UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

For the quarterly period ended September 30, 2016

OR

 

For the transition period from              to             

Commission file number:  000-54685

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes ☒  No☐

 

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 ☒    No ☐

 

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.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ☐    No ☒

The number of shares of common stock of the registrant outstanding as of October 31, 2016 was 175,054,822.

 

 

 

 

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

 

INDEX

 

 

 

 

 

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5

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6

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

CNL Healthcare Properties, Inc. (“Company”) was incorporated on June 8, 2010 and elected to be taxed as a real estate investment trust (“REIT”) for U.S. federal income tax purposes beginning with the year ended December 31, 2012.  The Company is externally advised by CNL Healthcare Corp. (“Advisor”) and its property manager is CNL Healthcare Manager Corp. (“Property Manager”), each of which is an affiliate of CNL Financial Group, LLC (“Sponsor”).  The Sponsor is an affiliate of CNL Financial Group, Inc. (“CNL”) and CNL Securities Corp. (“Managing Dealer”), the managing dealer of the Company’s public offerings (“Offerings”).  The Advisor is responsible for managing the Company’s affairs on a day-to-day basis and for identifying and making acquisitions and investments on behalf of the Company pursuant to an advisory agreement among the Company, the operating partnership and the Advisor.  Substantially all of the Company’s acquisition, operating, administrative and certain property management services are provided by affiliates of the Advisor and the Property Manager.  In addition, third-party sub-property managers have been engaged to provide certain property management services.

The Company conducts substantially all of its operations either directly or indirectly through: (1) an operating partnership, CHP Partners, LP, in which the Company is the sole limited partner and its wholly owned subsidiary, CHP GP, LLC, is the sole general partner; (2) a wholly owned taxable REIT subsidiary (“TRS”), CHP TRS Holding, Inc.; (3) property owner subsidiaries and lender subsidiaries, which are single purpose entities; and (4) investments in joint ventures.

On September 30, 2015, the Company completed its Offerings pursuant to a registration statement on Form S-11 under the Securities Act of 1933 with the Securities and Exchange Commission (“SEC”).  In October 2015, the Company deregistered the unsold shares of its common stock under its previous registration statement on Form S-11, except for 20,000,000 shares that the Company concurrently registered on Form S-3 under the Securities Exchange Act of 1933 with the SEC for the sale of additional shares of common stock through its distribution reinvestment plan (“Reinvestment Plan”).

With the completion of the Offerings, the Company’s focus is on actively managing a diversified portfolio of healthcare real estate or real estate-related assets within the seniors housing, medical office, post-acute care and acute care asset classes.  The types of seniors housing that the Company has acquired include independent and assisted living facilities, continuing care retirement communities, and Alzheimer’s / memory care facilities.  The types of medical offices that the Company has acquired include medical office buildings (“MOB”), specialty medical and diagnostic service facilities, surgery centers, outpatient rehabilitation facilities, and other facilities designed for clinical services.  The types of post-acute care facilities that the Company has acquired include skilled nursing facilities and inpatient rehabilitative hospitals.  The types of acute care facilities that the Company has acquired include specialty surgical hospitals.  The Company views, manages and evaluates its portfolio homogeneously as one collection of healthcare assets with a common goal of maximizing revenues and property income regardless of the asset class or asset type.

The Company has primarily leased its seniors housing properties to wholly owned TRS entities and engaged independent third-party managers under management agreements to operate the properties under the REIT Investment Diversification and Empowerment Act of 2007 (“RIDEA”) structures; however, the Company has also leased its properties to third-party tenants under triple-net or similar lease structures, where the tenant bears all or substantially all of the costs (including cost increases for real estate taxes, utilities, insurance and ordinary repairs).  Medical office, post-acute care and acute care properties have been leased on a triple-net, net or modified gross basis to third-party tenants.  In addition, most of the Company’s investments have been wholly owned, although, it has invested through partnerships with other entities where it is believed to be appropriate and beneficial.  The Company has and continues to invest in existing property developments or properties that have not reached full stabilization.

 

 

7

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

Basis of Presentation and Consolidation — The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and note disclosures required by generally accepted accounting principles in the United States (“GAAP”).  The unaudited condensed consolidated financial statements reflect all normal recurring adjustments, which, in the opinion of management, are necessary for the fair statement of the Company’s results for the interim period presented.  Operating results for the quarter and nine months ended September 30, 2016 may not be indicative of the results that may be expected for the year ending December 31, 2016.  Amounts as of December 31, 2015 included in the unaudited condensed consolidated financial statements have been derived from audited consolidated financial statements as of that date but do not include all disclosures required by GAAP.  These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

The accompanying unaudited condensed consolidated financial statements include the Company’s accounts, the accounts of wholly owned subsidiaries or subsidiaries for which the Company has a controlling interest, the accounts of variable interest entities (“VIEs”) in which the Company is the primary beneficiary and the accounts of other subsidiaries over which the Company has a controlling financial interest.   All material intercompany accounts and transactions have been eliminated in consolidation.

In accordance with the guidance for the consolidation of VIEs, the Company analyzes its variable interests, including loans, leases, guarantees, and equity investments, to determine if the entity in which it has a variable interest is a variable interest entity (“VIE”).  The Company’s analysis includes both quantitative and qualitative reviews.  The Company bases its quantitative analysis on the forecasted cash flows of the entity, and its qualitative analysis on its review of the design of the entity, its organizational structure including decision-making ability and financial agreements.  The Company also uses its quantitative and qualitative analyses to determine if it is the primary beneficiary of the VIE, and if such determination is made, it includes the accounts of the VIE in its consolidated financial statements.

Use of Estimates — The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements, the reported amounts of revenues and expenses during the reporting periods and the disclosure of contingent liabilities. For example, significant assumptions are made in the allocation of purchase price, the analysis of real estate impairments, the valuation of contingent assets and liabilities, and the valuation of restricted stock shares issued to the Advisor or Property Manager.  Accordingly, actual results could differ from those estimates.

Real Estate Held For Sale — The Company classifies the assets associated with any property as held for sale once management has the authority to approve and commits to a plan to sell the property, the property is available for immediate sale, there is an active program to locate a buyer, the sale of the property is probable and the transfer of the property is expected to occur within one year.  Upon the determination to classify a property as held for sale, the Company ceases recording further depreciation and amortization relating to the associated assets and those assets are measured at the lower of its carrying amount or fair value less disposition costs and are presented separately in the consolidated balance sheets for all periods presented.  In addition, the Company classifies real estate held for sale as discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on the Company’s operations and financial results.  

8

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

Adopted Accounting Pronouncements — In February 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2015-02, “Amendments to the Consolidation Analysis,” which requires amendments to both the VIE and voting models. The amendments (i) modify the identification of variable interests (fees paid to a decision maker or service provider), the VIE characteristics for a limited partnership or similar entity and primary beneficiary determination under the VIE model, and (ii) eliminate the presumption within the current voting model that a general partner controls a limited partnership or similar entity. The new guidance is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2015 with early adoption permitted.  The amendments may be applied using either a modified retrospective or full retrospective approach.  The Company retrospectively adopted ASU 2015-02 on January 1, 2016; the adoption of which modified the Company’s identification and conclusions for certain entities from variable interest entities to voting interest entities and resulted in the removal of the required disclosures related to those entities, but did not have a material impact to the Company’s consolidated financial position, results of operations or cash flows as the Company’s consolidation determinations for all of its VIEs remained unchanged.

In April 2015, the FASB issued ASU 2015-03, “Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs,” which requires that loan costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts or premiums. The new guidance is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2015 with early adoption permitted. The ASU is to be applied retrospectively for each period presented.  Upon adoption, an entity is required to comply with the applicable disclosures for a change in an accounting principle.  

The FASB subsequently issued ASU 2015-15, “Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements,” which clarifies that, given the absence of authoritative guidance in ASU 2015-03 regarding presentation and subsequent measurement of loan costs related to line-of-credit arrangements, the SEC Staff would not object to an entity deferring and presenting loan costs as an asset and subsequently amortizing the loan costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement.  

The Company adopted ASU 2015-03 on January 1, 2016; the adoption of which impacted the Company’s presentation of its consolidated financial position but did not have a material impact on the Company’s consolidated results of operations or cash flows.  Accordingly, the Company has retrospectively adjusted the presentation of loan costs for all periods presented.  The following table provides additional details by financial statement line item of the adjusted presentation in the Company’s condensed consolidated balance sheet as of December 31, 2015 (in thousands):

 

 

In September 2015, the FASB issued ASU 2015-16, “Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments,” which requires an acquirer to recognize provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined.  The amendments require that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date.  The new guidance is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2015 with early adoption permitted.  The Company adopted ASU 2015-16 on January 1, 2016; the adoption of which did not have a material impact to its consolidated financial position, results of operations or cash flows.

9

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

Recent Accounting Pronouncements — In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers,” as a new ASC topic (Topic 606).  The core principle of this ASU is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  The ASU further provides guidance for any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards (for example, lease contracts).  The FASB subsequently issued ASU 2015-14 to defer the effective date of ASU 2014-09 until annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, with earlier adoption permitted.  ASU 2014-09 can be adopted using one of two retrospective transition methods: (i) retrospectively to each prior reporting period presented or (ii) as a cumulative-effect adjustment as of the date of adoption.  The Company has not yet selected a transition method and is currently evaluating the impact this ASU will have on the Company’s consolidated financial position, results of operations and cash flows.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842): Accounting for Leases,” which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e. lessees and lessors).  The ASU requires lessees to recognize assets and liabilities on the balance sheet for the rights and obligations created by all leases with terms of more than 12 months.  The ASU further modifies lessors’ classification criteria for leases and the accounting for sales-type and direct financing leases.  The ASU will also require qualitative and quantitative disclosures designed to give financial statement users additional information on the amount, timing, and uncertainty of cash flows arising from leases.  The ASU is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2018 with early adoption permitted.  The ASU is to be applied using a modified retrospective approach.  The Company is currently evaluating the impact this ASU will have on the Company’s consolidated financial position, results of operations and cash flows.  

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments,” which will make eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows.  The ASU further clarifies how the predominance principle should be applied to cash receipts and payments relating to more than one class of cash flows. The ASU is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2017.  The ASU is to be applied retrospectively for each period presented.  The Company is currently evaluating the impact this ASU will have on the Company’s consolidated statement of cash flows.

 

 

10

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

The gross carrying amount and accumulated depreciation of the Company’s real estate assets as of September 30, 2016 and December 31, 2015 are as follows (in thousands):

 

Depreciation expense on the Company’s real estate investment properties, net was approximately $20.2 million and $60.1 million for the quarter and nine months ended September 30, 2016, respectively, and approximately $16.9 million and $44.8 million for the quarter and nine months ended September 30, 2015.

During 2016, the Company completed the construction on the final phase of the Raider Ranch community in Lubbock, Texas and all phases of the Watercrest at Katy community in Katy, Texas.  As such, the asset values related to these completed developments are included in real estate investment properties, net in the accompanying condensed consolidated balance sheet as of September 30, 2016.

Real Estate Held For Sale

In June 2016, the Company committed to a plan to sell the Dogwood Forest of Acworth property and classified the associated real estate as held for sale as of September 30, 2016. The sale of the Dogwood Forest of Acworth Property would not cause a strategic shift in the Company nor was it considered individually significant; therefore, it does not qualify as discontinued operations under ASU 2014-08.

As of September 30, 2016 and December 31, 2015, real estate held for sale consisted of the following (in thousands):

11

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

As of September 30, 2016, six of the Company’s seniors housing communities and one post-acute care facility have real estate under development or expansion / conversion projects with third-party developers as follows (in thousands):

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FOOTNOTES:

 

The development budgets include the cost of the land, construction costs, development fees, financing costs, start-up costs and initial operating deficits of the respective properties.  Generally, the Company has delegated to an affiliate of the developer of the respective community the management and administration of the development and construction.  In most cases, the developer is generally responsible for cost overruns beyond the approved development budget for the applicable project pursuant to a cost overrun guarantee.  Some of these developments were deemed to be VIEs; refer to Note 5. “Variable Interest Entities” for additional information.  

 

 

12

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

The gross carrying amount and accumulated amortization of the Company’s intangible assets and liabilities as of September 30, 2016 and December 31, 2015 are as follows (in thousands):

____________

FOOTNOTE:

Amortization on the Company’s intangible assets was approximately $10.7 million and $36.0 million for the quarter and nine months ended September 30, 2016, of which approximately $0.5 million and $1.5 million, respectively, were treated as a reduction of rental income from operating leases, approximately $0.1 million and $0.2 million, respectively, were treated as an increase of property operating expenses and approximately $10.1 million and $34.3 million, respectively, were included in depreciation and amortization.  Amortization on the Company’s intangible assets was approximately $11.6 million and $32.1 million for the quarter and nine months ended September 30, 2015, of which approximately $0.6 million and $1.5 million, respectively, were treated as a reduction of rental income from operating leases, approximately $0.08 million and $0.2 million, respectively, were treated as an increase of property operating expenses and approximately $10.9 million and $30.3 million, respectively, were included in depreciation and amortization.

Amortization on the Company’s intangible liabilities was approximately $0.4 million and $1.3 million for the quarter and nine months ended September 30, 2016, of which approximately $0.4 million and $1.2 million, respectively, were treated as an increase of rental income from operating leases and approximately $0.02 million and $0.07 million, respectively, were treated as a reduction of property operating expenses.  For the quarter and nine months ended September 30, 2015, amortization on the Company’s intangible liabilities was approximately $0.4 million and $1.2 million, of which approximately $0.4 million and $1.1 million, respectively, were treated as an increase of rental income from operating leases and approximately $0.02 million and $0.06 million were treated as a reduction of property operating expenses.

 

 

13

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

The aggregate carrying amount and major classifications of the consolidated assets that can be used to settle obligations of the VIEs and liabilities of the consolidated VIEs that are non-recourse to the Company as of September 30, 2016 and December 31, 2015 are as follows (in thousands):

The Company’s maximum exposure to loss as a result of its involvement with these VIEs is limited to its net investment in these entities which totaled approximately $74.4 million as of September 30, 2016. The Company’s exposure is limited because of the non-recourse nature of the borrowings of the VIEs.

As of September 30, 2016 and December 31, 2015, the Company had 10 and 12 subsidiaries, respectively, which are classified as VIEs due to the following factors and circumstances as of September 30, 2016:

The Company determined it is the primary beneficiary and holds a controlling financial interest in each of the aforementioned property and development entities due to its power to direct the activities that most significantly impact the economic performance of the entities, as well as its obligation to absorb the losses and its right to receive benefits from these entities that could potentially be significant to these entities. As such, the transactions and accounts of these VIEs are included in the accompanying condensed consolidated financial statements.

 

 

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

 

The following table provides a roll-forward of the fair value of the Company’s aggregate contingent purchase price consideration for the quarter and nine months ended September 30, 2016 and 2015 (in thousands):

 

 

 

 

The fair value of the contingent purchase price consideration is based on a then-current income approach that is primarily determined based on the present value and probability of future cash flows using internal underwriting models.  The income approach further includes estimates of risk-adjusted rate of return, capitalization rates for the respective property and/or lease-up assumptions.  Since these estimates include inputs that are less observable by the public and are not necessarily reflected in active markets, the measurements of the estimated fair value related to the Company’s contingent purchase price consideration are categorized as Level 3 on the three-level fair value hierarchy.  There were no transfers into and out of fair value measurement levels during the quarter and nine months ended September 30, 2016.

 

 

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

The following table provides details of the Company’s indebtedness as of September 30, 2016 and December 31, 2015 (in thousands):

_____________

FOOTNOTES:

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

The following table provides details of the fair market value and carrying value of the Company’s indebtedness as of September 30, 2016 and December 31, 2015 (in thousands):

 

These fair market values are based on current rates and spreads the Company would expect to obtain for similar borrowings.  Since this methodology includes inputs that are less observable by the public and are not necessarily reflected in active markets, the measurement of the estimated fair values related to the Company’s mortgage notes payable is categorized as Level 3 on the three-level valuation hierarchy.  The estimated fair value of accounts payable and accrued liabilities approximates the carrying value as of September 30, 2016 and December 31, 2015 because of the relatively short maturities of the obligations.

In August 2016, the Company extinguished approximately $34.4 million of construction loans related to the Wellmore of Tega Cay and Raider Ranch properties prior to their scheduled maturities.  In connection therewith, the Company wrote-off approximately $0.4 million of unamortized loan costs for both loans and paid an exit fee of approximately $1.1 million for the Wellmore of Tega Cay loan.  Both the unamortized loan costs and the exit fee are included in interest expense and loan cost amortization in the accompanying condensed consolidated statements of operations for the quarter and nine months ended September 30, 2016.

All of the Company’s mortgage and construction loans contain customary financial covenants and ratios; including (but not limited to): debt service coverage ratio, minimum occupancy levels, limitations on incurrence of additional indebtedness, etc.  

The credit facilities contain affirmative, negative, and financial covenants which are customary for loans of this type, including (but not limited to): (i) maximum leverage, (ii) minimum fixed charge coverage ratio, (iii) minimum consolidated net worth, (iv) restrictions on payments of cash distributions except if required by REIT requirements, (v) maximum secured indebtedness, (vi) maximum secured recourse debt, (vii) minimum unsecured interest coverage and (viii) limitations on certain types of investments and with respect to the pool of properties supporting borrowings under the credit facilities, minimum debt service coverage ratio, minimum weighted average occupancy, and remaining lease terms, as well as property type, MSA, operator, and asset value concentration limits.  The limitations on distributions include a limitation on the extent of allowable distributions, which are not to exceed the greater of 95% of adjusted FFO (as defined per the credit facilities) and the minimum amount of distributions required to maintain the Company’s REIT status.

As of September 30, 2016, the Company was in compliance with all financial covenants and ratios.

 

 

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

 

In March 2013, the Company entered into the advisor expense support and restricted stock agreement (“Advisor Expense Support Agreement”), whereby the Advisor agreed to provide expense support to the Company through forgoing the payment of fees in cash and acceptance of forfeitable restricted common stock (“Restricted Stock”) for services rendered and specified expenses incurred in an amount equal to the positive excess, if any, of (a) aggregate stockholder cash distributions declared for the applicable quarter, over (b) the Company’s aggregate modified funds from operations (as defined in the Advisor Expense Support Agreement).  The Advisor expense support amount was determined for each calendar quarter of the Company, on a non-cumulative basis, each quarter-end date (“Original Determination Date”).  In August 2013, the Company entered into the property manager expense support and restricted stock agreement (“Property Manager Expense Support Agreement”), whereby the Property Manager agreed to provide expense support to the Company through forgoing the payment of fees in cash and accepting Restricted Stock for services in an amount equal to the positive excess, if any, of (a) aggregate stockholder cash distributions declared for the applicable quarter, over (b) the Company’s aggregate modified funds from operations (as defined in the Property Manager Expense Support Agreement).  The Property Manager expense support amount was determined, on a non-cumulative basis, after the calculation of the Advisor expense support amount pursuant to the Property Manager Expense Support Agreement on each Original Determination Date.   

In exchange for services rendered and in consideration of the expense support provided, the Company issued, within 45 days following each Original Determination Date, a number of shares of restricted stock equal to the quotient of the expense support amounts provided by the Advisor and Property Manager for the preceding quarter divided by either: (1) the then-current public offering price per share of common stock during the Offerings or (2) the Company’s then-current net asset value (“NAV”) per share of common stock subsequent to the Offerings, on the terms and conditions and subject to the restrictions set forth in the Advisor Expense Support Agreement and the Property Manager Expense Support Agreement (“Original Expense Support Agreements”).  Any amounts settled, and for which restricted stock shares were issued, pursuant to the Original Expense Support Agreements have been permanently settled and the Company has no further obligation to pay such amounts to the Advisor or the Property Manager. The Restricted Stock is subordinated and forfeited to the extent that stockholders do not receive their invested capital plus a 6% cumulative, noncompounded annual return upon the ultimate liquidity of the Company. Since the vesting criteria is outside the control of the Advisor and Property Manager and involves both market conditions and counterparty performance conditions, the restricted stock shares are treated as unissued for financial reporting purposes until the vesting criteria are met.

In March 2016, the Company’s board of directors approved amended and restated expense support agreements with both the Advisor and Property Manager (“Amended Expense Support Agreements”) that are effective January 1, 2016 and change the calculation and determination date of the respective affiliate’s expense support amounts from each calendar quarter, on a non-cumulative basis, to each calendar year on a cumulative year-to-date basis (“Amended Determination Date”).  Under the terms of the Amended Expense Support Agreements, for each quarter within a calendar expense support year, the Company will record a proportional estimate of the cumulative year-to-date period based on an estimate of expense support amounts for the calendar expense support year.  Moreover, in exchange for services rendered and in consideration of the expense support provided under the Amended Expense Support Agreements, the Company will issue, within 90 days following the Amended Determination Date, a number of shares of restricted stock equal to the quotient of the expense support amounts provided by the Advisor and Property Manager for the preceding calendar year divided by the Company’s then-current NAV per share of common stock.  The terms of the Amended Expense Support Agreements automatically renew for consecutive one year periods, subject to the right of the Advisor or Property Manager to terminate their respective agreements upon 30 days’ written notice to the Company.

 

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

The following fees are expected to be or were settled and paid in the form of Restricted Stock in connection with the Amended Expense Support Agreements for the quarter and nine months ended September 30, 2016 and the Original Expense Support Agreements for the quarter and nine months ended September 30, 2015, and cumulatively as of September 30, 2016 under both agreements (in thousands, except offering price):

 

FOOTNOTES:

The Company maintained accounts totaling approximately $0.1 million as of December 31, 2015, at a bank in which the Company’s chairman served as a director during the year ended December 31, 2015.

In March 2015, the Company acquired Fieldstone Memory Care for a purchase price of $12.4 million from a related party of the Company’s Sponsor.    

The Company incurs operating expenses which, in general, relate to administration of the Company on an ongoing basis.  Pursuant to the advisory agreement, the Advisor shall reimburse the Company the amount by which the total operating expenses paid or incurred by the Company exceed, in any four consecutive fiscal quarters (“Expense Year”) commencing with the Expense Year ending June 30, 2013, the greater of 2% of average invested assets or 25% of net income (as defined in the advisory agreement) (“Limitation”), unless a majority of the Company’s independent directors determines that such excess expenses are justified based on unusual and non-recurring factors (“Expense Cap Test”).  In performing the Expense Cap Test, the Company uses operating expenses on a GAAP basis after making adjustments for the benefit of expense support under the Amended Expense Support Agreements.  For the Expense Year ended September 30, 2016, the Company did not incur operating expenses in excess of the Limitation.

 

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

The fees incurred by and reimbursable to the Managing Dealer in connection with the Company’s Offerings for the quarter and nine months ended September 30, 2016 and 2015, and related amounts unpaid as of September 30, 2016 and December 31, 2015 are as follows (in thousands):

The expenses and fees incurred by and reimbursable to the Company’s related parties for the quarter and nine months ended September 30, 2016 and 2015, and related amounts unpaid as of September 30, 2016 and December 31, 2015 are as follows (in thousands):

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

 

FOOTNOTES:

 

 

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

The following summarizes the terms of the Company’s, or its equity method investments’, derivative financial instruments and the corresponding asset (liability) as of September 30, 2016 and December 31, 2015 (in thousands):

_______________

FOOTNOTES:

Although the Company has determined that the majority of the inputs used to value its derivative financial instruments fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by the Company and its counterparties.  The Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative financial instruments and has determined that the credit valuation adjustments on the overall valuation adjustments are not significant to the overall valuation of its derivative financial instruments. As a result, the Company determined that its derivative financial instruments valuation in its entirety is classified in Level 2 of the fair value hierarchy. Determining fair value requires management to make certain estimates and judgments.  Changes in assumptions could have a positive or negative impact on the estimated fair values of such instruments which could, in turn, impact the Company’s or its joint venture’s results of operations.  

 

 

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

Stockholders’ Equity:

Distribution Reinvestment Plan — For the nine months ended September 30, 2016 and 2015, the Company received proceeds through its Reinvestment Plan of approximately $32.0 million (3.3 million shares) and $26.1 million (2.6 million shares), respectively.

Distributions — The following table details the Company’s historical share prices in its Offerings, including the prices pursuant to the Reinvestment Plan and the Company’s monthly cash and stock distributions per share:

 

FOOTNOTES:

During the nine months ended September 30, 2016 and 2015, the Company declared cash distributions of $55.5 million and $44.9 million, respectively, of which $23.5 million and $18.8 million, respectively, were paid in cash to stockholders and $32.0 million and $26.1 million, respectively, were reinvested pursuant to the Reinvestment Plan.  In addition, the Company declared and made stock distributions of approximately 3.2 million shares of common stock during the nine months ended September 30, 2015. The Company closed its Offerings on September 30, 2015 and discontinued its stock distributions concurrently.

Redemptions — During the nine months ended September 30, 2016 and 2015, the Company received requests for the redemption of common stock of approximately 2.7 million and 0.7 million shares, respectively, all of which were approved for redemption at an average price of $9.73 and $9.51, respectively, and for a total of approximately $25.8 million and $6.6 million, respectively.  

Promoted Interest — During the nine months ended September 30, 2016, the Company recorded, as a reduction to capital in excess of par value, approximately $6.7  million in distributions to holders of promoted interest related to the following completed developments (in thousands):

 

There were no such distributions during the nine months ended September 30, 2015.

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

 

Other comprehensive income (loss) — The following table reflects the effect of derivative financial instruments held by the Company, or its equity method investments, and included in the condensed consolidated statements of comprehensive loss for the quarter and nine months ended September 30, 2016 and 2015 (in thousands):

 

 

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2016 (UNAUDITED)

 

 

From time to time, the Company may be a party to legal proceedings in the ordinary course of, or incidental to the normal course of, its business, including proceedings to enforce its contractual or statutory rights.  While the Company cannot predict the outcome of these legal proceedings with certainty, based upon currently available information, the Company does not believe the final outcome of any pending or threatened legal proceeding will have a material adverse effect on its results of operations or financial condition.

The Company has seven remaining promoted interest agreements with third-party developers pursuant to which certain operating targets have been established that, upon meeting such targets, result in the developer being entitled to additional payments based on enumerated percentages of the assumed net proceeds of a deemed sale, subject to achievement of an established internal rate of return on the Company’s investment in the development.

Refer to Note 3. “Real Estate Assets, net” for additional information on the remaining development budgets for the Company’s real estate under development.

Refer to Note 6. “Contingent Purchase Price Consideration” for information on potential contingent purchase price considerations related to property acquisitions.

Refer to Note 8. “Related Party Arrangements” for information on contingent restricted stock shares due to the Company’s Advisor and Property Manager in connection with the Amended Expense Support Agreements.

 

 

Cobalt Rehabilitation Hospital of New Orleans

 

In October 2016, the Company acquired Cobalt Rehabilitation Hospital of New Orleans for approximately $28.6 million in a sale-leaseback transaction.  The recently developed post-acute care facility consists of a 65,345 square foot rehabilitation hospital in New Orleans, Louisiana.  The Company incurred an approximate $0.5 million investment service fee related to this acquisition payable to the Advisor.

 

The following summarizes the Company’s preliminary allocation of the purchase price for the above property, and the estimated fair values of the assets acquired (in thousands):

 

 

FOOTNOTE:

 

 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Caution Concerning Forward-Looking Statements

Statements contained under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Quarterly Report on Form 10-Q for the quarter and nine months ended September 30, 2016 that are not statements of historical or current fact may constitute “forward-looking statements” within the meaning of the Federal Private Securities Litigation Reform Act of 1995.  The Company intends that such forward-looking statements be subject to the safe harbor created by Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  Forward-looking statements are statements that do not relate strictly to historical or current facts, but reflect management’s current understandings, intentions, beliefs, plans, expectations, assumptions and/or predictions regarding the future of the Company’s business and its performance, the economy, and other future conditions and forecasts of future events and circumstances.  Forward-looking statements are typically identified by words such as “believes,” “expects,” “anticipates,” “intends,” “estimates,” “plans,” “continues,” “pro forma,” “may,” “will,” “seeks,” “should,” and “could” and words and terms of similar substance in connection with discussions of future operating or financial performance, business strategy and portfolios, projected growth prospects, cash flows, costs and financing needs, legal proceedings, amount and timing of anticipated future distributions, estimated per share net asset value of the Company’s common stock, and/or other matters.  The Company’s forward-looking statements are not guarantees of future performance.  While the Company’s management believes its forward-looking statements are reasonable, such statements are inherently susceptible to uncertainty and changes in circumstances.  As with any projection or forecast, forward-looking statements are necessarily dependent on assumptions, data and/or methods that may be incorrect or imprecise, and may not be realized.  The Company’s forward-looking statements are based on management’s current expectations and a variety of risks, uncertainties and other factors, many of which are beyond the Company’s ability to control or accurately predict.  Although the Company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, the Company’s actual results could differ materially from those set forth in the forward-looking statements due to a variety of risks, uncertainties and other factors.  

Important factors that could cause the Company's actual results to vary materially from those expressed or implied in its forward-looking statements include, but are not limited to, government regulation, economic, strategic, political and social conditions and the following: a worsening economic environment in the U.S. or globally, including financial market fluctuations; risks associated with the Company’s investment strategy, including its concentration in the healthcare sector; the illiquidity of an investment in the Company’s stock; liquidation at less than the subscription price of the Company’s stock; the impact of regulations requiring periodic valuation of the Company on a per share basis, including the uncertainties inherent in such valuations and that the amount that a stockholder would ultimately realize upon liquidation may vary significantly from the Company’s estimated net asset value; risks associated with real estate markets, including declining real estate values; risks associated with reliance on the Company’s advisor and its affiliates, including conflicts of interest; the Company’s failure to obtain, renew or extend necessary financing or to access the debt or equity markets; the use of debt to finance the Company’s business activities, including refinancing and interest rate risk and the Company’s failure to comply with debt covenants; the Company’s inability to identify and close on suitable investments; failure to successfully manage growth or integrate acquired properties and operations; the Company’s inability to make necessary improvements to properties on a timely or cost-efficient basis; risks related to property expansions and renovations; risks related to development projects or acquired property value-add conversions, if applicable, including construction delays, cost overruns, the Company’s inability to obtain necessary permits, and/or public opposition to these activities; competition for properties and/or tenants; defaults on or non-renewal of leases by tenants; failure to lease properties on favorable terms or at all; the impact of current and future environmental, zoning and other governmental regulations affecting the Company’s properties; the impact of changes in accounting rules; inaccuracies of the Company’s accounting estimates; unknown liabilities of acquired properties or liabilities caused by property managers or operators; material adverse actions or omissions by any joint venture partners; consequences of the Company’s net operating losses; increases in operating costs and other expenses; uninsured losses or losses in excess of the Company’s insurance coverage; the impact of outstanding and/or potential litigation; risks associated with the Company’s tax structuring; failure to qualify for and maintain the Company’s qualification as a REIT for federal income tax purposes; and the Company’s inability to protect its intellectual property and the value of its brand.  Given these uncertainties, the Company cautions you not to place undue reliance on forward-looking information.

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For further information regarding risks and uncertainties associated with the Company’s business, and other important factors that could cause the Company’s actual results to vary materially from those expressed or implied in its forward-looking statements, please refer to the factors listed and described in the Company’s  reports filed from time to time with the U.S. Securities and Exchange Commission, including, but not limited to, the Company’s quarterly reports on Form 10-Q and the Company’s annual reports on Form 10-K, copies of which may be obtained from the Company’s website at www.cnlhealthcareproperties.com.

All written and oral forward-looking statements attributable to the Company or persons acting on its behalf are qualified in their entirety by this cautionary note.  Forward-looking statements speak only as of the date on which they are made, and the Company undertakes no obligation to, and expressly disclaims any obligation to, publicly release the results of any revisions to its forward-looking statements to reflect new information, changed assumptions, the occurrence of unanticipated subsequent events or circumstances, or changes to future operating results over time, except as otherwise required by law.

Introduction

The following discussion is based on the condensed consolidated financial statements as of September 30, 2016 (unaudited) and December 31, 2015.  Amounts as of December 31, 2015, included in the unaudited condensed consolidated balance sheets have been derived from the audited consolidated financial statements as of that date. This information should be read in conjunction with the accompanying unaudited condensed consolidated balance sheets and the notes thereto, as well as the audited consolidated financial statements, notes and management’s discussion and analysis included in our annual report on Form 10-K for the year ended December 31, 2015.

Overview

CNL Healthcare Properties, Inc. is a Maryland corporation incorporated on June 8, 2010 that elected to be taxed as a REIT beginning with the year ended December 31, 2012 for U.S. federal income tax purposes. The terms “us,” “we,” “our,” “Company” and “CNL Healthcare Properties” include CNL Healthcare Properties, Inc. and each of its subsidiaries.

We are externally managed and advised by CNL Healthcare Corp., which serves as our Advisor and is responsible for managing our day-to-day affairs and for identifying and making acquisitions and investments on our behalf. We have also retained CNL Healthcare Manager Corp., our Property Manager, to manage our properties under a six year property management agreement, which is effective through June 8, 2017.

From July 2011 to September 2015, we raised approximately $1.7 billion through our Offerings. The net proceeds from our Offerings were contributed to CHP Partners, LP, our operating partnership, in exchange for partnership interests.  Substantially all of our assets are held by, and all operations are conducted, either directly or indirectly, through: (1) the Operating Partnership in which we are the sole limited partner and our wholly owned subsidiary, CHP GP, LLC, is the sole general partner; (2) a wholly owned TRS, CHP TRS Holding, Inc.; (3) property owner subsidiaries and lender subsidiaries, which are single purpose entities; and (4) investments in joint ventures.

On September 30, 2015, we completed our Offerings pursuant to a registration statement on Form S-11 under the Securities Act of 1933 with the SEC.  In October 2015, we deregistered the unsold shares of our common stock under our previous registration statement on Form S-11, except for 20,000,000 shares that we concurrently registered on Form S-3 under the Securities Exchange Act of 1933 with the SEC for the sale of additional shares of common stock through our Reinvestment Plan.

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Portfolio Overview

We believe recent demographic trends and compelling supply and demand indicators present a strong case for an investment focus on healthcare real estate or real estate-related assets. We believe that the healthcare sector will continue to provide attractive opportunities as compared to other asset sectors over the long-term.  Our healthcare investment portfolio is geographically diversified with properties in 34 states. The map below shows our current property allocations across geographic regions as of October 31, 2016:

 

 

As of October 31, 2016, our healthcare investment portfolio consisted of interests in 145 properties, including 74 seniors housing communities, 54 MOBs, 12 post-acute care facilities and five acute care hospitals.  Of our properties held at October 31, 2016, seven of our 74 seniors housing communities currently have real estate under development or current expansion projects and five were owned through an unconsolidated joint venture.  One of our 12 post-acute care facilities currently has real estate under development. The following table summarizes our healthcare portfolio by asset class and investment structure as of October 31, 2016:

 

 

FOOTNOTES:

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Portfolio Evaluation

We monitor the performance of our tenants and third-party operators to stay abreast of any material changes in the operations of the underlying properties by (1) reviewing the current, historical and prospective operating margins (measured by a tenant’s earnings before interest, taxes, depreciation, amortization and facility rent), (2) monitoring trends in the source of our tenants’ revenue, including the relative mix of public payors (including Medicare, Medicaid, etc.) and private payors (including commercial insurance and private pay patients), (3) evaluating the effect of evolving healthcare legislation and other regulations on our tenants’ profitability and liquidity, and (4) reviewing the competition and demographics of the local and surrounding areas in which the tenants operate.

In addition to operating statistics of the underlying properties, when evaluating the performance of our healthcare portfolio within the seniors housing and post-acute care asset classes, management reviews occupancy levels and monthly revenue per occupied unit (“RevPOU”), which we define as total revenue divided by average number of occupied units or beds during a month and is considered a performance metric within these asset classes.  Similarly, within the medical office and acute care asset classes, management reviews operating statistics of the underlying properties, including occupancy levels and monthly rent per square foot.  Lastly, when evaluating the performance of our third-party operators or developers, management reviews monthly financial statements, property level operating performance versus budgeted expectations, conducts periodic operational review calls with operators and conducts periodic property inspections or site visits.  All of the aforementioned metrics assist us in determining the ability of our properties or operators to achieve market rental rates, to assess the overall performance of our diversified healthcare portfolio, and to review compliance with leases, debt, licensure, real estate taxes, and other collateral.

Furthermore, in our evaluation of the properties that we have purchased and additional properties that we expect to purchase, we consider the operating stage of the investments within the following stages: development, value-add or stabilizing and stabilized.  Development properties are those in which we or our joint venture have purchased land for the development of new operating properties.  We typically hold rights as the owner or managing member of the development properties while a third-party or our joint venture partner manages the development, construction and certain day-to-day operations of the property subject to our oversight.  Stabilizing properties are either developed properties that have been fully constructed and in lease-up phase (typically 18 months post-construction) or existing (“value-add”) properties in which we expect to make capital investments to upgrade or expand.  A property is considered stabilized upon the earlier of (i) when the property reaches 85% occupancy for a trailing three month period, or (ii) a two year period from acquisition or completion of development.  For those assets that are above an 85% occupancy level and subsequently drop below 85%, they are reclassified to stabilizing until the assets attain the trailing three month 85% occupancy metric.

During the nine months ended September 30, 2016, we continued to invest in ground-up development and value-add or stabilizing properties.  During the construction and lease-up phase, these types of investments are expected to generate limited cash flows from operations and may result in near term downward pressure on our results of operations and net asset valuation.  However, we believe that investing a portion of our capital into these types of properties is beneficial because they are expected to provide a higher yield on cost and higher net asset valuations in the long-term as compared to stabilized acquisitions.  Additionally, these types of assets will result in our portfolio having a lower average age, which we believe will enhance our overall market value over the long-term.

Based on revenues for the nine months ended September 30, 2016, the Company’s portfolio is comprised of 88.7% stabilized properties, of which 2.9% are completed developments, and 11.3% value-add or stabilizing properties, of which 2.5% are recently completed developments that are currently in the lease-up phase.

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The following table lists our occupancy, RevPOU and rent per square feet by asset class within our healthcare portfolio as of September 30, 2016:

 

 

FOOTNOTE:

Significant Tenants and Operators

Our real estate portfolio is operated by a mix of national or regional operators and the following represents the significant tenants and operators that lease or manage 5% or more of our rentable space as of September 30, 2016:

 

 

 

FOOTNOTE:

While we are not directly impacted by the performance of the underlying properties leased to third-party tenants, we believe that the financial and operational performance of our tenants provides an indication about the health of our tenants and their ability to pay rent. To the extent that our tenants, managers or our joint venture partners experience operating difficulties and become unable to generate sufficient cash to make rent payments to us, there could be a material adverse impact on our consolidated results of operations, liquidity and/or financial condition. Our tenants and managers are generally contractually required to provide this information to us in accordance with their

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respective lease, management and/or joint venture agreement. Therefore, in order to mitigate the aforementioned risk, we monitor our investments through a variety of methods determined by the type of property.

We monitor the credit of our tenants to stay abreast of any material changes in quality. We monitor tenant credit quality by (1) reviewing financial statements that are publicly available or that are required to be delivered to us under the applicable lease, (2) direct interaction with onsite property managers, (3) monitoring news and rating agency reports regarding our tenants (or their parent companies) and their underlying businesses, (4) monitoring the timeliness of rent collections and (5) monitoring lease coverage.

Tenant Lease Expirations

Our asset management team collaborates with existing tenants to understand their current and anticipated space needs in advance of their lease term renewal date.  We work with and begin lease-related negotiations well in advance of the lease expirations or renewal period options in order for us to maintain a balanced lease rollover schedule and high occupancy levels, as well as to enhance the value of our properties through extended lease terms. Lease extensions are likely to create an obligation to pay lease commissions, lease incentives and/or tenant improvements and may also provide our tenants with some periods of reduced and/or “free rent.” Certain amendments or modifications to the terms of existing leases could require lender approval.

During the nine months ended September 30, 2016, our rental revenues from operating leases represented approximately 32.8% of our total revenues.  As of September 30, 2016, approximately 69.3% of our rental revenues from operating leases were scheduled to expire in 2021 or later.  Based on this, we do not expect lease turnover to have a significant impact on our cash flows from operations in the near term.  

The following table lists, on an aggregate basis, scheduled expirations for the remainder of 2016, each of the next nine years and thereafter on our consolidated healthcare investment portfolio (excludes real estate under development), assuming that none of the tenants exercise any of their renewal options, as of September 30, 2016 (in thousands, except for number of tenants and percentages):

 

 

FOOTNOTES:

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Real Estate Under Development

As of October 31, 2016, we had interests in five properties under development and two properties with expansion or conversion projects that will provide us with 611 additional units upon completion as follows:

 

 

FOOTNOTES:

The development budgets include the cost of the land, construction costs, development fees, financing costs, start-up costs and initial operating deficits of the respective properties.  Generally, we have delegated to an affiliate of the developer of the respective community the management and administration of the development and construction.  Each developer is generally responsible for any cost overruns beyond the approved development budget for the applicable project.

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Liquidity and Capital Resources

General

Our primary source of capital, through the close of our Offerings on September 30, 2015, was proceeds we received from our Offerings.  While our Offerings closed on September 30, 2015, we continue to provide existing stockholders the opportunity to designate their cash distributions for reinvestment through our Reinvestment Plan.  Potential future sources of capital include proceeds from collateralized or uncollateralized financings from banks or other lenders, proceeds from the sale of properties, other assets and undistributed operating cash flows.  If necessary, we may use financings or other sources of capital in the event of unforeseen significant capital expenditures.  As of September 30, 2016, we have approximately $28.4 million of available proceeds remaining under our Revolving Credit Facility, as discussed below.

Our principal demand for funds has been for acquisitions, the payment of debt service on our outstanding indebtedness and the payment of distributions.  Generally, we expect to meet short-term working capital needs from our cash flows from operations and proceeds from our Reinvestment Plan.  

We intend to strategically leverage our real properties and possibly other assets and use debt financing as a means of providing additional funds for the acquisition of properties, ongoing real estate under development and the diversification of our portfolio.  Our ability to increase our diversification through borrowing could be adversely affected by credit market conditions which result in lenders reducing or limiting funds available for loans, including loans collateralized by real estate.  We may also be negatively impacted by rising interest rates on any unhedged variable rate debt or the timing of when we seek to refinance existing debt.  In addition, we will continue to evaluate the need for additional interest rate protection in the form of interest rate swaps or caps on unhedged variable rate debt.

Sources of Liquidity and Capital Resources

Reinvestment Plan

For the nine months ended September 30, 2016 and 2015, we received proceeds from our Reinvestment Plan of approximately $32.0 million and $26.1 million, respectively, as existing stockholders continue to designate their cash distributions for reinvestment through our Reinvestment Plan.

Borrowings

We have borrowed and intend to continue borrowing money to fund ongoing real estate development and other enhancements to our portfolio, as well as to cover periodic shortfalls between distributions paid and cash flows from operating activities.  During the nine months ended September 30, 2016 and 2015, we borrowed proceeds of approximately $191.4 million and $299.9 million, respectively. These amounts were primarily used to fund real estate under development and acquire additional properties in 2015. While we have substantially completed our acquisition phase, we continue to monitor and evaluate additional acquisition opportunities and may borrow additional money to fund such acquisitions.

We may borrow money to pay distributions to stockholders, for working capital and for other corporate purposes.  See “Uses of Liquidity and Capital Resources – Distributions” below for additional information related to the payment of distributions with other sources for GAAP purposes.  In many cases, we have pledged our assets in connection with our borrowings and intend to encumber assets in connection with additional borrowings.  The aggregate amount of long-term financing is not expected to exceed 60% of our total assets on an annual basis.  As of September 30, 2016 and December 31, 2015, we had an aggregate debt leverage ratio of approximately 55.0% and 52.6%, respectively, of the aggregate carrying value of our assets.

Real Estate Held For Sale

In June 2016, we committed to a plan to sell the Dogwood Forest of Acworth property and classified the associated real estate as held for sale as of September 30, 2016.  We expect net sales proceeds will exceed the carrying value of the property and expect it to close by the end of the year.

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Tenant Workouts

In July 2015, an anchor tenant at two of our medical office buildings filed for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code.  In May 2016, we signed new lease agreements for a majority of the original leased spaces with the health system that purchased substantially all of the anchor tenant’s operations.  In addition, the anchor tenant rejected two of the previous space leases as part of its bankruptcy reorganization, which resulted in us assuming a sublease under the original lease structure with the anchor tenant and recording a loss on lease terminations of approximately $0.8 million related to the vacated space leases.  We do not expect the impact of this workout to have a material impact on our operating cash flows in future periods given that revenues attributable to the anchor tenant represented less than 1.0% of our total revenues for the year ended December 31, 2015.

During 2015, the tenant at two of our specialty hospitals experienced financial difficulty and defaulted on its lease agreements at both properties.  During the nine months ended September 30, 2015, we recorded an impairment provision of approximately $4.7 million related to the lease intangibles and a loss on lease termination of approximately $0.9 million related to deferred rent and other lease related assets.  In September 2015, in connection with consenting to the sale of the operations by our previous tenant to a third-party buyer at our specialty hospital in Beaumont, TX, we signed an amended and restated lease agreement with the buyer that included similar economic terms as the previous lease.  In January 2016, we executed a lease with a new tenant at our specialty hospital in Hurst, TX that included similar economic terms as the previous lease.  As incentive for entering into a long-term lease, the tenant was granted six months of “free rent” in 2016.  We expect this new lease to increase our operating cash flows in 2016 given the loss of revenues generated by the default on the previous lease during the year ended December 31, 2015.

Net Cash Provided by Operating Activities

We experienced positive cash flow from operating activities for the nine months ended September 30, 2016 and 2015 of approximately $57.0 million and $32.4 million, respectively.  The increase in cash flows from operating activities for the nine months ended September 30, 2016 as compared to the same period in 2015 was primarily the result of the following:

We expect that cash flows provided by operating activities will continue to grow as properties acquired are held for the entire period and additional value-add and completed development properties stabilize.  Since we have substantially completed our acquisition phase, we do not expect to incur significant acquisition fees and expenses in future periods and generally expect this to contribute to positive growth in our cash flows from operations in future periods.

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Expense Support Agreements

During the nine months ended September 30, 2015, our cash from operating activities was positively impacted by the Original Expense Support Agreements, which we entered into with our Advisor and Property Manager.  Pursuant to the Original Expense Support Agreements, our Advisor and Property Manager agreed to forgo the payment of fees in cash and accept Restricted Stock for services in an amount equal to the positive excess, if any, of (a) aggregate stockholder cash distributions declared for the applicable quarter, over (b) our aggregate modified funds from operations (as defined in the Original Expense Support Agreements).  The Advisor expense support amount was determined for each calendar quarter, on a non-cumulative basis, on each quarter-end date.  The Property Manager expense support amount was determined for each calendar quarter, on a non-cumulative basis, after the calculation of the Advisor expense support amount pursuant to the Property Manager Expense Support Agreement on each quarter-end date.  For the quarter and nine months ended September 30, 2015, our Advisor settled approximately $0.9 million and $2.3 million, respectively, of asset management fees in accordance with the terms of the Original Expense Support Agreements.  Any amounts settled, and for which restricted stock shares were issued, pursuant to the Original Expense Support Agreements have been permanently settled and we have no further obligation to pay such amounts to the Advisor or the Property Manager.

In March 2016, our board of directors approved the Amended Expense Support Agreements with both the Advisor and Property Manager that are effective January 1, 2016 and change the calculation and determination date of the respective affiliate’s expense support amounts from each calendar quarter, on a non-cumulative basis, to each calendar year on a cumulative year-to-date basis.  Under the terms of the Amended Expense Support Agreements, for each quarter within a calendar expense support year, we will record a proportional estimate of the cumulative year-to-date period based on an estimate of expense support amounts for the calendar expense support year.  Moreover, in exchange for services rendered and in consideration of the expense support provided, under the Amended Expense Support Agreements, we shall issue, within 90 days following each Amended Determination Date, a number of shares of Restricted Stock equal to the quotient of the expense support amounts provided by to the Advisor and Property Manager for the preceding calendar year divided by the then-current NAV per share of common stock.  The Restricted Stock is subordinated and forfeited to the extent that shareholders do not receive their invested capital plus a 6% cumulative noncompounded annual return upon ultimate liquidity of the company.  The terms of the Amended Expense Support Agreements automatically renew for consecutive one year periods, subject to the right of the Advisor or Property Manager to terminate their respective agreements upon 30 days’ written notice.  For the quarter and nine months ended September 30, 2016, we recognized approximately $0.9 million and $2.6 million, respectively, as an estimate of the annual expense support amount expected to be settled in accordance with the terms of the Amended Expense Support Agreements.  

Refer to Note 8. “Related Party Arrangements” for additional information.

Uses of Liquidity and Capital Resources

Lease Incentives

During the nine months ended September 30, 2016 and 2015, we paid approximately $2.3 million and $11.6 million, respectively, of costs on behalf of our tenants as lease incentives in connection with the build-out of space for certain tenants entering into new leases or extending existing leases at our MOBs.  Lease incentives are capitalized as deferred rent and amortized as straight-line rent over the respective lease terms.  While we expect the impact of these lease incentives to adversely impact our cash flows from operations in the near term, we anticipate that the new leasing activity will contribute to same-store NOI growth in future periods and that the extension of existing lease terms could increase the value of our properties.

Development Properties

In connection with our seniors housing and post-acute care developments, we funded approximately $60.8 million and $54.4 million in development costs during the nine months ended September 30, 2016 and 2015, respectively.  Pursuant to the development agreements for the active properties under development as of September 30, 2016, we expect to fund approximately $75.2 million of additional development and other costs.  We expect to fund the remaining development and other costs primarily from construction loans on each development or other cash flows from financing activities.

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As a result of our completed seniors housing developments continuing to move towards or achieving stabilization, we expect to pay additional amounts in future periods to the respective third-party developers as holders of a promoted interest in these properties.  We continue to monitor the lease-up of these properties to determine whether the established performance metrics have been met.  As of September 30, 2016, we have accrued a distribution to the holder of promoted interest for Dogwood Forest of Acworth of approximately $3.9 million of which approximately $1.9 million has been paid while the remaining $2.0 million will be retained until the completion of the Dogwood Forest of Grayson development which is expected to occur in the third quarter of 2017.  Our obligation to pay the promoted interest on the Dogwood Forest of Acworth property is not impacted by our decision to sell the property.  In addition, in connection with the Wellmore of Tega Cay transition from a managed property to leased, we paid approximately $2.8 million under our promoted interest agreement.

Debt Repayments

During the nine months ended September 30, 2016, we paid approximately $139.2 million of total repayments which was comprised of $90.3 million in repayments on our Revolving Credit Facility, $34.4 million in repayments on our mortgage loans for the Wellmore of Tega Cay Property and Raider Ranch Community, prior to the scheduled maturities, and $14.5 million of scheduled repayments.  During the nine months ended September 30, 2015, we paid approximately $111.7 million of total repayments which was comprised of $31.4 million in repayments on our Revolving Credit Facility, $64.5 million in repayments on our mortgage loans for the Perennial Communities and Medical Portfolio I Properties, respectively, prior to the scheduled maturities, $2.6 million of prepayments on our mortgage loan for the Capital Health Communities related to monies received under the Yield Guaranty and $13.2 million of scheduled repayments.

Stock Issuance and Offering Costs

Under the terms of the Offerings, certain affiliates and third-party broker dealers were entitled to receive selling commissions of up to 7% of gross offering proceeds on all shares sold, a marketing support fee of up to 3% of gross offering proceeds, and reimbursement of actual expenses incurred in connection with the Offerings.  In accordance with our articles of incorporation and the advisory agreement, the total amount of selling commissions, marketing support fees, due diligence expense reimbursements, and organizational and other offering costs to be paid by us could not exceed 15% of the gross aggregate proceeds of our Offerings.  

During the nine months ended September 30, 2016 and 2015, we paid approximately $0.03 million and $55.6 million, respectively, of stock issuance and offering costs.

Common Stock Redemptions

We have adopted a redemption plan that allows our stockholders who hold shares for at least one year to request that we redeem between 25% and 100% of their shares.  If we have sufficient funds available to do so and if we choose, in our sole discretion, to redeem shares, the number of shares we may redeem in any calendar year and the price at which they are redeemed are subject to conditions and limitations, including:

Our board of directors has the ability, in its sole discretion, to amend or suspend the redemption plan or to waive any specific conditions if it is deemed to be in our best interest.  

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The following tables present a summary of requests received and shares redeemed pursuant to our redemption plan during the nine months ended September 30, 2016 and 2015:

 

 

 

During the nine months ended September 30, 2016, we paid approximately $20.3 million in redemptions of common stock of which approximately $2.7 million related to prior year redemption requests that were payable as of December 31, 2015.  In addition, subsequent to September 30, 2016, we paid approximately $8.3  million in redemptions of common stock related to requests received for the quarter ended September 30, 2016.  During the nine months ended September 30, 2015, we paid approximately $4.7 million in redemptions of common stock of which approximately $0.9 million related to prior year redemption requests that were payable as of December 31, 2014.

Distributions

In order to qualify as a REIT, we are required to make distributions, other than capital gain distributions, to our stockholders each year in the amount of at least 90% of our taxable income. We may make distributions in the form of cash or other property, including distributions of our own securities.  While we generally expect to pay distributions from cash flows provided by operating activities, we have and may continue to cover periodic shortfalls between distributions paid and cash flows from operating activities from other sources; such as from cash flows provided by financing activities, a component of which could include borrowings, whether collateralized by our assets or unsecured, or proceeds of our Reinvestment Plan (“Other Sources”).

 

 

 

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The following table represents total cash distributions declared, distributions reinvested and cash distributions per share for quarter and nine months ended September 30, 2016 and 2015 (in thousands, except per share data):    

 

 

FOOTNOTES:

 

 

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We are not aware of any material trends or uncertainties, favorable or unfavorable, that may be reasonably anticipated to have a material impact on either capital resources or the revenues or income to be derived from the acquisition and operation of properties, loans and other permitted investments, other than those referred to in the risk factors identified in “Part II, Item 1A” of this report and the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2015.

Results of Operations

The following discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and the notes thereto of our Annual Report on Form 10-K for the year ended December 31, 2015.

As of September 30, 2016, we owned 134 consolidated operating real estate investment properties and our portfolio consisted of 5,433 units operated under management agreements with third-party operators and approximately 5.8 million rentable square feet that was 94.9% leased to third-party tenants.

 

 

Quarter and nine months ended September 30, 2016 as compared to the quarter and nine months ended September 30, 2015

Rental Income from Operating Leases. Rental income from operating leases was approximately $31.0 million and $92.7 million, respectively, for the quarter and nine months ended September 30, 2016 as compared to approximately $28.4 million and $72.3 million, respectively, for the quarter and nine months ended September 30, 2015.  The increase in rental income from operating leases resulted from the acquisition of additional leased properties subsequent to September 30, 2015 as detailed above as well as the increased rental income resulting from tenant workouts discussed above.  We expect this revenue stream to increase for the remainder of 2016 in comparison with the prior period as these investments are held in future periods.

Resident Fees and Services. Resident fees and services income was approximately $59.3 million and $174.6 million, respectively, for the quarter and nine months ended September 30, 2016 as compared to approximately $47.5 million and $129.3 million, respectively, for the quarter and nine months ended September 30, 2015.  The increase in resident fees and services is a result of the acquisition of additional managed properties subsequent to September 30, 2015 as detailed above and an increase in revenue at properties held for entire comparable periods (“same-store revenue”).  The increase in same-store revenue was partially offset by our decision to convert certain skilled nursing units to assisted living units at our Isle at Cedar Ridge and Isle at Watercrest - Bryan communities.  We expect this revenue stream to increase for the remainder of 2016 in comparison with the prior period as these investments are held in future periods, and our value-add and completed development properties stabilize.

Tenant Reimbursement Income. Tenant reimbursement income was approximately $5.2 million and $15.2 million, respectively, for the quarter and nine months ended September 30, 2016 as compared to approximately $4.0 million and $10.8 million, respectively, for the quarter and nine months ended September 30, 2015.  This amount is comprised of common area maintenance (“CAM”) revenue and the increase resulted from the acquisition of additional medical office leased properties subsequent to September 30, 2015 as detailed above.  We expect this revenue stream to increase for the remainder of 2016 in comparison with the prior period as these investments are held in future periods.    

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Property Operating Expenses. Property operating expenses were approximately $47.2 million and $139.6 million, respectively, for the quarter and nine months ended September 30, 2016 as compared to approximately $39.9 million and $105.1 million, respectively, for the quarter and nine months ended September 30, 2015.  This increase is a result of the acquisition of properties subsequent to September 30, 2015 as detailed above. We expect property operating expenses to increase for the remainder of 2016 in comparison with the prior period as these investments are held in future periods and as our value-add and completed development properties stabilize.

General and Administrative. General and administrative expenses were approximately $2.7 million and $9.7 million, respectively, for the quarter and nine months ended September 30, 2016, as compared to approximately $2.2 million and $6.8 million, respectively, for the quarter and nine months ended September 30, 2015.  General and administrative expenses were comprised primarily of personnel expenses of affiliates of our Advisor, directors’ and officers’ insurance, franchise taxes, accounting and legal fees, and board of director fees.  The increase in general and administrative expense was primarily attributed to increased costs as a result of the growth of our portfolio from the prior comparable periods.  Specifically, we incurred increased personnel expenses reimbursable to the Advisor due to increased accounting, legal and administrative activity as a result of the growth of the portfolio and related reporting.  We expect increases in general and administrative expenses for the remainder of 2016 in comparison with the prior period as the properties acquired subsequent to September 30, 2015 are operational for a full period and development operations begin and continue to ramp-up across periods.

Acquisition Fees and Expenses. Acquisition fees and expenses were approximately $0.3 million and $0.5 million for the quarter and nine months ended September 30, 2016, respectively, of which $0.2 million were capitalized as real estate under development for both the quarter and nine months ended September 30, 2016 related to true-ups of investment service fees for our completed development properties. We incurred approximately $11.3 million and $18.1 million, for the quarter and nine months ended September 30, 2015, respectively, of which $2.2 million were capitalized as real estate under development for both the quarter and nine months ended September 30, 2015.  Acquisition fees and expenses for the quarter and nine months ended September 30, 2015 related to the acquisition of 30 operating properties totaling approximately $655.1 million.  We had no acquisitions during the quarter and nine months ended September 30, 2016, but in October 2016 we completed the acquisition of the Cobalt Rehabilitation Hospital of New Orleans. We expect expenses to remain at low levels in future periods as we anticipate additional purchases of real estate will be limited.

Asset Management Fees. We incurred asset management fees payable to our Advisor of approximately $7.3 million and $21.7 million, respectively, for the quarter and nine months ended September 30, 2016, as compared to approximately $6.1 million and $16.1 million, respectively, for the quarter and nine months ended September 30, 2015.  For the quarter and nine months ended September 30, 2016, approximately $0.2 million and $0.5 million, respectively, of asset management fees were capitalized as real estate under development and we recognized a reduction in asset management fees of approximately $0.9 million and $2.6 million, respectively, as an estimate of the annual expense support amount expected to be settled in accordance with the terms of the Amended Expense Support Agreements.  For the quarter and nine months ended September 30, 2015, approximately $0.9 million and $2.3 million, respectively, in asset management fees were settled in accordance with the terms of the Original Expense Support Agreements and approximately $0.1 million and $0.4 million, respectively, were capitalized as real estate under development.  As described in Note 8. “Related Party Arrangements,” during the quarter and nine months ended September 30, 2016, asset management fees were reduced by $0.9 million and $2.6 million, respectively, because the shares of Restricted Stock that are expected to be accepted by the Advisor as payment for asset management services rendered under the Amended Expense Support Agreements, were valued at zero— the lowest possible value estimated at vesting.   For the quarter and nine months ended September 30, 2015, approximately $0.9 million and $2.3 million, respectively, in asset management fees were settled with issuance of Restricted Stock in accordance with the Expense Support Agreements.  Monthly asset management fees equal to 0.08334% of invested assets are paid to the Advisor for management of our real estate assets, including our pro rata share of our investments in unconsolidated entities, loans and other permitted investments.  We expect increases in asset management fees for the remainder of 2016 in comparison with the prior period as the properties acquired subsequent to September 30, 2015 are operational for a full period and more developments become operational; however, a portion of such fees may be settled in the form of Restricted Stock under the Amended Expense Support Agreements.

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Property Management Fees. We incurred property and construction management fees of approximately $5.5 million and $16.1 million, respectively, for the quarter and nine months ended September 30, 2016, as compared to approximately $4.9 million and $13.1 million, respectively, for the quarter and nine months ended September 30, 2015.  For the quarter and nine months ended September 30, 2016, approximately $0.7 million and $2.1 million, respectively, as compared to approximately $1.0 million and $2.6 million, respectively, for the quarter and nine months ended September 30, 2015, were capitalized as real estate under development.  Property management fees generally range from 2% to 5% of property revenues for leased properties, depending on the type of property, and are paid to third-party managers.  However, an oversight fee equal to 1% of property revenues is paid to the Property Manager for those properties managed by a third-party.  Overall property management fees primarily increased as a result of the increases in rental income from operating leases and resident fees and services from acquisitions subsequent to September 30, 2015, as well as the properties acquired during the quarter ended September 30, 2015 being owned for the entire nine months ended September 30, 2016.  We expect total property management fees will increase for the remainder of 2016 in comparison with the prior period as the properties acquired subsequent to September 30, 2015 are operational for a full period and more developments become operational; however, a portion of such fees may be settled in the form of Restricted Stock under the Amended Expense Support Agreements.

Impairment Provision. As described under “Liquidity and Capital Resources – Tenant Workouts,” during the nine months ended September 30, 2015, we recorded an impairment provision of $4.7 million to write-off the lease intangibles related to two of our specialty hospitals, as it was determined that the carrying value of these assets would not be recoverable.  There were no impairments during the quarter and nine months ended September 30, 2016.

Loss on Lease Terminations.  During the nine months ended September 30, 2016, we recorded a loss on lease terminations of approximately $0.8 million related to the bankruptcy reorganization of an anchor tenant at two of our medical office buildings as it was determined that certain deferred rents and other lease related assets would not be recoverable; refer to “Liquidity and Capital Resources – Tenant Workouts” above for additional information.  During the nine months ended September 30, 2015, we recorded a loss on lease terminations of approximately $0.9 million related to two of our specialty hospitals as it was determined that the carrying value of certain deferred rent and other lease related assets would not be recoverable.  

Contingent Purchase Price Consideration Adjustment. During the quarter and nine months ended September 30, 2016, we recorded fair value adjustments of approximately $0.5 million and ($0.2) million, respectively. These adjustments were related to Shores of Lake Phalen, Henderson Pavilion VI and Superior Residences of Panama City. Refer to Note 6. “Contingent Purchase Price Consideration” for additional information. During the quarter and nine months ended September 30, 2015, we recorded fair value adjustments of approximately ($0.3) million and ($0.6) million, respectively, related to the expiration of the Chestnut Commons Earn-out agreement and our Capital Health Yield Guaranty.

Depreciation and Amortization. Depreciation and amortization expenses were approximately $30.3 million and $94.4 million, respectively, for the quarter and nine months ended September 30, 2016, as compared to approximately $27.9 million and $75.1 million, respectively, for the quarter and nine months ended September 30, 2015.  Depreciation and amortization expenses are comprised of depreciation and amortization of the buildings, equipment, land improvements and in-place leases related to our real estate portfolio.  The increase in depreciation and amortization expense across periods resulted from the acquisition of additional properties subsequent to September 30, 2015 as detailed above.  We expect depreciation and amortization expense to increase for the remainder of 2016 in comparison with the prior period as these investments are held in future periods.

Interest Expense and Loan Cost Amortization. Interest expense and loan cost amortization were approximately $16.5 million and $45.8 million, respectively, for the quarter and nine months ended September 30, 2016, as compared to approximately $11.5 million and $32.2 million, respectively, for the quarter and nine months ended September 30, 2015.  For the quarter and nine months ended September 30, 2016, approximately $0.7 million and $1.9 million, respectively, was capitalized as development costs relating to our real estate under development, as compared to approximately $0.5 million and $1.8 million, respectively, for the quarter and nine months ended September 30, 2015.  Approximately $3.3 million and $12.7 million, respectively, of the increase for the quarter and nine months ended September 30, 2016, was primarily the result of an increase in our average debt outstanding to approximately $1.5 billion for both the quarter and nine months ended September 30, 2016, as compared with approximately $1.2

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billion for both the quarter and nine months ended September 30, 2015.  During the quarter and nine months ended September 30, 2016 and 2015, we recorded a write-off of approximately $0.4 million in loan costs and paid an exit fee of approximately $1.1 million in connection with an early extinguishment of debt. During the nine months ended September 30, 2015, we recorded a write-off of approximately $0.5 million in loan costs and paid approximately $0.3 million on the derecognition of a cash flow hedge in connection with the early extinguishment of debt.  

Equity in Earnings (Loss) of Unconsolidated Entity. Our unconsolidated entity relating to our investment in the Windsor Manor joint venture generated earnings (loss) of approximately $0.2 million and $0.1 million, respectively, for quarter and nine months ended September 30, 2016, as compared to losses of approximately ($0.2) million and ($0.7) million, respectively, for the quarter and nine months ended September 30, 2015.  Equity in loss of unconsolidated entities is determined using the hypothetical liquidation method book value (“HLBV”) method of accounting, which can create significant variability in earnings or loss from the joint venture while the preferred cash distributions that we anticipate to receive from the joint venture may be more consistent as result of our distribution preferences.

Income Tax Expense.  During the quarter and nine months ended September 30, 2016, we recognized income tax expense related to our properties of approximately $0.1 million and $0.2 million, respectively, as compared to approximately $0.2 million and $0.3 million, respectively, of income tax expense for the quarter and nine months ended September 30, 2015.

Net Loss Attributable to Noncontrolling Interests.  During the quarter and nine months ended September 30, 2016, net loss attributable to our co-venture partners was approximately $0.03 million and $0.05 million, respectively, as compared to net loss of approximately $0.01 million and $0.02 million, respectively, for the quarter and nine months ended September 30, 2015. In accordance with the provisions of each joint venture agreement, we allocate loss from operations to our co-venture partners based on their percentage ownership in each joint venture. These losses are primarily related to our Watercrest at Katy joint venture, which recently completed construction and we expect will generate income allocable to our co-venture partner in future periods as the property stabilizes.

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Net Operating Income

We generally expect to meet future cash needs for general and administrative expenses, debt service and distributions from NOI.  We define NOI, a non-GAAP measure, as rental income from operating leases, resident fees and services, tenant reimbursement income and interest income less the property operating expenses and property management fees from managed properties.  We use NOI as a key performance metric for internal monitoring and planning purposes, including the preparation of annual operating budgets and monthly operating reviews, as well as to facilitate analysis of future investment and business decisions.  It does not represent cash flows generated from operating activities in accordance with GAAP and should not be considered to be an alternative to net income or loss (determined in accordance with GAAP) as an indication of our operating performance or to be an alternative to cash flows from operating activities (determined in accordance with GAAP) as a measure of our liquidity.  We believe the presentation of this non-GAAP measure is important to the understanding of our operating results for the periods presented because it is an indicator of the return on property investment and provides a method of comparing property performance over time.  In addition, we have aggregated NOI on a “same-store” basis only for comparable properties that we have owned during the entirety of all periods presented.  Non-same-store NOI represents aggregated NOI from acquisitions made after July 1, 2015 or January 1, 2015, which are excluded as we did not own those properties during the entirety of all periods presented.  In understanding our operating results in the accompanying condensed consolidated financial statements, it is important to understand how the growth in our assets has impacted our results.  The chart below illustrates our net losses, and NOI for the quarter and nine months ended September 30, 2016 and 2015 (in thousands) and the amount invested in properties as of September 30, 2016 and 2015 (in millions):

 

 

Overall, our NOI for the nine months ended September 30, 2016 increased by approximately $32.1 million, of which $28.7 million was related to 40 operating properties acquired after January 1, 2015.  Our same-store NOI for the nine months ended September 30, 2016 increased by approximately $3.4 million, or 3.8%, as compared to the same period in the prior year.  The increase in same-store NOI is primarily attributable to year-over-year revenue and occupancy growth within our seniors housing properties — specifically, our Pacific Northwest Communities and Capital Health Communities.  However, the overall increase in same-store NOI at the aforementioned properties was partially offset by our decision to convert certain skilled nursing units to assisted living units at our Isle at Cedar Ridge and Isle at Watercrest - Bryan communities.  While this decision adversely impacted same-store NOI for the nine months ended September 30, 2016, we anticipate that, now that the conversion project was completed in Q3 2016, the converted units will contribute to same-store NOI growth in future periods and could increase the value of the properties.

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Funds from Operations and Modified Funds from Operations

Due to certain unique operating characteristics of real estate companies, as discussed below, the National Association of Real Estate Investment Trusts (“NAREIT”) promulgated a measure known as funds from operations (“FFO”), which we believe to be an appropriate supplemental measure to reflect the operating performance of a REIT.  The use of FFO is recommended by the REIT industry as a supplemental performance measure.  FFO is not equivalent to net income or loss as determined under GAAP.

We define FFO, a non-GAAP measure, consistent with the standards approved by the Board of Governors of NAREIT.  NAREIT defines FFO as net income or loss computed in accordance with GAAP, excluding gains or losses from sales of property, real estate asset impairment write-downs, plus depreciation and amortization of real estate related assets, and after adjustments for unconsolidated partnerships and joint ventures.  Our FFO calculation complies with NAREIT’s policy described above.

The historical accounting convention used for real estate assets requires straight-line depreciation of buildings and improvements, which implies that the value of real estate assets diminishes predictably over time, especially if such assets are not adequately maintained or repaired and renovated as required by relevant circumstances and/or is requested or required by lessees for operational purposes in order to maintain the value of the property. We believe that, because real estate values historically rise and fall with market conditions, including inflation, interest rates, the business cycle, unemployment and consumer spending, presentations of operating results for a REIT using historical accounting for depreciation may be less informative.  Historical accounting for real estate involves the use of GAAP.  Any other method of accounting for real estate such as the fair value method cannot be construed to be any more accurate or relevant than the comparable methodologies of real estate valuation found in GAAP.  Nevertheless, we believe that the use of FFO, which excludes the impact of real estate related depreciation and amortization, provides a more complete understanding of our performance to investors and to management, and when compared year over year, reflects the impact on our operations from trends in occupancy rates, rental rates, operating costs, general and administrative expenses, and interest costs, which may not be immediately apparent from net income or loss. However, FFO and modified funds from operations (“MFFO”), as described below, should not be construed to be more relevant or accurate than the current GAAP methodology in calculating net income or loss in its applicability in evaluating operating performance. The method utilized to evaluate the value and performance of real estate under GAAP should be construed as a more relevant measure of operational performance and considered more prominently than the non-GAAP FFO and MFFO measures and the adjustments to GAAP in calculating FFO and MFFO.

Changes in the accounting and reporting promulgations under GAAP (for acquisition fees and expenses for business combinations from a capitalization/depreciation model) to an expensed-as-incurred model that were put into effect in 2009, and other changes to GAAP accounting for real estate subsequent to the establishment of NAREIT’s definition of FFO, have prompted an increase in cash-settled expenses, specifically acquisition fees and expenses, as items that are expensed under GAAP and accounted for as operating expenses.  Our management believes these fees and expenses do not affect our overall long-term operating performance.  Publicly registered, non-listed REITs typically have a significant amount of acquisition activity and are substantially more dynamic during their initial years of investment and operation.  While other start up entities may also experience significant acquisition activity during their initial years, we believe that non-listed REITs are unique in that they have a limited life with targeted exit strategies within a relatively limited time frame after acquisition activity ceases.  Due to the above factors and other unique features of publicly registered, non-listed REITs, the Investment Program Association (“IPA”), an industry trade group, has standardized a measure known as MFFO which the IPA has recommended as a supplemental measure for publicly registered non-listed REITs and which we believe to be another appropriate supplemental measure to reflect the operating performance of a non-listed REIT.  MFFO is not equivalent to our net income or loss as determined under GAAP, and MFFO may not be a useful measure of the impact of long-term operating performance on value if we do not continue to operate with a limited life and targeted exit strategy, as currently intended.  We believe that because MFFO excludes costs that we consider more reflective of investing activities and other non-operating items included in FFO and also excludes acquisition fees and expenses that affect our operations only in periods in which properties are acquired, MFFO can provide, on a going forward basis, an indication of the sustainability (that is, the capacity to continue to be maintained) of our operating performance after the period in which we acquired our properties and once our portfolio is in place.  By providing MFFO, we believe we are presenting useful

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information that assists investors and analysts to better assess the sustainability of our operating performance after our properties have been acquired.  We also believe that MFFO is a recognized measure of sustainable operating performance by the non-listed REIT industry.

We define MFFO, a non-GAAP measure, consistent with the IPA’s Guideline 2010-01, Supplemental Performance Measure for Publicly Registered, Non-Listed REITs: MFFO, or the Practice Guideline, issued by the IPA in November 2010. The Practice Guideline defines MFFO as FFO further adjusted for the following items, as applicable, included in the determination of GAAP net income or loss: acquisition fees and expenses; amounts relating to deferred rent receivables and amortization of above and below market leases and liabilities (which are adjusted in order to remove the impact of GAAP straight-line adjustments from rental revenues); accretion of discounts and amortization of premiums on debt investments,  mark-to-market adjustments included in net income; gains or losses included in net income from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan, and unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity accounting and after adjustments for consolidated and unconsolidated partnerships and joint ventures, with such adjustments calculated to reflect MFFO on the same basis. The accretion of discounts and amortization of premiums on debt investments, unrealized gains and losses on hedges, foreign exchange, derivatives or securities holdings, unrealized gains and losses resulting from consolidations, as well as other listed cash flow adjustments are adjustments made to net income in calculating the cash flows provided by operating activities and, in some cases, reflect gains or losses which are unrealized and may not ultimately be realized.

Our MFFO calculation complies with the IPA’s Practice Guideline described above. In calculating MFFO, we exclude acquisition related expenses. Under GAAP, acquisition fees and expenses are characterized as operating expenses in determining operating net income or loss. These expenses are paid in cash by us.  All paid and accrued acquisition fees and expenses will have negative effects on returns to investors, the potential for future distributions, and cash flows generated by us, unless earnings from operations or net sales proceeds from the disposition of other properties are generated to cover the purchase price of the property.  

Our management uses MFFO and the adjustments used to calculate it in order to evaluate our performance against other non-listed REITs which have limited lives with short and defined acquisition periods and targeted exit strategies shortly thereafter.  As noted above, MFFO may not be a useful measure of the impact of long-term operating performance on value if we do not continue to operate in this manner.  We believe that our use of MFFO and the adjustments used to calculate it allow us to present our performance in a manner that reflects certain characteristics that are unique to non-listed REITs, such as their limited life, limited and defined acquisition period and targeted exit strategy, and hence that the use of such measures is useful to investors.  For example, acquisition costs are funded from our subscription proceeds and other financing sources and not from operations.  By excluding expensed acquisition costs, the use of MFFO provides information consistent with management’s analysis of the operating performance of the properties.

Presentation of this information is intended to provide useful information to investors as they compare the operating performance of different non-listed REITs, although it should be noted that not all REITs calculate FFO and MFFO the same way and as such comparisons with other REITs may not be meaningful.  Furthermore, FFO and MFFO are not necessarily indicative of cash flows available to fund cash needs and should not be considered as an alternative to net income (loss) or income (loss) from continuing operations as an indication of our performance, as an alternative to cash flows from operations, as an indication of our liquidity, or indicative of funds available to fund our cash needs including our ability to make distributions to our stockholders.  FFO and MFFO should be reviewed in conjunction with other GAAP measurements as an indication of our performance.  MFFO is useful in assisting management and investors in assessing the sustainability of operating performance in future operating periods, and in particular, after the offering and acquisition stages are complete and NAV is disclosed.  FFO and MFFO are not useful measures in evaluating NAV because impairments are taken into account in determining NAV but not in determining FFO and MFFO.

Neither the SEC, NAREIT nor any other regulatory body has passed judgment on the acceptability of the adjustments we use to calculate FFO or MFFO.  In the future, the SEC, NAREIT or another regulatory body may decide to standardize the allowable adjustments across the non-listed REIT industry and we would have to adjust our calculation and characterization of FFO or MFFO.

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The following table presents a reconciliation of net loss to FFO and MFFO for the quarter and nine months ended September 30, 2016 and 2015 (in thousands, except per share data):

 

 

FOOTNOTES:

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Off-Balance Sheet Arrangements

As of September 30, 2016, our off-balance sheet and other arrangements were not materially different from the amounts reported for the year ended December 31, 2015.  Refer to our annual report on Form 10-K for the year ended December 31, 2015 for a summary of our off-balance sheet and other arrangements.

Contractual Obligations

The following table presents our contractual obligations by payment period as of September 30, 2016 (in thousands):

 

 

FOOTNOTES:

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Critical Accounting Policies and Estimates

See Item 1. “Financial Statements” and our Annual Report on Form 10-K for the year ended December 31, 2015 for a summary of our critical accounting policies and estimates.

Recent Accounting Pronouncements

See Item 1. “Financial Information” for a summary of the impact of recent accounting pronouncements.

 

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risks

We may be exposed to interest rate changes primarily as a result of long-term debt used to acquire properties and to make loans and other permitted investments. Our management objectives related to interest rate risk will be to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs.  To achieve our objectives, we expect to borrow at fixed rates or variable rates with the lowest margins available, and in some cases, with the ability to convert variable rates to fixed rates.  With regard to variable rate financing, we will assess interest rate cash flow risk by continually identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating hedging opportunities.

The following is a schedule as of September 30, 2016, of our fixed and variable rate debt maturities for the remainder of 2016, and each of the next four years and thereafter (principal maturities only) (in thousands):

 

 

FOOTNOTE:

Management estimates that a one-percentage point increase or decrease in LIBOR in 2016, compared to LIBOR rates as of September 30, 2016, would result in fluctuation of interest expense on our variable rate debt of approximately $11.7 million for the year ending December 31, 2016.  This sensitivity analysis contains certain simplifying assumptions, and although it gives an indication of our exposure to changes in interest rates, it is not intended to predict future results and actual results will likely vary given that our sensitivity analysis on the effects of changes in LIBOR does not factor in a potential change in variable rate debt levels, any offsetting gains on interest rate swap contracts, or the impact of any LIBOR floors or caps.

As of September 30, 2016, the Company’s debt is comprised of approximately 24.8% in fixed rate debt, approximately 12.8% in variable rate debt with current or forward-starting interest rate swaps and approximately 62.4% of unhedged variable rate debt.  The remaining unhedged variable rate debt primarily relates to our construction loans and Revolving Credit Facility.  Overall, we believe longer term fixed rate debt could be beneficial in a rising interest rate or rising inflation rate environment and as such we continue to evaluate the need for additional interest rate protection on unhedged variable rate debt.

 

 

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Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Pursuant to Rule 13a-15(b) under the Exchange Act, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, our management, including our principal executive officer and principal financial officer, concluded that our disclosure controls and procedures are effective as of the end of the period covered by this report to provide reasonable assurance that material information required to be included in our periodic SEC reports is recorded, processed, summarized and reported within the time periods specified in the relevant SEC rules and forms.

Changes in Internal Control over Financial Reporting

During the most recent fiscal quarter, there were no changes in our internal controls over financial reporting (as defined under Rule 13a-15(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we may be a party to legal proceedings in the ordinary course of, or incidental to the normal course of, our business, including proceedings to enforce our contractual or statutory rights.  While we cannot predict the outcome of these legal proceedings with certainty, based upon currently available information, we do not believe the final outcome of any pending or threatened legal proceeding will have a material adverse effect on our results of operations or financial condition.

Item 1A. Risk Factors

There have been no material changes in our assessment of our risk factors from those set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Unregistered Sales of Equity Securities

During the period covered by this quarterly report, we did not sell any equity securities that were not registered under the Securities Act of 1933, and we did not repurchase any of our securities.

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Issuer Purchases of Equity Securities

The following table presents details regarding our repurchase of securities under our redemption plan between July 1, 2016 and September 30, 2016:  

 

 

FOOTNOTE:

Item 3. Defaults Upon Senior Securities - None

 

Item 4. Mine Safety Disclosure – Not Applicable

 

Item 5. Other Information - None

 

Item 6. Exhibits

The exhibits required by this item are set forth in the Exhibit Index attached hereto and are filed or incorporated as part of this report.

 

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, on the 10th day of November 2016.

 

 

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EXHIBIT INDEX

Exhibits

The following exhibits are included, or incorporated by reference in this Quarterly Report on Form 10-Q for the quarter and nine months ended September 30, 2016 (and are numbered in accordance with Item 601 of Regulation S-K).

 

 

 

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