UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

For the quarterly period ended September 30, 2018

OR

For the transition period from              to             

Commission file number:  000-54685

 

CNL Healthcare Properties, Inc.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code (407) 650-1000

 

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

 

Indicate by check mark whether the registrant has submitted electronically 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 such files).    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.

 

 

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 13(a) of the Exchange Act. ☐

 

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

The number of shares of common stock of the registrant outstanding as of October 31, 2018 was 173,973,581.

 

 

 

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

 

INDEX

 

 

 

 

 

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Item 1. Financial Statements

CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(in thousands, except per share data)

 

 

See accompanying notes to condensed consolidated financial statements

2

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(in thousands, except per share data)

 

 

See accompanying notes to condensed consolidated financial statements.

3

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (UNAUDITED)

(in thousands)

 

 

See accompanying notes to condensed consolidated financial statements.

 

 

4

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND REDEEMABLE NONCONTROLLING INTEREST

NINE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017 (UNAUDITED)

(in thousands, except per share data)

 

 

See accompanying notes to condensed consolidated financial statements.

 

 

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands)

 

 

See accompanying notes to condensed consolidated financial statements.

 

 

6

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENT

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

CNL Healthcare Properties, Inc. (“Company”) was incorporated on June 8, 2010 and elected to be taxed as a real estate investment trust (“REIT”) for United States (“U.S.”) federal income tax purposes beginning with the year ended December 31, 2012.  The Company is externally advised by CNL Healthcare Corp. (“Advisor”).  The Company’s properties were also managed by CNL Healthcare Manager Corp. (“Property Manager”) through June 28, 2018 as the property management agreement with the Property Manager was not renewed.  Subsequently, the responsibilities previously undertaken by the Property Manager have been performed by the Advisor.  Both the Advisor and Property Manager are affiliates of CNL Financial Group, LLC (“Sponsor”).  The Sponsor is an affiliate of CNL Financial Group, Inc. (“CNL”) and CNL Securities Corp. (“Managing Dealer”), the managing dealer of the Company’s public offerings (“Offerings”) and a wholly owned subsidiary of CNL.  The Advisor is responsible for managing the Company’s affairs on a day-to-day basis and for identifying and making acquisitions and investments on behalf of the Company pursuant to an advisory agreement among the Company, the CHP Partners, LP (“Operating Partnership”) and the Advisor.  Substantially all of the Company’s acquisition, operating, administrative and certain property management services are provided by affiliates of the Advisor.  In addition, third-party sub-property managers have been engaged to provide certain property management services.

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

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

In 2017, the Company began evaluating strategic alternatives to provide liquidity to its stockholders.  In June 2018, the Company announced it had formed a special committee consisting solely of its independent directors (“Special Committee”) to consider possible strategic alternatives to provide liquidity to investors, including, but not limited to (i) the listing of the Company’s or one of its subsidiaries’ common stock on a national securities exchange, (ii) an orderly disposition of the Company’s assets or one or more of the Company’s asset classes and the distribution of the net sale proceeds thereof to the stockholders of the Company and (iii) a potential business combination or other transaction with a third party or parties that provides the stockholders of the Company with cash and/or securities of a publicly traded company (collectively, among other options, “Possible Strategic Alternatives”).  The Special Committee engaged two investment bankers to act as financial advisors to the aforementioned Special Committee.  Although the Company has formed the Special Committee for the exploration of Possible Strategic Alternatives, the Company is not obligated to enter into any particular transaction or any transaction at all.

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

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENT

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

Basis of Presentation and Consolidation — The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and note disclosures required by generally accepted accounting principles in the U.S. (“GAAP”).  The unaudited condensed consolidated financial statements reflect all normal recurring adjustments, which, in the opinion of management, are necessary for the fair statement of the Company’s results for the interim period presented.  Operating results for the nine months ended September 30, 2018 may not be indicative of the results that may be expected for the year ending December 31, 2018. Amounts as of December 31, 2017 included in the unaudited condensed consolidated financial statements have been derived from audited consolidated financial statements as of that date but do not include all disclosures required by GAAP.  These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 (“Annual Report”).

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

In accordance with the guidance for the consolidation of a VIE, the Company is required to identify entities for which control is achieved through means other than voting rights and to determine the primary beneficiary of its VIEs.  The Company qualitatively assesses whether it is the primary beneficiary of a VIE and considers various factors including, but not limited to, the design of the entity, its organizational structure including decision-making ability and financial agreements, its ability and the rights of others to participate in policy making decisions, as well as its ability to replace the VIE manager and/or liquidate the entity.

Reclassifications – Certain amounts in the prior year’s condensed consolidated balance sheet, statement of operations and statement of cash flows have been reclassified to conform to the current year’s presentation with no effect on the other previously reported consolidated financial statements.

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

Adopted Accounting Pronouncements — In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers,” as a new Accounting Standards Codification (“ASC”) topic (Topic 606).  The core principle of this ASU is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  The ASU further provides guidance for any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards (for example, lease contracts).

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENT

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

The FASB subsequently issued ASU 2015-14 to defer the effective date of ASU 2014-09 until annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, with earlier adoption permitted.  In addition, the FASB issued ASU 2017-05, "Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20)," which clarifies the scope of subtopic 610-20, that was issued as a part of ASU 2014-09, as it relates to in-substance nonfinancial assets and must be adopted concurrently with ASC 606.  Both ASUs can be adopted using one of two retrospective transition methods: (i) retrospectively to each prior reporting period presented or (ii) as a cumulative-effect adjustment as of the date of adoption.  The Company adopted these ASUs using the modified retrospective approach as its transition method on January 1, 2018; the adoption of which did not have a material impact to its consolidated financial statements.

In August 2017, the FASB issued ASU 2017-12 “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities,” which amended the hedge accounting model to better reflect an entity’s risk management activities. The ASU expands an entities ability to hedge nonfinancial and financial risk components as well as reduce the complexity related to fair value hedges of interest rate risk. The ASU further eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item. The ASU is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2018.  The Company early adopted this ASU prospectively on January 1, 2018; the adoption of which did not have a material impact on the Company’s consolidated results of operations or cash flows.

Recent Accounting Pronouncements — In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842): Accounting for Leases,” which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e. lessees and lessors).  The ASU requires lessees to recognize assets and liabilities on the balance sheet for the rights and obligations created by all leases with terms of more than 12 months.  The ASU further modifies lessors’ classification criteria for leases and the accounting for sales-type and direct financing leases.  The ASU will also require qualitative and quantitative disclosures designed to give financial statement users additional information on the amount, timing, and uncertainty of cash flows arising from leases.  The ASU is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2018 with early adoption permitted.  The ASU is to be applied using a modified retrospective approach.  The Company continues to execute on its implementation plan for ASC 842 and expects to adopt this ASU on January 1, 2019.  The Company expects that adoption will impact the Company’s consolidated financial statements and related financial statement disclosures; specifically, (1) the Company’s consolidated financial position as it relates to the required presentation for arrangements such as ground or other leases in which the Company is the lessee, and (2) the allocation of consideration between lease and non-lease components for arrangements in which the Company is the lessor.  However, the Company does not expect the adoption of this ASU to have a material impact on the Company’s consolidated results of operations or cash flows.  In July 2018, the FASB issued ASU 2018-11, “Leases (Topic 842): Targeted Improvements,” which includes a practical expedient for lessors allowing them to elect to not separate lease and non-lease components in a contract for the purpose of revenue recognition and disclosure if certain criteria are met.  The Company plans to elect the practical expedient and apply to all leases that qualify under the established criteria.   

In June 2018, the FASB issued ASU 2018-07, “Compensation – Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting,” which expands the scope to include share-based payment transactions for acquiring goods and services from nonemployees. The amendments specify that Topic 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payments.  The amendments also clarify that this topic does not apply to share-based payments used to provide financing to the issuer or awards granted in conjunction with selling of goods or services to customers as a part of a contract accounted for under Revenue from Contracts with Customers (Topic 606).  The ASU is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2018.  The Company is assessing the impact of adoption of this ASU as related to the Company’s consolidated financial statements.

9

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENT

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement,” which modifies the disclosure requirements on fair value measurements. The amendments add disclosure requirements for the changes in unrealized gains and losses for the period that are held in other comprehensive income for recurring Level 3 fair value measurements as well as disclosure requirements for the range and weighted average of significant observable inputs used to develop Level 3 fair value measurements. The amendments also clarify that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date. The ASU is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2019.  The Company does not expect the adoption of this ASU to have a material impact on the Company’s consolidated financial statements.

Resident fees and services are operating revenues relating to the Company’s managed seniors housing properties, which are operated under RIDEA structures.  Resident fees and services directly relate to the provision of monthly goods and services that are generally bundled together under a single resident agreement.   The Company accounts for its resident agreements as a single performance obligation under ASC 606 given the Company’s overall promise to provide a series of stand-ready goods and services to its residents each month.  Resident fees and services are recorded in the period in which the goods are provided and the services performed and generally consist of (1) monthly rent, which covers occupancy of the residents’ unit as well as basic services, such as utilities, meals and certain housekeeping services, and (2) service level charges, such as assisted living care, memory care and ancillary services.  Resident agreements are generally short-term in nature, billed monthly in advance and cancelable by the residents with a 30-day notice.  Resident agreements may require the payment of upfront fees prior to moving into the community with any non-refundable portion of such fees being recorded as deferred revenue and amortized over the estimated resident stay.

The following tables represent the disaggregated revenue for resident fees and services during the nine months ended September 30, 2018 and 2017:

 

 

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENT

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

The gross carrying amount and accumulated depreciation of the Company’s real estate assets as of September 30, 2018 and December 31, 2017 are as follows, excluding assets held for sale (in thousands):

 

 

Depreciation expense on the Company’s real estate investment properties, net was approximately $12.8 million and $39.1 million for the quarter and nine months ended September 30, 2018, respectively, and approximately $13.2 million and $38.8 million for the quarter and nine months ended September 30, 2017. These amounts include depreciation through the determination date on assets held for sale; refer to Note 6. “Assets and Associated Liabilities Held For Sale and Discontinued Operations” for additional information.

The gross carrying amount and accumulated amortization of the Company’s intangible assets as of September 30, 2018 and December 31, 2017 are as follows, excluding assets held for sale (in thousands):

 

 

Amortization on the Company’s intangible assets was approximately $0.1 million and $2.4 million for the quarter and nine months ended September 30, 2018, all of which were included in depreciation and amortization.  Amortization on the Company’s intangible assets was approximately $2.8 million and $9.5 million for the quarter and nine months ended September 30, 2017, all of which were included in depreciation and amortization.

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENT

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

In August 2017, the Company committed to a plan to sell the Perennial Communities which are comprised of six skilled nursing facilities located in Arkansas, and classified the properties as held for sale. The sale of these properties would not cause a strategic shift in the Company nor would it be considered individually significant; therefore, the properties do not qualify as discontinued operations.

In March 2018, the Company committed to a plan to sell Physicians Regional Medical Center – Central Wing (“Physicians Regional”). In May 2018, the Company completed the sale of Physicians Regional, received net sales proceeds of approximately $5.8 million and recorded a gain on sale of real estate for financial reporting purposes of approximately $1.0 million in the accompanying condensed consolidated statements of operations for the nine months ended September 30, 2018. The sale of Physicians Regional did not cause a strategic shift in the Company nor was it considered individually significant; therefore, it did not qualify as discontinued operations.

In September 2018, the Company committed to a plan to sell 53 medical office buildings, five post-acute care facilities and five acute care hospitals across the US (“MOB/Healthcare Portfolio”), and classified the associated properties as held for sale.  The sale of these properties would cause a strategic shift in the Company and it is considered individually significant; therefore, the properties qualify as discontinued operations.

As of September 30, 2018 and December 31, 2017, assets held for sale consisted of the following (in thousands):

 

 

As of September 30, 2018 and December 31, 2017, liabilities associated with assets held for sale consisted of the following (in thousands):

 

 

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENT

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

The Company classified the revenues and expenses related to the Company’s MOB/Healthcare Portfolio as discontinued operations in the accompanying consolidated statements of operations. The following table is a summary of loss from discontinued operations for the quarter and nine months ended September 30, 2018 and 2017 (in thousands):

 

 

FOOTNOTE:

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENT

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

The aggregate carrying amount and major classifications of the consolidated assets that can be used to settle obligations of the VIEs and liabilities of the consolidated VIEs that are non-recourse to the Company as of September 30, 2018 and December 31, 2017 are as follows (in thousands):

 

 

_____________

FOOTNOTE:

The Company’s maximum exposure to loss as a result of its involvement with these VIEs is limited to its net investment in these entities which totaled approximately $74.3 million as of September 30, 2018. The Company’s exposure is limited because of the non-recourse nature of the borrowings of the VIEs.

As of September 30, 2018 and December 31, 2017, the Company had 9 and 10 subsidiaries which are classified as VIEs, respectively, due to the following factors and circumstances as of September 30, 2018:

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

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENT

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

The following table provides details of the Company’s indebtedness as of September 30, 2018 and December 31, 2017, excluding assets held for sale (in thousands):

 

 

FOOTNOTES:

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENT

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

The following is a schedule of future principal payments and maturity for the Company’s total indebtedness for the remainder of 2018, each of the next four years and thereafter, in the aggregate, as of September 30, 2018 (in thousands):

 

 

The following table provides details of the fair market value and carrying value of the Company’s indebtedness as of September 30, 2018 and December 31, 2017 (in millions):

 

 

These fair market values are based on current rates and spreads the Company would expect to obtain for similar borrowings.  Since this methodology includes inputs that are less observable by the public and are not necessarily reflected in active markets, the measurement of the estimated fair values related to the Company’s mortgage notes payable is categorized as Level 3 on the three-level valuation hierarchy.  The estimated fair value of accounts payable and accrued liabilities approximates the carrying value as of September 30, 2018 and December 31, 2017 because of the relatively short maturities of the obligations.

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

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

As of September 30, 2018, the Company was in compliance with all financial covenants.

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENT

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

In April 2018, the Company extended its advisory agreement with the Advisor through June 2019.  In addition, in April 2018, the Company and the Property Manager agreed that the property management agreement would expire on its stated date of June 28, 2018 and was not renewed.  During the quarter and nine months ended September 30, 2018, the Company paid approximately $0.2 million and $0.5 million, respectively, of cash distributions on restricted stock issued pursuant to the Advisor expense support agreement.  During the quarter and nine months ended September 30, 2017, the Company paid approximately $0.2 million and $0.4 million, respectively, of cash distributions on restricted stock issued pursuant to the Advisor expense support agreement.  These amounts have been recognized as compensation expense and included in general and administrative expense in the accompanying condensed consolidated statements of operations.

   

The expenses and fees incurred by and reimbursable to the Company’s related parties, including amounts included in income from discontinued operations, net of tax, for the quarter and nine months ended September 30, 2018 and 2017, and related amounts unpaid as of September 30, 2018 and December 31, 2017 are as follows (in thousands):

 

 

FOOTNOTES:

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENT

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

 

FOOTNOTES (continued):

The following summarizes the terms of the Company’s derivative financial instruments and the corresponding asset (liability) as of September 30, 2018 and December 31, 2017, including properties classified as held for sale (in thousands):

 

 

FOOTNOTES:

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENT

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

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

Stockholders’ Equity:

Distribution Reinvestment Plan — For the nine months ended September 30, 2018 and 2017, the Company received proceeds through its Reinvestment Plan of approximately $22.0 million (2.1 million shares) and $32.0 million (3.2 million shares), respectively.  In June 2018, in light of the Company’s decision to proceed with the exploration of strategic alternatives, the Company suspended the Reinvestment Plan and the Company’s common stock redemption plan (“Redemption Plan”).  

Distributions — During the nine months ended September 30, 2018 and 2017, the Company declared cash distributions of $60.8 million and $57.4 million, respectively, of which $38.8 million and $25.4 million, respectively, were paid in cash to stockholders and $0.0 million and $32.0 million, respectively, were reinvested pursuant to the Reinvestment Plan.  

Redemptions — During the nine months ended September 30, 2018 and 2017, the Company received requests for the redemption of common stock of approximately $44.7 million and $35.6 million, respectively, of which $28.3 million and $35.6 million, respectively, were approved for redemption at an average price of $10.14 and $9.98, respectively.  The remaining $16.4 million (1.6 million shares) of excess redemptions requests were placed in a redemption requests queue.  In June 2018, in light of the Company’s decision to proceed with the exploration of strategic alternatives, the Company suspended the Redemption Plan effective July 11, 2018.  The $16.4 million in unsatisfied redemption requests that were placed in the redemption queue will remain there until such time, if at all, that the Company’s board of directors reinstates the Redemption Plan.  Unless the Redemption Plan is reinstated by the Company’s board of directors, the Company will not as a general matter, accept or otherwise process any additional redemption requests received after July 11, 2018.  There can be no guarantee that the Redemption Plan will be reinstated by the Company’s board of directors.

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENT

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

Other comprehensive income— The following table reflects the effect of derivative financial instruments held by the Company and included in the condensed consolidated statements of comprehensive loss for the quarter and nine months ended September 30, 2018 and 2017 (in thousands):

 

 

 

 

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENT

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

 

The accompanying condensed consolidated financial statements include an interim tax provision for the quarter and nine months ended September 30, 2018 and 2017.  The Company recorded a total provision for income taxes of approximately $0.9 million and $2.4 million for the quarter and nine months ended September 30, 2018, respectively, and $0.1 million and $0.3 million for the quarter and nine months ended September 30, 2017, respectively.  Of the total provision for income taxes for the quarter and nine months ended September 30, 2018, approximately $0.2 million and $0.4 million, respectively, represents current income tax expense, and approximately $0.7 million and $2.0 million, respectively, represents a decrease to the Company’s net deferred tax assets which is primarily due to the utilization of a portion of the Company’s TRS’s federal and state net operating loss carry-forwards.  All of the approximate $0.1 million and $0.3 million of the Company’s total income tax expense for the quarter and nine months ended September 30, 2017 was classified as current income tax expense.

 

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

As of September 30, 2018, the Company has an expansion project with a third-party developer at its North Carolina Specialty Hospital in Durham, North Carolina, which is classified as held for sale.  The Company has a commitment to fund approximately $0.9 million of the remaining expansion project budget in addition to the approximate $1.3 million of accrued development costs related to this expansion project as of September 30, 2018.  

As a result of the Company’s completed seniors housing developments continuing to move towards or achieving stabilization, the Company monitors the lease-up of these properties to determine whether the established performance metrics have been met as of each reporting period.  The Company has six remaining promoted interest agreements with third-party developers pursuant to which certain operating targets have been established that, upon meeting such targets, result in the developer being entitled to additional payments based on enumerated percentages of the assumed net proceeds of a deemed sale, subject to achievement of an established internal rate of return on the Company’s investment in the development. As of September 30, 2018, one property had met its established performance metrics, and the Company estimated an accrual of approximately $2.7 million as a distribution to the holder of promoted interest in the accompanying consolidated balance sheet.  For the remaining five promoted interest agreements, the established performance metrics were not met nor probable of being met as of September 30, 2018.

The Company’s Advisor has approximately 1.3 million contingently issuable restricted stock shares for financial reporting purposes that were issued pursuant to the Advisor expense support agreement.  Refer to Note 9. “Related Party Arrangements” for information on distributions declared related to these restricted stock shares.

 

 

 

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Caution Concerning Forward-Looking Statements

Statements contained under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Quarterly Report on Form 10-Q for the quarter and nine months ended September 30, 2018 that are not statements of historical or current fact may constitute “forward-looking statements” within the meaning of the Federal Private Securities Litigation Reform Act of 1995.  The Company intends that such forward-looking statements be subject to the safe harbor created by Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  Forward-looking statements are statements that do not relate strictly to historical or current facts, but reflect management’s current understandings, intentions, beliefs, plans, expectations, assumptions and/or predictions regarding the future of the Company’s business and its performance, the economy, and other future conditions and forecasts of future events and circumstances.  Forward-looking statements are typically identified by words such as “believes,” “expects,” “anticipates,” “intends,” “estimates,” “plans,” “continues,” “pro forma,” “may,” “will,” “seeks,” “should,” and “could” and words and terms of similar substance in connection with discussions of future operating or financial performance, business strategy and portfolios, projected growth prospects, cash flows, costs and financing needs, legal proceedings, amount and timing of anticipated future distributions, estimated net asset value (“NAV”) per share of the Company’s common stock, and/or other matters.  The Company’s forward-looking statements are not guarantees of future performance.  While the Company’s management believes its forward-looking statements are reasonable, such statements are inherently susceptible to uncertainty and changes in circumstances.  As with any projection or forecast, forward-looking statements are necessarily dependent on assumptions, data and/or methods that may be incorrect or imprecise, and may not be realized.  The Company’s forward-looking statements are based on management’s current expectations and a variety of risks, uncertainties and other factors, many of which are beyond the Company’s ability to control or accurately predict.  Although the Company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, the Company’s actual results could differ materially from those set forth in the forward-looking statements due to a variety of risks, uncertainties and other factors.  

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

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

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

Introduction

The following discussion is based on the condensed consolidated financial statements as of September 30, 2018 (unaudited) and December 31, 2017.  Amounts as of December 31, 2017, included in the unaudited condensed consolidated balance sheets have been derived from the audited consolidated financial statements as of that date. This information should be read in conjunction with the accompanying unaudited condensed consolidated balance sheets and the notes thereto, as well as the audited consolidated financial statements, notes and management’s discussion and analysis included in our Annual Report on Form 10-K for the year ended December 31, 2017.

Overview

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

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

On September 30, 2015, we completed our Offerings pursuant to a registration statement on Form S-11 under the Securities Act of 1933 with the SEC.  In October 2015, we deregistered the unsold shares of our common stock under our previous registration statement on Form S-11, except for 20 million shares that we concurrently registered on Form S-3 under the Securities Exchange Act of 1933 with the SEC for the sale of additional shares of common stock through our Reinvestment Plan.  Effective as of July 11, 2018, the Company suspended the Reinvestment Plan and future distributions, if any, will be made in cash to stockholders who had previously participated in the Reinvestment Plan.

In April 2018, we extended the advisory agreement through June 2019.  In addition, in April 2018, we and the Property Manager agreed that the property management agreement would expire on its stated date of June 28, 2018.

In April 2018, our board of directors formed a Special Committee, consisting solely of independent directors to consider Possible Strategic Alternatives, which are further described in Note 1. “Organization.”  In connection with our consideration of the Possible Strategic Alternatives, as of September 30, 2018, our board of directors committed to a plan to sell our MOB/Healthcare Portfolio, and accordingly the MOB/Healthcare Portfolio has been classified as held for sale with the corresponding operations classified as discontinued operations.  There is no guarantee that we will enter into or consummate a transaction to sell the whole or any part of the MOB/Healthcare Portfolio.

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Our Advisor is responsible for managing our affairs on a day-to-day basis, managing and leasing our healthcare real estate investments, and for identifying, recommending and executing upon dispositions on our behalf pursuant to an advisory agreement.  Our Advisor and Property Manager are each wholly owned by affiliates of our Sponsor, which is an affiliate of CNL, a private investment management firm providing global real estate and alternative investments.  As a result, our Advisor and Property Manager each represent related parties and each have received or will receive compensation, fees and expense reimbursements for services related to managing of our business.

Portfolio Overview

We believe recent demographic trends and compelling supply and demand indicators present a strong case for an investment focus on healthcare real estate and real estate-related assets. We believe that the healthcare sector will continue to provide attractive opportunities as compared to other asset sectors over the long-term.  Our healthcare investment portfolio is geographically diversified with properties in 34 states. The map below shows our current property allocations across geographic regions as of September 30, 2018:

 

 

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As of September 30, 2018, our healthcare investment portfolio, including properties classified as held for sale, consisted of interests in 142 properties, including 72 seniors housing properties, 53 MOBs, 12 post-acute care facilities and five acute care hospitals. Of our properties held at September 30, 2018, five of our 72 seniors housing properties were owned through an unconsolidated joint venture and one was comprised of unimproved land.  One of our five acute care properties currently has an expansion project.  The following table summarizes our healthcare portfolio by asset class and investment structure as of September 30, 2018:

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FOOTNOTES:

Portfolio Evaluation

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

When evaluating the performance of our healthcare portfolio within the seniors housing and post-acute care asset classes, management reviews occupancy levels and monthly revenue per occupied unit which we define as total revenue divided by average number of occupied units or beds and is considered a performance metric within these asset classes.  Similarly, within the medical office and acute care asset classes, management reviews operating statistics of the underlying properties, including occupancy levels and rent per square foot.  Lastly, when evaluating the performance of our third-party operators or developers, management reviews monthly financial statements, property level operating performance versus budgeted expectations, conducts periodic operational review calls with operators and conducts periodic property inspections or site visits.   We do not consider this information to be a non-GAAP measure that can be reconciled to our GAAP financial statements because it includes the performance of properties that are leased to third-party tenants.  However, all of the aforementioned operating and statistical metrics assist us in determining the ability of our properties or operators to achieve market rental rates, to assess the overall performance of our diversified healthcare portfolio, and to review compliance with leases, debt, licensure, real estate taxes, and other collateral.

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Furthermore, in our evaluation of the properties, we consider the operating stage of the investments within the following stages: development, value-add or stabilizing and stabilized.  While we do not currently have any real estate under development, development properties are those in which we or our joint venture purchased land for the development of new operating properties.  We typically hold rights as the owner or managing member of the development properties while a third-party or our joint venture partner manages the development, construction and certain day-to-day operations of the property subject to our oversight.  Stabilizing properties are either developed properties that have been fully constructed and in lease-up phase (typically 18 months post-construction) or existing (“value-add”) properties in which we expect to make capital investments to upgrade or expand.  A property is considered stabilized upon the earlier of (i) when the property reaches 85% occupancy for a trailing three month period, or (ii) a two year period from acquisition or completion of development.  For those assets that are above an 85% occupancy level and subsequently drop below 85%, they are reclassified to stabilizing until the assets attain the trailing three month 85% occupancy metric.

Since inception, we invested approximately $298.8 million in 11 ground-up developments and four expansion projects.  During the nine months ended September 30, 2018, we funded additional amounts related to our completed developments, currently in the lease-up phase.  These types of investments are expected to generate limited cash flows from operations and may result in near term downward pressure on our results of operations and net asset valuation.  However, we believe that investing a portion of our capital into these types of properties has been beneficial because they are expected to provide a higher yield on cost and higher net asset valuations in the long-term as compared to stabilized acquisitions.  Additionally, these types of assets will result in our portfolio having a lower average age, which we believe will enhance our overall market value over the long-term.

Significant Tenants and Operators

Our real estate portfolio is operated by a mix of national or regional operators and the following represent the significant tenants and operators that lease or manage 5% or more of our rentable space as of September 30, 2018:

 

_________________

FOOTNOTE:

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

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

Tenant Lease Expirations

As of September 30, 2018, we owned 85 properties (of which 63 were classified as discontinued operations) that were leased to tenants on a triple-net, net or modified gross basis, and accounted for as operating leases.  During the nine months ended September 30, 2018, our rental income represented approximately 30.4% of our total revenues, including properties classified as held for sale.

Under the terms of our triple-net lease agreements, each tenant is responsible for payment of property taxes, general liability insurance, utilities, repairs and maintenance, including structural and roof expenses (“Triple-net Lease”). Each tenant is expected to pay real estate taxes directly to taxing authorities. However, if the tenant does not pay, we will be liable.

Under the terms of our net, modified gross or similar lease agreements for multi-tenant properties with third-party property managers, each tenant is responsible for the payment of their proportionate share of property taxes, general liability insurance, utilities, repairs and common area maintenance (“Modified Lease”). These amounts are billed monthly and recorded as tenant reimbursement income in the accompanying consolidated statements of operations.

Our asset management team collaborates with existing tenants to understand their current and anticipated space needs in advance of their lease term renewal date.  As of September 30, 2018, none of our rental income was scheduled to expire until 2022.  We work with and begin lease-related negotiations well in advance of the lease expirations or renewal period options in order for us to maintain a balanced lease rollover schedule and high occupancy levels, as well as to enhance the value of our properties through extended lease terms. Lease extensions are likely to create an obligation to pay lease commissions, lease incentives and/or tenant improvements and may also provide our tenants with some periods of reduced and/or “free rent.” Certain amendments or modifications to the terms of existing leases could require lender approval. We do not expect lease turnover to have a significant impact on our cash flows from operations in the near term.

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The following table lists, on an aggregate basis, scheduled expirations for the remainder of 2018, each of the next nine years and thereafter on our consolidated healthcare investment portfolio, excluding properties classified as discontinued operations, assuming that none of the tenants exercise any of their renewal options (in thousands, except for number of tenants and percentages) as of September 30, 2018:

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FOOTNOTES:

Liquidity and Capital Resources

General

Our primary source of capital includes proceeds from collateralized or uncollateralized financings from banks or other lenders, other assets and undistributed operating cash flows, and to a lesser extent, proceeds from the sale of properties.  If necessary, we may use financings or other sources of capital in the event of unforeseen significant capital expenditures.  As of September 30, 2018 we have approximately $27.6 million of undrawn availability remaining under our Revolving Credit Facility.  

We may also be negatively impacted by rising interest rates on any unhedged variable rate debt or the timing of when we seek to refinance existing debt.  As such, we have entered into interest rate protection in the form of interest rate caps and will continue to evaluate the need for additional interest rate protection in the form of interest rate swaps or caps on unhedged variable rate debt or variable rate debt with interest rate protection scheduled to mature.

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Sources of Liquidity and Capital Resources

Reinvestment Plan

For the nine months ended September 30, 2018 and 2017, we received proceeds from our Reinvestment Plan of approximately $22.0 million and $32.0 million, respectively.  In June 2018, in light of our decision to proceed with the exploration of strategic alternatives, we suspended our Reinvestment Plan.  As a consequence of the suspension of the Reinvestment Plan, stockholders who were participants in the Reinvestment Plan will receive cash distributions instead of additional shares of our common stock.

Borrowings

During the nine months ended September 30, 2018 and 2017, we borrowed proceeds of approximately $112.5 million and $206.5 million, respectively. We have borrowed money to fund real estate development and intend to continue borrowing money to fund other enhancements to our portfolio, as well as to cover periodic shortfalls between distributions paid and cash flows from operating activities.  Our principal demand for funds is expected to be for the payment of debt service on our outstanding indebtedness and the payment of distributions.  Generally, we expect to meet short-term working capital needs from our cash flows from operations. 

On an ongoing basis, we monitor our debt maturities, engage in dialogues with third-party lenders about various financing scenarios and analyze our overall portfolio borrowings in advance of scheduled maturity dates of the debt obligations to determine the optimal borrowing strategy.  As of December 31, 2017, we had approximately $254.3 million of debt obligations maturing in 2018 as well as approximately $531.3 million of additional debt obligations maturing in 2019.   During the quarter and nine months ended September 30, 2018, we completed refinancings, repayments and/or extensions totaling approximately $254.3 million of these previous debt obligations, of which approximately $42.7 million and approximately $211.6 million was previously scheduled to mature in 2018 and 2019, respectively. Refer to “Uses of Liquidity and Capital Resources – Debt Repayments” for additional information.

We have pledged our properties in connection with our borrowings and may continue to strategically leverage our real estate and use debt financing as a means of providing additional funds for the payment of distributions to stockholders, working capital and for other corporate purposes.  Our ability to increase our borrowings could be adversely affected by credit market conditions which result in lenders reducing or limiting funds available for loans, including loans collateralized by real estate.  We may also be negatively impacted by rising interest rates on our unhedged variable rate debt or the timing of when we seek to refinance existing debt.  In addition, we will continue to evaluate the need for additional interest rate protection in the form of interest rate swaps or caps on unhedged variable rate debt.

The aggregate amount of long-term financing is not expected to exceed 60% of our gross asset values (as defined in our credit facilities) on an annual basis. As of September 30, 2018 and December 31, 2017, we had an aggregate debt leverage ratio of approximately 54.3% and 53.5%, respectively, of our gross asset values, as defined.

Net Cash Provided by Operating Activities

We experienced positive cash flow from operating activities for the nine months ended September 30, 2018 and 2017 of approximately $52.5 million and $56.9 million, respectively.  The decrease in cash flows from operating activities for the nine months ended September 30, 2018 as compared to the same period in 2017 was primarily the result of the following:

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Expense Support Agreements

The expense support agreements, as amended, govern the fees and expenses charged by the Advisor and Property Manager to the Company.  Refer to our Annual Report on Form 10-K for further information.  Under the terms of the expense support agreements, for each quarter within a calendar expense support year, we will record a proportional estimate of the cumulative year-to-date period based on an estimate of expense support amounts for the calendar expense support year.  Moreover, in exchange for services rendered and in consideration of the expense support provided under the expense support agreements, we will issue, within 90 days following the determination date, a number of shares of restricted stock equal to the quotient of the expense support amounts provided by our Advisor for the preceding calendar year divided by our then-current NAV per share of common stock.  We did not recognize or estimate annual expense support for the nine months ended September 30, 2018 and 2017.  Since the property management agreement with our Property Manager expired on June 28, 2018, there will be no amounts due to the Property Manager subject to the provisions of the expense support agreements.

Proceeds from Sale of Real Estate

In May 2018, we completed the sale of Physicians Regional and received net sales proceeds of approximately $5.8 million, which were used to pay down the related mortgage loan.

Tenant Workout

In January 2016, we executed a lease with a new tenant at our specialty hospital in Hurst, TX that included similar economic terms as the previous lease.  This new lease increased our operating cash flows in 2016 given the loss in revenues as a result of the tenant default on the previous lease in 2015.  However, during 2017, the new tenant began to experience financial difficulties, and as a result, we entered into a forbearance agreement with this tenant in July 2017 that resulted in the majority of the remaining 2017 rent payments, which totaled approximately $0.9 million, being deferred until December 2018.  In June 2018, we amended the forbearance agreement, which resulted in the majority of rent payments through September 2018 being deferred until July 2019. For the nine months ended  September 30, 2018 and 2017, we deferred approximately $0.9 million and $0.5 million, respectively, of rent payments due under the lease in accordance with the original and amended forbearance agreements.  In total, as of September 30, 2018, we had deferred a total of approximately $1.7 million in rent payments due under the lease. We received the tenant’s full base rent payment for October 2018 pursuant to the amended forbearance agreement and will continue to monitor its performance for the remainder of 2018 and into 2019 through the term of the amended forbearance agreement.  

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Uses of Liquidity and Capital Resources

Lease Incentives

During the nine months ended September 30, 2018 and 2017, we paid approximately $4.0 million and $6.9 million, respectively, of costs on behalf of our tenants as lease incentives in connection with the build-out of space for certain tenants entering into new leases or extending existing leases at our MOBs.  Lease incentives are capitalized as deferred rent and amortized as straight-line rent over the respective lease terms.  While we expect the impact of these lease incentives to adversely impact our cash flows from operations in the near term, we anticipate that the new leasing activity will contribute to same-store NOI growth in future periods and that the extension of existing lease terms could increase the value of our properties.

Development Properties

As of December 31, 2017, we had substantially completed development on all of our properties.  In connection with our completed seniors housing, acute and post-acute care developments, we paid approximately $2.2 million and $46.3 million in development costs during the nine months ended September 30, 2018 and 2017, respectively.  We expect to fund approximately $3.0 million of development costs, of which $2.2 million is related to the expansion at North Carolina Specialty Hospital and approximately $0.8 million in remaining accrued development costs related to developer holdback fees on our completed developments.

As a result of our completed seniors housing developments continuing to lease-up towards and/or achieving stabilization, we continue to monitor these properties to determine whether the established performance metrics of their respective promoted interest agreements have been met.  During the nine months ended September 30, 2018, we paid an approximate $1.0 million distribution to the holder of a promoted interest related to the HarborChase of Villages Crossing development for which the performance metrics were met and the distribution accrued as of December 31, 2017. During the nine months ended September 30, 2018, we accrued $2.7 million as a distribution to the holder of promoted interest related to Dogwood Forest of Grayson as the property had met its established performance metrics as of September 30, 2018. During the nine months ended September 30, 2017, we paid an approximate $2.0 million distribution to the holder of a promoted interest related to the Dogwood Forest of Acworth development, which was accrued in the year ended December 31, 2016. For the remaining five promoted interest agreements, the established performance metrics were not met nor probable of being met as of September 30, 2018.

We expect to pay additional amounts in future periods to the respective third-party developers as holders of a promoted interest in these properties to the extent the established performance metrics are met.  However, no other performance metrics were met or probable of being met during the quarter and nine months ended September 30, 2018.  

Debt Repayments

During the nine months ended September 30, 2018, we paid approximately $88.7 million of total repayments which was comprised of approximately $25.0 million in repayments on our Revolving Credit Facility, approximately $24.3 million in repayments on certain mortgage loans prior to their scheduled maturities, approximately $24.9 million in repayments on a mortgage loan that matured in August 2018, as well as approximately $14.5 million in scheduled repayments on our mortgages and other notes payable. During the nine months ended September 30, 2017, we paid approximately $131.0 million of total repayments which was comprised of approximately $64.9 million in repayments on our Revolving Credit Facility, approximately $49.6 million in repayments on our mortgage loans for Knoxville Medical Office Properties and the Claremont Medical Office property prior to their scheduled maturities and approximately $16.5 million of scheduled repayments on our mortgages and other notes payable.

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As of December 31, 2017, we had approximately $254.3 million of debt obligations, including liabilities associated with assets held for sale, maturing in 2018 as well as approximately $531.3 million of additional debt obligations maturing in 2019.   During the quarter and nine months ended September 30, 2018, we completed refinancings, repayments and/or extensions totaling approximately $254.3 million of these previous debt obligations which were primarily comprised of the following transactions:

 

 

 

 

 

 

Additionally, in October 2018, we exercised our 12-month extension option related the Northwest Medical Park’s then-current mortgage loan of approximately $6.6 million.  The loan was scheduled to mature in 2018 and will now mature in 2019.  We will continue to make the monthly principal and interest payments as outlined in the loan agreement.

 

As of September 30, 2018, we have approximately $240.1 million of debt obligations, including liabilities associated with assets held for sale, coming due during the remainder of 2018, of which approximately $229.0 million relates to the Revolving Credit Facility for which we hold a 12-month extension option and approximately $6.7 million relates to our Northwest Medical Park mortgage loan that was extended in October 2018.  While the combination of the undrawn availability under our Revolving Credit Facility of approximately $27.6 million as of September 30, 2018 and our forecasted cash flows from operations for the remainder of 2018 are expected to be in excess of the remaining debt obligations coming due in 2018, we continue to look beyond into 2019 and explore various financing scenarios including, but not limited to, the following: (1) exercising 12-month extension options on both our Revolving Credit Facility coming due in December 2018 and our First Term Loan Facility coming due in February 2019, (2) using proceeds from the sale of real estate in order to repay certain debt obligations coming due, and/or (3) obtaining proceeds from other sources; such as from cash flows provided by financing activities, a component of which could include borrowings, whether collateralized by our assets or unsecured (“Other Sources”).  

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Distributions

In order to qualify as a REIT, we are required to make distributions, other than capital gain distributions, to our stockholders each year in the amount of at least 90% of our taxable income. We may make distributions in the form of cash or other property, including distributions of our own securities.  While we generally expect to pay distributions from cash flows provided by operating activities, we have and may continue to cover periodic shortfalls between distributions paid and cash flows from operating activities from Other Sources.  In June 2018, we suspended our Reinvestment Plan, effective July 11, 2018.  As a result of our suspension of our Reinvestment Plan, stockholders who were participants in our Reinvestment plan began to receive cash distributions instead of additional shares of our common stock beginning with the third quarter of 2018.

The following table represents total cash distributions declared, distributions reinvested and cash distributions per share for quarter and nine months ended September 30, 2018 and 2017 (in thousands, except per share data):    

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FOOTNOTES:

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Common Stock Redemptions

Our Redemption Plan, through its suspension in June 2018, was designed to provide eligible stockholders with limited interim liquidity by enabling them to sell shares back to us prior to any liquidity event.  Proceeds from our Reinvestment Plan were the primary source of available funds for redemption requests under the Redemption Plan on a quarterly basis with additional sources for excess redemption requests determined by our board of directors in accordance with the Redemption Plan.

During the nine months ended September 30, 2018, we received requests for the redemption of common stock of approximately $44.7 million, which exceeded proceeds received from our Reinvestment Plan by approximately $22.7 million.  Of the excess $22.7 million in redemption requests, approximately $6.3 million of the excess redemption requests related to the quarter ended March 31, 2018 were approved by our board of directors prior to the Redemption Plan’s suspension, while the approximate $16.4 million of remaining excess redemptions requests were placed in a redemption requests queue pursuant to our Redemption Plan.  Refer to Part II. “Other Information” – Item 2. “Unregistered Sales of Equity Securities and Use of Proceeds” for additional information of these redemption requests and additional information as to the priority, if any, of future redemptions.

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

Results of Operations

The following discussion and analysis should be read in conjunction with the accompanying unaudited condensed  consolidated financial statements and the notes thereto.

Quarter and nine months ended September 30, 2018 as compared to the quarter and nine months ended September 30, 2017

As of September 30, 2018, excluding properties classified as discontinued operations, unconsolidated investments and unimproved land, we owned 73 consolidated operating real estate investment properties and our portfolio consisted of units operated under management agreements with third-party operators and approximately 2.0 million rentable square feet that was 100.0% leased to third-party tenants.

 

Rental Income and Tenant Reimbursements. Rental income and tenant reimbursements was approximately $8.7 million and $26.2 million, respectively, for the quarter and nine months ended September 30, 2018 as compared to approximately $8.7 million and $27.1 million, respectively, for the quarter and nine months ended September 30, 2017.   The decrease in rental income and tenant reimbursements across periods primarily resulted from the transition of the Parc Communities in July 2017 from being leased to a third-party operator under a triple-net lease arrangement to being managed pursuant to a third-party management contract under a RIDEA structure (“Parc Communities Leased to Managed Transition”).  This decrease was partially offset by: (1) the completion of Welbrook Transitional Care Grand Junction development and the commencement of the related lease in March 2017; and (2) the completion of Wellmore of Lexington development and the commencement of the related lease in July 2017.

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Resident Fees and Services. Resident fees and services income was approximately $69.8 million and $205.8 million, respectively, for the quarter and nine months ended September 30, 2018 as compared to approximately $64.5 million and $182.6 million, respectively, for the quarter and nine months ended September 30, 2017.

The increase in resident fees and services is primarily a result of: (1) the Parc Communities Leased to Managed Transition; (2) year-over-year growth in occupancy rates within our seniors housing properties; (3) the continued lease-up of additional seniors housing units at two development properties and two expansion projects that were completed in 2017.

Property Operating Expenses. Property operating expenses were approximately $45.5 million and $134.0 million, respectively, for the quarter and nine months ended September 30, 2018 as compared to approximately $41.9 million and $120.4 million, respectively, for the quarter and nine months ended September 30, 2017. The increase in property operating expenses is primarily a result of: (1) the Parc Communities Leased to Managed Transition; (2) year-over-year growth in occupancy rates within our seniors housing properties; (3) the continued lease-up of additional seniors housing units at two development properties and two expansion projects that were completed in 2017.

Asset Management Fees. We incurred asset management fees payable to our Advisor of approximately $4.6 million and $13.7 million, respectively, for the quarter and nine months ended September 30, 2018, as compared to approximately $4.6 million and $13.2 million, respectively, for the quarter and nine months ended September 30, 2017. For the quarter and nine months ended September 30, 2018, no asset management fees were capitalized as real estate under development. For the quarter and nine months ended September 30, 2017, approximately $0.1 million and $0.5 million, respectively, of asset management fees were capitalized as real estate under development.  As described in Note 9. “Related Party Arrangements,” there was no expense support estimated during the quarter and nine months ended September 30, 2018 and 2017. Monthly asset management fees equal to 0.08334% of invested assets are paid to the Advisor for management of our real estate assets, including our pro rata share of our investments in unconsolidated entities, loans and other permitted investments.

Property Management Fees.  We incurred property management fees payable to our Property Manager and third party operators of approximately $2.8 million and $10.9 million for the quarter and nine months ended September 30, 2018, respectively, as compared to approximately $3.8 million and $10.9 million, respectively, for the quarter and nine months ended September 30, 2017.  Of these amounts, approximately $0.0 million and $1.7 million, respectively, for the quarter and nine months ended September 30, 2018 as compared to approximately $0.8 million and $2.4 million, respectively, for the quarter and nine months ended September 30, 2017 were payable to our Property Manager.   As discussed in Item 2. “Management’s Discussion and Analysis – Overview”, the property management agreement expired on its stated termination date of June 28, 2018 and was not extended.  As a result, we expect lower property management fees in future periods as we ceased incurring property management fees to our Property Manager at the end of the second quarter of 2018.

Depreciation and Amortization. Depreciation and amortization expenses were approximately $12.9 million and $41.5 million, respectively, for the quarter and nine months ended September 30, 2018, as compared to approximately $16.0 million and $48.3 million, respectively, for the quarter and nine months ended September 30, 2017.   Depreciation and amortization expenses are comprised of depreciation and amortization of the buildings, equipment, land improvements and in-place leases related to our real estate portfolio.  The decrease in depreciation and amortization expense across periods resulted from several intangible assets related to our seniors housing investments being fully amortized and certain assets being classified as held for sale, offset by an increase in depreciation related to the completion of our developments and expansions in 2017.

Interest Expense and Loan Cost Amortization. Interest expense and loan cost amortization were approximately $10.2 million and $31.1 million, respectively, for the quarter and nine months ended September 30, 2018, as compared to approximately $9.4 million and $25.9 million, respectively, for the quarter and nine months ended September 30, 2017. For both the quarter and nine months ended September 30, 2018, approximately $0.02 million of interest expense and loan cost amortization was capitalized as development costs relating to our real estate under development, as compared to approximately $0.1 million and $2.0 million, respectively, for the quarter and nine months ended September 30, 2017.  The increase in interest expense and loan cost amortization was primarily the result of an increase in our average debt outstanding to approximately $0.9 billion for the quarter and nine months ended September 30, 2018, as compared with approximately $0.9 billion for both the quarter and nine months ended

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September 30, 2017 and the increase in the London interbank offered rate (“LIBOR”) for the quarter and nine months ended September 30, 2018 as compared to the quarter and nine months ended September 30, 2017.  In addition, during the nine months ended September 30, 2018, we incurred a loss on the extinguishment of debt of approximately $0.1 million related to the refinancing of our mortgage loans.  

Equity in Earnings of Unconsolidated Entity. Our unconsolidated entity relating to our investment in the Windsor Manor joint venture generated earnings of approximately $0.3 million and $0.4 million, respectively, for quarter and nine months ended September 30, 2018, as compared to the earnings of approximately $0.1 million and $0.2 million, respectively, for the quarter and nine months ended September 30, 2017.  Equity in earnings of unconsolidated entities is determined using the hypothetical liquidation at book value (“HLBV”) method of accounting, which can create significant variability in earnings or loss from the joint venture while the preferred cash distributions that we anticipate to receive from the joint venture may be more consistent as result of our distribution preferences.

Net Loss Attributable to Noncontrolling Interests.  During the quarter and nine months ended September 30, 2018, net loss attributable to our co-venture partners was approximately $0.02 million and $0.1 million, respectively, as compared to approximately $0.1 million and $0.3 million, respectively, for the quarter and nine months ended September 30, 2017.  In accordance with the provisions of each joint venture agreement, we allocate loss from operations to our co-venture partners based on their percentage ownership in each joint venture. These losses are primarily related to our Fieldstone at Pear Orchard and our Watercrest at Katy joint ventures, which both completed construction in 2016 and are in the lease-up phase.

Loss from Discontinued Operations.  As discussed above in “Overview,” we classified the revenues and expenses related to our MOB/Healthcare Portfolio as discontinued operations as our board of directors committed to a plan to sell 53 medical office buildings, five post-acute care facilities and five acute care hospitals, and we believe the sale of these properties would cause a strategic shift in our operations.  Loss from discontinued operations was approximately $2.6 million and $9.5 million for the quarter and nine months ended September 30, 2018, respectively, as compared to approximately $2.7 million and $5.8 million for the quarter and nine months ended September 30, 2017, respectively.  The increase in loss from discontinued operations across periods is primarily due to an increase in interest expense paid resulting from higher average debt outstanding and higher interest rates for the nine months ended September 30, 2018, as compared to the nine months ended September 30, 2017, as well as financing coordination fees related to refinancings that were determined to be loan modifications for accounting purposes.  Refer to Note 6. “Assets and Associated Liabilities Held For Sale and Discontinued Operations” for additional information.  Additionally, we expect lower depreciation and amortization in future periods as we ceased depreciation and amortization as of September 30, 2018 on the MOB/Healthcare Portfolio as a result of the properties being classified as held for sale.

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Net Operating Income

We generally expect to meet future cash needs for general and administrative expenses, debt service and distributions from NOI.  We define NOI, a non-GAAP measure, as total revenues less the property operating expenses and property management fees from managed properties.  We use NOI as a key performance metric for internal monitoring and planning purposes, including the preparation of annual operating budgets and monthly operating reviews, as well as to facilitate analysis of future investment and business decisions.  It does not represent cash flows from operating activities in accordance with GAAP and should not be considered to be an alternative to net income or loss (determined in accordance with GAAP) as an indication of our operating performance or to be an alternative to cash flows from operating activities (determined in accordance with GAAP) as a measure of our liquidity.  We believe the presentation of this non-GAAP measure is important to the understanding of our operating results for the periods presented because it is an indicator of the return on property investment and provides a method of comparing property performance over time.  In addition, we have aggregated NOI on a “same-store” basis only for comparable properties that we have owned during the entirety of all periods presented.  Non-same-store NOI represents aggregated NOI from acquisitions made or developments completed after January 1, 2017, which are excluded as we did not own those properties during the entirety of all periods presented.  The chart below illustrates our net losses, and NOI for the quarter and nine months ended September 30, 2018 and 2017 (in thousands) and the amount invested in properties as of September 30, 2018 and 2017 (in millions), excluding properties classified as discontinued operations:

Overall, our NOI for the nine months ended September 30, 2018 increased by approximately $8.7 million as compared to the same period in the prior year.  Our non-same-store NOI of approximately $4.5 million for the nine months ended September 30, 2018 primarily related to the completion of four development properties and two expansion projects after January 1, 2017.  Our same-store NOI for the nine months ended September 30, 2018 increased by approximately $4.8 million, or 6.2%, as compared to the same period in the prior year.  The increase in same-store NOI is primarily attributable to the continued lease-up of additional seniors housing units at two development properties and one expansion project that were completed in 2016 as well as year-over-year revenue and occupancy growth within our seniors housing properties— specifically, our Pacific Northwest Communities.

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Funds from Operations and Modified Funds from Operations

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

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

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

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

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

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

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

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

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

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The following table presents a reconciliation of net loss to FFO and MFFO for the quarter and nine months ended September 30, 2018 and 2017 (in thousands, except per share data):

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________________

FOOTNOTES:

 

Contractual Obligations

The following table presents our contractual obligations by payment periods as of September 30, 2018, including liabilities associated with assets held for sale (in thousands):

________________

FOOTNOTES:

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Off-Balance Sheet Arrangements

As of September 30, 2018, our off-balance sheet and other arrangements were not materially different from the amounts reported for the year ended December 31, 2017.  Refer to our Annual Report for a summary of our off-balance sheet and other arrangements.

Related-Party Transactions

See Item 1. “Financial Statements” and our Annual Report on Form 10-K for the year ended December 31, 2017 for a summary of our related party transactions.

Critical Accounting Policies and Estimates

See Item 1. “Financial Statements” and our Annual Report on Form 10-K for the year ended December 31, 2017 for a summary of our critical accounting policies and estimates.

Recent Accounting Pronouncements

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

 

 

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

The following is a schedule as of September 30, 2018, of our fixed and variable rate debt maturities for the remainder of 2018, and each of the next four years and thereafter (principal maturities only), including liabilities associated with assets held for sale (in thousands):

 

____________

FOOTNOTE:

Assuming no interest rate protection, management estimates that a one-percentage point increase or decrease in LIBOR in 2018, compared to LIBOR rates as of September 30, 2018, would result in fluctuation of interest expense on our variable rate debt of approximately $12.9 million for the year ending December 31, 2018.  This sensitivity analysis contains certain simplifying assumptions, and although it gives an indication of our exposure to changes in interest rates, it is not intended to predict future results and actual results will likely vary given that our sensitivity analysis on the effects of changes in LIBOR does not factor in a potential change in variable rate debt levels, any offsetting gains on interest rate swap contracts, or the impact of any LIBOR floors or caps.

As of September 30, 2018, the Company’s debt is comprised of approximately 23.7% in fixed rate debt, approximately 60.0% in variable rate debt with current interest rate protection and approximately 16.3% of unhedged variable rate debt.  The remaining unhedged variable rate debt primarily relates to our construction loans and the Revolving Credit Facility.  Overall, we believe longer term fixed rate debt could be beneficial in a rising interest rate or rising inflation rate environment and as such we continue to evaluate the need for additional interest rate protection on unhedged variable rate debt or variable rate debt with interest rate protection scheduled to mature.

 

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Evaluation of Disclosure Controls and Procedures

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

Changes in Internal Control over Financial Reporting

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

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

There have been no material changes in our assessment of our risk factors from those set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017.

Unregistered Sales of Equity Securities

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

Issuer Purchases of Equity Securities

During the nine months ended September 30, 2018, we processed requests in the following order:

With respect to a stockholder whose shares are not redeemed due to insufficient funds in that quarter, the redemption request will be retained by us unless it is withdrawn by the stockholder, and such shares will be redeemed in subsequent quarters to the extent our board of directors reinstates the Redemption Plan and funds become available and before any subsequently received redemption requests are honored, subject to the priority for redemption

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requests listed above.  Until such time as we redeem the shares, a stockholder may withdraw its redemption request as to any remaining shares not redeemed.  Redeemed shares are considered retired and will not be reissued.

In June 2018, we suspended our Redemption Plan effective as of July 11, 2018.  We processed all redemption requests received in good order up until the close of business on July 11, 2018, which totaled approximately $16.4 million, or 1.6 million shares.  These unsatisfied redemption requests have been placed in the redemption queue and will remain there until such time, if at all, that our board of directors reinstates the Redemption Plan.  Unless the Redemption Plan is reinstated by our board of directors, the Company will not as a general matter accept or otherwise process any additional redemption requests received after July 11, 2018.  There can be no guarantee that the Redemption Plan will be reinstated by our board of directors.  

The following tables present a summary of requests received, shares redeemed and shares placed in the redemption queue, pursuant to our Redemption Plan during the nine months ended September 30, 2018 and 2017 (in thousands, except per share data):

 

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The following exhibits are included, or incorporated by reference in this Quarterly Report on Form 10-Q for the quarter and nine months ended September 30, 2018 (and are numbered in accordance with Item 601 of Regulation S-K).

 

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, on the 14th day of November 2018.

 

 

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