquisition of an interest in RMR Inc.
On June 5, 2015, we participated in a transaction with RMR Inc., RMR LLC, ABP Trust and three other REITs to which RMR LLC provides management services in which, among other things, we acquired 5,272,787 shares of RMR Inc.’s class A common stock, ABP Trust acquired 2,345,000 of our common shares and we amended our management agreements with RMR LLC and extended them for continuing 20 year terms, or the Up-C Transaction. In December 2015, we distributed 2,635,379 of the shares of RMR Inc.’s class A common stock that we received in the Up-C Transaction pro rata to our shareholders. We believe the Up-C Transaction provided several benefits to us, including an attractive investment in the equity securities of RMR Inc., the further alignment of the interests of RMR LLC and Adam Portnoy with our interests and greater transparency for us and our shareholders into the compensation practices and financial and operating results of RMR LLC. However,expect from our investment in RMR Inc.Five Star common shares.
Pursuant to the Transaction Agreement, we received additional Five Star common shares as of January 1, 2020, that increased our percentage ownership of Five Star common shares to 33.9%, up from our previous percentage ownership of 8.2%. We paid $75.0 million to Five Star for those additional shares by assuming certain of Five Star's working capital liabilities. Our investment in Five Star is subject to various risks, including, among others, the highly competitive nature of RMR LLC’s businessthe senior living industry; medical advances and healthcare services that allow some potential residents to defer the limited publictime when they require the special services available at senior living communities that Five Star manages; low unemployment in the United States combined with a competitive labor market for RMR Inc.’s securities, among others,within the senior living industry that are increasing our and Five Star's employment costs, including labor costs that Five Star incurs and which we are not obligated to fund or reimburse; significant regulatory requirements imposed on Five Star's business; and other factors. Many of these factors are beyond our and Five Star's control. As a result, we may result in us losing some or all of our investment in RMR Inc. or otherwise not realizingrealize the benefits we expect from our investment in Five Star common shares, and we could incur losses from our investment.
We may be required to pay a substantial termination fee to Five Star if Five Star terminates the Up-C Transaction. For further informationNew Management Agreements due to our default.
Under the New Management Agreements, if Five Star terminates such management agreements due to certain defaults by us, we are required to pay Five Star a termination fee equal to the present value of the base management fees that we would have paid to Five Star and the allocated incentive fee for the applicable communities, if any, between the date of termination and the scheduled initial expiration date of such management agreements (but not for a period exceeding 10 years), with such amounts determined based on the Up-C Transaction, see Note 7average base management and incentive fees for the applicable communities for each of the three calendar years ended prior to the date of termination. Further, the payment of the termination fee could have a material adverse effect on our financial condition, including our ability to pay distributions to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.shareholders.
The Up-C Transaction and the agreements entered into as part of the Up-C TransactionWe are amongparty to transactions with related persons, which increasesparties that may increase the risk of allegations of conflicts of interest, and such allegations may impair our ability to realize the benefits we expect from the Up-C Transaction.these transactions.
Because of the various relationships among us, GOV, RMR Inc., RMR LLC and the other REITsWe are party to transactions with related parties, including with entities controlled by Adam Portnoy or to which RMR LLC providesor its subsidiaries provide management services, the Up-C Transaction and theservices. Our agreements entered into as partwith related parties or in respect of the Up-C Transaction, including the amendment and extension of our management agreements for continuing 20 year terms, aretransactions among related persons. The Up-C Transaction and the terms thereof were negotiated and reviewed by a Joint Special Committee comprised solely of our Independent Trustees and the independent trustees of the other REITs to which RMR LLC then provided management services, or the Joint Special Committee, and were separately approved and adopted by our Independent Trustee who did not serve as an independent trustee of any of the other REITs, by a Special Committee of our Board of Trustees, comprised solely of our Independent Trustees, or our Special Committee, and by our Board of Trustees. Morgan Stanley & Co. LLC acted as financial advisor to the Joint Special Committee and Centerview Partners LLC acted as financial advisor to our Special Committee. Nonetheless, because of these various relationships, the Up-C Transaction was not negotiated on an arm’s length basis among unrelated third parties and therefore
may not be on terms as favorable to us or the other applicable REITs to which RMR LLC provides management services as itthey would have been if it wasthey had been negotiated on an arm’s length basis among unrelated parties. As a result of these relationships, we may beWe are subject to increasedthe risk that our shareholders or the shareholders of theFive Star, RMR Inc. or other REITs to which RMR LLC provides management servicesrelated parties may challenge the Up-C Transactionany such related party transactions and the agreements entered into as part of them. If such a challenge were to be successful, we might not realize the Up-C Transaction. Anybenefits expected from the transactions being challenged. Moreover, any such challenge could result in substantial costs and be a diversion toof our management’smanagement's attention, could have a material adverse effect on our reputation, business and growth and could adversely affect our ability to realize the benefits we expectexpected from the Up-C Transaction,transactions, whether or not the allegations have merit or are substantiated.
We may be at an increased risk for dissident shareholder activities due to perceived conflicts of interest arising from our management structure.structure and relationships.
InCompanies with business dealings with related persons and entities may more often be the past, in particular following periodstarget of volatility in the overall market or declines in the market price of a company’s securities, shareholder litigation, dissident shareholder trustee nominations, and dissident shareholder proposals have often been instituted against companiesand shareholder litigation alleging conflicts of interest in their business dealings with affiliated and related persons and entities.dealings. Our relationships with RMR Inc., RMR LLC, Five Star, AIC, the other businesses and entitiescompanies to which RMR LLC or its subsidiaries provide management services, Adam Portnoy and other related persons of RMR LLC may precipitate such activities. Certain proxy advisory firms which have significant influence over the voting by shareholders of public companies have, in the past, recommended, and in the future may recommend, that shareholders withhold votes for the election of our incumbent Trustees, and vote against our say on pay vote or other management proposals.proposals or vote for shareholder proposals that we oppose. These recommendations mayby proxy advisory firms have affected the outcomes of past Board of Trustees elections and votes on our say on pay, and similar recommendations in the future would likely affect the outcome of ourfuture Board of Trustees elections and impactvotes on our governance,say on pay, which may increase shareholder activism and litigation. These activities, if instituted against us, could result in substantial costs and diversion of our management’smanagement's attention and could have a material adverse impact on our reputation and business.
We may experience losses from our business dealings with AIC.
We, ABP Trust, Five Star and four other companies to which RMR LLC provides management services each own 14.3% of AIC, and we have invested approximately $6.0 million in AIC. We and those other AIC shareholders participate in a combined property insurance program arranged and insured and reinsured in part by AIC and we periodically consider the possibilities for expanding our relationship with AIC to other types of insurance. Our principal reason for investing in AIC and for purchasing insurance in these programs is to seek to improve our financial results by obtaining improved insurance coverages at lower costs than may be otherwise available to us or by participating in any profits which we may realize as an owner of AIC. While we believe we have in the past benefitted from these arrangements, these beneficial financial results may not occur in the future, and we may need to invest additional capital in order to continue to pursue these results. AIC’s business involves the risks typical of an insurance business, including the risk that it may not operate profitably. Accordingly, financial benefits from our business dealings with AIC may not be achieved in the future, and we may experience losses from these dealings.
Risks Related to Our Organization and Structure
Ownership limitations and certain provisions in our declaration of trust, bylaws and contracts,agreements, as well as certain provisions of Maryland law, may deter, delay or prevent a change in our control or unsolicited acquisition proposals.
Our declaration of trust prohibits any shareholder other than RMR LLC and its affiliates (as defined under Maryland law) and certain persons who have been exempted by our Board of Trustees from owning, directly and by attribution, more than 9.8% of the number or value of shares (whichever is more restrictive) of any class or series of our outstanding shares of beneficial interest, including our common shares. This provision of our declaration of trust is intended to, among other purposes, assist with our REIT compliance under the IRC and otherwise promote our orderly governance. However, this provision may also inhibit acquisitions of a significant stake in us and may deter, delay or prevent a change in control of us or unsolicited acquisition proposals that a shareholder may consider favorable. Additionally, provisions contained in our declaration of trust and bylaws or under Maryland law may have a similar impact, including, for example, provisions relating to:
the division of our Trustees into three classes, with the term of one class expiring each year, which could delay a change of control of us;
limitations on shareholder voting rights with respect to certain actions that are not approved by our Board of Trustees;
the authority of our Board of Trustees, and not our shareholders, to adopt, amend or repeal our bylaws and to fill vacancies on our Board of Trustees;
shareholder voting standards which require a supermajority for approval of certain actions;
the fact that only our Board of Trustees, or, if there are no Trustees, our officers, may call shareholder meetings and that shareholders are not entitled to act without a meeting;
required qualifications for an individual to serve as a Trustee and a requirement that certain of our Trustees be “Managing Trustees” and other Trustees be “Independent Trustees,” as defined in our governing documents;
limitations on the ability of our shareholders to propose nominees for election as trusteesTrustees and propose other business to be considered at a meeting of our shareholders;
limitations on the ability of our shareholders to remove our Trustees; and
the authority of our Board of Trustees to create and issue new classes or series of shares (including shares with voting rights and other rights and privileges that may deter a change in control) and issue additional common shares. shares;
In addition,restrictions on business combinations between us and an interested shareholder that have not first been approved by our shareholders agreement with respectBoard of Trustees (including a majority of Trustees not related to AIC provides that AICthe interested shareholder); and
the other shareholders of AIC may have rights to acquire our interests in AIC in the event that anyone acquires more than 9.8%authority of our shares or we experience some other change in control. Board of Trustees, without shareholder approval, to implement certain takeover defenses.
Our rights and the rights of our shareholders to take action against our Trustees and officers are limited.
Our declaration of trust limits the liability of our Trustees and officers to us and our shareholders for money damages to the maximum extent permitted under Maryland law. Under current Maryland law, our Trustees and officers will not have any liability to us and our shareholders for money damages other than liability resulting from:
actual receipt of an improper benefit or profit in money, property or services; or
active and deliberate dishonesty by the Trustee or officer that was established by a final judgment as being material to the cause of action adjudicated.
Our declaration of trust and indemnification agreements require us to indemnify, any present or former trustee or officer, to the maximum extent permitted by Maryland law, any present or former Trustee or officer who is made or threatened to be made a party to a proceeding by reason of his or her service in thosethese and certain other capacities. In addition, we may be obligated to pay or reimburse the expenses incurred by our present and former Trustees and officers without requiring a preliminary determination of their ultimate entitlement to indemnification. As a result, we and our shareholders may have more limited rights against our present and former Trustees and officers than might otherwise exist absent the provisions in our declaration of trust and indemnification agreements or that might exist with other companies, which could limit our shareholders’shareholders' recourse in the event of actions not in their best interest.
Disputes with Five Star or RMR LLC and shareholderShareholder litigation against us or our Trustees, and officers, employees, managers or other agents may be referred to bindingmandatory arbitration proceedings. proceedings, which follow different procedures than in-court litigation and may be more restrictive to shareholders asserting claims than in-court litigation.
Our contracts with Five Star and RMR LLC provideshareholders agree, by virtue of becoming shareholders, that any dispute arising under those contractsthey are bound by our governing documents, including the arbitration provisions of our bylaws, as they may be referredamended from time to binding arbitration proceedings. Similarly, ourtime. Our bylaws provide that certain disputesactions by one or more of our shareholders against us or againstany of our Trustees, and officers, employees, managers or other agents, other than disputes, or any portion thereof, regarding the meaning, interpretation or validity of any provision of our declaration of trust or bylaws, maywill be referred to mandatory, binding and final arbitration proceedings.proceedings if we, or any other party to such dispute, including any of our Trustees, officers, employees, managers or other agents, unilaterally so demands. As a result, we and our shareholders would not be able to pursue litigation in courtsstate or federal court against Five Star, RMR LLCus or our Trustees, officers, employees, managers or other agents, including, for example, claims alleging violations of federal securities laws or breach of fiduciary duties or similar director or officer duties under Maryland law, if we or any of our Trustees, officers, employees, managers or other parties against whom the claim is made unilaterally demands the matter be resolved by arbitration. Instead, our shareholders would be required to pursue such claims through binding and officers for disputes referredfinal arbitration.
Our bylaws provide that such arbitration proceedings would be conducted in accordance with the procedures of the Commercial Arbitration Rules of the American Arbitration Association, as modified in our bylaws. These procedures may provide materially more limited rights to our shareholders than litigation in a federal or state court. For example, arbitration in accordance with our bylaws.these procedures does not include the opportunity for a jury trial, document discovery is limited, arbitration hearings generally are not open to the public, there are no witness depositions in advance of arbitration hearings and arbitrators may have different qualifications or experiences than judges. In addition, the ability to collect attorneys’ fees or other damagesalthough our bylaws' arbitration provisions contemplate that arbitration may be limitedbrought in a representative capacity or on behalf of a class of our shareholders, the rules governing such representation or class arbitration may be different from, and less favorable to shareholders than, the rules governing representative or class action litigation in courts. Our bylaws also generally provide that each party to such an arbitration is required to bear its own costs in the arbitration, proceedings, whichincluding attorneys' fees, and that the arbitrators may not render an award that includes shifting of such costs or, in a derivative or class proceeding, award any portion of our award to any shareholder or such shareholder's attorneys. The arbitration provisions of our bylaws may discourage our shareholders from bringing, and attorneys from agreeing to represent partiesour shareholders wishing to commence suchbring, litigation against us or our Trustees, officers, employees, managers or other agents. Our agreements with Five Star and RMR LLC have similar arbitration provisions to those in our bylaws.
We believe that the arbitration provisions in our bylaws are enforceable under both state and federal law, including with respect to federal securities laws claims. We are a proceeding.Maryland real estate investment trust and Maryland courts have upheld the enforceability of arbitration bylaws. In addition, the United States Supreme Court has repeatedly upheld agreements to arbitrate other federal statutory claims, including those that implicate important federal policies. However, some academics, legal practitioners and others are of the view that charter or bylaw provisions mandating arbitration are not enforceable with respect to federal securities laws claims. It is possible that the arbitration provisions of our bylaws may ultimately be determined to be unenforceable.
By agreeing to the arbitration provisions of our bylaws, shareholders will not be deemed to have waived compliance by us with federal securities laws and the rules and regulations thereunder.
Our bylaws designate the Circuit Court for Baltimore City, Maryland as the sole and exclusive forum for certain actions and proceedings that may be initiated by our shareholders, which could limit our shareholders’shareholders' ability to obtain a favorable judicial forum for disputes with us or our Trustees, officers, manager, agentsemployees, managers or employees.agents.
Our bylaws currently provide that, unless the dispute has been referred to binding arbitration, the Circuit Court for Baltimore City, Maryland will be the sole and exclusive forum for: (1) any derivative action or proceeding brought on our behalf; (2) any action asserting a claim for breach of a fiduciary duty owed by any Trustee, officer, manager, agent or employee of ours to us or our shareholders; (3) any action asserting a claim against us or any Trustee, officer, manager, agent or employee of ours arising pursuant
to Maryland law, our declaration of trust or bylaws brought by or on behalf of a shareholder;shareholder, either on his, her or its own behalf, on our behalf or on behalf of any series or class of shares of beneficial interest of ours or by shareholders against us or any Trustee, officer, manager, agent or employee of ours, including any disputes, claims or controversies relating to the meaning, interpretation, effect, validity, performance or enforcement of our declaration of trust or bylaws; or (4) any action asserting a claim against us or any Trustee, officer, manager, agent or employee of ours that is governed by the internal affairs doctrine. Our bylaws currently also provide that the Circuit Court for Baltimore City, Maryland will be the sole and exclusive forum for any dispute, or portion thereof, regarding the meaning, interpretation or validity of any provision of our declaration of trust or bylaws. The exclusive forum provision of our bylaws does not apply to any action for which the Circuit Court for Baltimore City, Maryland does not have jurisdiction or to a dispute that has been referred to binding arbitration in accordance with our bylaws. The exclusive forum provision of our bylaws does not establish exclusive jurisdiction in the Circuit Court for Baltimore City, Maryland for claims that arise under the Securities Act, the Exchange Act or other federal securities laws if there is exclusive or concurrent jurisdiction in the federal courts. Any person or entity purchasing or otherwise acquiring or holding any interest in our shares of beneficial interest shall be deemed to have notice of and to have consented to these provisions of our bylaws, as they may be amended from time to time. These choiceThe arbitration and exclusive forum provisions of forum provisionsour bylaws may limit a shareholder’sshareholder's ability to bring a claim in a judicial forum that the shareholder believes is favorable for disputes with us or our Trustees, officers, manager,employees, managers or agents, or employees, which may discourage lawsuits against us and our Trustees, officers, manageremployees, managers or agents.
We may change our operational, financing and investment policies without shareholder approval and we may become more highly leveraged, which may increase our risk of default under our debt obligations.
Our Board of Trustees determines our operational, financing and investment policies and may amend or revise our policies, including our policies with respect to our intention to qualifyremain qualified for taxation as a REIT, acquisitions, dispositions, growth, operations, indebtedness, capitalization and distributions, or approve transactions that deviate from these policies, without a vote of, or notice to, our shareholders. Policy changes could adversely affect the market price of our common shares and our ability to make distributions to our shareholders. Further, our organizational documents do not limit the amount or percentage of indebtedness,
funded or otherwise, that we may incur. Our Board of Trustees may alter or eliminate our current policy on borrowing at any time without shareholder approval. If this policy changes, we could become more highly leveraged, which could result in an increase in our debt service costs. Higher leverage also increases the risk of default on our obligations. In addition, a change in our investment policies, including the manner in which we allocate our resources across our portfolio or the types of assets in which we seek to invest, may increase our exposure to interest rate risk, real estate market fluctuations and liquidity risk.
Our ownership interest in AIC may prevent shareholders from accumulating a large stake in us, from nominating or serving as Trustees, or from taking actions to otherwise control our business.
As an owner of AIC, we are licensed and approved as an insurance holding company; and any shareholder who owns or controls 10% or more of our securities or anyone who wishes to solicit proxies for election of, or to serve as, one of our Trustees or for another proposal of business not approved by our Board of Trustees may be required to receive pre-clearance from the concerned insurance regulators. These pre-approval procedures may discourage or prevent investors from purchasing our securities, from nominating persons to serve as our Trustees or from taking other actions.
Risks Related to Our Taxation
Our failure to remain qualified for taxation as a REIT under the IRC could have significant adverse consequences.
As a REIT, we generally do not pay federal or most state income taxes as long as we distribute all of our REIT taxable income and meet other qualifications set forth in the IRC. However, actual qualification for taxation as a REIT under the IRC depends on our satisfying complex statutory requirements, for which there are only limited judicial and administrative interpretations. We believe that we have been organized and have operated, and will continue to be organized and to operate, in a manner that qualified and will continue to qualify us to be taxed as a REIT under the IRC. However, we cannot be sure that the IRS, upon review or audit, will agree with this conclusion. Furthermore, we cannot be sure that the federal government, or any state or other taxation authority, will continue to afford favorable income tax treatment to REITs and their shareholders.
Maintaining our qualification for taxation as a REIT under the IRC will require us to continue to satisfy tests concerning, among other things, the nature of our assets, the sources of our income and the amounts we distribute to our shareholders. In order to meet these requirements, it may be necessary for us to sell or forgo attractive investments.
If we cease to qualify for taxation as a REIT under the IRC, then our ability to raise capital might be adversely affected, we will be in breach under our revolving credit facility and term loan agreements, we may be subject to material amounts of federal and state income taxes, our cash available for distribution to our shareholders could be reduced, and the market price of our common shares could decline. In addition, if we lose or revoke our qualification for taxation as a REIT under the IRC for a taxable year, we will generally be prevented from requalifying for taxation as a REIT for the next four taxable years.
Distributions to shareholders generally will not qualify for reduced tax rates applicable to “qualified dividends.”
Dividends payable by U.S. corporations to noncorporate shareholders, such as individuals, trusts and estates, are generally eligible for reduced federal income tax rates applicable to “qualified dividends.” Distributions paid by REITs generally are not
treated as “qualified dividends” under the IRC and the reduced rates applicable to such dividends do not generally apply. However, for tax years beginning after 2017 and before 2026, REIT dividends paid to noncorporate shareholders are generally taxed at an effective tax rate lower than applicable ordinary income tax rates due to the availability of a deduction under the IRC for specified forms of income from passthrough entities. More favorable rates will nevertheless continue to apply to regular corporate “qualified” dividends, which may cause some investors to perceive that an investment in a REIT is less attractive than an investment in a non-REIT entity that pays dividends, thereby reducing the demand and market price of our common shares.
REIT distribution requirements could adversely affect us and our ability to execute our business plan.shareholders.
We generally must distribute annually at least 90% of our REIT taxable income, subject to specified adjustments and excluding any net capital gain, in order to maintain our qualification for taxation as a REIT under the IRC. To the extent that we satisfy this distribution requirement, federal corporate income tax will not apply to the earnings that we distribute, but if we distribute less than 100% of our REIT taxable income, then we will be subject to federal corporate income tax on our undistributed taxable income. We intend to make distributions to our shareholders to comply with the REIT requirements of the IRC. In addition, we will be subject to a 4% nondeductible excise tax if the actual amount that we pay out to our shareholders in a calendar year is less than a minimum amount specified under federal tax laws.
From time to time, we may generate taxable income greater than our income for financial reporting purposes prepared in accordance with U.S. generally accepted accounting principles, or GAAP, or differences in timing between the recognition of taxable income and the actual receipt of cash may occur. If we do not have other funds available in these situations, among other things, we may borrow funds on unfavorable terms, sell investments at disadvantageous prices or distribute amounts that would otherwise be invested in future acquisitions in order to make distributions sufficient to enable us to pay out enough of our taxable income to satisfy the REIT distribution requirement and to avoid corporate income tax and the 4% excise tax in a particular year.
These alternatives could increase our costs or reduce our shareholders’shareholders' equity. Thus, compliance with the REIT distribution requirements may hinder our ability to grow, which could cause the market price of our common shares to decline.
Even if we remain qualified for taxation as a REIT under the IRC, we may face other tax liabilities that reduce our cash flow.
Even if we remain qualified for taxation as a REIT under the IRC, we may be subject to federal, state and local taxes on our income and assets, including taxes on any undistributed income, excise taxes, state or local income, property and transfer taxes, and other taxes. Also, some jurisdictions may in the future limit or eliminate favorable income tax deductions, including the dividends paid deduction, which could increase our income tax expense. In addition, in order to meet the requirements for qualification and taxation as a REIT under the IRC, prevent the recognition of particular types of non-cash income, or avert the imposition of a 100% tax that applies to specified gains derived by a REIT from dealer property or inventory, we may hold or dispose of some of our assets and conduct some of our operations through our TRSs or other subsidiary corporations that will be subject to corporate level income tax at regular rates. In addition, while we intend that our transactions with our TRSs will be conducted on arm’sarm's length bases, we may be subject to a 100% excise tax on a transaction that the IRS or a court determines was not conducted at arm’sarm's length. Any of these taxes would decrease cash available for distribution to our shareholders.
If arrangements involving our TRSs fail to comply as intended with the REIT qualification and taxation rules, we may fail to qualify for taxation as a REIT under the IRC or be subject to significant penalty taxes.
We lease manymost of our properties to our TRSs pursuant to arrangements that, under the IRC, are intended to qualify the rents we receive from our TRSs as income that satisfies the REIT gross income tests. We also intend that our transactions with our TRSs be conducted on arm’sarm's length bases so that we and our TRSs will not be subject to penalty taxes under the IRC applicable to mispriced transactions. While relief provisions can sometimes excuse REIT gross income test failures, significant penalty taxes may still be imposed.
For ourthose TRS arrangements intended to comply as intended with the REIT qualification and taxation rules under the IRC, a number of requirements must be satisfied, including:
•our TRSs may not directly or indirectly operate or manage a health carehealthcare facility, as defined by the IRC;
the leases to our TRSs must be respected as true leases for federal income tax purposes and not as service contracts, partnerships, joint ventures, financings or other types of arrangements;
the leased properties must constitute qualified health carehealthcare properties (including necessary or incidental property) under the IRC;
our leased properties must be managed and operated on behalf of the TRSs by independent contractors who are less than 35% affiliated with us and who are actively engaged (or have affiliates so engaged) in the trade or business of managing and operating qualified health carehealthcare properties for personsany person unrelated to us; and
the rental and other terms of the leases must be arm’sarm's length.
We cannot be sure that the IRS or a court will agree with our assessment that our TRS arrangements comply as intended with REIT qualification and taxation rules. If arrangements involving our TRSs fail to comply as we intended, we may fail to qualify for taxation as a REIT under the IRC or be subject to significant penalty taxes.
Legislative or other actions affecting REITs could materially and adversely affect us and our shareholders.
The rules dealing with U.S. federal, state, and local taxation are constantly under review by persons involved in the legislative process and by the IRS, the U.S. Department of the Treasury, and other taxation authorities. Changes to the tax laws, with or without retroactive application, could materially and adversely affect us and our shareholders. We cannot predict how changes in the tax laws might affect us or our shareholders. New legislation, Treasury regulations, administrative interpretations or court decisions could significantly and negatively affect our ability to qualifyremain qualified for taxation as a REIT or the tax consequences of such qualification.
In addition, December 2017 legislation has made substantial changes to the IRC. Among those changes are a significant permanent reduction in the generally applicable corporate income tax rate, changes in the taxation of individuals and other noncorporate taxpayers that generally reduce their taxes on a temporary basis subject to “sunset” provisions, the elimination or modification of various deductions (including substantial limitation of the deduction for personal state and local taxes imposed on individuals), and preferential taxation of income derived by individuals from passthrough entities in comparison to earnings received directly by individuals. This legislation also imposes additional limitations on the deduction of net operating losses, which may in the future cause us to make additional distributions that will be taxable to our shareholders to the extent of our current or accumulated earnings and profits in order to comply with the REIT distribution requirements. The effect of these and other changes made in this legislation is highly uncertain, both in terms of their direct effect on the taxation of an investment in our common shares and their indirect effect on the value of properties owned by us. Furthermore, many of the provisions of the new law will require guidance through the issuance of Treasury regulations in order to assess their effect. There may be a substantial delay before such regulations are promulgated, increasing the uncertainty as to the ultimate effect of the statutory amendments on us or our shareholders. It is also possible that there will be technical corrections legislation proposed with respect to the new law, the effect of which cannot be predicted and may be adversequalification to us orand our shareholders.
Risks Related to Our Securities
Our distributions to our shareholders may decline.
Following entry into the Transaction Agreement with Five Star, due to the lower cash flow we received, or expect to receive, from our senior living communities operated by Five Star, on April 18, 2019, we lowered our regular quarterly distribution rate to $0.15 per common share, or at an annual rate of $0.60 per common share. We intend to continue to make regular quarterly distributions to our shareholders. However:
our ability to make or sustain the rate of distributions will be adversely affected if any of the risks described in this Annual Report on Form 10-K occur;
our making of distributions is subject to compliance with restrictions contained in our credit facility and term loan agreements and may be subject to restrictions in future debt obligations we may incur; and
the timing and amount of any distributions will be determined at the discretion of our Board of Trustees and will depend on various factors that our Board of Trustees deems relevant, including our financial condition, our results of operations, our liquidity, our capital requirements, our funds from operations attributable to common shareholders, or FFO attributable to common shareholders, our normalized funds from operations attributable to common shareholders, or Normalized FFO attributable to common shareholders, restrictive covenants in our financial or other contractual arrangements, general economic conditions in the United States, requirements under the IRC to remain qualified for taxation as a REIT and restrictions under the laws of Maryland.
For these reasons, among others, our distribution rate may continue to decline or we may cease making distributions to our shareholders.
Changes in market conditions could adversely affect the value of our securities.
As with other publicly traded equity securities and REIT securities, the value of our common shares and other securities depends on various market conditions that are subject to change from time to time, including:
the extent of investor interest in our securities;
the general reputation of REITs and externally managed companies and the attractiveness of our equity securities in comparison to other equity securities, including securities issued by other real estate based companies or by other issuers less sensitive to rises in interest rates;
our underlying asset value;
investor confidence in the stock and bond markets, generally;
market interest rates;
national economic conditions;
changes in tax laws;
changes in our credit ratings; and
general market conditions.
We believe that one of the factors that investors consider important in deciding whether to buy or sell equity securities of a REIT is the distribution rate, considered as a percentage of the price of the equity securities, relative to market interest rates. Interest rates have been at historically low levels for an extended period of time. There is a general market perception that REIT shares outperform in low interest rate environments and underperform in rising interest rate environments when compared to the broader market. Since December 2016,The U.S. Federal Reserve steadily increased the targeted federal funds rate over the last several years, but recently took action to decrease its federal funds rate and may continue to make adjustments in the near future. If the U.S. Federal Reserve has raised its benchmarkincreases interest rate by one percentage point, and there are some market expectations that market interest rates will rise further in the near to intermediate term. If market interest rates continue to increase, or if there continues to beis a market expectation of such increases, prospective purchasers of REIT equity securities may
want to achieve a higher distribution rate. Thus, higher market interest rates, or the expectation of higher interest rates, could cause the value of our securities to decline.
Further issuances of equity securities may be dilutive to current shareholders.
The interests of our existing shareholders could be diluted if we issue additional equity securities to finance future acquisitions, or to repay indebtedness.indebtedness or for other reasons. Our ability to execute our business strategy depends on our access to an appropriate blend of debt financing, which may include secured and unsecured debt, and equity financing, which may include common and preferred shares.
The Notes are structurally subordinated to the payment of all indebtedness and other liabilities and any preferred equity of our subsidiaries.
We are the sole obligor on our outstanding senior unsecured notes, and our outstanding senior unsecured notes and any notes or other debt securities we may issue in the future, or, together with our outstanding senior unsecured notes, the Notes, and such Notes are not, and any Notes we may issue in the future may not be guaranteed by any of our subsidiaries. Our subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due on the Notes, or to make any funds available therefor, whether by dividend, distribution, loan or other payments. The rights of holders of Notes to benefit from any of the assets of our subsidiaries are subject to the prior satisfaction of claims of our subsidiaries’subsidiaries' creditors and any preferred equity holders. As a result, the Notes are, and, except to the extent that future Notes are guaranteed by our subsidiaries, will be, structurally subordinated to all of the debt and other liabilities and obligations of our subsidiaries, including guarantees of other indebtedness of ours, payment obligations under lease agreements, trade payables and preferred equity. As of December 31, 2017,2019, our subsidiaries had total indebtedness and other liabilities (excluding security and other deposits and guaranties) of $886.9$880.0 million.
The Notes are unsecured and effectively subordinated to all of our existing and future secured indebtedness to the extent of the value of the assets securing such indebtedness.
The outstanding Notes are not secured and any Notes we may issue in the future may not be secured. Upon any distribution to our creditors in a bankruptcy, liquidation, reorganization or similar proceeding relating to us or our property, the holders of our secured debt will be entitled to exercise the remedies available to a secured lender under applicable law and pursuant to the instruments governing such debt and to be paid in full, from the assets securing that secured debt before any payment may be made
with respect to Notes that are not secured by those assets. In that event, because such Notes will not be secured by any of our assets, it is possible that there will be no assets from which claims of holders of such Notes can be satisfied or, if any assets remain, that the remaining assets will be insufficient to satisfy those claims in full. If the value of such remaining assets is less than the aggregate outstanding principal amount of such Notes and accrued interest and all future debt ranking equally with such Notes, we will be unable to fully satisfy our obligations under such Notes. In addition, if we fail to meet our payment or other obligations under our secured debt, the holders of that secured debt would be entitled to foreclose on our assets securing that secured debt and liquidate those assets. Accordingly, we may not have sufficient funds to pay amounts due on such Notes. As a result, noteholders may lose a portion or the entire value of their investment in such Notes. Further, the terms of the outstanding Notes permit, and the terms of any Notes we may issue in the future may permit, us to incur additional secured indebtedness subject to compliance with certain debt ratios. The Notes that are not secured will be effectively subordinated to any such additional secured indebtedness. As of December 31, 2017,2019, we had $805.4$694.7 million in secured debt, net of unamortized debt issuance costs, premiums and discounts.
There may be no public market for certain of the Notes, and one may not develop, be maintained or be liquid.
We have not applied for listing of certain of the Notes on any securities exchange or for quotation on any automatic dealer quotation system, and we may not do so for Notes issued in the future. We can give no assurances concerning the liquidity of any market that may develop for such Notes, the ability of any holder to sell such Notes or the price at which holders would be able to sell such Notes. If a market for such Notes does not develop, holders may be unable to resell such Notes for an extended period of time, if at all. If a market for such Notes does develop, it may not continue or it may not be sufficiently liquid to allow holders to resell such Notes. Consequently, holders of suchthe Notes may not be able to liquidate their investment readily, and lenders may not readily accept such Notes as collateral for loans.
The Notes may trade at a discount from their initial issue price or principal amount, depending upon many factors, including prevailing interest rates, the ratings assigned by rating agencies, the market for similar securities and other factors, including general economic conditions and our financial condition, performance and prospects. Any decline in market prices, regardless of cause, may adversely affect the liquidity and trading markets for the Notes.
A downgrade in credit ratings could materially adversely affect the market price of the Notes and may increase our cost of capital.
The outstanding Notes are rated by two rating agencies and any Notes we may issue in the future may be rated by one or more rating agencies. These credit ratings are continually reviewed by rating agencies and may change at any time based upon, among other things, our results of operations and financial condition. In May 2019, our senior unsecured debt rating was downgraded by Moody's Investors Service following our announcement of the Restructuring Transaction. Negative changes in the ratings assigned to our debt securities could have an adverse effect on the market price of the Notes and our costscost and availability of capital, which could in turn have a material adverse effect on our results of operations and our ability to satisfy our debt service obligations.
Redemption may adversely affect noteholders’noteholders' return on the Notes.
We have the right to redeem some or all of the outstanding Notes prior to maturity and may have such a right with respect to any Notes we issue in the future. We may redeem such Notes at times when prevailing interest rates may be relatively low compared to the interest rate of such Notes. Accordingly, noteholders may not be able to reinvest the redemption proceeds in a comparable security at an effective interest rate as high as that of the Notes.
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
At December 31, 2017,2019, we had real estate investments in 440 properties (466 buildings), excluding properties classified as held for sale.424 properties. These investments represent gross book value of real estate assets at cost plus certain acquisition costs, before depreciation and purchase price allocations and less impairment write downs, totaling $8.5$8.4 billion at December 31, 2017. At2019. As of December 31, 2017, 252019, 11 properties (26 buildings) with an aggregate costgross book value of real estate assets of $1.3 billion and an aggregate carryinga net book value of $1.1 billion$859.0 million were subject to secured financing and capital lease obligations with an aggregate principal balance of $807.3$698.2 million, of which $620.0 million is related to a joint venture arrangement in which we own a 55% equity interest.
The following table summarizes certain information about our properties as of December 31, 2017.2019. All dollar amounts are in thousands:
|
| | | | | | | | | | | | | | |
Location of Properties by State | | Number of Properties | | Number of Buildings | |
Carrying Value of Investment (1) | | Net Book Value |
Alabama | | 8 |
| | 8 |
| | $ | 91,597 |
| | $ | 74,659 |
|
Arizona | | 11 |
| | 11 |
| | 183,959 |
| | 126,542 |
|
Arkansas | | 3 |
| | 3 |
| | 41,408 |
| | 29,216 |
|
California | | 28 |
| | 32 |
| | 883,275 |
| | 683,552 |
|
Colorado | | 12 |
| | 13 |
| | 130,306 |
| | 93,705 |
|
Connecticut | | 2 |
| | 2 |
| | 11,089 |
| | 8,891 |
|
Delaware | | 5 |
| | 6 |
| | 74,717 |
| | 47,083 |
|
District of Columbia | | 2 |
| | 2 |
| | 72,982 |
| | 63,259 |
|
Florida | | 30 |
| | 35 |
| | 716,477 |
| | 541,429 |
|
Georgia | | 33 |
| | 33 |
| | 461,578 |
| | 353,627 |
|
Hawaii | | 1 |
| | 1 |
| | 72,930 |
| | 61,971 |
|
Idaho | | 2 |
| | 2 |
| | 20,552 |
| | 17,272 |
|
Illinois | | 15 |
| | 16 |
| | 249,237 |
| | 182,014 |
|
Indiana | | 14 |
| | 14 |
| | 236,995 |
| | 186,180 |
|
Iowa | | 4 |
| | 4 |
| | 10,405 |
| | 4,256 |
|
Kansas | | 5 |
| | 5 |
| | 75,607 |
| | 49,603 |
|
Kentucky | | 9 |
| | 9 |
| | 102,020 |
| | 61,399 |
|
Louisiana | | 6 |
| | 6 |
| | 9,784 |
| | 6,567 |
|
Maryland | | 16 |
| | 16 |
| | 305,040 |
| | 235,647 |
|
Massachusetts | | 21 |
| | 24 |
| | 1,402,296 |
| | 986,759 |
|
Michigan | | 5 |
| | 5 |
| | 16,836 |
| | 10,720 |
|
Minnesota | | 10 |
| | 12 |
| | 155,885 |
| | 118,431 |
|
Mississippi | | 3 |
| | 3 |
| | 27,447 |
| | 22,157 |
|
Missouri | | 7 |
| | 7 |
| | 182,554 |
| | 137,100 |
|
Montana | | 1 |
| | 1 |
| | 32,153 |
| | 27,414 |
|
Nebraska | | 13 |
| | 13 |
| | 63,541 |
| | 43,969 |
|
Nevada | | 2 |
| | 2 |
| | 82,763 |
| | 66,973 |
|
New Jersey | | 5 |
| | 5 |
| | 194,282 |
| | 146,868 |
|
New Mexico | | 5 |
| | 6 |
| | 101,737 |
| | 76,203 |
|
New York | | 6 |
| | 7 |
| | 231,238 |
| | 189,653 |
|
North Carolina | | 19 |
| | 19 |
| | 287,155 |
| | 240,833 |
|
Ohio | | 4 |
| | 5 |
| | 73,932 |
| | 50,367 |
|
Oregon | | 3 |
| | 3 |
| | 136,772 |
| | 109,208 |
|
Pennsylvania | | 18 |
| | 18 |
| | 172,540 |
| | 126,352 |
|
Rhode Island | | 1 |
| | 1 |
| | 11,745 |
| | 9,353 |
|
South Carolina | | 23 |
| | 23 |
| | 203,969 |
| | 162,462 |
|
South Dakota | | 3 |
| | 3 |
| | 7,589 |
| | 2,897 |
|
Tennessee | | 14 |
| | 14 |
| | 104,270 |
| | 81,016 |
|
Texas | | 28 |
| | 28 |
| | 573,342 |
| | 421,654 |
|
Virginia | | 18 |
| | 20 |
| | 229,632 |
| | 174,144 |
|
Washington | | 6 |
| | 7 |
| | 103,422 |
| | 80,962 |
|
Wisconsin | | 17 |
| | 20 |
| | 321,057 |
| | 254,326 |
|
Wyoming | | 2 |
| | 2 |
| | 8,835 |
| | 3,593 |
|
Total | | 440 |
| | 466 |
| | $ | 8,474,950 |
| | $ | 6,370,286 |
|
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Office Portfolio | | Senior Housing Operating Portfolio | | All Other | | Consolidated |
State | | Number of Properties | Gross Book Value of Real Estate Assets(1) | Net Book Value | | Number of Properties | Gross Book Value of Real Estate Assets(1) | Net Book Value | | Number of Properties | Gross Book Value of Real Estate Assets(1) | Net Book Value | | Number of Properties | Gross Book Value of Real Estate Assets(1) | Net Book Value |
AL | | — | $ | — |
| $ | — |
| | 8 | $ | 94,554 |
| $ | 73,102 |
| | — | $ | — |
| $ | — |
| | 8 | $ | 94,554 |
| $ | 73,102 |
|
AR | | — | — |
| — |
| | 3 | 42,184 |
| 27,777 |
| | — | — |
| — |
| | 3 | 42,184 |
| 27,777 |
|
AZ | | 4 | 63,980 |
| 49,241 |
| | 6 | 134,403 |
| 87,010 |
| | 1 | 3,510 |
| 2,196 |
| | 11 | 201,893 |
| 138,447 |
|
CA | | 12 | 566,456 |
| 438,387 |
| | 12 | 233,389 |
| 177,273 |
| | 1 | 7,279 |
| 5,048 |
| | 25 | 807,124 |
| 620,708 |
|
CO | | 2 | 20,118 |
| 13,548 |
| | 1 | 51,095 |
| 44,295 |
| | 2 | 18,555 |
| 13,896 |
| | 5 | 89,768 |
| 71,739 |
|
CT | | 1 | 7,474 |
| 5,364 |
| | — | — |
| — |
| | — | — |
| — |
| | 1 | 7,474 |
| 5,364 |
|
DC | | 2 | 99,392 |
| 82,024 |
| | — | — |
| — |
| | — | — |
| — |
| | 2 | 99,392 |
| 82,024 |
|
DE | | — | — |
| — |
| | 6 | 97,365 |
| 65,143 |
| | — | — |
| — |
| | 6 | 97,365 |
| 65,143 |
|
FL | | 7 | 39,519 |
| 29,154 |
| | 17 | 541,811 |
| 377,471 |
| | 2 | 12,326 |
| 11,247 |
| | 26 | 593,656 |
| 417,872 |
|
GA | | 5 | 73,378 |
| 50,716 |
| | 22 | 283,385 |
| 198,674 |
| | 5 | 96,853 |
| 76,923 |
| | 32 | 453,616 |
| 326,313 |
|
HI | | 1 | 77,308 |
| 61,464 |
| | — | — |
| — |
| | — | — |
| — |
| | 1 | 77,308 |
| 61,464 |
|
ID | | — | — |
| — |
| | — | — |
| — |
| | 2 | 21,340 |
| 16,407 |
| | 2 | 21,340 |
| 16,407 |
|
IL | | 4 | 68,994 |
| 47,929 |
| | 11 | 175,501 |
| 113,226 |
| | 1 | 20,641 |
| 15,073 |
| | 16 | 265,136 |
| 176,228 |
|
IN | | 1 | 21,972 |
| 13,747 |
| | 11 | 166,789 |
| 125,433 |
| | 2 | 68,767 |
| 55,070 |
| | 14 | 257,528 |
| 194,250 |
|
KS | | 2 | 61,388 |
| 41,847 |
| | 3 | 58,439 |
| 39,272 |
| | — | — |
| — |
| | 5 | 119,827 |
| 81,119 |
|
KY | | — | — |
| — |
| | 9 | 101,352 |
| 61,200 |
| | — | — |
| — |
| | 9 | 101,352 |
| 61,200 |
|
MA | | 10 | 1,295,579 |
| 860,634 |
| | 1 | 31,853 |
| 20,739 |
| | — | — |
| — |
| | 11 | 1,327,432 |
| 881,373 |
|
MD | | 3 | 45,784 |
| 32,355 |
| | 11 | 240,932 |
| 178,609 |
| | 1 | 20,964 |
| 16,253 |
| | 15 | 307,680 |
| 227,217 |
|
MI | | — | — |
| — |
| | — | — |
| — |
| | 5 | 15,942 |
| 10,018 |
| | 5 | 15,942 |
| 10,018 |
|
MN | | 9 | 115,138 |
| 86,108 |
| | 1 | 50,881 |
| 36,206 |
| | 2 | 6,319 |
| 3,991 |
| | 12 | 172,338 |
| 126,305 |
|
MO | | 3 | 138,081 |
| 98,592 |
| | 5 | 68,678 |
| 48,803 |
| | — | — |
| — |
| | 8 | 206,759 |
| 147,395 |
|
MS | | — | — |
| — |
| | 2 | 2,601 |
| 2,601 |
| | — | — |
| — |
| | 2 | 2,601 |
| 2,601 |
|
MT | | — | — |
| — |
| | — | — |
| — |
| | 1 | 32,582 |
| 25,996 |
| | 1 | 32,582 |
| 25,996 |
|
NC | | 2 | 60,078 |
| 46,216 |
| | 16 | 223,693 |
| 179,121 |
| | 1 | 6,839 |
| 4,291 |
| | 19 | 290,610 |
| 229,628 |
|
NE | | — | — |
| — |
| | 1 | 7,568 |
| 5,219 |
| | 1 | 26,702 |
| 20,440 |
| | 2 | 34,270 |
| 25,659 |
|
NJ | | — | — |
| — |
| | 4 | 113,387 |
| 80,246 |
| | — | — |
| — |
| | 4 | 113,387 |
| 80,246 |
|
NM | | 2 | 38,846 |
| 29,892 |
| | 1 | 32,655 |
| 21,287 |
| | 3 | 33,303 |
| 23,533 |
| | 6 | 104,804 |
| 74,712 |
|
NV | | — | — |
| — |
| | 2 | 82,643 |
| 63,082 |
| | — | — |
| — |
| | 2 | 82,643 |
| 63,082 |
|
NY | | 3 | 84,478 |
| 61,585 |
| | 1 | 113,955 |
| 90,312 |
| | — | — |
| — |
| | 4 | 198,433 |
| 151,897 |
|
OH | | 3 | 27,703 |
| 19,725 |
| | 1 | 44,608 |
| 29,201 |
| | 1 | 4,204 |
| 1,850 |
| | 5 | 76,515 |
| 50,776 |
|
OR | | — | — |
| — |
| | 1 | 45,825 |
| 45,256 |
| | — | — |
| — |
| | 1 | 45,825 |
| 45,256 |
|
PA | | 6 | 73,521 |
| 55,133 |
| | 9 | 95,061 |
| 63,350 |
| | 2 | 3,535 |
| 2,255 |
| | 17 | 172,117 |
| 120,738 |
|
SC | | 3 | 22,191 |
| 14,970 |
| | 18 | 184,040 |
| 137,670 |
| | 2 | 3,935 |
| 2,529 |
| | 23 | 210,166 |
| 155,169 |
|
TN | | 1 | 9,491 |
| 6,585 |
| | 14 | 162,745 |
| 131,992 |
| | 2 | 15,667 |
| 12,050 |
| | 17 | 187,903 |
| 150,627 |
|
TX | | 11 | 242,255 |
| 172,296 |
| | 13 | 344,425 |
| 248,928 |
| | 1 | 20,502 |
| 15,408 |
| | 25 | 607,182 |
| 436,632 |
|
VA | | 8 | 121,094 |
| 84,955 |
| | 12 | 141,075 |
| 100,928 |
| | — | — |
| — |
| | 20 | 262,169 |
| 185,883 |
|
WA | | 2 | 38,226 |
| 26,515 |
| | — | — |
| — |
| | 4 | 33,585 |
| 24,268 |
| | 6 | 71,811 |
| 50,783 |
|
WI | | 10 | 169,236 |
| 128,620 |
| | 10 | 134,334 |
| 101,015 |
| | — | — |
| — |
| | 20 | 303,570 |
| 229,635 |
|
Total | | 117 | 3,581,680 |
| 2,557,602 |
| | 232 | 4,101,226 |
| 2,974,441 |
| | 42 | 473,350 |
| 358,742 |
| | 391 | 8,156,256 |
| 5,890,785 |
|
Held for Sale | | 21 | 158,572 |
| 133,124 |
| | 12 | 105,795 |
| 63,218 |
| | — | — |
| — |
| | 33 | 264,367 |
| 196,342 |
|
Grand Total | | 138 | $ | 3,740,252 |
| $ | 2,690,726 |
| | 244 | $ | 4,207,021 |
| $ | 3,037,659 |
| | 42 | $ | 473,350 |
| $ | 358,742 |
| | 424 | $ | 8,420,623 |
| $ | 6,087,127 |
|
(1) Represents the gross book value of real estate assets at cost plus certain acquisition costs, before depreciation and purchase price allocations and less impairment write downs, if any.
Of the properties listed above, 305 (305 buildings) are senior living communities, 125 (151 buildings) are MOBs and 10 (10 buildings) are wellness centers.
Item 3. Legal Proceedings.
From time to time, we may become involved in litigation matters incidental to the ordinary course of our business. Although we are unable to predict with certainty the eventual outcome of any litigation, we are currently not a party to any litigation which we expect to have a material adverse effect on our business.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5. Market for Registrant’sRegistrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common shares were traded on the New York Stock Exchange, or the NYSE (symbol: SNH), through June 30, 2016. Beginning on July 1, 2016, our common shares are traded on the Nasdaq (symbol: SNH)DHC). The following table sets forth for the periods indicated the high and low sale prices for our common shares as reported by the NYSE or Nasdaq, as applicable:
|
| | | | | | | | |
| | High | | Low |
2017 | | | | |
First Quarter | | $ | 20.95 |
| | $ | 18.62 |
|
Second Quarter | | $ | 22.52 |
| | $ | 20.20 |
|
Third Quarter | | $ | 20.73 |
| | $ | 18.51 |
|
Fourth Quarter | | $ | 19.98 |
| | $ | 18.26 |
|
|
| | | | | | | | |
| | High | | Low |
2016 | | | | |
First Quarter | | $ | 17.93 |
| | $ | 13.53 |
|
Second Quarter | | $ | 21.38 |
| | $ | 17.05 |
|
Third Quarter | | $ | 23.85 |
| | $ | 20.95 |
|
Fourth Quarter | | $ | 22.94 |
| | $ | 17.14 |
|
The closing price of our common shares on the Nasdaq on February 26, 2018 was $15.82 per share. As of February 1, 2018,26, 2020, there were 1,6581,586 shareholders of record of our common shares.shares, although there is a larger number of beneficial owners.
InformationIssuer purchases of equity securities. The following table provides information about cash distributions declared on our common shares is summarized inpurchases of our equity securities during the table below. Common share cash distributions are generally paid in the quarter following the quarter to which they relate.three months ended December 31, 2019:
|
| | | | | | | | |
| | Cash Distributions per Common Share |
| | 2017 | | 2016 |
First Quarter | | $ | 0.39 |
| | $ | 0.39 |
|
Second Quarter | | $ | 0.39 |
| | $ | 0.39 |
|
Third Quarter | | $ | 0.39 |
| | $ | 0.39 |
|
Fourth Quarter | | $ | 0.39 |
| | $ | 0.39 |
|
|
| | | | | | | | | | | | | | |
Calendar Month | | Number of Shares Purchased (1) | | Average Price Paid per Share | | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | Maximum Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs |
December 2019 | | 234 |
| | $ | 7.44 |
| | — |
| | $ | — |
|
Total | | 234 |
| | $ | 7.44 |
| | — |
| | $ | — |
|
We currently intend to continue to declare and pay common share distributions on a quarterly basis in cash. However, the timing, amount and form of future distributions is determined at the discretion of our Board of Trustees and will depend upon various factors that our Board of Trustees deems relevant, including, but not limited to, our financial condition, our results of operations, our liquidity, our capital requirements, our FFO, our Normalized FFO, restrictive covenants in our financial or other contractual arrangements, general economic conditions in the United States, requirements under the IRC to remain qualified for taxation as a REIT and restrictions under the laws of Maryland. Therefore, we cannot assure that we will continue to pay distributions in the future or that the amount of distributions we do pay will not decrease.
| |
(1) | These common share withholding and purchases were made to satisfy tax withholding and payment obligations of a former employee of RMR LLC in connection with the vesting of awards of our common shares. We withheld and purchased these 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. |
Item 6. Selected Financial Data.
The following table sets forth selected financial data for the periods and dates indicated. Comparative results are affected by property acquisitions and dispositions during the periods shown. This data should be read in conjunction with, and is qualified in its entirety by reference to “Management’s“Management's Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of this Annual Report on Form 10-K and to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K. Amounts in the table below (but not the footnotes to the table) are in thousands, except per share data.
| | | | 2017 | | 2016 | | 2015 | | 2014 | | 2013 | | Year Ended December 31, |
Income Statement Data: | | | | | | | | | | | |
| | | 2019 | | 2018 | | 2017 | | 2016 | | 2015 | |
Income (Loss) Statement Data: | | | | | | | | | | | | |
Rental income | | $ | 681,022 |
| | $ | 666,200 |
| | $ | 630,899 |
| | $ | 526,703 |
| | $ | 459,380 |
| | $ | 606,558 |
| | $ | 700,641 |
| | $ | 681,022 |
| | $ | 666,200 |
| | $ | 630,899 |
| |
Residents fees and services(1) | | $ | 393,797 |
| | $ | 391,822 |
| | $ | 367,874 |
| | $ | 318,184 |
| | $ | 302,058 |
| | $ | 433,597 |
| | $ | 416,523 |
| | $ | 393,707 |
| | $ | 391,822 |
| | $ | 367,874 |
| |
Net income(2)(3) | | $ | 151,803 |
| | $ | 141,295 |
| | $ | 123,968 |
| | $ | 158,637 |
| | $ | 151,164 |
| |
Net income attributable to common shareholders | | $ | 147,610 |
| | $ | 141,295 |
| | $ | 123,968 |
| | $ | 158,637 |
| | $ | 151,164 |
| |
Net (loss) income(2)(3) | | | $ | (82,878 | ) | | $ | 292,414 |
| | $ | 151,803 |
| | $ | 141,295 |
| | $ | 123,968 |
| |
Net (loss) income attributable to common shareholders | | | $ | (88,234 | ) | | $ | 286,872 |
| | $ | 147,610 |
| | $ | 141,295 |
| | $ | 123,968 |
| |
Common distributions declared(4) | | $ | 370,641 |
| | $ | 370,518 |
| | $ | 369,468 |
| | $ | 311,912 |
| | $ | 293,474 |
| | $ | (199,719 | ) | | $ | 370,786 |
| | $ | 370,641 |
| | $ | 370,518 |
| | $ | 369,468 |
| |
Weighted average shares outstanding (basic) | | 237,420 |
| | 237,345 |
| | 232,931 |
| | 198,868 |
| | 187,271 |
| | 237,604 |
| | 237,511 |
| | 237,420 |
| | 237,345 |
| | 232,931 |
| |
Weighted average shares outstanding (diluted) | | 237,452 |
| | 237,382 |
| | 232,963 |
| | 198,894 |
| | 187,414 |
| | 237,604 |
| | 237,546 |
| | 237,452 |
| | 237,382 |
| | 232,963 |
| |
Basic and Diluted Per Common Share Data: | | | | | | | | | | | | | | | | | | | | | |
Net income(2)(3) | | $ | 0.62 |
| | $ | 0.60 |
| | $ | 0.53 |
| | $ | 0.80 |
| | $ | 0.81 |
| |
Net (loss) income(2)(3) | | | $ | (0.37 | ) | | $ | 1.21 |
| | $ | 0.62 |
| | $ | 0.60 |
| | $ | 0.53 |
| |
Cash distributions declared to common shareholders(4) | | $ | 1.56 |
| | $ | 1.56 |
| | $ | 1.56 |
| (5) | | $ | 1.56 |
| | $ | 1.56 |
| | $ | 0.84 |
| | $ | 1.56 |
| | $ | 1.56 |
| | $ | 1.56 |
| | $ | 1.56 |
| (5) | |
Balance Sheet Data: | | | | | | | | | | | | | | | | | | | | | |
Real estate properties, at undepreciated cost, net of impairment losses | | $ | 7,824,763 |
| | $ | 7,617,547 |
| | $ | 7,456,940 |
| | $ | 6,222,360 |
| | $ | 5,263,625 |
| | $ | 7,461,586 |
| | $ | 7,876,300 |
| | $ | 7,824,763 |
| | $ | 7,617,547 |
| | $ | 7,456,940 |
| |
Total assets (6) | | $ | 7,294,019 |
| | $ | 7,227,754 |
| | $ | 7,160,090 |
| | $ | 5,941,930 |
| | $ | 4,742,317 |
| | $ | 6,653,826 |
| | $ | 7,160,426 |
| | $ | 7,294,019 |
| | $ | 7,227,754 |
| | $ | 7,160,090 |
| |
Total indebtedness (6) | | $ | 3,674,526 |
| | $ | 3,714,465 |
| | $ | 3,479,136 |
| | $ | 2,774,365 |
| | $ | 1,870,415 |
| | $ | 3,501,661 |
| | $ | 3,648,417 |
| | $ | 3,674,526 |
| | $ | 3,714,465 |
| | $ | 3,479,136 |
| |
Total equity | | $ | 3,277,188 |
| | $ | 3,199,405 |
| | $ | 3,359,760 |
| | $ | 2,952,407 |
| | $ | 2,776,989 |
| | $ | 2,877,050 |
| | $ | 3,179,870 |
| | $ | 3,277,188 |
| | $ | 3,199,405 |
| | $ | 3,359,760 |
| |
| |
(1) | We earnIncludes residents fees and services primarily earned from the provision of housing and services to the residents of our third party managed senior living communities. We recognize residents fees and services as the housing and services are provided. |
| |
(2) | Includes asset impairment charges of assets$115.2 million ($0.48 per basic and diluted share) and losses on equity securities, net, of $41.9 million ($0.18 per basic and diluted share) in 2019. Includes asset impairment charges of $66.3 million ($0.28 per basic and diluted share) and losses on equity securities, net of $20.7 million ($0.09 per basic and diluted share) in 2018. Includes asset impairment charges of $5.1 million ($0.02 per basic and diluted share) and losses on early extinguishmentsextinguishment of debt of $7.6 million (less than $0.03($0.03 per basic and diluted share) in 2017. Includes asset impairment of assets charges of $18.7 million ($0.08 per basic and diluted share) in 2016. Includes a loss on distribution to common shareholders of RMR Inc. common stock of $38.4 million ($0.16 per basic and diluted share), asset impairment of assets charges of $0.2 million (less than $0.01 per basic and diluted share) and losses on early extinguishmentsextinguishment of debt of $1.9 million ($0.01 per basic and diluted share) in 2015. Includes impairment of assets charges of $4.4 million ($0.02 per basic and diluted share) in 2014. Includes impairment of assets charges of $45.6 million ($0.24 per basic and diluted share) and losses on early extinguishments of debt of $0.8 million (less than $0.01 per basic and diluted share) in 2013. |
| |
(3) | Includes gain on sale of properties of $39.7 million ($0.17 per basic and diluted share) in 2019. Includes gain on sale of properties of $261.9 million ($1.10 per basic and diluted share) in 2018. Includes gain on sale of properties of $46.1 million ($0.19 per basic and diluted share) in 2017. Includes gain on sale of properties of $4.1 million ($0.02 per basic and diluted share) in 2016. Includes gains on sales of properties of $5.5 million ($0.03 per basic and diluted share) and $37.4 million ($0.20 per basic and diluted share) in 2014 and 2013, respectively. |
| |
(4) | On January 19, 2018,16, 2020, we declared a regular quarterly distribution of $0.39 per share, or $92.7 million, to be paidpayable to common shareholders of record on January 29, 2018.27, 2020 in the amount of $0.15 per share, or approximately $35.7 million. We paid this distribution on February 22, 2018.20, 2020. |
| |
(5) | Excludes a $0.13 per share non-cash distribution of RMR Inc. class A common stock to our common shareholders on December 14, 2015. |
| |
(6) | The periods presented have been restated to reflect the adoption of Accounting Standards Update No. 2015-03, Debt Issuance Costs, which requires the reclassification of certain debt issuance costs as an offset to the associated debt liability in our consolidated balance sheets. We adopted this standard on January 1, 2016. |
Item 7. Management’sManagement's Discussion and Analysis ofFinancial Condition and Results of Operations.
The following discussion should be read in conjunction with our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.
We are a REIT organized under Maryland law. AtAs of December 31, 2017,2019, we owned 440424 properties, (466 buildings)including 33 properties classified as held for sale, located in 4239 states and Washington, D.C., including one life science property owned in a joint venture arrangement in which we own a 55% equity interest. At December 31, 2017, the undepreciated carrying value of our properties, which represents2019, the gross book value of our real estate assets at cost plus certain acquisition costs, before depreciation and purchase price allocations and less impairment write downs, was $8.5$8.4 billion, excluding four senior living communitiesincluding $264.4 million of gross book value classified as held for sale. For the year ended December 31, 2017, 97% ofsale in our NOI came from properties where a majority of the revenues are derived from our tenants’ and residents’ private resources.consolidated balance sheet.
PORTFOLIO OVERVIEW
The following tables present an overview of our portfolio (dollars in thousands, except investment per unit or square foot data):
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(As of December 31, 2017) | | Number of Properties | | Number of Units or Square Feet | | | |
Carrying Value of Investment(1) | | % of Total Investment | | Investment per Unit or Square Foot(2) | | 2017 Revenues | | % of 2017 Revenues | | 2017 NOI(3) | | % of 2017 NOI |
Facility Type | | | | | | | | | | | | | | | | | | | | |
Independent living(4) | | 68 |
| | 16,150 |
| | | | $ | 2,281,959 |
| | 26.9 | % | | $ | 141,298 |
| | $ | 360,071 |
| | 33.5 | % | | $ | 190,125 |
| | 28.7 | % |
Assisted living(4) | | 198 |
| | 14,552 |
| | | | 2,142,994 |
| | 25.3 | % | | $ | 147,265 |
| | 296,022 |
| | 27.5 | % | | 165,469 |
| | 25.0 | % |
Skilled nursing facilities(4) | | 39 |
| | 4,131 |
| | | | 183,854 |
| | 2.2 | % | | $ | 44,506 |
| | 18,345 |
| | 1.7 | % | | 18,344 |
| | 2.8 | % |
Subtotal senior living communities | | 305 |
| | 34,833 |
| | | | 4,608,807 |
| | 54.4 | % | | $ | 132,312 |
| | 674,438 |
| | 62.7 | % | | 373,938 |
| | 56.5 | % |
MOBs(5) | | 125 |
| | 12,066,012 |
| | sq. ft. | | 3,688,033 |
| | 43.5 | % | | $ | 306 |
| | 382,127 |
| | 35.6 | % | | 269,197 |
| | 40.7 | % |
Wellness centers | | 10 |
| | 812,000 |
| | sq. ft. | | 178,110 |
| | 2.1 | % | | $ | 219 |
| | 18,254 |
| | 1.7 | % | | 18,254 |
| | 2.8 | % |
Total | | 440 |
| | | | | | $ | 8,474,950 |
| | 100.0 | % | | | | $ | 1,074,819 |
| | 100.0 | % | | $ | 661,389 |
| | 100.0 | % |
| | | | | | | | | | | | | | | | | | | | |
Tenant/Operator/Managed Properties | | | | | | | | | | | | | | | | | | |
Five Star | | 185 |
| | 20,133 |
| | | | $ | 2,330,630 |
| | 27.6 | % | | $ | 115,762 |
| | $ | 210,539 |
| | 19.6 | % | | $ | 210,539 |
| | 31.8 | % |
Sunrise / Marriott(6) | | 3 |
| | 1,197 |
| | | | — |
| | — | % | | $ | — |
| | 14,842 |
| | 1.4 | % | | 14,842 |
| | 2.2 | % |
Brookdale | | 18 |
| | 940 |
| | | | 69,669 |
| | 0.8 | % | | $ | 74,116 |
| | 9,220 |
| | 0.9 | % | | 9,220 |
| | 1.4 | % |
11 private senior living companies (combined) | | 29 |
| | 3,520 |
| | | | 569,461 |
| | 6.7 | % | | $ | 161,779 |
| | 46,040 |
| | 4.3 | % | | 46,040 |
| | 7.0 | % |
Subtotal triple net leased senior living communities | | 235 |
| | 25,790 |
| | | | 2,969,760 |
| | 35.1 | % | | $ | 115,152 |
| | 280,641 |
| | 26.2 | % | | 280,641 |
| | 42.4 | % |
Managed senior living communities(7) | | 70 |
| | 9,043 |
| | | | 1,639,047 |
| | 19.3 | % | | $ | 181,250 |
| | 393,797 |
| | 36.6 | % | | 93,297 |
| | 14.1 | % |
Subtotal senior living communities | | 305 |
| | 34,833 |
| | | | 4,608,807 |
| | 54.4 | % | | $ | 132,312 |
| | 674,438 |
| | 62.7 | % | | 373,938 |
| | 56.5 | % |
MOBs(5) | | 125 |
| | 12,066,012 |
| | sq. ft. | | 3,688,033 |
| | 43.5 | % | | $ | 306 |
| | 382,127 |
| | 35.6 | % | | 269,197 |
| | 40.7 | % |
Wellness centers | | 10 |
| | 812,000 |
| | sq. ft. | | 178,110 |
| | 2.1 | % | | $ | 219 |
| | 18,254 |
| | 1.7 | % | | 18,254 |
| | 2.8 | % |
Total | | 440 |
| | | | | | $ | 8,474,950 |
| | 100.0 | % | | | | $ | 1,074,819 |
| | 100.0 | % | | $ | 661,389 |
| | 100.0 | % |
Tenant/Managed Property Operating Statistics(8) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(As of December 31, 2019) | | Number of Properties | | Square Feet or Number of Units | |
Gross Book Value of Real Estate Assets(1) | | % of Total Gross Book Value of Real Estate Assets | | Investment per Square Foot or Unit(2) | | 2019 Revenues (3) | | % of 2019 Revenues | | 2019 NOI(3)(4) | | % of 2019 NOI |
Office Portfolio(5) | | 138 |
| | 11,878,421 |
| sq. ft. | $ | 3,740,252 |
| | 44.4 | % | | $ | 315 |
| | $ | 405,016 |
| | 38.9 | % | | $ | 272,668 |
| | 49.5 | % |
SHOP (6) | | 244 |
| | 29,013 |
| units | 4,207,021 |
| | 50.0 | % | | $ | 145,005 |
| | 571,495 |
| | 54.9 | % | | 214,773 |
| | 39.0 | % |
Other triple net leased senior living communities (7) | | 32 |
| | 2,605 |
| units | 295,240 |
| | 3.5 | % | | $ | 113,336 |
| | 44,919 |
| | 4.3 | % | | 44,919 |
| | 8.2 | % |
Wellness centers | | 10 |
| | 812,000 |
| sq. ft. | 178,110 |
| | 2.1 | % | | $ | 219 |
| | 18,725 |
| | 1.9 | % | | 18,725 |
| | 3.3 | % |
Total | | 424 |
| | | | $ | 8,420,623 |
| | 100.0 | % | | | | $ | 1,040,155 |
| | 100.0 | % | | $ | 551,085 |
| | 100.0 | % |
|
| | | | | | | | | | |
| | Rent Coverage | | Occupancy |
| | 2017 | | 2016 | | 2017 | | 2016 |
Five Star | | 1.15x | | 1.22x | | 82.6 | % | | 83.9 | % |
Brookdale | | 2.38x | | 2.64x | | 83.2 | % | | 85.6 | % |
11 private senior living companies (combined) | | 1.23x | | 1.26x | | 87.6 | % | | 88.8 | % |
Subtotal triple net leased senior living communities | | 1.21x | | 1.28x | | 83.4 | % | | 84.7 | % |
Managed senior living communities(7) | | N/A | | N/A | | 86.1 | % | | 87.3 | % |
Subtotal senior living communities | | 1.21x | | 1.28x | | 84.1 | % | | 85.4 | % |
MOBs(5) | | N/A | | N/A | | 95.0 | % | | 96.5 | % |
Wellness centers | | 1.76x | | 1.89x | | 100.0 | % | | 100.0 | % |
Total | | 1.24x | | 1.32x | | | | |
|
| | | | | | |
| | Occupancy |
| | As of and for the Year Ended December 31, |
| | 2019 | | 2018 |
Office Portfolio (8) | | 92.2 | % | | 94.5 | % |
SHOP (6)(9) | | 85.1 | % | | 86.2 | % |
Other triple net leases senior living communities (9)(10) | | 88.2 | % | | 88.4 | % |
Wellness centers | | 100.0 | % | | 100.0 | % |
| |
(1) | Represents the gross book value of real estate assets at cost plus certain acquisition costs, before depreciation and purchase price allocations and less impairment write downs,writedowns, if any. Amounts exclude investment carryinginclude $264,367 of gross book value of four senior living communities33 properties classified as held for sale as of December 31, 2017,2019, which amounts are included in other assets of properties held for sale in our Consolidated Balance Sheets.consolidated balance sheet. |
| |
(2) | Represents carryinggross book value of investmentreal estate assets divided by number of living units or rentable square feet or living units, as applicable, at December 31, 2017.2019. |
| |
(3) | Includes $23,802 of revenues and $22,699 of NOI from properties sold during the year ended December 31, 2019 and $53,223 of revenues and $24,165 of NOI from properties classified as held for sale as of December 31, 2019. |
| |
(4) | NOI is defined and calculated by reportable segment. Our definition of NOI and our reconciliation of net income (loss) attributable to consolidatedcommon shareholders to NOI are included below under the heading “Non-GAAP Financial Measures”. |
| |
(4) | Senior living communities are categorized by the type of living units which constitute a majority of the living units at the community. |
| |
(5) | These 125 MOB properties are comprised of 151 buildings. Our MOBmedical office and life science property leases include some triple net leases where, in addition to paying fixed rents, the tenants assume the obligation to operate and maintain the properties at their expense, and some net and modified gross leases where we are responsible for the operation and maintenance of the properties and we charge tenants for some or all of the property operating costs. A small percentage of our MOBmedical office and life science property leases are "full-service"full-service leases where we receive fixed rent from our tenants and no reimbursement for our property operating costs. |
| |
(6) | Marriott International, Inc., or Marriott, guarantees the lessee’s obligations under these leases. In December 2017, we entered two agreements to sell four senior livingIncludes communities that were leased to a subsidiary of Sunrise Senior Living, LLC, or Sunrise. The sale of one of theseFive Star and communities was completed in December 2017. We expect the closings of the sales of the remaining three communities to occurthat were managed by the end of the first quarter of 2018. The three communities were classified as heldFive Star for saleour account as of December 31, 2017. The gross carrying value of investment of these three communities was $107.4 million2019. Pursuant to the Restructuring Transaction, our previously existing master leases and management and pooling agreements with Five Star were terminated and replaced with new management and omnibus agreements, or the New Management Agreements, as of December 31, 2017.January 1, 2020, for all of our senior living communities operated by Five Star. |
| |
(7) | TheseTriple net leased senior living communities are managed bythat were leased to Five Star. The occupancy for the 12 month period ended or, if shorter, from the dateStar as of acquisitions through, December 31, 2017 was 85.8%.2019 are included in our SHOP segment. |
| |
(8) | OperatingMedical office and life science property occupancy data for MOBs are presentedis as of December 31, 20172019 and 2016 and includeincludes (i) space being fitted out for occupancy andof service assets undergoing redevelopment, (ii) space which is leased but is not occupied or is being offered for sublease by tenants; operatingtenants and (iii) space being fitted out for occupancy. |
| |
(9) | Excludes data for periods prior to our ownership of certain properties, data for properties sold or classified as held for sale and data for which there was a transfer of operations during the periods presented. |
| |
(10) | Operating data for other properties, tenantstriple net leased senior living communities leased to third party operators other than Five Star and managerswellness centers are presented based upon the operating results provided by our tenants and managers for the 12 months ended September 30, 20172019 and September 30, 2016,2018, or the most recent prior period for which tenant operating results are made available to us. Rent coverage is calculated as operating cash flows from our tenants’ facility operations of our properties, before subordinated charges, if any, divided by rents payable to us. We have not independently verified tenant operating data. Excludes data for periods prior to our ownership of certain properties, as well as data for properties sold or classified as held for sale, and data for which there was a transfer of operations during the periods presented. |
We have fourIn connection with the Restructuring Transaction, as discussed below, we determined to redefine our reportable segments to better reflect our current operating segments,environment. As of which three are separate reporting segments. We aggregate our triple netDecember 31, 2019, we report under the following two segments: Office Portfolio and SHOP. Our Office Portfolio segment consists of medical office properties leased senior living communities, our managed senior living communities and our MOBs into three reporting segments, based on their similar operating and economic characteristics. The first reporting segment includes triple net leased senior living communities that provide short term and long term residential careto medical providers and other services for residentsmedical related businesses, as well as life science properties leased to biotech laboratories and with respect to which we receive rents
from the operators. The second reporting segment includes managed senior living communities that provide short term and long term residential care and other services for residents where we pay fees to the operator to manage the communities for our account. The third reportingIn addition, our SHOP segment includes MOBs where the tenants pay us rent for space in medical offices, life science laboratories and other medical related facilities. Our fourth segment includes all of our other operations, including certain properties that offer wellness, fitness and spa services to members and with respect to which we receive rents from operators, which we do not consider to be sufficiently material to constitute a separate reporting segment.
Triple Net Leased Senior Living Communities.
The following chart presents a summary of our triple net leased senior living communitycommunities that provide short term and long term residential care and other services for residents and from which we received rents from Five Star until January 1, 2020. Pursuant to the Restructuring Transaction, effective January 1, 2020, our previously existing master leases asand management and pooling agreements with Five Star were terminated and replaced with the New Management Agreements for all of our senior living communities operated by Five Star.
We also continue to report “non-segment” operations, which consists of triple net leased senior living communities that are leased to operators other than Five Star from which we receive rents and wellness centers.
Office Portfolio
As of December 31, 20172019, we owned 138 medical office and life science properties located in 27 states and Washington, D.C. These properties have a total of 11.9 million square feet. During the year ended December 31, 2019, we entered into lease renewals for 1,255,512 square feet and new leases for 261,960 square feet at our medical office and life science properties. The weighted average annual rental rate for leases entered during 2019 was $29.64 per square foot, which was 5.1% higher than the previous weighted average annual rental rate for the same space. Weighted (by annualized rental income) average lease term for leases entered during 2019 was 10.2 years. Commitments for tenant improvements, leasing commission costs and concessions for leases we entered during 2019 totaled $37.4 million, or $24.66 per square foot on average (approximately $2.69 per square foot per year of the lease term).
As of December 31, 2019, lease expirations at our medical office and life science properties in our Office Portfolio segment are as follows (dollars in thousands).This summary should be read in conjunction with the more detailed descriptions of our leases set forth below and under "Business—Lease Terms" in Part I, Item 1 of this Annual Report on Form 10-K.:
|
| | | | | | | | | | | | | | | | | | | | | | | | | |
Tenant / Operator | | Number of Properties | | Number of Leases | | Units | | Investment Carrying Value of Properties (1) | | Net Book Value of Properties | | Annualized Rental Income(2) | | Lease Expiration | | Renewal Options |
Five Star | | 185 |
| | 5 |
| | 20,133 |
| | $ | 2,330,630 |
| | $ | 1,629,878 |
| | $ | 211,862 |
| | 2024-2032 | | 2 for 10 or 15 years each. |
Pacifica Senior Living, LLC | | 8 |
| | 8 |
| | 644 |
| | 133,869 |
| | 108,578 |
| | 13,424 |
| | 2023 | | 2 for 5 years each. |
Generations LLC | | 1 |
| | 1 |
| | 343 |
| | 96,651 |
| | 75,234 |
| | 4,708 |
| | 2030 | | 2 for 10 years each. |
Radiant Senior Living, Inc. | | 4 |
| | 4 |
| | 338 |
| | 73,299 |
| | 63,280 |
| | 5,172 |
| | 2023 and 2024 | | 2 for 10 years each. |
Stellar Senior Living, LLC | | 5 |
| | 1 |
| | 661 |
| | 72,461 |
| | 61,355 |
| | 5,920 |
| | 2027-2028 | | 2 for 10 years each. |
Brookdale Senior Living, Inc. | | 18 |
| | 1 |
| | 940 |
| | 69,669 |
| | 47,092 |
| | 10,070 |
| | 2032 | | 1 for 15 years. |
Senior Living Communities, LLC | | 1 |
| | 1 |
| | 213 |
| | 64,764 |
| | 55,967 |
| | 4,026 |
| | 2033 | | 2 for 5 years each. |
MorningStar Senior Living, LLC | | 1 |
| | 1 |
| | 238 |
| | 54,356 |
| | 46,779 |
| | 3,149 |
| | 2028 | | 2 for 5 years each. |
Oaks Senior Living, LLC | | 3 |
| | 3 |
| | 264 |
| | 49,585 |
| | 42,410 |
| | 4,523 |
| | 2024-2030 | | 2 for 10 years each and 2 for 5 years each. |
Healthquest, Inc. | | 3 |
| | 1 |
| | 361 |
| | 7,589 |
| | 2,897 |
| | 1,424 |
| | 2021 | | 1 for 10 years. |
Covenant Care, LLC | | 1 |
| | 1 |
| | 180 |
| | 7,490 |
| | 5,557 |
| | 2,025 |
| | 2030 | | 1 for 15 years. |
EmpRes Healthcare Management, LLC | | 1 |
| | 1 |
| | 103 |
| | 5,193 |
| | 2,013 |
| | 1,462 |
| | 2030 | | 1 for 10 years. |
The MacIntosh Company | | 1 |
| | 1 |
| | 175 |
| | 4,204 |
| | 2,044 |
| | 590 |
| | 2019 | | 1 for 10 years. |
Sunrise Senior Living, LLC.(3) | | 3 |
| | 3 |
| | 1,197 |
| | — |
| | — |
| | 11,930 |
| | 2023 | | 2 for 5 years each. |
Totals | | 235 |
| | 32 |
| | 25,790 |
| | $ | 2,969,760 |
| | $ | 2,143,084 |
| | $ | 280,285 |
| | | | |
|
| | | | | | | | | | | | | | | | | | | | | |
Year | | Number of Tenants | | Square Feet(1) | | Percent of Total | | Cumulative Percent of Total | | Annualized Rental Income(2) | | Percent of Total | | Cumulative Percent of Total |
2020 | | 135 | | 1,035,986 |
| | 9.5 | % | | 9.5 | % | | $ | 29,387 |
| | 7.7 | % | | 7.7 | % |
2021 | | 97 | | 889,029 |
| | 8.1 | % | | 17.6 | % | | 29,203 |
| | 7.7 | % | | 15.4 | % |
2022 | | 109 | | 1,289,076 |
| | 11.8 | % | | 29.4 | % | | 36,459 |
| | 9.6 | % | | 25.0 | % |
2023 | | 58 | | 1,038,299 |
| | 9.5 | % | | 38.9 | % | | 20,610 |
| | 5.4 | % | | 30.4 | % |
2024 | | 82 | | 1,839,074 |
| | 16.8 | % | | 55.7 | % | | 50,404 |
| | 13.3 | % | | 43.7 | % |
2025 | | 53 | | 920,957 |
| | 8.4 | % | | 64.1 | % | | 21,612 |
| | 5.7 | % | | 49.4 | % |
2026 | | 34 | | 695,274 |
| | 6.3 | % | | 70.4 | % | | 21,243 |
| | 5.6 | % | | 55.0 | % |
2027 | | 27 | | 470,907 |
| | 4.3 | % | | 74.7 | % | | 11,255 |
| | 3.0 | % | | 58.0 | % |
2028 | | 17 | | 1,440,951 |
| | 13.2 | % | | 87.9 | % | | 113,790 |
| | 30.0 | % | | 88.0 | % |
2029 and thereafter | | 52 | | 1,332,849 |
| | 12.1 | % | | 100.0 | % | | 45,909 |
| | 12.0 | % | | 100.0 | % |
Total | | 664 | | 10,952,402 |
| | 100.0 | % | | | | $ | 379,872 |
| | 100.0 | % | | |
| | | | | | | | | | | | | | |
Weighted average remaining lease term (in years) | | 5.5 |
| | | | | | 6.4 |
| | | | |
| |
(1) | Represents the gross book valueIncludes 100% of real estate assets before depreciation and purchase price allocations, less impairment write downs, if any. Amounts exclude investment carrying value of four senior living communities classified as held for sale as of December 31, 2017,square feet from a property owned in a joint venture arrangement in which are included in other assets in our Consolidated Balance Sheets.we own a 55% equity interest. |
| |
(2) | Annualized rental income for 2017 is based on rents pursuant to existing leases as of December 31, 2017. Includes percentage2019, including straight line rent totaling $10.2 millionadjustments, estimated recurring expense reimbursements for the year endedcertain net and modified gross leases and excluding lease value amortization at certain of our medical office and life science properties. Annualized rental income also includes 100% of rental income as reported under GAAP from a property owned in a joint venture arrangement in which we own a 55% equity interest. |
The following table presents information concerning our medical office and life science property tenants that represent 1% or more of total medical office and life science property annualized rental income as of December 31, 2019 (dollars in thousands):
|
| | | | | | | | | | | | | | | |
Tenant | | Square Feet Leased | | Percent of Total Square Feet Leased | | Annualized Rental Income(1) | | Percent of Total Annualized Rental Income(1) | | Lease Expiration |
Vertex Pharmaceuticals Inc. (2) | | 1,082,417 |
| | 9.9 | % | | $ | 94,956 |
| | 25.0 | % | | 2028 |
Advocate Aurora Health | | 643,499 |
| | 5.9 | % | | 16,896 |
| | 4.4 | % | | 2024 |
Cedars-Sinai Medical Center | | 145,065 |
| | 1.3 | % | | 15,265 |
| | 4.0 | % | | 2020 - 2032 |
Ology Bioservices, Inc. | | 165,586 |
| | 1.5 | % | | 8,324 |
| | 2.2 | % | | 2041 |
HCA Holdings, LLC | | 226,603 |
| | 2.1 | % | | 7,182 |
| | 1.9 | % | | 2020 - 2029 |
Medtronic, Inc. | | 376,828 |
| | 3.4 | % | | 6,983 |
| | 1.8 | % | | 2020 - 2022 |
Iqvia Holdings Inc. | | 176,839 |
| | 1.6 | % | | 5,379 |
| | 1.4 | % | | 2023 |
Magellan Health Inc. | | 232,521 |
| | 2.1 | % | | 4,496 |
| | 1.2 | % | | 2025 |
Sonova Holding AG | | 146,385 |
| | 1.3 | % | | 4,459 |
| | 1.2 | % | | 2024 |
Boston Children's Hospital | | 99,063 |
| | 0.9 | % | | 4,456 |
| | 1.2 | % | | 2028 |
Abbvie Inc. | | 197,976 |
| | 1.8 | % | | 4,395 |
| | 1.2 | % | | 2021 |
Seattle Genetics, Inc. | | 144,900 |
| | 1.3 | % | | 4,037 |
| | 1.1 | % | | 2024 |
Tokio Marine Holdings Inc. | | 81,072 |
| | 0.7 | % | | 3,949 |
| | 1.0 | % | | 2020 - 2033 |
Cigna Holding Co. | | 219,644 |
| | 2.0 | % | | 3,914 |
| | 1.0 | % | | 2024 |
United Healthcare Services, Inc. | | 149,719 |
| | 1.4 | % | | 3,898 |
| | 1.0 | % | | 2026 |
Duke University | | 126,225 |
| | 1.2 | % | | 3,686 |
| | 1.0 | % | | 2024 |
PerkinElmer, Inc. | | 105,462 |
| | 1.0 | % | | 3,681 |
| | 1.0 | % | | 2028 |
New York University | | 115,303 |
| | 1.1 | % | | 3,654 |
| | 1.0 | % | | 2020 - 2027 |
All other | | 6,517,295 |
| | 59.5 | % | | 180,262 |
| | 47.4 | % | | 2020 - 2035 |
Totals | | 10,952,402 |
| | 100.0 | % | | $ | 379,872 |
| | 100.0 | % | | |
| |
(1) | Annualized rental income is based on rents pursuant to existing leases as of December 31, 2017, based on increases in2019, including straight line rent adjustments and estimated recurring expense reimbursements for certain net and modified gross revenuesleases and excluding lease value amortization at certain of our medical office and life science properties. |
| |
(3)(2) | Marriott guarantees the lessee’s obligationsThe property leased by this tenant is owned by a joint venture arrangement in which we own a 55% equity interest. Rental income presented includes 100% of rental income as reported under these leases. In December 2017, we entered two agreements to sell four senior living communities leased to Sunrise. The sale of one of these communities was completed in December 2017. We expect the closings of the sales of the remaining three communities to occur by the end of the first quarter of 2018. The three communities were classified as held for sale as of December 31, 2017. The gross carrying value of investment of these three communities was $107.4 million as of December 31, 2017.GAAP. |
Five Star: We lease 185 senior living communities to Five Star for annualized rental income of $211.9 million asSenior Housing Operating Portfolio
As of December 31, 2017, including percentage rent based on increases in gross revenues at certain properties ($5.5 million in 2017). These annualized rental income amounts include rent payable to us as a result of our purchase of improvements to our properties leased to2019, Five Star pursuant to the terms of the leases. Five Star (Nasdaq: FVE) was our 100% owned subsidiary until we distributed its common shares to our shareholders in 2001. A large majority of the revenues at these senior living communities is derived from private resources. For the year ended December 31, 2017, Five Star paid percentage rent equal to 4% of the increase in gross revenues at certainoperated 244 of our senior living communities over base year gross revenues as specified in our SHOP segment, of which 166 communities were leased to Five Star and 78 communities were managed by Five Star for our account. Pursuant to the lease terms.
Lease No.Restructuring Transaction, effective January 1, expires in 20242020, or the Conversion Time, our previously existing master leases and includes 83 communities, including independentmanagement and pooling agreements with Five Star were terminated and replaced with the New Management Agreements for all of our senior living communities assisted living communities and SNFs. At December 31, 2017, the annualized rental income for Lease No. 1 included percentage rent of $1.5 million for 2017. Lease No. 2 expiresoperated by Five Star. The Conversion is a significant change in 2026 and includes 47 communities, including independent living communities, assisted living communities and SNFs. At December 31, 2017, the annualized rental income for Lease No. 2 included percentage
rent of $2.2 million for 2017. Lease No. 3 expires in 2028 and includes 17 communities, including independent living and assisted living communities. At December 31, 2017, the annualized rental income for Lease No. 3 included percentage rent of $0.8 million for 2017. Lease No. 4 expires in 2032 and includes 29 communities, including independent living communities, assisted living communities and SNFs. At December 31, 2017, the annualized rental income for Lease No. 4 included percentage rent of $1.0 million for 2017. Lease No. 5 expires in 2028 and includes nine senior living communities. Percentage rent under this lease commenced January 1, 2018.
For more information about our dealings and relationshipshistorical arrangements with Five Star and aboutmay result in our realizing significantly different operating results from our senior living communities in the risksfuture, including increased variability.
Also pursuant to the Restructuring Transaction, for the period beginning February 1, 2019 through December 31, 2019, the aggregate amount of monthly minimum rent payable to us by Five Star was reduced to $11.0 million as of February 1, 2019, which may ariseamount was then reduced during such period to approximately $10.8 million as a result of these related person transactions, pleasedispositions, and no additional rent was payable to us by Five Star for the period beginning February 1, 2019 to the Conversion Time. For further information regarding the Restructuring Transaction, the Transaction Agreement and our other business arrangements with Five Star, see “Risk Factors—Risks Related to Our Relationships with RMR Inc., RMR LLC and Five Star” in Part I, Item 1A of this Annual Report on Form 10-K, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Related Person Transactions” in Part II, Item 7 of this Annual Report on Form 10-K and Note 5 to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.
Pacifica Senior Living, LLC: We lease eight assisted living communities to affiliates of Pacifica Senior Living, LLC, or Pacifica, a privately owned company, until 2023. The rent payable to us under these leases is scheduled to increase at agreed upon times during the lease term. A large majority of the tenants’ revenues at these senior living communities is derived from private resources. Another affiliate of Pacifica has provided limited guarantees of these leases and these lease obligations are secured by deposits totaling approximately $3.8 million. On January 31, 2018, the tenant of one of these senior living communities notified us that it will not pay the rent due for the applicable community. The annual rent we received for the applicable community in 2017 was approximately $2.0 million, including $0.1 million of straight line rent adjustments. We hold a security deposit of $0.6 million for the rent due for the applicable community and a limited guarantee for one year’s rent at the applicable community. We are currently investigating the circumstances of this default and we expect to have negotiations with Pacifica about the modification or termination of this defaulted lease and our collection of guaranteed amounts due to us under this defaulted lease.
GenerationsLLC: We lease one independent living community to a subsidiary of Generations LLC, a privately owned company, until 2030. The rent payable to us under this lease is scheduled to increase at agreed upon times during the lease term. A large majority of this tenant’s revenues at this senior living community is derived from private resources. Generations LLC provides a limited guarantee of this lease.
Radiant Senior Living, Inc.: We lease four assisted living communities to subsidiaries of Radiant Senior Living, Inc., a privately owned company, until 2023 and 2024. The rent payable to us under these leases is scheduled to increase at agreed upon times during the lease terms. A large majority of our tenants’ revenues at these senior living communities is derived from private resources. These lease obligations are secured by security deposits totaling approximately $0.2 million.
Stellar Senior Living, LLC: We lease five senior living communities that include independent and assisted living units to subsidiaries of Stellar Senior Living, LLC until 2027 and 2028. At December 31, 2017, the annualized rental income for this lease included percentage rent of $0.2 million for 2017 based on increases in gross revenues at these communities. A large majority of our tenants’ revenues at these senior living communities is derived from private resources. The owner of Stellar Senior Living, LLC personally guarantees this lease.
Brookdale Senior Living, Inc.: We lease 18 assisted living communities to a subsidiary of Brookdale Senior Living, Inc. until 2032. At December 31, 2017, the annualized rental income for this lease included percentage rent of $1.9 million based on increases in gross revenues at these communities. A large majority of our tenant’s revenues at these senior living communities is derived from private resources. Brookdale Senior Living, Inc. guarantees the rent due to us under this lease.
Senior Living Communities, LLC: We lease one independent living community to a subsidiary of Senior Living Communities, LLC, a privately owned company, until 2033. At December 31, 2017, the annualized rental income for this lease included percentage rent of $0.3 million for 2017 based on increases in gross revenues at this community. A large majority of our tenant’s revenues at this senior living community is derived from private resources. An affiliate of the tenant guarantees this lease.
MorningStar Senior Living, LLC: We lease one independent living community to a subsidiary of MorningStar Senior Living, LLC, a privately owned company, until 2028. The rent payable to us under this lease is scheduled to increase at agreed upon times during the lease term. A large majority of our tenant’s revenues at this senior living community is derived from private resources.
Oaks Senior Living, LLC: We lease three assisted living communities to subsidiaries of Oaks Senior Living, LLC, a privately owned company, until 2024 and 2030. The rent payable to us under these leases is scheduled to increase at agreed upon
times during•Pursuant to the lease terms. A large majority of our tenants’ revenues at these senior living communities is derived from private resources. These lease obligations are secured by security deposits totaling approximately $1.0 million.
HealthQuest, Inc: We lease two SNFs and one independent living community to HealthQuest, Inc., a privately owned company, until 2021. The rent payable to us under these leases is scheduled to increase at agreed upon times during the lease term. The lease is guaranteed by the individual shareholder of HealthQuest, Inc.
Covenant Care, LLC: We lease one SNF to a subsidiary of Covenant Care, LLC, a privately owned company, until 2030. The rent payable to us is scheduled to increase at agreed upon times during the lease term. Covenant Care, LLC guarantees the lease and has secured its obligation with a security deposit of $0.9 million.
EmpRes HealthcareNew Management LLC: We lease one SNF to a subsidiary of EmpRes Healthcare Management, LLC, a privately owned company, until 2030. The rent payable to us under this lease is scheduled to increase at agreed upon times during the lease term. Evergreen Washington Healthcare, LLC guarantees this lease and has secured its obligation with a security deposit of $0.4 million.
The MacIntosh Company: We lease one SNF to The MacIntosh Company until 2019. A management company affiliate of this tenant and the former and current majority shareholders of the tenant guarantee this lease and the tenant has secured its obligation with a security deposit of $0.1 million.
Sunrise Senior Living, LLC: As of December 31, 2017, we leased three communities that included assisted living, independent living and SNF units to subsidiaries of Sunrise, which communities were previously owned by Marriott. In December 2017, we entered two agreements to sell four senior living communities leased to Sunrise. The sale of one of these communities was completed in December 2017. We expect the closings of the sales of the remaining three communities to occur by the end of the first quarter of 2018. At December 31, 2017, the annualized rental income for these leases included percentage rent of $2.3 million for 2017, including the community we sold in December, based on increases in gross revenues at these communities. A large majority of our tenants’ revenues at these senior living communities is derived from private resources. Marriott guarantees the rent due to us for these three communities.
Managed Senior Living Communities.
Agreements, Five Star managed 70 senior living communities for our account as of December 31, 2017. We lease our senior living communities that are managed by Five Star and include assisted living units or SNFs to our TRSs, and Five Star manages these communities pursuant to long term management and pooling agreements, pursuant to which Five Star generally receives:will receive
•a management fee equal to either 3% or 5% of the gross revenues realized at the applicable senior living communities
•plus reimbursement for its direct costs and expenses related to such communities,
as well as an annual incentive fee equal to either 35% or 20%15% of the amount by which the annual net operating incomeEBITDA of all communities on a combined basis exceeds the target EBITDA for all communities on a combined basis for such communities remaining after we realize an annual minimum return equal to either 8% or 7% of our invested capital, or,calendar year, provided that in no event shall the case of 10 communities, a specified amount plus 7% of our invested capital since December 31, 2015, and
aincentive fee for its management of capital expenditure projects equal to 3% of amounts funded by us.
Further, pursuant to our pooling agreements with Five Star, various calculations of revenues and expenses from the operationsbe greater than 1.5% of the applicablegross revenues realized at all communities covered by eachon a combined basis for such agreement are combined.calendar year.
Our management agreement with Five Star for the part of a senior living community locatedThe New Management Agreements expire in New York that is not2034, subject to the requirements of New York healthcare licensing laws, and the management agreement for one of our assisted living communities located in California, are not currently included in any of our pooling agreements with Five Star. We also have a pooling agreement with Five Star that combines our management agreements with Five Star for senior living communities consisting only of independent living units.
Our management agreements with Five Star generally expire between 2030 and 2041, and are subjectStar's right to automatic renewalextend for two consecutive 15five year terms if Five Star achieves certain performance targets for the combined managed communities portfolio, unless earlier terminated or timely notice of nonrenewal is delivered. These management agreementsThe New Management Agreements also generally provide that we, and in some cases Five Star, each haveus with the optionright to terminate the agreements uponNew Management Agreement for any community that does not earn 90% of the acquisition by a persontarget EBITDA for such community for two consecutive calendar years or groupin any two of three consecutive calendar years, with the measurement period commencing January 1, 2021 (and the first termination not possible until the beginning of calendar year 2023); provided we may not in any calendar year terminate communities representing more than 9.8%20% of the other’s voting stockcombined revenues for all communities for the calendar year prior to such termination. Pursuant to the Guaranty made by Five Star in favor of our applicable subsidiaries, Five Star has guaranteed the payment and upon certain change in control events
affecting the other party, as defined ineach of its applicable subsidiary's obligations under the applicable agreements, including the adoption of any shareholder proposal (other than a precatory proposal) with respect to the other party, or the election to the board of directors or trustees, as applicable, of the other party of any individual, if such proposal or individual was not approved, nominated or appointed, as the case may be, by a majority of the other party’s board of directors or board of trustees, as applicable, in office immediately prior to the making of such proposal or the nomination or appointment of such individual.New Management Agreements.
For more information aboutregarding our leases and management and pooling agreementsarrangements with Five Star, including the effects of certain of our property acquisitions and dispositions on these arrangements, please see Note 5 to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K, and for more information about our dealings and relationships with Five Star generally, and the risks which may arise as a result of these related person transactions, please see “Risk Factors—Risks Related to Our Relationships with RMR Inc., RMR LLC and Five Star” in Part I, Item 1A of this Annual Report on Form 10-K, “Management’s“Management's Discussion and Analysis of Financial Condition and Results of Operations—Related Person Transactions” in Part II, Item 7 of this Annual Report on Form 10-K and Note 7 to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.
MOBs.All Other
At December 31, 2017, we owned 125 MOBs (151 buildings) located in 28 states and Washington, D.C. These properties range in size from 1,700 to 1.1 million square feet and have a total of 12.1 million square feet. Leases at these properties have current terms expiring between 2018 and 2035, plus renewal options in some cases. The annualized rental income payable to us by tenants of these MOBs is $381.4 million per year, including scheduled increases and reimbursements of certain operating and tax expenses and excluding lease value amortization.
During the year ended December 31, 2017, we entered MOB lease renewals for 1,134,194 square feet and new MOB leases for 174,567 square feet, at weighted average rental rates that were 2.3% above rents previously charged for the same space. Weighted average lease terms for leases entered during 2017 were 5.9 years. Commitments for tenant improvements, leasing commission costs and concessions for leases we entered during 2017 totaled $26.6 million, or $20.31 per square foot on average (approximately $3.41 per square foot per year of the lease term).
The following chart presents a summary of our MOBs by state asAs of December 31, 2017:
|
| | | | | | | | | | | | | | | | | | | | | | | | |
State | | Number of Properties | | Number of Buildings | | Sq. Ft. | | Investment Carrying Value of Properties (1) | | Net Book Value of Properties | | Annualized Rental Income(2) | | % of Total MOB Annualized Rental Income(2) |
Arizona | | 4 |
| | 4 |
| | 405,364 |
| | $ | 60,409 |
| | $ | 49,752 |
| | $ | 6,281 |
| | 1.6 | % |
California | | 7 |
| | 12 |
| | 1,111,888 |
| | 531,689 |
| | 431,802 |
| | 56,292 |
| | 14.8 | % |
Colorado | | 2 |
| | 3 |
| | 77,113 |
| | 19,412 |
| | 15,366 |
| | 2,681 |
| | 0.7 | % |
Connecticut | | 2 |
| | 2 |
| | 96,962 |
| | 11,089 |
| | 8,891 |
| | 1,302 |
| | 0.3 | % |
District of Columbia | | 2 |
| | 2 |
| | 212,334 |
| | 72,982 |
| | 63,259 |
| | 9,849 |
| | 2.6 | % |
Florida | | 7 |
| | 12 |
| | 486,059 |
| | 104,668 |
| | 94,756 |
| | 13,322 |
| | 3.5 | % |
Georgia | | 6 |
| | 6 |
| | 419,507 |
| | 87,912 |
| | 66,729 |
| | 8,512 |
| | 2.2 | % |
Hawaii | | 1 |
| | 1 |
| | 204,063 |
| | 72,930 |
| | 61,971 |
| | 7,872 |
| | 2.1 | % |
Illinois | | 3 |
| | 4 |
| | 311,747 |
| | 59,467 |
| | 48,415 |
| | 7,920 |
| | 2.1 | % |
Indiana | | 1 |
| | 1 |
| | 94,238 |
| | 20,220 |
| | 14,394 |
| | 2,626 |
| | 0.7 | % |
Kansas | | 1 |
| | 1 |
| | 116,923 |
| | 15,470 |
| | 8,934 |
| | 2,239 |
| | 0.6 | % |
Louisiana | | 6 |
| | 6 |
| | 40,575 |
| | 9,784 |
| | 6,569 |
| | 734 |
| | 0.2 | % |
Maryland | | 3 |
| | 3 |
| | 192,856 |
| | 42,933 |
| | 32,710 |
| | 5,935 |
| | 1.6 | % |
Massachusetts | | 20 |
| | 23 |
| | 2,153,099 |
| | 1,368,478 |
| | 965,041 |
| | 125,304 |
| | 32.8 | % |
Minnesota | | 7 |
| | 9 |
| | 653,567 |
| | 99,014 |
| | 76,337 |
| | 15,193 |
| | 4.0 | % |
Mississippi | | 1 |
| | 1 |
| | 71,983 |
| | 13,252 |
| | 11,660 |
| | 1,174 |
| | 0.3 | % |
Missouri | | 2 |
| | 2 |
| | 452,165 |
| | 114,989 |
| | 85,818 |
| | 9,141 |
| | 2.4 | % |
New Jersey | | 1 |
| | 1 |
| | 205,439 |
| | 81,295 |
| | 64,378 |
| | 5,211 |
| | 1.4 | % |
New Mexico | | 1 |
| | 2 |
| | 292,074 |
| | 36,196 |
| | 30,656 |
| | 5,190 |
| | 1.4 | % |
New York | | 5 |
| | 6 |
| | 597,401 |
| | 120,472 |
| | 95,335 |
| | 16,504 |
| | 4.3 | % |
North Carolina | | 2 |
| | 2 |
| | 231,355 |
| | 59,607 |
| | 48,319 |
| | 6,106 |
| | 1.6 | % |
Ohio | | 2 |
| | 3 |
| | 327,796 |
| | 26,133 |
| | 20,242 |
| | 2,673 |
| | 0.7 | % |
Pennsylvania | | 7 |
| | 7 |
| | 440,456 |
| | 71,774 |
| | 58,655 |
| | 7,008 |
| | 1.8 | % |
South Carolina | | 3 |
| | 3 |
| | 217,850 |
| | 18,336 |
| | 15,600 |
| | 2,978 |
| | 0.8 | % |
Tennessee | | 1 |
| | 1 |
| | 33,796 |
| | 8,706 |
| | 6,911 |
| | 1,092 |
| | 0.3 | % |
Texas | | 15 |
| | 15 |
| | 1,017,160 |
| | 262,957 |
| | 203,213 |
| | 27,651 |
| | 7.2 | % |
Virginia | | 5 |
| | 7 |
| | 813,843 |
| | 90,859 |
| | 70,927 |
| | 9,647 |
| | 2.5 | % |
Washington | | 1 |
| | 2 |
| | 144,900 |
| | 38,000 |
| | 27,776 |
| | 4,079 |
| | 1.1 | % |
Wisconsin | | 7 |
| | 10 |
| | 643,499 |
| | 169,000 |
| | 136,499 |
| | 16,896 |
| | 4.4 | % |
| | | | | | | | | | | | | | |
Totals | | 125 |
| | 151 |
| | 12,066,012 |
| | $ | 3,688,033 |
| | $ | 2,820,915 |
| | $ | 381,412 |
| | 100.0 | % |
| |
(1) | Represents the gross book value of real estate assets before depreciation and purchase price allocations, less impairment write downs, if any. |
| |
(2) | Annualized rental income is based on our MOB rents pursuant to existing leases as of December 31, 2017. Annualized rental income includes straight line rent adjustments and estimated recurring expense reimbursements for certain net and modified gross leases and excludes lease value amortization. |
The following chart presents information concerning2019, lease expirations at our MOB tenants that represent 1% or more of total MOB annualized rental incomeother triple net leased senior living communities leased to third party operators other than Five Star and wellness centers are as of December 31, 2017follows (dollars in thousands):
|
| | | | | | | | | | | | | | | |
Tenant | | Sq. Ft. Leased | | % of Total MOB Sq. Ft. Leased | | Annualized Rental Income(1) | | % of Total MOB Annualized Rental Income(1) | | Lease Expiration |
Vertex Pharmaceuticals Inc. (2) | | 1,082,417 |
| | 9.4 | % | | $ | 91,120 |
| | 23.9 | % | | 2028 |
Aurora Health Care, Inc. | | 643,499 |
| | 5.6 | % | | 16,896 |
| | 4.4 | % | | 2024 |
Cedars-Sinai Medical Center | | 141,891 |
| | 1.2 | % | | 14,132 |
| | 3.7 | % | | 2018 - 2025 |
The Scripps Research Institute | | 164,091 |
| | 1.4 | % | | 10,177 |
| | 2.7 | % | | 2019 |
HCA Healthcare, Inc. | | 247,418 |
| | 2.2 | % | | 7,880 |
| | 2.1 | % | | 2018 - 2025 |
Reliant Medical Group, Inc. | | 362,427 |
| | 3.2 | % | | 7,595 |
| | 2.0 | % | | 2019 |
Ology Bioservices, Inc. | | 165,586 |
| | 1.4 | % | | 7,384 |
| | 1.9 | % | | 2031 |
Medtronic, Inc. | | 376,828 |
| | 3.3 | % | | 6,688 |
| | 1.7 | % | | 2020 - 2022 |
Magellan Health Inc. | | 232,521 |
| | 2.0 | % | | 5,228 |
| | 1.4 | % | | 2025 |
Sanofi S.A. | | 205,439 |
| | 1.8 | % | | 5,211 |
| | 1.4 | % | | 2026 |
Boston Children's Hospital | | 99,063 |
| | 0.9 | % | | 4,441 |
| | 1.2 | % | | 2028 |
Sonova Holding AG | | 146,385 |
| | 1.3 | % | | 4,393 |
| | 1.1 | % | | 2024 |
Abbvie Inc. | | 197,976 |
| | 1.7 | % | | 4,312 |
| | 1.1 | % | | 2021 |
Emory Healthcare, Inc. | | 221,471 |
| | 1.9 | % | | 4,121 |
| | 1.1 | % | | 2020 - 2023 |
Seattle Genetics, Inc. | | 144,900 |
| | 1.3 | % | | 4,079 |
| | 1.1 | % | | 2024 |
First Insurance Company of Hawaii | | 90,734 |
| | 0.8 | % | | 4,037 |
| | 1.1 | % | | 2018, 2033 |
Express Scripts Holding Co. | | 219,644 |
| | 1.9 | % | | 3,914 |
| | 1.0 | % | | 2024 |
United Healthcare Services, Inc. | | 149,719 |
| | 1.3 | % | | 3,704 |
| | 1.0 | % | | 2019 |
PerkinElmer, Inc. | | 105,462 |
| | 0.9 | % | | 3,681 |
| | 1.0 | % | | 2028 |
All other | | 6,460,511 |
| | 56.5 | % | | 172,419 |
| | 45.1 | % | | 2018 - 2035 |
Totals | | 11,457,982 |
| | 100.0 | % | | $ | 381,412 |
| | 100.0 | % | | |
| |
(1) | Annualized rental income is based on our MOB rents pursuant to existing leases as of December 31, 2017. Annualized rental income includes straight line rent adjustments and estimated recurring expense reimbursements for certain net and modified gross leases and excludes lease value amortization. |
| |
(2) | The property leased by this tenant is owned by a joint venture in which we own a 55% equity interest. Rental income presented includes 100% of rental income as reported under GAAP. |
Wellness Centers (included in “All Other Operations”). |
| | | | | | | | | | | | | | | | |
Year | | Number of Properties | | Number of Units or Square Feet | | Annualized Rental Income(1) | | Percent of Total | | Cumulative Percent of Total |
2020 | | — |
| | — |
| | $ | — |
| | — | % | | — | % |
2021 | | — |
| | — |
| | — |
| | — | % | | — | % |
2022 | | — |
| | — |
| | — |
| | — | % | | — | % |
2023 | | 7 |
| | 131 units and 354,000 sq. ft. |
| | 10,591 |
| | 21.5 | % | | 21.5 | % |
2024 | | 4 |
| | 288 units |
| | 4,062 |
| | 8.3 | % | | 29.8 | % |
2025 | | — |
| | — |
| | — |
| | — | % | | 29.8 | % |
2026 | | — |
| | — |
| | — |
| | — | % | | 29.8 | % |
2027 | | 4 |
| | 511 units |
| | 4,161 |
| | 8.5 | % | | 38.3 | % |
2028 | | 4 |
| | 458,000 sq. ft. |
| | 10,550 |
| | 21.4 | % | | 59.7 | % |
2029 and thereafter | | 23 |
| | 1,675 units |
| | 19,847 |
| | 40.3 | % | | 100.0 | % |
Total | | 42 |
| | | | $ | 49,211 |
| | 100.0 | % | | |
The following chart presents a summary of our wellness center leases as of December 31, 2017 (dollars in thousands). This summary should be read in conjunction with the more detailed description of our leases set forth below.
|
| | | | | | | | | | | | | | | | | | | | | | | | | |
Tenant | | Number of Properties | | Number of Leases | | Sq. Ft. | | Investment Carrying Value of Properties | | Net Book Value of Properties | | Annualized Rental Income(1) | | Lease Expirations | | Renewal Options |
Starmark Holdings, LLC | | 6 |
| | 3 |
| | 354,000 |
| | $ | 78,162 |
| | $ | 64,406 |
| | $ | 7,546 |
| | 2023 | | 3 for 10 years each. |
Life Time Fitness, Inc. | | 4 |
| | 1 |
| | 458,000 |
| | 99,948 |
| | 79,738 |
| | 10,550 |
| | 2028 | | 6 for 5 years each. |
Totals | | 10 |
| | 4 |
| | 812,000 |
| | $ | 178,110 |
| | $ | 144,144 |
| | $ | 18,096 |
| | | | |
| |
(1) | Annualized rental income is based on rents pursuant to existing leases as of December 31, 2017, including2019. Annualized rental income includes estimated percentage rents and straight line rent adjustments and excludingexcludes lease value amortization. |
GENERAL INDUSTRY TRENDS
Our medical office and life science properties have been impacted by at least two major industry trends for the past 10 years which are continuing at this time and that have impacted our investment activities.
StarmarkHoldings, LLC.First, medical practices are being consolidated into hospital systems. This has caused the number of free standing medical practices to decline. At the same time, the number of multi-practice medical office buildings that are anchor leased by hospital systems who employ doctors has increased. We lease six wellness centersbelieve hospital systems will continue the trend of providing an increasing amount of services in off campus medical offices away from main hospital campuses in order to subsidiariesreduce costs and serve as many patients as possible, which is reinforced by consumers' preference for healthcare services to be provided away from hospital campuses and closer to their residence or work locations.
Second, various advances in medical science have caused a large investment in new bio-medical research companies that require office, lab and medical products manufacturing space. We believe that about half of Starmark Holdings, LLC, a private company. These properties operate under the brand Wellbridgeour total investments in our Office Portfolio segment may be considered biotech and the leases are guaranteed by Starmark. These leases have current terms expiring in 2023 and require aggregate annualized rental income of $7.5 million, plus consumer price index based increases. The lease obligations for four of these wellness centers are secured by security deposits totaling approximately $1.2 million.
Life Time Fitness, Inc. We lease four wellness centers to a subsidiary of Life Time Fitness, Inc. Life Time Fitness, Inc. is a private company and guarantees the lease. The lease has a current term expiring in 2028 and requires aggregate annualized rental income of approximately $10.6 million.
Portfolio Lease Expiration Schedules.
The following tables set forth information regarding our lease expirations as of December 31, 2017 (dollars in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | |
| | Annualized Rental Income(1)(2) | | Percent of Total Annualized Rental Income Expiring | | Cumulative Percentage of Annualized Rental Income Expiring |
Year | | Triple Net Senior Living Communities | | MOBs | | Wellness Centers | | Total | | |
2018 | | $ | — |
| | $ | 20,852 |
| | $ | — |
| | $ | 20,852 |
| | 3.1 | % | | 3.1 | % |
2019 | | 590 |
| | 44,580 |
| | — |
| | 45,170 |
| | 6.6 | % | | 9.7 | % |
2020 | | — |
| | 32,817 |
| | — |
| | 32,817 |
| | 4.8 | % | | 14.5 | % |
2021 | | 1,424 |
| | 23,613 |
| | — |
| | 25,037 |
| | 3.7 | % | | 18.2 | % |
2022 | | — |
| | 28,477 |
| | — |
| | 28,477 |
| | 4.2 | % | | 22.4 | % |
2023 | | 25,354 |
| (3) | 14,318 |
| | 7,546 |
| | 47,218 |
| | 6.9 | % | | 29.3 | % |
2024 | | 70,755 |
| | 43,368 |
| | — |
| | 114,123 |
| | 16.8 | % | | 46.1 | % |
2025 | | — |
| | 13,676 |
| | — |
| | 13,676 |
| | 2.0 | % | | 48.1 | % |
2026 | | 68,241 |
| | 19,829 |
| | — |
| | 88,070 |
| | 13.0 | % | | 61.1 | % |
2027 and thereafter | | 113,921 |
| | 139,882 |
| | 10,550 |
| | 264,353 |
| | 38.9 | % | | 100.0 | % |
Total | | $ | 280,285 |
| | $ | 381,412 |
| | $ | 18,096 |
| | $ | 679,793 |
| | 100.0 | % | | |
Average remaining lease term for our triple net leased senior living communities, MOBs and wellness center properties (weighted by annualized rental income): 8.0 years.
| |
(1) | Annualized rental income is based on rents pursuant to existing leases as of December 31, 2017, including estimated percentage rents, straight line rent adjustments, estimated recurring expense reimbursements for certain net and modified gross leases and excluding lease value amortization at certain of our MOBs and wellness centers. Rental income amounts also include 100% of rental income as reported under GAAP from a property owned by a joint venture in which we own a 55% equity interest. |
| |
(2) | Excludes rent received from our managed senior living communities leased to our TRSs. If the NOI from our TRSs (three months ended December 31, 2017, annualized) were included in the foregoing table, the percent of total annualized rental income expiring in each of the following years would be: 2018 – 2.7%; 2019 – 5.9%; 2020 – 4.3%; 2021 – 3.2%; 2022 – 3.7%; 2023 – 6.1%; 2024 – 14.8%; 2025 – 1.8%; 2026 – 11.4%; and thereafter – 46.1%. In addition, if our leases to our TRSs using the terms of the management agreements for these communities were included in the foregoing table, the average remaining lease term for all properties (weighted by annualized rental income) would be 8.9 years. |
| |
(3) | Includes three communities leased to Sunrise that we expect to sell by the end of the first quarter of 2018 and one community leased to Pacifica that defaulted in February 2018. |
|
| | | | | | | | | | | | | | | | | | |
| | Number of Tenants (1) | | Percent of Total Number of Tenancies Expiring (1) | | Cumulative Percentage of Number of Tenancies Expiring (1) |
Year | | Triple Net Senior Living Communities | | MOBs | | Wellness Centers | | Total | | |
2018 | | — |
| | 126 |
| | — |
| | 126 |
| | 18.2 | % | | 18.2 | % |
2019 | | 1 |
| | 100 |
| | — |
| | 101 |
| | 14.6 | % | | 32.8 | % |
2020 | | — |
| | 97 |
| | — |
| | 97 |
| | 14.0 | % | | 46.8 | % |
2021 | | 1 |
| | 81 |
| | — |
| | 82 |
| | 11.8 | % | | 58.6 | % |
2022 | | — |
| | 89 |
| | — |
| | 89 |
| | 12.8 | % | | 71.4 | % |
2023 | | 2 |
| (2) | 37 |
| | 1 |
| | 40 |
| | 5.8 | % | | 77.2 | % |
2024 | | 3 |
| | 39 |
| | — |
| | 42 |
| | 6.1 | % | | 83.3 | % |
2025 | | — |
| | 30 |
| | — |
| | 30 |
| | 4.3 | % | | 87.6 | % |
2026 | | 1 |
| | 25 |
| | — |
| | 26 |
| | 3.8 | % | | 91.4 | % |
2027 and thereafter | | 10 |
| | 49 |
| | 1 |
| | 60 |
| | 8.6 | % | | 100.0 | % |
Total | | 18 |
| | 673 |
| | 2 |
| | 693 |
| | 100.0 | % | | |
| |
(1) | Excludes our managed senior living communities leased to our TRSs. |
| |
(2) | Includes three communities leased to Sunrise that we expect to sell by the end of the first quarter of 2018 and one community leased to Pacifica that defaulted in February 2018. |
Number of Living Units or Square Feet with Leases Expiring
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Living Units(1) | | Square Feet (2) |
Year | | Triple Net Senior Living Communities | | Percent of Total Living Units Expiring | | Cumulative Percentage of Total Living Units Expiring | | MOBs (Square Feet) | | Wellness Centers (Square Feet) | | Total Square Feet | | Percent of Total Square Feet Expiring | | Cumulative Percent of Total Square Feet Expiring |
2018 | | — |
| | — | % | | — | % | | 660,640 |
| | — |
| | 660,640 |
| | 5.4 | % | | 5.4 | % |
2019 | | 175 |
| | 0.7 | % | | 0.7 | % | | 1,410,045 |
| | — |
| | 1,410,045 |
| | 11.5 | % | | 16.9 | % |
2020 | | — |
| | — | % | | 0.7 | % | | 1,415,186 |
| | — |
| | 1,415,186 |
| | 11.5 | % | | 28.4 | % |
2021 | | 361 |
| | 1.4 | % | | 2.1 | % | | 737,864 |
| | — |
| | 737,864 |
| | 6.0 | % | | 34.4 | % |
2022 | | — |
| | — | % | | 2.1 | % | | 1,085,530 |
| | — |
| | 1,085,530 |
| | 8.8 | % | | 43.2 | % |
2023 | | 1,841 |
| (3) | 7.2 | % | | 9.3 | % | | 901,523 |
| | 354,000 |
| | 1,255,523 |
| | 10.2 | % | | 53.4 | % |
2024 | | 6,591 |
| | 25.6 | % | | 34.9 | % | | 1,639,722 |
| | — |
| | 1,639,722 |
| | 13.3 | % | | 66.7 | % |
2025 | | — |
| | — | % | | 34.9 | % | | 564,262 |
| | — |
| | 564,262 |
| | 4.6 | % | | 71.3 | % |
2026 | | 6,857 |
| | 26.6 | % | | 61.5 | % | | 658,539 |
| | — |
| | 658,539 |
| | 5.4 | % | | 76.7 | % |
2027 and thereafter | | 9,919 |
| | 38.5 | % | | 100.0 | % | | 2,384,671 |
| | 458,000 |
| | 2,842,671 |
| | 23.3 | % | | 100.0 | % |
Total | | 25,744 |
| | 100.0 | % | | | | 11,457,982 |
| | 812,000 |
| | 12,269,982 |
| | 100.0 | % | | |
| |
(1) | Excludes 9,043 living units from our managed senior living communities leased to our TRSs. If the number of living units included in our TRS leases using the terms of the management agreements for these communities were included in the foregoing table, the percent of total living units expiring in each of the following years would be: 2018 – 0.0%; 2019 – 0.5%; 2020 – 0.0%; 2021 – 1.0%; 2022 – 0.0%; 2023 – 5.3%; 2024 – 19.0%; 2025 – 0.0%; 2026 - 19.7% and thereafter – 54.5%. |
| |
(2) | Includes 100% of square feet from a property owned by a joint venture in which we own a 55% equity interest. |
| |
(3) | Includes three communities leased to Sunrise that we expect to sell by the end of the first quarter of 2018 and one community leased to Pacifica that defaulted in February 2018. |
GENERAL INDUSTRY TRENDSlife science properties.
We believe that the primary market for senior living services is individuals age 75 and older, and, according to U.S. Census data, that group is projected to be among the fastest growing age cohort in the United States over the next 20 years. Also, as a result of medical advances, seniors are living longer. Due to these demographic trends, we expect the demand for senior living services and housing to increase for the foreseeable future. Despite this trend, future economic downturns, softness in the U.S. housing market, higher levels of unemployment among our potential residents’residents' family members, lower levels of consumer confidence, stock market volatility and/or changes in demographics could adversely affect the ability of seniors to afford the resident fees or entrance fees at our senior living communities.
The medical advances which are increasing average life spans are also causing some seniors to defer relocatingdelay moving to senior living communities until they require greater care or to forgo moving to senior living communities altogether, but we do not believe this factor is sufficient to offset the long term positive demographic trends causing increased demand for senior living communities for the foreseeable future.
In recent years, a significant number of new senior living communities have been developed and continue to be developed. Although there are indications that the rate of newly started developments has recently declined, the increased supply of senior living communities that has resulted from recent development activity has increased competitive pressures on our tenantsmanagers and manager,tenants, particularly in certain geographic markets where we own senior living communities, and we expect these competitive challenges to continue for at least the next few years. These competitive challenges may prevent our tenantsmanagers and managertenants from maintaining or improving occupancy and rates at our senior living communities, which may increase the risk of default under our leases, reduce the rents and returns we may receive and earn from our leased and managed senior living communities and adversely affect the profitability of our senior living communities, and may cause the value of our properties to decline. In response to these competitive pressures, we have invested capital in our existing senior living communities and expect to continue to do so in order that our communities may remain competitive with newer communities.
Recently, the costs of insurance have increased significantly, and these increased costs have had an adverse effect on us and our managers and tenants. Increased insurance costs may adversely affect our managers' ability to operate our properties profitably and provide us with desirable returns and our tenants' ability to pay us rent or result in downward pressure on rents we can charge under new or renewed leases.
The senior living industry is subject to extensive and frequently changing federal, state and local laws and regulations. For further information regarding these laws and regulations, and possible legislative and regulatory changes, see "Business— Impact of Government Regulation and Reimbursement" in Part I, Item 1 of this Annual Report on Form 10-K.
Our MOBs have been impacted by at least two major industry trends for the past 10 years which are continuing at this time and that have impacted our investment activities.
First, medical practices are being consolidated into hospital systems. This has caused the number of free standing medical practices to decline. At the same time, the number of multi-practice medical office buildings that are anchor leased by hospital systems who employ doctors has increased. We believe hospital systems will continue the trend of providing an increasing amount of services in off campus MOBs away from main hospital campuses in order to reduce costs and serve as many patients as possible.
Second, various advances in medical science have caused a large investment in new bio-medical research companies that require office, lab and medical products manufacturing space. We believe that about half of our total investments in MOBs may be considered biotech and life science properties.
RESULTS OF OPERATIONS (dollars and square feet in thousands, unless otherwise noted)
The following table summarizes the results of operations of each of our segments for the years ended December 31, 2017, 20162019, 2018 and 2015:2017:
|
| | | | | | | | | | | | |
| | For the Year Ended December 31, |
| | 2017 | | 2016 | | 2015 |
Revenues: | | | | | | |
Triple net leased senior living communities | | $ | 280,641 |
| | $ | 275,697 |
| | $ | 256,035 |
|
Managed senior living communities | | 393,797 |
| | 391,822 |
| | 367,874 |
|
MOBs | | 382,127 |
| | 372,233 |
| | 356,586 |
|
All other operations | | 18,254 |
| | 18,270 |
| | 18,278 |
|
Total revenues | | $ | 1,074,819 |
| | $ | 1,058,022 |
| | $ | 998,773 |
|
Net income (loss) attributable to common shareholders: | | | | | | |
Triple net leased senior living communities | | $ | 228,417 |
| | $ | 168,719 |
| | $ | 160,403 |
|
Managed senior living communities | | 26,346 |
| | 6,372 |
| | 19,025 |
|
MOBs | | 111,199 |
| | 121,301 |
| | 126,859 |
|
All other operations | | (218,352 | ) | | (155,097 | ) | | (182,319 | ) |
Net income attributable to common shareholders | | $ | 147,610 |
| | $ | 141,295 |
| | $ | 123,968 |
|
|
| | | | | | | | | | | | |
| | For the Year Ended December 31, |
| | 2019 | | 2018 | | 2017 |
Revenues: | | | | | | |
Office Portfolio | | $ | 405,016 |
| | $ | 412,813 |
| | $ | 382,127 |
|
SHOP | | 571,495 |
| | 629,145 |
| | 604,246 |
|
Non-Segment | | 63,644 |
| | 75,206 |
| | 88,356 |
|
Total revenues | | $ | 1,040,155 |
| | $ | 1,117,164 |
| | $ | 1,074,729 |
|
Net (loss) income attributable to common shareholders: | | | | | | |
Office Portfolio | | $ | 68,884 |
| | $ | 66,905 |
| | $ | 111,199 |
|
SHOP | | 28,446 |
| | 182,380 |
| | 162,539 |
|
Non-Segment | | (185,564 | ) | | 37,587 |
| | (126,128 | ) |
Net (loss) income attributable to common shareholders | | $ | (88,234 | ) | | $ | 286,872 |
| | $ | 147,610 |
|
The following sections analyze and discuss the results of operations of each of our segments for the periods presented.
Year Ended December 31, 20172019 Compared to Year Ended December 31, 2016:2018:
Unless otherwise indicated, references in this section to changes or comparisons of results, income or expenses refer to comparisons of the results for the year ended December 31, 20172019 to the year ended December 31, 2016.2018. Our definition of NOI and our reconciliation of net income (loss) attributable to common shareholders to NOI and a description of why we believe NOI is an appropriate supplemental measure is included below under the heading “Non-GAAP Financial Measures.”
Triple net leased senior living communities: |
| | | | | | | | | | | | | | | |
| | For the Year Ended December 31, |
| | 2019 | | 2018 | | $ Change | | % Change |
NOI by segment: | | | | | | | | |
Office Portfolio | | $ | 272,668 |
| | $ | 285,081 |
| | $ | (12,413 | ) | | (4.4 | )% |
SHOP | | 214,773 |
| | 305,296 |
| | (90,523 | ) | | (29.7 | )% |
Non-Segment | | 63,644 |
| | 75,206 |
| | (11,562 | ) | | (15.4 | )% |
Total NOI | | 551,085 |
| | 665,583 |
| | (114,498 | ) | | (17.2 | )% |
| | | | | | | | |
Depreciation and amortization | | 289,025 |
| | 286,235 |
| | 2,790 |
| | 1.0 | % |
General and administrative | | 37,028 |
| | 85,885 |
| | (48,857 | ) | | (56.9 | )% |
Acquisition and certain other transaction related costs | | 13,102 |
| | 194 |
| | 12,908 |
| | nm |
|
Impairment of assets | | 115,201 |
| | 66,346 |
| | 48,855 |
| | 73.6 | % |
Gain on sale of properties | | 39,696 |
| | 261,916 |
| | (222,220 | ) | | (84.8 | )% |
Dividend income | | 1,846 |
| | 2,901 |
| | (1,055 | ) | | (36.4 | )% |
Losses on equity securities, net | | (41,898 | ) | | (20,724 | ) | | 21,174 |
| | 100.0 | % |
Interest and other income | | 941 |
| | 667 |
| | 274 |
| | 41.1 | % |
Interest expense | | (180,112 | ) | | (179,287 | ) | | 825 |
| | 0.5 | % |
Loss on early extinguishment of debt | | (44 | ) | | (22 | ) | | 22 |
| | 100.0 | % |
(Loss) income from continuing operations before income tax expense and equity in earnings of an investee | | (82,842 | ) | | 292,374 |
| | (375,216 | ) | | (128.3 | )% |
Income tax expense | | (436 | ) | | (476 | ) | | (40 | ) | | (8.4 | )% |
Equity in earnings of an investee | | 400 |
| | 516 |
| | (116 | ) | | (22.5 | )% |
Net (loss) income | | (82,878 | ) | | 292,414 |
| | (375,292 | ) | | (128.3 | )% |
Net income attributable to noncontrolling interest | | (5,356 | ) | | (5,542 | ) | | (186 | ) | | (3.4 | )% |
Net (loss) income attributable to common shareholders | | $ | (88,234 | ) | | $ | 286,872 |
| | $ | (375,106 | ) | | (130.8 | )% |
nm - not meaningful
Office Portfolio:
|
| | | | | | | | | | | | |
| | | | | | Comparable Properties(1) |
| | All Properties | |
| | As of and For the Year Ended December 31, | | As of and For the Year Ended December 31, |
| | |
| | 2017 | | 2016 | | 2017 | | 2016 |
Total properties | | 235 |
| | 236 |
| | 222 |
| | 222 |
|
# of units | | 25,790 |
| | 26,220 |
| | 23,798 |
| | 23,798 |
|
Tenant operating data(2) | | | | | | | | |
Occupancy | | 83.4 | % | | 84.7 | % | | 83.2 | % | | 84.7 | % |
Rent coverage | | 1.21x |
| | 1.28 | x | | 1.21 | x | | 1.27 | x |
|
| | | | | | | | | | | | |
| | Comparable Properties(1) | | All Properties |
| | As of December 31, | | As of December 31, |
| | 2019 | | 2018 | | 2019 | | 2018 |
Total buildings | | 110 |
| | 110 |
| | 138 |
| | 155 |
|
Total square feet(2) | | 10,303 |
| | 10,291 |
| | 11,878 |
| | 12,600 |
|
Occupancy(3) | | 93.9 | % | | 94.9 | % | | 92.2 | % | | 94.5 | % |
| |
(1) | Consists of triple net leased senior living communitiesmedical office and life science properties that we have owned and which have been in service continuously since January 1, 2016;2018, including our life science property owned in a joint venture arrangement in which we own a 55% equity interest; excludes communitiesproperties classified as held for sale, if any. |
| |
(2) | Prior periods exclude space remeasurements made subsequent to those periods. |
| |
(3) | Medical office and life science property occupancy includes (i) out of service assets undergoing redevelopment, (ii) space which is leased but is not occupied or is being offered for sublease by tenants, and (iii) space being fitted out for occupancy. Comparable property occupancy excludes out of service assets undergoing redevelopment. |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | Comparable(1) | | Non-Comparable | | |
| | Properties Results | | Properties Results | | Consolidated Properties Results |
| | 2019 | | 2018 | | $ Change | | % Change | | 2019 | | 2018 | | 2019 | | 2018 | | $ Change | | % Change |
Rental income | | $ | 352,002 |
| | $ | 352,089 |
| | $ | (87 | ) | | 0.0 | % | | $ | 53,014 |
| | $ | 60,724 |
| | $ | 405,016 |
| | $ | 412,813 |
| | $ | (7,797 | ) | | (1.9 | )% |
Property operating expenses | | (116,794 | ) | | (111,697 | ) | | 5,097 |
| | 4.6 | % | | (15,554 | ) | | (16,035 | ) | | (132,348 | ) | | (127,732 | ) | | 4,616 |
| | 3.6 | % |
NOI | | $ | 235,208 |
| | $ | 240,392 |
| | $ | (5,184 | ) | | (2.2 | )% | | $ | 37,460 |
| | $ | 44,689 |
| | $ | 272,668 |
| | $ | 285,081 |
| | $ | (12,413 | ) | | (4.4 | )% |
| |
(1) | Consists of medical office and life science properties that we have owned and which have been in service continuously since January 1, 2018, including our life science property owned in a joint venture arrangement in which we own a 55% equity interest; excludes properties classified as held for sale, if any. |
Rental income. Rental income decreased primarily due to our disposition of 17 properties since January 1, 2018 and a decrease in rental income at our comparable properties, partially offset by an increase in rental income from our acquisitions of four properties since January 1, 2018. Rental income at our comparable properties decreased primarily due to reduced occupancy, partially offset by an increase in tax escalation income and other expense reimbursement income and higher average rents achieved from our new and renewal leasing activity at certain of our comparable properties.
Property operating expenses. Property operating expenses consist of management fees, real estate taxes, utility expenses, insurance, salaries and benefit costs of property level personnel, repairs and maintenance expense, cleaning expense and other direct costs of operating these communities. The increase in property operating expenses is primarily the result of increases in real estate taxes and property operating expenses at our comparable properties and the net effect of our property acquisitions and dispositions since January 1, 2018. Property operating expenses at our comparable properties increased primarily due to increases in real estate taxes, insurance expense, salaries and benefit costs and other direct costs of operating our comparable properties.
Net operating income. The change in NOI reflects the net changes in rental income and property operating expenses described above.
SHOP:
|
| | | | | | | | | | | | |
| | Comparable Properties(1) | | All Properties |
| | As of and For the Year Ended December 31, | | As of and For the Year Ended December 31, |
| | 2019 | | 2018 | | 2019 | | 2018 |
Total properties | | 224 |
| | 224 |
| | 244 |
| | 260 |
|
# of units | | 26,065 |
| | 26,065 |
| | 29,013 |
| | 29,745 |
|
Occupancy (2) | | 85.7 | % | | 86.3 | % | | 85.0 | % | | 86.1 | % |
Average monthly rate (2) (3) | | 4,276 |
| | 4,270 |
| | 4,179 |
| | 4,214 |
|
| |
(1) | Consists of senior living communitiesthat we have owned and which have been operated by the same operator continuously since January 1, 2018; excludes communities classified as held for sale, if any. |
| |
(2) | Occupancy and average monthly rate exclude data for senior living communities that were leased prior to January 1, 2020. |
| |
(3) | Average monthly rate is calculated by taking the average daily rate, which is defined as total residents fees and services divided by occupied units during the period, and multiplying it by 30 days. |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | Comparable(1) | | Non-Comparable | | |
| | Properties Results | | Properties Results | | Consolidated Properties Results |
| | 2019 | | 2018 | | $ Change | | % Change | | 2019 | | 2018 | | 2019 | | 2018 | | $ Change | | % Change |
Rental income | | $ | 129,449 |
| | $ | 205,185 |
| | $ | (75,736 | ) | | (36.9 | )% | | $ | 8,449 |
| | $ | 7,437 |
| | $ | 137,898 |
| | $ | 212,622 |
| | $ | (74,724 | ) | | (35.1 | )% |
Residents fees and services | | 377,782 |
| | 379,340 |
| | (1,558 | ) | | (0.4 | )% | | 55,815 |
| | 37,183 |
| | 433,597 |
| | 416,523 |
| | 17,074 |
| | 4.1 | % |
Property operating expenses | | (299,825 | ) | | (291,580 | ) | | 8,245 |
| | 2.8 | % | | (56,897 | ) | | (32,269 | ) | | (356,722 | ) | | (323,849 | ) | | 32,873 |
| | 10.2 | % |
NOI | | $ | 207,406 |
| | $ | 292,945 |
| | $ | (85,539 | ) | | (29.2 | )% | | $ | 7,367 |
| | $ | 12,351 |
| | $ | 214,773 |
| | $ | 305,296 |
| | $ | (90,523 | ) | | (29.7 | )% |
| |
(1) | Consists of senior living communities thatwe have owned and which have been operated by the same operator continuously since January 1, 2018; excludes communities classified as held for sale, if any. |
Rental income. Rental income decreased primarily due to a decrease in rental income at our comparable properties and our disposition of 19 properties since January 1, 2018. Rental income decreased at our comparable properties primarily due to the reduction in the aggregate amount of rent payable to us by Five Star during the year ended December 31, 2019 pursuant to the Restructuring Transaction. See Note 5 to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K for information regarding the Restructuring Transaction.
Residents fees and services. Residents fees and services increased primarily due to our acquisition of five properties and the transfer of certain senior living communities we own from triple net leased senior living communities to managed senior living communities since January 1, 2018, partially offset by decreases in residents fees and services at our comparable properties. Residents fees and services at our comparable properties decreased primarily due to a decrease in occupancy at certain of our managed senior living communities.
Property operating expenses. Property operating expenses increased primarily due to our acquisitions and the transfer of certain senior living communities we own from triple net leased senior living communities to managed senior living communities since January 1, 2018 as well as an increase in property operating expenses at our comparable properties. Property operating expenses at our comparable properties increased primarily due to increased costs associated with staffing and increased maintenance, room turnover and other costs. Low unemployment and a competitive labor market are expected to continue to increase our staffing costs in 2020.
Net operating income. The change in NOI reflects the net changes in rental income, residents fees and services and property operating expenses described above.
Non-Segment(1):
|
| | | | | | | | | | | | |
| | Comparable Properties(2) | | All Properties |
| | As of and For the Year Ended December 31, | | As of and For the Year Ended December 31, |
| | 2019 | | 2018 | | 2019 | | 2018 |
Total properties: | | | | | | | | |
Other triple net leased senior living communities | | 32 |
| | 32 |
| | 32 |
| | 44 |
|
Wellness centers | | 10 |
| | 10 |
| | 10 |
| | 10 |
|
Rent coverage: | | | | | | | | |
Other triple net leased senior living communities (3) | | 1.65 | x | | 1.74 | x | | 1.65 | x | | 1.74 | x |
Wellness centers (3) | | 1.83 | x | | 2.03 | x | | 1.83 | x | | 2.03 | x |
| |
(1) | Non-segment operations include all of our other operations, including certain senior living communities leased to third party operators other than Five Star, as well as wellness centers, which segment we do not consider to be sufficiently material to constitute a separate reporting segment, and any operating expenses that are not attributable to a specific reporting segment. |
| |
(2) | Comparable properties consists of properties that we have owned and which have been leased to the same operator continuously since January 1, 2018; excludes properties classified as held for sale, if any. |
| |
(3) | All tenant operating data presented areis based upon the operating results provided by our tenants for the 12 months ended September 30, 20172019 and 20162018 or the most recent prior period for which tenant operating results are available to us. Rent coverage is calculated using the operating cash flows from |
our triple net lease tenants' operations of our properties, before subordinated charges, if any, divided by triple net lease minimum rents payable to us. We have not independently verified tenant operating data. Excludes data for historical periods prior to our ownership of certain properties, as well as data for properties sold or classified as held for sale during the periods presented.
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | Comparable(1) | | Non-Comparable | | |
| | Properties Results | | Properties Results | | Consolidated Properties Results |
| | 2019 | | 2018 | | $ Change | | % Change | | 2019 | | 2018 | | 2019 | | 2018 | | $ Change | | % Change |
Rental income | | $ | 49,446 |
| | $ | 48,928 |
| | $ | 518 |
| | 1.1 | % | | $ | 14,198 |
| | $ | 26,278 |
| | $ | 63,644 |
| | $ | 75,206 |
| | $ | (11,562 | ) | | (15.4 | )% |
NOI | | $ | 49,446 |
| | $ | 48,928 |
| | $ | 518 |
| | 1.1 | % | | $ | 14,198 |
| | $ | 26,278 |
| | $ | 63,644 |
| | $ | 75,206 |
| | $ | (11,562 | ) | | (15.4 | )% |
| |
(1) | Comparable properties consists of properties that we have owned and which have been leased to the same operator continuously since January 1, 2018; excludes properties classified as held for sale, if any. |
Rental income. Rental income decreased primarily due to the sale of 15 senior living communities leased to private operators and the transfer of certain senior living communities we own from triple net leased senior living communities to managed senior living communities since January 1, 2018, partially offset by increased rents resulting from our purchase of improvements at our comparable properties since January 1, 2018 and increased rents due to consumer price index adjustments pursuant to leases at certain of our wellness centers.
Net operating income. The change in NOI reflects the net changes in rental income described above.
References to changes in the income and expense categories below relate to the comparison of consolidated results for the year ended December 31, 2019, compared to the year ended December 31, 2018.
Depreciation and amortization expense. Depreciation and amortization expense increased primarily due to our acquisitions of nine properties and the purchase of capital improvements at certain of our properties since January 1, 2018, partially offset by our disposition of 51 properties, certain depreciable leasing related assets becoming fully depreciated and certain of our acquired resident agreements becoming fully amortized since January 1, 2018.
General and administrative expense. General and administrative expense consists of fees paid to RMR LLC under our business management agreement, legal and accounting fees, fees and expenses of our Trustees, equity compensation expense and other costs relating to our status as a publicly traded company. General and administrative expense decreased primarily due to a decrease in business management incentive fees as a result of no incentive fees recognized for 2019, compared to $40,642 of business management incentive fees that we recognized during 2018. In addition, we recognized a decrease in our base business management fees expense as a result of lower trading prices for our common shares during 2019 compared to 2018.
Acquisition and certain other transaction related costs. Acquisition and certain other transaction related costs primarily represents costs incurred in connection with the Restructuring Transaction.
Impairment of assets. For further information about our asset impairment charges, see Note 3 to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.
Gain on sale of properties. Gain on sale of properties is the result of our sale of certain office properties and senior living communities during 2019 and 2018. For further information regarding gain on sale of properties, see Note 3 to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.
Dividend income. The decrease in dividend income is the result of our sale of all of the RMR Inc. class A common stock that we owned on July 1, 2019, partially offset by an increase in dividends per share paid by RMR Inc. during 2019 compared to 2018.
Losses on equity securities, net. Losses on equity securities, net, represents the net unrealized gains and losses to adjust our investment in Five Star and RMR Inc. to their fair values.
Interest and other income. The increase in interest and other income is primarily due to an increase in average investable cash on hand and restricted cash.
Interest expense. Interest expense increased primarily due to an increase in borrowings under our revolving credit facility and changes in LIBOR, resulting in an increase in interest expense with respect to our floating rate debt. In addition, interest expense increased due to our February 2018 issuance of $500,000 of 4.75% senior unsecured notes due 2028. These increases were partially offset by our redemption in May 2019 of our $400,000 of 3.25% senior unsecured notes due 2019, our prepayment in December 2019 of our $350,000 term loan and a lower interest rate on our new $250,000 term loan obtained in December 2019.
Loss on early extinguishment of debt. We recognized a loss on early extinguishment of debt in connection with our prepayment of mortgage debts and of our $350,000 term loan.
Income tax expense. Income tax expense is the result of operating income we earned in certain jurisdictions that is subject to state income taxes.
Equity in earnings of an investee. Equity in earnings of an investee represents our proportionate share of earnings from our investment in AIC.
Year Ended December 31, 2018 Compared to Year Ended December 31, 2017:
Unless otherwise indicated, references in this section to changes or comparisons of results, income or expenses refer to comparisons of the results for the year ended December 31, 2018 to the year ended December 31, 2017. Our definition of NOI and our reconciliation of net income (loss) to NOI and a description of why we believe NOI is an appropriate supplemental measure is included below under the heading “Non-GAAP Financial Measures.”
|
| | | | | | | | | | | | | | | |
| | For the Year Ended December 31, |
| | 2018 | | 2017 | | $ Change | | % Change |
NOI by segment: | | | | | | | | |
Office Portfolio | | $ | 285,081 |
| | $ | 269,197 |
| | $ | 15,884 |
| | 5.9 | % |
SHOP | | 305,296 |
| | 303,684 |
| | 1,612 |
| | 0.5 | % |
Non-Segment | | 75,206 |
| | 88,356 |
| | (13,150 | ) | | (14.9 | )% |
Total NOI | | 665,583 |
| | 661,237 |
| | 4,346 |
| | 0.7 | % |
| | | | | | | | |
Depreciation and amortization | | 286,235 |
| | 276,861 |
| | 9,374 |
| | 3.4 | % |
General and administrative | | 85,885 |
| | 103,694 |
| | (17,809 | ) | | (17.2 | )% |
Acquisition and certain other transaction related costs | | 194 |
| | 403 |
| | (209 | ) | | (51.9 | )% |
Impairment of assets | | 66,346 |
| | 5,082 |
| | 61,264 |
| | nm |
|
Gain on sale of properties | | 261,916 |
| | 46,055 |
| | 215,861 |
| | nm |
|
Dividend income | | 2,901 |
| | 2,637 |
| | 264 |
| | 10.0 | % |
Unrealized losses on equity securities, net | | (20,724 | ) | | — |
| | 20,724 |
| | 100.0 | % |
Interest and other income | | 667 |
| | 406 |
| | 261 |
| | 64.3 | % |
Interest expense | | (179,287 | ) | | (165,019 | ) | | (14,268 | ) | | 8.6 | % |
Loss on early extinguishment of debt | | (22 | ) | | (7,627 | ) | | 7,605 |
| | (99.7 | )% |
Income from continuing operations before income tax expense and equity in earnings of an investee | | 292,374 |
| | 151,649 |
| | 140,725 |
| | 92.8 | % |
Income tax expense | | (476 | ) | | (454 | ) | | 22 |
| | 4.8 | % |
Equity in earnings of an investee | | 516 |
| | 608 |
| | (92 | ) | | (15.1 | )% |
Net income | | 292,414 |
| | 151,803 |
| | 140,611 |
| | 92.6 | % |
Net income attributable to noncontrolling interest | | (5,542 | ) | | (4,193 | ) | | 1,349 |
| | 32.2 | % |
Net income attributable to common shareholders | | $ | 286,872 |
| | $ | 147,610 |
| | $ | 139,262 |
| | 94.3 | % |
nm - not meaningful
Office Portfolio:
|
| | | | | | | | | | | | |
| | Comparable Properties(1) | | All Properties |
| | As of December 31, | | As of December 31, |
| | 2018 | | 2017 | | 2018 | | 2017 |
Total buildings | | 143 |
| | 143 |
| | 155 |
| | 151 |
|
Total square feet(2) | | 11,402 |
| | 11,402 |
| | 12,600 |
| | 12,066 |
|
Occupancy(3) | | 94.1 | % | | 94.9 | % | | 94.5 | % | | 95.0 | % |
| |
(1) | Consists of medical office and life science properties that we have owned and which have been in service continuously since January 1, 2017, including our life science property owned in a joint venture arrangement in which we own a 55% equity interest; excludes properties classified as held for sale, if any. |
| |
(2) | Prior periods exclude space remeasurements made subsequent to those periods. |
| |
(3) | Medical office and life science property occupancy includes (i) out of service assets undergoing redevelopment, (ii) space which is leased but is not occupied or is being offered for sublease by tenants, and (iii) space being fitted out for occupancy. |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | Comparable(1) | | Non-Comparable | | |
| | Properties Results | | Properties Results | | Consolidated Properties Results |
| | 2018 | | 2017 | | $ Change | | % Change | | 2018 | | 2017 | | 2018 | | 2017 | | $ Change | | % Change |
Rental income | | $ | 380,937 |
| | $ | 375,999 |
| | $ | 4,938 |
| | 1.3 | % | | $ | 31,876 |
| | $ | 6,128 |
| | $ | 412,813 |
| | $ | 382,127 |
| | $ | 30,686 |
| | 8.0 | % |
Property operating expenses | | (116,147 | ) | | (110,618 | ) | | 5,529 |
| | 5.0 | % | | (11,585 | ) | | (2,312 | ) | | (127,732 | ) | | (112,930 | ) | | 14,802 |
| | 13.1 | % |
NOI | | $ | 264,790 |
| | $ | 265,381 |
| | $ | (591 | ) | | (0.2 | )% | | $ | 20,291 |
| | $ | 3,816 |
| | $ | 285,081 |
| | $ | 269,197 |
| | $ | 15,884 |
| | 5.9 | % |
| |
(1) | Consists of medical office and life science properties that we have owned and which have been in service continuously since January 1, 2017, including our life science property owned in a joint venture arrangement in which we own a 55% equity interest; excludes properties classified as held for sale, if any. |
Rental income. Rental income increased primarily due to rental income from the ten medical office and life science properties we acquired since January 1, 2017 and an increase in rental income at our comparable properties. Rental income at our comparable properties increased primarily due to an increase in tax escalation income and other expense reimbursement income at certain of our comparable properties, partially offset by a decrease in occupancy at certain of our comparable properties.
Property operating expenses. The increase in property operating expenses is primarily the result of our property acquisitions and an increase in property operating expenses at our comparable properties. Property operating expenses at our comparable properties increased primarily due to increases in real estate taxes and other direct costs of operating these properties.
Net operating income. The change in NOI reflects the net changes in rental income and property operating expenses described above.
SHOP:
|
| | | | | | | | | | | | |
| | Comparable Properties(1) | | All Properties |
| | As of and For the Year Ended December 31, | | As of and For the Year Ended December 31, |
| | 2018 | | 2017 | | 2018 | | 2017 |
Total properties | | 252 |
| | 252 |
| | 260 |
| | 255 |
|
# of units | | 28,809 |
| | 28,809 |
| | 29,745 |
| | 29,176 |
|
Occupancy (2) | | 86.0 | % | | 85.8 | % | | 86.1 | % | | 85.8 | % |
Average monthly rate (2) (3) | | 4,266 |
| | 4,279 |
| | 4,214 |
| | 4,279 |
|
| |
(1) | Consists of senior living communities that we have owned and which have been operated by the same operator continuously since January 1, 2017; excludes communities classified as held for sale, if any. |
| |
(2) | Occupancy and average monthly rate exclude data for senior living communities that were leased prior to January 1, 2020. |
| |
(3) | Average monthly rate is calculated by taking the average daily rate, which is defined as total residents fees and services divided by occupied units during the period, and multiplying it by 30 days. |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | Comparable(1) | | Non-Comparable | | |
| | Properties Results | | Properties Results | | Consolidated Properties Results |
| | 2018 | | 2017 | | $ Change | | % Change | | 2018 | | 2017 | | 2018 | | 2017 | | $ Change | | % Change |
Rental income | | $ | 212,467 |
| | $ | 210,155 |
| | $ | 2,312 |
| | 1.1 | % | | $ | 155 |
| | $ | 384 |
| | $ | 212,622 |
| | $ | 210,539 |
| | $ | 2,083 |
| | 1.0 | % |
Residents fees and services | | 393,759 |
| | 393,602 |
| | 157 |
| | 0.0 | % | | 22,764 |
| | 105 |
| | 416,523 |
| | 393,707 |
| | 22,816 |
| | 5.8 | % |
Property operating expenses | | (306,886 | ) | | (300,347 | ) | | 6,539 |
| | 2.2 | % | | (16,963 | ) | | (215 | ) | | (323,849 | ) | | (300,562 | ) | | 23,287 |
| | 7.7 | % |
NOI | | $ | 299,340 |
| | $ | 303,410 |
| | $ | (4,070 | ) | | (1.3 | )% | | $ | 5,956 |
| | $ | 274 |
| | $ | 305,296 |
| | $ | 303,684 |
| | $ | 1,612 |
| | 0.5 | % |
| |
(1) | Consists of senior living communities that we have owned and which have been operated by the same operator continuously since January 1, 2017; excludes communities classified as held for sale, if any. |
Rental income. Rental income increased primarily due to an increase in rents at our comparable properties, partially offset by the sale of one senior living community previously leased to Five Star since January 1, 2017. Rental income at our comparable properties increased primarily due to increased rents resulting from our purchase of capital improvements since January 1, 2017.
Residents fees and services. Residents fees and services increased primarily due to our acquisition of four properties and the transfer of certain senior living communities we own from triple net leased senior living communities to managed senior living communities since January 1, 2017 as well as increases in residents fees and services at our comparable properties. Residents fees and services at our comparable properties increased modestly year over year on a comparable property basis primarily due to an increase in occupancy, partially offset by a decline in average monthly rates.
Property operating expenses. Property operating expenses increased primarily due to our acquisitions and the transfer of certain senior living communities we own from triple net leased senior living communities to managed senior living communities since January 1, 2017 as well as increases at our comparable properties. Property operating expenses at our comparable properties increased primarily due to increased costs associated with staffing and increased room turnover and maintenance costs.
Net operating income. The change in NOI reflects the net changes in rental income, residents fees and services and property operating expenses described above.
Non-Segment(1):
|
| | | | | | | | | | | | |
| | Comparable Properties(2) | | All Properties |
| | As of and For the Year Ended December 31, | | As of and For the Year Ended December 31, |
| | 2018 | | 2017 | | 2018 | | 2017 |
Total properties: | | | | | | | | |
Other triple net leased senior living communities | | 44 |
| | 44 |
| | 44 |
| | 50 |
|
Wellness centers | | 10 |
| | 10 |
| | 10 |
| | 10 |
|
Rent coverage: | | | | | | | | |
Other triple net leased senior living communities (3) | | 1.42 | x | | 1.50 | x | | 1.42 | x | | 1.50 | x |
Wellness centers (3) | | 2.01 | x | | 1.76 | x | | 2.01 | x | | 1.76 | x |
| |
(1) | Non-segment operations include all of our other operations, including certain senior living communities leased to third party operators other than Five Star, as well as wellness centers, which segment we do not consider to be sufficiently material to constitute a separate reporting segment, and any operating expenses that are not attributable to a specific reporting segment. |
| |
(2) | Comparable properties consists of properties that we have owned and which have been leased to the same operator continuously since January 1, 2017; excludes properties classified as held for sale, if any. |
| |
(3) | All tenant operating data presented is based upon the operating results provided by our tenants for the 12 months ended September 30, 2018 and 2017 or the most recent prior period for which tenant operating results was available to us as of the date we filed our Annual Report on Form 10-K for the year ended December 31, 2018. Rent coverage is calculated using the operating cash flows from our triple net lease tenants’tenants' operations of our properties, before subordinated charges, if any, divided by triple net lease minimum rents payable to us. We have not independently verified tenant operating data. Excludes data for historical periods prior to our ownership of certain properties, as well as data for properties sold or classified as held for sale during the periods presented. |
Triple net leased senior living communities, all properties:
|
| | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2017 | | 2016 | | Change | | % Change |
Rental income | | $ | 280,641 |
| | $ | 275,697 |
| | $ | 4,944 |
| | 1.8 | % |
Property operating expenses | | — |
| | (833 | ) | | (833 | ) | | (100.0 | )% |
Net operating income (NOI) | | 280,641 |
| | 274,864 |
| | 5,777 |
| | 2.1 | % |
| | | | | | | | |
Depreciation and amortization expense | | (81,976 | ) | | (78,361 | ) | | 3,615 |
| | 4.6 | % |
Impairment of assets | | — |
| | (6,583 | ) | | (6,583 | ) | | (100.0 | )% |
Operating income | | 198,665 |
| | 189,920 |
| | 8,745 |
| | 4.6 | % |
| | | | | | | | |
Interest expense | | (8,855 | ) | | (24,795 | ) | | (15,940 | ) | | (64.3 | )% |
Loss on early extinguishment of debt | | (7,294 | ) | | (467 | ) | | 6,827 |
| | 1,461.9 | % |
Gain on sale of properties | | 45,901 |
| | 4,061 |
| | 41,840 |
| | 1,030.3 | % |
Net income | | $ | 228,417 |
| | $ | 168,719 |
| | $ | 59,698 |
| | 35.4 | % |
Except as noted below under “Rental income,” we have not included a discussion and analysis of the results of our comparable properties data for the triple net leased senior living communities segment as we believe that such a comparison is generally consistent with the comparison of results for all our triple net leased senior living communities from period to period and a separate, comparable properties comparison is not meaningful.
Rental income. Rental income increased primarily due to rents from triple net leased senior living communities we acquired since January 1, 2016, and also due to increased rents resulting from our purchase of improvements since January 1, 2016. These increases were partially offset by reduced rental income resulting from our sales of three senior living communities since January 1, 2016. Rental income includes non-cash straight line rent adjustments totaling $3,063 and $4,133 for the years ended December 31, 2017 and 2016, respectively. Rental income increased year over year on a comparable property basis by $2,681, primarily as a result of our purchase of improvements at certain of these communities that we have owned continuously since January 1, 2016 and the resulting increased rent, pursuant to the terms of the applicable leases.
Property operating expenses. In the year ended December 31, 2016, we recorded $833 of property operating expenses related to bad debt reserves associated with lease defaults at two triple net leased senior living communities we acquired in 2015 which were previously leased to third party private operators. In 2016, we terminated these leases and entered management agreements with Five Star to manage the communities for our account under TRS structures.
Net operating income. We typically incur minimal property operating expenses at these communities, as the majority of those expenses are paid by our tenants. NOI increased due to the increase in rental income and decrease in property operating expenses as described above. The reconciliation of NOI to net income for our triple net leased senior living communities segment is shown in the table above. Our definition of NOI and our reconciliation of net income to consolidated NOI are included below under the heading “Non-GAAP Financial Measures”.
Depreciation and amortization expense. Depreciation and amortization expense increased primarily as a result of our acquisitions and our purchase of improvements since January 1, 2016.
Impairment of assets. Impairment of assets charges recorded in 2016 relate to writing off acquired lease intangible assets associated with the two communities where the tenants defaulted on their leases as discussed above, as well as the reduction of the carrying value of a SNF that we sold during the third quarter of 2016 to its sale price less cost to sell.
Interest expense. Interest expense relates to mortgage notes secured by certain of these communities. The decrease in interest expense is due to our prepayment of $320,379 in aggregate principal amount of mortgage notes since January 1, 2016 with a weighted average annual interest rate of 6.7%, as well as regularly scheduled amortization of mortgage notes secured by these communities.
Loss on early extinguishment of debt. We recognized losses on early extinguishment of debt in connection with our prepayment of mortgage debts during 2017 and 2016.
Gain on sale of properties. Gain on sale of properties is the result of our sale of one independent living community in December 2017 and one SNF in June 2016.
Managed senior living communities:
|
| | | | | | | | | | | | | | | | |
| | | | | | Comparable Properties(1) |
| | All Properties | |
| | As of and For the Year Ended December 31, | | As of and For the Year Ended December 31, |
| | |
| | 2017 | | 2016 | | 2017 | | 2016 |
Total properties | | 70 |
| | 68 |
| | 60 |
| | 60 |
|
# of units | | 9,043 |
| | 8,788 |
| | 8,106 |
| | 8,106 |
|
Occupancy | | 85.8 | % | | 87.2 | % | | 86.1 | % | | 87.2 | % |
Average monthly rate (2) | | $ | 4,279 |
| | $ | 4,243 |
| | $ | 4,265 |
| | $ | 4,213 |
|
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | Comparable(1) | | Non-Comparable | | |
| | Properties Results | | Properties Results | | Consolidated Properties Results |
| | 2018 | | 2017 | | $ Change | | % Change | | 2018 | | 2017 | | 2018 | | 2017 | | $ Change | | % Change |
Rental income | | $ | 67,366 |
| | $ | 67,027 |
| | $ | 339 |
| | 0.5 | % | | $ | 7,840 |
| | $ | 21,329 |
| | $ | 75,206 |
| | $ | 88,356 |
| | $ | (13,150 | ) | | (14.9 | )% |
NOI | | $ | 67,366 |
| | $ | 67,027 |
| | $ | 339 |
| | 0.5 | % | | $ | 7,840 |
| | $ | 21,329 |
| | $ | 75,206 |
| | $ | 88,356 |
| | $ | (13,150 | ) | | (14.9 | )% |
| |
(1) | ConsistsComparable properties consists of managed senior living communitiesproperties that we have owned and managed bywhich have been leased to the same operator continuously since January 1, 2016;2017; excludes communitiesproperties classified as held for sale, if any. |
| |
(2) | Average monthly rate is calculated by taking the average daily rate, which is defined as total residents fees and services divided by occupied units during the period, and multiplying it by 30 days. |
ManagedRental income. Rental income decreased primarily due to reduced rental income resulting from the sale of five senior living communities all properties:
|
| | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2017 | | 2016 | | Change | | % Change |
Residents fees and services | | $ | 393,797 |
| | $ | 391,822 |
| | $ | 1,975 |
| | 0.5 | % |
Property operating expenses | | (300,500 | ) | | (293,195 | ) | | 7,305 |
| | 2.5 | % |
Net operating income (NOI) | | 93,297 |
| | 98,627 |
| | (5,330 | ) | | (5.4 | )% |
| | | | | | | | |
Depreciation and amortization expense | | (62,266 | ) | | (81,482 | ) | | (19,216 | ) | | (23.6 | )% |
Impairment of assets | | — |
| | (2,174 | ) | | (2,174 | ) | | (100.0 | )% |
Operating income | | 31,031 |
| | 14,971 |
| | 16,060 |
| | 107.3 | % |
| | | | | | | | |
Interest expense | | (4,685 | ) | | (8,540 | ) | | (3,855 | ) | | (45.1 | )% |
Loss on early extinguishment of debt | | — |
| | (59 | ) | | (59 | ) | | (100.0 | )% |
Net income | | $ | 26,346 |
| | $ | 6,372 |
| | $ | 19,974 |
| | 313.5 | % |
Residents fees and services. Residents fees and services are the revenues earned at our managed senior living communities. We recognize these revenues as services are provided and related fees are accrued. Residents fees and services increased primarily dueleased to our acquisitionsprivate operators and the transfer of certain senior living communities we own from triple net leased senior living communities to managed senior living communities since January 1, 2016, as well as an increase in average monthly rates,2017, partially offset by a decline in occupancy.
Property operating expenses. Property operating expenses consistincreased rents resulting from our acquisition of management fees, real estate taxes, utility expenses, insurance, salaries and benefit costs of property level personnel, repairs and maintenance expense, cleaning expense and other direct costs of operating these communities. Property operating expenses increased primarily due to our acquisitionstwo properties and the transfer of certain senior living communities we own from triple net leased senior living communities to managed senior living communitiespurchase improvements at our comparable properties since January 1, 2016, increased salaries2017.
References to changes in the income and benefit costs associated with staffing, increased real estate taxes at certain of these communities and increased management fees as a result of the modifications made to our management and pooling agreements with Five Star that took effect on July 1, 2016.
Net operating income. NOI decreased dueexpense categories below relate to the increase in property operating expenses, partially offset bycomparison of consolidated results for the increase in residents fees and services described above. The reconciliation of NOIyear ended December 31, 2018, compared to net income for our managed senior living communities segment is shown in the table above. Our definition of NOI and our reconciliation of net income to consolidated NOI are included below under the heading “Non-GAAP Financial Measures”.year ended December 31, 2017.
Depreciation and amortization expense. Depreciation and amortization expense includes the depreciation of owned property and equipment as well as the amortization expense related to in place resident agreements assumed upon the acquisition of a community. Depreciation and amortization expense decreased as a result of certain of our in place resident agreements becoming fully amortized since January 2016, partially offset by an increase in depreciation expense due to acquisitions and our purchases of improvements since January 2016.
Impairment of assets. Impairment of assets charges recorded in 2016 relate to the reduction of the carrying value of a senior living community that we sold in December 2016 to its estimated fair value less cost to sell.
Interest expense. Interest expense relates to mortgage notes secured by certain of these communities. The decrease in interest expense is due to our prepayment of $103,370 in aggregate principal amount of mortgage notes since January 1, 2016 with a weighted average annual interest rate of 6.0%, as well as regularly scheduled amortization of mortgage notes secured by these communities.
Loss on early extinguishment of debt. We recognized losses on early extinguishment of debt in connection with our prepayment of mortgage notes during 2016.
Managed senior living communities, comparable properties (managed senior living communities owned and managed by the same operator continuously since January 1, 2016; excludes communities classified as held for sale, if any):
|
| | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2017 | | 2016 | | Change | | % Change |
Residents fees and services | | $ | 366,115 |
| | $ | 366,701 |
| | $ | (586 | ) | | (0.2 | )% |
Property operating expenses | | (277,194 | ) | | (273,479 | ) | | 3,715 |
| | 1.4 | % |
Net operating income (NOI) | | 88,921 |
| | 93,222 |
| | (4,301 | ) | | (4.6 | )% |
| | | | | | | | |
Depreciation and amortization expense | | (51,442 | ) | | (64,934 | ) | | (13,492 | ) | | (20.8 | )% |
Operating income | | 37,479 |
| | 28,288 |
| | 9,191 |
| | 32.5 | % |
| | | | | | | | |
Interest expense | | (2,228 | ) | | (6,209 | ) | | (3,981 | ) | | (64.1 | )% |
Loss on early extinguishment of debt | | — |
| | (59 | ) | | (59 | ) | | (100.0 | )% |
Net income | | $ | 35,251 |
| | $ | 22,020 |
| | $ | 13,231 |
| | 60.1 | % |
Residents fees and services. Residents fees and services are the revenues earned at our managed senior living communities. We recognize these revenues as services are provided and related fees are accrued. Residents fees and services decreased slightly year over year on a comparable property basis primarily due to a decline in occupancy, partially offset by an increase in average monthly rates.
Property operating expenses. Property operating expenses consist of management fees, real estate taxes, utility expenses, insurance, salaries and benefit costs of property level personnel, repairs and maintenance expense, cleaning expense and other direct costs of operating these communities. Property operating expenses increased primarily due to increased salaries and benefit costs associated with staffing, as well as increased real estate taxes, utility expenses, insurance expense and management fees as a result of the modifications made to our management and pooling agreements with Five Star that took effect on July 1, 2016.
Net operating income. The decrease in NOI reflects the net changes in residents fees and services and property operating expenses described above. The reconciliation of NOI to net income for our managed senior living communities segment, comparable properties, is shown in the table above. Our definition of NOI and our reconciliation of net income to consolidated NOI are included below under the heading “Non-GAAP Financial Measures.”
Depreciation and amortization expense. Depreciation and amortization expense includes the depreciation of owned property and equipment, as well as the amortization expense related to in place resident agreements assumed upon the acquisition of a community. Depreciation and amortization expense decreased as a result of certain of our in place resident agreements becoming fully amortized since January 1, 2016, partially offset by an increase in depreciation expense due to our purchase of improvements since January 1, 2016.
Interest expense. Interest expense relates to mortgage notes secured by certain of these communities. The decrease in interest expense is due to our prepayment of $103,370 in aggregate principal amount of mortgage notes since January 1, 2016 with a weighted average annual interest rate of 6.0%, as well as regularly scheduled amortization of mortgage notes secured by these communities.
Loss on early extinguishment of debt. We recognized losses on early extinguishment of debt in connection with our prepayment of mortgage notes during 2016.
MOBs:
|
| | | | | | | | | | | | |
| | All Properties | | Comparable Properties(1) |
| | As of and For the Year Ended December 31, | | As of and For the Year Ended December 31, |
| | |
| | 2017 | | 2016 | | 2017 | | 2016 |
Total properties | | 125 |
| | 119 |
| | 116 |
| | 116 |
|
Total buildings | | 151 |
| | 145 |
| | 140 |
| | 140 |
|
Total square feet(2) | | 12,066 |
| | 11,431 |
| | 11,046 |
| | 11,041 |
|
Occupancy(3) | | 95.0 | % | | 96.5 | % | | 94.8 | % | | 96.3 | % |
| |
(1) | Consists of MOBs we have owned continuously since January 1, 2016; includes our MOB (two buildings) that is owned in a joint venture arrangement; excludes properties classified as held for sale, if any. |
| |
(2) | Prior periods exclude space re-measurements made subsequent to those periods. |
| |
(3) | MOB occupancy includes (i) space being fitted out for occupancy and (ii) space which is leased, but is not occupied or is being offered for sublease by tenants. |
MOBs, all properties:
|
| | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2017 | | 2016 | | Change | | % Change |
Rental income | | $ | 382,127 |
| | $ | 372,233 |
| | $ | 9,894 |
| | 2.7 | % |
Property operating expenses | | (112,930 | ) | | (105,762 | ) | | 7,168 |
| | 6.8 | % |
Net operating income (NOI) | | 269,197 |
| | 266,471 |
| | 2,726 |
| | 1.0 | % |
| | | | | | | | |
Depreciation and amortization expense | | (128,827 | ) | | (124,196 | ) | | 4,631 |
| | 3.7 | % |
Impairment of assets | | — |
| | (7,122 | ) | | (7,122 | ) | | (100.0 | )% |
Operating income | | 140,370 |
| | 135,153 |
| | 5,217 |
| | 3.9 | % |
| | | | | | | | |
Interest expense | | (24,919 | ) | | (13,852 | ) | | 11,067 |
| | 79.9 | % |
Loss on early extinguishment of debt | | (59 | ) | | — |
| | 59 |
| | 100.0 | % |
Net income | | 115,392 |
| | 121,301 |
| | (5,909 | ) | | (4.9 | )% |
Net income attributable to noncontrolling interest | | (4,193 | ) | | — |
| | 4,193 |
| | 100.0 | % |
Net income attributable to common shareholders | | $ | 111,199 |
| | $ | 121,301 |
| | $ | (10,102 | ) | | (8.3 | )% |
Rental income. Rental income increased primarily due to rents from MOBs we acquired since January 1, 2016, as well as certain changes at our comparable MOB properties discussed below. Rental income includes non-cash straight line rent adjustments totaling $10,346 and $12,922 and net amortization of approximately $5,128 and $4,720 of above and below market lease adjustments for the years ended December 31, 2017 and 2016, respectively.
Property operating expenses. Property operating expenses consist of real estate taxes, utility expenses, property management fees, repairs and maintenance expense, cleaning expense and other direct costs of operating these properties. Property operating expenses increased primarily due to our acquisitions since January 1, 2016, as well as certain changes at our comparable MOB properties discussed below.
Net operating income. NOI increased due to the increase in rental income, partially offset by the increased property operating expenses described above. The reconciliation of NOI to net income for our MOB segment is shown in the table above. Our definition of NOI and our reconciliation of net income to consolidated NOI are included below under the heading “Non-GAAP Financial Measures”.
Depreciation and amortization expense.Depreciation and amortization expense increased primarily due to our acquisitions of 16 properties and the purchase of capital improvements since January 1, 2016, an increase in the amortization of leasing costs and depreciation expense on fixed assets and an increase in amortization of acquired in place real estate leases that we amortize over the respective lease terms.
Impairment of assets. Impairment of assets for the year ended December 31, 2016 relates to reducing the carrying value of five MOBs (five buildings) and one land parcel to their estimated sales prices less costs to sell.
Interest expense. Interest expense relates to mortgage notes secured by certain of these properties. The increase in interest expense is the result of our obtaining, in July 2016, an aggregate $620,000 secured debt financing with a weighted average fixed annual interest rate of 3.5%,2017, partially offset by our prepaymentdisposition of $45,789 in principal amount of a mortgage notesix senior living communities since January 1, 2016 with an annual interest rate of 5.6%, as well as the regularly scheduled amortization of mortgage notes.2017.
Loss on early extinguishment of debt. We recognized losses on early extinguishment of debt in connection with our prepayment of mortgage notes during 2017.
Net income attributable to noncontrolling interest. Net income attributable to noncontrolling interest represents the net income attributable to a sovereign investor that owns 45% of one of our MOBs (two buildings) through the joint venture agreement we entered in March 2017.
MOBs, comparable properties (MOBs we have owned continuously since January 1, 2016; includes our MOB (two buildings) that is owned in a joint venture arrangement and excluding properties classified as held for sale, if any):
|
| | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2017 | | 2016 | | Change | | % Change |
Rental income | | $ | 363,858 |
| | $ | 361,861 |
| | $ | 1,997 |
| | 0.6 | % |
Property operating expenses | | (108,568 | ) | | (103,605 | ) | | 4,963 |
| | 4.8 | % |
Net operating income (NOI) | | 255,290 |
| | 258,256 |
| | (2,966 | ) | | (1.1 | )% |
| | | | | | | | |
Depreciation and amortization expense | | (123,140 | ) | | (121,580 | ) | | 1,560 |
| | 1.3 | % |
Operating income | | 132,150 |
| | 136,676 |
| | (4,526 | ) | | (3.3 | )% |
| | | | | | | | |
Interest expense | | (24,919 | ) | | (13,852 | ) | | 11,067 |
| | 79.9 | % |
Loss on early extinguishment of debt | | (59 | ) | | — |
| | 59 |
| | 100.0 | % |
Net income | | 107,172 |
| | 122,824 |
| | (15,652 | ) | | (12.7 | )% |
Net income attributable to noncontrolling interest | | (4,193 | ) | | — |
| | 4,193 |
| | 100.0 | % |
Net income attributable to common shareholders | | $ | 102,979 |
| | $ | 122,824 |
| | $ | (19,845 | ) | | (16.2 | )% |
Rental income. Rental income increased primarily due to an increase in tax escalation income and other reimbursable expenses and increased rents from net leasing activity at certain of these properties. Rental income includes non-cash straight line rent adjustments totaling $8,966 and $12,241 and net amortization of approximately $4,984 and $4,421 of acquired above and below market lease adjustments for the years ended December 31, 2017 and 2016, respectively.
Property operating expenses. Property operating expenses consist of real estate taxes, utility expenses, property management fees, salaries and benefit costs of property level personnel, repairs and maintenance expense, cleaning expense and other direct costs of operating these properties. Property operating expenses increased primarily as a result of increases in real estate taxes at certain of these properties and other direct costs of operating these properties.
Net operating income. NOI reflects the net changes in rental income and property operating expenses described above. The reconciliation of NOI to net income for our MOB segment for comparable properties is shown in the table above. Our definition
of NOI and our reconciliation of net income to consolidated NOI are included below under the heading “Non-GAAP Financial Measures”.
Depreciation and amortization expense. Depreciation and amortization expense increased due to an increase in the amortization of leasing costs and depreciation expense on fixed assets acquired since January 1, 2016, partially offset by a reduction in amortization of acquired in place real estate leases that we amortize over the respective lease terms.
Interest expense. Interest expense relates to mortgage notes secured by certain of these properties. The increase in interest expense is the result of our obtaining, in July 2016, an aggregate $620,000 secured debt financing with a weighted average fixed annual interest rate of 3.5%, partially offset by our prepayment of $45,789 in principal amount of a mortgage note since January 1, 2016 with an annual interest rate of 5.6%, as well as the regularly scheduled amortization of mortgage notes.
Loss on early extinguishment of debt. We recognized losses on early extinguishment of debt in connection with our prepayment of mortgage notes during 2017.
Net income attributable to noncontrolling interest. Net income attributable to noncontrolling interest represents the net income attributable to a sovereign investor that owns 45% of one of our MOBs (two buildings) through the joint venture agreement we entered in March 2017.
All other operations:(1)
|
| | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2017 | | 2016 | | Change | | % Change |
Rental income | | $ | 18,254 |
| | $ | 18,270 |
| | $ | (16 | ) | | (0.1 | )% |
Expenses: | | | | | | | | |
Depreciation and amortization expense | | (3,792 | ) | | (3,792 | ) | | — |
| | — | % |
General and administrative | | (103,702 | ) | | (46,559 | ) | | 57,143 |
| | 123 | % |
Acquisition and certain other transaction related costs | | (547 | ) | | (2,085 | ) | | (1,538 | ) | | (73.8 | )% |
Impairment of assets | | (5,082 | ) | | (2,795 | ) | | 2,287 |
| | 81.8 | % |
Total expenses | | (113,123 | ) | | (55,231 | ) | | 57,892 |
| | 104.8 | % |
Operating loss | | (94,869 | ) | | (36,961 | ) | | 57,908 |
| | 156.7 | % |
| | | | | | | | |
Dividend income | | 2,637 |
| | 2,108 |
| | 529 |
| | 25.1 | % |
Interest and other income | | 406 |
| | 430 |
| | (24 | ) | | (5.6 | )% |
Interest expense | | (126,560 | ) | | (120,387 | ) | | 6,173 |
| | 5.1 | % |
Loss on early extinguishment of debt | | (274 | ) | | — |
| | 274 |
| | 100.0 | % |
Loss from continuing operations before income tax expense and equity in earnings of an investee | | (218,660 | ) | | (154,810 | ) | | 63,850 |
| | 41.2 | % |
Income tax expense | | (454 | ) | | (424 | ) | | 30 |
| | 7.1 | % |
Equity in earnings of an investee | | 608 |
| | 137 |
| | 471 |
| | 343.8 | % |
Loss before gain on sale of properties | | (218,506 | ) | | (155,097 | ) | | 63,409 |
| | 40.9 | % |
Gain on sale of properties | | 154 |
| | — |
| | 154 |
| | 100.0 | % |
Net loss | | $ | (218,352 | ) | | $ | (155,097 | ) | | $ | 63,255 |
| | 40.8 | % |
| |
(1) | All other operations includes all of our other operations, including certain properties that offer wellness, fitness and spa services to members, which segment we do not consider to be sufficiently material to constitute a separate reporting segment, and any operating expenses that are not attributable to a specific reporting segment. |
Rental income. Rental income includes non-cash straight line rent of approximately $549 for each of the years ended December 31, 2017 and 2016. Rental income also includes net amortization of approximately $221 of acquired real estate leases and obligations for each of the years ended December 31, 2017 and 2016.
Depreciation and amortization expense. Depreciation and amortization expense remained consistent as we have had no acquisitions or capital expenditures in this segment since January 1, 2016. We depreciate our long lived wellness center assets on a straight line basis.
General andadministrative expense.expense. General and administrative expense consists of fees paid to RMR LLC under our business management agreements, legal and accounting fees, fees and expenses of our Trustees, equity compensation expense and
other costs relating to our status as a publicly traded company. General and administrative expense increaseddecreased primarily due to an increasea decrease in our business management fees of $57,616, including $55,740 ofincentive fees. We recognized business management incentive fees that we recognized for the year ended December 31, 2017of $40,642 during 2018 as a result of our total shareholder return, as defined, exceeding the returns for the SNL U.S. REIT Healthcare index over the applicable three year measurement period ended December 31, 2017. Ourby 9.6%, compared to $55,740 of business management incentive fees recognized during 2017. In addition, we recognized a decrease in our base business management fees expense as a result of lower trading prices for 2017 were paid in cash in January 2018.our common shares during 2018 compared to 2017.
Acquisition and certain other transaction related costs. Acquisition and certain other transaction related costs include legal and diligence costs incurred in connection with our acquisition, disposition and operations transaction activities that we expensed under GAAP.
Impairment of assets. For further information about our asset impairment charges, see Note 3 to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.
Gain on sale of properties. Gain on sale of properties is the years endedresult of our sale of five senior living communities during 2018 and one senior living community in December 31, 2017 and 2016, we recorded impairment of assets charges of $5,082 and $2,795, respectively, to reduce the carrying value ofa permanent land eminent domain taking at our investmentwellness center in Five Star shares to its estimated fair value due to the market value of this investment being significantly below our carrying value for an extended period.Romeoville, Illinois that occurred in 2017.
Dividend income. income. Dividend income reflects cash dividends received from our investment in RMR Inc.
Unrealized losses on equity securities. Unrealized losses on equity securities represents the net unrealized losses to adjust our investments in RMR Inc. and Five Star to their fair value as of December 31, 2018 in accordance with a change in GAAP standards effective January 1, 2018. We sold our investment in RMR Inc. on July 1, 2019.
Interest and other income. The decreaseincrease in interest and other income is primarily due to decreasedan increase in average investable cash on hand.hand and restricted cash.
Interest expense.Interest expense increased primarily due to our February 2018 issuance of $250,000$500,000 of 6.25%4.75% senior unsecured notes due 2046 in February 2016, as well as an increase2028, changes in LIBOR rates, resultingimpacting our floating rate debt and our assumption of certain mortgage notes in an increase in interest expense onconnection with our acquisitions since January 1, 2017. These increases were partially offset by lower borrowings under our revolving credit facility and term loans, partially offset by decreased borrowings under our revolving credit facility.prepayment of certain mortgage debts since January 1, 2017.
Loss on early extinguishment of debt. We recognized a loss on early extinguishment of debt in August 2017connection with our prepayment of mortgage debts and in connection with the amendments to the agreements governing our revolving credit facility and our $200,000 term loan.
Income tax expense.expense. Income tax expense primarily reflectsis the result of operating income we earned in certain jurisdictions that is subject to state income taxes payable in certain jurisdictions.taxes.
Equity in earnings of an investee.Equity in earnings of an investee represents our proportionate share of earnings from AIC.
Gain on sale of properties. Gain on sale of properties represents a permanent land eminent domain taking at our wellness center in Romeoville, IL that occurred in 2017.
Year Ended December 31, 2016 Compared to Year Ended December 31, 2015:
Triple net leased senior living communities:
|
| | | | | | | | | | | | |
| | | | | | Comparable Properties(1) |
| | All Properties | |
| | As of and For the Year Ended December 31, | | As of and For the Year Ended December 31, |
| | |
| | 2016 | | 2015 | | 2016 | | 2015 |
Total properties | | 236 |
| | 231 |
| | 209 |
| | 209 |
|
# of units | | 26,220 |
| | 26,114 |
| | 23,509 |
| | 23,509 |
|
Tenant operating data(2) | | | | | | | | |
Occupancy | | 85.1 | % | | 85.6 | % | | 84.4 | % | | 85.3 | % |
Rent coverage | | 1.31 | x | | 1.35 | x | | 1.33 | x | | 1.36 | x |
| |
(1) | Consists of triple net leased senior living communities owned continuously since January 1, 2015; excludes communities classified as held for sale, if any. |
| |
(2) | All tenant operating data presented are based upon the operating results provided by our tenants for the 12 months ended September 30, 2016 and 2015 or the most recent prior period for which tenant operating results were available to us at the time we originally published our results for the year ended December 31, 2016. Rent coverage is calculated as operating cash flow from our triple net lease tenants’ operations of our properties, before subordinated charges, if any, divided by triple net lease minimum rents payable to us. We have not independently verified tenant operating data. Excludes data for historical periods prior to our ownership of certain properties, as well as data for properties sold during the periods presented. |
Triple net leased senior living communities, all properties:
|
| | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2016 | | 2015 | | Change | | % Change |
Rental income | | $ | 275,697 |
| | $ | 256,035 |
| | $ | 19,662 |
| | 7.7 | % |
Property operating expenses | | (833 | ) | | — |
| | 833 |
| | 100.0 | % |
Net operating income (NOI) | | 274,864 |
| | 256,035 |
| | 18,829 |
| | 7.4 | % |
| | | | | | | | |
Depreciation and amortization expense | | (78,361 | ) | | (70,417 | ) | | 7,944 |
| | 11.3 | % |
Impairment of assets | | (6,583 | ) | | (194 | ) | | 6,389 |
| | 3,293.3 | % |
Operating income | | 189,920 |
| | 185,424 |
| | 4,496 |
| | 2.4 | % |
| | | | | | | | |
Interest expense | | (24,795 | ) | | (25,015 | ) | | (220 | ) | | (0.9 | )% |
Loss on early extinguishment of debt | | (467 | ) | | (6 | ) | | 461 |
| | 7,683.3 | % |
Gain on sale of properties | | 4,061 |
| | — |
| | 4,061 |
| | 100.0 | % |
Net income | | $ | 168,719 |
| | $ | 160,403 |
| | $ | 8,316 |
| | 5.2 | % |
Except as noted below under “Rental income,” we have not included a discussion and analysis of the results of our comparable properties data for the triple net leased senior living communities segment as we believe that such a comparison is generally consistent with the comparison of results for all our triple net leased senior living communities from period to period and a separate, comparable properties comparison is not meaningful.
Rental income. Rental income increased primarily due to rents from the triple net leased senior living communities we acquired in 2015 and 2016 and also increased due to increased rents resulting from our purchase of improvements in the amount of $54,393 at these communities since January 1, 2015, pursuant to the terms of the applicable leases. These increases in rental income were partially offset by reduced rental income resulting from our sales of six senior living communities since January 1, 2015. Rental income includes non-cash straight line rent adjustments totaling $4,133 and $4,051 for the years ended December 31, 2016 and 2015, respectively. Rental income increased year over year on a comparable property basis by $3,129, primarily as a result of our purchase of improvements at certain of the communities we have owned continuously since January 1, 2015 and the resulting increased rent, pursuant to the terms of the applicable leases.
Property operating expenses. Property operating expenses recorded in 2016 relate to bad debt reserves associated with the lease defaults at two triple net leased senior living communities we acquired in 2015 which were previously leased to third party private operators. In April and July 2016, we terminated these leases and entered management agreements with Five Star to manage the communities for our account under a TRS structure. In connection with the termination of one of these leases, we received $2,365 in amounts due under the lease, which we recorded as rental income.
Net operating income. NOI increased due to the increase in rental income described above. The reconciliation of NOI to net income for our triple net leased senior living communities segment is shown in the table above. Our definition of NOI and our reconciliation of net income to consolidated NOI are included below under the heading “Non-GAAP Financial Measures”.
Depreciation and amortization expense. Depreciation and amortization expense increased primarily as a result of our acquisitions and our purchase of improvements as described above.
Impairment of assets. Impairment of assets charges recorded in 2016 relate to writing off acquired lease intangible assets associated with the two communities where the tenants defaulted on their leases as discussed above, as well as the reduction of the carrying value of a SNF that we sold during the third quarter of 2016 to its sale price less cost to sell. During 2015, we recorded impairment of assets charges of $194 related to the sales of senior living communities in 2015.
Interest expense. Interest expense relates to mortgage notes and capital leases secured by certain of these communities. The decrease in interest expense is primarily due to our prepayment of certain mortgage notes as described below, as well as regularly scheduled amortization of our mortgage notes secured by these communities.
Loss on early extinguishment of debt. We recognized losses on early extinguishment of debt in connection with our prepayment of mortgage notes during 2016 and 2015.
Gain on sale of properties. Gain on sale of properties is the result of our sale of one SNF in June 2016.
Managed senior living communities:
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| | | | | | | | | | | | | | | | |
| | | | | | Comparable Properties(1) |
| | All Properties | |
| | As of and For the Year Ended December 31, | | As of and For the Year Ended December 31, |
| | |
| | 2016 | | 2015 | | 2016 | | 2015 |
Total properties | | 68 |
| | 65 |
| | 46 |
| | 46 |
|
# of units | | 8,788 |
| | 8,585 |
| | 7,208 |
| | 7,208 |
|
Occupancy | | 87.2 | % | | 88.1 | % | | 87.0 | % | | 88.0 | % |
Average monthly rate(2) | | $ | 4,243 |
| | $ | 4,213 |
| | $ | 4,336 |
| | $ | 4,264 |
|
| |
(1) | Consists of managed senior living communities owned and managed by the same operator continuously since January 1, 2015; excludes communities classified as held for sale, if any. |
| |
(2) | Average monthly rate is calculated by taking the average daily rate, which is defined as total residents fees and services divided by occupied units during the period, and multiplying it by 30 days. |
Managed senior living communities, all properties:
|
| | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2016 | | 2015 | | Change | | % Change |
Residents fees and services | | $ | 391,822 |
| | $ | 367,874 |
| | $ | 23,948 |
| | 6.5 | % |
Property operating expenses | | (293,195 | ) | | (278,242 | ) | | 14,953 |
| | 5.4 | % |
Net operating income (NOI) | | 98,627 |
| | 89,632 |
| | 8,995 |
| | 10.0 | % |
| | | | | | | | |
Depreciation and amortization expense | | (81,482 | ) | | (60,600 | ) | | 20,882 |
| | 34.5 | % |
Impairment of assets | | (2,174 | ) | | — |
| | 2,174 |
| | 100.0 | % |
Operating income | | 14,971 |
| | 29,032 |
| | (14,061 | ) | | (48.4 | )% |
| | | | | | | | |
Interest expense | | (8,540 | ) | | (9,973 | ) | | (1,433 | ) | | (14.4 | )% |
Loss on early extinguishment of debt | | (59 | ) | | (34 | ) | | 25 |
| | 73.5 | % |
Net income | | $ | 6,372 |
| | $ | 19,025 |
| | $ | (12,653 | ) | | (66.5 | )% |
Residents fees and services. Residents fees and services are the revenues earned at our managed senior living communities. We recognize these revenues as services are provided and related fees are accrued. Residents fees and services increased primarily due to our acquisitions and the transfer of certain other senior living communities we own from triple net leased senior living communities to managed senior living communities since January 1, 2015.
Property operating expenses. Property operating expenses consist of management fees, real estate taxes, utility expenses, insurance, salaries and benefit costs of property level personnel, repairs and maintenance expense, cleaning expense and other direct costs of operating these communities. Property operating expenses increased primarily due to our acquisitions, the transfer of certain senior living communities we own from triple net leased senior living communities to managed senior living communities since January 1, 2015, management fees earned by Five Star as a result of the modifications made to our management and pooling agreements with Five Star that took effect on July 1, 2016 and increased expenses incurred during the fourth quarter of 2016 due to casualty losses and evacuation costs as a result of a hurricane.
Net operating income. NOI increased due to the changes in residents fees and services and property operating expenses described above. The reconciliation of NOI to net income for our managed senior living communities segment is shown in the table above. Our definition of NOI and our reconciliation of net income to consolidated NOI are included below under the heading “Non-GAAP Financial Measures”.
Depreciation and amortization expense. Depreciation and amortization expense includes the depreciation of owned property and equipment as well as the amortization expense related to in place resident agreements assumed upon the acquisition
of a community. Depreciation and amortization expense increased primarily as a result of the acquisitions and transfers of certain communities from leased to managed communities described above.
Impairment of assets. Impairment of assets for the year ended December 31, 2016 relates to reducing the carrying value of a formerly managed memory care building to its estimated sale prices less cost to sell.
Interest expense. Interest expense relates to mortgage notes secured by certain of these communities. The decrease in interest expense is due to our prepayment and repayment of $149,325 in aggregate principal amount of mortgage notes since January 1, 2015 with a weighted average annual interest rate of 5.94%, as well as regularly scheduled amortization of our mortgage notes, partially offset by our assumption of $94,786 in aggregate principal amount of mortgage notes with a weighted average annual interest rate of 4.12% in connection with our acquisitions since January 1, 2015.
Loss on early extinguishment of debt. We recognized losses on early extinguishment of debt in connection with our prepayment of mortgage notes during 2016 and 2015.
Managed senior living communities, comparable properties (managed senior living communities owned and managed by the same operator continuously since January 1, 2015; excludes communities classified as held for sale, if any):
|
| | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2016 | | 2015 | | Change | | % Change |
Residents fees and services | | $ | 331,855 |
| | $ | 331,270 |
| | $ | 585 |
| | 0.2 | % |
Property operating expenses | | (248,785 | ) | | (249,174 | ) | | (389 | ) | | (0.2 | )% |
Net operating income (NOI) | | 83,070 |
| | 82,096 |
| | 974 |
| | 1.2 | % |
| | | | | | | | |
Depreciation and amortization expense | | (37,442 | ) | | (34,704 | ) | | 2,738 |
| | 7.9 | % |
Operating income | | 45,628 |
| | 47,392 |
| | (1,764 | ) | | (3.7 | )% |
| | | | | | | | |
Interest expense | | (4,110 | ) | | (7,199 | ) | | (3,089 | ) | | (42.9 | )% |
Loss on early extinguishment of debt | | (59 | ) | | (34 | ) | | 25 |
| | 73.5 | % |
Net income | | $ | 41,459 |
| | $ | 40,159 |
| | $ | 1,300 |
| | 3.2 | % |
Residents fees and services. Residents fees and services are the revenues earned at our managed senior living communities. We recognize these revenues as services are provided and related fees are accrued. Residents fees and services increased slightly year over year on a comparable property basis primarily due to an increase in average monthly rates of 1.7% at the 46 communities we have owned continuously since January 1, 2015 partially offset by a decrease in occupancy.
Property operating expenses. Property operating expenses consist of management fees, real estate taxes, utility expenses, insurance, salaries and benefit costs of property level personnel, repairs and maintenance expense, cleaning expense and other direct costs of operating these communities. Property operating expenses decreased slightly during the year ended December 31, 2016 compared to the year ended December 31, 2015 primarily due to decreased salaries and benefit costs of property level personnel, partially offset by an increase in management fees earned by Five Star as a result of the modifications made to our management and pooling agreements with Five Star that took effect July 1, 2016, and increased expenses incurred during the fourth quarter of 2016 due to casualty losses and evacuation costs as a result of a hurricane.
Net operating income. The decrease in NOI reflects the net changes in residents fees and services and property operating expenses described above. The reconciliation of NOI to net income for our managed senior living communities segment, comparable properties, is shown in the table above. Our definition of NOI and our reconciliation of net income to consolidated NOI are included below under the heading “Non-GAAP Financial Measures”.
Depreciation and amortization expense. Depreciation and amortization expense includes the depreciation of owned property and equipment, as well as the amortization expense of in place resident agreements assumed upon the acquisition of a community. Depreciation and amortization expense increased primarily as a result of our funding of capital improvements since January 1, 2015.
Interest expense. Interest expense relates to mortgage notes secured by certain of these communities. The decrease in interest expense is due to our prepayment and repayment of $149,325 in aggregate principal amount of mortgage notes since
January 1, 2015 with a weighted average annual interest rate of 5.94%, as well as regularly scheduled amortization of our mortgage notes secured by these communities.
Loss on early extinguishment of debt. We recognized losses on early extinguishment of debt in connection with our prepayment of mortgage notes during 2016 and 2015.
MOBs:
|
| | | | | | | | | | | | |
| | All Properties | | Comparable Properties(1) |
| | As of and For the Year Ended December 31, | | As of and For the Year Ended December 31, |
| | |
| | 2016 | | 2015 | | 2016 | | 2015 |
Total properties | | 119 |
| | 121 |
| | 93 |
| | 93 |
|
Total buildings | | 145 |
| | 145 |
| | 117 |
| | 117 |
|
Total square feet(2) | | 11,431 |
| | 11,316 |
| | 8,872 |
| | 8,870 |
|
Occupancy(3) | | 96.5 | % | | 96.4 | % | | 95.4 | % | | 95.4 | % |
| |
(1) | Consists of MOBs we have owned continuously since January 1, 2015; excludes properties classified as held for sale, if any. |
| |
(2) | Prior periods exclude space re-measurements made subsequent to those periods. |
| |
(3) | MOB occupancy includes (i) space being fitted out for occupancy and (ii) space which is leased, but is not occupied or is being offered for sublease by tenants. |
MOBs, all properties:
|
| | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2016 | | 2015 | | Change | | % Change |
Rental income | | $ | 372,233 |
| | $ | 356,586 |
| | $ | 15,647 |
| | 4.4 | % |
Property operating expenses | | (105,762 | ) | | (99,337 | ) | | 6,425 |
| | (6.5 | )% |
Net operating income (NOI) | | 266,471 |
| | 257,249 |
| | 9,222 |
| | 3.6 | % |
| | | | | | | | |
Depreciation and amortization expense | | (124,196 | ) | | (122,974 | ) | | 1,222 |
| | (1.0 | )% |
Impairment of assets | | (7,122 | ) | | — |
| | 7,122 |
| | 100.0 | % |
Operating income | | 135,153 |
| | 134,275 |
| | 878 |
| | 0.7 | % |
| | | | | | | | |
Interest expense | | (13,852 | ) | | (6,214 | ) | | 7,638 |
| | 122.9 | % |
Loss on early extinguishment of debt | | — |
| | (250 | ) | | (250 | ) | | 100.0 | % |
Income from continuing operations
| | 121,301 |
| | 127,811 |
| | (6,510 | ) | | (5.1 | )% |
Discontinued operations: | | | | | | | | |
Loss from discontinued operations | | — |
| | (350 | ) | | (350 | ) | | (100.0 | )% |
Loss on impairment of assets from discontinued operations | | — |
| | (602 | ) | | (602 | ) | | (100.0 | )% |
Net income | | $ | 121,301 |
| | $ | 126,859 |
| | $ | (5,558 | ) | | (4.4 | )% |
Rental income. Rental income increased primarily due to rents from MOBs we acquired since January 1, 2015, as well as certain changes at our comparable MOB properties, as discussed below. Rental income includes non-cash straight line rent adjustments totaling $12,922 and $13,438 and net amortization of approximately $4,720 and $3,840 of above and below market lease adjustments for the years ended December 31, 2016 and 2015, respectively.
Property operating expenses. Property operating expenses consist of real estate taxes, utility expenses, property management fees, repairs and maintenance expense, cleaning expense and other direct costs of operating these properties. Property operating expenses increased primarily due to our acquisitions since January 1, 2015, as well as certain changes at our comparable MOB properties discussed below.
Net operating income. NOI increased due to the increase in rental income, partially offset by the increased property operating expenses described above. The reconciliation of NOI to net income for our MOB segment is shown in the table above. Our definition of NOI and our reconciliation of net income to consolidated NOI are included below under the heading “Non-GAAP Financial Measures”.
Depreciation and amortization expense. Depreciation and amortization expense increased primarily due to an increase in depreciation expense related to our acquisitions and funding of capital expenditures since January 1, 2015, partially offset by a decrease in the amortization of acquired in place real estate leases during the year ended December 31, 2016 that we amortize over the respective lease terms.
Impairment of assets. Impairment of assets for the year ended December 31, 2016 relates to reducing the carrying value of five MOBs (five buildings) and one land parcel to their estimated sales prices less costs to sell.
Interest expense. Interest expense relates to mortgage notes secured by certain of our MOBs. The increase in interest expense is the result of our obtaining, in July 2016, an aggregate $620,000 secured debt financing with a weighted average fixed annual interest rate of 3.53%, partially offset by our prepayment of $70,000 in aggregate principal amount of mortgage notes since January 1, 2015 with a weighted average annual interest rate of 5.39%, as well as the regularly scheduled amortization of our mortgage notes.
Loss on early extinguishment of debt. We recognized losses on early extinguishment of debt in 2015 in connection with our prepayment of mortgage notes.
Loss onimpairment of assets and loss from discontinued operations. Loss on impairment of assets from discontinued operations and loss from discontinued operations for the year ended December 31, 2015 relate to one MOB (four buildings) which we sold in April 2015.
MOBs, comparable properties (MOBs we have owned continuously since January 1, 2015; excludes properties classified as held for sale, if any):
|
| | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2016 | | 2015 | | Change | | % Change |
Rental income | | $ | 320,328 |
| | $ | 313,463 |
| | $ | 6,865 |
| | 2.2 | % |
Property operating expenses | | (95,788 | ) | | (91,881 | ) | | 3,907 |
| | 4.3 | % |
Net operating income (NOI) | | 224,540 |
| | 221,582 |
| | 2,958 |
| | 1.3 | % |
| | | | | | | | |
Depreciation and amortization expense | | (102,005 | ) | | (103,015 | ) | | (1,010 | ) | | (1.0 | )% |
Operating income | | 122,535 |
| | 118,567 |
| | 3,968 |
| | 3.3 | % |
| | | | | | | | |
Interest expense | | (13,187 | ) | | (5,214 | ) | | 7,973 |
| | 152.9 | % |
Loss on early extinguishment of debt | | — |
| | (250 | ) | | (250 | ) | | (100.0 | )% |
Net income | | $ | 109,348 |
| | $ | 113,103 |
| | $ | (3,755 | ) | | (3.3 | )% |
Rental income. Rental income increased primarily due to an increase in tax escalation income and other reimbursable expenses and increased rents from net leasing activity at certain of these properties. Rental income includes non-cash straight line rent adjustments totaling $10,025 and $11,039 and net amortization of approximately $4,469 and $3,647 of acquired above and below market lease adjustments for the years ended December 31, 2016 and 2015, respectively.
Property operating expenses. Property operating expenses consist of real estate taxes, utility expenses, property management fees, repairs and maintenance expense, cleaning expense and other direct costs of operating these properties. Property operating expense increased primarily because of increases in real estate taxes and salaries and benefit costs of property level personnel at certain MOBs and other direct costs of operating these properties, partially offset by decreased landscaping, snow
removal and utility expenses at certain of these properties during the year ended December 31, 2016 compared to the year ended December 31, 2015.
Net operating income. NOI reflects the net changes in rental income and property operating expenses described above. The reconciliation of NOI to net income for our MOB segment for comparable properties is shown in the table above. Our definition of NOI and our reconciliation of net income to consolidated NOI are included below under the heading “Non-GAAP Financial Measures”.
Depreciation and amortization expense. Depreciation and amortization expense decreased slightly due to a reduction in amortization of acquired in place real estate leases that we amortize over the respective lease terms, partially offset by an increase in the amortization of leasing costs and depreciation expense on fixed assets.
Interest expense. Interest expense relates to mortgage notes secured by certain of these properties. The increase in interest expense is the result of our obtaining, in July 2016, an aggregate $620,000 secured debt financing with a weighted average fixed annual interest rate of 3.53%, partially offset by our prepayment of $52,000 in aggregate principal amount of mortgage notes since January 1, 2015 with a weighted average annual interest rate of 5.64% as well as the regularly scheduled amortization of our mortgage notes.
Loss on early extinguishment of debt. We recognized losses on early extinguishment of debt in connection with our prepayment of mortgage notes in 2015.
All other operations:(1)
|
| | | | | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2016 | | 2015 | | Change | | % Change |
Rental income | | $ | 18,270 |
| | $ | 18,278 |
| | $ | (8 | ) | | — | % |
| | | | | | | | |
Expenses: | | | | | | | | |
Depreciation and amortization expense | | (3,792 | ) | | (3,792 | ) | | — |
| | — | % |
General and administrative | | (46,559 | ) | | (42,830 | ) | | 3,729 |
| | 8.7 | % |
Acquisition and certain other transaction related costs | | (2,085 | ) | | (6,853 | ) | | (4,768 | ) | | (69.6 | )% |
Impairment of assets | | (2,795 | ) | | — |
| | 2,795 |
| | 100.0 | % |
Total expenses | | (55,231 | ) | | (53,475 | ) | | 1,756 |
| | 3.3 | % |
Operating loss | | (36,961 | ) | | (35,197 | ) | | 1,764 |
| | 5.0 | % |
| | | | | | | | |
Dividend income | | 2,108 |
| | 2,773 |
| | (665 | ) | | (24.0 | )% |
Interest and other income | | 430 |
| | 379 |
| | 51 |
| | 13.5 | % |
Interest expense | | (120,387 | ) | | (109,679 | ) | | 10,708 |
| | 9.8 | % |
Loss on distribution to common shareholders of The RMR Group Inc. common stock | | — |
| | (38,437 | ) | | (38,437 | ) | | (100.0 | )% |
Loss on early extinguishment of debt | | — |
| | (1,604 | ) | | (1,604 | ) | | (100.0 | )% |
Loss before income tax expense and equity in earnings of an investee | | (154,810 | ) | | (181,765 | ) | | (26,955 | ) | | (14.8 | )% |
Income tax expense | | (424 | ) | | (574 | ) | | (150 | ) | | (26.1 | )% |
Equity in earnings of an investee | | 137 |
| | 20 |
| | 117 |
| | 585.0 | % |
Net loss | | $ | (155,097 | ) | | $ | (182,319 | ) | | $ | (27,222 | ) | | (14.9 | )% |
| |
(1) | All other operations includes all of our other operations, including certain properties that offer wellness, fitness and spa services to members, which segment we do not consider to be sufficiently material to constitute a separate reporting segment, and any operating expenses that are not attributable to a specific reporting segment. |
Rental income. Rental income includes non-cash straight line rent adjustments totaling approximately $550 in each of the years ended December 31, 2016 and 2015. Rental income also includes net amortization of approximately $221 of acquired real estate leases and obligations in each of the years ended December 31, 2016 and 2015. The slight decrease for the year ended December 31, 2016 is due to a non-recurring true-up of rental income recorded in the year ended December 31, 2015.
Depreciation and amortization expense. Depreciation and amortization expense remained consistent as we have had no acquisitions or capital expenditures in this segment since January 1, 2015. We depreciate our long lived wellness center assets on a straight line basis.
General andadministrative expense. General and administrative expense consists of fees paid to RMR LLC under our business management agreements, legal and accounting fees, fees and expenses of our Trustees, equity compensation expense and other costs relating to our status as a publicly owned company. General and administrative expense increased primarily due to our acquisitions since January 1, 2015 and increased equity compensation expense resulting from an increase in the market price of our common shares.
Acquisition and certain other transaction related costs. Acquisition and certain other transaction related costs include legal and diligence costs incurred in connection with our acquisition, disposition and operations transaction activities during the years ended December 31, 2016 and 2015. Acquisition and certain other transaction related costs decreased during the year ended December 31, 2016 due to a decrease in acquisition activity, partially offset by an increase in disposition and certain other transaction activities during the year ended December 31, 2016 compared to the year ended December 31, 2015.
Impairment of assets. At December 31, 2016, we recorded impairment of assets charges of $2,795 to reduce the carrying value of our investment in Five Star shares to its estimated fair value due to the market value of this investment being significantly below our carrying value for an extended period.AIC.
Dividend income. Dividend income reflects cash dividends received from our investment in RMR Inc.
Interest and other income. Interest and other income increased slightly for the year ended December 31, 2016 compared to the year ended December 31, 2015 primarily due to increased investable cash on hand.
Interest expense. Interest expense increased due to our September 2015 term loan borrowing of $200,000 at an interest rate of LIBOR plus a premium of 180 basis points, our issuance of $250,000 of 6.25% senior unsecured notes due 2046 in February 2016 and increased borrowings under our revolving credit facility during the year ended December 31, 2016 compared to the year ended December 31, 2015. These increases were partially offset by our November 2015 prepayment of our $250,000 of 4.30% senior unsecured notes due 2016.
Loss on distributionto common shareholdersof The RMR Group Inc.common stock. We recorded a $38,437 loss on the distribution of RMR Inc. shares we distributed to our shareholders in December 2015, which represented the difference between our carrying value and the fair value of the RMR Inc. shares on the distribution date.
Loss on early extinguishment of debt. In December 2014, we entered an agreement to acquire 38 senior living communities. Simultaneous with entering this agreement, we obtained a bridge loan commitment for $700,000. In February 2015, we terminated the bridge loan commitment and recognized a loss of $1,409 on early extinguishment of debt in the first quarter of 2015. In September 2015, we amended our revolving credit facility agreement, which resulted in a loss on early extinguishment of debt of $21 related to the write off of certain capitalized but unamortized costs of the prior revolving credit facility agreement. In November 2015, we prepaid our $250,000 of 4.30% senior unsecured notes due January 2016, which resulted in a loss on early extinguishment of debt of $175 related to the write off of certain unamortized origination costs of the notes.
Equity in earnings of an investee. Equity in earnings of an investee represents our proportionate share of earnings from AIC.
Non-GAAP Financial Measures (dollars in thousands, except per share amounts)
We provide below calculationspresent certain "non-GAAP financial measures" within the meaning of ourapplicable SEC rules, including FFO attributable to common shareholders, Normalized FFO attributable to common shareholders and NOI for the years ended December 31, 2017, 20162019, 2018 and 2015.2017. These measures do not represent cash generated by operating activities in accordance with GAAP and should not be considered alternatives to net income (loss) or net income (loss) attributable to common shareholders or operating income as indicators of our operating performance or as measures of our liquidity. These measures should be considered in conjunction with net income (loss) and net income (loss) attributable to common shareholders and operating income as presented in our consolidated statements of comprehensive income. Other real estate companiesincome (loss). We consider these non-GAAP measures to be appropriate supplemental measures of operating performance for a REIT, along with net income (loss) and net income (loss) attributable to common shareholders. We believe these measures provide useful information to investors because by excluding the effects of certain historical amounts, such as depreciation and amortization, they may facilitate a comparison of our operating performance between periods and with other REITs and, in the case of NOI, reflecting only those income and expense items that are generated and incurred at the property level may calculate FFO, Normalized FFO or NOI differently than we do.help both investors and management to understand the operations at our properties.
Funds From Operations and Normalized Funds From Operations Attributable to Common Shareholders
We calculate FFO attributable to common shareholders and Normalized FFO attributable to common shareholders as shown below. FFO attributable to common shareholders is calculated on the basis defined by the National Association of Real Estate Investment Trusts, or Nareit, which is net income (loss) attributable to common shareholders, calculated in accordance with GAAP, excluding any gain or loss on sale of real estate andproperties, loss on impairment of real estate assets and gains or losses on equity securities, net, if any, plus real estate depreciation and amortization and the difference between net income attributable to common shareholders andminus FFO attributable to noncontrolling interest, as well as certain other adjustments currently not applicable to us. Our calculation ofIn calculating Normalized FFO differs from Nareit’s definition of FFO becauseattributable to common shareholders, we adjust for the items shown below and include business management incentive fees, if any, only in the fourth quarter
versus the quarter when they are recognized as expense in accordance with GAAP due to their quarterly volatility not necessarily being indicative of our core operating performance and the uncertainty as to whether any such business management incentive fees will be payable when all contingencies for determining such fees are known at the end of the calendar year, and we exclude acquisition and certain other transaction related costs expensed under GAAP such as legal and professional fees associated with our acquisition and disposition activities, gains and losses on early extinguishment of debt, if any, loss on distribution to common shareholders of RMR Inc. common stock, if any, and Normalizedyear. FFO from noncontrolling interest, net of FFO, if any. We consider FFO and Normalized FFO to be appropriate supplemental measures of operating performance for a REIT, along with net income, net income attributable to common shareholders and operating income. We believe that FFO and Normalized FFO provide useful informationattributable to investors, because by excluding the effects of certain historical amounts, such as depreciation and amortization expense, FFO and Normalized FFO may facilitate a comparison of our operating performance between periods and with other REITs. FFO and Normalized FFOcommon shareholders are among the factors considered by our Board of Trustees when determining the amount of distributions to our shareholders. Other factors include, but are not limited to, requirements to maintain our qualification for taxation as a REIT, limitations in our revolving credit facility and term loan agreements and our public debt covenants, the availability to us of debt and equity capital, our expectation of our future capital requirements and operating performance, and our expected needs for and availability of cash to pay our obligations. Other real estate companies and REITs may calculate FFO attributable to common shareholders and Normalized FFO attributable to common shareholders differently than we do.
Our calculations of FFO attributable to common shareholders and Normalized FFO attributable to common shareholders for the years ended December 31, 2017, 20162019, 2018 and 20152017 and reconciliations of net income (loss) attributable to common shareholders, the most directly comparable financial measure under GAAP reported in our Consolidated Financial Statements,consolidated financial statements, to FFO attributable to common shareholders and Normalized FFO attributable to common shareholders appear in the following table. This table also provides a comparison of distributions to shareholders, FFO attributable to common shareholders and Normalized FFO attributable to common shareholders and net income (loss) attributable to common shareholders per share for these periods.
|
| | | | | | | | | | | | |
| | For the Year Ended December 31, |
| | 2017 | | 2016 | | 2015 |
Net income attributable to common shareholders | | $ | 147,610 |
| | $ | 141,295 |
| | $ | 123,968 |
|
Depreciation and amortization expense | | 276,861 |
| | 287,831 |
| | 257,783 |
|
Noncontrolling interest's share of net FFO adjustments | | (16,370 | ) | | — |
| | — |
|
Gain on sale of properties | | (46,055 | ) | | (4,061 | ) | | — |
|
Impairment of assets from continuing operations | | 5,082 |
| | 18,674 |
| | 194 |
|
Impairment of assets from discontinued operations | | — |
| | — |
| | 602 |
|
FFO | | 367,128 |
| | 443,739 |
| | 382,547 |
|
| | | | | | |
Acquisition and certain other transaction related costs | | 547 |
| | 2,085 |
| | 6,853 |
|
Loss on distribution to common shareholders of RMR Inc. common stock(1) | | — |
| | — |
| | 38,437 |
|
Loss on early extinguishment of debt | | 7,627 |
| | 526 |
| | 1,894 |
|
Normalized FFO attributable to SNH | | $ | 375,302 |
| | $ | 446,350 |
| | $ | 429,731 |
|
| | | | | | |
Weighted average shares outstanding (basic) | | 237,420 |
| | 237,345 |
| | 232,931 |
|
Weighted average shares outstanding (diluted) | | 237,452 |
| | 237,382 |
| | 232,963 |
|
| | | | | | |
Net income per share (basic and diluted) | | $ | 0.62 |
| | $ | 0.60 |
| | $ | 0.53 |
|
FFO per share (basic and diluted) | | $ | 1.55 |
| | $ | 1.87 |
| | $ | 1.64 |
|
Normalized FFO per share (basic and diluted) | | $ | 1.58 |
| | $ | 1.88 |
| | $ | 1.84 |
|
Distributions declared per share | | $ | 1.56 |
| | $ | 1.56 |
| | $ | 1.56 |
|
|
| | | | | | | | | | | | |
| | For the Year Ended December 31, |
| | 2019 | | 2018 | | 2017 |
Net (loss) income attributable to common shareholders | | $ | (88,234 | ) | | $ | 286,872 |
| | $ | 147,610 |
|
Depreciation and amortization | | 289,025 |
| | 286,235 |
| | 276,861 |
|
FFO attributable to noncontrolling interest | | (21,147 | ) | | (21,200 | ) | | (16,370 | ) |
Gain on sale of properties | | (39,696 | ) | | (261,916 | ) | | (46,055 | ) |
Impairment of assets | | 115,201 |
| | 66,346 |
| | 5,082 |
|
Losses on equity securities, net | | 41,898 |
| | 20,724 |
| | — |
|
FFO attributable to common shareholders | | 297,047 |
| | 377,061 |
| | 367,128 |
|
| | | | | | |
Acquisition and certain other transaction related costs | | 13,102 |
| | 194 |
| | 403 |
|
Loss on early extinguishment of debt | | 44 |
| | 22 |
| | 7,627 |
|
Normalized FFO attributable to common shareholders | | $ | 310,193 |
| | $ | 377,277 |
| | $ | 375,158 |
|
| | | | | | |
Weighted average common shares outstanding (basic) | | 237,604 |
| | 237,511 |
| | 237,420 |
|
Weighted average common shares outstanding (diluted) | | 237,604 |
| | 237,546 |
| | 237,452 |
|
| | | | | | |
Per common share data (basic and diluted): | | | | | | |
Net (loss) income attributable to common shareholders | | $ | (0.37 | ) | | $ | 1.21 |
| | $ | 0.62 |
|
FFO attributable to common shareholders | | $ | 1.25 |
| | $ | 1.59 |
| | $ | 1.55 |
|
Normalized FFO attributable to common shareholders | | $ | 1.31 |
| | $ | 1.59 |
| | $ | 1.58 |
|
Distributions declared | | $ | 0.84 |
| | $ | 1.56 |
| | $ | 1.56 |
|
| |
(1) | In 2015, we recognized a $38,437 non-cash loss on the distribution of shares of RMR Inc. shares to our shareholders as a result of the closing price of RMR Inc.’s shares being lower than our carrying amount per share on the distribution date. |
Property Net Operating Income (NOI)
We calculate NOI as shown below. The calculation of NOI excludes certain components of net income (loss) in order to provide results that are more closely related to our property level results of operations. We define NOI as income from our real estate less our property operating expenses. NOI excludes amortization of capitalized tenant improvement costs and leasing commissions that we record as depreciation and amortization. We consider NOI to be an appropriate supplemental measure to net income because it may help both investors and management to understand the operations of our properties. We use NOI to evaluate individual and company wide property level performance,performance. Other real estate companies and REITs may calculate NOI differently than we believe that NOI provides useful information to investors regarding our results
of operations because it reflects only those income and expense items that are generated and incurred at the property level and may facilitate comparisons of our operating performance between periods and with other REITs.do.
The calculation of NOI by reportable segment is included above in this Item 7. The following table includes the reconciliation of net income (loss) to NOI for the years ended December 31, 2017, 20162019, 2018 and 2015.2017.
|
| | | | | | | | | | | | | |
| | For the Year Ended December 31, |
| | 2017 | | 2016 | | 2015 |
Reconciliation of Net Income to NOI: | | |
| | |
| | |
|
Net income | | $ | 151,803 |
| | $ | 141,295 |
| | $ | 123,968 |
|
Gain on sale of properties | | (46,055 | ) | | (4,061 | ) | | — |
|
Income before gain on sale of properties | | 105,748 |
| | 137,234 |
| | 123,968 |
|
Discontinued operations | | | | | | |
Loss from discontinued operations | | — |
| | — |
| | 350 |
|
Loss on impairment of assets from discontinued operations | | — |
| | — |
| | 602 |
|
Income from continuing operations | | 105,748 |
| — |
| 137,234 |
| | 124,920 |
|
Equity in earnings of an investee | | (608 | ) | | (137 | ) | | (20 | ) |
Income tax expense | | 454 |
| | 424 |
| | 574 |
|
Loss on early extinguishment of debt | | 7,627 |
| | 526 |
| | 1,894 |
|
Loss on distribution to common shareholders of RMR common stock | | — |
| | — |
| | 38,437 |
|
Interest expense | | 165,019 |
| | 167,574 |
| | 150,881 |
|
Interest and other income | | (406 | ) | | (430 | ) | | (379 | ) |
Dividend income | | (2,637 | ) | | (2,108 | ) | | (2,773 | ) |
Operating income | | 275,197 |
| | 303,083 |
| | 313,534 |
|
| | | | | |
|
|
Impairment of assets | | 5,082 |
| | 18,674 |
| | 194 |
|
Acquisition and certain other transaction related costs | | 547 |
| | 2,085 |
| | 6,853 |
|
General and administrative expense | | 103,702 |
| | 46,559 |
| | 42,830 |
|
Depreciation and amortization expense | | 276,861 |
| | 287,831 |
| | 257,783 |
|
Total NOI | | $ | 661,389 |
| | $ | 658,232 |
| | $ | 621,194 |
|
| | | | | | |
Triple net leased senior living communities NOI | | $ | 280,641 |
| | $ | 274,864 |
| | $ | 256,035 |
|
Managed senior living communities NOI | | 93,297 |
| | 98,627 |
| | 89,632 |
|
MOB NOI | | 269,197 |
| | 266,471 |
| | 257,249 |
|
All other operations NOI | | 18,254 |
| | 18,270 |
| | 18,278 |
|
Total NOI | | $ | 661,389 |
| | $ | 658,232 |
| | $ | 621,194 |
|
|
| | | | | | | | | | | | |
| | For the Year Ended December 31, |
| | 2019 | | 2018 | | 2017 |
Reconciliation of Net Income (Loss) to NOI: | | |
| | |
| | |
|
Net (loss) income | | $ | (82,878 | ) | | $ | 292,414 |
| | $ | 151,803 |
|
| | | | | | |
Equity in earnings of an investee | | (400 | ) | | (516 | ) | | (608 | ) |
Income tax expense | | 436 |
| | 476 |
| | 454 |
|
(Loss) income from continuing operations before income tax expense and equity in earnings of an investee | | (82,842 | ) | | 292,374 |
| | 151,649 |
|
Loss on early extinguishment of debt | | 44 |
| | 22 |
| | 7,627 |
|
Interest expense | | 180,112 |
| | 179,287 |
| | 165,019 |
|
Interest and other income | | (941 | ) | | (667 | ) | | (406 | ) |
Losses on equity securities, net | | 41,898 |
| | 20,724 |
| | — |
|
Dividend income | | (1,846 | ) | | (2,901 | ) | | (2,637 | ) |
Gain on sale of properties | | (39,696 | ) | | (261,916 | ) | | (46,055 | ) |
Impairment of assets | | 115,201 |
| | 66,346 |
| | 5,082 |
|
Acquisition and certain other transaction related costs | | 13,102 |
| | 194 |
| | 403 |
|
General and administrative | | 37,028 |
| | 85,885 |
| | 103,694 |
|
Depreciation and amortization | | 289,025 |
| | 286,235 |
| | 276,861 |
|
Total NOI | | $ | 551,085 |
| | $ | 665,583 |
| | $ | 661,237 |
|
| | | | | | |
Office Portfolio NOI | | $ | 272,668 |
| | $ | 285,081 |
| | $ | 269,197 |
|
SHOP NOI | | 214,773 |
| | 305,296 |
| | 303,684 |
|
Non-Segment NOI | | 63,644 |
| | 75,206 |
| | 88,356 |
|
Total NOI | | $ | 551,085 |
| | $ | 665,583 |
| | $ | 661,237 |
|
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of fundscash to meet operating and capital expenses, andpay debt service obligations and make distributions to pay distributions on our common sharesshareholders are the operating cash flows we generate as rental income from our leased properties, residents fees and services revenues from our managed communities, proceeds from the disposition of certain properties and borrowings under our revolving credit facility. To reduce our leverage, we have sold properties and other assets and have identified additional properties to sell, with a focus on the sale of underperforming senior living communities and non-core assets. We believe that these sources will be sufficient to meet our operating and capital expenses, andpay debt service obligations and paymake distributions onto our common sharesshareholders for the next 12 months and for the foreseeable future thereafter. Our future cash flows from operating activities will depend primarily upon:
our ability to maintain or increase the occupancy of, and the rental rates at, our properties;
our ability to control operating expenses and capital expenses at our properties;
our manager's ability to operate our managed senior living communities so as to maintain or increase our returns; and
our ability to purchase additional properties which produce cash flows in excess of our cost of acquisition capital and the related property operating expenses.
Following entry into the Transaction Agreement, due to the lower cash flows we would receive from our senior living communities operated by Five Star, on April 18, 2019, we lowered our regular quarterly distribution rate to $0.15 per common share ($0.60 per common share annually), which was based on a target distribution payout ratio of approximately 80% of projected cash available for distribution after the disposition of certain properties and the stabilization of our transitioned senior living communities.
Pursuant to the Restructuring Transaction, on January 1, 2020, Five Star issued 10,268,158 Five Star common shares to us and an aggregate of 16,118,849 Five Star common shares to our shareholders of record as of December 13, 2019. In consideration
of these share issuances, we assumed $75.0 million of Five Star's working capital liabilities related to our senior living communities that were previously leased to Five Star. For further information regarding the Restructuring Transaction, see Note 5 to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.
The following is a summary of our sources and uses of cash flows for the periods presented (dollars in thousands):
|
| | | | | | | | |
| | Year Ended December 31, |
| | 2019 | | 2018 |
Cash and cash equivalents and restricted cash at beginning of period | | $ | 70,071 |
| | $ | 47,321 |
|
Net cash provided by (used in): | | | | |
Operating activities | | 265,845 |
| | 392,840 |
|
Investing activities | | 86,171 |
| | 99,091 |
|
Financing activities | | (369,863 | ) | | (469,181 | ) |
Cash and cash equivalents and restricted cash at end of period | | $ | 52,224 |
| | $ | 70,071 |
|
Our Operating Liquidity and Resources
We generally receive minimum rents from our tenants monthly or quarterly, from certain of our tenants, we receive percentage rents from our senior living community tenants monthly, quarterly or annually and we receive residents fees and services revenues, net of expenses, from our managed senior living communities monthly. Our changes in cash flows for the year ended December 31, 2017 compared to the year ended December 31, 2016 were as follows: (1) cash provided by operating activities decreased to $407.1 million in 2017monthly and we receive percentage rents from $426.8 million in 2016; (2) cash used for investing activities decreased to $221.4 million in 2017 from $292.9 million in 2016; and (3) cash used for financing activities increased to $186.1 million in 2017 from $139.8 million in 2016.certain of our senior living community tenants monthly, quarterly or annually.
The decrease in cash provided by operating activities for the year ended December 31, 20172019 compared to the prior year was primarily due to the reduction in the aggregate amount of rent payable to us by Five Star during 2019 pursuant to the Restructuring Transaction, as described in Note 5 to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K, and reduced NOI as a result of an increase in restricted cash balances associated with our joint venture arrangement which was established in 2017, as well as working capital changes in 2017, dispositions of properties during 2019, partially offset by acquisitions during 2017. Cash used fora decrease in business management fees expense in 2019 compared to 2018.
Our Investing Liquidity and Resources
The decrease in cash provided by investing activities decreased in 2017, primarily due to a greater number of acquisitions duringfor the year ended December 31, 20162019 compared to the prior year was primarily due to an increase in purchases of fixed assets and improvements and lower proceeds from the sale of real estate properties during 2019 compared to 2018, partially offset by the proceeds from our sale of all of the RMR Inc. class A common stock that we owned in July 2019 and a decrease in real estate acquisitions in 2019 compared to 2018.
The following is a summary of cash used for capital expenditures, development, redevelopment and other activities for the periods presented (dollars in thousands):
|
| | | | | | | | |
| | For the Year Ended December 31, |
| | 2019 | | 2018 |
Office Portfolio segment capital expenditures: | | | | |
Tenant improvements(1) | | $ | 14,920 |
| | $ | 12,045 |
|
Leasing costs (2) | | 11,617 |
| | 6,178 |
|
Building improvements (3) | | 17,099 |
| | 16,402 |
|
SHOP segment fixed assets and capital improvements | | 17,196 |
| | 13,001 |
|
Recurring capital expenditures | | $ | 60,832 |
| | $ | 47,626 |
|
| | | | |
Development, redevelopment and other activities - Office Portfolio segment (4) | | 30,763 |
| | 9,942 |
|
Development, redevelopment and other activities - SHOP segment(4) (5) (6) | | 144,957 |
| | 45,084 |
|
Total development, redevelopment and other activities | | $ | 175,720 |
| | $ | 55,026 |
|
| |
(1) | Office Portfolio segment tenant improvements generally include capital expenditures to improve tenants' space or amounts paid directly to tenants to improve their space. |
| |
(2) | Office Portfolio segment leasing costs generally include leasing related costs, such as brokerage commissions and tenant inducements. |
| |
(3) | Office Portfolio segment building improvements generally include expenditures to replace obsolete building components that extend the useful life of existing assets. |
| |
(4) | Development, redevelopment and other activities generally include capital expenditures that reposition a property or result in new sources of revenue. |
| |
(5) | Includes capital improvements for communities leased to Five Star and for communities managed by Five Star for our account. |
| |
(6) | Pursuant to the Restructuring Transaction, we purchased $49,155 of fixed assets and capital improvements related to certain of our senior living communities that were leased to Five Star during 2019. |
During the year ended December 31, 2017, partially offset2019, we invested $1.7 million in revenue producing capital improvements at certain of our triple net leased senior living communities leased to private operators, and, as a result, annual rents payable to us increased by higher proceeds fromapproximately $0.09 million pursuant to the saleterms of properties duringthe applicable leases. We used cash on hand and borrowings under our revolving credit facility to fund these purchases. These capital improvement amounts are not included in the table above.
During the year ended December 31, 2017.2019, commitments made for expenditures in connection with leasing space in our medical office and life science properties, such as tenant improvements and leasing costs, were as follows (dollars and square feet in thousands, except per square foot amounts):
|
| | | | | | | | | | | | |
| | New Leases | | Renewals | | Total |
Square feet leased during the year | | 262 |
| | 1,256 |
| | 1,518 |
|
Total leasing costs and concession commitments(1) | | $ | 14,044 |
| | $ | 23,374 |
| | $ | 37,418 |
|
Total leasing costs and concession commitments per square foot(1) | | $ | 53.61 |
| | $ | 18.62 |
| | $ | 24.66 |
|
Weighted average lease term (years)(2) | | 8.1 |
| | 10.6 |
| | 10.2 |
|
Total leasing costs and concession commitments per square foot per year(1) | | $ | 6.67 |
| | $ | 1.98 |
| | $ | 2.69 |
|
| |
(1) | Includes commitments made for leasing expenditures and concessions, such as tenant improvements, leasing commissions, tenant reimbursements and free rent. |
| |
(2) | Weighted based on annualized rental income pursuant to existing leases as of December 31, 2019, including straight line rent adjustments and estimated recurring expense reimbursements, and excluding lease value amortization. |
In July 2019, we completed our sale of 2,637,408 shares of class A common stock of RMR Inc. in an underwritten public offering at a price to the public of $40.00 per common share. We received $98.6 million in net proceeds after deducting underwriting discounts and commissions and other offering expenses, which we used to repay amounts outstanding under our revolving credit facility.
Also in July 2019, a tenant in our Office Portfolio segment vacated three buildings with an aggregate of 164,091 square feet in California. We have evaluated our options and have begun a full redevelopment of these buildings. The redevelopment of these buildings may take significant capital expenditures and time.
Following the Conversion, we plan to invest capital into our senior living communities to better position these communities in their respective markets in order to increase our returns in future years.
For further information regarding our acquisitions and dispositions, see Note 3 to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.
Our Financing Liquidity and Resources
The decrease in cash used forin financing activities for the year ended December 31, 20172019 compared to the prior year was primarily due primarily to nethigher repayments of debt partially offset by proceeds fromin 2018 related to our joint venture arrangementsale of real estate properties discussed above and a reduction in March 2017.distributions paid to our shareholders in 2019 .
Our Investment and Financing Liquidity and Resources
As of December 31, 2017, we had $31.2 million of cash and cash equivalents and $404.0 million available to borrow under our revolving credit facility. We expect to use cash balances, borrowings under our revolving credit facility, net proceeds from offerings of debt or equity securities, net proceeds from the disposition of assets and the cash flows from our operations to fund our operations, debt repayments, distributions, property acquisitions, capital expenditures and other general business purposes. We believe these funding sources will be sufficient to fund these activities for the next 12 months and the foreseeable future thereafter.
In order to fund acquisitions and to meet cash needs that may result from timing differences between our receipt of rents and our desire or need to make distributions or pay operating or capital expenses, we maintain a $1.0 billion unsecured revolving credit facility. In August 2017, we amended the agreement governingThe maturity date of our revolving credit facility. As a result of the amendment, the interest rate payable on borrowings under the facility was reduced from LIBOR plus a premium of 130 basis points per annum to LIBOR plus a premium of 120 basis points per annum, and the facility fee was reduced from 30 basis points per annum to 25 basis points per annum on the total amount of lending commitments under the facility. The interest rate premium and facility fee are each subject to adjustment based upon changes to our credit ratings. Also as a result of the amendment, the stated maturity date of the facility was extended from January 15, 2018 tois January 15, 2022, and, subject to the payment of an extension fee and meeting other conditions, we have anthe option to extend the maturity date of thisthe facility for an additional year. TheOur revolving credit facility also includes a feature pursuant to which in certain circumstances maximum borrowings may be increased to up to $2.0 billion. Weprovides that we can borrow, repay and re-borrow funds available under our revolving credit facility until maturity, and no principal repayment is due until maturity. The facility also includes a feature pursuant to which in certain circumstances maximum borrowings under the facility may be increased to up to $2.0 billion. Our revolving credit facility requires interest to
be paid on borrowings at the annual rate of LIBOR plus a premium (currently 120 basis points per annum) that is subject to adjustment based upon changes to our credit ratings, plus a facility fee of 25 basis points per annum on the total amount of lending commitments. As of December 31, 2017,2019, the annual interest rate required on borrowings under our revolving credit facility was 2.7%2.8%. As of December 31, 20172019 and February 26, 2018,28, 2020, we had $596.0$537.5 million and $294.0$593.0 million outstanding under our revolving credit facility, respectively.
When significant amounts are outstanding under our revolving credit facility, or as the maturities of our indebtedness approach, we intend to explore refinancing alternatives. Such alternatives may include incurring additional debt, selling certain properties and issuing new equity securities. In addition, we may also seek to participate in joint ventures or other arrangements that may provide us additional sources of financing. We currently have an effective shelf registration statement that allows us to issue public securities on an expedited basis, but it does not assure that there will be buyers for such securities. We may also assume debt in connection with our acquisitions of properties or place new mortgagesdebt on properties we own.
We have a $350.0$250.0 million unsecured term loan that matures on January 15,June 12, 2020. Subject to the satisfaction of certain conditions, including the payment of an extension fee, we have the option to extend the maturity date by six months. We obtained this term loan in December 2019. This term loan includes a feature under which maximum borrowings may be increased to up to $700.0 million in certain circumstances. This term loan requires annual interest to be paid at the rate of LIBOR plus a premium (currently 140of 125 basis points per annum) that is subject to adjustment based upon changes to our credit ratings. As of At December 31, 2017,2019, the annual interest rate payable on amounts outstanding under this term loan was 2.8%2.9%.
We used the net proceeds from our $250.0 million term loan, together with proceeds from our dispositions, borrowings under our revolving credit facility and cash on hand, to prepay in full our $350.0 million senior unsecured term loan that was scheduled to mature on January 15, 2020. The interest rate on the new term loan is LIBOR plus 125 basis points.
We also have a $200.0 million unsecured term loan that matures on September 28, 2022. This term loan includes a feature under which maximum borrowings may be increased to up to $400.0 million in certain circumstances. In August 2017, we amendedThis term loan requires interest to be paid at the agreement governing this term loan. As a resultrate of the amendment, the interest rate payable on borrowings under the facility was reduced from LIBOR plus a premium of 180 basis points per annum to LIBOR plus a premium of(currently 135 basis points per annumannum) that is subject to adjustment based upon changes to our credit ratings. As of At December 31, 2017,2019, the annual interest rate payable on amounts outstanding under this term loan was 2.9%3.2%.
In March 2017,During the year ended December 31, 2019, we entered a joint venture with a sovereign investor for one ofpaid quarterly cash distributions to our MOBs (two buildings) located in Boston, Massachusetts. The investor contributedshareholders totaling approximately $261.0$199.7 million for a 45% equity interest in the joint venture, and we retained the remaining 55% equity interest in the joint venture. Net proceeds that we received from this transaction were approximately $255.9 million, after transaction costs. We used the proceeds from this transaction to repay a portion of the amounts outstanding under our revolving credit facility.
In April 2017, we prepaid a mortgage note secured by 17 of our properties with an outstanding principal balance of approximately $277.8 million plus a premium of $5.4 million plus accrued interest, a maturity date in September 2019 and an annual interest rate of 6.71%. In May 2017, we prepaid, at par plus accrued interest, a mortgage note secured by one of our properties with an outstanding principal balance of approximately $10.6 million, a maturity date in August 2017 and an annual interest rate of 6.15%. In June 2017, we prepaid, at par plus accrued interest, a mortgage note secured by one of our properties with an outstanding principal balance of approximately $8.8 million, a maturity date in August 2037 and an annual interest rate of 5.95%. In December 2017, we prepaid, at par plus accrued interest, a mortgage note secured by one of our properties with an outstanding principal balance of approximately $8.4 million, a maturity date in April 2018 and an annual interest rate of 6.73%. In January 2018, we prepaid, at par plus accrued interest, a mortgage note secured by one of our properties with an outstanding principal balance of approximately $4.3 million, a maturity date in September 2043 and an annual interest rate of 4.375%. We funded these prepayments withusing cash on hand and borrowings under our revolving credit facility.
In February 2018,For further information regarding the distributions we issued $500.0 million of 4.750% senior unsecured notes due 2028. We used the net proceedspaid during 2019, see Note 4 to our Consolidated Financial Statements included in Part IV, Item 15 of this offering to reduce amounts outstanding under our revolving credit facility.
In January 2017, we acquired one MOB (one building) located in Kansas with approximately 117,000 square feet for approximately $15.1 million, excluding closing costs. In July 2017, we acquired one MOB (one building) located in Maryland with approximately 59,000 square feet for a purchase price of approximately $16.2 million, excluding closing costs. We funded these acquisitions with cashAnnual Report on hand and borrowings under our revolving credit facility. Form 10-K.
In October 2017, we acquired two MOBs (two buildings) located in Minnesota and North Carolina with a total of approximately 255,000 square feet for an aggregate purchase price of approximately $38.5 million, excluding closing costs. We funded these acquisitions with cash on hand and borrowings under our revolving credit facility.
In November 2017, we acquired one MOB (one building) located in California with approximately 63,000 square feet for approximately $26.5 million, excluding closing costs. We funded this acquisition with cash on hand and borrowings under our revolving credit facility.
In December 2017, we acquired one MOB (one building) located in Virginia with approximately 136,000 square feet for approximately $15.6 million, excluding closing costs. We funded this acquisition with cash on hand and borrowings under our revolving credit facility.
In November 2017, we entered a transaction agreement with Five Star pursuant to which we agreed to acquire six senior living communities from Five Star. The aggregate purchase price for these six senior living communities is approximately $104.0 million, including our assumption of approximately $33.7 million of mortgage debt secured by certain of these senior living communities with a weighted average annual interest rate of 6.2% and excluding closing costs. In December 2017, we acquired two of these senior living communities for approximately $39.2 million, excluding closing costs. In January 2018, we acquired one of these senior living communities for approximately $19.7 million, excluding closing costs. In February 2018, we acquired one of these senior living communities for approximately $22.2 million, including the assumption of approximately $16.8 million of mortgage note and excluding closing costs. We funded these acquisitions with cash on hand and borrowings under our revolving credit facility. In connection with our acquisition of these senior living communities, we entered management and pooling agreements with Five Star for Five Star to manage these senior living communities for us and we expect to enter management and pooling agreements with Five Star concurrent with our acquisition of the remaining two senior living communities. The closings of the acquisitions of the remaining two senior living communities for an aggregate purchase price of approximately $23.3 million, including the assumption of approximately $16.8 million of mortgage debt, are expected to occur as third party approvals are received by the end of the first quarter of 2018.
In January 2018, we acquired three MOBs (three buildings) located in Kansas, Missouri and California with a total of approximately 400,000 square feet for an aggregate purchase price of approximately $91.2 million, excluding closing costs. We funded these acquisitions with cash on hand and borrowing under our revolving credit facility.
In November 2017, we entered an agreement to acquire one MOB (one building) located in Virginia with a total of approximately 135,000 square feet for an aggregate purchase price of approximately $22.8 million, including the assumption of approximately $11.2 million of mortgage note, excluding closing costs.
In December 2017, we entered two agreements to sell four senior living communities with a total of 1,619 living units and currently leased to Sunrise for an aggregate sales price of $368.0 million, excluding closing costs. The sale of one of these communities was completed in December 2017 for a sales price of $55.0 million, excluding closing costs, resulting in a gain of approximately $45.9 million. We expect the closings of the sales of the remaining three communities for an aggregate sales price of $313.0 million to occur by the end of the first quarter of 2018.
Our pending acquisitions and sales are subject to conditions; accordingly, we may not acquire or sell these properties, as applicable, or these acquisitions or sales may be delayed or the terms of these acquisitions or sales and any related management and pooling agreements may change.
During the year ended December 31, 2017, we invested $51.9 million in revenue producing capital improvements at certain of our triple net leased senior living communities, and, as a result, annualized rental income payable to us increased by approximately $4.9 million pursuant to the terms of the applicable leases. We used cash on hand and borrowings under our revolving credit facility to fund these purchases.
During the years ended December 31, 2017 and 2016, amounts capitalized for leasing costs and building improvements at our MOBs and capital expenditures at our managed senior living communities were as follows (dollars in thousands):
|
| | | | | | | | |
| | For the Year Ended December 31, |
| | 2017 | | 2016 |
MOB tenant improvements(1) | | $ | 9,278 |
| | $ | 12,237 |
|
MOB leasing costs(2) | | 8,331 |
| | 4,870 |
|
MOB building improvements(3) | | 14,934 |
| | 13,426 |
|
Managed senior living communities capital improvements | | 12,077 |
| | 16,300 |
|
Development, redevelopment and other activities(4) | | 28,118 |
| | 31,835 |
|
Total capital expenditures | | $ | 72,738 |
| | $ | 78,668 |
|
| |
(1) | MOB tenant improvements generally include capital expenditures to improve tenants' space or amounts paid directly to tenants to improve their space. |
| |
(2) | MOB leasing costs generally include leasing related costs, such as brokerage commissions and tenant inducements. |
| |
(3) | MOB building improvements generally include capital expenditures to replace obsolete building components and capital expenditures that extend the useful life of existing assets. |
| |
(4) | Development, redevelopment and other activities generally include (1) capital expenditures that are identified at the time of acquisition of a property and incurred within a short period thereafter; and (2) capital expenditure projects that reposition a property or result in new sources of revenues. |
During the year ended December 31, 2017, commitments made for expenditures in connection with leasing space in our MOBs, such as tenant improvements and leasing costs, were as follows (dollars and square feet in thousands, except per square foot amounts):
|
| | | | | | | | | | | | |
| | New Leases | | Renewals | | Total |
Square feet leased during the year | | 175 |
| | 1,134 |
| | 1,309 |
|
Total leasing costs and concession commitments(1) | | $ | 7,180 |
| | $ | 19,398 |
| | $ | 26,578 |
|
Total leasing costs and concession commitments per square foot(1) | | $ | 41.14 |
| | $ | 17.10 |
| | $ | 20.31 |
|
Weighted average lease term (years)(2) | | 7.5 |
| | 5.7 |
| | 5.9 |
|
Total leasing costs and concession commitments per square foot per year(1) | | $ | 5.52 |
| | $ | 3.00 |
| | $ | 3.41 |
|
| |
(1) | Includes commitments made for leasing expenditures and concessions, such as tenant improvements, leasing commissions, tenant reimbursements and free rent. |
| |
(2) | Weighted based on annualized rental income pursuant to existing leases as of December 31, 2017, including straight line rent adjustments, estimated recurring expense reimbursements and excluding lease value amortization. |
We funded or expect to fund the foregoing capital commitments at our MOBs using cash on hand and borrowings under our revolving credit facility.
As of December 31, 2017, our contractual obligations were as follows (dollars in thousands):
|
| | | | | | | | | | | | | | | | | | | | |
| | Payment due by period |
Contractual Obligations | | Total | | Less than 1 year | | 1-3 years | | 3-5 years | | More than 5 years |
Borrowings under revolving credit facility | | $ | 596,000 |
| | $ | — |
| | $ | — |
| | $ | 596,000 |
| | $ | — |
|
Term loans | | 550,000 |
| | — |
| | 350,000 |
| | 200,000 |
| | — |
|
Senior unsecured notes | | 1,750,000 |
| | — |
| | 600,000 |
| | 300,000 |
| | 850,000 |
|
Mortgage notes payable | | 796,616 |
| | 94,949 |
| | 52,440 |
| | 23,857 |
| | 625,370 |
|
Capital lease obligations | | 10,694 |
| | 862 |
| | 2,021 |
| | 2,472 |
| | 5,339 |
|
Ground lease obligations | | 8,476 |
| | 386 |
| | 773 |
| | 695 |
| | 6,622 |
|
Purchase obligations(1) | | 181,000 |
| | 181,000 |
| | — |
| | — |
| | — |
|
Projected interest expense(2) | | 1,185,071 |
| | 118,075 |
| | 188,473 |
| | 112,844 |
| | 765,679 |
|
Tenant related obligations(3) | | 20,681 |
| | 14,621 |
| | 5,718 |
| | 79 |
| | 263 |
|
Business management incentive fee expense (4) | | 55,740 |
| | 55,740 |
| | — |
| | — |
| | — |
|
Total | | $ | 5,154,278 |
| | $ | 465,633 |
| | $ | 1,199,425 |
| | $ | 1,235,947 |
| | $ | 2,253,273 |
|
| |
(1) | Represents the contractual purchase price for three MOBs we acquired in January 2018 for an aggregate purchase price of $93.4 million, two senior living communities we acquired in January and February 2018 for an aggregate purchase price of $41.6 million and one MOB and two senior living communities we agreed to acquire in November 2017 for an aggregate purchase price of $46.1 million, in each case excluding acquisition related costs. |
| |
(2) | Projected interest expense is attributable to only our debt obligations at existing rates as of December 31, 2017 and is not intended to estimate future interest costs which may result from debt prepayments, additional borrowings under our revolving credit facility, new debt issuances or changes in interest rates. |
| |
(3) | Committed tenant related obligations include leasing commissions and tenant improvements and are based on leases in effect as of December 31, 2017. |
| |
(4) | Represents business management incentive fees for the year ended December 31, 2017 due to RMR LLC under our business management agreement. This fee was paid to RMR LLC in January 2018. |
On January 19, 2018,16, 2020, we declared a regular quarterly distribution of $0.39 per common share, or $92.7 million,payable to our common shareholders of record on January 29, 2018 for27, 2020 in the quarter ended December 31, 2017.amount of $0.15 per share, or approximately $35.7 million. We paid this distribution to shareholders on February 22, 201820, 2020 using cash on hand and borrowings under our revolving credit facility.
We believe we will have access to various types of financings, including debt or equity offerings, to fund our future acquisitions and to pay our debts and other obligations as they become due. Our ability to complete, and the costs associated with,
future debt transactions depends primarily upon credit market conditions and our then creditworthiness. We have no control over market conditions. Our credit ratings depend upon evaluations by credit rating agencies of our business practices and plans, including our ability to maintain our earnings, to stagger our debt maturities and to balance our use of debt and equity capital so that our financial performance and leverage ratios afford us flexibility to withstand any reasonably anticipated adverse changes. Similarly, our ability to raise equity capital in the future will depend primarily upon equity capital market conditions and our ability to conduct our business to maintain and grow our operating cash flows. We intend to conduct our business activities in a manner which will afford us reasonable access to capital for investment and financing activities, but we cannot be sure that we will be able to successfully carry out that intention.
In April 2019, our issuer credit rating was downgraded from BBB- to BB+ by S&P following our announcement of the restructuring of our business arrangements with Five Star. The ratings on our senior notes were reaffirmed at BBB- by S&P and, as a result, the interest rate premium on our revolving credit facility and our $200.0 million term loan was not changed.
In May 2019, our senior unsecured debt rating was downgraded from Baa3 to Ba1 by Moody's Investors Service following our announcement of the Transaction Agreement. The interest rate premium on our revolving credit facility and our $200.0 million term loan was not changed.
In May 2019, we redeemed at par all of our outstanding 3.25% senior notes due 2019 for a redemption price equal to principal amount of $400.0 million. We funded this redemption with cash on hand and borrowings under our revolving credit facility.
In May 2019, we prepaid, at par plus accrued interest, a mortgage note secured by four of our senior living communities with an outstanding principal balance of approximately $42.2 million, a maturity date in July 2019 and an annual interest rate of 3.79%. We prepaid this mortgage using cash on hand and borrowings under our revolving credit facility.
We have $200.0 million of 6.75% senior unsecured notes due in April 2020. We expect to pay this debt using borrowings under our revolving credit facility and proceeds from our dispositions.
For further information regarding our outstanding debt, see Note 8 to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.
Contractual Obligations
As of December 31, 2019, our contractual obligations were as follows (dollars in thousands):
|
| | | | | | | | | | | | | | | | | | | | |
| | Payment due by period |
Contractual Obligations | | Total | | Less than 1 year | | 1-3 years | | 3-5 years | | More than 5 years |
Borrowings under revolving credit facility | | $ | 537,500 |
| | $ | — |
| | $ | 537,500 |
| | $ | — |
| | $ | — |
|
Term loans | | 450,000 |
| | 250,000 |
| | 200,000 |
| | — |
| | — |
|
Senior unsecured notes | | 1,850,000 |
| | 200,000 |
| | 300,000 |
| | 250,000 |
| | 1,100,000 |
|
Mortgage notes payable | | 689,361 |
| | 2,737 |
| | 40,997 |
| | 15,783 |
| | 629,844 |
|
Capital lease obligations | | 8,874 |
| | 1,062 |
| | 2,472 |
| | 3,000 |
| | 2,340 |
|
Ground lease obligations | | 6,345 |
| | 308 |
| | 535 |
| | 412 |
| | 5,090 |
|
Projected interest expense (1) | | 1,358,006 |
| | 146,591 |
| | 240,455 |
| | 180,483 |
| | 790,477 |
|
Tenant related obligations (2) | | 23,994 |
| | 13,346 |
| | 9,071 |
| | 1,577 |
| | — |
|
Total | | $ | 4,924,080 |
| | $ | 614,044 |
| | $ | 1,331,030 |
| | $ | 451,255 |
| | $ | 2,527,751 |
|
| |
(1) | Projected interest expense is attributable to only our debt obligations at existing rates as of December 31, 2019 and is not intended to estimate future interest costs which may result from debt prepayments, additional borrowings under our revolving credit facility, new debt issuances or changes in interest rates. |
| |
(2) | Committed tenant related obligations include leasing commissions and tenant improvements and are based on leases in effect as of December 31, 2019. |
Off Balance Sheet Arrangements
As of December 31, 2017,2019, we had no off balance sheet arrangements that have had or that we expect would be reasonably likely to have a material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Debt Covenants
Our principal debt obligations at December 31, 2017 were: (1) outstanding borrowings under our $1.0 billion revolving credit facility; (2) six public issuances of senior unsecured notes, including: (a) $400.0 million principal amount at an annual interest rate of 3.25% due 2019, (b) $200.0 million principal amount at an annual interest rate of 6.75% due 2020, (c) $300.0 million principal amount at an annual interest rate of 6.75% due 2021, (d) $250.0 million principal amount at an annual interest rate of 4.75% due 2024, (e) $350.0 million principal amount at an annual interest rate of 5.625% due 2042 and (f) $250.0 million principal amount at an annual interest rate of 6.25% due 2046; (3) our $350.0 million principal amount term loan due 2020; (4) our $200.0 million principal amount term loan due 2022; and (5) $796.6 million aggregate principal amount of mortgage notes secured by 23 of our properties (24 buildings) with maturity dates between 2018 and 2043. We also have two properties encumbered by capital leases with lease obligations totaling $10.7 million at December 31, 2017; the capital leases expire in 2026. We had $596.0 million outstanding under our revolving credit facility as of December 31, 2017. Our senior unsecured notes are governed by our senior unsecured notes indentures and their supplements. Our revolving credit facility and term loan agreements and our senior unsecured notes indentures and their supplements provide for acceleration of payment of all amounts outstanding upon the occurrence and continuation of certain events of default, such as, in the case of our revolving credit facility and term loan agreements, a change of control of us, as defined, which includes RMR LLC ceasing to act as our business and property manager. Our senior unsecured notes indentures and their supplements and our revolving credit facility and term loan agreements also contain a number of covenants whichthat restrict our ability to incur debts, including debts secured by mortgages on our properties, in excess of calculated amounts and require us to maintain various financial ratios, and our revolving credit facility and term loan agreements containscontain covenants whichthat restrict our ability to make distributions to our shareholders in certain circumstances. As of December 31, 2017,2019, we believe we were in compliance with all of the covenants under our senior unsecured notes indentures and their supplements, our revolving credit facility and term loan agreements and our other debt obligations.
Neither our senior unsecured notes indentures and their supplements, nor our revolving credit facility and term loan agreements, contain provisions for acceleration which could be triggered by our debt ratings. However, under our revolving credit facility and term loan agreements, our senior unsecured debt ratings are used to determine the fees and interest rates we pay. Accordingly, if our debt ratings are further downgraded, our interest expense and related costs under our revolving credit facility and term loan agreements wouldmay increase.
See "—Our Financing Liquidity and Resources" above for information regarding recent downgrades of our issuer credit rating and senior unsecured debt rating that did not result in a change in the interest rate premiums under our revolving credit facility or term loans.
Our senior unsecured notes indentures and their supplements contain cross default provisions to any other debts of more than $20.0 million ($50.0 million or more in the case of our senior unsecured notes indentureindentures and supplementsupplements entered in February 2016)2016 and February 2018). Similarly, our revolving credit facility and term loan agreements have cross default provisions to other indebtedness that is recourse of $25.0 million or more and indebtedness that is non-recourse of $75.0 million or more.
The loan agreements governing the aggregate $620.0 million secured debt financing we obtained in July 2016on the property owned by our joint venture contain customary covenants and provide for acceleration of payment of all amounts due thereunder upon the occurrence and continuation of certain events of default.
For further information regarding our principal debt obligations, see Note 8 to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.
Related Person Transactions
We have relationships and historical and continuing transactions with RMR LLC, RMR Inc., Five Star and others related to them. For example: we have no employees and the personnel and various services we require to operate our business are provided to us by RMR LLC pursuant to our business management agreement and property management agreementagreements with RMR LLC; RMR Inc. is the managing member of RMR LLC; Adam D. Portnoy, the Chair of our Board of Trustees and one of our Managing Trustees, is the sole trustee, an officer and the controlling shareholder of ABP Trust, which is controlled by its current sole trustee, our Managing Trustee, is the
controlling shareholder of RMR Inc.;, and he is also a managing director and the president and chief executive officer of RMR Inc., an officer and employee of RMR LLC and the chair of the board of directors and a managing director of Five Star; Jennifer B. Clark, our other Managing Trustee and our Secretary, is a managing director and the executive vice president, general counsel and secretary of RMR Inc., an officer of ABP Trust, an officer and employee of RMR LLC and a managing director and the secretary of Five Star; each of our officers is also an officer and employee of RMR LLC; and, until July 1, 2019, we ownowned shares of class A common stock of RMR Inc. We also have relationships and historical and continuing transactions with other companies to which RMR LLC or its subsidiaries provide management services and some of which may have trustees, directors andor officers who are also trustees, directors or officers of us, RMR LLC or RMR Inc., including:including Five Star, which is our former subsidiary and former largest tenant, and is currently the manager of most of our managed senior living communities and ofwith which we restructured our business arrangements as of January 1, 2020. We and a wholly owned subsidiary ofAdam D. Portnoy, directly and indirectly through ABP Trust and its subsidiaries, are significant stockholders; D&R Yonkers LLC, which is owned by our President and Chief Operating Officer and Five Star’s chief financial officer and treasurer and to which onestockholders of our TRSs subleases a part of a senior living community we own in order to accommodate certain requirements of New York healthcare licensing laws; SIR, from which we purchased entities owning 23 MOBs, or the CCIT MOBs, that SIR acquired in connection with its acquisition of Cole Corporate Income Trust, Inc., or CCIT, in January 2015; and AIC, of which we, ABP Trust, Five Star, owning, as of December 31, 2019, 8.2% (33.9% as of January 1, 2020) and four other companies to which RMR LLC provides management services each own 14.3% and which arranges and insures or reinsures in part a combined property insurance program for us and its six other shareholders. 35.3% (6.3% as of January 1, 2020), respectively, of outstanding Five Star common shares.
For further information about these and other such relationships and related person transactions, see Notes 3, 5, 6 and 7 to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K, which are incorporated herein by reference and our other filings with the SEC including our definitive Proxy Statement for our 20182020 Annual Meeting of Shareholders, or our definitive Proxy Statement, to be filed with the SEC within 120 days after the fiscal year ended December 31, 2017.2019. For further information about these transactions and relationships and about the risks that may arise as a result of these and other related person transactions and relationships, see elsewhere in this Annual Report on Form 10-K, including “Warning Concerning Forward LookingForward-Looking Statements,” Part I, Item 1, “Business” and Part I, Item 1A, “Risk Factors.” Our filings with the SEC and copies of certain of our agreements with these related persons, including our business management agreement and property management agreementagreements with RMR LLC, the New Management Agreements, our prior leases, forms of management agreements and related pooling agreements with Five Star, our 20172019 and 20162017 transaction agreements with Five Star, our agreements with D&R Yonkers LLC and its owners, the purchase and sale agreement for our purchase from SIR of the CCIT MOBs, the consent agreement with Adam Portnoy and Barry Portnoy and certain of theirhis affiliates related to theirhis acquisition of Five Star common shares and our shareholders agreement with AIC and its six other shareholders, are available as exhibits to our public filings with the SEC and accessible at the SEC’sSEC's website, www.sec.gov. We may engage in additional transactions with related persons, including businesses to which RMR LLC or its subsidiaries provide management services.
Critical Accounting Policies
Our critical accounting policies are those that will have the most impact on the reporting of our financial condition and results of operations and those requiring significant judgments and estimates. We believe that our judgments and estimates have been and will be consistently applied and produce financial information that fairly presents our results of operations. Our most critical accounting policies involve our investments in real property. These policies affect our:
allocation of purchase prices among various asset categories, including allocations to above and below market leases, for properties, and the related impact on the recognition of rental income and depreciation and amortization expense;expenses; and
assessment of the carrying values and impairments of long lived assets; and
classification of leases.assets.
We allocate the acquisition costpurchase prices of each property investmentour properties to various property components such as land, buildingsbuilding and improvements and intangibles based on their relativedeterminations of the fair values and each component generally has a different useful life. For acquired real estate, we record building, land and improvements, and, if applicable,of these assets assuming the value of in place leases, the fair market value of above or below market leases and customer relationships at fair value.properties are vacant. We allocate the excess, if any, of the consideration overdetermine the fair value of assets acquiredeach property using methods similar to goodwill. We base purchase price allocationsthose used by independent appraisers, which may involve estimated cash flows that are based on a number of factors, including capitalization rates and the determination of useful lives on our estimates and, underdiscount rates, among others. In some circumstances, studies fromwe engage independent real estate appraisersappraisal firms to provide market information and evaluations thatwhich are relevant to our purchase price allocations and determinations of depreciable useful lives; however, our management iswe are ultimately responsible for the purchase price allocations and determinationdeterminations of useful lives.
We compute depreciation expense usingallocate a portion of the straight line method over estimated useful lives of uppurchase price to 40 years. We do not depreciate the allocated cost of land. We amortize capitalized above market and below market leases based on the present value (using an interest rate which reflects the risks associated with acquired in place leases at the time each property was acquired by us) of the difference, if any, between (i) the contractual amounts to be paid pursuant to the acquired in place leases and (ii) our estimates of fair market lease values (included in acquired real estate leases) asrates for the corresponding leases, measured over a reductionperiod equal to rental income over the remaining non-cancelable terms of the respective leases. We amortize capitalizedThe terms of below market leases that include bargain renewal options, if any, are further adjusted if we determine that renewal is probable. We allocate a portion of the purchase price to acquired in place leases and tenant relationships based upon market estimates to lease up the property based on the leases in place at the time of purchase. In making these allocations, we consider factors such as estimated carrying costs during the expected lease up periods, including real estate taxes, insurance and other operating income and expenses and costs, such as leasing commissions, legal and other related expenses, to execute similar leases in current market conditions at the time a property was acquired by us. We allocate this aggregate value between acquired in place lease values (presented as acquired real estate lease obligations) as an increase to rental income over the remaining termsand tenant relationships based on our evaluation of the respective leases. We amortizespecific characteristics of each tenant's lease. However, we have not separated the value of tenant relationships from the value of acquired in place leases exclusive ofbecause such value and related amortization expense is immaterial to our consolidated financial statements. If the value of above markettenant relationships becomes material in the future, we may separately allocate those amounts and below market in place leases to expenseamortize the allocated amount over the remaining non-cancelable periodsestimated life of the respective leases. If a lease is terminated prior to its stated expiration, all unamortized amounts relating to that lease are written off. Purchase price allocations require us to make certain assumptions and estimates. Incorrect assumptions and estimates may result in inaccurate depreciation and amortization charges over future periods.relationships.
We periodically evaluate our properties for impairment. Impairment indicators may include declining tenant occupancy, weakour concerns about a tenant’s financial condition (which may be endangered by a rent default or declining tenant profitability, cash flowother information which comes to our attention) or liquidity, our decision to dispose of an asset before the end of its estimated useful life and legislative, as well as market or industry changes that could permanently reduce the value of a property. If indicators of impairment are present, we evaluate the carrying value of the related property by comparing it to the expected future undiscounted cash flows to be generated from that property. If the sum of these expected future cash flows is less than the carrying value, we reduce the net carrying value of the property to its estimated fair value. This analysis requires us to judge whether indicators of impairment exist and to estimate likely future cash flows. The future net undiscounted cash flows are subjective and are based in part on assumptions regarding hold periods, market rents and terminal capitalization rates. If we misjudge or estimate incorrectly or if future tenant operations, market or industry factors differ from our expectations we may record an impairment charge that is inappropriate or fail to record a charge when we should have done so, or the amount of any such charges may be inaccurate.
Each time we enter a new lease or materially modify an existing lease, we evaluate its classification as either a capital or operating lease. The classification of a lease as capital or operating affects the carrying value of a property, as well as our recognition of rental payments as revenue. These evaluations require us to make estimates of, among other things, the remaining useful life and fair market value of a leased property, appropriate discount rates and future cash flows. Incorrect assumptions or estimates may result in misclassification of our leases.
These accounting policies involve significant judgments made based upon our experience and the experience of our management and our Board of Trustees, including judgments about current valuations, ultimate realizable value, estimated useful lives, salvage or residual value, the ability and willingness of our tenants to perform their obligations to us, and the current and likely future operating and competitive environments in which our properties are operated. In the future, we may need to revise our carrying value assessments to incorporate information which is not now known, and such revisions could increase or decrease our depreciation expense or impairment charges related to properties we own, result in the classification of our leases as other than operating leases or decrease the carrying values of our assets.
Impact of Inflation
Inflation in the past several years in the United States has been modest, but recently there have been indications of inflation in the U.S. economy and some market forecasts indicate an expectation of increased inflation in the near to intermediate term. Future inflation might have both positive and negative impacts on our business. Inflation might cause the value of our real estate assets to increase. In an inflationary environment, the percentage rents which we receive based upon a percentage of our tenants’ tenants'
revenues should increase. Further, inflation may permit us to increase rents upon renewal or enter into new leases for the leased space for increased rent amounts. Offsetting these benefits, inflation might cause our costs of equity and debt capital and operating costs to increase. An increase in our capital costs or in our operating costs may result in decreased earnings unless it is offset by increased revenues. In periods of rapid inflation, our tenants’tenants' or managers’managers' operating costs may increase faster than revenues, which may have an adverse impact upon us if our tenants’tenants' or managers’managers' operating income from our properties becomes insufficient to pay our rents or returns. To mitigate the adverse impact of increased tenant financial distress upon us, we generally require our tenants to provide guarantees for our rent.
To mitigate the adverse impact of any increased cost of debt capital in the event of material inflation, we previously have purchased interest rate cap agreements and we may enter into additional interest rate hedge arrangements in the future. The decision to enter into these agreements was and will be based on various factors, including the amount of our floating rate debt outstanding, our belief that material interest rate increases are likely to occur, the costs of, and our expected benefit from, these agreements and upon possible requirements of our borrowing arrangements.
Generally,Other than continued increases in labor costs discussed above in "Risk Factors" in Part I, Item 1A of this Annual Report on Form 10-K, we do not expect inflation to have a material impact on our financial results for the next 12 months or for the current foreseeable future thereafter.
Impact of Government Reimbursement
For the year ended December 31, 2017,2019, approximately 97% of our NOI was generated from properties where a majority of the revenues are derived from our tenants’tenants' and residents’residents' private resources, and the remaining 3% of our NOI was generated from properties where a majority of the revenues are derived from Medicare and Medicaid payments. Nonetheless, we own, and our tenants and manager operate, facilities in many states that participate in federal and state healthcare payment programs, including the federal Medicare and state Medicaid programs and other federal and state healthcare payment programs. Also, some of our MOBmedical office and life science property tenants participate in federal Medicare and state Medicaid programs and other government healthcare payment programs. Because of shifting policy priorities, the current and projected federal budget deficit, other federal spending priorities and challenging fiscal conditions in some states, there have been numerous recent legislative and regulatory actions or proposed actions with respect to federal Medicare rates, state Medicaid rates and federal payments to states for Medicaid programs, as well as existing regulations that impact these matters. Further, there are other existing and recently enacted legislation, and related
litigation, related to government payments, insurance and healthcare delivery. Examples of these, and other information regarding such matters and developments, are provided under the caption “Business—Government“Business-Government Regulation and Reimbursement” above in this Annual Report on Form 10-K. We cannot currently predict the type and magnitude of the potential Medicare and Medicaid policy changes, rate changes or other changes that may be implemented, but we believe that some of these changes will cause these government funded healthcare programs to fail to provide rates that match our and our tenants’tenants' increasing expenses and that such changes may be material and adverse to our future financial results.
Seasonality
Skilled nursing and assisted livingSenior housing operations have historically reflected modest seasonality. During fourth quarter holiday periods, residents at such facilities are sometimes discharged to spend time with family and admission decisions are often deferred. The first quarter of each calendar year usually coincides with increased illness among residents which can result in increased costs or discharges to hospitals. As a result of these and other factors, these operations sometimes produce greater earnings in the second and third quarters of a calendar year and lesser earnings in the fourth and first calendar quarters. We do not expect these seasonal differences to have a material impact upon the ability of our tenants to pay our rent or our ability to fund our managed senior living operations or our other businesses. Our MOBsmedical office and life science properties and wellness center businesscenters do not typically experience seasonality.
Impact of Climate Change
The political debateConcerns about climate change hashave resulted in various treaties, laws and regulations whichthat are intended to limit carbon emissions. We believe theseemissions and address other environmental concerns. These and other laws being enacted or proposed may cause energy or other costs at our properties to increase in the future.increase. We do not expect the direct impact of these possible increases in energy costs resulting from laws designed to address climate change to be material to our results of operations, because the increased costs either maywould be the responsibility of our tenants directly or in large partthe longer term, passed through and paid by us totenants of our tenants as additional rent. Also, althoughproperties. Although we do not believe it is likely in the foreseeable future, laws enacted to mitigate climate change may make some of our buildings obsolete or cause us to make material investments in our properties, which could materially and adversely affect our financial condition or the financial condition of our tenants or managers and results of operations.their ability to pay rent or returns to us.
In an effort to reduce the effects of any increased energy costs in the future, we continuously study ways to improve the energy efficiency at all of our properties. Our property manager, RMR LLC, is a member of the Energy Star PartnerENERGY STAR program, a joint
program of the U.S. Environmental Protection Agency and the U.S. Department of Energy that is focused on promoting energy efficiency at commercial properties through its “ENERGY STAR” labelpartner program, and a member of the U.S. Green Building Council, a nonprofit organization focused on promoting energy efficiency at commercial properties through its leadership in energy and environmental design, or LEED®, green building program.
Some observers believe severe weather in different parts of the world over the last few years is evidence of global climate change. Severe weather may have an adverse effect on certain properties we own. Rising sea levels could cause flooding at some of our properties, which may have an adverse effect on individual properties we own. We mitigate these risks by procuring, or requiring our tenants to procure, insurance coverage we believe adequate to protect us from material damages and losses resulting from the consequences of losses caused by climate change. However, we cannot be sure that our mitigation efforts will be sufficient or that future storms, rising sea levels or other changes that may occur due to future climate change could not have a material adverse effect on our financial results.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to risks associated with market changes in interest rates. We manage our exposure to this market risk by monitoring available financing alternatives. Other than as described below, we do not currently foresee any significant changes in our exposure to fluctuations in interest rates or in how we manage this exposure in the near future.
Although we have no present plans to do so, we may in the future enter into hedge arrangements or derivative contracts from time to time to mitigate our exposure to changes in interest rates.
Fixed Rate Debt
At December 31, 2017,2019, our outstanding fixed rate debt included the following (dollars in thousands):
| | | | | | Annual | | Annual | | | | | | | | Annual | | Annual | | | | |
| | Principal | | Interest | | Interest | | | | Interest | | Principal | | Interest | | Interest | | | | Interest |
Debt (1) | | Balance (2) | | Rate (2) | | Expense | | Maturity | | Payments Due | | Balance (1) | | Rate (1) | | Expense | | Maturity | | Payments Due |
Senior unsecured notes | | $ | 400,000 |
| | 3.25 | % | | $ | 13,000 |
| | 2019 | | Semi-Annually | | $ | 200,000 |
| | 6.75 | % | | $ | 13,500 |
| | 2020 | | Semi-Annually |
Senior unsecured notes | | 350,000 |
| | 5.63 | % | | 19,705 |
| | 2042 | | Quarterly | | 300,000 |
| | 6.75 | % | | 20,250 |
| | 2021 | | Semi-Annually |
Senior unsecured notes | | 300,000 |
| | 6.75 | % | | 20,250 |
| | 2021 | | Semi-Annually | | 250,000 |
| | 4.75 | % | | 11,875 |
| | 2024 | | Semi-Annually |
Senior unsecured notes | | 250,000 |
| | 4.75 | % | | 11,875 |
| | 2024 | | Semi-Annually | | 500,000 |
| | 4.75 | % | | 23,750 |
| | 2028 | | Semi-Annually |
Senior unsecured notes | | 250,000 |
| | 6.25 | % | | 15,625 |
| | 2046 | | Quarterly | | 350,000 |
| | 5.63 | % | | 19,705 |
| | 2042 | | Quarterly |
Senior unsecured notes | | 200,000 |
| | 6.75 | % | | 13,500 |
| | 2020 | | Semi-Annually | | 250,000 |
| | 6.25 | % | | 15,625 |
| | 2046 | | Quarterly |
Mortgage notes(3)(2) | | 620,000 |
| | 3.53 | % | | 21,886 |
| | 2026 | | Monthly | | 1,426 |
| | 7.49 | % | | 107 |
| | 2022 | | Monthly |
Mortgage note | | 67,749 |
| | 4.47 | % | | 3,028 |
| | 2018 | | Monthly | |
Mortgage note | | 43,558 |
| | 3.79 | % | | 1,651 |
| | 2019 | | Monthly | |
Mortgage notes | | | 12,513 |
| | 6.28 | % | | 786 |
| | 2022 | | Monthly |
Mortgage note | | 13,741 |
| | 6.28 | % | | 863 |
| | 2022 | | Monthly | | 10,958 |
| | 4.85 | % | | 531 |
| | 2022 | | Monthly |
Mortgage notes | | 12,552 |
| | 6.31 | % | | 792 |
| | 2018 | | Monthly | | 16,131 |
| | 5.75 | % | | 928 |
| | 2022 | | Monthly |
Mortgage notes | | 11,858 |
| | 6.24 | % | | 740 |
| | 2018 | | Monthly | |
Mortgage note | | 11,392 |
| | 4.85 | % | | 553 |
| | 2022 | | Monthly | | 16,056 |
| | 6.64 | % | | 1,066 |
| | 2023 | | Monthly |
Mortgage note | | 6,430 |
| | 4.69 | % | | 302 |
| | 2019 | | Monthly | |
Mortgage note (4) | | 4,338 |
| | 4.38 | % | | 190 |
| | 2043 | | Monthly | |
Mortgage note | | 2,603 |
| | 7.49 | % | | 195 |
| | 2022 | | Monthly | |
Capital leases | | | 8,874 |
| | 7.70 | % | | 683 |
| | 2026 | | Monthly |
Mortgage notes (3) | | | 620,000 |
| | 3.53 | % | | 21,886 |
| | 2026 | | Monthly |
Mortgage note (2) (4) | | | 1,589 |
| | 6.25 | % | | 99 |
| | 2026 | | Monthly |
Mortgage note | | 2,395 |
| | 6.25 | % | | 150 |
| | 2033 | | Monthly | | 10,688 |
| | 4.44 | % | | 475 |
| | 2043 | | Monthly |
| | $ | 2,546,616 |
| | | | $ | 124,305 |
| | | | | | $ | 2,548,235 |
| | | | $ | 131,266 |
| | | | |
No principal repayments are due under our unsecured notes until maturity. Our mortgage debtsnotes generally require principal and interest payments through maturity pursuant to amortization schedules. Because these debts require interest to be paid at a fixed rate, changes in market interest rates during the term of these debts will not affect our interest obligations. If these debts were refinanced at interest rates which are 100 basis pointsone percentage point higher or lower than shown above, our annual interest cost would increase or decrease by approximately $25.5$25.4 million.
Changes in market interest rates also would affect the fair value of our fixed rate debt obligations; increases in market interest rates decrease the fair value of our fixed rate debt, while decreases in market interest rates increase the fair value of our fixed rate debt. Based on the balances outstanding at December 31, 2017,2019, and discounted cash flowflows analyses through the respective maturity dates, and assuming no other changes in factors that may affect the fair value of our fixed rate debt obligations, a hypothetical immediate 100 basisone percentage point changeincrease in interest rates would change the fair value of those obligations by approximately $47.4$38.8 million.
Our senior unsecured notes and certain of our mortgages contain provisions that allow us to make repayments earlier than the stated maturity date. In some cases, we are not allowed to make early repayment prior to a cutoff date and we are generally allowed to make prepayments only at a premium equal to a make whole amount, as defined, which is generally designed to preserve a stated yield to the noteholder. In the past, we have repurchased and retired some of our outstanding debts and we may do so again in the future. These prepayment rights and our ability to repurchase and retire outstanding debt may afford us opportunities to mitigate the risk of refinancing our debts at maturity at higher rates by refinancing prior to maturity.
Borrowings under our revolving credit facility and term loans are in U.S. dollars and interest is required to be paid at the rate of LIBOR plus premiums that are subject to adjustment based upon changes to our credit ratings. Accordingly, we are exposed to interest rate risk for changes in U.S. dollar based short term rates, specifically LIBOR.LIBOR, and to changes in our credit ratings. In addition, upon renewal or refinancing of our revolving credit facility or our term loans, we are vulnerable to increases in interest rate premiums due to market conditions or our perceived credit characteristics. Generally, a change in interest rates would not affect the value of our floating rate debt but would affect our operating results.
(2) Based on weighted average number of shares outstanding (basic and diluted) for the year ended December 31, 2017.2019.
The foregoing tables show the impact of an immediate increase in floating interest rates. If interest rates were to changeincrease gradually over time, the impact would be spread over time. Our exposure to fluctuations in floating interest rates will increase or decrease in the future with increases or decreases in the amount of our borrowings outstanding under our revolving credit facility or other floating rate debt.
Item 8. Financial Statements and Supplementary Data.
The information required by this item is included in Part IV, Item 15 of this Annual Report on Form 10-K.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
As of the end of the period covered by this Annual Report on Form 10-K, our management carried out an evaluation, under the supervision and with the participation of our then Managing Trustees, our President and Chief Operating Officer and our Chief Financial Officer and Treasurer, of the effectiveness of our disclosure controls and procedures pursuant to the Exchange Act Rules 13a-15 and 15d-15. Based upon that evaluation, our then Managing Trustees, our President and Chief Operating Officer and our Chief Financial Officer and Treasurer concluded that our disclosure controls and procedures are effective.
There have been no changes in our internal control over financial reporting during the quarter ended December 31, 20172019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
We are responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control system is designed to provide reasonable assurance to our management and Board of Trustees regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Ernst & Young LLP, the independent registered public accounting firm that audited our 20172019 Consolidated Financial Statements included in this Annual Report on Form 10-K, has issued an attestation report on our internal control over financial reporting. The report appears elsewhere herein.
Item 9B. Other Information.
None.
Item 10. Directors, Executive Officers and Corporate Governance.
We have a Code of Conduct that applies to our officers and Trustees, RMR Inc. and RMR LLC, senior level officers of RMR LLC, senior level officers and directors of RMR Inc. and certain other officers and employees of RMR LLC. Our Code of Conduct is posted on our website, www.snhreit.com.www.dhcreit.com. A printed copy of our Code of Conduct is also available free of charge to any person who requests a copy by writing to our Secretary, Senior Housing PropertiesDiversified Healthcare Trust, Two Newton Place, 255 Washington Street, Suite 300, Newton, MA 02458-1634. We intend to disclose anysatisfy the requirements under Item 5.05 of Form 8-K regarding disclosure of amendments to, or waivers tofrom, provisions of our Code of Conduct applicableto apply to our principal executive officer, principal financial officer, principal accounting officer or controller, (oror any personpersons performing similar functions)functions, on our website.
The remainder of the information required by Item 10 is incorporated by reference to our definitive Proxy Statement.
Item 11. Executive Compensation.
The information required by Item 11 is incorporated by reference to our definitive Proxy Statement.
The information required by Item 13 is incorporated by reference to our definitive Proxy Statement.
The information required by Item 14 is incorporated by reference to our definitive Proxy Statement.
Item 15. Exhibits and Financial Statement Schedules.
The following consolidated financial statements and financial statement schedules of Senior Housing PropertiesDiversified Healthcare Trust are included on the pages indicated:
All other schedules for which provision is made in the applicable accounting regulations of the SEC are not required under the related instructions, or are inapplicable, and therefore have been omitted.
(+) Management contract or compensatory plan or arrangement.
Item 16. Form 10-K Summary.
None.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2017,2019, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 27, 2018March 2, 2020 expressed an unqualified opinion thereon.
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’sCompany's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 20172019 and 2016,2018, the related consolidated statements of comprehensive income (loss), shareholders' equity and cash flows for each of the three years in the period ended December 31, 2017,2019, and the related notes and financial statement schedulesschedule listed in the Index at itemItem 15(a), and our report dated February 27, 2018,March 2, 2020 expressed an unqualified opinion thereon.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.