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EX-31.2 - EX-31.2 - WELLTOWER INC.l38660exv31w2.htm
EX-23 - EX-23 - WELLTOWER INC.l38660exv23.htm
EX-21 - EX-21 - WELLTOWER INC.l38660exv21.htm
EX-24.1 - EX-24.1 - WELLTOWER INC.l38660exv24w1.htm
EX-24.8 - EX-24.8 - WELLTOWER INC.l38660exv24w8.htm
EX-24.7 - EX-24.7 - WELLTOWER INC.l38660exv24w7.htm
EX-24.5 - EX-24.5 - WELLTOWER INC.l38660exv24w5.htm
EX-32.1 - EX-32.1 - WELLTOWER INC.l38660exv32w1.htm
EX-24.3 - EX-24.3 - WELLTOWER INC.l38660exv24w3.htm
EX-24.4 - EX-24.4 - WELLTOWER INC.l38660exv24w4.htm
EX-24.6 - EX-24.6 - WELLTOWER INC.l38660exv24w6.htm
EX-24.9 - EX-24.9 - WELLTOWER INC.l38660exv24w9.htm
EX-24.2 - EX-24.2 - WELLTOWER INC.l38660exv24w2.htm
EX-24.10 - EX-24.10 - WELLTOWER INC.l38660exv24w10.htm
EX-24.11 - EX-24.11 - WELLTOWER INC.l38660exv24w11.htm
EX-24.12 - EX-24.12 - WELLTOWER INC.l38660exv24w12.htm
EX-12 - EX-12 - WELLTOWER INC.l38660exv12.htm
EX-32.2 - EX-32.2 - WELLTOWER INC.l38660exv32w2.htm
EX-31.1 - EX-31.1 - WELLTOWER INC.l38660exv31w1.htm
Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2009
Commission File No. 1-8923
 
(HEALTH CARE REIT LOGO)
 
HEALTH CARE REIT, INC.
(Exact name of registrant as specified in its charter)
 
     
Delaware
(State or other jurisdiction of
incorporation or organization)
  34-1096634
(I.R.S. Employer
Identification Number)
One SeaGate, Suite 1500, Toledo, Ohio
(Address of principal executive office)
  43604
(Zip Code)
 
(419) 247-2800
 
(Registrant’s telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of Each Class   Name of Each Exchange on Which Registered
 
Common Stock, $1.00 par value
  New York Stock Exchange
7.875% Series D Cumulative
Redeemable Preferred Stock, $1.00 par value
  New York Stock Exchange
7.625% Series F Cumulative
Redeemable Preferred Stock, $1.00 par value
  New York Stock Exchange
7.5% Series G Cumulative
Convertible Preferred Stock, $1.00 par value
  New York Stock Exchange
 
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes o     No þ
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months; and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. þ
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer þ Accelerated filer o Non-accelerated filer o Smaller reporting company o
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ
 
The aggregate market value of the shares of voting common stock held by non-affiliates of the registrant, computed by reference to the closing sales price of such shares on the New York Stock Exchange as of the last business day of the registrant’s most recently completed second fiscal quarter was $3,811,648,657.
 
As of February 12, 2010, there were 123,687,306 shares of common stock outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the registrant’s definitive proxy statement for the annual stockholders’ meeting to be held May 6, 2010, are incorporated by reference into Part III.
 


 

 
HEALTH CARE REIT, INC.
2009 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS
 
                 
        Page
 
PART I
  Item 1.     Business     3  
  Item 1A.     Risk Factors     28  
  Item 1B.     Unresolved Staff Comments     35  
  Item 2.     Properties     36  
  Item 3.     Legal Proceedings     39  
  Item 4.     Submission of Matters to a Vote of Security Holders     39  
 
PART II
  Item 5.     Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities     40  
  Item 6.     Selected Financial Data     42  
  Item 7.     Management’s Discussion and Analysis of Financial Condition and Results of Operations     44  
  Item 7A.     Quantitative and Qualitative Disclosures About Market Risk     70  
  Item 8.     Financial Statements and Supplementary Data     72  
  Item 9.     Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     109  
  Item 9A.     Controls and Procedures     109  
  Item 9B.     Other Information     112  
 
PART III
  Item 10.     Directors, Executive Officers and Corporate Governance     112  
  Item 11.     Executive Compensation     112  
  Item 12.     Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     112  
  Item 13.     Certain Relationships and Related Transactions and Director Independence     112  
  Item 14.     Principal Accounting Fees and Services     112  
 
PART IV
  Item 15.     Exhibits and Financial Statement Schedules     113  
 EX-12
 EX-21
 EX-23
 EX-24.1
 EX-24.2
 EX-24.3
 EX-24.4
 EX-24.5
 EX-24.6
 EX-24.7
 EX-24.8
 EX-24.9
 EX-24.10
 EX-24.11
 EX-24.12
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2


Table of Contents

 
PART I
 
Item 1.   Business
 
General
 
Health Care REIT, Inc., an S&P 500 company with headquarters in Toledo, Ohio, is a real estate investment trust (“REIT”) that invests in senior housing and health care real estate. We also provide an extensive array of property management and development services. As of December 31, 2009, our broadly diversified portfolio consisted of 590 properties in 39 states. Founded in 1970, we were the first real estate investment trust to invest exclusively in health care facilities. More information is available on the Internet at www.hcreit.com.
 
Our primary objectives are to protect stockholder capital and enhance stockholder value. We seek to pay consistent cash dividends to stockholders and create opportunities to increase dividend payments to stockholders as a result of annual increases in rental and interest income and portfolio growth. To meet these objectives, we invest in the full spectrum of senior housing and health care real estate and diversify our investment portfolio by property type, operator/tenant and geographic location.
 
Depending upon the availability and cost of external capital, we believe our liquidity is sufficient to fund operations, meet debt service obligations (both principal and interest), make dividend distributions and complete construction projects in process. We also continue to evaluate opportunities to finance future investments. New investments are generally funded from temporary borrowings under our unsecured line of credit arrangement, internally generated cash and the proceeds from sales of real property. Our investments generate internal cash from rent and interest receipts and principal payments on loans receivable. Permanent financing for future investments, which replaces funds drawn under the unsecured line of credit arrangement, has historically been provided through a combination of public and private offerings of debt and equity securities and the incurrence or assumption of secured debt.
 
References herein to “we,” “us,” “our” or the “Company” refer to Health Care REIT, Inc. and its subsidiaries unless specifically noted otherwise.
 
Portfolio of Properties
 
The following table summarizes our portfolio as of December 31, 2009:
 
                                                 
    Investments
    Percentage of
    Number of
    # Beds/Units
    Investment per
       
Type of Property
  (In thousands)     Investments     Properties     or Sq. Ft.     metric (1)     States  
 
Independent living/CCRCs
  $ 1,210,005       19.8 %     50       7,046 units     $ 174,552 per unit       19  
Assisted living facilities
    1,312,167       21.6 %     179       11,116 units       119,273 per unit       30  
Skilled nursing facilities
    1,496,360       24.6 %     214       28,692 beds       52,153 per bed       26  
Hospitals
    639,930       10.5 %     29       1,716 beds       461,084 per bed       13  
Medical office buildings
    1,427,341       23.5 %     118       5,634,181 sq. ft.       259 per sq. ft.       23  
                                                 
Totals
  $ 6,085,803       100.0 %     590                       39  
                                                 
 
 
(1) Investment per metric was computed by using the total investment amount of $6,299,748,000 which includes real estate investments and unfunded construction commitments for which initial funding has commenced which amounted to $6,085,803,000 and $213,945,000, respectively.
 
Property Types
 
Our property types include investment properties and medical office buildings. Under the investment property segment, we invest in senior housing and health care real estate through acquisition and financing of primarily single tenant properties. Properties acquired are typically leased under triple-net leases. We are not involved in the management of our investment properties. Our primary investment property types include independent living/


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continuing care retirement communities, assisted living facilities, skilled nursing facilities and hospitals. The medical office building segment is primarily self-managed and consists of health care related properties acquired or developed for the medical profession. The medical office building leases have lease terms that typically include fixed increasers and operating expense reimbursement. Our properties include stand-alone facilities that provide one level of service, combination facilities that provide multiple levels of service, and communities or campuses that provide a wide range of services. The following is a summary of our various property types.
 
Independent Living/Continuing Care Retirement Communities
 
These communities may include one or more of the following property types.
 
Independent Living Facilities.  Independent living facilities are age-restricted, multifamily properties with central dining facilities that provide residents access to meals and other services such as housekeeping, linen service, transportation and social and recreational activities.
 
Continuing Care Retirement Communities.  Continuing care retirement communities include a combination of detached homes, an independent living facility, an assisted living facility and/or a skilled nursing facility on one campus. These communities are appealing to residents because there is no need for relocating when health and medical needs change. Resident payment plans vary, but can include entrance fees, condominium fees and rental fees. Many of these communities also charge monthly maintenance fees in exchange for a living unit, meals and some health services.
 
Early Stage Senior Housing.  Early stage senior housing communities contain primarily for-sale single-family homes, townhomes, cluster homes, mobile homes and/or condominiums with no specialized services. These communities are typically restricted or targeted to adults at least 55 years of age or older. Residents generally lead an independent lifestyle. Communities may include amenities such as a clubhouse, golf course and recreational spaces.
 
Assisted Living Facilities
 
Assisted living facilities are state regulated rental properties that provide the same services as independent living facilities, but also provide supportive care from trained employees to residents who require assistance with activities of daily living, including management of medications, bathing, dressing, toileting, ambulating and eating.
 
Alzheimer’s/Dementia Care Facilities.  Certain assisted living facilities may include state licensed settings that specialize in caring for those afflicted with Alzheimer’s disease and/or similar forms of dementia.
 
Skilled Nursing Facilities
 
Skilled nursing facilities are licensed daily rate or rental properties where the majority of individuals require 24-hour nursing and/or medical care. Generally, these properties are licensed for Medicaid and/or Medicare reimbursement.
 
Hospitals
 
Our hospitals generally include acute care hospitals, inpatient rehabilitation hospitals, and long-term acute care hospitals. Acute care hospitals provide a wide range of inpatient and outpatient services, including, but not limited to, surgery, rehabilitation, therapy and clinical laboratories. Inpatient rehabilitation hospitals provide inpatient services for patients with intensive rehabilitation needs. Long-term acute care hospitals provide inpatient services for patients with complex medical conditions that require more intensive care, monitoring or emergency support than is available in most skilled nursing facilities.
 
Medical Office Buildings
 
The medical office building portfolio consists of health care related buildings that include physician offices, ambulatory surgery centers, diagnostic facilities or labs. Our portfolio has a strong affiliation with health systems:


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approximately 75% of the buildings are either located on campus or affiliated with hospitals through a satellite location.
 
Investments
 
We invest in senior housing and health care real estate. We diversify our investment portfolio by property type, operator/tenant and geographic location. In determining whether to invest in a property, we focus on the following: (1) the experience of the obligor’s management team; (2) the historical and projected financial and operational performance of the property; (3) the credit of the obligor; (4) the security for the lease or loan; and (5) the capital committed to the property by the obligor. We conduct market research and analysis for all potential investments. In addition, we review the value of all properties, the interest rates and covenant requirements of any debt to be assumed and the anticipated sources of repayment of any existing debt that is not to be assumed.
 
We monitor our investments through a variety of methods determined by the type of property. Our asset management process for investment properties generally includes review of monthly financial statements and other operating data for each property, periodic review of obligor creditworthiness, periodic property inspections and review of covenant compliance relating to licensure, real estate taxes, letters of credit and other collateral. Our internal property management division actively manages and monitors the medical office building portfolio with a comprehensive process including tenant relations, tenant lease expirations, the mix of health service providers, hospital/health system relationships, property performance, capital improvement needs and market conditions among other things. In monitoring our portfolio, our personnel use a proprietary database to collect and analyze property-specific data. Additionally, we conduct extensive research to ascertain industry trends and risks.
 
Through asset management and research, we evaluate the operating environment in each property’s market to determine whether payment risk is likely to increase. When we identify unacceptable levels of payment risk, we seek to mitigate, eliminate or transfer the risk. We categorize the risk as obligor, property or market risk. For obligor risk, we typically find a substitute operator/tenant to run the property. For property risk, we usually work with the operator/tenant to institute property-level management changes to address the risk. Finally, for market risk, we often encourage an obligor to change its capital structure, including refinancing the property or raising additional equity. Through these asset management and research efforts, we are generally able to intervene at an early stage to address payment risk, and in so doing, support both the collectability of revenue and the value of our investment.
 
Depending upon market conditions, we believe that new investments will be available in the future with spreads over our cost of capital that will generate appropriate returns to our stockholders.
 
Segment Reporting
 
Our business consists of two business segments — investment properties and medical office buildings. For additional information regarding business segments, see Note 18 to our audited consolidated financial statements.
 
Investment Properties
 
Real Property.  Our investment properties are those in which we do not participate in the management of the property and are primarily land, building, improvements and related rights that are leased to operators under long-term operating leases. The net value of our investment properties (excluding construction in progress) aggregated approximately $3,795,765,000 at December 31, 2009. The leases generally have a fixed contractual term of 12 to 15 years and contain one or more five to 15-year renewal options. Most of our rents are received under triple-net leases requiring the operator to pay rent and all additional charges incurred in the operation of the leased property. The tenants are required to repair, rebuild and maintain the leased properties. Substantially all of these operating leases are designed with either fixed or contingent escalating rent structures. Leases with fixed annual rental escalators are generally recognized on a straight-line basis over the initial lease period, subject to a collectability assessment. Rental income related to leases with contingent rental escalators is generally recorded based on the contractual cash rental payments due for the period.
 
At December 31, 2009, 84% of our investment properties was subject to master leases. A master lease is a lease of multiple properties to one tenant entity under a single lease agreement. From time to time, we may acquire


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additional properties that are then leased to the tenant under the master lease. The tenant is required to make one monthly payment that represents rent on all the properties that are subject to the master lease. Typically, the master lease tenant can exercise its right to purchase the properties or to renew the master lease only with respect to all leased properties at the same time. This bundling feature benefits us because the tenant cannot limit the purchase or renewal to the better performing properties and terminate the leasing arrangement with respect to the poorer performing properties. This spreads our risk among the entire group of properties within the master lease. The bundling feature may provide a similar advantage if the master lease tenant is in bankruptcy. Subject to certain restrictions, a debtor in bankruptcy has the right to assume or reject each of its leases. It is our intent that a tenant in bankruptcy would be required to assume or reject the master lease as a whole, rather than deciding on a property by property basis.
 
Construction.  We currently provide for the construction of properties for tenants as part of long-term operating leases. We capitalize certain interest costs associated with funds used to pay for the construction of properties owned by us. The amount capitalized is based upon the amount advanced during the construction period using the rate of interest that approximates our cost of financing. Our interest expense is reduced by the amount capitalized. We also typically charge a transaction fee at the commencement of construction which we defer and amortize to income over the term of the resulting lease. The construction period commences upon funding and terminates upon the earlier of the completion of the applicable property or the end of a specified period. During the construction period, we advance funds to the tenants in accordance with agreed upon terms and conditions which require, among other things, periodic site visits by a Company representative. During the construction period, we generally require an additional credit enhancement in the form of payment and performance bonds and/or completion guaranties. At December 31, 2009, we had outstanding construction investments of $435,334,000 and were committed to providing additional funds of approximately $184,848,000 to complete construction for investment properties.
 
Real Estate Loans.  Our real estate loans are typically structured to provide us with interest income, principal amortization and transaction fees and are generally secured by a first, second or third mortgage lien, leasehold mortgage, corporate guaranties and/or personal guaranties. At December 31, 2009, we had outstanding real estate loans of $427,363,000. The interest yield averaged approximately 7.96% per annum on our outstanding real estate loan balances. Our yield on real estate loans depends upon a number of factors, including the stated interest rate, average principal amount outstanding during the term of the loan and any interest rate adjustments. The real estate loans outstanding at December 31, 2009 are generally subject to three to 20-year terms with principal amortization schedules and/or balloon payments of the outstanding principal balances at the end of the term. Typically, real estate loans are cross-defaulted and cross-collateralized with other real estate loans, operating leases or agreements between us and the obligor and its affiliates.
 
Medical Office Buildings
 
Our medical office building portfolio is primarily self-managed and consists principally of multi-tenant properties leased to health care providers. Our leases have favorable lease terms that typically include fixed increasers and some form of operating expense reimbursement by the tenant. As of December 31, 2009 87% of our portfolio included leases with full pass thru, 10% with a partial expense reimbursement (modified gross) and 3% with no expense reimbursement (gross). Our medical office building leases are non-cancellable operating leases that have a weighted average remaining term of six years at December 31, 2009 and are normally credit enhanced by guaranties and/or letters of credit. The net value of our medical office buildings (excluding construction in progress) aggregated approximately $1,405,843,000 at December 31, 2009. We also had outstanding construction investments of $21,498,000 and expected to provide additional funds of approximately $29,097,000 to complete construction for medical office buildings.
 
Development Services Group
 
Through our subsidiary, HCN Development Services Group, Inc. (“DSG”), we provide services such as property development, facility and medical equipment planning and implementation services to health care systems, physician groups and third party medical property owners. Formerly known as Hospital Affiliates Development Corporation or “HADC,” DSG develops and constructs new “build-to-suit” and multi-tenant facilities


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for us, and in some instances, for third parties who are expected to develop long-term relationships with the Company.
 
Equity Investments
 
Equity investments at December 31, 2009 and 2008 include an investment in a public company that has a readily determinable fair market value. We classify this equity investment as available-for-sale and, accordingly, record this investment at its fair market value with unrealized gains and losses included in accumulated other comprehensive income, a separate component of stockholders’ equity. Equity investments at December 31, 2009 and 2008 also include an investment in a private company. We do not have the ability to exercise influence over the company, so the investment is accounted for under the cost method. Under the cost method of accounting, investments in private companies are carried at cost and are adjusted only for other-than-temporary declines in fair value, return of capital and additional investments. These equity investments represented a minimal ownership interest in these companies. Additionally, equity investments at December 31, 2009 include an investment in an unconsolidated joint venture.
 
Investments in Unconsolidated Joint Ventures.  Investments in entities which we do not consolidate but for which we have the ability to exercise significant influence over operating and financial policies are reported under the equity method of accounting. Under the equity method of accounting, our share of the investee’s earnings or losses is included in our consolidated results of operations. The initial carrying value of investments in unconsolidated joint ventures is based on the amount paid to purchase the joint venture interest or the estimated fair value of the assets prior to the sale of interests in the joint venture. We evaluate our equity method investments for impairment based upon a comparison of the estimated fair value of the equity method investment to its carrying value. When we determine a decline in the estimated fair value of such an investment below its carrying value is other-than-temporary, an impairment is recorded.
 
Borrowing Policies
 
We utilize a combination of debt and equity to fund the purchase of new properties and to provide loan financing. Our debt and equity levels are determined by management to maintain a conservative credit profile. Generally, we intend to issue unsecured, fixed rate public debt with long-term maturities to approximate the maturities on our leases and loans. For short-term purposes, we may borrow on our unsecured line of credit arrangement. We replace these borrowings with long-term capital such as senior unsecured notes, common stock or preferred stock. When terms are deemed favorable, we may invest in properties subject to existing mortgage indebtedness. In addition, we may obtain secured financing for unleveraged properties in which we have invested or may refinance properties acquired on a leveraged basis. It is our intent to limit secured indebtedness. In our agreements with our lenders, we are subject to restrictions with respect to secured and unsecured indebtedness.
 
Competition
 
We compete with other real estate investment trusts, real estate partnerships, private equity and hedge fund investors, banks, insurance companies, finance/investment companies, government-sponsored agencies, taxable and tax-exempt bond funds, health care operators, developers and other investors in the acquisition, development, leasing and financing of health care and senior housing properties. Some of our competitors are larger with greater resources and lower costs of capital than us. Increased competition inhibits our ability to identify and successfully complete investments. We compete for investments based on a number of factors including rates, financings offered, underwriting criteria and reputation. Our ability to successfully compete is also impacted by economic and population trends, availability of acceptable investment opportunities, our ability to negotiate beneficial investment terms, availability and cost of capital, construction and renovation costs and new and existing laws and regulations.
 
The operators/tenants of our properties compete on a local and regional basis with operators/tenants of properties that provide comparable services. Operators/tenants compete for patients and residents based on a number of factors including quality of care, reputation, physical appearance of properties, services offered, family preferences, physicians, staff and price. We also face competition from other health care facilities for tenants, such as physicians and other health care providers that provide comparable facilities and services.


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For additional information on the risks associated with our business, please see “Item 1A — Risk Factors” of this Annual Report on Form 10-K.
 
Employees
 
As of December 31, 2009, we had 217 employees.
 
Customer Concentrations
 
The following table summarizes certain information about our customer concentrations as of December 31, 2009 (dollars in thousands):
 
                         
    Number of
    Total
    Percent of
 
    Properties     Investment     Investment(1)  
 
Concentration by investment:
                       
Senior Living Communities, LLC
    10     $ 419,406       7 %
Brookdale Senior Living, Inc
    86       310,126       5 %
Signature Healthcare LLC
    32       270,775       5 %
Emeritus Corporation
    21       241,288       4 %
Life Care Centers of America, Inc. 
    18       204,558       3 %
Remaining portfolio
    423       4,639,650       76 %
                         
Totals
    590     $ 6,085,803       100 %
                         
 
 
(1) Investments with our top five customers comprised 25% of total investments at December 31, 2008.
 
Certain Government Regulations
 
Health Law Matters — Generally
 
Typically, operators of assisted living and independent living facilities do not receive significant funding from governmental programs and are regulated by the applicable state, not the federal government. Operators of skilled nursing facilities and hospitals do receive significant funding from governmental programs and are subject to federal and state laws that regulate the type and quality of the medical and/or nursing care provided, ancillary services (e.g., respiratory, occupational, physical and infusion therapies), qualifications of the administrative personnel and nursing staff, the adequacy of the physical plant and equipment, reimbursement and rate setting and operating policies. In addition, as described below, operators are subject to extensive laws and regulations pertaining to health care fraud and abuse, including kickbacks, physician self-referrals and false claims. Hospitals, physician group practice clinics, and other health care providers that operate in our portfolio are subject to extensive federal, state and local licensure, certification, and inspection laws and regulations. Our tenants’ failure to comply with any of these laws could result in loss of accreditation, denial of reimbursement, imposition of fines, suspension or decertification or exclusion from federal and state health care programs, loss of license or closure of the facility.
 
Licensing and Certification
 
The primary regulations that affect assisted living facilities are state licensing laws. In granting and renewing these licenses, the regulatory authorities consider numerous factors relating to a property’s physical plant and operations including, but not limited to, admission and discharge standards and staffing and training. A decision to grant or renew a license is also affected by a property’s record with respect to patient and consumer rights and medication guidelines and rules. Certain of the senior housing facilities mortgaged to or owned by us may require the resident to pay an entrance or upfront fee, a portion of which may be refundable. These entrance fee communities are subject to significant state regulatory oversight, including, for example, oversight of each facility’s financial condition, establishment and monitoring of reserve requirements and other financial restrictions, the right of residents to cancel their contracts within a specified period of time, lien rights in favor of residents, restrictions on change of ownership and similar matters. Such oversight and the rights of residents within these


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entrance fee communities may have an effect on the revenue or operations of the operators of such facilities and therefore may adversely affect us.
 
Skilled nursing facilities are subject to a variety of licensure and certificate of need (“CON”) laws and regulations. CON laws in those states that have them generally require a facility to demonstrate the need for constructing a new facility, adding beds or expanding an existing facility, investing in major capital equipment or adding new services, changing the ownership or control of an existing licensed facility, or terminating services that have been previously approved through the CON process. The CON laws and regulations may restrict the ability of operators to add new properties or expand an existing facility’s size or services. In addition, CON laws may constrain the ability of an operator to transfer responsibility for operating a particular facility to a new operator. If we have to replace a barred property operator (as discussed below), our ability to replace the operator may be affected by CON rules and policies governing changes in control.
 
With respect to licensure, generally our skilled nursing facilities and hospitals are required to be licensed and certified for participation in the Medicare, Medicaid, and other federal health care programs. This generally requires license renewals and compliance surveys on an annual or bi-annual basis. The failure of our operators to maintain or renew any required license or regulatory approval or the failure to correct serious survey deficiencies identified in compliance surveys could prevent them from continuing operations at a property. In addition, if a property is found out of compliance with the conditions of participation in Medicare, Medicaid or other health care programs, the property may be barred from participation in government reimbursement programs. Any of these occurrences may impair the ability of our operators to meet their obligations to us. If we have to replace a barred property operator, our ability to replace the operator may be affected by federal and state rules and policies governing changes in control. This may result in payment delays, an inability to find a replacement operator, a significant working capital commitment from us to a new operator or other difficulties.
 
Reimbursement
 
Assisted Living Facilities.  Approximately 21% of our rental revenues for the year ended December 31, 2009 were attributable to assisted living facilities. The majority of the revenues received by the operators of our assisted living facilities are from private pay sources. The remaining revenue source is primarily Medicaid under certain waiver programs. As a part of the Omnibus Budget Reconciliation Act (“OBRA”) of 1981, Congress established a waiver program enabling some states to offer Medicaid reimbursement to assisted living facilities as an alternative to institutional long-term care services. The provisions of OBRA and the subsequent OBRA Acts of 1987 and 1990 permit states to seek a waiver from typical Medicaid requirements to develop cost-effective alternatives to long-term care, including Medicaid payments for assisted living and home health. At December 31, 2009, four of our 22 assisted living operators received Medicaid reimbursement pursuant to Medicaid waiver programs. For the twelve months ended September 30, 2009, approximately 9% of the revenues at our assisted living facilities were from Medicaid reimbursement. There can be no guarantee that a state Medicaid program operating pursuant to a waiver will be able to maintain its waiver status.
 
Rates paid by self-pay residents are set by the facilities and are largely determined by local market conditions and operating costs. Generally, facilities receive a higher payment per day for a private pay resident than for a Medicaid beneficiary who requires a comparable level of care. The level of Medicaid reimbursement varies from state to state. Thus, the revenues generated by operators of our assisted living facilities may be adversely affected by payor mix, acuity level and changes in Medicaid eligibility and reimbursement levels. In addition, a state could lose its Medicaid waiver and no longer be permitted to utilize Medicaid dollars to reimburse for assisted living services. Changes in revenues could in turn have a material adverse effect on an operator’s ability to meet its obligations to us.
 
Skilled Nursing Facilities and Hospitals.  Skilled nursing facilities and hospitals typically receive most of their revenues from Medicare and Medicaid, with the balance representing private pay, including private insurance. Consequently, changes in federal or state reimbursement policies may also adversely affect an operator’s ability to cover its expenses, including our rent or debt service. Skilled nursing facilities and hospitals are subject to periodic pre- and post-payment reviews and other audits by federal and state authorities. A review or audit of claims of a property operator could result in recoupments, denials or delays of payments in the future, which could have a material adverse effect on the operator’s ability to meet its obligations to us. Due to the significant judgments and


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estimates inherent in payor settlement accounting, no assurance can be given as to the adequacy of any reserves maintained by our property operators for potential adjustments to reimbursements for payor settlements. Due to budgetary constraints, governmental payors may limit or reduce payments to skilled nursing facilities and hospitals. As a result of government reimbursement programs being subject to such budgetary pressures and legislative and administrative actions, an operator’s ability to meet its obligations to us may be significantly impaired.
 
Medicare Reimbursement and Skilled Nursing Facilities.  For the twelve months ended September 30, 2009, approximately 30% of the revenues at our skilled nursing facilities (which comprised 31% of our rental revenues for the year ended December 31, 2009) were from Medicare reimbursement. Skilled nursing facilities are reimbursed under the skilled nursing facility prospective payment system. This type of reimbursement program puts facilities at risk to the extent that their costs exceed the fixed payments under the prospective payment system. In addition, there is a risk that payments under the prospective payment system may be set too low, which could result in immediate financial difficulties for skilled nursing facilities and cause operators to seek bankruptcy protection. Skilled nursing facilities have had these types of difficulties since the implementation of the prospective payment system.
 
Skilled nursing facilities received a full Medicare market basket update of 3.4% for federal fiscal year 2009. The Centers for Medicare & Medicaid Services (“CMS”), an agency of the U.S. Department of Health and Human Services, has announced that skilled nursing facilities will receive an additional 1.1% net decrease in Medicare payments for fiscal year 2010. This 1.1% net decrease is the result of a 3.3% decrease in payments due to recalibration of the case-mix indexes combined with a 2.2% increase in payments through “market basket” changes for fiscal year 2010. Section 5008 of the Deficit Reduction Act of 2005 directs the Secretary (as defined in that statute) to conduct a demonstration program beginning January 1, 2008 assessing the costs and outcomes of patients discharged from hospitals in a variety of post-acute care settings, including skilled nursing facilities. The outcome of that demonstration program could lead to changes in Medicare coverage and reimbursement for post-acute care. It is not known how either the demonstration program, or any other changes in Medicare reimbursement or regulatory obligations that might be proposed, might impact tenants of the Company’s properties.
 
The Balanced Budget Act of 1997 mandated caps on Medicare reimbursement for certain therapy services. However, Congress imposed various moratoriums on the implementation of those caps. For 2010, the annual payment cap of $1,860 per patient applies to occupational therapy and a separate $1,860 cap applies to speech and physical therapy. Congress has permitted patients exceeding the cap to obtain additional Medicare coverage through a waiver program if the therapy is deemed medically necessary. The waiver program was historically extended, most recently by the Medicare Improvements for Patients and Providers Act of 2008 through December 31, 2009. Health care reform bills considered by Congress in 2009 would have extended this waiver program through at least 2010, but due to Congressional inactivity these provisions were not passed before the waiver expired on December 31, 2009. Patients will therefore need to use private funds to pay for the cost of therapy above the caps. If patients are unable to satisfy their out-of-pocket cost responsibility to reimburse an operator for services rendered, the operator’s ability to meet its obligations to us could be adversely impacted.
 
Medicare Reimbursement and Hospitals.  For the twelve months ended September 30, 2009, approximately 53% of the revenues at our hospitals (which comprised 8% of our rental revenues for the year ended December 31, 2009) were from Medicare. Hospitals generally are reimbursed by Medicare under the diagnosis related group prospective payment system reimbursement methodology for inpatient hospitals, the long-term acute care hospital prospective payment system for long-term acute care hospitals or the inpatient rehabilitation facility prospective payment system. Acute care hospitals provide a wide range of inpatient and outpatient services including, but not limited to, surgery, rehabilitation, therapy and clinical laboratories. Long-term acute care hospitals provide inpatient services for patients with complex medical conditions that require more intensive care, monitoring or emergency support than that available in most skilled nursing facilities. Inpatient rehabilitation facilities provide intensive rehabilitation services in an inpatient setting for patients requiring at least three hours of rehabilitation services a day.
 
With respect to Medicare’s diagnosis related group/outpatient prospective payment system methodology for regular hospitals, reimbursement for inpatient services is made on the basis of a fixed, prospective rate based on the principal diagnosis of the patient. Hospitals are at risk to the extent that their costs in treating a specific case exceed the fixed payment. The diagnosis related group reimbursement system was changed in 2008, with the expansion of


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diagnosis groups from 538 to 745 diagnosis related groups to greater reflect severity. One additional diagnosis related group was added in 2009, for a new total of 746. It is possible that this change in the DRG system will adversely impact reimbursement for some of our hospitals. In some cases, a hospital might be able to qualify for an outlier payment if the hospital’s losses exceed a threshold.
 
Medicaid Reimbursement.  Medicaid is a major payor source for residents in our skilled nursing facilities and hospitals. For the twelve months ended September 30, 2009, approximately 50% of the revenues of our skilled nursing facilities and 3% of the revenues of our hospitals were attributable to Medicaid payments. The federal government and the states share responsibility for financing Medicaid. The federal matching rate, known as the Federal Medical Assistance Percentage, varies by state based on relative per capita income, but is at least 50% in all states. On average, Medicaid is the largest component of total state spending, representing approximately 21% of total state spending. The percentage of Medicaid dollars used for long-term care varies from state to state due in part to different ratios of elderly population and eligibility requirements. Within certain federal guidelines, states have a wide range of discretion to determine eligibility and reimbursement methodology. Many states reimburse long-term care facilities using fixed daily rates, which are applied prospectively based on patient acuity and the historical costs incurred in providing patient care. Reasonable costs typically include allowances for staffing, administrative and general, and property and equipment (e.g., real estate taxes, depreciation and fair rental).
 
In most states, Medicaid does not fully reimburse the cost of providing skilled nursing services. Certain states are attempting to slow the rate of growth in Medicaid expenditures by freezing rates or restricting eligibility and benefits. At the beginning of state fiscal year 2010, states in which we have skilled nursing property investments held rates flat on average for fiscal year 2010. Our skilled nursing portfolio’s average Medicaid rate will likely vary throughout the year as states continue to make interim changes to their budgets and Medicaid funding. In addition, Medicaid rates may decline if revenues in a particular state are not sufficient to fund budgeted expenditures.
 
The Medicare Part D drug benefit became effective January 1, 2006. Nursing home residents dually eligible for Medicare (and enrolled in one of the new Part D plans) and Medicaid may now enroll and receive reimbursement for drugs through Medicare Part D rather than through Medicaid. Part D will result in increased administrative responsibilities for nursing home operators because enrollment in Part D is voluntary and residents have the choice of multiple prescription drug plans. Operators may also experience increased expenses to the extent that patients’ specific prescribed drugs may not be on the Part D drug plan formulary for the plan in which specific patients are enrolled.
 
The reimbursement methodologies applied to health care facilities continue to evolve. Federal and state authorities have considered and may seek to implement new or modified reimbursement methodologies that may negatively impact health care property operations. The impact of any such change, if implemented, may result in a material adverse effect on our skilled nursing and hospital property operations. No assurance can be given that current revenue sources or levels will be maintained. Accordingly, there can be no assurance that payments under a government reimbursement program are currently, or will be in the future, sufficient to fully reimburse the property operators for their operating and capital expenses. As a result, an operator’s ability to meet its obligations to us could be adversely impacted.
 
Finally, federal legislative efforts to reform the health care industry may have a significant impact on Medicare, Medicaid, and private insurance coverage and reimbursement for services provided by skilled nursing facilities and other health care providers. Any such health care reform could have a substantial and material adverse effect on all parties directly or indirectly involved in the health care system.
 
Other Related Laws
 
Skilled nursing facilities and hospitals (and assisted living or CCRC facilities that receive Medicaid payments) are subject to federal, state and local laws and regulations that govern the operations and financial and other arrangements that may be entered into by health care providers. Certain of these laws prohibit direct or indirect payments of any kind for the purpose of inducing or encouraging the referral of patients for medical products or services reimbursable by governmental programs. Other laws require providers to furnish only medically necessary services and submit to the government valid and accurate statements for each service. Still other laws require providers to comply with a variety of safety, health and other requirements relating to the condition of the licensed


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property and the quality of care provided. Sanctions for violations of these laws and regulations may include, but are not limited to, criminal and/or civil penalties and fines and a loss of licensure, immediate termination of governmental payments, and exclusion from eligibility for any governmental reimbursement. In certain circumstances, violation of these rules (such as those prohibiting abusive and fraudulent behavior) with respect to one property may subject other facilities under common control or ownership to sanctions, including exclusion from participation in the Medicare and Medicaid programs. In the ordinary course of its business, a property operator is regularly subjected to inquiries, investigations and audits by federal and state agencies that oversee these laws and regulations.
 
Each skilled nursing and hospital property (and any assisted living or CCRC property that receives Medicaid payments) is subject to the federal anti-kickback statute that generally prohibits persons from offering, providing, soliciting or receiving remuneration to induce either the referral of an individual or the furnishing of a good or service for which payment may be made under a federal health care program such as the Medicare and Medicaid programs. Skilled nursing facilities and hospitals are also subject to the federal Ethics in Patient Referral Act of 1989, commonly referred to as the Stark Law. The Stark Law generally prohibits the submission of claims to Medicare for payment if the claim results from a physician referral for certain designated services and the physician has a financial relationship with the health service provider that does not qualify under one of the exceptions for a financial relationship under the Stark Law. Similar prohibitions on physician self-referrals and submission of claims apply to state Medicaid programs. Further, skilled nursing facilities and hospitals (and assisted living or CCRC facilities that receive Medicaid payments) are subject to substantial financial penalties under the Civil Monetary Penalties Act and the False Claims Act and, in particular, actions under the False Claims Act’s “whistleblower” provisions. Private enforcement of health care fraud has increased due in large part to amendments to the False Claims Act that encourage private individuals to sue on behalf of the government. These whistleblower suits by private individuals, known as qui tam actions, may be filed by almost anyone, including present and former patients, nurses and other employees. Some cases have been brought under the federal False Claims Act asserting claims for treble damages and up to $11,000 per claim on the basis of the alleged failure of a nursing facility to meet applicable regulations relating to the operation of the nursing facility. Prosecutions, investigations or whistleblower actions could have a material adverse effect on a property operator’s liquidity, financial condition and results of operations which could adversely affect the ability of the operator to meet its obligations to us. Finally, various state false claim and anti-kickback laws also may apply to each property operator. Violation of any of the foregoing statutes can result in criminal and/or civil penalties that could have a material adverse effect on the ability of an operator to meet its obligations to us.
 
Other legislative developments over the past several years, including the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”), have greatly expanded the definition of health care fraud and related offenses and broadened its scope to include private health care plans in addition to government payors. Congress also has greatly increased funding for the Department of Justice, Federal Bureau of Investigation and the Office of the Inspector General of the Department of Health and Human Services to audit, investigate and prosecute suspected health care fraud. Moreover, a significant portion of the billions in health care fraud recoveries over the past several years has also been returned to government agencies to further fund their fraud investigation and prosecution efforts.
 
Additionally, other HIPAA provisions and regulations provide for communication of health information through standard electronic transaction formats and for the privacy and security of health information. In order to comply with the regulations, health care providers must undergo significant operational and technical changes. Operators also face significant financial exposure if they fail to maintain the privacy and security of medical records and personal, identifiable health information about individuals. The Health Information Technology for Economic and Clinical Health (“HITECH”) Act, passed in February 2009, modified the Secretary of Health and Human Services’ authority to impose civil money penalties for HIPAA violations occurring after February 18, 2009. HITECH directs the HHS Secretary to provide for periodic audits to ensure covered entities and their business associates (as that term is defined under HIPAA) comply with applicable HITECH requirements, increasing the likelihood that a HIPAA violation will result in an enforcement action. CMS issued an interim Final Rule effective November 2009 which conforms HIPAA enforcement regulations to the HITECH Act, increasing the maximum penalty to $1.5 million for certain types of violations.


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In November 2002, CMS began a national Nursing Home Quality Initiative (NHQI). Under this initiative, historical survey information, the NHQI Pilot Evaluation Report and the NHQI Overview is made available to the public on-line. The NHQI website provides consumer and provider information regarding the quality of care in nursing homes. The data allows consumers, providers, states and researchers to compare quality information that shows how well nursing homes are caring for their residents’ physical and clinical needs. The posted nursing home quality measures come from resident assessment data that nursing homes routinely collect on the residents at specified intervals during their stay. If the operators of nursing facilities are unable to achieve quality of care ratings that are comparable or superior to those of their competitors, they may lose market share to other facilities, reducing their revenues and adversely impacting their ability to make rental payments.
 
Finally, government investigation and enforcement of health care laws has increased dramatically over the past several years and is expected to continue. Some of these enforcement actions represent novel legal theories and expansions in the application of false claims laws. The costs for an operator of a health care property associated with both defending such enforcement actions and the undertakings in settlement agreements can be substantial and could have a material adverse effect on the ability of an operator to meet its obligations to us.
 
Environmental Laws
 
A wide variety of federal, state and local environmental and occupational health and safety laws and regulations affect health care facility operations or special medical properties. Under various federal, state and local environmental laws, ordinances and regulations, an owner of real property or a secured lender (such as the Company) may be liable for the costs of removal or remediation of hazardous or toxic substances at, under or disposed of in connection with such property, as well as other potential costs relating to hazardous or toxic substances (including government fines and damages for injuries to persons and adjacent property). The cost of any required remediation, removal, fines or personal or property damages and the owner’s or secured lender’s liability for such costs could exceed the value of the property, and/or the assets of the owner or secured lender. In addition, the presence of such substances, or the failure to properly dispose of or remediate such substances, may adversely affect the owner’s ability to sell or rent such property or to borrow using such property as collateral which, in turn, would reduce revenues.
 
Taxation
 
Federal Income Tax Considerations
 
The following summary of the taxation of the Company and the material federal tax consequences to the holders of our debt and equity securities is for general information only and is not tax advice. This summary does not address all aspects of taxation that may be relevant to certain types of holders of stock or securities (including, but not limited to, insurance companies, tax-exempt entities, financial institutions or broker-dealers, persons holding shares of common stock as part of a hedging, integrated conversion, or constructive sale transaction or a straddle, traders in securities that use a mark-to-market method of accounting for their securities, investors in pass-through entities and foreign corporations and persons who are not citizens or residents of the United States).
 
This summary does not discuss all of the aspects of U.S. federal income taxation that may be relevant to you in light of your particular investment or other circumstances. In addition, this summary does not discuss any state or local income taxation or foreign income taxation or other tax consequences. This summary is based on current U.S. federal income tax law. Subsequent developments in U.S. federal income tax law, including changes in law or differing interpretations, which may be applied retroactively, could have a material effect on the U.S. federal income tax consequences of purchasing, owning and disposing of our securities as set forth in this summary. Before you purchase our securities, you should consult your own tax advisor regarding the particular U.S. federal, state, local, foreign and other tax consequences of acquiring, owning and selling our securities.
 
General
 
We elected to be taxed as a real estate investment trust (a “REIT”) commencing with our first taxable year. We intend to continue to operate in such a manner as to qualify as a REIT, but there is no guarantee that we will qualify or remain qualified as a REIT for subsequent years. Qualification and taxation as a REIT depends upon our ability to


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meet a variety of qualification tests imposed under federal income tax law with respect to income, assets, distribution level and diversity of share ownership as discussed below under “— Qualification as a REIT.” There can be no assurance that we will be owned and organized and will operate in a manner so as to qualify or remain qualified.
 
In any year in which we qualify as a REIT, in general, we will not be subject to federal income tax on that portion of our REIT taxable income or capital gain that is distributed to stockholders. We may, however, be subject to tax at normal corporate rates on any taxable income or capital gain not distributed. If we elect to retain and pay income tax on our net long-term capital gain, stockholders are required to include their proportionate share of our undistributed long-term capital gain in income, but they will receive a refundable credit for their share of any taxes paid by us on such gain.
 
Despite the REIT election, we may be subject to federal income and excise tax as follows:
 
  •  To the extent that we do not distribute all of our net capital gain or distribute at least 90%, but less than 100%, of our “REIT taxable income,” as adjusted, we will be subject to tax on the undistributed amount at regular corporate tax rates;
 
  •  We may be subject to the “alternative minimum tax” (the “AMT”) on certain tax preference items to the extent that the AMT exceeds our regular tax;
 
  •  If we have net income from the sale or other disposition of “foreclosure property” that is held primarily for sale to customers in the ordinary course of business or other non-qualifying income from foreclosure property, such income will be taxed at the highest corporate rate;
 
  •  Any net income from prohibited transactions (which are, in general, sales or other dispositions of property held primarily for sale to customers in the ordinary course of business, other than dispositions of foreclosure property and dispositions of property due to an involuntary conversion) will be subject to a 100% tax;
 
  •  If we fail to satisfy either the 75% or 95% gross income tests (as discussed below), but nonetheless maintain our qualification as a REIT because certain other requirements are met, we will be subject to a 100% tax on an amount equal to (1) the gross income attributable to the greater of (i) 75% of our gross income over the amount of qualifying gross income for purposes of the 75% gross income test (discussed below) or (ii) 95% of our gross income (90% of our gross income for taxable years beginning on or before October 22, 2004) over the amount of qualifying gross income for purposes of the 95% gross income test (discussed below) multiplied by (2) a fraction intended to reflect our profitability;
 
  •  If we fail to distribute during each year at least the sum of (1) 85% of our REIT ordinary income for the year, (2) 95% of our REIT capital gain net income for such year (other than capital gain that we elect to retain and pay tax on) and (3) any undistributed taxable income from preceding periods, we will be subject to a 4% excise tax on the excess of such required distribution over amounts actually distributed; and
 
  •  We will be subject to a 100% tax on the amount of any rents from real property, deductions or excess interest paid to us by any of our “taxable REIT subsidiaries” that would be reduced through reallocation under certain federal income tax principles in order to more clearly reflect income of the taxable REIT subsidiary. See “— Qualification as a REIT — Investments in Taxable REIT Subsidiaries.”
 
If we acquire any assets from a corporation, which is or has been a “C” corporation, in a carryover basis transaction, we could be liable for specified liabilities that are inherited from the “C” corporation. A “C” corporation is generally defined as a corporation that is required to pay full corporate level federal income tax. If we recognize gain on the disposition of the assets during the ten-year period beginning on the date on which the assets were acquired by us, then, to the extent of the assets’ “built-in gain” (i.e., the excess of the fair market value of the asset over the adjusted tax basis in the asset, in each case determined as of the beginning of the ten-year period), we will be subject to tax on the gain at the highest regular corporate rate applicable. The results described in this paragraph with respect to the recognition of built-in gain assume that the built-in gain assets, at the time the built-in gain assets were subject to a conversion transaction (either where a “C” corporation elected REIT status or a REIT acquired the assets from a “C” corporation), were not treated as sold to an unrelated party and gain recognized.


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Qualification as a REIT
 
A REIT is defined as a corporation, trust or association:
 
  (1)  which is managed by one or more trustees or directors;
 
  (2)  the beneficial ownership of which is evidenced by transferable shares or by transferable certificates of beneficial interest;
 
  (3)  which would be taxable as a domestic corporation but for the federal income tax law relating to REITs;
 
  (4)  which is neither a financial institution nor an insurance company;
 
  (5)  the beneficial ownership of which is held by 100 or more persons in each taxable year of the REIT except for its first taxable year;
 
  (6)  not more than 50% in value of the outstanding stock of which is owned during the last half of each taxable year, excluding its first taxable year, directly or indirectly, by or for five or fewer individuals (which includes certain entities) (the “Five or Fewer Requirement”); and
 
  (7)  which meets certain income and asset tests described below.
 
Conditions (1) to (4), inclusive, must be met during the entire taxable year and 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. For purposes of conditions (5) and (6), pension funds and certain other tax-exempt entities are treated as individuals, subject to a “look-through” exception in the case of condition (6).
 
Based on publicly available information, we believe we have satisfied the share ownership requirements set forth in (5) and (6) above. In addition, Article VI of our Amended and Restated By-Laws provides for restrictions regarding ownership and transfer of shares. These restrictions are intended to assist us in continuing to satisfy the share ownership requirements described in (5) and (6) above. These restrictions, however, may not ensure that we will, in all cases, be able to satisfy the share ownership requirements described in (5) and (6) above.
 
We have complied with, and will continue to comply with, regulatory rules to send annual letters to certain of our stockholders requesting information regarding the actual ownership of our stock. If, despite sending the annual letters, we do not know, or after exercising reasonable diligence would not have known, whether we failed to meet the Five or Fewer Requirement, we will be treated as having met the Five or Fewer Requirement. If we fail to comply with these regulatory rules, we will be subject to a monetary penalty. If our failure to comply was due to intentional disregard of the requirement, the penalty would be increased. However, if our failure to comply were due to reasonable cause and not willful neglect, no penalty would be imposed.
 
We may own a number of properties through wholly owned subsidiaries. A corporation will qualify as a “qualified REIT subsidiary” if 100% of its stock is owned by a REIT, and the REIT does not elect to treat the subsidiary as a taxable REIT subsidiary. A “qualified REIT subsidiary” will not be treated as a separate corporation, and all assets, liabilities and items of income, deductions and credits of a “qualified REIT subsidiary” will be treated as assets, liabilities and items (as the case may be) of the REIT. A “qualified REIT subsidiary” is not subject to federal income tax, and our ownership of the voting stock of a qualified REIT subsidiary will not violate the restrictions against ownership of securities of any one issuer which constitute more than 10% of the value or total voting power of such issuer or more than 5% of the value of our total assets, as described below under “— Asset Tests.”
 
If we invest in a partnership, a limited liability company or a trust taxed as a partnership or as a disregarded entity, we will be deemed to own a proportionate share of the partnership’s, limited liability company’s or trust’s assets. Likewise, we will be treated as receiving our share of the income and loss of the partnership, limited liability company or trust, and the gross income will retain the same character in our hands as it has in the hands of the


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partnership, limited liability company or trust. These “look-through” rules apply for purposes of the income tests and assets tests described below.
 
Income Tests.  There are two separate percentage tests relating to our sources of gross income that we must satisfy for each taxable year.
 
  •  At least 75% of our gross income (excluding gross income from certain sales of property held primarily for sale) must be directly or indirectly derived each taxable year from “rents from real property,” other income from investments relating to real property or mortgages on real property or certain income from qualified temporary investments.
 
  •  At least 95% of our gross income (excluding gross income from certain sales of property held primarily for sale) must be directly or indirectly derived each taxable year from any of the sources qualifying for the 75% gross income test and from dividends (including dividends from taxable REIT subsidiaries) and interest.
 
For taxable years beginning on or before October 22, 2004, (1) payments to us under an interest rate swap or cap agreement, option, futures contract, forward rate agreement or any similar financial instrument entered into by us to reduce interest rate risk on indebtedness incurred or to be incurred and (2) gain from the sale or other disposition of any such investment are treated as income qualifying under the 95% gross income test. As to transactions entered into in taxable years beginning after October 22, 2004, any of our income from a “clearly identified” hedging transaction that is entered into by us in the normal course of business, directly or indirectly, to manage the risk of interest rate movements, price changes or currency fluctuations with respect to borrowings or obligations incurred or to be incurred by us, or such other risks that are prescribed by the Internal Revenue Service, is excluded from the 95% gross income test.
 
For transactions entered into after July 30, 2008, any of our income from a “clearly identified” hedging transaction that is entered into by us in the normal course of business, directly or indirectly, to manage the risk of interest rate movements, price changes or currency fluctuations with respect to borrowings or obligations incurred or to be incurred by us is excluded from the 95% and 75% gross income tests.
 
For transactions entered into after July 30, 2008, any of our income from a “clearly identified” hedging transaction entered into by us primarily to manage risk of currency fluctuations with respect to any item of income or gain that is included in gross income in the 95% and 75% gross income tests is excluded from the 95% and 75% gross income tests.
 
In general, a hedging transaction is “clearly identified” if (1) the transaction is identified as a hedging transaction before the end of the day on which it is entered into and (2) the items or risks being hedged are identified “substantially contemporaneously” with the hedging transaction. An identification is not substantially contemporaneous if it is made more than 35 days after entering into the hedging transaction.
 
As to gains and items of income recognized after July 30, 2008, “passive foreign exchange gain” for any taxable year will not constitute gross income for purposes of the 95% gross income test and “real estate foreign exchange gain” for any taxable year will not constitute gross income for purposes of the 75% gross income test. Real estate foreign exchange gain is foreign currency gain (as defined in Internal Revenue Code section 988(b)(1)) which is attributable to: (i) any qualifying item of income or gain for purposes of the 75% gross income test; (ii) the acquisition or ownership of obligations secured by mortgages on real property or interests in real property; or (iii) becoming or being the obligor under obligations secured by mortgages on real property or on interests in real property. Real estate foreign exchange gain also includes Internal Revenue Code section 987 gain attributable to a qualified business unit (a “QBU”) of a REIT if the QBU itself meets the 75% income test for the taxable year and the 75% asset test at the close of each quarter that the REIT has directly or indirectly held the QBU. Real estate foreign exchange gain also includes any other foreign currency gain as determined by the Secretary of the Treasury. Passive foreign exchange gain includes all real estate foreign exchange gain and foreign currency gain which is attributable to: (i) any qualifying item of income or gain for purposes of the 95% gross income test; (ii) the acquisition or ownership of obligations; (iii) becoming or being the obligor under obligations; and (iv) any other foreign currency gain as determined by the Secretary of the Treasury.


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Generally, other than income from “clearly identified” hedging transactions entered into by us in the normal course of business, any foreign currency gain derived by us from dealing, or engaging in substantial and regular trading, in securities will constitute gross income which does not qualify under the 95% or 75% gross income tests.
 
Rents received by us will qualify as “rents from real property” for purposes of satisfying the gross income tests for a REIT only if several conditions are met:
 
  •  The amount of rent must not be based in whole or in part on the income or profits of any person, although rents generally will not be excluded merely because they are based on a fixed percentage or percentages of receipts or sales.
 
  •  Rents received from a tenant will not qualify as rents from real property if the REIT, or an owner of 10% or more of the REIT, also directly or constructively owns 10% or more of the tenant, unless the tenant is our taxable REIT subsidiary and certain other requirements are met with respect to the real property being rented.
 
  •  If rent attributable to personal property leased in connection with a lease of real property is greater than 15% of the total rent received under the lease, then the portion of rent attributable to such personal property will not qualify as “rents from real property.”
 
  •  For rents to qualify as rents from real property, we generally must not furnish or render services to tenants, other than through a taxable REIT subsidiary or an “independent contractor” from whom we derive no income, except that we may directly provide services that are “usually or customarily rendered” in the geographic area in which the property is located in connection with the rental of real property for occupancy only, or are not otherwise considered “rendered to the occupant for his convenience.”
 
  •  For taxable years beginning after July 30, 2008, the REIT may lease qualified health care property (as defined in Internal Revenue Code section 856(e)(6)(D)) on an arm’s-length basis to a taxable REIT subsidiary if the property is operated on behalf of such subsidiary by a person who is an eligible independent contractor (as defined in Internal Revenue Code section 856(d)(9)(A)). Generally, the rent that the REIT receives from the taxable REIT subsidiary will be treated as “rents from real property.”
 
For taxable years beginning after August 5, 1997, a REIT has been permitted to render a de minimis amount of impermissible services to tenants and still treat amounts received with respect to that property as rent from real property. The amount received or accrued by the REIT during the taxable year for the impermissible services with respect to a property may not exceed 1% of all amounts received or accrued by the REIT directly or indirectly from the property. The amount received for any service or management operation for this purpose shall be deemed to be not less than 150% of the direct cost of the REIT in furnishing or rendering the service or providing the management or operation. Furthermore, impermissible services may be furnished to tenants by a taxable REIT subsidiary subject to certain conditions, and we may still treat rents received with respect to the property as rent from real property.
 
The term “interest” generally does not include any amount if the determination of the amount depends in whole or in part on the income or profits of any person, although an amount generally will not be excluded from the term “interest” solely by reason of being based on a fixed percentage of receipts or sales.
 
If we fail to satisfy one or both of the 75% or 95% gross income tests for any taxable year, we may nevertheless qualify as a REIT for such year if we are eligible for relief. For taxable years beginning on or before October 22, 2004, these relief provisions generally will be available if: (1) our failure to meet such tests was due to reasonable cause and not due to willful neglect; (2) we attach a schedule of the sources of our income to our return; and (3) any incorrect information on the schedule was not due to fraud with intent to evade tax. For taxable years beginning after October 22, 2004, these relief provisions generally will be available if (1) following our identification of the failure, we file a schedule for such taxable year describing each item of our gross income, and (2) the failure to meet such tests was due to reasonable cause and not due to willful neglect.
 
It is not now possible to determine the circumstances under which we may be entitled to the benefit of these relief provisions. If these relief provisions apply, a 100% tax is imposed on an amount equal to (a) the gross income attributable to (1) 75% of our gross income over the amount of qualifying gross income for purposes of the 75% income test and (2) 95% of our gross income (90% of our gross income for taxable years beginning on or before


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October 22, 2004) over the amount of qualifying gross income for purposes of the 95% income test, multiplied by (b) a fraction intended to reflect our profitability.
 
The Secretary of the Treasury is given broad authority to determine whether particular items of income or gain qualify or not under the 75% and 95% gross income tests, or are to be excluded from the measure of gross income for such purposes.
 
Asset Tests.  Within 30 days after the close of each quarter of our taxable year, we must also satisfy several tests relating to the nature and diversification of our assets determined in accordance with generally accepted accounting principles. At least 75% of the value of our total assets must be represented by real estate assets, cash, cash items (including receivables arising in the ordinary course of our operation), government securities and qualified temporary investments. Although the remaining 25% of our assets generally may be invested without restriction, we are prohibited from owning securities representing more than 10% of either the vote (the “10% vote test”) or value (the “10% value test”) of the outstanding securities of any issuer other than a qualified REIT subsidiary, another REIT or a taxable REIT subsidiary. Further, no more than 25% of the total assets may be represented by securities of one or more taxable REIT subsidiaries (the “25% asset test”) and no more than 5% of the value of our total assets may be represented by securities of any non-governmental issuer other than a qualified REIT subsidiary (the “5% asset test”), another REIT or a taxable REIT subsidiary. Each of the 10% vote test, the 10% value test and the 25% and 5% asset tests must be satisfied at the end of each quarter. There are special rules which provide relief if the value related tests are not satisfied due to changes in the value of the assets of a REIT.
 
For taxable years beginning after December 31, 2000, certain items are excluded from the 10% value test, including: (1) straight debt securities of an issuer (including straight debt that provides certain contingent payments); (2) any loan to an individual or an estate; (3) any rental agreement described in Section 467 of the Internal Revenue Code, other than with a “related person”; (4) any obligation to pay rents from real property; (5) certain securities issued by a state or any subdivision thereof, the District of Columbia, a foreign government, or any political subdivision thereof, or the Commonwealth of Puerto Rico; (6) any security issued by a REIT; and (7) any other arrangement that, as determined by the Secretary of the Treasury, is excepted from the definition of security (“excluded securities”). Special rules apply to straight debt securities issued by corporations and entities taxable as partnerships for federal income tax purposes. If a REIT, or its taxable REIT subsidiary, holds (1) straight debt securities of a corporate or partnership issuer and (2) securities of such issuer that are not excluded securities and have an aggregate value greater than 1% of such issuer’s outstanding securities, the straight debt securities will be included in the 10% value test.
 
For taxable years beginning after December 31, 2000, a REIT’s interest as a partner in a partnership is not treated as a security for purposes of applying the 10% value test to securities issued by the partnership. Further, any debt instrument issued by a partnership will not be a security for purposes of applying the 10% value test (1) to the extent of the REIT’s interest as a partner in the partnership and (2) if at least 75% of the partnership’s gross income (excluding gross income from prohibited transactions) would qualify for the 75% gross income test. For taxable years beginning after October 22, 2004, for purposes of the 10% value test, a REIT’s interest in a partnership’s assets is determined by the REIT’s proportionate interest in any securities issued by the partnership (other than the excluded securities described in the preceding paragraph).
 
For taxable years beginning after July 30, 2008, if the REIT or its QBU uses a foreign currency as its functional currency, the term “cash” includes such foreign currency, but only to the extent such foreign currency is (i) held for use in the normal course of the activities of the REIT or QBU which give rise to items of income or gain that are included in the 95% and 75% gross income tests or are directly related to acquiring or holding assets qualifying under the 75% asset test, and (ii) not held in connection with dealing or engaging in substantial and regular trading in securities.
 
With respect to corrections of failures for which the requirements for corrections are satisfied after October 22, 2004, regardless of whether such failures occurred in taxable years beginning on, before or after such date, as to violations of the 10% vote test, the 10% value test or the 5% asset test, a REIT may avoid disqualification as a REIT by disposing of sufficient assets to cure a violation that does not exceed the lesser of 1% of the REIT’s assets at the end of the relevant quarter or $10,000,000, provided that the disposition occurs within six months following the last day of the quarter in which the REIT first identified the assets. For violations of any of the REIT asset tests due to


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reasonable cause and not willful neglect that exceed the thresholds described in the preceding sentence, a REIT can avoid disqualification as a REIT after the close of a taxable quarter by taking certain steps, including disposition of sufficient assets within the six month period described above to meet the applicable asset test, paying a tax equal to the greater of $50,000 or the highest corporate tax rate multiplied by the net income generated by the non-qualifying assets during the period of time that the assets were held as non-qualifying assets and filing a schedule with the Internal Revenue Service that describes the non-qualifying assets.
 
Investments in Taxable REIT Subsidiaries.  For taxable years beginning after December 31, 2000, REITs may own more than 10% of the voting power and value of securities in taxable REIT subsidiaries. We and any taxable corporate entity in which we own an interest are allowed to jointly elect to treat such entity as a “taxable REIT subsidiary.”
 
Certain of our subsidiaries have elected to be treated as a taxable REIT subsidiary. Taxable REIT subsidiaries are subject to full corporate level federal taxation on their earnings but are permitted to engage in certain types of activities that cannot be performed directly by REITs without jeopardizing their REIT status. Our taxable REIT subsidiaries will attempt to minimize the amount of these taxes, but there can be no assurance whether or the extent to which measures taken to minimize taxes will be successful. To the extent our taxable REIT subsidiaries are required to pay federal, state or local taxes, the cash available for distribution as dividends to us from our taxable REIT subsidiaries will be reduced.
 
The amount of interest on related-party debt that a taxable REIT subsidiary may deduct is limited. Further, a 100% tax applies to any interest payments by a taxable REIT subsidiary to its affiliated REIT to the extent the interest rate is not commercially reasonable. A taxable REIT subsidiary is permitted to deduct interest payments to unrelated parties without any of these restrictions.
 
The Internal Revenue Service may reallocate costs between a REIT and its taxable REIT subsidiary where there is a lack of arm’s-length dealing between the parties. Any deductible expenses allocated away from a taxable REIT subsidiary would increase its tax liability. Further, any amount by which a REIT understates its deductions and overstates those of its taxable REIT subsidiary will, subject to certain exceptions, be subject to a 100% tax. Additional taxable REIT subsidiary elections may be made in the future for additional entities in which we own an interest.
 
Annual Distribution Requirements.  In order to avoid being taxed as a regular corporation, we are required to make distributions (other than capital gain distributions) to our stockholders which qualify for the dividends paid deduction in an amount at least equal to (1) the sum of (i) 90% of our “REIT taxable income” (computed without regard to the dividends paid deduction and our net capital gain) and (ii) 90% of the after-tax net income, if any, from foreclosure property, minus (2) a portion of certain items of non-cash income. These 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 tax return for that year and if paid on or before the first regular distribution payment after such declaration. The amount distributed must not be preferential. This means that every stockholder of the class of stock to which a distribution is made must be treated the same as every other stockholder of that class, and no class of stock may be treated otherwise than in accordance with its dividend rights as a class. To the extent that we do not distribute all of our net capital gain or distribute at least 90%, but less than 100%, of our “REIT taxable income,” as adjusted, we will be subject to tax on the undistributed amount at regular corporate tax rates. Finally, as discussed above, we may be subject to an excise tax if we fail to meet certain other distribution requirements. We intend to make timely distributions sufficient to satisfy these annual distribution requirements.
 
It is possible that, from time to time, we may not have sufficient cash or other liquid assets to meet the 90% distribution requirement, or to distribute such greater amount as may be necessary to avoid income and excise taxation, due to, among other things, (1) timing differences between (i) the actual receipt of income and actual payment of deductible expenses and (ii) the inclusion of income and deduction of expenses in arriving at our taxable income, or (2) the payment of severance benefits that may not be deductible to us. In the event that timing differences occur, we may find it necessary to arrange for borrowings or, if possible, pay dividends in the form of taxable stock dividends in order to meet the distribution requirement.


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Under certain circumstances, in the event of a deficiency determined by the Internal Revenue Service, we may be able to rectify a resulting failure to meet the distribution requirement for a year by paying “deficiency dividends” to stockholders in a later year, which may be included in our deduction for distributions paid for the earlier year. Thus, we may be able to avoid being taxed on amounts distributed as deficiency dividends; however, we will be required to pay applicable penalties and interest based upon the amount of any deduction taken for deficiency dividend distributions.
 
The Internal Revenue Service issued Revenue Procedure 2008-68, which provided temporary relief to publicly traded REITs seeking to preserve liquidity by electing cash/stock dividends. Under Revenue Procedure 2008-68, a REIT may treat the entire dividend, including the stock portion, as a taxable dividend distribution, thereby qualifying for the dividends-paid deduction, provided certain requirements are satisfied. The cash portion of the dividend may be as low as 10%. The Revenue Procedure, as amplified by Revenue Procedure 2010-12, applies to dividends declared on or before December 31, 2012, and with respect to a taxable year ending on or before December 31, 2011.
 
Failure to Qualify as a REIT
 
If we fail to qualify for taxation as a REIT in any taxable year, we will be subject to federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates. Distributions to stockholders in any year in which we fail to qualify as a REIT will not be deductible nor will any particular amount of distributions be required to be made in any year. All distributions to stockholders will be taxable as ordinary income to the extent of current and accumulated earnings and profits allocable to these distributions and, subject to certain limitations, will be eligible for the dividends received deduction for corporate stockholders. Unless entitled to relief under specific statutory provisions, we also will be disqualified from taxation as a REIT for the four taxable years following the year during which qualification was lost. It is not possible to state whether in all circumstances we would be entitled to statutory relief. Failure to qualify for even one year could result in our need to incur indebtedness or liquidate investments in order to pay potentially significant resulting tax liabilities.
 
In addition to the relief described above under “— Income Tests” and “— Asset Tests,” relief is available in the event that we violate a provision of the Internal Revenue Code that would result in our failure to qualify as a REIT if: (1) the violation is due to reasonable cause and not due to willful neglect; (2) we pay a penalty of $50,000 for each failure to satisfy the provision; and (3) the violation does not include a violation described under “— Income Tests” or “— Asset Tests” above. It is not now possible to determine the circumstances under which we may be entitled to the benefit of these relief provisions.
 
Federal Income Taxation of Holders of Our Stock
 
Treatment of Taxable U.S. Stockholders.  The following summary applies to you only if you are a “U.S. stockholder.” A “U.S. stockholder” is a holder of shares of stock who, for United States federal income tax purposes, is:
 
  •  a citizen or resident of the United States;
 
  •  a corporation, partnership or other entity classified as a corporation or partnership for these purposes, created or organized in or under the laws of the United States or of any political subdivision of the United States, including any state;
 
  •  an estate, the income of which is subject to United States federal income taxation regardless of its source; or
 
  •  a trust, if, in general, a U.S. court is able to exercise primary supervision over the trust’s administration and one or more U.S. persons, within the meaning of the Internal Revenue Code, has the authority to control all of the trust’s substantial decisions.
 
So long as we qualify for taxation as a REIT, distributions on shares of our stock made out of the current or accumulated earnings and profits allocable to these distributions (and not designated as capital gain dividends) will be includable as ordinary income for federal income tax purposes. None of these distributions will be eligible for the dividends received deduction for U.S. corporate stockholders.


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Generally, for taxable years ending after May 6, 2003 through December 31, 2010, the maximum marginal rate of tax payable by individuals on dividends received from corporations that are subject to a corporate level of tax is 15%. Except in limited circumstances, this tax rate will not apply to dividends paid to you by us on our shares, because generally we are not subject to federal income tax on the portion of our REIT taxable income or capital gains distributed to our stockholders. The reduced maximum federal income tax rate will apply to that portion, if any, of dividends received by you with respect to our shares that are attributable to: (1) dividends received by us from non-REIT corporations or other taxable REIT subsidiaries; (2) income from the prior year with respect to which we were required to pay federal corporate income tax during the prior year (if, for example, we did not distribute 100% of our REIT taxable income for the prior year); or (3) the amount of any earnings and profits that were distributed by us and accumulated in a non-REIT year.
 
Distributions that are designated as capital gain dividends will be taxed as long-term capital gains (to the extent they do not exceed our actual net capital gain for the taxable year), without regard to the period for which you held our stock. However, if you are a corporation, you may be required to treat a portion of some capital gain dividends as ordinary income.
 
If we elect to retain and pay income tax on any net long-term capital gain, you would include in income, as long-term capital gain, your proportionate share of this net long-term capital gain. You would also receive a refundable tax credit for your proportionate share of the tax paid by us on such retained capital gains, and you would have an increase in the basis of your shares of our stock in an amount equal to your includable capital gains less your share of the tax deemed paid.
 
You may not include in your federal income tax return any of our net operating losses or capital losses. Federal income tax rules may also require that certain minimum tax adjustments and preferences be apportioned to you. In addition, any distribution declared by us in October, November or December of any year on a specified date in any such month shall be treated as both paid by us and received by you on December 31 of that year, provided that the distribution is actually paid by us no later than January 31 of the following year.
 
We will be treated as having sufficient earnings and profits to treat as a dividend any distribution up to the amount required to be distributed in order to avoid imposition of the 4% excise tax discussed under “— General” and “— Qualification as a REIT — Annual Distribution Requirements” above. As a result, you may be required to treat as taxable dividends certain distributions that would otherwise result in a tax-free return of capital. Moreover, any “deficiency dividend” will be treated as a dividend (an ordinary dividend or a capital gain dividend, as the case may be), regardless of our earnings and profits. Any other distributions in excess of current or accumulated earnings and profits will not be taxable to you to the extent these distributions do not exceed the adjusted tax basis of your shares of our stock. You will be required to reduce the tax basis of your shares of our stock by the amount of these distributions until the basis has been reduced to zero, after which these distributions will be taxable as capital gain, if the shares of our stock are held as capital assets. The tax basis as so reduced will be used in computing the capital gain or loss, if any, realized upon sale of the shares of our stock. Any loss upon a sale or exchange of shares of our stock which were held for six months or less (after application of certain holding period rules) will generally be treated as a long-term capital loss to the extent you previously received capital gain distributions with respect to these shares of our stock.
 
Upon the sale or exchange of any shares of our stock to or with a person other than us or a sale or exchange of all shares of our stock (whether actually or constructively owned) with us, you will generally recognize capital gain or loss equal to the difference between the amount realized on the sale or exchange and your adjusted tax basis in these shares of our stock. This gain will be capital gain if you held these shares of our stock as a capital asset.
 
If we redeem any of your shares in us, the treatment can only be determined on the basis of particular facts at the time of redemption. In general, you will recognize gain or loss (as opposed to dividend income) equal to the difference between the amount received by you in the redemption and your adjusted tax basis in your shares redeemed if such redemption: (1) results in a “complete termination” of your interest in all classes of our equity securities; (2) is a “substantially disproportionate redemption”; or (3) is “not essentially equivalent to a dividend” with respect to you. In applying these tests, you must take into account your ownership of all classes of our equity securities (e.g., common stock, preferred stock, depositary shares and warrants). You also must take into account any equity securities that are considered to be constructively owned by you.


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If, as a result of a redemption by us of your shares, you no longer own (either actually or constructively) any of our equity securities or only own (actually and constructively) an insubstantial percentage of our equity securities, then it is probable that the redemption of your shares would be considered “not essentially equivalent to a dividend” and, thus, would result in gain or loss to you. However, whether a distribution is “not essentially equivalent to a dividend” depends on all of the facts and circumstances, and if you rely on any of these tests at the time of redemption, you should consult your tax advisor to determine their application to the particular situation.
 
Generally, if the redemption does not meet the tests described above, then the proceeds received by you from the redemption of your shares will be treated as a distribution taxable as a dividend to the extent of the allocable portion of current or accumulated earnings and profits. If the redemption is taxed as a dividend, your adjusted tax basis in the redeemed shares will be transferred to any other shareholdings in us that you own. If you own no other shareholdings in us, under certain circumstances, such basis may be transferred to a related person, or it may be lost entirely.
 
Gain from the sale or exchange of our shares held for more than one year is taxed at a maximum long-term capital gain rate, which is currently 15%. Pursuant to Internal Revenue Service guidance, we may classify portions of our capital gain dividends as gains eligible for the long-term capital gains rate or as gain taxable to individual stockholders at a maximum rate of 25%.
 
Treatment of Tax-Exempt U.S. Stockholders.  Tax-exempt entities, including qualified employee pension and profit sharing trusts and individual retirement accounts (“Exempt Organizations”), generally are exempt from federal income taxation. However, they are subject to taxation on their unrelated business taxable income (“UBTI”). The Internal Revenue Service has issued a published revenue ruling that dividend distributions from a REIT to an exempt employee pension trust do not constitute UBTI, provided that the shares of the REIT are not otherwise used in an unrelated trade or business of the exempt employee pension trust. Based on this ruling, amounts distributed by us to Exempt Organizations generally should not constitute UBTI. However, if an Exempt Organization finances its acquisition of the shares of our stock with debt, a portion of its income from us will constitute UBTI pursuant to the “debt financed property” rules. Likewise, a portion of the Exempt Organization’s income from us would constitute UBTI if we held a residual interest in a real estate mortgage investment conduit.
 
In addition, in certain circumstances, a pension trust that owns more than 10% of our stock is required to treat a percentage of our dividends as UBTI. This rule applies to a pension trust holding more than 10% of our stock only if: (1) the percentage of our income that is UBTI (determined as if we were a pension trust) is at least 5%; (2) we qualify as a REIT by reason of the modification of the Five or Fewer Requirement that allows beneficiaries of the pension trust to be treated as holding shares in proportion to their actuarial interests in the pension trust; and (3) either (i) one pension trust owns more than 25% of the value of our stock, or (ii) a group of pension trusts individually holding more than 10% of the value of our stock collectively own more than 50% of the value of our stock.
 
Backup Withholding and Information Reporting.  Under certain circumstances, you may be subject to backup withholding at applicable rates on payments made with respect to, or cash proceeds of a sale or exchange of, shares of our stock. Backup withholding will apply only if you: (1) fail to provide a correct taxpayer identification number, which if you are an individual, is ordinarily your social security number; (2) furnish an incorrect taxpayer identification number; (3) are notified by the Internal Revenue Service that you have failed to properly report payments of interest or dividends; or (4) fail to certify, under penalties of perjury, that you have furnished a correct taxpayer identification number and that the Internal Revenue Service has not notified you that you are subject to backup withholding.
 
Backup withholding will not apply with respect to payments made to certain exempt recipients, such as corporations and tax-exempt organizations. You should consult with a tax advisor regarding qualification for exemption from backup withholding, and the procedure for obtaining an exemption. Backup withholding is not an additional tax. Rather, the amount of any backup withholding with respect to a payment to a stockholder will be allowed as a credit against such stockholder’s United States federal income tax liability and may entitle such stockholder to a refund, provided that the required information is provided to the Internal Revenue Service. In addition, withholding a portion of capital gain distributions made to stockholders may be required for stockholders who fail to certify their non-foreign status.


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Taxation of Foreign Stockholders.  The following summary applies to you only if you are a foreign person. The federal taxation of foreign persons is a highly complex matter that may be affected by many considerations.
 
Except as discussed below, distributions to you of cash generated by our real estate operations in the form of ordinary dividends, but not by the sale or exchange of our capital assets, generally will be subject to U.S. withholding tax at a rate of 30%, unless an applicable tax treaty reduces that tax and you file with us the required form evidencing the lower rate.
 
In general, you will be subject to United States federal income tax on a graduated rate basis rather than withholding with respect to your investment in our stock if such investment is “effectively connected” with your conduct of a trade or business in the United States. A corporate foreign stockholder that receives income that is, or is treated as, effectively connected with a United States trade or business may also be subject to the branch profits tax, which is payable in addition to regular United States corporate income tax. The following discussion will apply to foreign stockholders whose investment in us is not so effectively connected. We expect to withhold United States income tax, as described below, on the gross amount of any distributions paid to you unless (1) you file an Internal Revenue Service Form W-8ECI with us claiming that the distribution is “effectively connected” or (2) certain other exceptions apply.
 
Distributions by us that are attributable to gain from the sale or exchange of a United States real property interest will be taxed to you under the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”) as if these distributions were gains “effectively connected” with a United States trade or business. Accordingly, you will be taxed at the normal capital gain rates applicable to a U.S. stockholder on these amounts, subject to any applicable alternative minimum tax and a special alternative minimum tax in the case of nonresident alien individuals. Distributions subject to FIRPTA may also be subject to a branch profits tax in the hands of a corporate foreign stockholder that is not entitled to treaty exemption.
 
We will be required to withhold from distributions subject to FIRPTA, and remit to the Internal Revenue Service, 35% of designated capital gain dividends, or, if greater, 35% of the amount of any distributions that could be designated as capital gain dividends. In addition, if we designate prior distributions as capital gain dividends, subsequent distributions, up to the amount of the prior distributions not withheld against, will be treated as capital gain dividends for purposes of withholding.
 
For taxable years beginning after October 22, 2004, any capital gain dividend with respect to any class of stock that is “regularly traded” on an established securities market will be treated as an ordinary dividend if the foreign stockholder did not own more than 5% of such class of stock at any time during the taxable year. Once this provision takes effect, foreign stockholders generally will not be required to report distributions received from us on U.S. federal income tax returns and all distributions treated as dividends for U.S. federal income tax purposes including any capital gain dividend will be subject to a 30% U.S. withholding tax (unless reduced under an applicable income tax treaty) as discussed above. In addition, the branch profits tax will no longer apply to such distributions.
 
Unless our shares constitute a “United States real property interest” within the meaning of FIRPTA or are effectively connected with a U.S. trade or business, a sale of our shares by you generally will not be subject to United States taxation. Our shares will not constitute a United States real property interest if we qualify as a “domestically controlled REIT.” We believe that we, and expect to continue to, qualify as a domestically controlled REIT. A domestically controlled REIT is a REIT in which at all times during a specified testing period less than 50% in value of its shares is held directly or indirectly by foreign stockholders. However, if you are a nonresident alien individual who is present in the United States for 183 days or more during the taxable year and certain other conditions apply, you will be subject to a 30% tax on such capital gains. In any event, a purchaser of our shares from you will not be required under FIRPTA to withhold on the purchase price if the purchased shares are “regularly traded” on an established securities market or if we are a domestically controlled REIT. Otherwise, under FIRPTA, the purchaser may be required to withhold 10% of the purchase price and remit such amount to the Internal Revenue Service.
 
Backup withholding tax and information reporting will generally not apply to distributions paid to you outside the United States that are treated as: (1) dividends to which the 30% or lower treaty rate withholding tax discussed


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above applies; (2) capital gains dividends; or (3) distributions attributable to gain from the sale or exchange by us of U.S. real property interests. Payment of the proceeds of a sale of stock within the United States or conducted through certain U.S. related financial intermediaries is subject to both backup withholding and information reporting unless the beneficial owner certifies under penalties of perjury that he or she is not a U.S. person (and the payor does not have actual knowledge that the beneficial owner is a U.S. person) or otherwise established an exemption. You may obtain a refund of any amounts withheld under the backup withholding rules by filing the appropriate claim for refund with the Internal Revenue Service.
 
U.S. Federal Income Taxation of Holders of Depositary Shares
 
Owners of our depositary shares will be treated as if you were owners of the series of preferred stock represented by the depositary shares. Thus, you will be required to take into account the income and deductions to which you would be entitled if you were a holder of the underlying series of preferred stock.
 
Conversion or Exchange of Shares for Preferred Stock.  No gain or loss will be recognized upon the withdrawal of preferred stock in exchange for depositary shares and the tax basis of each share of preferred stock will, upon exchange, be the same as the aggregate tax basis of the depositary shares exchanged. If you held your depositary shares as a capital asset at the time of the exchange for shares of preferred stock, the holding period for your shares of preferred stock will include the period during which you owned the depositary shares.
 
U.S. Federal Income and Estate Taxation of Holders of Our Debt Securities
 
The following is a general summary of the United States federal income tax consequences and, in the case that you are a holder that is a non-U.S. holder, as defined below, the United States federal estate tax consequences, of purchasing, owning and disposing of debt securities periodically offered under one or more indentures (the “notes”). This summary assumes that you hold the notes as capital assets. This summary applies to you only if you are the initial holder of the notes and you acquire the notes for a price equal to the issue price of the notes. The issue price of the notes is the first price at which a substantial amount of the notes is sold other than to bond houses, brokers or similar persons or organizations acting in the capacity of underwriters, placement agents or wholesalers. In addition, this summary does not consider any foreign, state, local or other tax laws that may be applicable to us or a purchaser of the notes.
 
U.S. Holders
 
The following summary applies to you only if you are a U.S. holder, as defined below.
 
Definition of a U.S. Holder.  A “U.S. holder” is a beneficial owner of a note or notes that is for United States federal income tax purposes:
 
  •  a citizen or resident of the United States;
 
  •  a corporation, partnership or other entity classified as a corporation or partnership for these purposes, created or organized in or under the laws of the United States or of any political subdivision of the United States, including any state;
 
  •  an estate, the income of which is subject to United States federal income taxation regardless of its source; or
 
  •  a trust, if, in general, a U.S. court is able to exercise primary supervision over the trust’s administration and one or more U.S. persons, within the meaning of the Internal Revenue Code, has the authority to control all of the trust’s substantial decisions.
 
Payments of Interest.  Stated interest on the notes generally will be taxed as ordinary interest income from domestic sources at the time it is paid or accrues in accordance with your method of accounting for tax purposes.


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Sale, Exchange or Other Disposition of Notes.  The adjusted tax basis in your note acquired at a premium will generally be your cost. You generally will recognize taxable gain or loss when you sell or otherwise dispose of your notes equal to the difference, if any, between:
 
  •  the amount realized on the sale or other disposition, less any amount attributable to any accrued interest, which will be taxable in the manner described under “— Payments of Interest” above; and
 
  •  your adjusted tax basis in the notes.
 
Your gain or loss generally will be capital gain or loss. This capital gain or loss will be long-term capital gain or loss if at the time of the sale or other disposition you have held the notes for more than one year. Subject to limited exceptions, your capital losses cannot be used to offset your ordinary income.
 
Backup Withholding and Information Reporting.  In general, “backup withholding” may apply to any payments made to you of principal and interest on your note, and to payment of the proceeds of a sale or other disposition of your note before maturity, if you are a non-corporate U.S. holder and: (1) fail to provide a correct taxpayer identification number, which if you are an individual, is ordinarily your social security number; (2) furnish an incorrect taxpayer identification number; (3) are notified by the Internal Revenue Service that you have failed to properly report payments of interest or dividends; or (4) fail to certify, under penalties of perjury, that you have furnished a correct taxpayer identification number and that the Internal Revenue Service has not notified you that you are subject to backup withholding.
 
The amount of any reportable payments, including interest, made to you (unless you are an exempt recipient) and the amount of tax withheld, if any, with respect to such payments will be reported to you and to the Internal Revenue Service for each calendar year. You should consult your tax advisor regarding your qualification for an exemption from backup withholding and the procedures for obtaining such an exemption, if applicable. The backup withholding tax is not an additional tax and will be credited against your U.S. federal income tax liability, provided that correct information is provided to the Internal Revenue Service.
 
Non-U.S. Holders
 
The following summary applies to you if you are a beneficial owner of a note and are not a U.S. holder, as defined above (a “non-U.S. holder”).
 
Special rules may apply to certain non-U.S. holders such as “controlled foreign corporations,” “passive foreign investment companies” and “foreign personal holding companies.” Such entities are encouraged to consult their tax advisors to determine the United States federal, state, local and other tax consequences that may be relevant to them.
 
U.S. Federal Withholding Tax.  Subject to the discussion below, U.S. federal withholding tax will not apply to payments by us or our paying agent, in its capacity as such, of principal and interest on your notes under the “portfolio interest” exception of the Internal Revenue Code, provided that:
 
  •  you do not, directly or indirectly, actually or constructively, own 10% or more of the total combined voting power of all classes of our stock entitled to vote;
 
  •  you are not (1) a controlled foreign corporation for U.S. federal income tax purposes that is related, directly or indirectly, to us through sufficient stock ownership, as provided in the Internal Revenue Code, or (2) a bank receiving interest described in Section 881(c)(3)(A) of the Internal Revenue Code;
 
  •  such interest is not effectively connected with your conduct of a U.S. trade or business; and
 
  •  you provide a signed written statement, under penalties of perjury, which can reliably be related to you, certifying that you are not a U.S. person within the meaning of the Internal Revenue Code and providing your name and address to:
 
  •  us or our paying agent; or
 
  •  a securities clearing organization, bank or other financial institution that holds customers’ securities in the ordinary course of its trade or business and holds your notes on your behalf and that certifies to us or our paying agent under penalties of perjury that it, or the bank or financial institution between it and you, has


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  received from you your signed, written statement and provides us or our paying agent with a copy of such statement.
 
Treasury regulations provide that:
 
  •  if you are a foreign partnership, the certification requirement will generally apply to your partners, and you will be required to provide certain information;
 
  •  if you are a foreign trust, the certification requirement will generally be applied to you or your beneficial owners depending on whether you are a “foreign complex trust,” “foreign simple trust,” or “foreign grantor trust” as defined in the Treasury regulations; and
 
  •  look-through rules will apply for tiered partnerships, foreign simple trusts and foreign grantor trusts.
 
If you are a foreign partnership or a foreign trust, you should consult your own tax advisor regarding your status under these Treasury regulations and the certification requirements applicable to you.
 
If you cannot satisfy the portfolio interest requirements described above, payments of interest will be subject to the 30% United States withholding tax, unless you provide us with a properly executed (1) Internal Revenue Service Form W-8BEN claiming an exemption from or reduction in withholding under the benefit of an applicable treaty or (2) Internal Revenue Service Form W-8ECI stating that interest paid on the note is not subject to withholding tax because it is effectively connected with your conduct of a trade or business in the United States. Alternative documentation may be applicable in certain circumstances.
 
If you are engaged in a trade or business in the United States and interest on a note is effectively connected with the conduct of that trade or business, you will be required to pay United States federal income tax on that interest on a net income basis (although you will be exempt from the 30% withholding tax provided the certification requirement described above is met) in the same manner as if you were a U.S. person, except as otherwise provided by an applicable tax treaty. If you are a foreign corporation, you may be required to pay a branch profits tax on the earnings and profits that are effectively connected to the conduct of your trade or business in the United States.
 
Sale, Exchange or other Disposition of Notes.  You generally will not have to pay U.S. federal income tax on any gain or income realized from the sale, redemption, retirement at maturity or other disposition of your notes, unless:
 
  •  in the case of gain, you are an individual who is present in the United States for 183 days or more during the taxable year of the sale or other disposition of your notes, and specific other conditions are met;
 
  •  you are subject to tax provisions applicable to certain United States expatriates; or
 
  •  the gain is effectively connected with your conduct of a U.S. trade or business.
 
If you are engaged in a trade or business in the United States, and gain with respect to your notes is effectively connected with the conduct of that trade or business, you generally will be subject to U.S. income tax on a net basis on the gain. In addition, if you are a foreign corporation, you may be subject to a branch profits tax on your effectively connected earnings and profits for the taxable year, as adjusted for certain items.
 
U.S. Federal Estate Tax.  If you are an individual and are not a U.S. citizen or a resident of the United States, as specially defined for U.S. federal estate tax purposes, at the time of your death, your notes will generally not be subject to the U.S. federal estate tax, unless, at the time of your death (1) you owned actually or constructively 10% or more of the total combined voting power of all our classes of stock entitled to vote, or (2) interest on the notes is effectively connected with your conduct of a U.S. trade or business.
 
Backup Withholding and Information Reporting.  Backup withholding will not apply to payments of principal or interest made by us or our paying agent, in its capacity as such, to you if you have provided the required certification that you are a non-U.S. holder as described in “— U.S. Federal Withholding Tax” above, and provided that neither we nor our paying agent have actual knowledge that you are a U.S. holder, as described in “— U.S. Holders” above. We or our paying agent may, however, report payments of interest on the notes.


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The gross proceeds from the disposition of your notes may be subject to information reporting and backup withholding tax. If you sell your notes outside the United States through a non-U.S. office of a non-U.S. broker and the sales proceeds are paid to you outside the United States, then the U.S. backup withholding and information reporting requirements generally will not apply to that payment. However, U.S. information reporting, but not backup withholding, will apply to a payment of sales proceeds, even if that payment is made outside the United States, if you sell your notes through a non-U.S. office of a broker that:
 
  •  is a U.S. person, as defined in the Internal Revenue Code;
 
  •  derives 50% or more of its gross income in specific periods from the conduct of a trade or business in the United States;
 
  •  is a “controlled foreign corporation” for U.S. federal income tax purposes; or
 
  •  is a foreign partnership, if at any time during its tax year, one or more of its partners are U.S. persons who in the aggregate hold more than 50% of the income or capital interests in the partnership, or the foreign partnership is engaged in a U.S. trade or business, unless the broker has documentary evidence in its files that you are a non-U.S. person and certain other conditions are met or you otherwise establish an exemption. If you receive payments of the proceeds of a sale of your notes to or through a U.S. office of a broker, the payment is subject to both U.S. backup withholding and information reporting unless you provide a Form W-8BEN certifying that you are a non-U.S. person or you otherwise establish an exemption.
 
You should consult your own tax advisor regarding application of backup withholding in your particular circumstance and the availability of and procedure for obtaining an exemption from backup withholding. Any amounts withheld under the backup withholding rules from a payment to you will be allowed as a refund or credit against your U.S. federal income tax liability, provided the required information is furnished to the Internal Revenue Service.
 
U.S. Federal Income and Estate Taxation of Holders of Our Warrants
 
Exercise of Warrants.  You will not generally recognize gain or loss upon the exercise of a warrant. Your basis in the debt securities, preferred stock, depositary shares or common stock, as the case may be, received upon the exercise of the warrant will be equal to the sum of your adjusted tax basis in the warrant and the exercise price paid. Your holding period in the debt securities, preferred stock, depositary shares or common stock, as the case may be, received upon the exercise of the warrant will not include the period during which the warrant was held by you.
 
Expiration of Warrants.  Upon the expiration of a warrant, you will recognize a capital loss in an amount equal to your adjusted tax basis in the warrant.
 
Sale or Exchange of Warrants.  Upon the sale or exchange of a warrant to a person other than us, you will recognize gain or loss in an amount equal to the difference between the amount realized on the sale or exchange and your adjusted tax basis in the warrant. Such gain or loss will be capital gain or loss and will be long-term capital gain or loss if the warrant was held for more than one year. Upon the sale of the warrant to us, the Internal Revenue Service may argue that you should recognize ordinary income on the sale. You are advised to consult your own tax advisors as to the consequences of a sale of a warrant to us.
 
Potential Legislation or Other Actions Affecting Tax Consequences
 
Current and prospective securities holders should recognize that the present federal income tax treatment of an investment in us may be modified by legislative, judicial or administrative action at any time and that any such action may affect investments and commitments previously made. The rules dealing with federal income taxation are constantly under review by persons involved in the legislative process and by the Internal Revenue Service and the Treasury Department, resulting in revisions of regulations and revised interpretations of established concepts as well as statutory changes. Revisions in federal tax laws and interpretations of these laws could adversely affect the tax consequences of an investment in us.


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Internet Access to Our SEC Filings
 
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports, as well as our proxy statements and other materials that are filed with, or furnished to, the Securities and Exchange Commission are made available, free of charge, on the Internet at www.hcreit.com, as soon as reasonably practicable after they are filed with, or furnished to, the Securities and Exchange Commission.
 
Item 1A.   Risk Factors
 
Forward-Looking Statements and Risk Factors
 
This section discusses the most significant factors that affect our business, operations and financial condition. It does not describe all risks and uncertainties applicable to us, our industry or ownership of our securities. If any of the following risks, as well as other risks and uncertainties that are not yet identified or that we currently think are not material, actually occur, we could be materially adversely affected. In that event, the value of our securities could decline.
 
This Annual Report on Form 10-K and the documents incorporated by reference contain statements that constitute “forward-looking statements” as that term is defined in the federal securities laws. These forward-looking statements include, but are not limited to, those regarding:
 
  •  the possible expansion of our portfolio;
 
  •  the sale of properties;
 
  •  the performance of our operators/tenants and properties;
 
  •  our ability to enter into agreements with new viable tenants for vacant space or for properties that we take back from financially troubled tenants, if any;
 
  •  our occupancy rates;
 
  •  our ability to acquire, develop and/or manage properties;
 
  •  our ability to make distributions to stockholders;
 
  •  our policies and plans regarding investments, financings and other matters;
 
  •  our tax status as a real estate investment trust;
 
  •  our critical accounting policies;
 
  •  our ability to appropriately balance the use of debt and equity;
 
  •  our ability to access capital markets or other sources of funds; and
 
  •  our ability to meet our earnings guidance.
 
When we use words such as “may,” “will,” “intend,” “should,” “believe,” “expect,” “anticipate,” “project,” “estimate” or similar expressions, we are making forward-looking statements. Forward-looking statements are not guarantees of future performance and involve risks and uncertainties. Our expected results may not be achieved, and actual results may differ materially from our expectations. This may be a result of various factors, including, but not limited to:
 
  •  the status of the economy;
 
  •  the status of capital markets, including availability and cost of capital;
 
  •  issues facing the health care industry, including compliance with, and changes to, regulations and payment policies, responding to government investigations and punitive settlements and operators’/tenants’ difficulty in cost-effectively obtaining and maintaining adequate liability and other insurance;
 
  •  changes in financing terms;


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  •  competition within the health care and senior housing industries;
 
  •  negative developments in the operating results or financial condition of operators/tenants, including, but not limited to, their ability to pay rent and repay loans;
 
  •  our ability to transition or sell facilities with profitable results;
 
  •  the failure to make new investments as and when anticipated;
 
  •  acts of God affecting our properties;
 
  •  our ability to re-lease space at similar rates as vacancies occur;
 
  •  our ability to timely reinvest sale proceeds at similar rates to assets sold;
 
  •  operator/tenant bankruptcies or insolvencies;
 
  •  government regulations affecting Medicare and Medicaid reimbursement rates and operational requirements;
 
  •  liability or contract claims by or against operators/tenants;
 
  •  unanticipated difficulties and/or expenditures relating to future acquisitions;
 
  •  environmental laws affecting our properties;
 
  •  changes in rules or practices governing our financial reporting;
 
  •  other legal and operational matters, including REIT qualification and key management personnel recruitment and retention; and
 
  •  the risks described below:
 
Risk factors related to our operators’ revenues and expenses
 
Our investment property operators’ revenues are primarily driven by occupancy, Medicare and Medicaid reimbursement, if applicable, and private pay rates. Expenses for these facilities are primarily driven by the costs of labor, food, utilities, taxes, insurance and rent or debt service. Revenues from government reimbursement have, and may continue to, come under pressure due to reimbursement cuts and state budget shortfalls. Liability insurance and staffing costs continue to increase for our operators. To the extent that any decrease in revenues and/or any increase in operating expenses result in a property not generating enough cash to make payments to us, the credit of our operator and the value of other collateral would have to be relied upon.
 
The ongoing credit and liquidity crisis, and the weakening economy, may have an adverse effect on our operators and tenants, including their ability to access credit or maintain occupancy rates. If the operations, cash flows or financial condition of our operators are materially adversely impacted by the current economic conditions, our revenue and operations may be adversely affected.
 
Increased competition may affect our operators’ ability to meet their obligations to us
 
The operators of our properties compete on a local and regional basis with operators of properties and other health care providers that provide comparable services. We cannot be certain that the operators of all of our facilities will be able to achieve and maintain occupancy and rate levels that will enable them to meet all of their obligations to us. Our operators are expected to encounter increased competition in the future that could limit their ability to attract residents or expand their businesses.
 
Risk factors related to obligor bankruptcies
 
We are exposed to the risk that our obligors may not be able to meet the rent, principal and interest or other payments due us, which may result in an obligor bankruptcy or insolvency, or that an obligor might become subject to bankruptcy or insolvency proceedings for other reasons. Although our operating lease agreements provide us with the right to evict a tenant, demand immediate payment of rent and exercise other remedies, and our loans


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provide us with the right to terminate any funding obligation, demand immediate repayment of principal and unpaid interest, foreclose on the collateral and exercise other remedies, the bankruptcy and insolvency laws afford certain rights to a party that has filed for bankruptcy or reorganization. An obligor in bankruptcy or subject to insolvency proceedings may be able to limit or delay our ability to collect unpaid rent in the case of a lease or to receive unpaid principal and interest in the case of a loan, and to exercise other rights and remedies.
 
We may be required to fund certain expenses (e.g., real estate taxes and maintenance) to preserve the value of an investment property, avoid the imposition of liens on a property and/or transition a property to a new tenant. In some instances, we have terminated our lease with a tenant and relet the property to another tenant. In some of those situations, we have provided working capital loans to and limited indemnification of the new obligor. If we cannot transition a leased property to a new tenant, we may take possession of that property, which may expose us to certain successor liabilities. Should such events occur, our revenue and operating cash flow may be adversely affected.
 
Transfers of health care facilities may require regulatory approvals and these facilities may not have efficient alternative uses
 
Transfers of health care facilities to successor operators frequently are subject to regulatory approvals, including change of ownership approvals under certificate of need (“CON”) laws, state licensure laws and Medicare and Medicaid provider arrangements, that are not required for transfers of other types of real estate. The replacement of an operator could be delayed by the approval process of any federal, state or local agency necessary for the transfer of the facility or the replacement of the operator licensed to manage the facility. Alternatively, given the specialized nature of our facilities, we may be required to spend substantial time and funds to adapt these properties to other uses. If we are unable to timely transfer properties to successor operators or find efficient alternative uses, our revenue and operations may be adversely affected.
 
Risk factors related to government regulations
 
Our obligors’ businesses are affected by government reimbursement and private payor rates. To the extent that an operator/tenant receives a significant portion of its revenues from governmental payors, primarily Medicare and Medicaid, such revenues may be subject to statutory and regulatory changes, retroactive rate adjustments, recovery of program overpayments or set-offs, administrative rulings, policy interpretations, payment or other delays by fiscal intermediaries or carriers, government funding restrictions (at a program level or with respect to specific facilities) and interruption or delays in payments due to any ongoing governmental investigations and audits at such property. In recent years, governmental payors have frozen or reduced payments to health care providers due to budgetary pressures. Health care reimbursement will likely continue to be of paramount importance to federal and state authorities. We cannot make any assessment as to the ultimate timing or effect any future legislative reforms may have on the financial condition of our obligors and properties. There can be no assurance that adequate reimbursement levels will be available for services provided by any property operator, whether the property receives reimbursement from Medicare, Medicaid or private payors. Significant limits on the scope of services reimbursed and on reimbursement rates and fees could have a material adverse effect on an obligor’s liquidity, financial condition and results of operations, which could adversely affect the ability of an obligor to meet its obligations to us. See “Item 1 — Business — Certain Government Regulations — Reimbursement” above.
 
Our operators and tenants generally are subject to extensive federal, state and local licensure, certification and inspection laws and regulations. Our operators’ or tenants’ failure to comply with any of these laws could result in loss of accreditation, denial of reimbursement, imposition of fines, suspension or decertification from federal and state health care programs, loss of license or closure of the facility. Such actions may have an effect on our operators’ or tenants’ ability to make lease payments to us and, therefore, adversely impact us. See “Item 1 — Business — Certain Government Regulations — Other Related Laws” above.
 
Many of our properties may require a license and/or CON to operate. Failure to obtain a license or CON, or loss of a required license or CON would prevent a facility from operating in the manner intended by the operators or tenants. These events could materially adversely affect our operators’ or tenants’ ability to make rent payments to us. State and local laws also may regulate expansion, including the addition of new beds or services or acquisition of


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medical equipment, and the construction of health care facilities, by requiring a CON or other similar approval. See “Item 1 — Business — Certain Government Regulations — Licensing and Certification” above.
 
The American Reinvestment and Recovery Act of 2009, which was signed into law on February 17, 2009, provides $87 billion in additional federal Medicaid funding for states’ Medicaid expenditures between October 1, 2008 and December 31, 2010. Under this Act, states meeting certain eligibility requirements will temporarily receive additional money in the form of an increase in the federal medical assistance percentage (FMAP). Thus, for a limited period of time, the share of Medicaid costs that are paid for by the federal government will go up, and each state’s share will go down. We cannot predict whether states are, or will remain, eligible to receive the additional federal Medicaid funding, or whether the states will have sufficient funds for their Medicaid programs. We also cannot predict the impact that this broad-based, far-reaching legislation will have on the U.S. economy or our business.
 
Risk factors related to liability claims and insurance costs
 
In recent years, skilled nursing and seniors housing operators have experienced substantial increases in both the number and size of patient care liability claims. As a result, general and professional liability costs have increased in some markets. However, a recent report and state survey found that the liability insurance market is beginning to stabilize in most markets. In 2008, national average liability loss costs were stable for the first time in nearly a decade. State-led tort reform efforts have greatly contributed to decreasing costs. In some markets general and professional liability insurance coverage continues to be restricted or very costly, which may adversely affect the property operators’ future operations, cash flows and financial condition, and may have a material adverse effect on the property operators’ ability to meet their obligations to us.
 
Risk factors related to acquisitions
 
We are exposed to the risk that some of our acquisitions may not prove to be successful. We could encounter unanticipated difficulties and expenditures relating to any acquired properties, including contingent liabilities, and acquired properties might require significant management attention that would otherwise be devoted to our ongoing business. If we agree to provide construction funding to an operator/tenant and the project is not completed, we may need to take steps to ensure completion of the project. Moreover, if we issue equity securities or incur additional debt, or both, to finance future acquisitions, it may reduce our per share financial results. These costs may negatively affect our results of operations.
 
Risk factors related to joint ventures
 
We have entered into, and may continue in the future to enter into, partnerships or joint ventures with other persons or entities. Joint venture investments involve risks, including the possibility that our partner might become insolvent or otherwise refuse to make capital contributions when due; that our partner might at any time have investment goals which are inconsistent with ours; that we could become engaged in a dispute with our partner, which could require us to expend additional resources to resolve such disputes; and that our partner may be in a position to take action or withhold consent contrary to our instructions or requests. In addition, our ability to transfer our interest in a joint venture to a third party may be restricted. In some instances, we and our partner may each have the right to trigger a buy-sell arrangement, which could cause us to sell our interest, or acquire our partner’s interest, at a time when we otherwise would not have initiated such a transaction. Joint ventures require us to share decision-making authority with our partners, which limits our ability to control the properties in the joint ventures. Even when we have a controlling interest, certain major decisions may require partner approval.
 
Risk factors related to life sciences facilities
 
Our tenants in the life sciences industry face high levels of regulation, expense and uncertainty that may adversely affect their ability to make payments to us. Research, development and clinical testing of products and technologies can be very expensive and sources of funds may not be available to our life sciences tenants in the future. The products and technologies that are developed and manufactured by our life sciences tenants may require regulatory approval prior to being made, marketed, sold and used. The regulatory process can be costly, long and


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unpredictable. Even after a tenant gains regulatory approval and market acceptance, the product still presents regulatory and liability risks, such as safety concerns, competition from new products and eventually the expiration of patent protection. These factors may affect the ability of our life sciences tenants to make timely payments to us, which may adversely affect our revenue and operations.
 
Risk factors related to indebtedness
 
Permanent financing for our investments is typically provided through a combination of public and private offerings of debt and equity securities and the incurrence or assumption of secured debt. The incurrence or assumption of indebtedness may cause us to become more leveraged, which could (1) require us to dedicate a greater portion of our cash flow to the payment of debt service, (2) make us more vulnerable to a downturn in the economy, (3) limit our ability to obtain additional financing, or (4) negatively affect our credit ratings or outlook by one or more of the noted rating agencies.
 
Our debt agreements contain various covenants, restrictions and events of default. Among other things, these provisions require us to maintain certain financial ratios and minimum net worth and impose certain limits on our ability to incur indebtedness, create liens and make investments or acquisitions. Breaches of these covenants could result in defaults under the instruments governing the applicable indebtedness, in addition to any other indebtedness cross-defaulted against such instruments. These defaults could have a material adverse impact on our business, results of operations and financial condition.
 
Risk factors related to our credit ratings
 
As of February 12, 2010, our senior unsecured notes were rated Baa2 (stable), BBB- (positive) and BBB (stable) by Moody’s Investors Service, Standard & Poor’s Ratings Services and Fitch Ratings, respectively. We plan to manage the Company to maintain investment grade status with a capital structure consistent with our current profile, but there can be no assurance that we will be able to maintain our current credit ratings. Any downgrades in terms of ratings or outlook by any or all of the noted rating agencies could have a material adverse impact on our cost and availability of capital, which could in turn have a material adverse impact on our consolidated results of operations, liquidity and/or financial condition.
 
Risk factors related to interest rate swaps
 
We enter into interest rate swap agreements from time to time to manage some of our exposure to interest rate volatility. These swap agreements involve risks, such as the risk that counterparties may fail to honor their obligations under these arrangements. In addition, these arrangements may not be effective in reducing our exposure to changes in interest rates. When we use forward-starting interest rate swaps, there is a risk that we will not complete the long-term borrowing against which the swap is intended to hedge. If such events occur, our results of operations may be adversely affected.
 
Risk factors related to environmental laws
 
Under various federal and state laws, owners or operators of real estate may be required to respond to the presence or release of hazardous substances on the property and may be held liable for property damage, personal injuries or penalties that result from environmental contamination or exposure to hazardous substances. We may become liable to reimburse the government for damages and costs it incurs in connection with the contamination. Generally, such liability attaches to a person based on the person’s relationship to the property. Our tenants or borrowers are primarily responsible for the condition of the property. Moreover, we review environmental site assessments of the properties that we own or encumber prior to taking an interest in them. Those assessments are designed to meet the “all appropriate inquiry” standard, which we believe qualifies us for the innocent purchaser defense if environmental liabilities arise. Based upon such assessments, we do not believe that any of our properties are subject to material environmental contamination. However, environmental liabilities may be present in our properties and we may incur costs to remediate contamination, which could have a material adverse effect on our business or financial condition or the business or financial condition of our obligors.


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Risk factors related to facilities that require entrance fees
 
Certain of our senior housing facilities require the payment of an upfront entrance fee by the resident, a portion of which may be refundable by the operator. Some of these facilities are subject to substantial oversight by state regulators relating to these funds. As a result of this oversight, residents of these facilities may have a variety of rights, including, for example, the right to cancel their contracts within a specified period of time and certain lien rights. The oversight and rights of residents within these facilities may have an effect on the revenue or operations of the operators of such facilities and therefore may negatively impact us.
 
Risk factors related to facilities under construction or development
 
At any given time, we may be in the process of constructing one or more new facilities that ultimately will require a CON and license before they can be utilized by the operator for their intended use. The operator also may need to obtain Medicare and Medicaid certification and enter into Medicare and Medicaid provider agreements and/or third party payor contracts. In the event that the operator is unable to obtain the necessary CON, licensure, certification, provider agreements or contracts after the completion of construction, there is a risk that we will not be able to earn any revenues on the facility until either the initial operator obtains a license or certification to operate the new facility and the necessary provider agreements or contracts or we can find and contract with a new operator that is able to obtain a license to operate the facility for its intended use and the necessary provider agreements or contracts.
 
In connection with our renovation, redevelopment, development and related construction activities, we may be unable to obtain, or suffer delays in obtaining, necessary zoning, land-use, building, occupancy and other required governmental permits and authorizations. These factors could result in increased costs or our abandonment of these projects. In addition, we may not be able to obtain financing on favorable terms, which may render us unable to proceed with our development activities, and we may not be able to complete construction and lease-up of a property on schedule, which could result in increased debt service expense or construction costs.
 
Additionally, the time frame required for development, construction and lease-up of these properties means that we may have to wait years for significant cash returns. Because we are required to make cash distributions to our stockholders, if the cash flow from operations or refinancing is not sufficient, we may be forced to borrow additional money to fund such distributions. Newly developed and acquired properties may not produce the cash flow that we expect, which could adversely affect our overall financial performance.
 
In deciding whether to acquire or develop a particular property, we make assumptions regarding the expected future performance of that property. In particular, we estimate the return on our investment based on expected occupancy and rental rates. If our financial projections with respect to a new property are inaccurate, and the property is unable to achieve the expected occupancy and rental rates, it may fail to perform as we expected in analyzing our investment. Our estimate of the costs of repositioning or redeveloping an acquired property may prove to be inaccurate, which may result in our failure to meet our profitability goals. Additionally, we may acquire new properties that are not fully leased, and the cash flow from existing operations may be insufficient to pay the operating expenses and debt service associated with that property.
 
We do not know if our tenants will renew their existing leases, and if they do not, we may be unable to lease the properties on as favorable terms, or at all
 
We cannot predict whether our tenants will renew existing leases at the end of their lease terms, which expire at various times through 2079. If these leases are not renewed, we would be required to find other tenants to occupy those properties or sell them. There can be no assurance that we would be able to identify suitable replacement tenants or enter into leases with new tenants on terms as favorable to us as the current leases or that we would be able to lease those properties at all.
 
Our ownership of properties through ground leases exposes us to the loss of such properties upon breach or termination of the ground leases
 
We have acquired an interest in certain of our properties by acquiring a leasehold interest in the property on which the building is located, and we may acquire additional properties in the future through the purchase of interests in ground leases. As the lessee under a ground lease, we are exposed to the possibility of losing the property upon termination of the ground lease or an earlier breach of the ground lease by us.


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Illiquidity of real estate investments could significantly impede our ability to respond to adverse changes in the performance of our properties
 
Real estate investments are relatively illiquid. Our ability to quickly sell or exchange any of our properties in response to changes in economic and other conditions will be limited. No assurances can be given that we will recognize full value for any property that we are required to sell for liquidity reasons. Our inability to respond rapidly to changes in the performance of our investments could adversely affect our financial condition and results of operations. In addition, we are exposed to the risks inherent in concentrating investments in real estate, and in particular, the seniors housing and health care industries. A downturn in the real estate industry could adversely affect the value of our properties and our ability to sell properties for a price or on terms acceptable to us.
 
Risk factors related to reinvestment of sale proceeds
 
From time to time, we will have cash available from (1) the proceeds of sales of our securities, (2) principal payments on our loans receivable and (3) the sale of properties, including non-elective dispositions, under the terms of master leases or similar financial support arrangements. In order to maintain current revenues and continue generating attractive returns, we expect to re-invest these proceeds in a timely manner. We compete for real estate investments with a broad variety of potential investors. This competition for attractive investments may negatively affect our ability to make timely investments on terms acceptable to us.
 
Failure to properly manage our rapid growth could distract our management or increase our expenses
 
We have experienced rapid growth and development in a relatively short period of time and expect to continue this rapid growth in the future. This growth has resulted in increased levels of responsibility for our management. Future property acquisitions could place significant additional demands on, and require us to expand, our management, resources and personnel. Our failure to manage any such rapid growth effectively could harm our business and, in particular, our financial condition, results of operations and cash flows, which could negatively affect our ability to make distributions to stockholders. Our growth could also increase our capital requirements, which may require us to issue potentially dilutive equity securities and incur additional debt.
 
We might fail to qualify or remain qualified as a REIT
 
We intend to operate as a REIT under the Internal Revenue Code and believe we have and will continue to operate in such a manner. If we lose our status as a REIT, we will face serious tax consequences that will substantially reduce the funds available for satisfying our obligations and for distribution to our stockholders for each of the years involved because:
 
  •  we would not be allowed a deduction for distributions to stockholders in computing our taxable income and would be subject to federal income tax at regular corporate rates;
 
  •  we could be subject to the federal alternative minimum tax and possibly increased state and local taxes; and
 
  •  unless we are entitled to relief under statutory provisions, we could not elect to be subject to tax as a REIT for four taxable years following the year during which we were disqualified.
 
Since REIT qualification requires us to meet a number of complex requirements, it is possible that we may fail to fulfill them, and if we do, our earnings will be reduced by the amount of federal taxes owed. A reduction in our earnings would affect the amount we could distribute to our stockholders. If we do not qualify as a REIT, we would not be required to make distributions to stockholders since a non-REIT is not required, in order to maintain REIT status or avoid an excise tax, to pay dividends to stockholders. See “Item 1 — Business — Federal Income Tax Considerations” for a discussion of the provisions of the Internal Revenue Code that apply to us and the effects of non-qualification.
 
In addition, if we fail to qualify as a REIT, all distributions to stockholders would continue to be treated as dividends to the extent of our current and accumulated earnings and profits, although corporate stockholders may be eligible for the dividends received deduction, and individual stockholders may be eligible for taxation at the rates generally applicable to long-term capital gains (currently at a maximum rate of 15%) with respect to distributions.
 
As a result of all these factors, our failure to qualify as a REIT also could impair our ability to implement our business strategy and would adversely affect the value of our common stock.


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Qualification as a REIT involves the application of highly technical and complex Internal Revenue Code provisions for which there are only limited judicial and administrative interpretations. The determination of various factual matters and circumstances not entirely within our control may affect our ability to remain qualified as a REIT. Although we believe that we qualify as a REIT, we cannot assure you that we will continue to qualify or remain qualified as a REIT for tax purposes. See “Item 1 — Business — Taxation — Federal Income Tax Considerations” included in this Annual Report on Form 10-K.
 
The 90% annual distribution requirement will decrease our liquidity and may limit our ability to engage in otherwise beneficial transactions
 
To comply with the 90% distribution requirement applicable to REITs and to avoid the nondeductible excise tax, we must make distributions to our stockholders. See “Item 1 — Business — Taxation — Federal Income Tax Considerations — Qualification as a REIT — Annual Distribution Requirements” included in this Annual Report on Form 10-K. Although we anticipate that we generally will have sufficient cash or liquid assets to enable us to satisfy the REIT distribution requirement, it is possible that, from time to time, we may not have sufficient cash or other liquid assets to meet the 90% distribution requirement, or we may decide to retain cash or distribute such greater amount as may be necessary to avoid income and excise taxation. This may be due to timing differences between the actual receipt of income and actual payment of deductible expenses, on the one hand, and the inclusion of that income and deduction of those expenses in arriving at our taxable income, on the other hand. In addition, non-deductible expenses such as principal amortization or repayments or capital expenditures in excess of non-cash deductions may cause us to fail to have sufficient cash or liquid assets to enable us to satisfy the 90% distribution requirement. In the event that timing differences occur, or we deem it appropriate to retain cash, we may borrow funds, issue additional equity securities (although we cannot assure you that we will be able to do so), pay taxable stock dividends, if possible, distribute other property or securities or engage in a transaction intended to enable us to meet the REIT distribution requirements. This may require us to raise additional capital to meet our obligations.
 
The amount of additional indebtedness we may incur is limited by the terms of our line of credit arrangement and the indentures governing our senior unsecured notes. In addition, adverse economic conditions may impact the availability of additional funds or could cause the terms on which we are able to borrow additional funds to become unfavorable. In those circumstances, we may be required to raise additional equity in the capital markets. Our access to capital depends upon a number of factors over which we have little or no control, including rising interest rates, inflation and other general market conditions and the market’s perception of our growth potential and our current and potential future earnings and cash distributions and the market price of the shares of our capital stock. We cannot assure you that we will be able to raise the capital necessary to make future investments or to meet our obligations and commitments as they mature.
 
Other risk factors
 
We are also subject to other risks. First, our Second Restated Certificate of Incorporation and Second Amended and Restated By-Laws contain anti-takeover provisions (staggered board provisions, restrictions on share ownership and transfer and super majority stockholder approval requirements for business combinations) that could make it more difficult for or even prevent a third party from acquiring us without the approval of our incumbent Board of Directors. Provisions and agreements that inhibit or discourage takeover attempts could reduce the market value of our common stock.
 
Additionally, we are dependent on key personnel. Although we have entered into employment agreements with our executive officers, losing any one of them could, at least temporarily, have an adverse impact on our operations. We believe that losing more than one could have a material adverse impact on our business.
 
Item 1B.   Unresolved Staff Comments
 
None.


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Item 2.   Properties
 
We lease our corporate headquarters located at One SeaGate, Suite 1500, Toledo, Ohio 43604. We also own corporate offices in Ohio and Tennessee, lease corporate offices in Florida and have ground leases relating to certain of our investment properties and medical office buildings. The following table sets forth certain information regarding the properties that comprise our investments as of December 31, 2009 (dollars in thousands):
 
                                 
    Number of
    Number of
    Total
    Annualized
 
Property Location
  Properties     Units     Investment     Income(1)  
 
Independent Living Facilities/CCRCs:
                               
Arizona
    2       105     $ 11,825     $ 935  
California
    8       1,310       162,858       18,462  
Colorado
    2       582       78,420       8,297  
Florida
    5       842       218,924       11,347  
Georgia
    4       417       74,977       6,310  
Idaho
    1       254       12,360       1,760  
Indiana
    2       597       98,556       7,610  
Kansas
    1       120       11,555       1,375  
Maryland
    1       0       800       0  
Massachusetts
    5       219       76,600       5,580  
Missouri
    1       65       5,570       570  
Nevada
    1       93       6,240       1,176  
North Carolina
    3       345       46,191       2,262  
Ohio
    1       288       99,749       0  
Pennsylvania
    4       0       28,778       0  
South Carolina
    6       1,198       235,883       16,149  
Texas
    1       403       10,134       1,427  
Washington
    1       70       4,881       543  
Wisconsin
    1       138       25,704       2,264  
                                 
Total Independent Living Facilities/CCRCs
    50       7,046       1,210,005       86,067  
Assisted Living Facilities:
                               
Arizona
    3       132     $ 13,255     $ 1,636  
California
    8       609       64,008       7,937  
Colorado
    1       46       3,845       583  
Connecticut
    5       530       38,682       5,508  
Delaware
    1       97       18,880       2,439  
Florida
    11       682       59,916       5,097  
Georgia
    1       45       1,521       210  
Illinois
    7       688       130,017       6,648  
Indiana
    2       78       4,429       718  
Iowa
    1       236       37,215       1,075  
Kansas
    1       119       9,717       1,253  
Louisiana
    1       123       6,183       1,302  
Massachusetts
    5       397       117,027       13,122  
Mississippi
    1       78       6,899       992  
Montana
    3       205       13,344       1,917  
Nevada
    4       494       73,852       7,791  
New Jersey
    2       90       6,576       1,025  
New York
    4       284       52,814       4,511  
North Carolina
    40       1,866       157,337       22,392  
Ohio
    7       481       40,631       4,636  


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    Number of
    Number of
    Total
    Annualized
 
Property Location
  Properties     Units     Investment     Income(1)  
 
Oklahoma
    17       644       32,279       4,657  
Oregon
    1       46       4,041       703  
Pennsylvania
    4       302       45,641       4,456  
South Carolina
    2       124       6,424       928  
Tennessee
    3       194       37,130       3,246  
Texas
    24       1,254       106,407       10,812  
Utah
    1       81       6,099       791  
Virginia
    4       225       30,334       3,903  
Washington
    5       342       97,345       8,928  
Wisconsin
    10       624       90,319       9,044  
                                 
Total Assisted Living Facilities
    179       11,116       1,312,167       138,260  
 
                                 
    Number of
    Number of
    Total
    Annualized
 
    Properties     Beds     Investment     Income(1)  
 
Skilled Nursing Facilities:
                               
Alabama
    7       1,013     $ 33,580     $ 4,797  
Arizona
    1       162       12,790       1,348  
Colorado
    3       474       20,763       2,598  
Connecticut
    6       728       19,145       1,881  
Florida
    37       4,724       223,493       27,868  
Georgia
    3       500       14,764       2,041  
Idaho
    3       393       28,586       3,769  
Illinois
    4       406       26,122       3,115  
Indiana
    6       643       29,746       3,943  
Kansas
    2       343       39,279       3,406  
Kentucky
    10       1,265       57,855       7,721  
Louisiana
    7       854       30,852       3,300  
Maryland
    2       240       14,072       1,474  
Massachusetts
    22       3,086       218,453       26,445  
Michigan
    1       97       4,273       455  
Mississippi
    11       1,527       40,922       5,996  
Missouri
    3       407       15,483       1,642  
New Hampshire
    1       68       4,143       518  
New Jersey
    1       176       4,273       530  
Ohio
    20       2,746       175,784       19,758  
Oklahoma
    3       668       18,654       2,596  
Oregon
    1       114       3,667       645  
Pennsylvania
    2       341       12,101       1,497  
Tennessee
    22       3,008       203,188       26,258  
Texas
    26       3,470       182,959       19,356  
Virginia
    10       1,239       61,413       6,191  
                                 
Total Skilled Nursing Facilities
    214       28,692       1,496,360       179,148  

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    Number of
    Number of
    Total
    Annualized
 
    Properties     Beds     Investment     Income(1)  
 
Hospitals:
                               
California
    5       569     $ 168,420     $ 7,298  
Idaho
    1       60       23,446       2,460  
Illinois
    1       72       5,550       0  
Indiana
    2       90       30,759       3,440  
Kentucky
    1       60       29,456       2,843  
Louisiana
    1       50       11,211       744  
Massachusetts
    2       0       11,120       450  
Nebraska
    1       60       80,686       0  
New Jersey
    1       76       36,783       3,570  
Ohio
    2       102       34,069       3,583  
Oklahoma
    2       91       11,553       1,092  
Texas
    9       424       173,058       16,612  
Wisconsin
    1       62       23,819       2,632  
                                 
Total Hospitals
    29       1,716       639,930       44,724  
 
                                 
    Number of
          Total
    Annualized
 
    Properties     Sq. Ft.     Investment     Income(1)  
 
Medical Office Buildings:
                               
Alabama
    5       303,908     $ 40,981     $ 3,972  
Alaska
    1       63,164       27,609       2,525  
Arizona
    5       339,205       86,817       5,564  
California
    9       534,333       163,156       11,066  
Colorado
    1       36,386       6,887       585  
Florida
    26       918,153       255,033       18,009  
Georgia
    7       286,151       64,923       5,843  
Illinois
    3       71,345       10,080       1,323  
Indiana
    1       90,403       21,232       1,913  
Kentucky
    1       59,011       9,383       171  
Missouri
    2       170,373       28,600       1,412  
Nevada
    9       324,992       109,974       7,904  
New Jersey
    5       406,985       106,787       9,108  
New York
    7       276,388       58,352       5,219  
North Carolina
    10       156,398       23,983       1,550  
Ohio
    1       20,106       7,013       696  
Oklahoma
    1       44,803       11,852       1,097  
Pennsylvania
    1       98,132       20,982       2,016  
South Carolina
    1       47,114       16,564       921  
Tennessee
    5       247,417       62,467       5,764  
Texas
    15       787,643       192,444       14,685  
Virginia
    1       58,142       11,244       1,165  
Wisconsin
    1       293,629       90,978       7,567  
                                 
Total Medical Office Buildings
    118       5,634,181       1,427,341       110,075  
                                 
Total All Properties
    590             $ 6,085,803     $ 558,274  
                                 
 
 
(1) Reflects contract rate of interest for loans, annual straight-line rent for leases with fixed escalators or annual cash rent for leases with contingent escalators, net of collectability reserves if applicable.

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The following table sets forth occupancy and average annualized income for these property types:
 
                             
          Average Annualized Income
    Occupancy(1)     (2)
 
  2009     2008     2009     2008
 
Medical office buildings
    91.3 %     90.4 %   $ 20     $18 per sq ft
Investment properties:
                           
Independent living/CCRCs
    89.6 %     90.6 %   $ 12,215     $11,701 per unit
Assisted living facilities
    89.0 %     88.8 %   $ 12,438     $10,805 per unit
Skilled nursing facilities
    84.2 %     83.9 %   $ 6,244     $5,972 per bed
Hospitals
    56.5 %     49.5 %   $ 26,063     $28,107 per bed
 
 
(1) Medical office building occupancy represents the percentage of total rentable square feet leased and occupied (including month-to-month and holdover leases and excluding terminations and discontinued operations) as of December 31, 2009 and 2008. Occupancy for investment properties represents average quarterly operating occupancy based on the quarters ended September 30, 2009 and 2008 and excludes properties that are unstabilized, closed or for which data is not available or meaningful. The Company uses unaudited, periodic financial information provided solely by tenants/borrowers to calculate occupancy for investment properties and has not independently verified the information.
 
(2) Average annualized income represents annualized income divided by total beds, units or square feet.
 
The following table sets forth information regarding lease expirations as of December 31, 2009 (dollars in thousands):
 
                                                         
    Independent
    Assisted
    Skilled
          Total
    Medical
       
    Living/
    Living
    Nursing
          Investment
    Office
    Total Rental
 
Year
  CCRCs     Facilities     Facilities     Hospitals     Properties     Buildings     Income(1)  
 
2010
  $ 0     $ 0     $ 2,937     $ 0     $ 2,937     $ 6,756     $ 9,693  
2011
    0       988       0       0       988       10,137       11,125  
2012
    1,760       3,741       6,887       0       12,388       10,655       23,043  
2013
    6,932       1,516       0       0       8,448       8,465       16,913  
2014
    0       2,859       6,230       0       9,089       10,928       20,017  
2015
    0       0       1,934       0       1,934       8,822       10,756  
2016
    0       0       6,374       0       6,374       13,497       19,871  
2017
    0       14,742       3,632       2,350       20,724       5,860       26,584  
2018
    3,997       33,873       16,705       0       54,575       2,399       56,974  
2019
    0       18,636       17,851       0       36,487       9,461       45,948  
Thereafter
    71,170       45,071       101,820       40,304       258,365       22,343       280,708  
                                                         
Total
  $ 83,859     $ 121,426     $ 164,370     $ 42,654     $ 412,309     $ 109,323     $ 521,632  
                                                         
 
 
(1) Rental income represents annualized base rent for effective lease agreements. The amounts are derived from the current contracted monthly base rent including straight-line for leases with fixed escalators or annual cash rent for leases with contingent escalators, net of collectability reserves, if applicable. Rental income does not include common area maintenance charges or the amortization of above/below market lease intangibles.
 
Item 3.   Legal Proceedings
 
From time to time, there are various legal proceedings pending to which we are a party or to which some of our properties are subject arising in the normal course of business. We do not believe that the ultimate resolution of these proceedings will have a material adverse effect on our consolidated financial position or results of operations.
 
Item 4.   Submission of Matters to a Vote of Security Holders
 
None.


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PART II
 
Item 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
There were 5,071 stockholders of record as of February 12, 2010. The following table sets forth, for the periods indicated, the high and low prices of our common stock on the New York Stock Exchange, as reported on the Composite Tape, and common dividends paid per share:
 
                         
    Sales Price     Dividends
 
    High     Low     Paid  
 
2009
                       
First Quarter
  $ 42.32     $ 25.86     $ 0.68  
Second Quarter
    36.41       29.62       0.68  
Third Quarter
    44.40       32.64       0.68  
Fourth Quarter
    46.74       40.53       0.68  
2008
                       
First Quarter
  $ 46.45     $ 39.26     $ 0.66  
Second Quarter
    50.49       44.00       0.68  
Third Quarter
    53.98       42.54       0.68  
Fourth Quarter
    53.50       30.14       0.68  
 
Our Board of Directors has approved a quarterly dividend rate of $0.68 per share of common stock per quarter. Our dividend policy is reviewed annually by the Board of Directors. The declaration and payment of quarterly dividends remains subject to the review and approval of the Board of Directors.


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Stockholder Return Performance Presentation
 
Set forth below is a line graph comparing the yearly percentage change and the cumulative total stockholder return on our shares of common stock against the cumulative total return of the S & P Composite-500 Stock Index and the FTSE NAREIT Equity Index. As of December 31, 2009, 106 companies comprised the FTSE NAREIT Equity Index. The Index consists of REITs identified by NAREIT as equity (those REITs which have at least 75% of their investments in real property). Upon written request sent to the Senior Vice President-Administration and Corporate Secretary, Health Care REIT, Inc., One SeaGate, Suite 1500, P.O. Box 1475, Toledo, Ohio, 43603-1475, we will provide stockholders with the names of the component issuers. The data are based on the closing prices as of December 31 for each of the five years. 2004 equals $100 and dividends are assumed to be reinvested.
 
(PERFORMANCE GRAPH)
 
                                     
      12/31/04     12/31/05     12/31/06     12/31/07     12/31/08     12/31/09
S & P 500
    100.0     104.91     121.48     128.15     80.74     102.11
Health Care REIT, Inc. 
    100.0     95.33     130.59     143.19     143.62     162.08
FTSE NAREIT Equity
    100.0     112.17     151.49     127.72     79.54     101.80
                                     
 
Except to the extent that we specifically incorporate this information by reference, the foregoing Stockholder Return Performance Presentation shall not be deemed incorporated by reference by any general statement incorporating by reference this Annual Report on Form 10-K into any filing under the Securities Act of 1933, as amended, or under the Securities Exchange Act of 1934, as amended. This information shall not otherwise be deemed filed under such acts.


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Item 6.   Selected Financial Data
 
The following selected financial data for the five years ended December 31, 2009 are derived from our audited consolidated financial statements (in thousands, except per share data):
 
                                         
    Year Ended December 31,  
    2005     2006     2007     2008     2009  
 
Operating Data
                                       
Revenues(1)
  $ 220,948     $ 267,609     $ 429,486     $ 526,406     $ 568,973  
Expenses:
                                       
Interest expense(1)
    65,522       82,718       131,271       130,153       106,231  
Depreciation and amortization(1)
    55,517       71,897       124,232       144,361       157,049  
Property operating expenses(1)
    0       1,003       33,410       42,634       45,896  
General and administrative(1)
    15,881       25,922       37,465       47,193       49,691  
Provision for loan losses
    1,200       1,000       0       94       23,261  
Realized loss on derivatives
    0       0       0       23,393       0  
Loss (gain) on extinguishment of debt
    21,484       0       (1,081 )     (2,094 )     25,107  
                                         
Total expenses
    159,604       182,540       325,297       385,734       407,235  
                                         
Income from continuing operations before income taxes
    61,344       85,069       104,189       140,672       161,738  
Income tax expense
    (282 )     (82 )     (188 )     (1,306 )     (168 )
                                         
Income from continuing operations
    61,062       84,987       104,001       139,366       161,570  
Income from discontinued operations, net(1)
    23,224       17,669       34,592       144,059       31,357  
                                         
Net income
    84,286       102,656       138,593       283,425       192,927  
Preferred stock dividends
    21,594       21,463       25,130       23,201       22,079  
Net income attributable to noncontrolling interests
    0       13       238       126       (342 )
                                         
Net income attributable to common stockholders
  $ 62,692     $ 81,180     $ 113,225     $ 260,098     $ 171,190  
                                         
Other Data
                                       
Average number of common shares outstanding:
                                       
Basic
    54,110       61,661       78,861       93,732       114,207  
Diluted
    54,499       62,045       79,409       94,309       114,612  
Per Share Data
                                       
Basic:
                                       
Income from continuing operations attributable to common stockholders
  $ 0.73     $ 1.03     $ 1.00     $ 1.24     $ 1.22  
Discontinued operations, net
    0.43       0.29       0.44       1.54       0.27  
                                         
Net income attributable to common stockholders*
  $ 1.16     $ 1.32     $ 1.44     $ 2.77     $ 1.50  
                                         
Diluted:
                                       
Income from continuing operations attributable to common stockholders
  $ 0.72     $ 1.02     $ 0.99     $ 1.23     $ 1.22  
Discontinued operations, net
    0.43       0.28       0.44       1.53       0.27  
                                         
Net income attributable to common stockholders*
  $ 1.15     $ 1.31     $ 1.43     $ 2.76     $ 1.49  
                                         
Cash distributions per common share
  $ 2.46     $ 2.8809     $ 2.2791     $ 2.70     $ 2.72  
 
 
Amounts may not sum due to rounding


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(1) We have reclassified the income and expenses attributable to the properties sold prior to or held for sale at December 31, 2009, to discontinued operations for all periods presented. See Note 3 to our audited consolidated financial statements.
 
                                         
    December 31,  
    2005     2006     2007     2008     2009  
 
Balance Sheet Data
                                       
Net real estate investments
  $ 2,849,518     $ 4,122,893     $ 5,012,620     $ 5,854,179     $ 6,080,620  
Total assets
    2,972,164       4,282,885       5,219,240       6,215,031       6,367,186  
Total long-term obligations
    1,500,818       2,191,698       2,683,760       2,847,676       2,414,022  
Total liabilities
    1,541,408       2,295,561       2,784,289       2,976,746       2,559,735  
Total redeemable preferred stock
    276,875       338,993       330,243       289,929       288,683  
Total stockholders’ equity
    1,430,756       1,987,324       2,434,951       3,238,285       3,807,451  


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Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion and analysis is based primarily on the consolidated financial statements of Health Care REIT, Inc. for the periods presented and should be read together with the notes thereto contained in this Annual Report on Form 10-K. Other important factors are identified in “Item 1 — Business” and “Item 1A — Risk Factors” above.
 
Executive Overview
 
Company Overview
 
Health Care REIT, Inc., an S&P 500 company, is a real estate investment trust that invests in senior housing and health care real estate. Founded in 1970, we were the first REIT to invest exclusively in health care properties. The following table summarizes our portfolio as of December 31, 2009:
 
                                                 
    Investments
    Percentage of
    Number of
    # Beds/Units
    Investment per
       
Type of Property
  (in thousands)     Investments     Properties     or Sq. Ft.     metric(1)     States  
 
Independent living/CCRCs
  $ 1,210,005       19.8 %     50       7,046 units     $ 174,552 per unit       19  
Assisted living facilities
    1,312,167       21.6 %     179       11,116 units       119,273 per unit       30  
Skilled nursing facilities
    1,496,360       24.6 %     214       28,692 beds       52,153 per bed       26  
Hospitals
    639,930       10.5 %     29       1,716 beds       461,084 per bed       13  
Medical office buildings
    1,427,341       23.5 %     118       5,634,181sq. ft.       259 per sq. ft.       23  
                                                 
Totals
  $ 6,085,803       100.0 %     590                       39  
                                                 
 
 
(1) Investment per metric was computed by using the total investment amount of $6,299,748,000 which includes real estate investments and unfunded construction commitments for which initial funding has commenced which amounted to $6,085,803,000 and $213,945,000, respectively.
 
Health Care Industry
 
The demand for health care services, and consequently health care properties, is projected to reach unprecedented levels in the near future. The Centers for Medicare and Medicaid Services projects that national health expenditures will rise to $3.4 trillion in 2015 or 17.7% of gross domestic product (“GDP”). This is up from $2 trillion or 15.9% of GDP in 2005. Health expenditures per capita are projected to rise approximately 4.7% per year from 2005 to 2015. While demographics are the primary driver of demand, economic conditions and availability of services contribute to health care service utilization rates. We believe the health care property market is less susceptible to fluctuations and economic downturns relative to other property sectors. Investor interest in the market remains strong, especially in specific sectors such as medical office buildings, regardless of the current stringent lending environment. As a REIT, we believe we are situated to benefit from any turbulence in the capital markets due to our access to capital.
 
The total U.S. population is projected to increase by 16.4% through 2030. The elderly are an important component of health care utilization, especially independent living services, assisted living services, skilled nursing services, inpatient and outpatient hospital services and physician ambulatory care. The elderly population aged 65 and over is projected to increase by 76.6% through 2030. Most health care services are provided within a health care facility such as a hospital, a physician’s office or a senior housing facility. Therefore, we believe there will be continued demand for companies such as ours with expertise in health care real estate.


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The following chart illustrates the projected increase in the elderly population aged 65 and over:
 
(CHART)
 
Source: U.S. Census Bureau
 
Health care real estate investment opportunities tend to increase as demand for health care services increases. We recognize the need for health care real estate as it correlates to health care service demand. Health care providers require real estate to house their businesses and expand their services. We believe that investment opportunities in health care real estate will continue to be present due to the:
 
  •  Specialized nature of the industry which enhances the credibility and experience of our company;
 
  •  Projected population growth combined with stable or increasing health care utilization rates which ensures demand; and
 
  •  On-going merger and acquisition activity.
 
Recent Developments.  Both the Senate and House of Representatives have passed legislation to reform the U.S. health care system. By the time this report is released, final reform legislation may already have been passed. The legislation involves the expansion of insurance coverage primarily through reform of the private insurance market, as well as changes to existing government programs. The reform efforts are intended to lead to more efficient, effective care, reduce waste, and benefit the most efficient, quality-conscious providers. As a company, we are well-situated to respond to any changes in health care delivery and organization resulting from this legislation. Future reform, broadened insurance coverage, changes in Medicare and Medicaid, changes in provider reimbursement, and changes in health care sector funding could have a significant impact on our operators’ financial situation and strategy, which we will continue to monitor.
 
Economic Outlook
 
Beginning in late 2007, the U.S. and global economy entered a serious recession. The current economic environment is characterized by a severe residential housing slump, depressed commercial real estate valuations, weakened consumer confidence, rising unemployment and concerns regarding inflation, deflation and stagflation. Numerous financial systems around the globe have become illiquid and banks have become less willing to lend to other banks and borrowers. Further, capital markets have become and remain volatile as risk is repriced and investments are revalued. Uncertainty remains in terms of the depth and duration of these adverse economic conditions.
 
The conditions described above have created an environment of limited capital availability and increasing capital costs. This was most evident in the credit markets, where lending institutions cut back on loans, tightened credit standards and significantly increased interest rate spreads. The equity markets were characterized by sporadic accessibility until late 2008, when share prices in most sectors declined significantly. Continued volatility in the capital markets could limit our ability to access debt or equity funds which, in turn, could impact our ability to finance future investments and react to changing economic and business conditions. This difficult operating environment also may make it more difficult for some of our operators/tenants to meet their obligations to us.


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During 2008, our focus gradually shifted from investment to capital preservation. To that end, our efforts in 2009 were directed towards: liquidity, portfolio management and investment strategy.
 
  •  Liquidity.  Liquidity has become increasingly important and we have concentrated our efforts on further strengthening our balance sheet. We raised over $1 billion in funds during each of 2008 and 2009 from a combination of common stock offerings, our dividend reinvestment plan, our equity shelf program, property sales and loan payoffs. As always, we will continue to closely monitor the credit and capital markets for opportunities to raise reasonably priced capital.
 
  •  Portfolio Management.  Our investment approach has produced a portfolio that is very diverse with strong property level payment coverages. Yet, today’s adverse economic conditions can negatively impact even the strongest portfolio. Our portfolio management program is designed to maintain our portfolio’s strength through a combination of extensive industry research, stringent origination and underwriting protocols and a rigorous asset management process.
 
  •  Investment Strategy.  For the short-term, we expect to fund our ongoing development projects and will evaluate new investments selectively and only when funding sources are clearly identified. However, we will continue to strengthen our existing customer relationships and begin to cultivate new relationships. We remain focused on preserving liquidity, but we intend to take advantage of what we believe will be increasingly attractive investment opportunities over time.
 
Business Strategy
 
Our primary objectives are to protect stockholder capital and enhance stockholder value. We seek to pay consistent cash dividends to stockholders and create opportunities to increase dividend payments to stockholders as a result of annual increases in rental and interest income and portfolio growth. To meet these objectives, we invest across the full spectrum of senior housing and health care real estate and diversify our investment portfolio by property type, operator/tenant and geographic location.
 
Substantially all of our revenues and sources of cash flows from operations are derived from operating lease rentals and interest earned on outstanding loans receivable. These items represent our primary source of liquidity to fund distributions and are dependent upon our obligors’ continued ability to make contractual rent and interest payments to us. To the extent that our obligors experience operating difficulties and are unable to generate sufficient cash to make payments to us, there could be a material adverse impact on our consolidated results of operations, liquidity and/or financial condition. To mitigate this risk, we monitor our investments through a variety of methods determined by the type of property and operator/tenant. Our asset management process includes review of monthly financial statements for each property, periodic review of obligor credit, periodic property inspections and review of covenant compliance relating to licensure, real estate taxes, letters of credit and other collateral. In monitoring our portfolio, our personnel use a proprietary database to collect and analyze property-specific data. Additionally, we conduct extensive research to ascertain industry trends and risks. Through these asset management and research efforts, we are typically able to intervene at an early stage to address payment risk, and in so doing, support both the collectability of revenue and the value of our investment.
 
In addition to our asset management and research efforts, we also structure our investments to help mitigate payment risk. Operating leases and loans are normally credit enhanced by guaranties and/or letters of credit. In addition, operating leases are typically structured as master leases and loans are generally cross-defaulted and cross-collateralized with other loans, operating leases or agreements between us and the obligor and its affiliates.
 
For the year ended December 31, 2009, rental income and interest income represented 90% and 7%, respectively, of total gross revenues (including discontinued operations). Substantially all of our operating leases are designed with either fixed or contingent escalating rent structures. Leases with fixed annual rental escalators are generally recognized on a straight-line basis over the initial lease period, subject to a collectability assessment. Rental income related to leases with contingent rental escalators is generally recorded based on the contractual cash rental payments due for the period. Our yield on loans receivable depends upon a number of factors, including the stated interest rate, the average principal amount outstanding during the term of the loan and any interest rate adjustments.


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Depending upon the availability and cost of external capital, we believe our liquidity is sufficient to fund operations, meet debt service obligations (both principal and interest), make dividend distributions and complete construction projects in process. We also anticipate evaluating opportunities to finance future investments. New investments are generally funded from temporary borrowings under our unsecured line of credit arrangement, internally generated cash and the proceeds from sales of real property. Our investments generate internal cash from rent and interest receipts and principal payments on loans receivable. Permanent financing for future investments, which replaces funds drawn under the unsecured line of credit arrangement, has historically been provided through a combination of public and private offerings of debt and equity securities and the incurrence or assumption of secured debt.
 
Depending upon market conditions, we believe that new investments will be available in the future with spreads over our cost of capital that will generate appropriate returns to our stockholders. We expect to complete gross new investments of $1.0 to $1.2 billion in 2010, comprised of new investments totaling $700,000,000 to $800,000,000 and funded new development of $300,000,000 to $400,000,000. We anticipate the sale of real property and the repayment of loans receivable totaling approximately $300,000,000 during 2010. It is possible that additional loan repayments or sales of real property may occur in the future. To the extent that loan repayments and real property sales exceed new investments, our revenues and cash flows from operations could be adversely affected. We expect to reinvest the proceeds from any loan repayments and real property sales in new investments. To the extent that new investment requirements exceed our available cash on-hand, we expect to borrow under our unsecured line of credit arrangement. At December 31, 2009, we had $35,476,000 of cash and cash equivalents, $23,237,000 of restricted cash and $1,010,000,000 of available borrowing capacity under our unsecured line of credit arrangement. Our investment activity may exceed our borrowing capacity under our unsecured line of credit. To the extent that we are unable to issue equity or debt securities to provide additional capital, we may not be able to fund all of our potential investments, which could have an adverse effect on our revenues and cash flows from operations.
 
Key Transactions in 2009
 
We completed the following key transactions during the year ended December 31, 2009:
 
  •  we completed $716,649,000 of gross investments offset by $280,569,000 of investment payoffs;
 
  •  we were added to the S&P 500 Index in January 2009;
 
  •  we completed a public offering of 5,816,870 shares of common stock with net proceeds of approximately $210,880,000 in February 2009;
 
  •  we completed $265,527,000 of first mortgage loans secured by 31 senior housing properties with multiple levels of service. The debt has terms ranging from seven to ten years. The debt had weighted average initial interest rates of 5.98% after giving effect to certain interest rate swap agreements. KeyBank Capital Markets, Inc. originated the loans and sold them to Freddie Mac;
 
  •  we extinguished $81,715,000 of secured debt with weighted average interest rates of 7.21% prior to maturity;
 
  •  we extinguished $183,147,000 of unsecured senior notes with weighted average interest rates of 7.82%; and
 
  •  we completed a public offering of 9,200,000 shares of common stock with net proceeds of approximately $356,554,000 in September 2009.
 
Recent Events
 
We completed the following investments in February 2010:
 
  •  We completed the acquisition of a portfolio of 17 medical office buildings located in Wisconsin totaling 1.15 million square feet through a joint venture with Hammes Company. Our $192 million investment includes the assumption of $106 million in secured debt at an average rate of 7.35%. The assets will be 100%


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  master leased to Aurora Health Care, an investment grade rated, non-profit health system based in Wisconsin. Our initial cash yield is 9.1% and the leases have an average remaining term of 13 years.
 
  •  We formed a $668 million joint venture with Forest City Enterprises (NYSE:FCE.A and FCE.B). We acquired a 49% interest in a seven-building life sciences campus with 1.2 million square feet located in University Park in Cambridge, MA. The value of our investment is $327 million. We invested $170 million of cash and the joint venture assumed $320 million of non-recourse secured debt with a weighted average interest rate of 7.1%. Projected 2010 cash net operating income for the portfolio is approximately $51 million.
 
Key Performance Indicators, Trends and Uncertainties
 
We utilize several key performance indicators to evaluate the various aspects of our business. These indicators are discussed below and relate to operating performance, credit strength and concentration risk. Management uses these key performance indicators to facilitate internal and external comparisons to our historical operating results and in making operating decisions.
 
Operating Performance.  We believe that net income attributable to common stockholders (“NICS”) is the most appropriate earnings measure. Other useful supplemental measures of our operating performance include funds from operations (“FFO”) and net operating income (“NOI”); however, these supplemental measures are not defined by U.S. generally accepted accounting principles (“U.S. GAAP”). Please refer to the section entitled “Non-GAAP Financial Measures” for further discussion of FFO and NOI and for reconciliations of FFO and NOI. These earnings measures and their relative per share amounts are widely used by investors and analysts in the valuation, comparison and investment recommendations of REITs. The following table reflects the recent historical trends of our operating performance measures (in thousands, except per share data):
 
                         
    Year Ended  
    December 31,
    December 31,
    December 31,
 
    2007     2008     2009  
 
Net income attributable to common stockholders
  $ 113,225     $ 260,098     $ 171,190  
Funds from operations
    248,070       258,868       289,521  
Net operating income
    455,680       526,136       547,678  
Per share data (fully diluted):
                       
Net income attributable to common stockholders
  $ 1.43     $ 2.76     $ 1.49  
Funds from operations
    3.12       2.74       2.53  
 
Credit Strength.  We measure our credit strength both in terms of leverage ratios and coverage ratios. Our leverage ratios include debt to book capitalization, debt to undepreciated book capitalization and debt to market capitalization. The leverage ratios indicate how much of our balance sheet capitalization is related to total debt. Our coverage ratios include interest coverage ratio and fixed charge coverage ratio. The coverage ratios indicate our ability to service interest and fixed charges (interest plus preferred dividends and secured debt principal amortizations). We expect to maintain capitalization ratios and coverage ratios sufficient to maintain investment grade ratings with Moody’s Investors Service, Standard & Poor’s Ratings Services and Fitch Ratings. The coverage ratios are based on adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) which is discussed in further detail, and reconciled to net income, below in “Non-GAAP Financial Measures.” Leverage ratios and coverage ratios are widely used by investors, analysts and rating agencies in the valuation, comparison,


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investment recommendations and rating of companies. The following table reflects the recent historical trends for our credit strength measures:
 
                         
    Year Ended  
    December 31,
    December 31,
    December 31,
 
    2007     2008     2009  
 
Debt to book capitalization ratio
    52 %     47 %     39 %
Debt to undepreciated book capitalization ratio
    48 %     43 %     35 %
Debt to market capitalization ratio
    39 %     38 %     30 %
Adjusted interest coverage ratio
    2.94 x     3.84 x     3.78 x
Adjusted fixed charge coverage ratio
    2.41 x     3.20 x     3.09 x
 
Concentration Risk.  We evaluate our concentration risk in terms of asset mix, investment mix, customer mix and geographic mix. Concentration risk is a valuable measure in understanding what portion of our investments could be at risk if certain sectors were to experience downturns. Asset mix measures the portion of our investments that are real property. In order to qualify as an equity REIT, at least 75% of our real estate investments must be real property whereby each property, which includes the land, buildings, improvements, intangibles and related rights, is owned by us and leased to an operator pursuant to a long-term operating lease. Investment mix measures the portion of our investments that relate to our various property types. Customer mix measures the portion of our investments that relate to our top five customers. Geographic mix measures the portion of our investments that relate to our top five states. The following table reflects our recent historical trends of concentration risk:
 
                         
    December 31,
    December 31,
    December 31,
 
    2007     2008     2009  
 
Asset mix:
                       
Real property
    92 %     92 %     93 %
Loans receivable
    8 %     8 %     7 %
Investment mix:
                       
Assisted living facilities
    21 %     20 %     22 %
Skilled nursing facilities
    32 %     27 %     25 %
Independent/CCRC
    15 %     19 %     20 %
Hospitals
    7 %     11 %     10 %
Medical office buildings
    25 %     23 %     23 %
Customer mix:
                       
Senior Living Communities, LLC
    4 %     6 %     7 %
Brookdale Senior Living Inc
    5 %     5 %     5 %
Signature Healthcare LLC
    6 %     5 %     5 %
Emeritus Corporation
    7 %     4 %     4 %
Life Care Centers of America, Inc. 
    5 %     5 %     3 %
Remaining portfolio
    73 %     75 %     76 %
Geographic mix:
                       
Florida
    15 %     14 %     12 %
Texas
    13 %     11 %     11 %
California
    7 %     8 %     9 %
Massachusetts
    7 %     7 %     7 %
Ohio
                    6 %
Tennessee
    6 %     6 %        
Remaining portfolio
    52 %     54 %     55 %
 
We evaluate our key performance indicators in conjunction with current expectations to determine if historical trends are indicative of future results. Our expected results may not be achieved and actual results may differ


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materially from our expectations. Management regularly monitors various economic and other factors to develop strategic and tactical plans designed to improve performance and maximize our competitive position. Our ability to achieve our financial objectives is dependent upon our ability to effectively execute these plans and to appropriately respond to emerging economic and company-specific trends. Please refer to “Item 1A — Risk Factors” above for further discussion.
 
Portfolio Update
 
Net operating income.  The primary performance measure for our properties is net operating income (“NOI”) as discussed below in “Non-GAAP Financial Measures.” The following table summarizes our net operating income for the periods indicated (in thousands):
 
                         
    Year Ended  
    December 31,
    December 31,
    December 31,
 
    2007     2008     2009  
 
Net operating income:
                       
Investment properties
  $ 379,516     $ 436,811     $ 457,690  
Medical office buildings
    74,636       87,633       88,818  
Non-segment/corporate
    1,528       1,692       1,170  
                         
Net operating income
  $ 455,680     $ 526,136     $ 547,678  
                         
 
Payment coverage.  Payment coverage of the operators in our investment property portfolio has stabilized. Our overall payment coverage is at 2.01 times and represents an increase of two basis points from 2007 and an increase of five basis points from 2008. The following table reflects our recent historical trends of portfolio coverage. Coverage data reflects the 12 months ended for the periods presented. CBMF represents the ratio of facilities’ earnings before interest, taxes, depreciation, amortization, rent and management fees to contractual rent or interest due us. CAMF represents the ratio of earnings before interest, taxes, depreciation, amortization, and rent (but after imputed management fees) to contractual rent or interest due us.
 
                                                 
    September 30, 2007     September 30, 2008     September 30, 2009  
    CBMF     CAMF     CBMF     CAMF     CBMF     CAMF  
 
Independent living/CCRCs
    1.47 x     1.26 x     1.31 x     1.11 x     1.27 x     1.08 x
Assisted living facilities
    1.57 x     1.35 x     1.55 x     1.32 x     1.58 x     1.36 x
Skilled nursing facilities
    2.25 x     1.65 x     2.26 x     1.66 x     2.29 x     1.69 x
Hospitals
    2.72 x     2.16 x     2.26 x     1.83 x     2.47 x     2.14 x
                                                 
Weighted averages
    1.99 x     1.55 x     1.96 x     1.52 x     2.01 x     1.59 x
 
Corporate Governance
 
Maintaining investor confidence and trust has become increasingly important in today’s business environment. Our Board of Directors and management are strongly committed to policies and procedures that reflect the highest level of ethical business practices. Our corporate governance guidelines provide the framework for our business operations and emphasize our commitment to increase stockholder value while meeting all applicable legal requirements. The Board of Directors adopted and annually reviews its Corporate Governance Guidelines. These guidelines meet the listing standards adopted by the New York Stock Exchange and are available on the Internet at www.hcreit.com and from us upon written request sent to the Senior Vice President — Administration and Corporate Secretary, Health Care REIT, Inc., One SeaGate, Suite 1500, P.O. Box 1475, Toledo, Ohio, 43603-1475.
 
Liquidity and Capital Resources
 
Sources and Uses of Cash
 
Our primary sources of cash include rent and interest receipts, borrowings under our unsecured line of credit arrangement, public and private offerings of debt and equity securities, proceeds from the sales of real property and principal payments on loans receivable. Our primary uses of cash include dividend distributions, debt service


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payments (including principal and interest), real property acquisitions, loan advances and general and administrative expenses. These sources and uses of cash are reflected in our Consolidated Statements of Cash Flows and are discussed in further detail below.
 
The following is a summary of our sources and uses of cash flows (dollars in thousands):
 
                                                                         
          One Year
          One Year
    Two Year
 
    Year Ended     Change     Year Ended     Change     Change  
    Dec. 31, 2007     Dec. 31, 2008     $     %     Dec. 31, 2009     $     %     $     %  
 
Cash and cash equivalents at beginning of period
  $ 36,216     $ 30,269     $ (5,947 )     (16 )%   $ 23,370     $ (6,899 )     (23 )%   $ (12,846 )     (35 )%
Cash provided from operating activities
    283,987       360,683       76,696       27 %     381,259       20,576       6 %     97,272       34 %
Cash used in investing activities
    (905,440 )     (1,035,525 )     (130,085 )     14 %     (270,060 )     765,465       (74 )%     635,380       (70 )%
Cash provided from (used in) financing activities
    615,506       667,943       52,437       9 %     (99,093 )     (767,036 )     n/a       (714,599 )     n/a  
                                                                         
Cash and cash equivalents at end of period
  $ 30,269     $ 23,370     $ (6,899 )     (23 )%   $ 35,476     $ 12,106       52 %   $ 5,207       17 %
                                                                         
 
Operating Activities.  The increases in net cash provided from operating activities are primarily attributable to net income excluding gains/losses on sales of real property and impairments. See the discussion of investing activities and results of operations below for additional details. To the extent that we acquire or dispose of additional properties in the future, our results of operations will change accordingly.
 
The following is a summary of our straight-line rent (dollars in thousands):
 
                                                                         
    Year Ended     One Year Change     Year Ended     One Year Change     Two Year Change  
    Dec. 31, 2007     Dec. 31, 2008     $     %     Dec. 31, 2009     $     %     $     %  
 
Gross straight-line rental income
  $ 17,029     $ 20,489     $ 3,460       20 %   $ 19,415     $ (1,074 )     (5 )%   $ 2,386       14 %
Cash receipts due to real property sales
    (4,527 )     (2,187 )     2,340       (52 )%     (4,422 )     (2,235 )     102 %     105       (2 )%
Prepaid rent receipts
    (12,942 )     (26,095 )     (13,153 )     102 %     (26,252 )     (157 )     1 %     (13,310 )     103 %
Amortization related to above/ (below) market leases, net
    792       1,039       247       31 %     1,713       674       65 %     921       116 %
                                                                         
    $ 352     $ (6,754 )   $ (7,106 )     n/a     $ (9,546 )   $ (2,792 )     41 %   $ (9,898 )     n/a  
                                                                         
 
Gross straight-line rental income represents the non-cash difference between contractual cash rent due and the average rent recognized pursuant to U.S. GAAP for leases with fixed rental escalators, net of collectability reserves, if any. This amount is positive in the first half of a lease term (but declining every year due to annual increases in cash rent due) and is negative in the second half of a lease term. The fluctuation in cash receipts due to real property sales is attributable to a decline in straight-line rent receivable balances on properties sold. The change in prepaid rent cash receipts is due to the mix of real property acquisitions during the periods presented. We typically receive prepaid rent in connection with investment property acquisitions.


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Investing Activities.  The changes in net cash used in investing activities are primarily attributable to changes in loans receivable and real property investments. The following is a summary of our investment and disposition activities (dollars in thousands):
 
                                                 
    Year Ended  
    December 31, 2007(1)     December 31, 2008     December 31, 2009  
    Facilities     Amount     Facilities     Amount     Facilities     Amount  
 
Real property acquisitions:
                                               
Independent living/CCRCs
    1     $ 43,000       2     $ 68,300                  
Assisted living facilities
    4       36,233       3       45,490                  
Skilled nursing facilities
    8       122,875       1       11,360       1     $ 11,650  
Hospitals
    1       11,923       7       196,303       1       20,500  
Medical office buildings
    28       381,134       7       121,809       1       35,523  
Land parcels
            8,928       1       10,000               0  
                                                 
Total acquisitions
    42       604,093       21       453,262       3       67,673  
Less: Assumed debt
            (166,188 )             0               0  
Assumed other assets/(liabilities), net
            (2,432 )             (1,899 )             0  
                                                 
Cash disbursed for acquisitions
            435,473               451,363               67,673  
Construction in progress additions
            295,102               595,452               492,897  
Capital improvements to existing properties
            39,976               25,561               38,389  
                                                 
Total cash invested in real property
            770,551               1,072,376               598,959  
Real property dispositions:
                                               
Independent living/CCRCs
    1       5,346       2       15,547       1       24,342  
Assisted living facilities
    10       57,351       30       148,075       11       30,978  
Skilled nursing facilities
    7       18,107       4       6,290       9       45,835  
Hospitals
            0       1       8,735       2       40,841  
Medical office buildings
            0       1       6,781       13       44,717  
Land parcels
            3,073               73               0  
                                                 
Total dispositions
    18       83,877       38       185,501       36       186,713  
Less: Gains on sales of real property
            14,437               163,933               43,394  
LandAmerica settlement
            0               2,500               0  
Extinguishment of other assets/(liabilities)
            0               (116 )             0  
Seller financing on sales of real property
            0               (64,771 )             (6,100 )
                                                 
Proceeds from real property sales
            98,314               287,047               224,007  
                                                 
Net cash investments in real property
    24     $ 672,237       (17 )   $ 785,329       (33 )   $ 374,952  
                                                 
Advances on real estate loans receivable:
                                               
Investments in new loans
          $ 205,770             $ 121,493             $ 20,036  
Draws on existing loans
            30,124               21,265               54,381  
                                                 
Total gross investments in real estate loans
            235,894               142,758               74,417  
Less: Seller financing on sales of real property
                            (59,649 )             0  
                                                 
Net cash advances on real estate loans receivable
            235,894               83,109               74,417  
Receipts on real estate loans receivable:
                                               
Loan payoffs
            42,028               8,815               93,856  
Principal payments on loans
            10,318               9,354               17,923  
                                                 
Total principal receipts on real estate loans
            52,346               18,169               111,779  
                                                 
Net cash advances/(receipts) on real estate loans
          $ 183,548             $ 64,940             $ (37,362 )
                                                 
 
 
(1) 2007 includes the Rendina/Paramount acquisition.


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The investment in Rendina/Paramount primarily represented cash consideration of $141,967,000 offset by $4,000 of cash assumed from Paramount.
 
Financing Activities.  The changes in net cash provided from or used in financing activities are primarily attributable to changes related to our debt, common stock issuances, and cash distributions to stockholders.
 
The changes in our senior unsecured notes include: (i) the issuance $400,000,000 of our 4.75% convertible senior unsecured notes in July 2007; (ii) the extinguishment of $52,500,000 of 7.5% senior unsecured notes in August 2007; (iii) the extinguishment of $42,330,000 of 7.625% senior unsecured notes in March 2008; and (iv) the extinguishment of $183,147,000 of senior unsecured notes with a weighted-average interest rate of 7.82% in 2009 and recognized extinguishment losses of $19,269,000.
 
During the year ended December 31, 2009, we extinguished 20 secured debt loans totaling $81,715,000 with a weighted-average interest rate of 7.21% and recognized extinguishment losses of $5,838,000. During the year ended December 31, 2008, we extinguished eight secured debt loans totaling $50,475,000 with a weighted-average interest rate of 6.67% and recognized extinguishment gains of $2,094,000. During the year ended December 31, 2007, we extinguished five secured debt loans totaling $29,797,000 with a weighted-average interest rate of 7.34%.
 
In November 2007, we repurchased $50,000,000 liquidation amount of preferred securities of a subsidiary trust and, in December 2007, obtained the satisfaction and discharge of a related $51,000,000 liability of an operating partnership and recorded a $1,081,000 gain on extinguishment of debt.
 
The change in common stock is primarily attributable to public issuances and issuances under our dividend reinvestment and stock purchase plan (“DRIP”) and our equity shelf program. The remaining difference in common stock issuances is primarily due to issuances pursuant to stock incentive plans.
 
The following is a summary of our common stock issuances for the years presented (dollars in thousands, except per share amounts):
 
                                 
Date Issued
  Shares Issued     Average Price     Gross Proceeds     Net Proceeds  
 
April 2007 public issuance
    6,325,000     $ 44.01     $ 278,363     $ 265,294  
December 2007 public issuance
    3,500,000       42.14       147,490       147,139  
2007 Dividend reinvestment plan issuances
    1,626,000       41.81       67,985       67,985  
2007 Option exercises
    401,630       27.82       11,175       11,175  
                                 
2007 Totals
    11,852,630             $ 505,013     $ 491,593  
                                 
March 2008 public issuance
    3,000,000     $ 41.44     $ 124,320     $ 118,555  
July 2008 public issuance
    4,600,000       44.50       204,700       193,157  
September 2008 public issuance
    8,050,000       48.00       386,400       369,699  
2008 Dividend reinvestment plan issuances
    1,546,074       43.37       67,055       67,055  
2008 Equity shelf program issuances
    794,221       39.28       31,196       30,272  
2008 Option exercises
    118,895       29.83       3,547       3,547  
                                 
2008 Totals
    18,109,190             $ 817,218     $ 782,285  
                                 
February 2009 public issuance
    5,816,870     $ 36.85     $ 214,352     $ 210,880  
September 2009 public issuance
    9,200,000       40.40       371,680       356,554  
2009 Dividend reinvestment plan issuances
    1,499,497       37.22       55,818       55,818  
2009 Equity shelf program issuances
    1,952,600       40.69       79,447       77,605  
2009 Option exercises
    96,166       38.23       3,676       3,676  
                                 
2009 Totals
    18,565,133             $ 724,973     $ 704,533  
                                 
 
In order to qualify as a REIT for federal income tax purposes, we must distribute at least 90% of our taxable income (including 100% of capital gains) to our stockholders. The increases in dividends are primarily attributable to increases in the number of outstanding common and preferred shares as discussed above, increases in our annual


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common stock dividend per share and the payment of a prorated dividend of $0.2991 in February 2007 as a result of the $0.3409 prorated dividend paid in December 2006 in conjunction with the Windrose merger.
 
The following is a summary of our dividend payments (in thousands, except per share amounts):
 
                                                 
    Year Ended  
    December 31, 2007     December 31, 2008     December 31, 2009  
    Per Share     Amount     Per Share     Amount     Per Share     Amount  
 
Common Stock
  $ 2.2791     $ 182,969     $ 2.70     $ 253,659     $ 2.72     $ 311,760  
Series D Preferred Stock
    1.96875       7,875       1.96875       7,875       1.96875       7,875  
Series E Preferred Stock
    1.50       112       1.50       112       1.50       112  
Series F Preferred Stock
    1.90625       13,344       1.90625       13,344       1.90625       13,344  
Series G Preferred Stock
    1.875       3,799       1.875       1,870       1.875       748  
                                                 
Totals
          $ 208,099             $ 276,860             $ 333,839  
                                                 
 
Off-Balance Sheet Arrangements
 
At December 31, 2009, we had three outstanding letter of credit obligations totaling $3,579,000 and expiring between 2010 and 2013. Please see Note 10 to our consolidated financial statements for additional information.
 
We are exposed to various market risks, including the potential loss arising from adverse changes in interest rates. We may or may not elect to use financial derivative instruments to hedge interest rate exposure. These decisions are principally based on the general trend in interest rates at the applicable dates, our perception of the future volatility of interest rates and our relative levels of variable rate debt and variable rate investments. Please see Note 9 to our audited consolidated financial statements for additional information.
 
Contractual Obligations
 
The following table summarizes our payment requirements under contractual obligations as of December 31, 2009 (in thousands):
 
                                         
    Payments Due by Period  
Contractual Obligations
  Total     2010     2011-2012     2013-2014     Thereafter  
 
Unsecured line of credit arrangement
  $ 140,000     $ 0     $ 140,000     $ 0     $ 0  
Senior unsecured notes(1)
    1,661,853       0       76,853       300,000       1,285,000  
Secured debt(1)
    623,046       12,204       31,904       196,019       382,919  
Contractual interest obligations
    1,108,235       126,204       248,331       206,646       527,054  
Capital lease obligations
    0       0       0       0       0  
Operating lease obligations
    182,040       4,603       9,018       8,744       159,675  
Purchase obligations
    224,265       95,237       129,028       0       0  
Other long-term liabilities
    5,283       412       1,065       1,903       1,903  
                                         
Total contractual obligations
  $ 3,944,722     $ 238,660     $ 636,199     $ 713,312     $ 2,356,551  
                                         
 
 
(1) Amounts represent principal amounts due and do not reflect unamortized premiums/discounts or other fair value adjustments as reflected on the balance sheet.
 
At December 31, 2009, we had an unsecured credit arrangement with a consortium of sixteen banks providing for a revolving line of credit in the amount of $1,150,000,000, which is scheduled to expire on August 5, 2011 (with the ability to extend for one year at our discretion if we are in compliance with all covenants). Borrowings under the agreement are subject to interest payable in periods no longer than three months at either the agent bank’s prime rate of interest or the applicable margin over LIBOR interest rate, at our option (0.84% at December 31, 2009). The applicable margin is based on our ratings with Moody’s Investors Service and Standard & Poor’s Ratings Services and was 0.6% at December 31, 2009. In addition, we pay a facility fee annually to each bank based on the bank’s


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commitment under the revolving credit facility. The facility fee depends on our ratings with Moody’s Investors Service and Standard & Poor’s Ratings Services and was 0.15% at December 31, 2009. We also pay an annual agent’s fee of $50,000. Principal is due upon expiration of the agreement. At December 31, 2009, we had $140,000,000 outstanding under the unsecured line of credit arrangement and estimated total contractual interest obligations of $2,196,000. Contractual interest obligations are estimated based on the assumption that the balance of $140,000,000 at December 31, 2009 is constant until maturity at interest rates in effect at December 31, 2009.
 
We have $1,661,853,000 of senior unsecured notes principal outstanding with fixed annual interest rates ranging from 4.75% to 8.0%, payable semi-annually. Total contractual interest obligations on senior unsecured notes totaled $904,406,000 at December 31, 2009. $735,000,000 of our senior unsecured notes are convertible notes that also contain put features. Please see Note 8 to our consolidated financial statements for additional information.
 
Additionally, we have secured debt with total outstanding principal of $623,046,000, collateralized by owned properties, with annual interest rates ranging from 4.89% to 6.99%, payable monthly. The carrying values of the properties securing the mortgage loans totaled $901,013,000 at December 31, 2009. Total contractual interest obligations on mortgage loans totaled $201,633,000 at December 31, 2009.
 
At December 31, 2009, we had operating lease obligations of $182,040,000 relating primarily to ground leases at certain of our properties and office space leases.
 
Purchase obligations are comprised of unfunded construction commitments and contingent purchase obligations. At December 31, 2009, we had outstanding construction financings of $456,832,000 for leased properties and were committed to providing additional financing of approximately $213,945,000 to complete construction. At December 31, 2009, we had contingent purchase obligations totaling $10,320,000. These contingent purchase obligations primarily relate to deferred acquisition fundings and capital improvements. Deferred acquisition fundings are contingent upon a tenant satisfying certain conditions in the lease. Upon funding, amounts due from the tenant are increased to reflect the additional investment in the property.
 
Other long-term liabilities relate to our Supplemental Executive Retirement Plan (“SERP”) and certain non-compete agreements. We have a SERP, a non-qualified defined benefit pension plan, which provides one executive officer with supplemental deferred retirement benefits. The SERP provides an opportunity for participants to receive retirement benefits that cannot be paid under our tax-qualified plans because of the restrictions imposed by ERISA and the Internal Revenue Code of 1986, as amended. Benefits are based on compensation and length of service and the SERP is unfunded. No contributions by the Company are anticipated for the 2010 fiscal year. Benefit payments are expected to total $4,758,000 during the next five fiscal years and no benefit payments are expected to occur during the succeeding five fiscal years. We use a December 31 measurement date for the SERP. The accrued liability on our balance sheet for the SERP was $3,287,000 at December 31, 2009 ($3,109,000 at December 31, 2008).
 
In connection with the Windrose merger, we entered into consulting agreements with Fred S. Klipsch and Frederick L. Farrar, which expired in December 2008. We entered into a new consulting agreement with Mr. Farrar in December 2008, which expired in December 2009. Each consultant has agreed not to compete with the Company for a period of two years following termination or expiration of the agreement. In exchange for complying with the covenant not to compete, Messers. Klipsch and Farrar are entitled to receive eight quarterly payments of $75,000 and $37,500, respectively, with the first payment to be made on the date of termination or expiration of the agreement. The first payment to Mr. Klipsch was made in December 2008. The first payment to Mr. Farrar was made in January 2010.
 
Capital Structure
 
As of December 31, 2009, we had stockholders’ equity of $3,807,451,000 and a total outstanding debt balance of $2,414,022,000, which represents a debt to total book capitalization ratio of 39%. Our ratio of debt to market capitalization was 30% at December 31, 2009. For the twelve months ended December 31, 2009, our adjusted interest coverage ratio was 3.78 to 1.00. For the twelve months ended December 31, 2009, our adjusted fixed charge coverage ratio was 3.09 to 1.00. Also, at December 31, 2009, we had $35,476,000 of cash and cash equivalents,


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$23,237,000 of restricted cash and $1,010,000,000 of available borrowing capacity under our unsecured line of credit arrangement.
 
Our debt agreements contain various covenants, restrictions and events of default. Among other things, these provisions require us to maintain certain financial ratios and minimum net worth and impose certain limits on our ability to incur indebtedness, create liens and make investments or acquisitions. As of December 31, 2009, we were in compliance with all of the covenants under our debt agreements. None of our debt agreements contain provisions for acceleration which could be triggered by our debt ratings with Moody’s Investors Service and Standard & Poor’s Ratings Services. However, under our unsecured line of credit arrangement, these ratings on our senior unsecured notes are used to determine the fees and interest payable.
 
As of February 12, 2010, our senior unsecured notes were rated Baa2 (stable), BBB- (positive) and BBB (stable) by Moody’s Investors Service, Standard & Poor’s Ratings Services and Fitch Ratings, respectively. We plan to manage the company to maintain investment grade status with a capital structure consistent with our current profile. Any downgrades in terms of ratings or outlook by any or all of the noted rating agencies could have a material adverse impact on our cost and availability of capital, which could in turn have a material adverse impact on our consolidated results of operations, liquidity and/or financial condition.
 
On May 7, 2009, we filed an open-ended automatic or “universal” shelf registration statement with the Securities and Exchange Commission covering an indeterminate amount of future offerings of debt securities, common stock, preferred stock, depositary shares, warrants and units. As of February 12, 2010, we had an effective registration statement on file in connection with our enhanced DRIP program under which we may issue up to 10,760,247 shares of common stock. As of February 12, 2010, 6,402,507 shares of common stock remained available for issuance under this registration statement. In November 2008, we entered into an Equity Distribution Agreement with UBS Securities LLC relating to the offer and sale from time to time of up to $250,000,000 aggregate amount of our common stock (“Equity Shelf Program”). As of February 12, 2010, we had $139,356,000 of remaining capacity under the Equity Shelf Program. Depending upon market conditions, we anticipate issuing securities under our registration statements to invest in additional properties and to repay borrowings under our unsecured line of credit arrangement.
 
Results of Operations
 
Our primary sources of revenue include rent and interest. Our primary expenses include interest expense, depreciation and amortization, property operating expenses and general and administrative expenses. These revenues and expenses are reflected in our Consolidated Statements of Income and are discussed in further detail below. The following is a summary of our results of operations (dollars in thousands except per share amounts):
 
                                                                         
                      One Year
    Two Year
 
    Year Ended     One Year Change     Year Ended     Change     Change  
    Dec. 31, 2007     Dec. 31, 2008     $     %     Dec. 31, 2009     $     %     $     %  
 
Net income attributable to common stockholders
  $ 113,225     $ 260,098     $ 146,873       130 %   $ 171,190     $ (88,908 )     (34 )%   $ 57,965       51 %
Funds from operations
    248,070       258,868       10,798       4 %     289,521       30,653       12 %     41,451       17 %
Net operating income
    455,680       526,136       70,456       15 %     547,678       21,542       4 %     91,998       20 %
Adjusted EBITDA
    439,702       595,365       155,663       35 %     525,791       (69,574 )     (12 )%     86,089       20 %
 
The components of the changes in revenues, expenses and other items are discussed in detail below. The following is a summary of certain items that impact the results of operations for the year ended December 31, 2009:
 
  •  $3,909,000 ($0.03 per diluted share) of non-recurring general and administrative expenses;
 
  •  $25,107,000 ($0.22 per diluted share) of net losses on extinguishments of debt;
 
  •  $25,223,000 ($0.22 per diluted share) of impairment charges;
 
  •  $23,261,000 ($0.20 per diluted share) of provisions for loan losses;
 
  •  $8,059,000 ($0.07 per diluted share) of additional other income related to a lease termination;


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  •  $2,400,000 ($0.02 per diluted share) of prepayment fees; and
 
  •  $43,394,000 ($0.38 per diluted share) of gains on the sales of real property.
 
The following is a summary of certain items that impact the results of operations for the year ended December 31, 2008:
 
  •  $2,291,000 ($0.02 per diluted share) of non-recurring terminated transaction costs;
 
  •  $1,325,000 ($0.01 per diluted share) of non-recurring income tax expense;
 
  •  $23,393,000 ($0.25 per diluted share) of realized loss on derivatives;
 
  •  $32,648,000 ($0.35 per diluted share) of impairment charges;
 
  •  $2,094,000 ($0.02 per diluted share) of net gains on extinguishments of debt;
 
  •  $2,500,000 ($0.03 per diluted share) of additional other income related to a lease termination; and
 
  •  $163,933,000 ($1.74 per diluted share) of gains on the sales of real property.
 
The following is a summary of certain items that impact the results of operations for the year ended December 31, 2007:
 
  •  $1,750,000 ($0.02 per diluted share) of one-time acquisition finders’ fees;
 
  •  $1,081,000 ($0.01 per diluted share) of net gains on extinguishments of debt;
 
  •  $3,900,000 ($0.05 per diluted share) of additional other income related to the payoff of a warrant equity investment; and
 
  •  $14,437,000 ($0.18 per diluted share) of gains on the sales of real property.
 
The increase in fully diluted average common shares outstanding is primarily the result of public common stock offerings and common stock issuances pursuant to our DRIP and equity shelf program (“ESP”). The following table represents the changes in outstanding common stock for the period from January 1, 2007 to December 31, 2009 (in thousands):
 
                                 
    Year Ended        
    Dec. 31,
    Dec. 31,
    Dec. 31,
       
    2007     2008     2009     Totals  
 
Beginning balance
    73,192       85,496       104,704       73,192  
Public offerings
    9,825       15,650       15,017       40,492  
DRIP issuances
    1,626       1,546       1,499       4,671  
ESP issuances
    0       794       1,953       2,747  
Preferred stock conversions
    212       975       30       1,217  
Option exercises
    402       119       96       617  
Other, net
    239       124       86       449  
                                 
Ending balance
    85,496       104,704       123,385       123,385  
                                 
Average number of common shares outstanding:
                               
Basic
    78,861       93,732       114,207          
Diluted
    79,409       94,309       114,612          
 
We evaluate our business and make resource allocations on our two business segments — investment properties and medical office buildings. Under the investment property segment, properties are primarily leased under triple-net leases and we are not involved in the management of the property. Under the medical office building segment, our properties are typically leased under gross leases, modified gross leases or triple-net leases, to multiple tenants, and generally require a certain level of property management. There are no intersegment sales or transfers. Non-segment revenue consists mainly of interest income on non-real estate investments and other income. Non-


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property specific revenues and expenses are not allocated to individual segments in determining net operating income. Please see Note 18 to our consolidated financial statements for additional information.
 
Investment Properties
 
The following is a summary of our results of operations for the investment properties segment (dollars in thousands):
 
                                                                         
    Year Ended                 Year Ended                          
    Dec. 31,
    Dec. 31,
    One Year Change     Dec. 31,
    One Year Change     Two Year Change  
    2007     2008     $     %     2009     $     %     $     %  
 
Revenues:
                                                                       
Rental income
  $ 291,471     $ 349,782     $ 58,311       20 %   $ 388,260     $ 38,478       11 %   $ 96,789       33 %
Interest income
    25,823       40,063       14,240       55 %     40,885       822       2 %     15,062       58 %
Other income
    8,010       7,899       (111 )     (1 )%     3,269       (4,630 )     (59 )%     (4,741 )     (59 )%
Prepayment fees
    0       0       0       n/a       2,400       2,400       n/a       2,400       n/a  
                                                                         
      325,304       397,744       72,440       22 %     434,814       37,070       9 %     109,510       34 %
Expenses:
                                                                       
Interest expense
    (3,422 )     (1,467 )     1,955       (57 )%     9,644       11,111       n/a       13,066       n/a  
Depreciation and amortization
    83,134       97,108       13,974       17 %     107,998       10,890       11 %     24,864       30 %
Loss/(gain) on extinguishment of debt
    0       (808 )     (808 )     n/a       2,057       2,865       n/a       2,057       n/a  
Provision for loan losses
    0       94       94       n/a       23,261       23,167       24646 %     23,261       n/a  
                                                                         
      79,712       94,927       15,215       19 %     142,960       48,033       51 %     63,248       79 %
                                                                         
Income from continuing operations before income taxes
    245,592       302,817       57,225       23 %     291,854       (10,963 )     (4 )%     46,262       19 %
Income tax (expense) benefit
    293       (1,693 )     (1,986 )     n/a       (607 )     1,086       (64 )%     (900 )     n/a  
                                                                         
Income from continuing operations
    245,885       301,124       55,239       22 %     291,247       (9,877 )     (3 )%     45,362       18 %
Discontinued operations:
                                                                       
Gain on sales of properties
    14,437       164,998       150,561       1043 %     46,439       (118,559 )     (72 )%     32,002       222 %
Impairment of assets
    0       0       0       n/a       (10,266 )     (10,266 )     n/a       (10,266 )     n/a  
Income from discontinued operations, net
    21,925       15,598       (6,327 )     (29 )%     13,424       (2,174 )     (14 )%     (8,501 )     (39 )%
                                                                         
      36,362       180,596       144,234       397 %     49,597       (130,999 )     (73 )%     13,235       36 %
                                                                         
Net income attributable to common stockholders
  $ 282,247     $ 481,720     $ 199,473       71 %   $ 340,844     $ (140,876 )     (29 )%   $ 58,597       21 %
                                                                         
 
The increase in rental income is primarily attributable to the acquisitions of new investment properties from which we receive rent. See the discussion of investing activities in “Liquidity and Capital Resources” above for further information. Certain of our leases contain annual rental escalators that are contingent upon changes in the Consumer Price Index and/or changes in the gross operating revenues of the tenant’s properties. These escalators are not fixed, so no straight-line rent is recorded; however, rental income is recorded based on the contractual cash rental payments due for the period. If gross operating revenues at our facilities and/or the Consumer Price Index do not increase, a portion of our revenues may not continue to increase. Sales of real property would offset revenue increases and, to the extent that they exceed new acquisitions, could result in decreased revenues. Our leases could renew above or below current rent rates, resulting in an increase or decrease in rental income. Interest income increased from 2007 primarily due to an increase in the balance of outstanding loans.


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Interest expense for the years ended December 31, 2009, 2008 and 2007 represents $12,229,000, $7,176,000 and $8,763,000, respectively, of secured debt interest expense offset by interest allocated to discontinued operations. The change in secured debt interest expense is due to the net effect and timing of assumptions, extinguishments and principal amortizations. During the year ended December 31, 2009, we extinguished 12 investment property secured debt loans and recognized extinguishment losses of $2,057,000. During the year ended December 31, 2008, we extinguished four investment property secured debt loans and recognized extinguishment gains of $808,000. The following is a summary of our investment property secured debt principal activity (dollars in thousands):
 
                                                 
    Year Ended December 31, 2007     Year Ended December 31, 2008     Year Ended December 31, 2009  
          Weighted Average
          Weighted Average
          Weighted Average
 
    Amount     Interest Rate     Amount     Interest Rate     Amount     Interest Rate  
 
Beginning balance
  $ 129,617       7.134 %   $ 114,543       7.000 %   $ 94,234       6.996 %
Debt issued
                                    265,527       5.982 %
Debt extinguished
    (12,083 )     8.421 %     (17,821 )     7.022 %     (47,502 )     7.414 %
Principal payments
    (2,991 )     7.085 %     (2,488 )     6.974 %     (13,767 )     7.640 %
                                                 
Ending balance
  $ 114,543       7.000 %   $ 94,234       6.996 %   $ 298,492       5.998 %
                                                 
Monthly averages
  $ 121,562       7.065 %   $ 103,927       6.996 %   $ 205,549       6.309 %
 
Depreciation and amortization increased primarily as a result of additional investments in properties owned directly by us. See the discussion of investing activities in “Liquidity and Capital Resources” above for additional details. To the extent that we acquire or dispose of additional properties in the future, our provision for depreciation and amortization will change accordingly.
 
At December 31, 2009, we had two skilled nursing facilities and one hospital that satisfied the requirements for held for sale treatment. We did not recognize an impairment loss on the skilled nursing facilities as the fair value less estimated costs to sell exceeded our carrying value. In determining the fair value of the hospital, we used a combination of third party appraisals based on market comparable transactions, other market listings and asset quality. Management’s estimates projected that the carrying value of the asset was more than the estimated fair value and an impairment charge of $10,266,000 was recorded to reduce the property to its estimated fair value less costs to sell. During the year ended December 31, 2009, we sold 23 investment properties with carrying values of $141,996,000 for net gains of $46,439,000. The following illustrates the reclassification impact as a result of classifying investment properties as discontinued operations for the periods presented. Please refer to Note 3 to our consolidated financial statements for further discussion.
 
                         
    Year Ended December 31,  
    2007     2008     2009  
 
Revenues:
                       
Rental Income
  $ 54,212     $ 39,067     $ 14,817  
Other income
    0       0       8,059  
Expenses:
                       
Interest expense
    12,185       8,643       2,585  
Depreciation and amortization
    20,102       14,826       6,867  
                         
Income (loss) from discontinued operations, net
  $ 21,925     $ 15,598     $ 13,424  
                         
 
During the three months ended December 31, 2007, we recognized $3,900,000 of additional other income related to the payoff of a warrant equity investment. During the three months ended March 31, 2008, we determined that $1,325,000 of income taxes were due in connection with that investment gain. During the three months ended December 31, 2008, we recognized $2,500,000 of additional other income related to a lease termination. During the three months ended December 31, 2009, we recognized $8,059,000 of additional other income related to a lease termination, which is included in discontinued operations, and $2,400,000 of prepayment fees.


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As a result of our quarterly evaluations, we recorded $23,261,000 of provision for loan losses during the year ended December 31, 2009. This amount includes the write-off of loans totaling $25,578,000 primarily relating to certain early stage senior housing operators offset by a net reduction in the allowance for loan losses of $2,457,000. The provision for loan losses is related to our critical accounting estimate for the allowance for loan losses and is discussed below in “Critical Accounting Policies.”
 
Medical Office Buildings
 
The following is a summary of our results of operations for the medical office building segment (dollars in thousands):
 
                                                                         
    Year Ended     One Year
    Year Ended     One Year
    Two Year
 
    Dec. 31,
    Dec. 31,
    Change     Dec. 31,
    Change     Change  
    2007     2008     $     %     2009     $     %     $     %  
 
Revenues: