Attached files
| file | filename |
|---|---|
| EX-31.4 - EXHIBIT 31.4 - Griffin-American Healthcare REIT III, Inc. | ex314-2017xq110xqgahr3.htm |
| EX-31.3 - EXHIBIT 31.3 - Griffin-American Healthcare REIT III, Inc. | ex313-2017xq110xqgahr3.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(Amendment No. 1)
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2017 | |
or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to | |
Commission File Number: 000-55434
GRIFFIN-AMERICAN HEALTHCARE REIT III, INC.
(Exact name of registrant as specified in its charter)
Maryland | 46-1749436 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
18191 Von Karman Avenue, Suite 300, Irvine, California | 92612 | |
(Address of principal executive offices) | (Zip Code) | |
(949) 270-9200
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
___________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 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. x 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). x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ¨ | Accelerated filer | ¨ | |
Non-accelerated filer | x (Do not check if a smaller reporting company) | Smaller reporting company | ¨ | |
Emerging growth company | ¨ | |||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) 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 x No
As of May 12, 2017, there were 197,892,384 shares of common stock of Griffin-American Healthcare REIT III, Inc. outstanding.
EXPLANATORY NOTE
We are filing this Amendment No. 1, or the Amendment, to our Quarterly Report on Form 10-Q for the quarter ended March 31, 2017, as originally filed with the Securities and Exchange Commission, or the SEC, on May 15, 2017, or the Original Report. The purpose of this Amendment is to correct information regarding our funds from operations and modified funds from operations for the three months ended March 31, 2017 contained in Part I, Item 2, and Part II, Item 1A, that was previously disclosed in our Original Report due to an inadvertent error. This Amendment hereby amends and restates the cover page, Part I, Item 2, Part II, Item 1A and the list of exhibits contained in Part II, Item 6, in their entirety.
In accordance with Rule 12b-15 under the Securities Exchange Act of 1934, as amended, or the Exchange Act, Part I, Item 2, and Part II, Item 1A and Item 6, of the Original Report are hereby amended and restated in their entirety below. The Amendment does not affect any other items in the Original Report, including our financial statements and the notes to the financial statements. In addition, the cover page has been updated and amended. As a result of the Amendment, we are also filing as exhibits to the Amendment new certifications as required by Rule 13a-14(a) under the Exchange Act. Except as otherwise indicated, the Amendment speaks as of the date of the Original Report and reflects only the changes discussed above. Accordingly, this Amendment should be read in conjunction with the Original Report.
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PART I — FINANCIAL INFORMATION
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The use of the words “we,” “us” or “our” refers to Griffin-American Healthcare REIT III, Inc. and its subsidiaries, including Griffin-American Healthcare REIT III Holdings, LP, except where the context otherwise requires.
The following discussion should be read in conjunction with our condensed consolidated financial statements and notes thereto in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2017, as filed with the United States Securities and Exchange Commission, or SEC, on May 15, 2017, and in our 2016 Annual Report on Form 10-K, as filed with the SEC on March 15, 2017. Such condensed consolidated financial statements and information have been prepared to reflect our financial position as of March 31, 2017 and December 31, 2016, together with our results of operations and cash flows for the three months ended March 31, 2017 and 2016.
Forward-Looking Statements
Historical results and trends should not be taken as indicative of future operations. Our statements contained in this report that are not historical factual statements are “forward-looking statements.” Actual results may differ materially from those included in the forward-looking statements. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations, are generally identifiable by use of the words “expect,” “project,” “may,” “will,” “should,” “could,” “would,” “intend,” “plan,” “anticipate,” “estimate,” “believe,” “continue,” “predict,” “potential,” “seek” and any other comparable and derivative terms or the negatives thereof. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on our operations on a consolidated basis include, but are not limited to: changes in economic conditions generally and the real estate market specifically; legislative and regulatory changes, including changes to laws governing the taxation of real estate investment trusts, or REITs; the availability of capital; changes in interest and foreign currency exchange rates; competition in the real estate industry; the supply and demand for operating properties in our proposed market areas; changes in accounting principles generally accepted in the United States of America, or GAAP, policies or guidelines applicable to REITs; the availability of financing; and our ongoing relationship with American Healthcare Investors, LLC, or American Healthcare Investors, and Griffin Capital Company, LLC, or Griffin Capital (formerly known as Griffin Capital Corporation), or collectively, our co-sponsors, and their affiliates. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Additional information concerning us and our business, including additional factors that could materially affect our financial results, is included herein and in our other filings with the SEC.
Overview and Background
Griffin-American Healthcare REIT III, Inc., a Maryland corporation, was incorporated on January 11, 2013, and therefore we consider that our date of inception. We were initially capitalized on January 15, 2013. We invest in a diversified portfolio of real estate properties, focusing primarily on medical office buildings, hospitals, skilled nursing facilities, senior housing and other healthcare-related facilities. We also operate healthcare-related facilities utilizing the structure permitted by the REIT Investment Diversification and Empowerment Act of 2007, which is commonly referred to as a “RIDEA” structure (the provisions of the Internal Revenue Code of 1986, as amended, or the Code, authorizing the RIDEA structure were enacted as part of the Housing and Economic Recovery Act of 2008). We also originate and acquire secured loans and real estate-related investments on an infrequent and opportunistic basis. We generally seek investments that produce current income. We qualified to be taxed as a REIT under the Code for federal income tax purposes beginning with our taxable year ended December 31, 2014, and we intend to continue to qualify to be taxed as a REIT.
As of April 22, 2015, the deregistration date of our initial public offering, or our initial offering, we had received and accepted subscriptions in our initial offering for 184,930,598 shares of our common stock, or $1,842,618,000, excluding shares of our common stock issued pursuant to our distribution reinvestment plan, or the DRIP. As of April 22, 2015, a total of $18,511,000 in distributions were reinvested that resulted in 1,948,563 shares of our common stock being issued pursuant to the DRIP portion of our initial offering.
On March 25, 2015, we filed a Registration Statement on Form S-3 under the Securities Act of 1933, as amended, or the Securities Act, to register a maximum of $250,000,000 of additional shares of our common stock pursuant to our distribution reinvestment plan, or the Secondary DRIP Offering. The Registration Statement on Form S-3 was automatically effective with the SEC upon its filing; however, we did not commence offering shares pursuant to the Secondary DRIP Offering until April 22, 2015, following the deregistration of our initial offering. Effective October 5, 2016, we amended and restated the DRIP, or the Amended and Restated DRIP, to amend the price at which shares of our common stock are issued pursuant to the Secondary DRIP Offering. See Note 13, Equity — Distribution Reinvestment Plan, to our condensed consolidated financial statements for a further discussion. As of March 31, 2017, a total of $123,844,000 in distributions were reinvested and 13,186,735 shares of our common stock were issued pursuant to the Secondary DRIP Offering.
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On October 5, 2016, our board of directors, or our board, at the recommendation of the audit committee of our board, comprised solely of independent directors, unanimously approved and established an estimated per share net asset value, or NAV, of our common stock of $9.01. We are providing this estimated per share NAV to assist broker-dealers in connection with their obligations under National Association of Securities Dealers Conduct Rule 2340, as required by the Financial Industry Regulatory Authority, or FINRA, with respect to customer account statements. The estimated per share NAV is based on the estimated value of our assets less the estimated value of our liabilities, divided by the number of shares outstanding on a fully diluted basis, calculated as of June 30, 2016. This valuation was performed in accordance with the methodology provided in Practice Guideline 2013-01, Valuations of Publicly Registered Non-Listed REITs, issued by the Investment Program Association, or the IPA, in April 2013, in addition to guidance from the SEC. Going forward, we intend to publish an updated estimated per share NAV on at least an annual basis. See our Current Report on Form 8-K filed with the SEC on October 7, 2016, for more information on the methodologies and assumptions used to determine, and the limitations and risks of, our estimated per share NAV.
We conduct substantially all of our operations through Griffin-American Healthcare REIT III Holdings, LP, or our operating partnership. We are externally advised by Griffin-American Healthcare REIT III Advisor, LLC, or Griffin-American Advisor, or our advisor, pursuant to an advisory agreement, or the Advisory Agreement, between us and our advisor. The Advisory Agreement was effective as of February 26, 2014 and had a one-year term, subject to successive one-year renewals upon the mutual consent of the parties. The Advisory Agreement was last renewed pursuant to the mutual consent of the parties on February 14, 2017 and expires on February 26, 2018. Our advisor uses its best efforts, subject to the oversight, review and approval of our board, to, among other things, research, identify, review and make investments in and dispositions of properties and securities on our behalf consistent with our investment policies and objectives. Our advisor performs its duties and responsibilities under the Advisory Agreement as our fiduciary. Our advisor is 75.0% owned and managed by American Healthcare Investors, and 25.0% owned by a wholly owned subsidiary of Griffin Capital. Effective March 1, 2015, American Healthcare Investors is 47.1% owned by AHI Group Holdings, LLC, or AHI Group Holdings, 45.1% indirectly owned by Colony NorthStar, Inc. (NYSE: CLNS), or Colony NorthStar (formerly known as NorthStar Asset Management Group Inc. prior to its merger with Colony Capital, Inc. and NorthStar Realty Finance Corp. on January 10, 2017), and 7.8% owned by James F. Flaherty III, one of Colony NorthStar’s partners. We are not affiliated with Griffin Capital, Griffin Capital Securities, LLC, or our dealer manager, Colony NorthStar, or Mr. Flaherty; however, we are affiliated with Griffin-American Advisor, American Healthcare Investors and AHI Group Holdings.
We currently operate through six reportable business segments: medical office buildings, hospitals, skilled nursing facilities, senior housing, senior housing — RIDEA and integrated senior health campuses. As of March 31, 2017, we owned and/or operated 94 properties, comprising 98 buildings, and 108 integrated senior health campuses including completed development projects, or approximately 12,521,000 square feet of gross leasable area, or GLA, for an aggregate contract purchase price of $2,852,681,000. In addition, as of March 31, 2017, we have invested $94,858,000 in real estate-related investments, net of principal repayments. As of March 31, 2017, our portfolio capitalization rate was approximately 7.4%, which estimate was based upon total property portfolio net operating income from each property’s forward looking pro forma projections for the expected year one property performance, including any contractual rent increases contained in such leases for year one, divided by the contract purchase price of the total property portfolio, exclusive of any acquisition fees and expenses paid.
Critical Accounting Policies
The complete listing of our Critical Accounting Policies was previously disclosed in our 2016 Annual Report on Form 10-K, as filed with the SEC on March 15, 2017, and there have been no material changes to our Critical Accounting Policies as disclosed therein, except as noted below.
Interim Unaudited Financial Data
Our condensed consolidated financial statements have been prepared by us in accordance with GAAP in conjunction with the rules and regulations of the SEC. Certain information and footnote disclosures required for annual financial statements have been condensed or excluded pursuant to SEC rules and regulations. Accordingly, our condensed consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. Our condensed consolidated financial statements reflect all adjustments, which are, in our view, of a normal recurring nature and necessary for a fair presentation of our financial position, results of operations and cash flows for the interim period. Interim results of operations are not necessarily indicative of the results to be expected for the full year; such full year results may be less favorable. Our condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements and the notes thereto included in our 2016 Annual Report on Form 10-K, as filed with the SEC on March 15, 2017.
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Property Acquisitions
In accordance with Accounting Standards Codification Topic 805, Business Combinations, and Accounting Standards Update, or ASU, 2017-01, Clarifying the Definition of a Business, or ASU 2017-01, we determine whether a transaction is a business combination, which requires that the assets acquired and liabilities assumed constitute a business. If the assets acquired are not a business, we account for the transaction as an asset acquisition. Under both methods, we recognize the identifiable assets acquired and liabilities assumed. We immediately expense acquisition related expenses associated with a business combination and capitalize acquisition related expenses directly associated with an asset acquisition.
Recently Issued Accounting Pronouncements
For a discussion of recently issued accounting pronouncements, see Note 2, Summary of Significant Accounting Policies — Recently Issued Accounting Pronouncements, to our condensed consolidated financial statements.
Acquisitions in 2017
For a discussion of property acquisitions in 2017, see Note 3, Real Estate Investments, Net and Note 21, Subsequent Events — Property Acquisition, to our condensed consolidated financial statements.
Factors Which May Influence Results of Operations
We are not aware of any material trends or uncertainties, other than national economic conditions affecting real estate generally, that may reasonably be expected to have a material impact, favorable or unfavorable, on revenues or income from the acquisition, management and operation of properties other than those listed in Part II, Item 1A. Risk Factors, of this Amendment No. 1 to Quarterly Report on Form 10-Q/A and those Risk Factors previously disclosed in our 2016 Annual Report on Form 10-K, as filed with the SEC on March 15, 2017.
Revenues
The amount of revenues generated by our properties depends principally on our ability to maintain the occupancy rates of currently leased space and to lease currently available space and space available from lease terminations at the then existing rental rates. Negative trends in one or more of these factors could adversely affect our revenue in future periods.
Scheduled Lease Expirations
Excluding our senior housing — RIDEA facilities and our integrated senior health campuses, as of March 31, 2017, our properties were 94.4% leased and during the remainder of 2017, 4.7% of the leased GLA is scheduled to expire. Our senior housing — RIDEA facilities and integrated senior health campuses were 83.9% and 85.2%, respectively, leased for the three months ended March 31, 2017 and substantially all of our leases with residents at such properties are for a term of one year or less. Our leasing strategy focuses on negotiating renewals for leases scheduled to expire during the next twelve months. In the future, if we are unable to negotiate renewals, we will try to identify new tenants or collaborate with existing tenants who are seeking additional space to occupy.
As of March 31, 2017, our remaining weighted average lease term was 8.9 years, excluding our senior housing — RIDEA facilities and our integrated senior health campuses.
Results of Operations
Comparison of Three Months Ended March 31, 2017 and 2016
Our primary sources of revenue include rent and resident fees and services from our properties. Our primary expenses include property operating expenses and rental expenses. In general, we expect amounts related to our portfolio of operating properties to increase in the future based on a full year of operations as well as any additional real estate and real estate-related investments we may acquire. Our results of operations are not indicative of those expected in future periods.
We segregate our operations into reporting segments in order to assess the performance of our business in the same way that management reviews our performance and makes operating decisions. Accordingly, when we acquired our first medical office building in June 2014; senior housing facility in September 2014; hospital in December 2014; senior housing — RIDEA portfolio in May 2015; skilled nursing facilities in October 2015; and integrated senior health campuses in December 2015, we added a new reportable business segment at such time. As of March 31, 2017, we operated through six reportable business segments: medical office buildings, hospitals, skilled nursing facilities, senior housing, senior housing — RIDEA and integrated senior health campuses.
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Except where otherwise noted, the changes in our results of operations are primarily due to owning 98 buildings and 108 integrated senior health campuses as of March 31, 2017, as compared to owning 82 buildings and 100 integrated senior health campuses as of March 31, 2016. As of March 31, 2017 and 2016, we owned the following types of properties:
March 31, | |||||||||||||||||||
2017 | 2016 | ||||||||||||||||||
Number of Buildings/Campuses | Aggregate Contract Purchase Price | Leased % | Number of Buildings/Campuses | Aggregate Contract Purchase Price | Leased % | ||||||||||||||
Integrated senior health campuses | 108 | $ | 1,437,230,000 | (1 | ) | 100 | $ | 1,126,251,000 | (1 | ) | |||||||||
Medical office buildings | 62 | 654,245,000 | 92.0 | % | 56 | 583,845,000 | 93.0 | % | |||||||||||
Senior housing | 14 | 173,391,000 | 100 | % | 10 | 134,860,000 | 100 | % | |||||||||||
Senior housing — RIDEA | 13 | 320,035,000 | (2 | ) | 13 | 320,035,000 | (2 | ) | |||||||||||
Skilled nursing facilities | 7 | 128,000,000 | 100 | % | 1 | 40,000,000 | 100 | % | |||||||||||
Hospitals | 2 | 139,780,000 | 100 | % | 2 | 139,780,000 | 100 | % | |||||||||||
Total/weighted average(3) | 206 | $ | 2,852,681,000 | 94.4 | % | 182 | $ | 2,344,771,000 | 94.5 | % | |||||||||
___________
(1) | For the three months ended March 31, 2017 and 2016, the leased percentage for the resident units of our integrated senior health campuses was 85.2% and 88.2%, respectively. |
(2) | For the three months ended March 31, 2017 and 2016, the leased percentage for the resident units of our senior housing — RIDEA facilities was 83.9% and 85.8%, respectively. |
(3) | Leased percentage excludes our senior housing — RIDEA facilities and integrated senior health campuses. |
Revenues
For the three months ended March 31, 2017 and 2016, resident fees and services consisted of rental fees related to resident leases, extended health care fees and other ancillary services. For the three months ended March 31, 2017 and 2016, real estate revenue primarily consisted of base rent and expense recoveries.
Revenues by reportable segment consisted of the following for the periods then ended:
Three Months Ended March 31, | |||||||
2017 | 2016 | ||||||
Resident Fees and Services | |||||||
Integrated senior health campuses | $ | 209,189,000 | $ | 203,057,000 | |||
Senior housing — RIDEA | 15,864,000 | 15,298,000 | |||||
Total resident fees and services | 225,053,000 | 218,355,000 | |||||
Real Estate Revenue | |||||||
Medical office buildings | 19,525,000 | 17,082,000 | |||||
Senior housing | 5,109,000 | 4,707,000 | |||||
Hospitals | 3,023,000 | 7,205,000 | |||||
Skilled nursing facilities | 3,691,000 | 1,156,000 | |||||
Total real estate revenue | 31,348,000 | 30,150,000 | |||||
Total revenues | $ | 256,401,000 | $ | 248,505,000 | |||
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Property Operating Expenses and Rental Expenses
For the three months ended March 31, 2017 and 2016, property operating expenses primarily consisted of administration and benefits expense of $172,120,000 and $164,635,000, respectively. Property operating expenses and property operating expenses as a percentage of resident fees and services, as well as rental expenses and rental expenses as a percentage of real estate revenue, by operating segment consisted of the following for the periods then ended:
Three Months Ended March 31, | |||||||||||||
2017 | 2016 | ||||||||||||
Property Operating Expenses | |||||||||||||
Integrated senior health campuses | $ | 188,179,000 | 90.0 | % | $ | 182,513,000 | 89.9 | % | |||||
Senior housing — RIDEA | 10,920,000 | 68.8 | % | 10,485,000 | 68.5 | % | |||||||
Total property operating expenses | $ | 199,099,000 | 88.5 | % | $ | 192,998,000 | 88.4 | % | |||||
Rental Expenses | |||||||||||||
Medical office buildings | $ | 7,451,000 | 38.2 | % | $ | 6,090,000 | 35.7 | % | |||||
Hospitals | 384,000 | 12.7 | % | 437,000 | 6.1 | % | |||||||
Senior housing | 160,000 | 3.1 | % | 129,000 | 2.7 | % | |||||||
Skilled nursing facilities | 400,000 | 10.8 | % | 75,000 | 6.5 | % | |||||||
Total rental expenses | $ | 8,395,000 | 26.8 | % | $ | 6,731,000 | 22.3 | % | |||||
Integrated senior health campuses and senior housing — RIDEA facilities typically have a higher percentage of operating expenses to revenue than multi-tenant medical office buildings, hospitals, senior housing facilities and skilled nursing facilities. We anticipate that the percentage of operating expenses to revenue will fluctuate based on the types of property we acquire, own and/or operate in the future.
General and Administrative
General and administrative expenses consisted of the following for the periods then ended:
Three Months Ended March 31, | |||||||
2017 | 2016 | ||||||
Asset management fees — affiliates | $ | 4,646,000 | $ | 3,894,000 | |||
Bad debt expense | 1,659,000 | 759,000 | |||||
Professional and legal fees | 554,000 | 1,120,000 | |||||
Stock compensation expense | — | 195,000 | |||||
Transfer agent services | 352,000 | 434,000 | |||||
Franchise taxes | 277,000 | 223,000 | |||||
Bank charges | 98,000 | 80,000 | |||||
Directors’ and officers’ liability insurance | 80,000 | 78,000 | |||||
Board of directors fees | 58,000 | 70,000 | |||||
Restricted stock compensation | 43,000 | 23,000 | |||||
Other | 96,000 | 18,000 | |||||
Total | $ | 7,863,000 | $ | 6,894,000 | |||
The increase in general and administrative expenses for the three months ended March 31, 2017 as compared to the three months ended March 31, 2016 was primarily due to the increase in asset management fees and bad debt expense, partially offset by the decrease in professional and legal fees. The increase in asset management fees for the three months ended March 31, 2017 as compared to the three months ended March 31, 2016 was primarily the result of purchasing additional properties in 2017 and the remainder of 2016.
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Acquisition Related Expenses
For the three months ended March 31, 2017, acquisition related expenses were $318,000, which primarily related to additional expenses associated with prior year property acquisitions accounted for as business combinations. For the three months ended March 31, 2016, acquisition related expenses were $3,415,000, which primarily related to expenses associated with our six property acquisitions accounted for as business combinations, including acquisition fees of $1,946,000 incurred to our advisor and its affiliates.
Depreciation and Amortization
For the three months ended March 31, 2017 and 2016, depreciation and amortization was $29,822,000 and $70,896,000, respectively, which primarily consisted of depreciation on our operating properties of $20,009,000 and $15,461,000, respectively, and amortization on our identified intangible assets of $9,653,000 and $55,208,000, respectively. The decrease in amortization expense during the three months ended March 31, 2017 was primarily the result of $52,764,000 in amortization on our identified intangible assets recognized during the three months ended March 31, 2016, which related to $211,317,000 of in-place leases of our integrated senior health campuses and senior housing — RIDEA properties that were fully amortized during 2016.
Interest Expense
For the three months ended March 31, 2017 and 2016, interest expense, including gain (loss) in fair value of derivative financial instruments, was $14,259,000 and $9,707,000, respectively. Interest expense consisted of the following for the periods then ended:
Three Months Ended March 31, | |||||||
2017 | 2016 | ||||||
Interest expense — lines of credit and term loan and derivative financial instruments | $ | 6,617,000 | $ | 4,651,000 | |||
Interest expense — mortgage loans payable | 6,012,000 | 3,854,000 | |||||
Amortization of deferred financing costs — lines of credit and term loan | 917,000 | 743,000 | |||||
Amortization of debt discount/premium, net | 574,000 | 113,000 | |||||
Amortization of deferred financing costs — mortgage loans payable | 475,000 | 86,000 | |||||
(Gain) loss in fair value of derivative financial instruments | (336,000 | ) | 260,000 | ||||
Total | $ | 14,259,000 | $ | 9,707,000 | |||
Liquidity and Capital Resources
Our sources of funds primarily consist of operating cash flows and borrowings. We terminated the primary portion of our initial offering on March 12, 2015. In the normal course of business, our principal demands for funds are for our payment of operating expenses, interest on our current and future indebtedness and distributions to our stockholders and for acquisitions of real estate and real estate-related investments.
Our total capacity to pay operating expenses, interest and distributions and acquire real estate and real estate-related investments is a function of our current cash position, our borrowing capacity on our lines of credit, as well as any future indebtedness that we may incur. As of March 31, 2017, our cash on hand was $29,085,000 and we had $146,284,000 available on our lines of credit and term loan. We believe that these resources will be sufficient to satisfy our cash requirements for the foreseeable future, and we do not anticipate a need to raise funds from other sources within the next 12 months.
We estimate that we will require approximately $35,162,000 to pay interest on our outstanding indebtedness in the remainder of 2017, based on interest rates in effect as of March 31, 2017. In addition, we estimate that we will require $4,615,000 to pay principal on our outstanding indebtedness in the remainder of 2017. We also require resources to make certain payments to our advisor and its affiliates. See Note 14, Related Party Transactions, to our condensed consolidated financial statements, for a further discussion of our payments to our advisor and its affiliates. Generally, cash needs for such items will be met from operations and borrowings.
Our advisor evaluates potential investments and engages in negotiations with real estate sellers, developers, brokers, investment managers, lenders and others on our behalf. When we acquire a property, our advisor prepares a capital plan that contemplates the estimated capital needs of that investment. In addition to operating expenses, capital needs may also include costs of refurbishment, tenant improvements or other major capital expenditures. The capital plan also sets forth the anticipated sources of the necessary capital, which may include a line of credit or other loans established with respect to the investment, operating cash generated by the investment, additional equity investments from us or joint venture partners or, when necessary,
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capital reserves. Any capital reserve would be established from proceeds from sales of other investments, borrowings, operating cash generated by other investments or other cash on hand. In some cases, a lender may require us to establish capital reserves for a particular investment. The capital plan for each investment will be adjusted through ongoing, regular reviews of our portfolio or as necessary to respond to unanticipated additional capital needs.
Other Liquidity Needs
In the event that there is a shortfall in net cash available due to various factors, including, without limitation, the timing of distributions or the timing of the collection of receivables, we may seek to obtain capital to pay distributions by means of secured or unsecured debt financing through one or more third parties, or our advisor or its affiliates. We may also pay distributions from cash from capital transactions, including, without limitation, the sale of one or more of our properties.
Based on the properties we owned as of March 31, 2017, we estimate that our expenditures for capital improvements and tenant improvements will require up to $61,667,000 for the remaining nine months of 2017. As of March 31, 2017, we had $8,609,000 of restricted cash in loan impounds and reserve accounts for capital expenditures, some of which may be used to fund our estimated expenditures for capital improvements and tenant improvements. We cannot provide assurance, however, that we will not exceed these estimated expenditure and distribution levels or be able to obtain additional sources of financing on commercially favorable terms or at all.
If we experience lower occupancy levels, reduced rental rates, reduced revenues as a result of asset sales, or increased capital expenditures and leasing costs compared to historical levels due to competitive market conditions for new and renewed leases, the effect would be a reduction of net cash provided by operating activities. If such a reduction of net cash provided by operating activities is realized, we may have a cash flow deficit in subsequent periods. Our estimate of net cash available is based on various assumptions which are difficult to predict, including the levels of leasing activity and related leasing costs. Any changes in these assumptions could impact our financial results and our ability to fund working capital and unanticipated cash needs.
Cash Flows
The following table sets forth changes in cash flows:
Three Months Ended March 31, | |||||||
2017 | 2016 | ||||||
Cash and cash equivalents — beginning of period | $ | 29,123,000 | $ | 48,953,000 | |||
Net cash provided by operating activities | 47,243,000 | 59,216,000 | |||||
Net cash used in investing activities | (86,326,000 | ) | (128,705,000 | ) | |||
Net cash provided by financing activities | 39,025,000 | 63,717,000 | |||||
Effect of foreign currency translation on cash and cash equivalents | 20,000 | 16,000 | |||||
Cash and cash equivalents — end of period | $ | 29,085,000 | $ | 43,197,000 | |||
The following summary discussion of our changes in our cash flows is based on our condensed consolidated statements of cash flows and is not meant to be an all-inclusive discussion of the changes in our cash flows for the periods presented below.
Operating Activities
For the three months ended March 31, 2017 and 2016, cash flows provided by operating activities primarily related to the cash flows provided by our property operations, offset by the payment of general and administrative expenses. See — Results of Operations above for a further discussion. We anticipate cash flows from operating activities to increase as we purchase additional properties.
Investing Activities
For the three months ended March 31, 2017, cash flows used in investing activities primarily related to our 2017 property acquisition and our acquisition of previously leased real estate investments in the amount of $89,264,000, partially offset by a principal repayment on real estate notes receivable in the amount of $1,388,000. For the three months ended March 31, 2016, cash flows used in investing activities related primarily to our six property acquisitions in the amount of $106,131,000 and capital expenditures of $15,495,000. We may continue to acquire additional real estate and real estate-related investments, but generally anticipate that cash flows used in investing activities will continue to decrease due to fewer anticipated acquisitions as a result of the termination of the primary portion of our initial offering in March 2015.
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Financing Activities
For the three months ended March 31, 2017, cash flows provided by financing activities primarily related to net borrowings under our lines of credit and term loan in the amount of $64,399,000, partially offset by distributions to our common stockholders of $13,401,000, settlement of a mortgage loan payable of $7,625,000 and share repurchases of $7,128,000. For the three months ended March 31, 2016, cash flows provided by financing activities primarily related to net borrowings under our lines of credit and term loan in the amount of $87,503,000 and borrowings under our mortgage loans payable of $1,149,000, partially offset by distributions to our common stockholders of $12,262,000, the payment of deferred financing cost of $6,918,000, share repurchases of $2,351,000 and principal payments on our mortgage loans payable in the amount of $1,368,000. Overall, we anticipate cash flows from financing activities to decrease in the future since we terminated the primary portion of our initial offering on March 12, 2015. However, we anticipate borrowings under our lines of credit and term loan and other indebtedness to increase if we acquire additional real estate and real estate-related investments.
Distributions
Our board has authorized, on a quarterly basis, a daily distribution to our stockholders of record as of the close of business on each day of the quarterly periods commencing on May 14, 2014 and ending on June 30, 2017. The distributions were or will be calculated based on 365 days in the calendar year and are equal to $0.001643836 per share of our common stock, which is equal to an annualized distribution rate of 6.0%, assuming a purchase price of $10.00 per share. The daily distributions were or will be aggregated and paid monthly in arrears in cash or shares of our common stock pursuant to the DRIP and the Secondary DRIP Offering, only from legally available funds.
The amount of the distributions paid to our stockholders is determined quarterly by our board and is dependent on a number of factors, including funds available for payment of distributions, our financial condition, capital expenditure requirements and annual distribution requirements needed to maintain our qualification as a REIT under the Code. We have not established any limit on the amount of offering proceeds that may be used to fund distributions, except that, in accordance with our organizational documents and Maryland law, we may not make distributions that would: (i) cause us to be unable to pay our debts as they become due in the usual course of business or (ii) cause our total assets to be less than the sum of our total liabilities plus senior liquidation preferences.
The distributions paid for the three months ended March 31, 2017 and 2016, along with the amount of distributions reinvested pursuant to the Secondary DRIP Offering, and the sources of our distributions as compared to cash flows from operations were as follows:
Three Months Ended March 31, | |||||||||||||
2017 | 2016 | ||||||||||||
Distributions paid in cash | $ | 13,401,000 | $ | 12,262,000 | |||||||||
Distributions reinvested | 15,681,000 | 16,110,000 | |||||||||||
$ | 29,082,000 | $ | 28,372,000 | ||||||||||
Sources of distributions: | |||||||||||||
Cash flows from operations | $ | 29,082,000 | 100 | % | $ | 28,372,000 | 100 | % | |||||
Proceeds from borrowings | — | — | — | — | |||||||||
$ | 29,082,000 | 100 | % | $ | 28,372,000 | 100 | % | ||||||
Under GAAP, acquisition related expenses related to property acquisitions accounted for as business combinations are expensed, and therefore, are subtracted from cash flows from operations. However, these expenses may be paid from debt.
Any distributions of amounts in excess of our current and accumulated earnings and profits have resulted in a return of capital to our stockholders, and all or any portion of a distribution to our stockholders may have been paid from offering proceeds. The payment of distributions from our initial offering proceeds could reduce the amount of capital we ultimately invest in assets and negatively impact the amount of income available for future distributions.
As of March 31, 2017, we had an amount payable of $2,023,000 to our advisor or its affiliates primarily for asset and property management fees, which will be paid from cash flows from operations in the future as it becomes due and payable by us in the ordinary course of business consistent with our past practice.
As of March 31, 2017, no amounts due to our advisor or its affiliates had been deferred, waived or forgiven other than $37,000 in asset management fees waived by our advisor in 2014, which was equal to the amount of distributions payable to our stockholders for the period from May 14, 2014, the date we received and accepted subscriptions aggregating at least the minimum offering of $2,000,000 required pursuant to our initial offering, through June 5, 2014, the date we acquired our first
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property. In addition, our advisor agreed to waive the disposition fee that may otherwise have been due to our advisor pursuant to the Advisory Agreement for the disposition of an integrated senior health campus in 2017. Our advisor did not receive any additional securities, shares of our stock, or any other form of consideration or any repayment as a result of the waiver of such asset management fees and disposition fee. Other than the waiver of such asset management fees by our advisor in order to provide us with additional funds to pay initial distributions to our stockholders through June 5, 2014 and waiver of the disposition fee in 2017, our advisor and its affiliates, including our co-sponsors, have no obligation to defer or forgive fees owed by us to our advisor or its affiliates or to advance any funds to us. In the future, if our advisor or its affiliates do not defer, waive or forgive amounts due to them, this would negatively affect our cash flows from operations, which could result in us paying distributions, or a portion thereof, using borrowed funds. As a result, the amount of proceeds from borrowings available for investment and operations would be reduced, or we may incur additional interest expense as a result of borrowed funds.
The distributions paid for the three months ended March 31, 2017 and 2016, along with the amount of distributions reinvested pursuant to the Secondary DRIP Offering, and the sources of our distributions as compared to funds from operations attributable to controlling interest, or FFO, were as follows:
Three Months Ended March 31, | |||||||||||||
2017 | 2016 | ||||||||||||
Distributions paid in cash | $ | 13,401,000 | $ | 12,262,000 | |||||||||
Distributions reinvested | 15,681,000 | 16,110,000 | |||||||||||
$ | 29,082,000 | $ | 28,372,000 | ||||||||||
Sources of distributions: | |||||||||||||
FFO attributable to controlling interest | $ | 23,745,000 | 81.6 | % | $ | 21,036,000 | 74.1 | % | |||||
Proceeds from borrowings | 5,337,000 | 18.4 | 7,336,000 | 25.9 | |||||||||
$ | 29,082,000 | 100 | % | $ | 28,372,000 | 100 | % | ||||||
The payment of distributions from sources other than FFO may reduce the amount of proceeds available for investment and operations or cause us to incur additional interest expense as a result of borrowed funds. For a further discussion of FFO, a non-GAAP financial measure, including a reconciliation of our GAAP net loss to FFO, see Funds from Operations and Modified Funds from Operations section below.
Financing
We intend to continue to finance a portion of the purchase price of our investments in real estate and real estate-related investments by borrowing funds. We anticipate that our overall leverage will not exceed 45.0% of the combined fair market value of all of our properties and other real estate-related investments, as determined at the end of each calendar year. For these purposes, the market value of each asset will be equal to the purchase price paid for the asset or, if the asset was appraised subsequent to the date of purchase, then the market value will be equal to the value reported in the most recent independent appraisal of the asset. Our policies do not limit the amount we may borrow with respect to any individual investment. As of March 31, 2017, our aggregate borrowings were 38.5% of the combined market value of all of our real estate and real estate-related investments.
Under our charter, we have a limitation on borrowing that precludes us from borrowing in excess of 300% of our net assets without the approval of a majority of our independent directors. Net assets for purposes of this calculation are defined to be our total assets (other than intangibles), valued at cost prior to deducting depreciation, amortization, bad debt and other similar non-cash reserves, less total liabilities. Generally, the preceding calculation is expected to approximate 75.0% of the aggregate cost of our real estate and real estate-related investments before depreciation, amortization, bad debt and other similar non-cash reserves. In addition, we may incur mortgage debt and pledge some or all of our real properties as security for that debt to obtain funds to acquire additional real estate or for working capital. We may also borrow funds to satisfy the REIT tax qualification requirement that we distribute at least 90.0% of our annual taxable income, excluding net capital gains, to our stockholders. Furthermore, we may borrow if we otherwise deem it necessary or advisable to ensure that we maintain our qualification as a REIT for federal income tax purposes. As of May 15, 2017 and March 31, 2017, our leverage did not exceed 300% of the value of our net assets.
Mortgage Loans Payable, Net
For a discussion of our mortgage loans payable, net, see Note 7, Mortgage Loans Payable, Net, to our condensed consolidated financial statements.
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Lines of Credit and Term Loan
For a discussion of our lines of credit and term loan, see Note 8, Lines of Credit and Term Loan, to our condensed consolidated financial statements.
REIT Requirements
In order to maintain our qualification as a REIT for federal income tax purposes, we are required to make distributions to our stockholders of at least 90.0% of our annual taxable income, excluding net capital gains. In the event that there is a shortfall in net cash available due to factors including, without limitation, the timing of such distributions or the timing of the collection of receivables, we may seek to obtain capital to pay distributions by means of secured and unsecured debt financing through one or more unaffiliated parties. We may also pay distributions from cash from capital transactions including, without limitation, the sale of one or more of our properties or from the proceeds of our initial offering.
Commitments and Contingencies
For a discussion of our commitments and contingencies, see Note 11, Commitments and Contingencies, to our condensed consolidated financial statements.
Debt Service Requirements
Our principal liquidity need is the payment of principal and interest on our outstanding indebtedness. As of March 31, 2017, we had $506,813,000 ($486,509,000, including discount/premium and deferred financing costs, net) of fixed-rate and variable-rate mortgage loans payable outstanding secured by our properties. As of March 31, 2017, we had $713,716,000 outstanding and $146,284,000 remained available under our lines of credit and term loan. See Note 8, Lines of Credit and Term Loan, to our condensed consolidated financial statements.
We are required by the terms of certain loan documents to meet certain covenants, such as leverage ratios, net worth ratios, debt service coverage ratios, fixed charge coverage ratios and reporting requirements. As of May 15, 2017, we were in compliance with all such covenants and requirements on our mortgage loans payable and our lines of credit and term loan. As of March 31, 2017, the weighted average effective interest rate on our outstanding debt, factoring in our fixed-rate interest rate swaps and interest rate cap, was 4.02% per annum.
Contractual Obligations
The following table provides information with respect to: (i) the maturity and scheduled principal repayment of our secured mortgage loans payable and our lines of credit and term loan; (ii) interest payments on our mortgage loans payable, lines of credit and term loan and fixed interest rate swaps and interest rate cap; and (iii) ground and other lease obligations and capital leases as of March 31, 2017:
Payments Due by Period | |||||||||||||||||||
2017 | 2018-2019 | 2020-2021 | Thereafter | Total | |||||||||||||||
Principal payments — fixed-rate debt | $ | 4,573,000 | $ | 13,049,000 | $ | 24,585,000 | $ | 261,898,000 | $ | 304,105,000 | |||||||||
Interest payments — fixed-rate debt | 8,292,000 | 21,794,000 | 19,519,000 | 98,589,000 | 148,194,000 | ||||||||||||||
Principal payments — variable-rate debt | 42,000 | 881,315,000 | 35,067,000 | — | 916,424,000 | ||||||||||||||
Interest payments — variable-rate debt (based on rates in effect as of March 31, 2017) | 26,870,000 | 47,193,000 | 2,142,000 | — | 76,205,000 | ||||||||||||||
Ground and other lease obligations | 14,005,000 | 45,231,000 | 47,927,000 | 225,725,000 | 332,888,000 | ||||||||||||||
Capital leases | 5,657,000 | 12,070,000 | 4,761,000 | 85,000 | 22,573,000 | ||||||||||||||
Total | $ | 59,439,000 | $ | 1,020,652,000 | $ | 134,001,000 | $ | 586,297,000 | $ | 1,800,389,000 | |||||||||
The table above does not reflect any payments expected under our contingent consideration obligations in the estimated amount of $8,993,000, the majority of which we expect to pay in 2018. For a further discussion of our contingent consideration obligations, see Note 15, Fair Value Measurements — Assets and Liabilities Reported at Fair Value — Contingent Consideration, to our condensed consolidated financial statements.
Off-Balance Sheet Arrangements
As of March 31, 2017, we had no off-balance sheet transactions, nor do we currently have any such arrangements or obligations.
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Inflation
During the three months ended March 31, 2017 and 2016, inflation has not significantly affected our operations because of the moderate inflation rate; however, we expect to be exposed to inflation risk as income from future long-term leases will be the primary source of our cash flows from operations. There are provisions in the majority of our tenant leases that will protect us from the impact of inflation. These provisions will include negotiated rental increases, reimbursement billings for operating expense pass-through charges, and real estate tax and insurance reimbursements on a per square foot allowance. However, due to the long-term nature of the anticipated leases, among other factors, the leases may not re-set frequently enough to cover inflation.
Related Party Transactions
For a discussion of related party transactions, see Note 14, Related Party Transactions, to our condensed consolidated financial statements.
Funds from Operations and Modified Funds from Operations
Due to certain unique operating characteristics of real estate companies, the National Association of Real Estate Investment Trusts, or NAREIT, an industry trade group, has promulgated a measure known as funds from operations, a non-GAAP measure, which we believe to be an appropriate supplemental performance measure to reflect the operating performance of a REIT. The use of funds from operations is recommended by the REIT industry as a supplemental performance measure, and our management uses FFO to evaluate our performance over time. FFO is not equivalent to our net income (loss) as determined under GAAP.
We define FFO, a non-GAAP measure, consistent with the standards established by the White Paper on funds from operations approved by the Board of Governors of NAREIT, as revised in February 2004, or the White Paper. The White Paper defines funds from operations as net income (loss) computed in accordance with GAAP, excluding gains or losses from sales of property and asset impairment writedowns, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures are calculated to reflect funds from operations. 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, which is the case if such assets are not adequately maintained or repaired and renovated as required by relevant circumstances and/or as requested or required by lessees for operational purposes in order to maintain the value disclosed. We believe that, since 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. In addition, we believe it is appropriate to exclude impairment charges, as this is a fair value adjustment that is largely based on market fluctuations and assessments regarding general market conditions, which can change over time. Testing for an impairment of an asset is a continuous process and is analyzed on a quarterly basis. If certain impairment indications exist in an asset, and if the asset’s carrying, or book value, exceeds the total estimated undiscounted future cash flows (including net rental and lease revenues, net proceeds on the sale of the property and any other ancillary cash flows at a property or group level under GAAP) from such asset, an impairment charge would be recognized. Investors should note, however, that determinations of whether impairment charges have been incurred are based partly on anticipated operating performance, because estimated undiscounted future cash flows from a property, including estimated future net rental and lease revenues, net proceeds on the sale of the property and certain other ancillary cash flows, are taken into account in determining whether an impairment charge has been incurred. While impairment charges are excluded from the calculation of FFO as described above, investors are cautioned that due to the fact that impairments are based on estimated future undiscounted cash flows and that we intend to have a relatively limited term of our operations, it could be difficult to recover any impairment charges through the eventual sale of the property.
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 and impairments, provides a further understanding of our performance to investors and to our 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 (loss).
However, FFO and modified funds from operations attributable to controlling interest, or MFFO, as described below, should not be construed to be more relevant or accurate than the current GAAP methodology in calculating net income (loss) or in its applicability in evaluating our operating performance. The method utilized to evaluate the value and performance of real
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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 rules under GAAP that were put into effect 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 as operating expenses under GAAP. We believe 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 publicly registered, non-listed REITs are unique in that they have a limited life with targeted exit strategies within a relatively limited time frame after the acquisition activity ceases. We have used the proceeds raised in our initial offering to acquire properties, and we intend to begin the process of achieving a liquidity event (i.e., listing of our shares of common stock on a national securities exchange, a merger or sale, the sale of all or substantially all of our assets or another similar transaction) within five years after the completion of our offering stage, which is generally comparable to other publicly registered, non-listed REITs. Thus, we do not intend to continuously purchase assets and intend to have a limited life. Due to the above factors and other unique features of publicly registered, non-listed REITs, the IPA, an industry trade group, has standardized a measure known as modified funds from operations, which the IPA has recommended as a supplemental performance measure for publicly registered, non-listed REITs and which we believe to be another appropriate supplemental performance measure to reflect the operating performance of a publicly registered, non-listed REIT having the characteristics described above. MFFO is not equivalent to our net income (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 acquisition fees and expenses that affect our operations only in periods in which properties are acquired and that we consider more reflective of investing activities, as well as other non-operating items included in FFO, 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 are acquiring our properties and once our portfolio is in place. By providing MFFO, we believe we are presenting useful information that assists investors and analysts to better assess the sustainability of our operating performance after our offering stage has been completed and our properties have been acquired. We also believe that MFFO is a recognized measure of sustainable operating performance by the publicly registered, non-listed REIT industry. Further, we believe MFFO is useful in comparing the sustainability of our operating performance after our offering stage and acquisitions are completed with the sustainability of the operating performance of other real estate companies that are not as involved in acquisition activities. Investors are cautioned that MFFO should only be used to assess the sustainability of our operating performance after our offering stage has been completed and properties have been acquired, as it excludes acquisition fees and expenses that have a negative effect on our operating performance during the periods in which properties are acquired.
We define MFFO, a non-GAAP measure, consistent with the IPA’s Guideline 2010-01, Supplemental Performance Measure for Publicly Registered, Non-Listed REITs: Modified Funds from Operations, or the Practice Guideline, issued by the IPA in November 2010. The Practice Guideline defines modified funds from operations as funds from operations further adjusted for the following items included in the determination of GAAP net income (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 reflect such payments from a GAAP accrual basis to closer to an expected to be received cash basis of disclosing the rent and lease payments); accretion of discounts and amortization of premiums on debt investments; mark-to-market adjustments included in net income (loss); gains or losses included in net income (loss) 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; 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 modified funds from operations 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 (loss) in calculating cash flows from operations and, in some cases, reflect gains or losses which are unrealized and may not ultimately be realized. We are responsible for managing interest rate, hedge and foreign exchange risk, and we do not rely on another party to manage such risk. In as much as interest rate hedges will not be a fundamental part of our operations, we believe it is appropriate to exclude such gains and losses in calculating MFFO, as such gains and losses are based on market fluctuations and may not be directly related or attributable to our operations.
Our MFFO calculation complies with the IPA’s Practice Guideline described above. In calculating MFFO, we exclude acquisition related expenses (which include gains and losses on contingent consideration), amortization of above- and below-market leases, amortization of loan and closing costs, change in deferred rent receivables, fair value adjustments of derivative financial instruments, gains or losses on foreign currency transactions and the adjustments of such items related to unconsolidated properties and noncontrolling interests. The other adjustments included in the IPA’s Practice Guideline are not
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applicable to us for the three months ended March 31, 2017 and 2016. Acquisition fees and expenses are paid in cash by us, and we have not set aside cash on hand to be used to fund acquisition fees and expenses. The purchase of real estate and real estate-related investments, and the corresponding expenses associated with that process, is a key operational feature of our business plan in order to generate operating revenues and cash flows to make distributions to our stockholders. However, we do not intend to fund acquisition fees and expenses in the future from operating revenues and cash flows, nor from the sale of properties and subsequent redeployment of capital and concurrent incurring of acquisition fees and expenses. Acquisition fees and expenses include payments to our advisor or its affiliates and third parties. Such fees and expenses are not reimbursed by our advisor or its affiliates and third parties, and therefore if there is no further cash on hand to fund future acquisition fees and expenses, such fees and expenses will need to be paid from additional debt. Certain acquisition related expenses under GAAP are considered operating expenses and as expenses included in the determination of net income (loss) and income (loss) from continuing operations, both of which are performance measures under GAAP. 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, these fees and expenses and other costs related to such property. In the future, we may pay acquisition fees or reimburse acquisition expenses due to our advisor and its affiliates, or a portion thereof, with net proceeds from borrowed funds, operational earnings or cash flows, net proceeds from the sale of properties or ancillary cash flows. As a result, the amount of proceeds from borrowings available for investment and operations would be reduced, or we may incur additional interest expense as a result of borrowed funds. Nevertheless, our advisor or its affiliates will not accrue any claim on our assets if acquisition fees and expenses are not paid from cash on hand.
Further, under GAAP, certain contemplated non-cash fair value and other non-cash adjustments are considered operating non-cash adjustments to net income (loss) in determining cash flows from operations. In addition, we view fair value adjustments of derivatives and gains and losses from dispositions of assets as items which are unrealized and may not ultimately be realized or as items which are not reflective of on-going operations and are therefore typically adjusted for when assessing operating performance.
Our management uses MFFO and the adjustments used to calculate it in order to evaluate our performance against other publicly registered, non-listed REITs which intend to 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 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 publicly registered, 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 may be useful to investors. For example, acquisition fees and expenses are intended to be funded from the proceeds of our initial offering and other financing sources and not from operations. By excluding expensed acquisition fees and expenses, the use of MFFO provides information consistent with management’s analysis of the operating performance of the properties. Additionally, fair value adjustments, which are based on the impact of current market fluctuations and underlying assessments of general market conditions, but can also result from operational factors such as rental and occupancy rates, may not be directly related or attributable to our current operating performance. By excluding such charges that may reflect anticipated and unrealized gains or losses, we believe MFFO provides useful supplemental information.
Presentation of this information is intended to provide useful information to investors as they compare the operating performance of different REITs, although it should be noted that not all REITs calculate funds from operations and modified funds from operations the same way, so comparisons with other REITs may not be meaningful. Furthermore, FFO and MFFO are not necessarily indicative of cash flow 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, which is 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 measurements as an indication of our performance. MFFO may be 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 net asset value is disclosed. FFO and MFFO are not useful measures in evaluating net asset value because impairments are taken into account in determining net asset value 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 that 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 publicly registered, non-listed REIT industry and we would have to adjust our calculation and characterization of FFO or MFFO.
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The following is a reconciliation of net loss, which is the most directly comparable GAAP financial measure, to FFO and MFFO for the three months ended March 31, 2017 and 2016:
Three Months Ended March 31, | |||||||
2017 | 2016 | ||||||
Net loss | $ | (7,527,000 | ) | $ | (47,062,000 | ) | |
Add: | |||||||
Depreciation and amortization — consolidated properties | 29,822,000 | 70,896,000 | |||||
Depreciation and amortization — unconsolidated properties | 264,000 | 345,000 | |||||
Impairment of real estate investment | 3,969,000 | — | |||||
Loss on disposition of real estate investment | 227,000 | — | |||||
Net loss attributable to redeemable noncontrolling interests and noncontrolling interests | 4,008,000 | 12,795,000 | |||||
Less: | |||||||
Depreciation, amortization, impairment and loss on disposition related to redeemable noncontrolling interests and noncontrolling interests | (7,018,000 | ) | (15,938,000 | ) | |||
FFO attributable to controlling interest | $ | 23,745,000 | $ | 21,036,000 | |||
Acquisition related expenses(1) | $ | 318,000 | $ | 3,415,000 | |||
Amortization of above- and below-market leases(2) | 169,000 | 260,000 | |||||
Amortization of loan and closing costs(3) | 53,000 | 104,000 | |||||
Change in deferred rent receivables(4) | (1,341,000 | ) | 148,000 | ||||
(Gain) loss in fair value of derivative financial instruments(5) | (336,000 | ) | 260,000 | ||||
Foreign currency (gain) loss(6) | (513,000 | ) | 1,475,000 | ||||
Adjustments for unconsolidated properties(7) | 478,000 | 549,000 | |||||
Adjustments for redeemable noncontrolling interests and noncontrolling interests(7) | (110,000 | ) | (653,000 | ) | |||
MFFO attributable to controlling interest | $ | 22,463,000 | $ | 26,594,000 | |||
Weighted average common shares outstanding — basic and diluted | 196,897,807 | 192,240,851 | |||||
Net loss per common share — basic and diluted | $ | (0.04 | ) | $ | (0.24 | ) | |
FFO attributable to controlling interest per common share — basic and diluted | $ | 0.12 | $ | 0.11 | |||
MFFO attributable to controlling interest per common share — basic and diluted | $ | 0.11 | $ | 0.14 | |||
___________
(1) | In evaluating investments in real estate, we differentiate the costs to acquire the investment from the operations derived from the investment. Such information would be comparable only for publicly registered, non-listed REITs that have completed their acquisition activity and have other similar operating characteristics. By excluding expensed acquisition related expenses, we believe MFFO provides useful supplemental information that is comparable for each type of real estate investment and is consistent with management’s analysis of the investing and operating performance of our properties. Acquisition fees and expenses include payments to our advisor or its affiliates and third parties. Acquisition related expenses under GAAP are considered operating expenses and as expenses included in the determination of net income (loss) and income (loss) from continuing operations, both of which are performance measures under GAAP. 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, these fees and expenses and other costs related to such property. |
(2) | Under GAAP, above- and below-market leases are assumed to diminish predictably in value over time and amortized, similar to depreciation and amortization of other real estate-related assets that are excluded from FFO. However, because real estate values and market lease rates historically rise or fall with market conditions, including inflation, interest rates, the business cycle, unemployment and consumer spending, we believe that by excluding charges relating to the amortization of above- and below-market leases, MFFO may provide useful supplemental information on the performance of the real estate. |
(3) | Under GAAP, direct loan and closing costs are amortized over the term of our notes receivable and debt security investment as an adjustment to the yield on our notes receivable or debt security investment. This may result in income |
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recognition that is different than the contractual cash flows under our notes receivable and debt security investment. By adjusting for the amortization of the loan and closing costs related to our real estate notes receivable and debt security investment, MFFO may provide useful supplemental information on the realized economic impact of our notes receivable and debt security investment terms, providing insight on the expected contractual cash flows of such notes receivable and debt security investment, and aligns results with our analysis of operating performance.
(4) | Under GAAP, rental revenue or rental expense is recognized on a straight-line basis over the terms of the related lease (including rent holidays). This may result in income recognition that is significantly different than the underlying contract terms. By adjusting for the change in deferred rent receivables, MFFO may provide useful supplemental information on the realized economic impact of lease terms, providing insight on the expected contractual cash flows of such lease terms, and aligns results with our analysis of operating performance. |
(5) | Under GAAP, we are required to record our derivative financial instruments at fair value at each reporting period. We believe that adjusting for the change in fair value of our derivative financial instruments is appropriate because such adjustments may not be reflective of on-going operations and reflect unrealized impacts on value based only on then current market conditions, although they may be based upon general market conditions. The need to reflect the change in fair value of our derivative financial instruments is a continuous process and is analyzed on a quarterly basis in accordance with GAAP. |
(6) | We believe that adjusting for the change in foreign currency exchange rates provides useful information because such adjustments may not be reflective of on-going operations. |
(7) | Includes all adjustments to eliminate the unconsolidated properties’ share or redeemable noncontrolling interests and noncontrolling interests’ share, as applicable, of the adjustments described in notes (1) – (6) above to convert our FFO to MFFO. |
Net Operating Income
Net operating income, or NOI, is a non-GAAP financial measure that is defined as net income (loss), computed in accordance with GAAP, generated from properties before general and administrative expenses, acquisition related expenses, depreciation and amortization, interest expense, foreign currency gain (loss), other income, net, loss from unconsolidated entities and income tax benefit (expense). Acquisition fees and expenses are paid in cash by us, and we have not set aside cash on hand to be used to fund acquisition fees and expenses. The purchase of real estate and real estate-related investments, and the corresponding expenses associated with that process, is a key operational feature of our business plan in order to generate operating revenues and cash flows to make distributions to our stockholders. Acquisition fees and expenses include payments to our advisor or its affiliates and third parties. Such fees and expenses are not reimbursed by our advisor or its affiliates and third parties, and therefore if there is no further cash on hand to fund future acquisition fees and expenses, such fees and expenses will need to be paid from additional debt. As a result, the amount of proceeds available for investment, operations and non-operating expenses would be reduced, or we may incur additional interest expense as a result of borrowed funds. Nevertheless, our advisor or its affiliates will not accrue any claim on our assets if acquisition fees and expenses are not paid from cash on hand. Acquisition related expenses in connection with property acquisitions accounted for as business combinations under GAAP are considered operating expenses and as expenses included in the determination of net income (loss) and income (loss) from continuing operations, both of which are performance measures under GAAP. All paid and accrued acquisition fees and expenses 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, these fees and expenses and other costs related to such property.
NOI is not equivalent to our net income (loss) or income (loss) from continuing operations as determined under GAAP and may not be a useful measure in measuring operational income or cash flows. Furthermore, NOI is not necessarily indicative of cash flow 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, which is an indication of our liquidity, or indicative of funds available to fund our cash needs including our ability to make distributions to our stockholders. NOI should not be construed to be more relevant or accurate than the current GAAP methodology in calculating net income (loss) or in its applicability in evaluating our operating performance. Investors are also cautioned that NOI should only be used to assess our operational performance in periods in which we have not incurred or accrued any acquisition related expenses.
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We believe that NOI is an appropriate supplemental performance measure to reflect the operating performance of our operating assets because NOI excludes certain items that are not associated with the management of the properties. We believe that NOI is a widely accepted measure of comparative operating performance in the real estate community. However, our use of the term NOI may not be comparable to that of other real estate companies as they may have different methodologies for computing this amount.
The following is a reconciliation of net loss, which is the most directly comparable GAAP financial measure, to NOI for the three months ended March 31, 2017 and 2016:
Three Months Ended March 31, | |||||||
2017 | 2016 | ||||||
Net loss | $ | (7,527,000 | ) | $ | (47,062,000 | ) | |
General and administrative | 7,863,000 | 6,894,000 | |||||
Acquisition related expenses | 318,000 | 3,415,000 | |||||
Depreciation and amortization | 29,822,000 | 70,896,000 | |||||
Interest expense | 14,259,000 | 9,707,000 | |||||
Impairment of real estate investment | 3,969,000 | — | |||||
Loss from unconsolidated entities | 962,000 | 2,616,000 | |||||
Foreign currency (gain) loss | (513,000 | ) | 1,475,000 | ||||
Other income, net | (33,000 | ) | (224,000 | ) | |||
Income tax (benefit) expense | (213,000 | ) | 1,059,000 | ||||
Net operating income | $ | 48,907,000 | $ | 48,776,000 | |||
Subsequent Events
For a discussion of subsequent events, see Note 21, Subsequent Events, to our condensed consolidated financial statements.
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PART II — OTHER INFORMATION
Item 1A. Risk Factors.
The use of the words “we,” “us” or “our” refers to Griffin-American Healthcare REIT III, Inc. and its subsidiaries, including Griffin-American Healthcare REIT III Holdings, LP, except where the context otherwise requires.
There were no material changes from the risk factors previously disclosed in our 2016 Annual Report on Form 10-K, as filed with the SEC on March 15, 2017, except as noted below.
We have not had sufficient cash available from operations to pay distributions, and therefore, we have paid distributions from the net proceeds of our initial offering, and in the future, may pay distributions from borrowings in anticipation of future cash flows or from other sources. Any such distributions may reduce the amount of capital we ultimately invest in assets, may negatively impact the value of our stockholders’ investment and may cause subsequent investors to experience dilution.
We have used the net proceeds from our initial offering, borrowed funds or other sources, to pay cash distributions to our stockholders, which may reduce the amount of proceeds available for investment and operations, cause us to incur additional interest expense as a result of borrowed funds or cause subsequent investors to experience dilution. Further, if the aggregate amount of cash distributed in any given year exceeds the amount of our current and accumulated earnings and profits, the excess amount will be deemed a return of capital. Therefore, distributions payable to our stockholders may include a return of capital, rather than a return on capital. We have not established any limit on the amount of proceeds from our initial offering that may be used to fund distributions, except that, in accordance with our organizational documents and Maryland law, we may not make distributions that would: (i) cause us to be unable to pay our debts as they become due in the usual course of business; or (ii) cause our total assets to be less than the sum of our total liabilities plus senior liquidation preferences. The actual amount and timing of distributions is determined by our board, in its sole discretion and typically depends on the amount of funds available for distribution, which will depend on items such as our financial condition, current and projected capital expenditure requirements, tax considerations and annual distribution requirements needed to qualify as a REIT. As a result, our distribution rate and payment frequency may vary from time to time.
Our board has authorized, on a quarterly basis, a daily distribution to our stockholders of record as of the close of business on each day of the quarterly periods commencing on May 14, 2014 and ending on June 30, 2017. The daily distributions were or will be calculated based on 365 days in the calendar year and are equal to $0.001643836 per share of our common stock, which is equal to an annualized distribution rate of 6.0%, assuming a purchase price of $10.00 per share. These daily distributions were or will be aggregated and paid in cash or shares of our common stock pursuant to the DRIP portion of our initial offering and the Secondary DRIP Offering monthly in arrears, only from legally available funds.
The distributions paid for the three months ended March 31, 2017 and 2016, along with the amount of distributions reinvested pursuant to the Secondary DRIP Offering and the sources of our distributions as compared to cash flows from operations were as follows:
Three Months Ended March 31, | |||||||||||||
2017 | 2016 | ||||||||||||
Distributions paid in cash | $ | 13,401,000 | $ | 12,262,000 | |||||||||
Distributions reinvested | 15,681,000 | 16,110,000 | |||||||||||
$ | 29,082,000 | $ | 28,372,000 | ||||||||||
Sources of distributions: | |||||||||||||
Cash flows from operations | $ | 29,082,000 | 100 | % | $ | 28,372,000 | 100 | % | |||||
Proceeds from borrowings | — | — | — | — | |||||||||
$ | 29,082,000 | 100 | % | $ | 28,372,000 | 100 | % | ||||||
Under GAAP, acquisition related expenses related to property acquisitions accounted for as business combinations are expensed, and therefore subtracted from cash flows from operations. However, these expenses may be paid from debt.
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Any distributions of amounts in excess of our current and accumulated earnings and profits have resulted in a return of capital to our stockholders, and all or any portion of a distribution to our stockholders may have been paid from offering proceeds. The payment of distributions from our initial offering proceeds could reduce the amount of capital we ultimately invest in assets and negatively impact the amount of income available for future distributions.
As of March 31, 2017, we had an amount payable of $2,023,000 to our advisor or its affiliates primarily for asset and property management fees, which will be paid from cash flows from operations in the future as it becomes due and payable by us in the ordinary course of business consistent with our past practice.
As of March 31, 2017, no amounts due to our advisor or its affiliates had been deferred, waived or forgiven other than $37,000 in asset management fees waived by our advisor in 2014, which was equal to the amount of distributions payable to our stockholders for the period from May 14, 2014, the date we received and accepted subscriptions aggregating at least the minimum offering of $2,000,000 required pursuant to the initial offering, through June 5, 2014, the day prior to the date we acquired our first property. In addition, our advisor agreed to waive the disposition fee that may otherwise have been due to our advisor pursuant to the Advisory Agreement for the disposition of an integrated senior health campus in 2017. Our advisor did not receive any additional securities, shares of our stock, or any other form of consideration or any repayment as a result of the waiver of such asset management fees and disposition fee. Other than the waiver of such asset management fees by our advisor in order to provide us with additional funds to pay initial distributions to our stockholders through June 5, 2014 and waiver of the disposition fee in 2017, our advisor and its affiliates, including our co-sponsors, have no obligation to defer or forgive fees owed by us to our advisor or its affiliates or to advance any funds to us. In the future, if our advisor or its affiliates do not defer, waive or forgive amounts due to them, this would negatively affect our cash flows from operations, which could result in us paying distributions, or a portion thereof, using borrowed funds. As a result, the amount of proceeds from borrowings available for investment and operations would be reduced, or we may incur additional interest expense as a result of borrowed funds.
The distributions paid for the three months ended March 31, 2017 and 2016, along with the amount of distributions reinvested pursuant the Secondary DRIP Offering and the sources of our distributions as compared to FFO were as follows:
Three Months Ended March 31, | |||||||||||||
2017 | 2016 | ||||||||||||
Distributions paid in cash | $ | 13,401,000 | $ | 12,262,000 | |||||||||
Distributions reinvested | 15,681,000 | 16,110,000 | |||||||||||
$ | 29,082,000 | $ | 28,372,000 | ||||||||||
Sources of distributions: | |||||||||||||
FFO attributable to controlling interest | $ | 23,745,000 | 81.6 | % | $ | 21,036,000 | 74.1 | % | |||||
Proceeds from borrowings | 5,337,000 | 18.4 | 7,336,000 | 25.9 | |||||||||
$ | 29,082,000 | 100 | % | $ | 28,372,000 | 100 | % | ||||||
The payment of distributions from sources other than FFO may reduce the amount of proceeds available for investment and operations or cause us to incur additional interest expense as a result of borrowed funds. For a further discussion of FFO, a non-GAAP financial measure, including a reconciliation of our GAAP net loss to FFO, see Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Funds from Operations and Modified Funds from Operations.
A high concentration of our properties in a particular geographic area would magnify the effects of downturns in that geographic area.
To the extent that we have a concentration of properties in any particular geographic area, any adverse situation that disproportionately effects that geographic area would have a magnified adverse effect on our portfolio. As of May 15, 2017, properties located in Indiana accounted for approximately 35.3% of the annualized base rent or annualized net operating income of our total property portfolio. Accordingly, there is a geographic concentration of risk subject to fluctuations in such state’s economy.
Reductions in reimbursement from third-party payers, including Medicare and Medicaid, could adversely affect the profitability of our tenants and hinder their ability to make rent payments to us.
Sources of revenue for our tenants include the federal Medicare program, state Medicaid programs, private insurance carriers and health maintenance organizations, among others. Efforts by such payers to reduce healthcare costs will likely continue, which may result in reductions or slower growth in reimbursement for certain services provided by some of our tenants. In addition, the healthcare billing rules and regulations are complex, and the failure of any of our tenants to comply with various laws and regulations could jeopardize their ability to continue participating in Medicare, Medicaid and other
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government sponsored payment programs. Moreover, the state and federal governmental healthcare programs are subject to reductions by state and federal legislative actions. The American Taxpayer Relief Act of 2012 prevented the reduction in physician reimbursement of Medicare from being implemented in 2013. The Protecting Access to Medicare Act of 2014 prevented the reduction of 24.4% in the physician fee schedule by replacing the scheduled reduction with a 0.5% increase to the physician fee schedule through December 31, 2014, and no increase for January 1, 2015 through March 31, 2015. The potential 21.0% cut in reimbursement that was to be effective April 1, 2015 was removed by the Medicare Access & CHIP Reauthorization Act of 2015, or MACRA, and replaced with two new methodologies that will focus upon payment based upon quality outcomes. The first model is the Merit-Based Incentive Payment System, or MIPS, which will combine the Physician Quality Reporting System, or PQRS, and Meaningful Use program with the Value Based Modifier program to provide for one payment model based upon (i) quality, (ii) resource use, (iii) clinical practice improvement and (iv) advancing care information through the use of certified Electronic Health Record, or EHR, technology. The second model is the Advanced Alternative Payment Models, or APM, which require the physician to participate in a risk share arrangement for reimbursement related to his or her patients while utilizing a certified health record and reporting on specific quality metrics. There are a number of physicians that will not qualify for the APM payment method. Therefore, this change in reimbursement models may impact our tenants’ payments and create uncertainty in the tenants’ financial condition.
The healthcare industry continues to face various challenges, including increased government and private payer pressure on healthcare providers to control or reduce costs. It is possible that our tenants will continue to experience a shift in payer mix away from fee-for-service payers, resulting in an increase in the percentage of revenues attributable to reimbursement based upon value based principles and quality driven managed care programs, and general industry trends that include pressures to control healthcare costs. The federal government’s goal is to move approximately 90.0% of its reimbursement for providers to be based upon quality outcome models. Pressures to control healthcare costs and a shift away from traditional health insurance reimbursement to payment based upon quality outcomes have increased the uncertainty of payments.
In 2014, state insurance exchanges were implemented which provide a new mechanism for individuals to obtain insurance. At this time, the number of payers that are participating in the state insurance exchanges varies, and in some regions there are very limited insurance plans available for individuals to choose from when purchasing insurance. In addition, not all healthcare providers will maintain participation agreements with the payers that are participating in the state health insurance exchange. Therefore, it is possible that our tenants may incur a change in their reimbursement if the tenant does not have a participation agreement with the state insurance exchange payers and a large number of individuals elect to purchase insurance from the state insurance exchange. Further, the rates of reimbursement from the state insurance exchange payers to healthcare providers will vary greatly. The rates of reimbursement will be subject to negotiation between the healthcare provider and the payer, which may vary based upon the market, the healthcare provider’s quality metrics, the number of providers participating in the area and the patient population, among other factors. Therefore, it is uncertain whether healthcare providers will incur a decrease in reimbursement from the state insurance exchange, which may impact a tenant’s ability to pay rent.
On March 23, 2010, President Obama signed into law the Patient Protection and Affordable Care Act of 2010, or the Patient Protection and Affordable Care Act, and on March 30, 2010, President Obama signed into law the Health Care and Education Reconciliation Act of 2010, or the Reconciliation Act, which in part modified the Patient Protection and Affordable Care Act. Together, the two acts serve as the primary vehicle for comprehensive healthcare reform in the U.S., or collectively, the Healthcare Reform Act. The insurance plans that participated on the health insurance exchanges created by the Healthcare Reform Act were expecting to receive risk corridor payments to address the high risk claims that it paid through the exchange product. However, the federal government currently owes the insurance companies approximately $8.3 billion under the risk corridor payment program that is currently disputed by the federal government. The federal government is currently defending several lawsuits from the insurance plans that participate on the health insurance exchange. If the insurance companies do not receive the payments, the insurance companies may cease to participate on the insurance exchange which limits insurance options for patients. If patients do not have access to insurance coverage, it may adversely impact the tenants’ revenues and the tenants’ ability to pay rent.
In addition, the healthcare legislation passed in 2010 included new payment models with new shared savings programs and demonstration programs that include bundled payment models and payments contingent upon reporting on satisfaction of quality benchmarks. The new payment models will likely change how physicians are paid for services. These changes could have a material adverse effect on the financial condition of some or all of our tenants. The financial impact on our tenants could restrict their ability to make rent payments to us, which would have a material adverse effect on our business, financial condition and results of operations and our ability to pay distributions to our stockholders.
Furthermore, beginning in 2016, the Centers for Medicare and Medicaid Services will apply a negative payment adjustment to individual eligible professionals, Comprehensive Primary Care practice sites and group practices participating in the Physician Quality Reporting System, or PQRS, group practice reporting option (including Accountable Care Organizations) that did not satisfactorily report PQRS in 2014. Program participation during a calendar year will affect payments two years
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later. Providers can appeal the determination, but if the provider is not successful, the provider’s reimbursement may be adversely impacted, which would adversely impact a tenant’s ability to make rent payments to us.
Moreover, President Trump signed an Executive Order on January 20, 2017 to “ease the burden of Obamacare.” At this time, the implications of this Executive Order are unknown, but it is possible that it may adversely impact the insurance exchanges or remove the requirement for all individuals to obtain insurance. If individuals are not required to have insurance or if the insurance exchange products are not available to the general public, it is possible that our tenants will not have as many patients that have insurance coverage which will adversely impact the tenants’ revenues and ability to pay rent. At this time, the implications of the Executive Order are unknown.
On May 4, 2017, members of the House of Representatives approved legislation to repeal portions of the Healthcare Reform Act. The legislation still must be approved by the Senate, where it is expected to be debated at length and may not be approved. Alternatively, any final bill that is approved by the Senate, the House of Representatives and the President may have modifications from the version approved by the House of Representatives on May 4, 2017. The current legislation approved by the House of Representatives focuses upon, among other items, modifying the individual responsibility to purchase insurance, modifying employer obligations to purchase insurance and modifying the funding for Medicaid programs. The legislation could impact the number of individuals that have insurance to pay for healthcare services, which could impact our tenants’ collections. At this time, it is uncertain whether any healthcare reform legislation will ultimately become law. If our tenants’ patients do not have insurance, it could adversely impact the tenants’ ability to pay rent and operate a practice.
Comprehensive healthcare reform legislation, the effects of which are not yet known, could materially adversely affect our business, financial condition and results of operations and our ability to pay distributions to our stockholders.
The Healthcare Reform Act is intended to reduce the number of individuals in the U.S. without health insurance and effect significant other changes to the ways in which healthcare is organized, delivered and reimbursed. Included within the legislation is a limitation on physician-owned hospitals from expanding, unless the facility satisfies very narrow federal exceptions to this limitation. Therefore, if our tenants are physicians that own and refer to a hospital, the hospital would be limited in its operations and expansion potential, which may limit the hospital’s services and resulting revenues and may impact the owner’s ability to make rental payments. The legislation will become effective through a phased approach, having begun in 2010 and concluding in 2018. On June 28, 2012, the United States Supreme Court upheld the individual mandate under the Healthcare Reform Act, although substantially limiting its expansion of Medicaid. At this time, the effects of healthcare reform and its impact on our properties are not yet known but could materially adversely affect our business, financial condition, results of operations and ability to pay distributions to our stockholders.
On May 4, 2017, members of the House of Representatives approved legislation to repeal portions of the Healthcare Reform Act. The legislation still must be approved by the Senate, where it is expected to be debated at length and may not be approved. Alternatively, any final bill that is approved by the Senate, the House of Representatives and the President may have modifications from the version approved by the House of Representatives on May 4, 2017. The current legislation approved by the House of Representatives focuses upon, among other items, modifying the individual responsibility to purchase insurance, modifying employer obligations to purchase insurance and modifying the funding for Medicaid programs. The legislation could impact the number of individuals that have insurance to pay for healthcare services, which could impact our tenants’ collections. At this time, it is uncertain whether any healthcare reform legislation will ultimately become law. If our tenants’ patients do not have insurance, it could adversely impact the tenants’ ability to pay rent and operate a practice.
We, our tenants and our operators for our skilled nursing, senior housing and integrated senior health campuses may be subject to various government reviews, audits and investigations that could adversely affect our business, including an obligation to refund amounts previously paid to us, potential criminal charges, the imposition of fines, and/or the loss of the right to participate in Medicare and Medicaid programs.
As a result of our tenants’ participation in the Medicaid and Medicare programs, we, our tenants and our operators for our skilled nursing, senior housing and integrated senior health campuses are subject to various governmental reviews, audits and investigations to verify compliance with these programs and applicable laws and regulations. We, our tenants and our operators for our skilled nursing, senior housing and integrated senior health campuses are also subject to audits under various government programs, including Recovery Audit Contractors, Zone Program Integrity Contractors, Program Safeguard Contractors and Medicaid Integrity Contractors programs, in which third party firms engaged by Centers for Medicare & Medicaid Services, or CMS, conduct extensive reviews of claims data and medical and other records to identify potential improper payments under the Medicare and Medicaid programs. Private pay sources also reserve the right to conduct audits. Billing and reimbursement errors and disagreements occur in the healthcare industry. We, our tenants and our operators for our skilled nursing, senior housing and integrated senior health campuses may be engaged in reviews, audits and appeals of claims for reimbursement due to the subjectivities inherent in the process related to patient diagnosis and care, record keeping, claims
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processing and other aspects of the patient service and reimbursement processes, and the errors and disagreements those subjectivities can produce. An adverse review, audit or investigation could result in:
• | an obligation to refund amounts previously paid to us, our tenants or our operators pursuant to the Medicare or Medicaid programs or from private payors, in amounts that could be material to our business; |
• | state or federal agencies imposing fines, penalties and other sanctions on us, our tenants or our operators; |
• | loss of our right, our tenants’ right or our operators’ right to participate in the Medicare or Medicaid programs or one or more private payor networks; |
• | an increase in private litigation against us, our tenants or our operators; and |
• | damage to our reputation in various markets. |
While we, our tenants and our operators for our skilled nursing, senior housing and integrated senior health campuses have always been subject to post-payment audits and reviews, more intensive “probe reviews” appear to be a permanent procedure with our fiscal intermediaries. Generally, findings of overpayment from CMS contractors are eligible for appeal through the CMS defined continuum, but there may be rare instances that are not eligible for appeal. We, our tenants and our operators for our skilled nursing, senior housing and integrated senior health campuses utilize all defenses at our disposal to demonstrate that the services provided meet all clinical and regulatory requirements for reimbursement.
If the government or court were to conclude that such errors, deficiencies or disagreements constituted criminal violations, or were to conclude that such errors, deficiencies or disagreements resulted in the submission of false claims to federal healthcare programs, or if the government were to discover other problems in addition to the ones identified by the probe reviews that rose to actionable levels, we and certain of our officers, and our tenants and operators for our skilled nursing, senior housing and integrated senior health campuses and certain of their officers, might face potential criminal charges and/or civil claims, administrative sanctions and penalties for amounts that could be material to our business, results of operations and financial condition. In addition, we and/or some of the key personnel of our operating subsidiaries, or those of our tenants and operators for our skilled nursing, senior housing and integrated senior health campuses, could be temporarily or permanently excluded from future participation in state and federal healthcare reimbursement programs such as Medicaid and Medicare. In any event, it is likely that a governmental investigation alone, regardless of its outcome, would divert material time, resources and attention from our management team and our staff, or those of our tenants and our operators for our skilled nursing, senior housing and integrated senior health campuses and could have a materially detrimental impact on our results of operations during and after any such investigation or proceedings.
In cases where claim and documentation review by any CMS contractor results in repeated poor performance, a facility can be subjected to protracted oversight. This oversight may include repeat education and re-probe, extended pre-payment review, referral to recovery audit or integrity contractors, or extrapolation of an error rate to other reimbursement outside of specifically reviewed claims. Sustained failure to demonstrate improvement towards meeting all claim filing and documentation requirements could ultimately lead to Medicare and Medicaid decertification, which could have a materially detrimental impact on our results of operations. Adverse actions by CMS may also cause third party payer or licensure authorities to audit our tenants. These additional audits could result in termination of third party payer agreements or licensure of the facility, which would also adversely impact our operations.
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Item 6. Exhibits.
The following exhibits are included, or incorporated by reference, in this Amendment No. 1 to Quarterly Report on Form 10-Q/A for the period ended March 31, 2017 (and are numbered in accordance with Item 601 of Regulation S-K).
3.1 | Articles of Amendment and Restatement of Griffin-American Healthcare REIT III, Inc. dated January 15, 2014 (included as Exhibit 3.1 to Pre-Effective Amendment No. 5 to our Registration Statement on Form S-11 (File No. 333-186073) filed January 16, 2014 and incorporated herein by reference) |
3.2 | Bylaws of Griffin-American Healthcare REIT III, Inc. (included as Exhibit 3.2 to our Registration Statement on Form S-11 (File No. 333-186073) filed January 17, 2013 and incorporated herein by reference) |
4.1 | Amended and Restated Distribution Reinvestment Plan of Griffin-American Healthcare REIT III, Inc. (included as Exhibit 4.1 to our Current Report on Form 8-K (File No. 000-55434) filed October 7, 2016 and incorporated herein by reference) |
31.1** | Certification of Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
31.2** | Certification of Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
31.3* | Certification of Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
31.4* | Certification of Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
32.1** | Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002 |
32.2** | Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002 |
101.INS** | XBRL Instance Document |
101.SCH** | XBRL Taxonomy Extension Schema Document |
101.CAL** | XBRL Taxonomy Extension Calculation Linkbase Document |
101.LAB** | XBRL Taxonomy Extension Label Linkbase Document |
101.PRE** | XBRL Taxonomy Extension Presentation Linkbase Document |
101.DEF** | XBRL Taxonomy Extension Definition Linkbase Document |
___________
* | Filed herewith. |
** | Previously filed or furnished, as the case may be, with the Original Report, originally filed with the SEC on May 15, 2017, which is being amended hereby. |
The exhibits listed above have been filed separately with the SEC in conjunction with our Quarterly Report on Form 10-Q, as amended by the Amendment, or have been incorporated by reference into our Quarterly Report on Form 10-Q, as amended by the Amendment. Upon request, we will furnish to each of our stockholders a copy of any such exhibit. Requests should be addressed to the Corporate Secretary, Griffin-American Healthcare REIT III, Inc., 18191 Von Karman Avenue, Suite 300, Irvine, California 92612.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Griffin-American Healthcare REIT III, Inc. (Registrant) | ||||||
May 23, 2017 | By: | /s/ JEFFREY T. HANSON | ||||
Date | Jeffrey T. Hanson | |||||
Chief Executive Officer and Chairman of the Board of Directors | ||||||
(Principal Executive Officer) | ||||||
May 23, 2017 | By: | /s/ BRIAN S. PEAY | ||||
Date | Brian S. Peay | |||||
Chief Financial Officer | ||||||
(Principal Financial Officer and Principal Accounting Officer) | ||||||
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EXHIBIT INDEX
The following exhibits are included, or incorporated by reference, in this Amendment No. 1 to Quarterly Report on Form 10-Q/A for the period ended March 31, 2017 (and are numbered in accordance with Item 601 of Regulation S-K).
3.1 | Articles of Amendment and Restatement of Griffin-American Healthcare REIT III, Inc. dated January 15, 2014 (included as Exhibit 3.1 to Pre-Effective Amendment No. 5 to our Registration Statement on Form S-11 (File No. 333-186073) filed January 16, 2014 and incorporated herein by reference) |
3.2 | Bylaws of Griffin-American Healthcare REIT III, Inc. (included as Exhibit 3.2 to our Registration Statement on Form S-11 (File No. 333-186073) filed January 17, 2013 and incorporated herein by reference) |
4.1 | Amended and Restated Distribution Reinvestment Plan of Griffin-American Healthcare REIT III, Inc. (included as Exhibit 4.1 to our Current Report on Form 8-K (File No. 000-55434) filed October 7, 2016 and incorporated herein by reference) |
31.1** | Certification of Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
31.2** | Certification of Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
31.3* | Certification of Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
31.4* | Certification of Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
32.1** | Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002 |
32.2** | Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002 |
101.INS** | XBRL Instance Document |
101.SCH** | XBRL Taxonomy Extension Schema Document |
101.CAL** | XBRL Taxonomy Extension Calculation Linkbase Document |
101.LAB** | XBRL Taxonomy Extension Label Linkbase Document |
101.PRE** | XBRL Taxonomy Extension Presentation Linkbase Document |
101.DEF** | XBRL Taxonomy Extension Definition Linkbase Document |
___________
* | Filed herewith. |
** | Previously filed or furnished, as the case may be, with the Original Report, originally filed with the SEC on May 15, 2017, which is being amended hereby. |
The exhibits listed above have been filed separately with the SEC in conjunction with our Quarterly Report on Form 10-Q, as amended by the Amendment, or have been incorporated by reference into our Quarterly Report on Form 10-Q, as amended by the Amendment. Upon request, we will furnish to each of our stockholders a copy of any such exhibit. Requests should be addressed to the Corporate Secretary, Griffin-American Healthcare REIT III, Inc., 18191 Von Karman Avenue, Suite 300, Irvine, California 92612.
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