ITEM 1. BUSINESS
Our Company
Sentio Healthcare Properties, Inc., a Maryland corporation (the “Company”), was formed on October 16, 2006 under the General Corporation Law of Maryland for the purpose of engaging in the business of investing in and owning commercial real estate. As used in this report, the “Company”, “we”, “us” and “our” refer to Sentio Healthcare Properties, Inc. and its consolidated subsidiaries, except where context otherwise requires. We have qualified, and intend to continue to qualify, as a real estate investment trust (“REIT”) for federal tax purposes.
Since January 1, 2012, our business has been managed by Sentio Investments, LLC (the “Advisor”) pursuant to an advisory agreement (the “Advisory Agreement”). The Advisor is responsible for managing our affairs on a day-to-day basis and for identifying and making acquisitions and investments on our behalf under the terms of the Advisory Agreement. Our Advisor has contractual and fiduciary responsibilities to us and our stockholders. Under the terms of the Advisory Agreement, our Advisor will use commercially reasonable efforts to present to us investment opportunities and to provide a continuing and suitable investment program consistent with the investment policies and objectives adopted by our board of directors. Currently, we have no direct employees and all management and administrative personnel responsible for conducting our business are employed by our Advisor.
We are structured as an umbrella partnership REIT, referred to as an “UPREIT,” under which substantially all of our business is, and will be, conducted through a majority owned subsidiary, Sentio Healthcare Properties OP, L.P, a Delaware limited partnership (the “Operating Partnership”), formed on October 17, 2006. We are the sole general partner of the Operating Partnership and have control over its affairs. The Operating Partnership owns, either directly or indirectly through subsidiaries, all of our assets. We conduct substantially all of our operations through the Operating Partnership. Our financial statements and the financial statements of the Operating Partnership are consolidated in the accompanying condensed consolidated financial statements. All intercompany accounts and transactions have been eliminated in consolidation.
On February 10, 2013, we entered into a series of agreements, which have been amended at various points after February 10, 2013, with Sentinel RE Investment Holdings LP (the “Investor”), an affiliate of Kohlberg Kravis Roberts & Co. L.P. (together with its affiliates, “KKR”) for the purpose of obtaining up to a $158.7 million of equity funding to be used to finance future investment opportunities (such investment and the related agreements, as amended, are referred to herein collectively as the “KKR Equity Commitment”). Pursuant to the KKR Equity Commitment, we may issue and sell to the Investor and its affiliates on a private placement basis from time to time over a period of up to three years, up to $158.7 million in aggregate issuance amount of preferred securities in the Company and the Operating Partnership.
As of December 31, 2014, we had issued and outstanding 11,472,765 shares of common stock, and 1,000 shares of 3% Senior Cumulative Preferred Stock, Series C (the “Series C Preferred Stock”). All 1,000 shares of the Series C Preferred Stock were issued to the Investor pursuant to the KKR Equity Commitment. In addition, as of December 31, 2014 the Operating Partnership had issued and outstanding 20,000 Common Units, 1,000 Series A Preferred Units (the “Series A Preferred Units”), and 946,560 Series B Convertible Preferred Units (the “Series B Preferred Units”). As of December 31, 2014, we held all of the issued and outstanding Common Units, and all of the issued and outstanding Series A Preferred Units. All of the issued and outstanding Series B Preferred Units were issued to the Investor in connection with the KKR Equity Commitment.
In connection with the KKR Equity Commitment, we entered into an agreement with our Advisor and the Investor (the “Transition Agreement”) that sets forth the terms for a transition to an internal management structure for the Company. The Transition Agreement, as amended, requires that, the existing external advisory structure will remain in place upon substantially the same terms as currently in effect through February 10, 2017, upon which time the advisory function will be internalized in accordance with procedures set forth in the Transition Agreement.
We commenced our initial public offering of our common stock on June 20, 2008. We stopped making offers under our initial public offering on February 3, 2011 after raising gross offering proceeds of $123.9 million from the sale of approximately 12.4 million shares, including shares sold under the distribution reinvestment plan. On February 4, 2011, we commenced a follow-on offering of our common stock. We suspended primary offering sales in our follow-on offering on April 29, 2011 and completed the final sale of shares under the distribution reinvestment plan on May 10, 2011. We raised gross offering proceeds under the follow-on offering of $8.4 million from the sale of approximately 800,000 shares, including shares sold under the distribution reinvestment plan.
On June 19, 2013, we filed a registration statement on Form S-3 to register up to $99,000,000 of shares of common stock to be offered to our existing stockholders pursuant to an amended and restated distribution reinvestment plan (the “DRIP offering”). The DRIP offering shares were initially offered at a purchase price of $10.02, which was the current estimated per-share value of our common stock. Effective February 28, 2014, DRIP offering shares were offered at a purchase price of $11.63 per share, which is our most recent estimated per-share value.
Investment Objectives
Our investment objectives are to:
•preserve stockholder capital by acquiring and operating real estate and real estate-related investments;
•realize growth in the value of your investment by:
•purchasing stabilized, income-producing properties with the potential for capital appreciation and
•profiting from the purchase, development or repositioning of other properties;
•provide stockholders with current income from the operations of the properties we acquire (including the income from properties we develop or reposition once they are stabilized) and from the interest income from loans we originate; and
•evaluate options to provide long-term liquidity to our stockholders within seven years of the termination of our primary public offering after accomplishing the above objectives by:
•liquidating our assets,
•listing our shares on a national securities exchange,
•another liquidity event such as a merger with another company, or
•expanding our stock repurchase program to redeem upon stockholder request up to 10% of our prior-year outstanding shares utilizing proceeds from the sale of our properties or other sources of funds irrespective of the amount of proceeds raised under our distribution reinvestment plan.
We intend to invest primarily in existing leased properties as well as other properties where we believe there are opportunities to enhance cash flow and value. We may also originate development loans with unaffiliated third parties in which we have the potential to participate in the value creation or obtain an increasing interest in the property. We cannot assure you that we will attain these objectives or that our capital will not decrease. We may not change our investment policies or investment restrictions except upon approval of the independent directors committee. Decisions relating to the purchase or sale of properties or the origination of loans will be made by our Advisor, subject to approval by our board of directors.
We currently own nine properties through joint ventures and we may acquire additional properties through joint venture investments in the future. This is one of the ways we anticipate diversifying the portfolio of properties we own in terms of geographic region, property type and tenant industry group. Joint ventures will also allow us to acquire an interest in a property without requiring that we fund the entire purchase price. In determining whether to recommend a particular joint venture investment, our Advisor will evaluate the structure of the joint venture and the real property that the joint venture owns (or will acquire) using the same criteria for the selection of our other real estate investments.
Investment Strategy
Our independent directors committee will review our investment policies at least annually to determine whether these policies continue to be in the best interest of our stockholders, except as specifically provided otherwise under the terms of preferred stock that we issue, we may change our investment policies without stockholder approval. Our Advisor will recommend property acquisitions or loan originations to our investment committee, which will approve or reject proposed investments.
Our objective is to acquire a long-term stabilized portfolio of real estate properties that consists of at least 50% core properties. We may also acquire value-added and opportunistic properties and real estate related investments. We may acquire more value-added and opportunistic properties than core properties, with a view to achieving a more balanced portfolio of properties through a combination of development efforts, refinancings and subsequent acquisitions.
We intend for our investments in real estate assets to be concentrated in the healthcare sector. To date, our investments have been exclusively in the healthcare sector.
Healthcare real estate includes a variety of property types, including senior housing facilities, medical office buildings, hospital facilities, skilled nursing facilities, outpatient centers, and other healthcare related facilities. According to The National Coalition on Healthcare, by 2016 nearly $1 in every $5 in the U.S. will be spent on healthcare, and the aging US population is expected to continue to fuel the need for healthcare services. The over age 65 population of the United States is projected to grow 36% between 2010 and 2020, compared with 9% for the general population, according to the US Census Bureau. Presently, the healthcare real estate market is fragmented, with a local or regional focus, offering opportunities for consolidation and market dominance. We believe that a diversified portfolio of healthcare properties minimizes risks associated with third-party payors, such as Medicare and Medicaid, while also allowing us to capitalize on the favorable demographic trends described above.
Our Advisor believes that investment opportunities in healthcare properties are ordinarily not readily available to investors other than large institutional investors and experienced real estate operators with specialized knowledge, experience in specific geographic areas, industry expertise and established relationships with operators of these property types.
Although we intend to focus on acquiring and developing a portfolio of healthcare properties and real estate-related assets, we may also invest in other real estate types that we believe may assist us in meeting our investment objectives. Our charter limits our investments in unimproved real property or mortgage loans on unimproved real property to 10% of our total assets, but we are not otherwise restricted in the proportion of our portfolio that we must allocate to investment in any specific type of property. We do not expect to engage in the underwriting of securities of other issuers.
Acquisition Policies
Core Properties
We expect to invest in “core” institutional grade properties that are:
•owned and operated with a low to moderate level of permanent mortgage financing;
•of a high-quality and currently producing income;
•leased to a diversified tenant base, though we are not restricted from investing in properties occupied by a single tenant if the property meets other key investment criteria or to a single tenant/operator for certain healthcare properties;
•leased on terms that generally allow for annual rental increases, and
•operated by companies that specialize in the specific healthcare service being delivered at a specific community,
Value-Added Properties
We may acquire “value-added” properties, which include properties that are currently under construction and/or have existing building structures in need of redevelopment, re-leasing or repositioning. We may acquire properties with low occupancy rates or vacant properties when we believe our leasing or development efforts could add significant value. Our value-added properties will employ moderate to high levels of indebtedness, which will be determined on a property-by-property basis. Our long-term investment objective for investment in value-added properties is to develop and transform these properties into the same type of core property investments with lower levels of permanent mortgage indebtedness as described above.
Opportunistic Properties
We also may acquire opportunistic properties. We define “opportunistic” properties primarily as unimproved land that we will develop. We will construct or develop the property through the use of third-parties or through developers affiliated with our Advisor. We will invest in opportunistic properties with a view of developing a core property. Similar to our value-added properties, we expect to incur a moderate to high level of indebtedness when acquiring opportunistic properties, but with the long-term goal of developing the property into a core property with a lower level of permanent mortgage indebtedness. The development of properties is subject to risks relating to a builder’s ability to control construction costs or to build in conformity with plans, specifications and timetables. We may help ensure performance by the builders of properties that are under construction at the price contracted by obtaining either a performance bond or completion bond. As an alternative to a performance bond or completion bond, we may rely upon the substantial net worth of the contractor or developer or a personal guarantee provided by a high net worth affiliate of the person entering into the construction or development contract. Our opportunistic property acquisitions will generally be located in growth areas within our target markets.
Target Market Criteria
We intend to acquire healthcare properties located in markets with strong fundamentals and strong supply and demand dynamics primarily throughout the United States. Among the most important criteria we expect to use in evaluating the markets in which we purchase properties are:
•historic and projected population growth;
•historically high levels of tenant demand for healthcare services and lower historic investment volatility for the type of property being acquired;
•markets with historic and growing numbers of qualified and affordable workforce;
•historic market liquidity for buying and selling of commercial real estate;
•stable household income and economic conditions; and
•sound real estate fundamentals, such as high occupancy rates and potential for increasing rental rates.
Leases and Tenant Improvements
For our investments in multi-tenant medical office buildings we expect a portion of any tenant improvements to be funded by us from the cash on hand or through borrowings. Additionally, when a tenant or resident at one of our properties vacates its space, it is likely that we will be required to expend funds for tenant improvements and refurbishments to the vacated space in order to attract new tenants. If we do not have adequate cash on hand to fund tenant improvements and refurbishments, we may use debt financing in order to fulfill our obligations under lease agreements with new tenants.
Mortgages, Debt Securities and Other Real Estate-Related Investments
Although we expect that substantially all of our acquisitions will be of the types of properties described above, we may acquire or originate other investments, including mortgages and other illiquid real estate-related securities. To the extent that our Advisor determines that it is advantageous for us to originate or acquire mortgage loans or other real estate-related investments, we will seek to obtain fixed income through the receipt of payments from these investments. If we invest in mortgages and other real estate-related investments, we do not expect that we would invest more than 20% of our long-term stabilized asset portfolio in such investments.
Our charter does not limit the amount that we invest in mortgage loans or other real estate-related investments and from time to time, the percentage of our assets invested in these investments may exceed 20% of our total assets. While we have no intention of becoming a mortgage REIT, we may acquire or make the following:
•first and second mortgages;
•convertible mortgages;
•construction loans on real estate;
•mortgage loan participation investments;
•common, preferred and convertible preferred equity securities issued by real estate companies;
•mezzanine and bridge loans; and
•other illiquid real estate-related securities.
Joint Ventures and Other Arrangements
We currently own nine properties through joint ventures and we may acquire additional properties through joint venture investments in the future, including ventures with affiliates of our Advisor. Among other reasons, we have acquired properties through joint ventures in order to diversify our portfolio of properties in terms of geographic region, property type and tenant industry group. Joint ventures also allow us to acquire an interest in a property without requiring that we fund the entire purchase price. In addition, certain properties may be available to us only through joint ventures. In determining whether to recommend a particular joint venture, our Advisor will evaluate the structure of the joint venture and the real property that such joint venture owns, or is being formed to own, under the same criteria described elsewhere in this Form 10-K. These entities may employ debt financing consistent with our borrowing policies. See “Borrowing Policies” below. They may also include ventures with developers who contribute land, development services and expertise rather than equity. We have not established the specific terms we will require in the joint venture agreements we may enter. We will establish the terms with respect to any particular joint venture agreement on a case-by-case basis.
We may enter into joint ventures with affiliates of our Advisor for the acquisition of properties, but only if the independent directors committee (by majority vote) approves the transaction as being fair and reasonable to us and on substantially the same terms and conditions as those received by the affiliated equity joint venturers. If such a joint venture also involves a third party that negotiated the terms of its participation on an arms-length basis, then our investment must be either on terms and conditions no worse than those received by the affiliate or on terms and conditions no worse than those received by a third-party equity joint venturer that negotiated the terms of its participation on an arms-length basis.
Borrowing Policies
Debt Financing
When we refer to debt financing, we are referring to all types of debt financing at fixed or variable interest rates or some combination of both. For our stabilized core properties, our long-term goal will be to use low to moderate levels of debt financing with leverage ranging from 50% to 65% of the value of the asset. For the value-added and opportunistic properties, our goal will be to acquire and develop or redevelop these properties using moderate to high levels of debt financing with leverage ranging from 65% to 75% of the cost of the asset. We may exceed these debt levels on an individual property basis. Once these value-added and opportunistic properties are developed, redeveloped and stabilized with tenants, we plan to reduce the levels of debt to fall within target debt ranges appropriate for core properties. While we seek to fall within the outlined targets on a portfolio basis, for any specific property we may exceed these estimates. While we do not expect to utilize debt financing in excess of 300% of our net assets (equivalent to 75% of the cost of our tangible assets), upon the vote of a majority of our independent directors, we will be able to temporarily exceed this debt limitation. It is likely that our debt financing will be secured by the underlying property, but it will not necessarily be the case each time. We may enter into interest rate protection agreements to mitigate interest rate fluctuation exposure if we believe the benefit of such contracts outweigh the costs of purchasing these instruments.
Other Indebtedness
We may also incur indebtedness for working capital requirements, tenant improvements, capital improvements, leasing commissions and, if necessary, to make distributions, including those necessary to maintain our qualification as a REIT for federal income tax purposes. We will endeavor to borrow such funds on an unsecured basis but we may secure indebtedness with properties if our independent directors committee determines that it is in our best interests.
Our Advisor may also create an affiliated entity that will purchase properties using debt financing and hold them for us pending our ability to acquire the properties at a low to moderate level of indebtedness. Any properties that we purchase from the affiliated acquisition holding company will meet our core investment criteria and be approved by our independent directors committee. Our purchase price for the property would reflect the costs associated with holding the property. In no event will we acquire the property at an amount in excess of its current appraised value as determined by an independent expert selected by our independent directors not otherwise interested in the transaction.
Competition
We compete with a considerable number of other real estate companies seeking to acquire, develop and reposition commercial real estate many of which may have greater marketing and financial resources than we do. Principal factors of competition in our business are the quality of properties (including the design and condition of improvements), leasing terms (including rent and other charges and allowances for tenant improvements), attractiveness and convenience of location, the quality and breadth of tenant services provided and reputation as an owner and operator of quality properties in the relevant sector and market. Our ability to compete also depends on, among other factors, trends in the national and local economies, financial condition and operating results of current and prospective tenants, availability and cost of capital, construction and renovation costs, taxes, governmental regulations, legislation and population trends.
We may hold interests in properties located in the same geographic locations as other entities managed by our Advisor or our Advisor’s affiliates. Our properties may face competition in these geographic regions from such other properties owned, operated or managed by other entities managed by our Advisor or our Advisor’s affiliates. Our Advisor or its affiliates may have interests that vary from those we may have in such geographic markets.
Government Regulation
We, the properties that we own, and the properties we expect to own are subject to federal, state and local laws and regulations relating to environmental protection and human health and safety. Federal laws such as the National Environmental Policy Act, the Comprehensive Environmental Response, Compensation, and Liability Act, the Resource Conservation and Recovery Act, the Federal Water Pollution Control Act, the Federal Clean Air Act, the Toxic Substances Control Act, the Emergency Planning and Community Right to Know Act and the Hazard Communication Act govern such matters as wastewater discharges, air emissions, the operation and removal of underground and above-ground storage tanks, the use, storage, treatment, transportation and disposal of solid and hazardous materials and the remediation of contamination associated with disposals. Some of these laws and regulations impose joint and several liabilities on tenants, owners or operators for the costs to investigate or remediate contaminated properties, regardless of fault or whether the acts causing the contamination were legal. Compliance with these laws and any new or more stringent laws or regulations may require us to incur material expenditures. Future laws, ordinances or regulations may impose material environmental liability. In addition, there are various federal, state and local fire, health, life-safety and similar regulations with which we may be required to comply, and which may subject us to liability in the form of fines or damages for noncompliance.
Our properties may be affected by our tenants’ operations, the existing condition of land when we buy it, operations in the vicinity of our properties, such as the presence of underground storage tanks, or activities of unrelated third parties. The presence of hazardous substances, or the failure to properly remediate these substances, may make it difficult or impossible to sell or rent such property.
The healthcare industry is highly regulated by federal, state and local licensing requirements, facility inspections, reimbursement policies, regulations concerning capital and other expenditures, certification requirements and other laws, regulations and rules. In addition, regulators require compliance with a variety of safety, health, staffing and other requirements relating to the design and conditions of the licensed facility and quality of care provided. Additional laws and regulations may be enacted or adopted that could require changes in the design of properties and certain operations of our tenants and third-party operators. The failure of any tenant or operator to comply with such laws, requirements and regulations could affect a tenant’s or operator’s ability to operate the facilities that we own.
One of our properties is a skilled nursing facility where the property operator receives most of its revenues from Medicare and Medicaid, with the balance representing private pay, including private insurance. Consequently, changes in federal, state or local reimbursement policies may also adversely affect an operator’s ability to cover its expenses, including our rent or debt service. Skilled nursing facilities and hospitals are subject to periodic pre- and post-payment reviews and other audits by federal and state authorities. A review or audit of claims of a property operator could result in recoupments, denials or delays of payments in the future, which could have a material adverse effect on the operator’s ability to meet its obligations to us.
Acquisition Activity
At December 31, 2014, we owned or had joint venture interests in 30 properties. All of these properties are included in the properties summary as provided under “Item 2 Properties” referenced below.
We have acquired our properties to date with a combination of the proceeds from our public offering proceeds and from the sale of preferred securities in us and our Operating Partnership pursuant to the KKR Equity Commitment, and the proceeds of debt incurred upon the acquisition of such properties.
As of December 31, 2014, we operated in three reportable business segments: senior living operations, triple-net leased properties, and medical office building. Financial Information by segment is presented in Note 10 to our accompanying consolidated financial statements.
Employees
We have no employees and our executive officers are employees of our Advisor. Substantially all of our work is performed by employees of our Advisor. We are dependent on our Advisor for certain services that are essential to us, including the identification, evaluation, negotiation, purchase and disposition of properties; the oversight and management of the daily operations of our real estate portfolio; and other general and administrative responsibilities. In the event that our Advisor was unable to provide these services, we will be required to obtain such services from other sources.
Available Information
Information about us is available on our website (http://www.sentiohealthcareproperties.com). We make available, free of charge, on our Internet website, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with the SEC. These materials are also available at no cost in print to any person who requests it by contacting our Investor Services Department at 189 South Orange Avenue, Suite 1700, Orlando, Florida 32801; telephone (407) 999-7679. Our filings with the SEC are available to the public over the Internet at the SEC’s website at http://www.sec.gov. You may read and copy any filed document at the SEC’s public reference room in Washington, D.C. at 100 F Street, N.E., Room 1580, Washington D.C. Please call the SEC at (800) SEC-0330 for further information about the public reference rooms.
ITEM 1A.
ITEM 1A. RISK FACTORS
The risks and uncertainties described below can adversely affect our business, operating results, prospects and financial condition. These risks and uncertainties could cause our actual results to differ materially from those presented in our forward looking statement.
General
Because no public trading market for our shares currently exists and all repurchases under our stock repurchase program have been suspended since March 2014, it will be difficult for our stockholders to sell their shares and, if they are able to sell their shares, it will likely be at a substantial discount to the estimated value per share. As such, our stockholders should purchase shares in our distribution reinvestment plan only if they will not need to realize the cash value of their investment for an extended period.
Our charter does not require our directors to seek stockholder approval to liquidate our assets by a specified date, nor does our charter require our directors to list our shares for trading on a national securities exchange by a specified date. There is no public market for our shares and we currently have no plans to list our shares on a national securities exchange. Until our shares are listed, if ever, stockholders may not sell their shares unless the buyer meets the applicable suitability and minimum purchase standards. In addition, in March 2014, we suspended all repurchases under our stock repurchase program and do not anticipate resuming any repurchases under the program. Therefore, it will be difficult for our stockholders to sell their shares promptly or at all. If a stockholder is able to sell his or her shares, it would likely be at a substantial discount to our estimated value per share. It is also likely that our shares would not be accepted as the primary collateral for a loan. Because of the illiquid nature of our shares, our stockholders should purchase shares in our distribution reinvestment plan only as a long-term investment and be prepared to hold them for an indefinite period of time.
The estimated value per share of our common stock may not reflect the value that stockholders will receive for their investment.
On February 28, 2014, our board of directors approved an estimated value per share of our common stock of $11.63 based on the estimated value of our assets attributable to our common stock less the estimated value of our liabilities attributable to our common stock, divided by the number of shares of common stock outstanding, all as of December 31, 2013. We provided this estimated value per share to assist broker dealers that participated in our initial and follow-on public offerings in meeting their customer account statement reporting obligations under the rules of the Financial Industry Regulatory Authority (“FINRA”).
FINRA rules provide no guidance on the methodology an issuer must use to determine its estimated value per share. As with any valuation methodology, our Advisor’s methodology is based upon a number of estimates and assumptions that may not be accurate or complete. Different parties with different assumptions and estimates could derive a different estimated value per share, and these differences could be significant. The estimated value per share is not audited and does not represent the fair value of our assets or liabilities according to generally accepted accounting principles (“GAAP”). Accordingly, with respect to the estimated value per share, we can give no assurance that:
·a stockholder would be able to resell his or her shares at this estimated value;
·a stockholder would ultimately realize distributions per share equal to our estimated value per share upon liquidation of our assets and settlement of our liabilities or a sale of the company;
·our shares of common stock would trade at the estimated value per share on a national securities exchange;
·an independent third - party appraiser or other third - party valuation firm would agree with our estimated value per share; or
·the methodology used to estimate our value per share would or would not be acceptable to FINRA or for compliance with Employee Retirement Income Security Act (“ERISA”) reporting requirements.
The value of our shares will fluctuate over time in response to developments related to individual assets in our portfolio and the management of those assets and in response to the real estate and finance markets. As such, the estimated value per share does not take into account developments in our portfolio since December 31, 2013. For a full description of the methodologies used to value our assets and liabilities in connection with the calculation of the estimated value per share, see Part II, Item 5, “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities - Market Information.”
Disruptions in the financial markets and uncertain economic conditions could adversely affect our ability to secure debt financing on attractive terms and the values of the investments we make.
Despite improved access to capital for some companies, the capital and credit markets continue to experience volatility and disruption, and the health of the global capital markets remains a concern. The banking industry has been experiencing improved earnings, but the relatively low growth economic environment has caused the markets to question whether financial institutions are truly appropriately capitalized. The downgrade of the U.S. government debt has increased these concerns, especially for the larger, money center banks. Smaller financial institutions have continued to work with borrowers to amend and extend existing loans; however, as these loans reach maturity, there is the potential for future credit losses.
We intend to rely on debt financing to finance our properties. As a result of credit market factors, we may not be able to obtain debt financing at attractive terms. As such, we may be forced to use a greater proportion of equity to finance our acquisitions, reducing the number of acquisitions we would otherwise make. If the current debt market environment persists we may modify our investment strategy in order to optimize our portfolio performance. Our options would include limiting or eliminating the use of debt and focusing on those higher yielding investments that do not require the use of leverage to meet our portfolio goals.
Disruptions in the financial markets and uncertain economic conditions could adversely affect the values of our investments. Instability in the capital markets may constrain equity and debt capital available for investment in real estate, resulting in fewer buyers seeking to acquire properties and possible increases in capitalization rates and lower property values. Furthermore, declining economic conditions could negatively impact real estate fundamentals and result in lower occupancy, lower rental rates and declining values in real estate that we own or may acquire. These could have the following negative effects on us:
•the values of our investments in properties could decrease below the amounts we paid for the investments;
•revenues from our properties could decrease due to lower occupancy rates, reduced rental rates and potential increases in uncollectible receivables;
•we may not be able to refinance our indebtedness or to obtain additional debt financing on attractive terms.
These factors could impair our ability to make distributions to and decrease the value of our stockholders’ investment in us.
We have previously identified a material weakness in our internal control over financial reporting in connection with the restatement of previously issued financial statements. Failure to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act and effective disclosure controls and procedures could have a material adverse effect on our business.
As a public company, we are required to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002. Internal control over financial reporting is complex and may be revised over time to adapt to changes in our business, or changes in applicable accounting rules. Management has certified in this report that our internal controls over financial reporting and our disclosure controls and procedures were effective as of December 31, 2014. In addition, management previously certified that our internal controls over financial reporting and our disclosure controls and procedures were effective as of December 31, 2011. However, in connection the restatement of an error in our consolidated financial statements for the year ended December 31, 2011, our management subsequently determined that there was a material weakness in our internal control over financial reporting with respect to our consolidated financial statements for the year ended December 31, 2011. As a result of this determination, management concluded that our internal control over financial reporting and our disclosure controls and procedures were not effective as of December 31, 2011. The specific material weakness was described in Part II-Item 9A, “Controls and Procedures” under “Management’s Report on Internal Control Over Financial Reporting” in our 2012 Form 10-K.
We cannot assure you that our internal control over financial reporting will be effective in the future or that a material weakness will not be discovered with respect to a prior period for which we believe that internal controls were effective. Matters impacting our internal controls may cause us to be unable to report our financial information on a timely basis, or may cause us to restate previously issued financial information, and thereby subject us to adverse regulatory consequences, including sanctions or investigations by the SEC. There could also be a negative reaction in the financial markets due to a loss of investor confidence in us and the reliability of our financial statements. Confidence in the reliability of our financial statements is also likely to suffer if we report a material weakness in our internal control over financial reporting. This could materially adversely affect us by, for example, impairing our ability to raise capital or obtaining other financing.
We are dependent upon our Advisor, Sentio Investments, LLC, to conduct our operations. Any adverse changes in the financial health of our Advisor, or our relationship with our Advisor could hinder our operating performance and the return on your investment. Furthermore, if our Advisor became unable to continue in that role, we may have difficulty finding a qualified successor, and any successor advisor may not be as well suited to manage us and our portfolio.
We are dependent on our Advisor, Sentio Investments, LLC to manage our operations and our portfolio of real estate assets. Our Advisor has limited operating history and it will depend upon the fees and other compensation that it will receive from us in connection with the purchase, management and sale of our properties to conduct its operations. Any adverse changes in the financial condition of our Advisor or our relationship with our Advisor could hinder its ability to successfully manage our operations and our portfolio of investments. If our Advisor cannot meet its obligations as they arise, or if it is unable to provide adequate service to us as required under the terms of its agreement with us, we may have to find another Advisor. If we are required to find a new Advisor we may have difficulty doing so, and any successor advisor may not be as well suited to manage us and our portfolio. As we have no employees and are entirely dependent on our Advisor to manage our operations, these potential changes could result in a significant disruption of our business.
The inability of our Advisor to retain or obtain key personnel, property managers and leasing agents could delay or hinder implementation of our investment strategies, which could impair our ability to make distributions and could reduce the value of our stockholders’ investment.
Our success depends to a significant degree upon the contributions of John Mark Ramsey, the President and Chief Executive Officer of our Advisor. Neither we nor our Advisor have an employment agreement with Mr. Ramsey or with any of the other executive officers. If Mr. Ramsey were to cease his affiliation with our Advisor, our Advisor may be unable to find a suitable replacement, and our operating results could suffer. We believe that our future success depends, in large part, upon our Advisor’s and our facility operators’ ability to hire and retain highly skilled managerial, operational and marketing personnel. Competition for highly skilled personnel is intense, and our Advisor and any facility managers we retain may be unsuccessful in attracting and retaining such skilled personnel. If we lose or are unable to obtain the services of highly skilled personnel or facility managers, our ability to implement our investment strategies could be delayed or hindered, and the value of our stockholders’ investments may decline.
If we are unable to find or experience delays in finding suitable investments, we may experience a disruption of distributions and a lower rate of return to investors.
Our ability to achieve our investment objectives and to make distributions depends upon the performance of our Advisor in the acquisition and operation of our investments, and upon the performance of the facility managers in the management of our properties and the identification of prospective tenants. Additionally, disruptions and dislocations in the credit markets in recent years have materially impacted the cost and availability of debt to finance real estate acquisitions, which is a key component of our acquisition strategy. This lack of available debt could result in a further reduction of suitable investment opportunities and create a competitive advantage to other entities that have greater financial resources than we do. We may be delayed in making investments in properties due to delays in negotiating or obtaining the necessary purchase documentation for properties or delays in locating suitable investments or other factors. We cannot be sure that our Advisor will be successful in obtaining suitable investments on financially attractive terms or that our investment objectives will be achieved. We may also make other real estate investments, such as investments in public and private real estate companies which own real estate properties and make real estate investments. We will hold uninvested funds in an interest-bearing account or invest the proceeds in short-term, investment-grade securities. We expect the rates of return on these short-term investments to be substantially less than the returns we make on real estate investments. If we are unable to invest in properties or other real estate investments for an extended period of time, distributions to our stockholders may be delayed and may be lower and the value of our stockholders’ investment could be reduced.
If we are limited in the number and type of investments we may make, then the value of our stockholders’ investment in us will fluctuate with the performance of the specific properties we acquire.
If we are unable to secure new capital, we will be limited in the investments we may make resulting in less diversification in terms of the number of investments owned and the geographic regions in which our investments are located. In that case, the likelihood that any single property’s performance would materially reduce our overall profitability will increase. We are not limited in the number or size of our investments or the percentage of net proceeds we may dedicate to a single investment. In addition, any inability to secure new capital would increase our fixed operating expenses as a percentage of gross income, and our net income and the distributions we make to stockholders would be reduced.
We may be restricted in our ability to obtain additional capital from the KKR Equity Commitment.
As of March 15, 2015, the Investor owns 48.9% of the partnership interest of the Operating Partnership. In order to issue additional Series B Preferred Units to the Investor we need to obtain lender consents approving a “change-of-control” transaction. Although we are currently pursuing receipt of such lender consents, we cannot predict when, if ever, such consents will be received. If we are unable to obtain such lender consents, the Investor will have no obligation to purchase additional Series B Preferred Units under the KKR Equity Commitment and we will need to restructure the KKR Equity Commitment to retain access to the full amount of capital committed by the Investor. If we are unable to successfully restructure the KKR Equity Commitment we will not be able to fund future investments with capital from the KKR Equity Commitment.
The cash distributions our stockholders receive may be less frequent or lower in amount than expected.
We currently expect to make distributions to our stockholders quarterly. All expenses we incur in our operations are deducted from cash funds generated by operations prior to computing the amount of cash available to be paid as distributions to our stockholders. Our directors will determine the amount and timing of distributions. Our directors will consider all relevant factors, including the amount of cash available for distribution, capital expenditure and reserve requirements and general operational requirements. We cannot determine with certainty that sufficient cash will be available to make distributions to our stockholders. We may borrow funds, return capital or sell assets to make distributions. With limited prior operations, we cannot predict the amount of distributions our stockholders may receive. We may be unable to pay or maintain cash distributions or increase distributions over time, and we may need to cease distributions to stockholders.
A limit on the percentage of our securities a person may own may discourage a takeover or business combination, which could prevent our stockholders from realizing a premium price for their stock.
In order for us to qualify as a REIT, no more than 50% of our outstanding stock may be beneficially owned, directly or indirectly, by five or fewer individuals (including certain types of entities) at any time during the last half of each taxable year beginning after our first taxable year. To assure that we do not fail to qualify as a REIT under this test, our charter restricts direct or indirect ownership by one person or entity to no more than 9.8% in number of shares or value, whichever is more restrictive, of the outstanding shares of any class or series of our stock unless exempted by our board of directors. This restriction may have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price to our stockholders.
Our charter permits our board of directors to issue stock or securities convertible or exchangeable into equity securities, with terms that may subordinate the rights of our common stockholders or discourage a third party from acquiring us in a manner that could result in a premium price to our stockholders.
Our board of directors may increase or decrease the aggregate number of shares of stock or the number of shares of stock of any class or series that we have authority to issue and classify or reclassify any unissued common stock or preferred stock and establish the preferences, conversion or other rights, voting powers, restrictions, limitations as to distributions, qualifications and terms or conditions of redemption of any such stock. Our board of directors could authorize the issuance of preferred stock or securities convertible or exchangeable into equity securities, with terms and conditions that could have priority as to distributions and amounts payable upon liquidation over the rights of the holders of our common stock. Such preferred stock and convertible or exchangeable securities could also have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price to holders of our common stock.
Our stockholders will have limited control over changes in our policies and operations, which increases the uncertainty and risks of an investment in us.
Our board of directors determines our major policies, including our policies regarding financing, growth, debt capitalization, REIT qualification and distributions. Our board of directors may amend or revise these and other policies without a vote of the common stockholders. Under Maryland General Corporation Law and our charter, our stockholders have a right to vote only on limited matters. Our board’s broad discretion in setting policies and our stockholders’ inability to exert control over those policies increases the uncertainty and risks of an investment on us.
We may change our targeted investments without stockholder consent.
We may make adjustments to our target portfolio based on real estate market conditions and investment opportunities, and we may change our targeted investments and investment guidelines at any time without the consent of our common stockholders, which could result in our making investments that are different from, and possibly riskier than, the investments described in our prospectus. A change in our targeted investments or investment guidelines may increase our exposure to interest rate risk, default risk and real estate market fluctuations, all of which could adversely affect the value of our common stock and our ability to make distributions to our stockholders.
A stockholder’s interest in us may be diluted if we issue additional stock.
Our common stockholders do not have preemptive rights to any stock we issue in the future. Therefore, in the event that we (1) sell stock in the future, including stock issued pursuant to our distribution reinvestment plan, (2) sell securities that are convertible into stock, (3) issue stock in a private offering, (4) issue stock upon the exercise of the options granted to our independent directors, employees of our Advisor or others, or (5) issue stock to sellers of properties acquired by us in connection with an exchange of limited partnership interests in the Operating Partnership, holders of our common stock will experience dilution of their percentage ownership in us. Depending on the terms of such transactions, most notably the price per share, which may be less than the price paid per share in our public offerings, and the value of our properties, holders of our common stock might also experience a dilution in the book value per share of their stock.
A stockholder’s interest in us may be diluted if we issue additional units in our operating partnership.
Holders of common units of the Operating Partnership will receive distributions per unit in the same amount as the distributions we pay per share to our stockholders and will generally have the right to exchange their units of the Operating Partnership for shares of our common stock. In connection with the KKR Equity Commitment we have issued preferred units in the Operating Partnership with terms and conditions that have priority as to distributions and amounts payable upon liquidation over common units and we may issue additional preferred units in the future. The holders of such preferred units will be entitled to receive distributions in preference to our stockholders. In the event we issue additional units in the Operating Partnership, investors holding our common stock will experience potential dilution in their percentage ownership interest in us. Depending on the terms of such transactions, holders of our common stock might also experience a dilution in the book value per share of their stock.
Although we are not currently afforded the protection of the Maryland General Corporation Law relating to business combinations our board of directors could opt into these provisions of Maryland law in the future, which may discourage others from trying to acquire control of us and may prevent our stockholders from receiving a premium price for their stock in connection with a business combination.
Under Maryland law, “business combinations” between a Maryland corporation and certain interested stockholders or affiliates of interested stockholders are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder. These business combinations include a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities. Also under Maryland law, control shares of a Maryland corporation acquired in a control share acquisition have no voting rights except to the extent approved by a vote of two-thirds of the votes entitled to be cast on the matter. Shares owned by the acquirer, by officers or by directors who are employees of the corporation, are not entitled to vote on the matter. Should our board opt into these provisions of Maryland law, it may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer. Similarly, provisions of Title 3, Subtitle 8 of the Maryland General Corporation Law could provide similar anti-takeover protection.
Our stockholder’s and our rights to recover claims against our independent directors are limited, which could reduce our stockholders’ and our recovery against our independent directors if they negligently cause us to incur losses.
Our charter provides that no independent director shall be liable to us or our stockholders for monetary damages and that we will generally indemnify them for losses unless they are grossly negligent or engage in willful misconduct. As a result, our stockholders and we may have more limited rights against our independent directors than might otherwise exist under common law, which could reduce our stockholders’ and our recovery from these persons if they act in a negligent manner. In addition, we may be obligated to fund the defense costs incurred by our independent directors (as well as by our other directors, officers, employees and agents) in some cases, which would decrease the cash otherwise available for distributions to our stockholders.
If we are unable to obtain funding for future capital needs, cash distributions to our stockholders could be reduced and the value of our investments could decline.
If we need additional capital in the future to improve or maintain our properties or for any other reason, we will have to obtain financing from other sources, such as cash flow from operations, borrowings, property sales or future equity offerings. These sources of funding may not be available on attractive terms or at all. If we cannot procure additional funding for capital improvements, our investments may generate lower cash flows or decline in value, or both.
Our Advisor does not have as strong an economic incentive to avoid losses as do sponsors who have made significant equity investments in the companies they sponsor.
Our Advisor has not made an equity investment in us. Therefore, our Advisor has little exposure to losses in the value of our stock. Without this exposure, our investors may be at a greater risk of loss because our Advisor does not have as much to lose from a decrease in the value of our stock as do those sponsors who make more significant equity investments in the companies they sponsor.
If we do not successfully implement our long-term liquidity strategy, our stockholders may have to hold their investment for an indefinite period.
Although we presently intend to provide long-term liquidity to our stockholders within seven years of the termination of our primary public offering, our charter does not require our board of directors to pursue such a liquidity event. Our board of directors will review our long-term liquidity strategy annually and a majority of our independent directors may decide to amend or suspend the strategy if it is deemed to be in the best interest of our stockholders to do so. Market conditions and other factors could cause us to delay the commencement of a liquidity event beyond 2018. If our board of directors does elect to pursue a liquidity strategy, we would be under no obligation to conclude the process within a set time. The timing of a listing of our shares on a national securities exchange, the sale of assets or other liquidity event will depend on real estate and financial markets, economic conditions in the areas in which properties are located, and federal income tax effects on stockholders, that may prevail in the future. If our board of directors were to adopt a plan of liquidation, we cannot guarantee that we would be able to liquidate all assets. After adoption of a plan of liquidation, we would remain in existence until all properties and assets are liquidated. If we do not pursue a liquidity event, or delay such an event due to market conditions, our stockholders’ shares may continue to be illiquid and they may, for an indefinite period of time, be unable to convert their investment to cash easily and could suffer losses on their investment.
If we internalize our management functions, your interest in us could be diluted, and we could incur other significant costs associated with being self-managed.
In connection with the KKR Equity Commitment, we have entered into an agreement (the “Transition Agreement”) with our Advisor and the Investor that sets forth the terms for a transition to an internal management structure for the Company. The Transition Agreement, as amended, requires that the existing external advisory structure will remain in place upon substantially the same terms as currently in effect until February 10, 2017, upon which time the advisory function will be internalized in accordance with procedures set forth in the Transition Agreement. If we internalize in accordance with the terms of the Transition Agreement, we would no longer bear the costs of the various fees we expect to pay to our Advisor under the Advisory Agreement. However, our direct expenses would include general and administrative costs, including legal, accounting and other expenses related to corporate governance and SEC reporting and compliance. We would also incur the compensation and benefits costs of our officers and other employees and consultants that we now expect to be paid by our Advisor. In addition, we may issue equity awards to officers, employees and consultants, which awards would decrease net income and funds from operations and may dilute your investment. We cannot currently estimate the costs we would incur if we became self-managed. If the expenses we assume as a result of an internalization are higher than the expenses we avoid paying to our Advisor, our net income per share and funds from operations per share would be lower as a result of the internalization than it otherwise would have been, potentially decreasing the amount of funds available to distribute to our stockholders and the value of our shares.
As currently organized, we will not directly employ any employees. If we, in accordance with the Transition Agreement, internalize our operations, we would employ personnel and would be subject to potential liabilities commonly faced by employers, such as workers disability and compensation claims, potential labor disputes and other employee-related liabilities and grievances. Nothing in our charter prohibits us from entering into the transaction described above.
If we internalize our management functions, we could have difficulty integrating these functions as a stand-alone entity. We could fail to properly identify the appropriate mix of personnel and capital needs to operate as a stand-alone entity. An inability to manage an internalization transaction effectively could thus result in our incurring excess costs and/or suffering deficiencies in our disclosure controls and procedures or our internal control over financial reporting. Such deficiencies could cause us to incur additional costs, and our management’s attention could be diverted from effectively managing our portfolio of investments.
Our equity commitment transaction with KKR dilutes the interests of our common shareholders and grants important rights to KKR.
On October 18, 2013, the first purchase of securities was completed by KKR pursuant to the Securities Purchase Agreement dated as of February 10, 2013, and amended at various times thereafter, between us, our Operating Partnership, and the Investor. Under the KKR Equity Commitment, we may issue and sell to the Investor and its affiliates from time to time over a period of up to three years, up to $158.7 million in aggregate issuance amount of preferred securities in the Company and the Operating Partnership.
In connection with the put exercises under the KKR Equity Commitment through December 31, 2014, the Investor has acquired 1,000 shares of Series C Preferred Stock and 946,560 Series B Preferred Units for an aggregate purchase price of $94.8 million. After giving effect to these transactions, on an as-converted basis, the Investor owns 45% of the partnership interest of the Operating Partnership.
The KKR Equity Commitment and the transactions contemplated thereby will likely result in a change of control of the Company. Based on the capitalization of the Company as of December 31, 2014 if the maximum amount of $158.7 million is drawn by us under the KKR Equity Commitment, then KKR would hold 57.9% of our voting capital stock as well as the same percentage of our as-converted common stock by virtue of their combined interests in the Series C Preferred Stock and Series B Preferred Units.
Disclosure concerning the terms, rights and conditions of the Series C Preferred Stock and the Series B Preferred Units, the transfer and registration thereof and the other provisions of the KKR Equity Commitment are described in the Company’s Current Reports on Form 8-K filed with the Securities and Exchange Commission on February 12, 2013, December 30, 2014 and January 22, 2015. There can be no assurance that the interests of KKR are aligned with that of our other stockholders. Investor interests can differ from each other and from other corporate interests and it is possible that this significant stockholder with a stake in corporate management may have interests that differ from us and those of other stockholders.
Risks Related to Conflicts of Interest
Our Advisor and its affiliates, including our officers, one of whom is also a director, may face conflicts of interest caused by compensation arrangements with us and other sponsored programs, which could result in actions that are not in the long-term best interests of our stockholders.
Our Advisor will receive substantial fees from us that are partially tied to the performance of our stockholders’ investment. These fees could influence our Advisor’s advice to us, as well as the judgment of our officers, one of whom is also a director. Among other matters, the compensation arrangements could affect their judgment with respect to:
•the continuation, renewal or enforcement of our Advisory Agreement with the Advisor;
•public offerings of equity by us, which would likely entitle the Advisor to increased acquisition and asset-management fees;
•sales of properties and other investments (including, subject to the approval of our conflicts committee, sales to affiliates), which may entitle the Advisor to disposition fees and reduce asset management fees;
•acquisitions of properties and other investments, which entitle the Advisor to acquisition and asset-management fees, and, in the case of acquisitions of investments from other Advisor-sponsored programs, might entitle the Advisor to disposition fees and possible subordinated incentive fees in connection with its services for the seller;
•borrowings to acquire properties and other investments, which borrowings will increase the acquisition and asset-management fees payable to the Advisor;
•whether and when we seek to list our common stock on a national securities exchange, which listing could entitle our Advisor to a success-based listing fee; and
•whether and when we seek to sell the company or its assets, which sale could entitle our Advisor to success-based fees.
Our Advisor will face conflicts of interest relating to the purchase and leasing of properties, and such conflicts may not be resolved in our favor, which could limit our investment opportunities, impair our ability to make distributions and reduce the value of our stockholders’ investments in us.
We rely on our Advisor to identify suitable investment opportunities. Our agreement with our Advisor does not restrict our Advisor from sponsoring or providing advisory services to other programs. Therefore, we may be buying properties at the same time as other entities that are affiliated with or sponsored by our Advisor. Other programs sponsored by our Advisor or its affiliates may also rely on our Advisor for investment opportunities. Many investment opportunities would be suitable for us as well as other programs. Our Advisor could direct attractive investment opportunities or tenants to other entities. Such events could result in our investing in properties that provide less attractive returns, thus reducing the level of distributions which we may be able to pay to stockholders and the value of their investments in us.
We may purchase properties from persons with whom our Advisor or its affiliates have prior business relationships and our Advisor’s interest in preserving its relationship with these persons could result in us paying a higher price for the properties than we would otherwise pay.
We may have the opportunity to purchase properties from third parties, including affiliates of our directors who have prior business relationships with our Advisor or its affiliates. If we purchase properties from such third parties, our Advisor may experience a conflict between our interests and its interest in preserving any ongoing business relationship with these sellers.
Our Advisor will face conflicts of interest relating to joint ventures that we may form with affiliates of our Advisor, which conflicts could result in a disproportionate benefit to the other venture partners at our expense.
We may enter into joint venture agreements with third parties (including entities that are affiliated with our Advisor or our independent directors) for the acquisition or improvement of properties. Our Advisor may have conflicts of interest in determining which program should enter into any particular joint venture agreement. The co-venturer may have economic or business interests or goals that are or may become inconsistent with our business interests or goals. In addition, our Advisor may face a conflict in structuring the terms of the relationship between our interests and the interest of the affiliated co-venturer and in managing the joint venture. Since our Advisor and its affiliates will control both the affiliated co-venturer and, to a certain extent, us, agreements and transactions between the co-venturers with respect to any such joint venture will not have the benefit of arm’s-length negotiation of the type normally conducted between unrelated co-venturers. Co-venturers may thus benefit to our and our stockholders’ detriment.
Our Advisor and its affiliates receive fees and other compensation based upon our property acquisitions, the property we own and the sale of our properties and therefore our Advisor and its affiliates may make recommendations to us that we buy, hold or sell property in order to increase their compensation. Our Advisor will have considerable discretion with respect to the terms and timing of our acquisition, disposition and leasing transactions.
Our Advisor receives commissions, fees and other compensation based upon our investments. Therefore, our Advisor may recommend that we purchase properties that generate fees for our Advisor, but are not necessarily the most suitable investment for our portfolio. In some instances our Advisor may benefit by us retaining ownership of our assets, while our stockholders may be better served by sale or disposition. In other instances they may benefit by us selling the properties which may entitle our Advisor to disposition fees and possible success-based sales fees. In addition, our Advisor’s ability to receive asset management fees and reimbursements depends on our continued investment in properties and in other assets which generate fees to them. Therefore, the interest of our Advisor in receiving fees may conflict with our interests.
If the competing demands for the time of our Advisor and our officers result in them spending insufficient time on our business, we may miss investment opportunities or have less efficient operations, which could reduce our profitability and result in lower distributions to our stockholders.
We do not have any employees. We rely on the employees of our Advisor for the day-to-day operation of our business. The amount of time that our Advisor spends on our business will vary from time to time and is expected to be more while we are raising money and acquiring properties. Our Advisor, including our officers, may have interests in other programs and may engage in other business activities. As a result, they may face conflicts of interest in allocating their time between us and other programs and activities in which they are involved. During times of intense activity in other programs and ventures, they may devote less time and fewer resources to our business than are necessary or appropriate to manage our business. We expect that as our real estate activities expand, our Advisor will attempt to hire additional employees who would devote substantially all of their time to our business. There is no assurance that our Advisor will devote adequate time to our business. If our Advisor suffers or is distracted by adverse financial or operational problems in connection with its operations unrelated to us, it may allocate less time and resources to our operations. If any of these things occur, the returns on our investments, our ability to make distributions to stockholders and the value of their investments in us may suffer.
Our officers, one of whom is also a director, face conflicts of interest related to the positions they hold with our, which could hinder our ability to successfully implement our business strategy and to generate returns to our stockholders.
Our officers, one of whom is also a director, are also officers of our Advisor. As a result, they owe fiduciary duties to the entity’s members, which fiduciary duties may from time to time conflict with the fiduciary duties that they owe to us and our stockholders. Their loyalties to this other entity could result in actions or inactions that are detrimental to our business, which could harm the implementation of our business strategy and our investment, property management and leasing opportunities. If we do not successfully implement our business strategy, we may be unable to generate cash needed to make distributions our stockholders and to maintain or increase the value of our assets.
General Risks Related to Investments in Real Estate and Real-Estate Related Investments
Economic and regulatory changes that impact the real estate market may reduce our net income and the value of our properties.
By owning our stock, stockholders are subjected to the risks associated with owning real estate. The performance of an investment in us is subject to, among other things, risks related to the ownership and operation of real estate, including but not limited to:
•worsening general or local economic conditions and financial markets could cause lower demand, tenant defaults, and reduced occupancy and rental rates, some or all of which would cause an overall decrease in revenue from rents;
•increases in competing properties in an area which could require increased concessions to tenants and reduced rental rates;
•increases in interest rates or unavailability of permanent mortgage funds which may render the sale of a property difficult or unattractive; and
•changes in laws and government regulations, including those governing real estate usage, zoning and taxes.
Some or all of the foregoing factors may affect our properties, which would reduce our net income, and our ability to make distributions to our stockholders.
A concentration of our investments in the healthcare sector may leave our profitability vulnerable to a downturn or slowdown in the sector.
We expect to concentrate our investments in the healthcare sector. As a result, we will be subject to risks inherent in investments in a single type of property. If our investments are substantially in the healthcare sector, then the potential effects on our revenues, and as a result, on cash available for distribution to our stockholders, resulting from a downturn or slowdown in the healthcare sector could be more pronounced than if we had more fully diversified our investments.
Competition with third parties for properties and other investments may result in our paying higher prices for properties which could reduce our profitability and the return on investment.
We compete with many other entities engaged in real estate investment activities, including individuals, corporations, banks, insurance companies, other REITs, and real estate limited partnerships, many of which have greater resources than we do. Some of these investors may enjoy significant competitive advantages that result from, among other things, a lower cost of capital and enhanced operating efficiencies. In addition, the number of entities and the amount of funds competing for suitable investments may increase. Any such increase would result in increased demand for these assets and increased prices. If competitive pressures cause us to pay higher prices for properties, our ultimate profitability may be reduced and the value of our properties may not appreciate or may decrease significantly below the amount paid for such properties. At the time we elect to dispose of one or more of our properties, we will be in competition with sellers of similar properties to locate suitable purchasers, which may result in us receiving lower proceeds from the disposal or result in us not being able to dispose of the property due to the lack of an acceptable return. This may cause our stockholders to experience a lower return on their investments in us.
The healthcare properties we own may derive a substantial portion of their income from third-party payors.
Most of our healthcare facilities will be directly affected by risks associated with the healthcare industry. Some of our lessees will derive a substantial portion of their net operating revenues from third-party payors, including the Medicare and Medicaid programs. These programs are highly regulated by federal, state and local laws, rules and regulations and are subject to frequent and substantial change. There are no assurances that payments from governmental payors will remain at levels comparable to present levels or will, in the future, be sufficient to cover the costs allocable to patients eligible for reimbursement under these programs.
Failure to comply with government regulations could adversely affect our healthcare tenants and operators.
The healthcare industry is highly regulated by federal, state and local licensing requirements, facility inspections, reimbursement policies, regulations concerning capital and other expenditures, certification requirements and other laws, regulations and rules. In addition, regulators require compliance with a variety of safety, health, staffing and other requirements relating to the design and conditions of the licensed facility and quality of care provided. Additional laws and regulations may be enacted or adopted that could require changes in the design of properties and certain operations of our tenants and third-party operators. The failure of any tenant or operator to comply with such laws, requirements and regulations could affect a tenant’s or operator’s ability to operate the facilities that we own.
In some states, advocacy groups have been created to monitor the quality of care at health care facilities, and these groups have brought litigation against operators. Additionally, in some instances, private litigation by patients has succeeded in winning large demand awards for alleged abuses. The effect of this litigation and potential litigation has increased the costs of monitoring and reporting quality of care compliance incurred by our tenants. In addition, the cost of liability and medical malpractice insurance has increased and may continue to increase as long as the present litigation environment affecting the operations of health care facilities continues. Continued cost increases could cause our tenants to be unable to pay their lease payments, decreasing our cash flow available for distribution.
Our tenants may be affected by the financial deterioration, insolvency and/or bankruptcy of other significant operators in the healthcare industry.
Certain companies in the healthcare industry, including some key senior housing operators, none of which are currently our tenants, are experiencing considerable financial, legal and/or regulatory difficulties which have resulted or may result in financial deterioration and, in some cases, insolvency and/or bankruptcy. The adverse effects on these companies could have a significant impact on the industry as a whole, including but not limited to negative public perception by investors, lenders and consumers. As a result, our tenants could experience the damaging financial effects of a weakened industry driven by negative industry headlines, ultimately making them unable to meet their obligations to us, and our business could be adversely affected.
We may be unable to complete development and re-development projects on advantageous terms.
As part of our investment plan, we intend to develop new and re-develop existing properties. Such activities involve significant risks that could adversely affect our financial condition, results of operations, cash flow and ability to make distributions on our common stock, which include:
•we may not be able to obtain, or may experience delays in obtaining, all necessary zoning, land-use, building, occupancy and other governmental permits and authorizations;
•we may not be able to obtain financing for development projects on favorable terms and complete construction on schedule or within budget, resulting in increased debt service expense and construction costs and delays in leasing the properties and generating cash flow; and
•the properties may perform below anticipated levels, producing cash flow below budgeted amounts and limiting our ability to sell such properties to third parties or affiliates.
Newly developed and acquired properties may not produce the cash flow that we expect, which could adversely affect our overall financial performance.
We intend to acquire and develop real estate properties. In deciding whether to acquire or develop a particular property, we make assumptions regarding the expected future performance of that property. If our estimated return on investment proves to be inaccurate, it may fail to perform as we expected. With certain properties we plan to acquire, our business plan contemplates repositioning or redeveloping that property with the goal of increasing its cash flow, value or both. Our estimate of the costs of repositioning or redeveloping an acquired property may prove to be inaccurate, which may result in our failure to meet our profitability goals. Additionally, we may acquire new properties not fully leased, and the cash flow from existing operations may be insufficient to pay the operating expenses and debt service associated with that property until the property is more fully leased. If one or more of these new properties do not perform as expected or we are unable to successfully integrate new properties into our existing operations, our financial performance and our ability to make distributions may be adversely affected.
Reduced occupancy levels could reduce our revenues from rents and our distributions to our stockholders and cause the value of our stockholders’ investment in us to decline.
The success of our investments depends upon the occupancy levels, rental income and operating expenses of our properties and our company. In the event of tenant default or bankruptcy, we may experience delays in enforcing our rights as landlord and may incur costs in protecting our investment and re-leasing our property. In the event of tenant default or bankruptcy, or lease termination or expiration, we may be unable to re-lease the property for the rent previously received. We may be unable to sell a property with low occupancy without incurring a loss. These events and others could cause us to reduce the amount of distributions we make to stockholders and the value of our stockholders’ investment in us to decline.
Rising expenses at both the property and the company level could reduce our net income and our cash available for distribution to stockholders.
Our properties are subject to operating risks common to real estate in general, any or all of which may reduce our net income. If any property is not substantially occupied or if rents are being paid in an amount that is insufficient to cover operating expenses, we could be required to expend funds with respect to that property for operating expenses. The properties are subject to increases in tax rates, utility costs, operating expenses, insurance costs, repairs and maintenance and administrative expenses. If we are unable to lease properties on a basis requiring the tenants to pay such expenses, we would be required to pay some or all of those costs which would reduce our income and cash available for distribution to stockholders.
Costs incurred in complying with governmental laws and regulations may reduce our net income and the cash available for distributions.
Our company and the properties we own are subject to federal, state and local laws and regulations relating to environmental protection and human health and safety. Federal laws such as the National Environmental Policy Act, the Comprehensive Environmental Response, Compensation, and Liability Act, the Resource Conservation and Recovery Act, the Federal Water Pollution Control Act, the Federal Clean Air Act, the Toxic Substances Control Act, the Emergency Planning and Community Right to Know Act and the Hazard Communication Act govern such matters as wastewater discharges, air emissions, the operation and removal of underground and above-ground storage tanks, the use, storage, treatment, transportation and disposal of solid and hazardous materials and the remediation of contamination associated with disposals. The properties we own and those we expect to acquire are subject to the Americans with Disabilities Act of 1990 which generally requires that certain types of buildings and services be made accessible and available to people with disabilities. These laws may require us to make modifications to our properties. Some of these laws and regulations impose joint and several liability on tenants, owners or operators for the costs to investigate or remediate contaminated properties, regardless of fault or whether the acts causing the contamination were legal. Compliance with these laws and any new or more stringent laws or regulations may require us to incur material expenditures. Future laws, ordinances or regulations may impose material environmental liability. In addition, there are various federal, state and local fire, health, life-safety and similar regulations with which we may be required to comply, and which may subject us to liability in the form of fines or damages for noncompliance.
Our properties may be affected by our tenants’ operations, the existing condition of land when we buy it, operations in the vicinity of our properties, such as the presence of underground storage tanks, or activities of unrelated third parties. The presence of hazardous substances, or the failure to properly remediate these substances, may make it difficult or impossible to sell or rent such property. Any material expenditures, fines, or damages we must pay will reduce our ability to make distributions and may reduce the value of our stockholders’ investments in us.
Discovery of environmentally hazardous conditions may reduce our cash available for distribution to our stockholders.
Under various federal, state and local environmental laws, ordinances and regulations, a current or previous real property owner or operator may be liable for the cost to remove or remediate hazardous or toxic substances on, under or in such property. These costs could be substantial. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. Environmental laws also may impose restrictions on the manner in which property may be used or businesses may be operated, and these restrictions may require substantial expenditures or prevent us from entering into leases with prospective tenants that may be impacted by such laws. Environmental laws provide for sanctions for noncompliance and may be enforced by governmental agencies or, in certain circumstances, by private parties. Certain environmental laws and common law principles could be used to impose liability for release of and exposure to hazardous substances, including asbestos-containing materials into the air. Third parties may seek recovery from real property owners or operators for personal injury or property damage associated with exposure to released hazardous substances. The cost of defending against claims of liability, of complying with environmental regulatory requirements, of remediating any contaminated property, or of paying personal injury claims could be substantial and reduce our ability to make distributions and the value of our stockholders’ investments in us.
Any uninsured losses or high insurance premiums will reduce our net income and the amount of our cash distributions to stockholders.
Our Advisor will attempt to obtain adequate insurance to cover significant areas of risk to us as a company and to our properties. However, there are types of losses at the property level, generally catastrophic in nature, such as losses due to wars, acts of terrorism, earthquakes, floods, hurricanes, pollution or environmental matters, which are uninsurable or not economically insurable, or may be insured subject to limitations, such as large deductibles or co-payments. We may not have adequate coverage for such losses. If any of our properties incurs a casualty loss that is not fully insured, the value of our assets will be reduced by any such uninsured loss. In addition, other than any working capital reserve or other reserves we may establish, we have no source of funding to repair or reconstruct any uninsured damaged property. Also, to the extent we must pay unexpectedly large amounts for insurance, we could suffer reduced earnings that would result in lower distributions to stockholders.
We may have difficulty selling real estate investments, and our ability to distribute all or a portion of the net proceeds from such sale to our stockholders may be limited.
Equity real estate investments are relatively illiquid. Therefore, we will have a limited ability to vary our portfolio in response to changes in economic or other conditions. In addition, the liquidity of real estate investments has been further reduced by the recent turmoil in the capital markets, which has constrained equity and debt capital available for investment in commercial real estate, resulting in fewer buyers seeking to acquire commercial properties and consequent reductions in property values. As a result of these factors we will also have a limited ability to sell assets in order to fund working capital and similar capital needs. When we sell any of our properties, we may not realize a gain on such sale. We may not elect to distribute any proceeds from the sale of properties to our stockholders; for example, we may use such proceeds to:
•purchase additional properties;
•repay debt, if any;
•buy out interests of any co-venturers or other partners in any joint venture to which we are a party;
•create working capital reserves; or
•make repairs, maintenance, tenant improvements or other capital improvements or expenditures to our remaining properties.
Our ability to sell our properties may also be limited by our need to avoid a 100% penalty tax that is imposed on gain recognized by a REIT from the sale of property characterized as dealer property. In order to ensure that we avoid such characterization, we may be required to hold our properties for a minimum period of time, generally two years, and comply with certain other requirements in the Internal Revenue Code.
Real estate market conditions at the time we decide to dispose of a property may be unfavorable which could reduce the price we receive for a property and lower the return on our stockholders’ investments in us.
We intend to hold the properties in which we invest until we determine that selling or otherwise disposing of properties would help us to achieve our investment objectives. General economic conditions, availability of financing, interest rates and other factors, including supply and demand, all of which are beyond our control, affect the real estate market. We may be unable to sell a property for the price, on the terms, or within the time frame we want. Accordingly, the gain or loss on our stockholders’ investments in us could be affected by fluctuating market conditions.
As part of otherwise attractive portfolios of properties, we may acquire some properties with existing lock-out provisions, which may inhibit us from selling a property, or may require us to maintain specified debt levels for a period of years on some properties.
Loan provisions could materially restrict us from selling or otherwise disposing of or refinancing properties. These provisions would affect our ability to turn our investments into cash and thus affect cash available for distributions to our stockholders. Loan provisions may prohibit us from reducing the outstanding indebtedness with respect to properties, refinancing such indebtedness on a non-recourse basis at maturity, or increasing the amount of indebtedness with respect to such properties.
Loan provisions could impair our ability to take actions that would otherwise be in the best interests of our stockholders and, therefore, may have an adverse impact on the value of our stock, relative to the value that would result if the loan provisions did not exist. In particular, loan provisions could preclude us from participating in major transactions that could result in a disposition of our assets or a change in control even though that disposition or change in control might be in the best interests of our stockholders.
If we sell properties by providing financing to purchasers of our properties, distribution of net sales proceeds to our stockholders would be delayed and defaults by the purchasers could reduce our cash available for distribution to stockholders.
If we provide financing to purchasers, we will bear the risk that the purchaser may default. Purchaser defaults could reduce our cash distributions to our stockholders. Even in the absence of a purchaser default, the distribution of the proceeds of sales to our stockholders, or their reinvestment in other assets, will be delayed until the promissory notes or other property we may accept upon a sale are actually paid, sold, refinanced or otherwise disposed of or completion of foreclosure proceedings.
Actions of our joint venture partners could subject us to liabilities in excess of those contemplated or prevent us from taking actions which are in the best interests of our stockholders which could result in lower investment returns to our stockholders.
We have entered into joint ventures with other third parties to acquire or improve properties, and we may do so in the future. We may also purchase properties in partnerships, co-tenancies or other co-ownership arrangements. Such investments may involve risks not otherwise present when acquiring real estate directly, including, for example:
•joint venturers may share certain approval rights over major decisions;
•a co-venturer, co-owner or partner may at any time have economic or business interests or goals which are or which become inconsistent with our business interests or goals, including inconsistent goals relating to the sale of properties held in the joint venture or the timing of termination or liquidation of the joint venture;
•the possibility that our co-venturer, co-owner or partner in an investment might become insolvent or bankrupt;
•the possibility that we may incur liabilities as a result of an action taken by our co-venturer, co-owner or partner;
• a co-venturer, co-owner or partner may be in a position to take action contrary to our instructions or requests or contrary to our policies or objectives, including our policy with respect to qualifying and maintaining our qualification as a REIT;
•disputes between us and our co-venturers may result in litigation or arbitration that would increase our expenses and prevent its officers and directors from focusing their time and effort on our business and result in subjecting the properties owned by the applicable joint venture to additional risk; or
•under certain joint venture arrangements, neither joint venture partner may have the power to control the venture, and an impasse could be reached which might have a negative influence on the joint venture.
These events might subject us to liabilities in excess of those contemplated and thus reduce our stockholders’ investment returns. If we have a right of first refusal or buy/sell right to buy out a co-venturer, co-owner or partner, we may be unable to finance such a buy-out if it becomes exercisable or we may be required to purchase such interest at a time when it would not otherwise be in our best interest to do so. If our interest is subject to a buy/sell right, we may not have sufficient cash, available borrowing capacity or other capital resources to allow us to elect to purchase an interest of a co-venturer subject to the buy/sell right, in which case we may be forced to sell our interest as the result of the exercise of such right when we would otherwise prefer to keep our interest. Finally, we may not be able to sell our interest in a joint venture if we desire to exit the venture.
If we originate or invest in mortgage loans as part of our plan to acquire the underlying property, our mortgage loans may be affected by unfavorable real estate market conditions, including interest rate fluctuations, which could decrease the value of those loans and the return on our stockholders’ investments in us.
If we originate or invest in mortgage loans, we will be at risk of defaults by the borrowers on those mortgage loans as well as interest rate risks. To the extent we incur delays in liquidating such defaulted mortgage loans, we may not be able to obtain sufficient proceeds to repay all amounts due to us under the mortgage loan. Further, we will not know whether the values of the properties securing the mortgage loans will remain at the levels existing on the dates of origination of those mortgage loans. If the values of the underlying properties fall, our risk will increase because of the lower value of the security associated with such loans. In addition, interest rate fluctuations could reduce our returns as compared to market interest rates and reduce the value of the mortgage loans in the event we sell them.
Construction loans involve a high risk of loss if we are unsuccessful in raising the unfunded portion of the loan or if a borrower otherwise fails to complete the construction of a project.
We have originated a construction loan. If we are unsuccessful in raising the unfunded portion of a construction loan, there could be adverse consequences associated with the loan, including a loss of the value of the property securing the loan if the construction is not completed and the borrower is unable to raise funds to complete it from other sources; a borrower claim against us for failure to perform under the loan documents; increased costs to the borrower that the borrower is unable to pay; a bankruptcy filing by the borrower; and abandonment by the borrower of the collateral for the loan. Further, other non-cash flowing assets such as land loans and pre-development loans may fail to qualify for construction financing and may need to be liquidated based on the “as-is” value as opposed to a valuation based on the ability to construct certain real property improvements. The occurrence of such events may have a negative impact on our results of operations.
Risks of cost overruns and non-completion of the construction or development of the properties underlying loans we originate or acquire may materially and adversely affect our investment.
The development, renovation, or refurbishment by a borrower under a mortgaged or leveraged property involves risks of cost overruns and non-completion. Costs of construction to bring a property up to standards established for the market position intended for that property may exceed original estimates, possibly making a project uneconomical. Other risks may include environmental risks and the possibility of construction, rehabilitation and subsequent leasing of the property not being completed on schedule. If such construction or renovation is not completed in a timely manner, or if it costs more than expected, the borrower may experience a prolonged impairment of net operating income and may not be able to make payments on our investment.
Investments in real estate-related securities may be illiquid, and we may not be able to adjust our portfolio in response to changes in economic and other conditions.
If we invest in certain real estate-related securities that we may purchase in connection with privately negotiated transactions, they will not be registered under the relevant securities laws, resulting in a prohibition against their transfer, sale, pledge or other disposition except in a transaction that is exempt from the registration requirements of, or is otherwise in accordance with, those laws. As a result, our ability to vary our long-term stabilized portfolio in response to changes in economic and other conditions may be relatively limited. The mezzanine and bridge loans we may purchase will be particularly illiquid investments due to their short life. Moreover, in the event of a borrower’s default on an illiquid real estate security, the unsuitability for securitization and potential lack of recovery of our investment could pose serious risks of loss to our investment portfolio.
Delays in restructuring or liquidating non-performing real estate-related securities could reduce the return on our stockholders’ investment.
If we invest in real estate-related securities, they may become non-performing after acquisition for a wide variety of reasons. Such non-performing real estate investments may require a substantial amount of workout negotiations and/or restructuring, which may entail, among other things, a substantial reduction in the interest rate and a substantial write-down of such loan or asset. However, even if a restructuring is successfully accomplished, upon maturity of such real estate security, replacement “takeout” financing may not be available. We may find it necessary or desirable to foreclose on some of the collateral securing one or more of our investments. Intercreditor provisions may substantially interfere with our ability to do so. Even if foreclosure is an option, the foreclosure process can be lengthy and expensive. Borrowers often resist foreclosure actions by asserting numerous claims, counterclaims and defenses, including, without limitation, lender liability claims and defenses, in an effort to prolong the foreclosure action. In some states, foreclosure actions can take up to several years or more to litigate. At any time during the foreclosure proceedings, the borrower may file for bankruptcy, which would have the effect of staying the foreclosure action and further delaying the foreclosure process. Foreclosure litigation tends to create a negative public image of the collateral property and may result in disrupting ongoing leasing and management of the property. Foreclosure actions by senior lenders may substantially affect the amount that we may receive from an investment.
Our stockholders’ investment return may be reduced if we are required to register as an investment company under the Investment Company Act; if we or our subsidiaries become an unregistered investment company, we could not continue our business.
Neither we nor any of our subsidiaries intend to register as investment companies under the Investment Company Act. If we or our subsidiaries were obligated to register as investment companies, we would have to comply with a variety of substantive requirements under the Investment Company Act that impose, among other things:
•limitations on capital structure;
•restrictions on specified investments;
•prohibitions on transactions with affiliates; and
•compliance with reporting, record keeping, voting, proxy disclosure and other rules and regulations that would significantly increase our operating expenses.
Under the relevant provisions of Section 3(a)(1) of the Investment Company Act, an investment company is any issuer that:
•is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading in securities (the “primarily engaged test”); or
•is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire “investment securities” having a value exceeding 40% of the value of such issuer’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis (the “40% test”). “Investment securities” excludes U.S. government securities and securities of majority-owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company under Section 3(c)(1) or Section 3(c)(7) (relating to private investment companies).
We believe that we and our Operating Partnership satisfy both exceptions above. With respect to the 40% test, most of the entities through which we and our Operating Partnership own our assets are majority-owned subsidiaries that are not themselves investment companies and are not relying on the exceptions from the definition of investment company under Section 3(c)(1) or Section 3(c)(7).
With respect to the primarily engaged test, we and our Operating Partnership are holding companies and do not intend to invest or trade in securities ourselves. Rather, through the majority-owned subsidiaries of our Operating Partnership, we and our Operating Partnership are primarily engaged in the non-investment company businesses of these subsidiaries, namely the business of purchasing or otherwise acquiring real estate and real estate-related assets.
We believe that most of the subsidiaries of our Operating Partnership will be able to rely on Section 3(c)(5)(C) of the Investment Company Act for an exception from the definition of an investment company. (Any other subsidiaries of our Operating Partnership should be able to rely on the exceptions for private investment companies pursuant to Section 3(c)(1) and Section 3(c)(7) of the Investment Company Act.) As reflected in no-action letters, the SEC staff’s position on Section 3(c) (5)(C) generally requires that an issuer maintain at least 55% of its assets in “mortgages and other liens on and interests in real estate,” or qualifying assets; at least 80% of its assets in qualifying assets plus real estate-related assets; and no more than 20% of the value of its assets in other than qualifying assets and real estate-related assets, which we refer to as miscellaneous assets. To constitute a qualifying asset under this 55% requirement, a real estate interest must meet various criteria based on no-action letters. We expect that each of the subsidiaries of our Operating Partnership relying on Section 3(c)(5)(C) will invest at least 55% of its assets in qualifying assets, and approximately an additional 25% of its assets in other types of real estate-related assets. We expect to rely on guidance published by the SEC staff or on our analyses of guidance published with respect to types of assets to determine which assets are qualifying real estate assets and real estate-related assets.
To maintain compliance with the Investment Company Act, our subsidiaries may be unable to sell assets we would otherwise want them to sell and may need to sell assets we would otherwise wish them to retain. In addition, our subsidiaries may have to acquire additional assets that they might not otherwise have acquired or may have to forego opportunities to make investments that we would otherwise want them to make and would be important to our investment strategy. Moreover, the SEC or its staff may issue interpretations with respect to various types of assets that are contrary to our views and current SEC staff interpretations are subject to change, which increases the risk of non-compliance and the risk that we may be forced to make adverse changes to our portfolio. In this regard, we note that in 2011 the SEC issued a concept release indicating that the SEC and its staff were reviewing interpretive issues relating to Section 3(c)(5)(C) and soliciting views on the application of Section 3(c)(5)(C) to companies engaged in the business of acquiring mortgages and mortgage-related instruments. If we were required to register as an investment company but failed to do so, we would be prohibited from engaging in our business and criminal and civil actions could be brought against us. In addition, our contracts would be unenforceable unless a court required enforcement and a court could appoint a receiver to take control of us and liquidate our business.
Rapid changes in the values of our assets may make it more difficult for us to maintain our qualification as a REIT or our exception from the definition of an investment company under the Investment Company Act.
If the market value or income potential of our qualifying real estate assets changes as compared to the market value or income potential of our non-qualifying assets, or if the market value or income potential of our assets that are considered “real estate-related assets” under the Investment Company Act or REIT qualification tests changes as compared to the market value or income potential of our assets that are not considered “real estate-related assets” under the Investment Company Act or REIT qualification tests, whether as a result of increased interest rates, prepayment rates or other factors, we may need to modify our investment portfolio in order to maintain our REIT qualification or exception from the definition of an investment company. If the decline in asset values or income occurs quickly, this may be especially difficult, if not impossible, to accomplish. This difficulty may be exacerbated by the illiquid nature of many of the assets that we may own. We may have to make investment decisions that we otherwise would not make absent REIT and Investment Company Act considerations.
Risks Associated with Debt Financing
We will use debt financing to acquire properties and otherwise incur other indebtedness, which will increase our expenses and could subject us to the risk of losing properties in foreclosure if our cash flow is insufficient to make loan payments.
We have and expect to continue to acquire properties using debt financing. We intend to incur indebtedness up to 300% of our net assets (equivalent to 75% of the cost of our tangible assets), but upon a vote of the majority of our independent directors we may exceed this level of indebtedness. We may borrow funds for working capital requirements, tenant improvements, capital improvements, and leasing commissions. We may also borrow funds to make distributions including but not limited to funds to satisfy the REIT tax qualification requirement that we distribute at least 90% of our annual REIT taxable income (excluding net capital gains) to our stockholders. We may also borrow if we otherwise deem it necessary or advisable to ensure that we maintain our qualification as a REIT for federal income tax purposes or to avoid taxation on undistributed income or gain. To the extent we borrow funds; we may raise additional equity capital or sell properties to pay such debt.
If there is a shortfall between the cash flow from a property and the cash flow needed to service acquisition financing on that property, then the amount available for distributions to stockholders may be reduced. In addition, incurring mortgage debt increases the risk of loss since defaults on indebtedness secured by a property may result in lenders initiating foreclosure actions. In that case, we could lose the property securing the loan that is in default, thus reducing the value of our stockholders’ investment. For tax purposes, a foreclosure of any of our properties would be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the property, we would recognize taxable income on foreclosure, but we would not receive any cash proceeds. We may give full or partial guarantees to lenders of mortgage debt to the entities that own our properties. When we give a guaranty on behalf of an entity that owns one of our properties, we will be responsible to the lender for satisfaction of the debt if it is not paid by such entity. If any mortgages contain cross-collateralization or cross-default provisions, a default on a single property could affect multiple properties. If any of our properties are foreclosed upon due to a default, the value of our stockholders’ investments in us will be reduced. Liquidity in the global credit markets has been significantly contracted by market disruptions during the past two years, making it costly to obtain new debt financing, when debt financing is available at all. To the extent that market conditions prevent us from obtaining temporary acquisition financing on financially attractive terms, our ability to make suitable investments in commercial real estate could be delayed or limited. If we are unable to invest equity proceeds in suitable real estate investments for an extended period of time, distributions to our stockholders may be suspended and may be lower and the value of investments in our shares could be reduced.
Lenders may require us to enter into restrictive covenants relating to our operations, which could limit our ability to make distributions to our stockholders.
When providing financing, a lender may impose restrictions on us that affect our distribution and operating policies and our ability to incur additional debt. Loan documents we enter into may contain covenants that limit our ability to further mortgage the property, discontinue insurance coverage, or replace our Advisor. These or other limitations may limit our flexibility and prevent us from achieving our operating plans.
Non-compliance with the financial covenants included in the documents evidencing our outstanding debt obligations may result in the lender imposing additional restrictions on our operations or constitute an event of default under such documents. Such events would harm our financial condition, results of operations and the return on our stockholders’ investment in us.
The documents evidencing our outstanding debt obligations typically include restrictive financial covenants, including that specified loan-to-value and debt service coverage ratios be maintained with respect to our financed properties before we can exercise certain rights under the documents relating to such properties. A breach of the financial covenants in these documents may result in the lender imposing additional restrictions on our operations, such as our ability to incur additional debt, or may allow the lender to impose cash traps with respect to cash flow from the property securing the loan. In addition, such a breach may constitute an event of default and the lender could require us to repay the debt immediately. If we fail to make such repayment in a timely manner, the lender may be entitled to take possession of any property securing the loan.
As of December 31, 2014, the average occupancy level at our Woodbury Mews property was below the minimum required under the financial covenants in our loan documents, violating a covenant of this loan. The lender has waived compliance with this covenant for the quarter ended December 31, 2014, but we can provide no assurances that the lender will continue to waive compliance with this covenant in future quarters. Any such violation constitutes an event of default under the loan agreement, and if we do not secure a waiver of this covenant in future quarters in which the property does not satisfy the minimum occupancy level, the lender could, in its discretion, declare the loan to be immediately due and payable, take possession of the Woodbury Mews property, enforce the Company’s guarantee of up to 25% of the loan balance, or exercise other remedies available to it under law. In addition, an event of default under the loan would increase the interest rate charged under the loan and adversely affect our ability to exercise the third extension option available under the loan upon its expiration in October 2015. Any of these actions would have an adverse effect on our financial condition, results of operations and the return on our stockholders’ investment in us.
High levels of debt or increases in interest rates could increase the amount of our loan payments, reduce the cash available for distribution to stockholders and subject us to the risk of losing properties in foreclosure if our cash flow is insufficient to make loan payments.
Our policies do not limit us from incurring debt. High debt levels would cause us to incur higher interest charges, would result in higher debt service payments, and could be accompanied by restrictive covenants. Interest we pay could reduce cash available for distribution to stockholders. Additionally, if we incur variable rate debt, increases in interest rates would increase our interest costs, which would reduce our cash flows and our ability to make distributions to our stockholders. In addition, if we need to repay existing debt during periods of rising interest rates, we could be required to liquidate one or more of our investments in properties at times which may not permit realization of the maximum return on such investments and could result in a loss.
High mortgage rates may make it difficult for us to finance or refinance properties, which could reduce the number of properties we can acquire, our cash flows from operations and the amount of cash distributions we can make
If mortgage debt is unavailable at reasonable rates, we may not be able to finance the purchase of properties. If we place mortgage debt on properties, we run the risk of being unable to refinance the properties when the debt becomes due or of being unable to refinance on favorable terms. If interest rates are higher when we refinance the properties, our income could be reduced. We may be unable to refinance properties. If any of these events occurs, our cash flow would be reduced. This, in turn, would reduce cash available for distribution to you and may hinder our ability to raise capital by issuing more stock or borrowing more money.
Federal Income Tax Risks
Failure to qualify as a REIT would subject us to federal income tax, which would reduce the cash available for distribution to you.
We expect to operate in a manner that will allow us to continue to qualify as a REIT for federal income tax purposes. However, the federal income tax laws governing REITs are extremely complex, and interpretations of the federal income tax laws governing qualification as a REIT are limited. Qualifying as a REIT requires us to meet various tests regarding the nature of our assets and our income, the ownership of our outstanding stock, and the amount of our distributions on an ongoing basis. While we intend to operate so that we will qualify as a REIT, given the highly complex nature of the rules governing REITs, the ongoing importance of factual determinations, including the tax treatment of certain investments we may make, and the possibility of future changes in our circumstances, no assurance can be given that we will so qualify for any particular year. If we fail to qualify as a REIT in any calendar year and we do not qualify for certain statutory relief provisions, we would be required to pay federal income tax on our taxable income. We might need to borrow money or sell assets to pay that tax. Our payment of income tax would decrease the amount of our income available for distribution to you. Furthermore, if we fail to maintain our qualification as a REIT and we do not qualify for certain statutory relief provisions, we no longer would be required to distribute substantially all of our REIT taxable income to our stockholders. Unless our failure to qualify as a REIT were excused under federal tax laws, we would be disqualified from taxation as a REIT for the four taxable years following the year during which qualification was lost.
Even if we qualify as a REIT for federal income tax purposes, we may be subject to other tax liabilities that reduce our cash flow and our ability to make distributions to our stockholders.
Even if we qualify as a REIT for federal income tax purposes, we may be subject to some federal, state and local taxes on our income or property. For example:
•In order to qualify as a REIT, we must distribute annually at least 90% of our REIT taxable income to our stockholders (which is determined without regard to the dividends-paid deduction or net capital gain). To the extent that we satisfy the distribution requirement but distribute less than 100% of our REIT taxable income, we will be subject to federal corporate income tax on the undistributed income.
•We will be subject to a 4% nondeductible excise tax on the amount, if any, by which distributions we pay in any calendar year are less than the sum of 85% of our ordinary income, 95% of our capital gain net income and 100% of our undistributed income from prior years.
•If we elect to treat property that we acquire in connection with a foreclosure of a mortgage loan or certain leasehold terminations as “foreclosure property,” we may avoid the 100% tax on gain from a resale of that property, but the income from the sale or operation of that property may be subject to corporate income tax at the highest applicable rate.
•If we sell an asset, other than foreclosure property, that we hold primarily for sale to customers in the ordinary course of business, our gain would be subject to the 100% “prohibited transaction” tax unless such sale were made by one of our taxable REIT subsidiaries.
We intend to make distributions to our stockholders to comply with the REIT requirements of the Internal Revenue Code.
To maintain our REIT status, we may be forced to forego otherwise attractive opportunities, which may delay or hinder our ability to meet our investment objectives and reduce the overall return to our stockholders.
To qualify as a REIT, we must satisfy certain tests on an ongoing basis concerning, among other things, the sources of our income, nature of our assets and the amounts we distribute to our stockholders. We may be required to make distributions to stockholders at times when it would be more advantageous to reinvest cash in our business or when we do not have funds readily available for distribution. Compliance with the REIT requirements may hinder our ability to operate solely on the basis of maximizing profits and the value of our stockholders’ investments in us.
If we borrow money to meet the REIT minimum distribution requirement or for other working capital needs, our expenses will increase, our net income will be reduced by the amount of interest we pay on the money we borrow and we will be obligated to repay the money we borrow from future earnings or by selling assets, which will decrease future distributions to stockholders.
To qualify as a REIT, we generally must distribute annually to our stockholders a minimum of 90% of our taxable income, excluding capital gains. We will be subject to regular corporate income taxes to the extent that we distribute less than 100% of our REIT taxable income each year. Additionally, we will be subject to a 4% nondeductible excise tax on any amount by which distributions paid (or deemed paid) by us in any calendar year are less than the sum of 85% of our ordinary income, 95% of our capital gain net income and 100% of our undistributed income from previous years. Payments we make to redeem our shares generally are not taken into account for purposes of these distribution requirements. If we do not have sufficient cash to make distributions necessary to preserve our REIT status for any year or to avoid taxation, we may be forced to borrow funds or sell assets even if the market conditions at that time are not favorable for these borrowings or sales. We may decide to borrow funds in order to meet the REIT minimum distribution requirements even if our management believes that the then prevailing market conditions generally are not favorable for such borrowings or that such borrowings would not be advisable in the absence of such tax considerations. Distributions made in excess of our net income will generally constitute a return of capital to stockholders.
If we were to pay a “preferential dividend” to certain stockholders, our status as a REIT could be adversely affected.
In order to qualify as a REIT, we must distribute to our stockholders at least 90% of our annual REIT taxable income (excluding net capital gain), determined without regard to the deduction for dividends paid. In order for distributions to be counted as satisfying the annual distribution requirements for REITs, and to provide us with a REIT-level tax deduction, the distribution must not be “preferential dividends.” A dividend is not a preferential dividend if the distribution is pro rata among all outstanding shares of stock within a particular class, and in accordance with the preferences among different classes of stock as set forth in our organizational documents. There is no de minimis exception with respect to preferential dividends; therefore, if the Internal Revenue Service were to take the position that we paid a preferential dividend, we may be deemed to have failed the 90% distribution test, and our status as a REIT could be terminated for the year in which such determination is made if we were unable to cure such failure.
If the Operating Partnership is classified as a “publicly-traded partnership” under the Internal Revenue Code, it could be subjected to tax on its income and the amount of distributions we make to our stockholders will be less.
We structured the Operating Partnership so that it would be classified as a partnership for federal income tax purposes. In this regard, the Internal Revenue Code generally classifies “publicly traded partnerships” (as defined in Section 7704 of the Internal Revenue Code) as associations taxable as corporations (rather than as partnerships), unless substantially all of their taxable income consists of specified types of passive income. In order to minimize the risk that the Internal Revenue Code would classify the Operating Partnership as a “publicly traded partnership” for tax purposes, we placed certain restrictions on the transfer and/or redemption of partnership units in our operating partnership. If the Internal Revenue Service were to assert successfully that the Operating Partnership is a “publicly traded partnership,” and substantially all of the Operating Partnership’s gross income did not consist of the specified types of passive income, the Internal Revenue Code would treat our Operating Partnership as an association taxable as a corporation. In such event, the character of our assets and items of gross income would change and would likely prevent us from qualifying and maintaining our status as a REIT. In addition, the imposition of a corporate tax on our Operating Partnership would reduce the amount of cash distributable to us from our Operating Partnership and therefore would reduce our amount of cash available to make distributions to our stockholders.
The tax on prohibited transactions will limit our ability to engage in transactions, including certain methods of securitizing mortgage loans that would be treated as sales for federal income tax purposes.
A REIT’s net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of assets, other than foreclosure property, deemed held primarily for sale to customers in the ordinary course of business. We might be subject to this tax if we were to dispose of or securitize loans in a manner that was treated as a sale of the loans for federal income tax purposes. Therefore, in order to avoid the prohibited transactions tax, we may choose not to engage in certain sales of loans at the REIT level, and may limit the structures we utilize for our securitization transactions, even though the sales or structures might otherwise be beneficial to us.
It may be possible to reduce the impact of the prohibited transaction tax by conducting certain activities through taxable REIT subsidiaries. However, to the extent that we engage in such activities through taxable REIT subsidiaries, the income associated with such activities may be subject to full corporate income tax.
Dividends payable by REITs do not qualify for the reduced tax rates.
The maximum tax rate for dividends payable to domestic stockholders that are individuals, trusts and estates is 20%. Dividends payable by REITs, however, are generally not eligible for this rate. The more favorable rates applicable to regular corporate dividends could cause investors who are individuals, trusts or estates to perceive investments in REITs to be relatively less attractive than investments in stock of non-REIT corporations that pay dividends, which could adversely affect the value of the stock of REITs, including our common stock.
Distributions to tax-exempt investors may be classified as unrelated business taxable income and tax-exempt investors would be required to pay tax on the unrelated business taxable income and to file income tax returns.
Neither ordinary nor capital gain distributions with respect to our common stock nor gain from the sale of stock should generally constitute unrelated business taxable income to a tax-exempt investor. However, there are certain exceptions to this rule. In particular:
•under certain circumstances, part of the income and gain recognized by certain qualified employee pension trusts with respect to our stock may be treated as unrelated business taxable income if our stock is predominately held by qualified employee pension trusts, such that we are a “pension-held” REIT (which we do not expect to be the case);
•part of the income and gain recognized by a tax exempt investor with respect to our stock would constitute unrelated business taxable income if such investor incurs debt in order to acquire the common stock; and
•part or all of the income or gain recognized with respect to our stock held by social clubs, voluntary employee benefit associations, supplemental unemployment benefit trusts and qualified group legal services plans which are exempt from federal income taxation under Sections 501(c)(7), (9), (17), or (20) of the Code may be treated as unrelated business taxable income.
Foreign investors may be subject to FIRPTA tax on the sale of our stock if we are unable to qualify as a “domestically controlled” REIT.
A foreign person disposing of a U.S. real property interest, including stock of a U.S. corporation whose assets consist principally of U.S. real property interests is generally subject to a tax, known as the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”) tax, on the gain recognized on the disposition. Distributions that are attributable to gains from the disposition of US real property interests by a REIT are subject to FIRPTA tax for foreign investors as though they were engaged in a trade or business and the distribution constitutes income which is effectively connected with such a business. Such FIRPTA tax does not apply, if the REIT is “domestically controlled.” A REIT is “domestically controlled” if less than 50% of the REIT’s capital stock, by value, has been owned directly or indirectly by persons who are not qualifying U.S. persons during a continuous five-year period ending on the date of disposition or, if shorter, during the entire period of the REIT’s existence.
We cannot be sure that we will qualify as a “domestically controlled” REIT. If we were to fail to so qualify, gain realized by foreign investors on a sale of our stock would be subject to FIRPTA tax, unless our stock were traded on an established securities market and the foreign investor did not at any time during a specified testing period directly or indirectly own more than 5% of the value of our outstanding common stock.
Retirement Plan Risks
If the fiduciary of an employee benefit plan subject to ERISA (such as a profit sharing, Section 401(k) or pension plan) or an owner of a retirement arrangement subject to Section 4975 of the Internal Revenue Code (such as an individual retirement account (“IRA”)) fails to meet the fiduciary and other standards under ERISA or the Internal Revenue Code as a result of an investment in our stock, the fiduciary could be subject to penalties and other sanctions.
There are special considerations that apply to employee benefit plans subject to the ERISA (such as profit sharing, Section 401(k) or pension plans) and other retirement plans or accounts subject to Section 4975 of the Internal Revenue Code (such as an IRA) that are investing in our shares. Fiduciaries and IRA owners investing the assets of such a plan or account in our common stock should satisfy themselves that:
•the investment is consistent with their fiduciary and other obligations under ERISA and the Internal Revenue Code;
•the investment is made in accordance with the documents and instruments governing the plan or IRA, including the plan’s or account’s investment policy;
•the investment satisfies the prudence and diversification requirements of Sections 404(a)(1)(B) and 404(a)(1)(C) of ERISA and other applicable provisions of ERISA and the Internal Revenue Code;
•the investment in our shares, for which no public market currently exists, is consistent with the liquidity needs of the plan or IRA;
•the investment will not produce an unacceptable amount of “unrelated business taxable income” for the plan or IRA; and
•the investment will not constitute a prohibited transaction under Section 406 of ERISA or Section 4975 of the Internal Revenue Code.
With respect to the annual valuation requirements described above, we will provide an estimated value for our shares. We can make no claim whether such estimated value will or will not satisfy the applicable annual valuation requirements under ERISA and the Internal Revenue Code. The Department of Labor or the Internal Revenue Service may determine that a plan fiduciary or an IRA custodian is required to take further steps to determine the value of our common stock. In the absence of an appropriate determination of value, a plan fiduciary or an IRA custodian may be subject to damages, penalties or other sanctions.
Failure to satisfy the fiduciary standards of conduct and other applicable requirements of ERISA and the Internal Revenue Code may result in the imposition of civil and criminal penalties and could subject the fiduciary to claims for damages or for equitable remedies, including liability for investment losses. In addition, if an investment in our shares constitutes a prohibited transaction under ERISA or the Internal Revenue Code, the fiduciary or IRA owner who authorized or directed the investment may be subject to the imposition of excise taxes with respect to the amount invested. In addition, the investment transaction must be undone. In the case of a prohibited transaction involving an IRA owner, the IRA may be disqualified as a tax-exempt account and all of the assets of the IRA may be deemed distributed and subjected to tax. ERISA plan fiduciaries and IRA owners should consult with counsel before making an investment in our common stock.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None
ITEM 2.
ITEM 2. PROPERTIES
As of December 31, 2014, our portfolio consisted of 30 healthcare facilities. The following table provides summary information regarding our facilities.
(1)This investment is accounted for on the equity method and discussed further in Note 6 to our Consolidated Financial Statements included in this report.
The following table shows tenant lease expirations related to the Company’s medical office building and triple net segments for the next ten years:
(1)This table excludes the Company’s Senior Living segment given that these properties represent month-to-month leases. The leases that expire in 2015 in the medical office building and triple net leased segments represents less than one percent of the Company’s consolidated revenues for the year ended December 31, 2014.
The weighted average annual effective rent for the senior living segment for the year ended December 31, 2014 is $65,179 per unit, based on total revenue per unit.
The weighted average annual effective rent for the medical office building and triple net segments for the year ended December 31, 2014 is $26.68 and $29.13 per square foot, based on total revenue per square foot.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
From time to time in the ordinary course of business, we may become subject to legal proceeding, claims, or disputes. As of the date hereof, we are not a party to any pending legal proceedings.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not Applicable
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
During the period covered by this report, there was no established public trading market for our shares of common stock.
On February 28, 2014, our Board of Directors approved an estimated per-share value of our common stock equal to $11.63 per share, calculated as of December 31, 2013.
In arriving at this estimate, our overall objective was to determine an estimated per-share value that is supported by a methodology and assumptions that are appropriate and that employ procedures and calculations that can be reliably repeated in future periods. In furtherance of this objective, we engaged HealthTrust, LLC (“HealthTrust”), an independent third-party commercial real estate valuation firm, to appraise all of our real estate assets. Our board of directors, including all of the independent directors, reviewed the qualifications of HealthTrust to appraise our real estate portfolio and determined that HealthTrust possesses the experience and professional competence necessary to be relied upon as experts with respect to the valuation of our real estate assets. The compensation we pay to HealthTrust is based on the scope of the work requested and not on the appraised values of our real estate assets.
HealthTrust’s analyses, opinions, and conclusions were developed in conformity with the Code of Professional Ethics and the Standards of Professional Appraisal Practice of the Appraisal Institute and in conformity with the Uniform Standards of Professional Appraisal Practice. They appraised each of our real estate assets individually, collecting all reasonably available material information deemed relevant in appraising our real estate properties, including property-level historical and projected operating revenues and expenses provided by our Advisor. Each appraisal was reviewed, approved and signed by an individual with the professional designation of Member of the Appraisal Institute.
Our board of directors also considered the qualifications of the Advisor, including its professional staff, and determined that the Advisor possesses the experience and professional competence necessary to be relied upon as an expert with respect to the valuation of our assets and liabilities and the shares of our common stock. Our Advisor prepared a report that recommended an estimated per-share value based on the appraisals prepared by HealthTrust and its own estimates of valuation with respect to our debt and non-real estate assets and liabilities. Our board of directors reviewed the report prepared by our Advisor, which recommended an estimated per-share value, and considered all information provided in light of its own knowledge regarding our assets and liabilities and unanimously agreed upon an estimated value of $11.63 per share, which is consistent with the recommendations of our Advisor and the independent appraisals.
Our estimated per-share value was calculated by aggregating the appraised value of our individual real estate assets and the estimated fair value of our other assets, subtracting the estimated fair value of our liabilities, including preferred investor liquidation preferences, adjusting the valuations for interests in joint ventures on selected assets, and dividing the total by the number of our common shares outstanding.
The following table summarizes the material components of the estimated net asset value per share for 2013 and 2012. Our estimated aggregate share value below is the same as our net asset value. It does not reflect any portfolio premium.
The estimated per-share value at December 31, 2013 and 2012 was determined using a methodology that follows the recommendations of the Investment Program Association, a trade association for non-listed direct investments (the “IPA”) outlined in the IPA Practice Guideline 2013-01 titled Valuations of Publicly Registered Non-Listed REITs, which was adopted in May 2013.
(1)Our real estate assets were appraised as of November 30, 2013 and September 30, 2012, for the December 31, 2013 and 2012 valuations, respectively, using valuation methods that we believe are typically used by investors for properties similar to ours, including capitalization of the property net operating income, comparison with sales of similar properties and a cost approach. We do not believe that there have been any material changes in the value of our real estate assets between the appraisal dates and the respective valuation dates. In determining the appraised value of our real estate assets, HealthTrust placed primary emphasis on a direct capitalization analysis, with the other approaches used principally to confirm the reasonableness of the value conclusion and to value assets in lease up. Using this methodology, the appraised value of our real estate assets reflects an overall increase from original purchase price, exclusive of acquisition costs, plus post-acquisition capital investments, of 26.0%.
The key assumptions used by HealthTrust to value our real estate assets are as follow:
We believe that the assumptions employed in the property appraisals are reasonable and within the ranges used for properties similar to ours and held by investors with similar expectations to our investors. However, a change in the assumptions utilized by the independent appraisers would impact the calculation of the value of our real estate assets. For example, assuming all other factors remain unchanged, a change in the assumed capitalization rate by 0.50% would yield a change in our net asset value ranging from an increase of approximately $1.29 per share to a decrease of approximately $1.14 per share. Based upon the property net operating income for our properties as estimated by the independent appraisers, the aggregate appraised value of the portfolio was $354.0 million at December 31, 2013 and $281.3 million at December 31, 2012.
(2)The fair value of our debt instruments was estimated using discounted cash flow models, which incorporate assumptions that we believe reflect the terms currently available on similar borrowing arrangements to borrowers with credit profiles similar to ours. Borrowing arrangements considered in determining appropriate discount rates include loan term, lender criteria and property characteristics.
(3)The liquidation preference of preferred interests reflects the payments that would be due to our Series C Preferred Stock holder and the Series B Convertible Preferred Unit holder at December 31, 2013, as determined in accordance with the terms of the governing documents.
(4)The fair value of our non-real estate assets and liabilities is estimated at December 31, 2013 and December 31, 2012 to reflect book value given their typically short-term (less than 1 year) settlement periods. Such adjustment also includes the effect of ownership of certain of our properties by joint venture partners and the amount that would be paid to our Advisor as a promote in accordance with IPA Practice Guidelines.
Our estimated per-share value of $11.63 as of December 31, 2013 has been positively affected by the performance of our portfolio as well as the overall strength of healthcare real estate market dynamics. We previously reported estimated per-share valuations of $11.63 (as of December 31, 2013) and $10.02 (as of December 31, 2012) on Current Reports on Form 8-K dated February 14, 2013 and December 22, 2011, respectively.
Limitations and Risks
As with any valuation methodology, our methodology is based upon a number of estimates and assumptions that may not be accurate or complete (see the footnotes to the table above). The above estimated per-share value does not reflect costs that would be incurred in connection with the sale of individual properties, or the premium, if any, that could result for a sale of the entire portfolio and related costs of such a disposition including payments to our Advisor. Different parties with different assumptions and estimates could derive a different estimated per-share value. Accordingly, with respect to our estimated per-share value, we can provide no assurance that:
·a stockholder would be able to realize this estimated value per share upon attempting to resell his or her shares;
·we would be able to achieve, for our stockholders, the estimated value per share, upon a listing of our shares of common stock on a national securities exchange, selling our real estate portfolio, or merging with another company; or
·the estimated share value or the methodologies relied upon to estimate the share value, will be found by any regulatory authority to comply with FINRA, ERISA, or any other regulatory requirements.
Furthermore, the estimated value of our shares was calculated as of a particular point in time. The value of our shares will fluctuate over time in response to, among other things, changes in real estate market fundamentals, capital markets activities, and attributes specific to the properties within our portfolio.
Stock Repurchase Program
In 2007, we adopted a stock repurchase program for investors who had held their shares for at least one year. Under our stock repurchase program, the repurchase price varied depending on the purchase price paid by the stockholder and the number of years the shares are held. Our board of directors may amend, suspend or terminate the program at any time with 30 days prior notice to stockholders. We have no obligation to repurchase our stockholders’ shares. In 2009, our board of directors waived the one-year holding period in the event of the death of a stockholder and adjusted the repurchase price to 100% of such stockholder’s purchase price irrespective of how long the stockholder held the shares.
Our stock repurchase program has been suspended since May 29, 2011 for all repurchases, except repurchases due to death of a stockholder. On March 31, 2014, we informed our stockholders of the suspension of the share repurchase program following the March 2014 redemption date. The Company redeemed all stock repurchase requests received prior to March 31, 2014 due to death. Thereafter no shares will be repurchased until the repurchase program is reinstated.
During the twelve months ended December 31, 2014, we redeemed shares pursuant to our stock repurchase program as follows:
(1)With respect to redemptions requested within one year of the death of a stockholder, we may, but will not be obligated to, redeem shares even if such redemption causes the number of shares redeemed to exceed 5% of the number of shares outstanding at the end of the prior calendar year.
Our board of directors reserves the right in its sole discretion at any time and from time to time, upon 30 days prior notice to our stockholders, to amend, reinstate or terminate our stock repurchase program.
Stockholders
As of March 15, 2015, we had approximately 11.5 million shares of common stock outstanding held by 3,275 stockholders of record.
Distributions
In order to meet the requirements for being treated as a REIT under the Internal Revenue Code, we must pay distributions to our shareholders each taxable year equal to at least 90% of our net ordinary taxable income. Until proceeds from our equity issuances are invested and generating operating cash flow sufficient to make distributions to stockholders, we may pay all or a substantial portion of our distributions from equity proceeds or from borrowings in anticipation of future cash flow. Our board generally declares distributions on a quarterly basis, which are paid on a quarterly basis. Quarterly distributions are paid based on daily record dates so our investor will be entitled to be paid distributions beginning on the day that they purchase shares.
During the years ended December 31, 2014 and 2013, we paid distributions, including any distributions reinvested, aggregating approximately $5.8 million and $6.2 million, respectively to our stockholders. From October 16, 2006 (date of inception) to December 31, 2014, distributions declared were approximately $30.8 million. Of this amount, $5.6 million has been reinvested through our distribution reinvestment plan and $23.7 million has been paid in cash to stockholders. Since inception, we have experienced a cumulative positive cash flow from operations of approximately $23.6 million. Accordingly, from our inception to date, our total distributions have exceeded our cash flows from operations.
The following table shows the distributions declared on daily record dates for each day during the period from January 1, 2013 through December 31, 2014, aggregated by quarter.
(1)Distributions are declared based on daily record dates and paid quarterly.
Our board of directors declared distributions for daily record dates occurring in the first quarter of 2013 in amounts per share that, if declared and paid each day for a 365-day period, would equate to an annualized rate of $.475 per share (4.75% based on share price of $10.00). Commencing with the declaration of distribution for daily record dates occurring in the second quarter of 2013 and thereafter, our board of directors has declared distributions in amounts per share that, if declared and paid each day for a 365-day period, would equate to an annualized rate of $.50 per share (5.00% based on share price of $10.00).
The declaration of distributions is at the discretion of our board of directors and our board will determine the amount of distributions on a regular basis. The amount of distributions will depend on our funds from operations, financial condition, capital requirements, annual distribution requirements under the REIT provisions of the Internal Revenue Code and other factors our board of directors deems relevant. We may amend or terminate the distribution reinvestment plan for any reason at any time upon 10 days prior written notice to participants.
Recent Sales of Unregistered Securities
Information regarding sales of unregistered securities during the period covered by this report has been previously disclosed in the Company’s current Reports on Form 8-K filed with the SEC on April 8, 2014, June 20, 2014, August 19, 2014, November 20, 2014, December 19, 2014 and January 6, 2015.
Equity Compensation Plans
Information about securities authorized for issuance under our equity compensation plans required for this item is included in Part III, Item 12 herein.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following should be read with the sections titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the notes thereto.
(1)Dividend per common share is calculated based on days outstanding during the year.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our consolidated financial statements and notes appearing elsewhere in this Form 10-K. See also “Special Note about Forward Looking Statements” preceding Item 1 of this report.
Overview
We were incorporated on October 16, 2006 for the purpose of engaging in the business of investing in and owning commercial real estate. We intend to invest primarily in investment real estate including health care properties and other real estate related assets located in markets in the United States.
Since January 1, 2012, our business has been managed by our Advisor pursuant to the Advisory Agreement. The Advisor is responsible for managing our affairs on a day-to-day basis and for identifying and making acquisitions and investments on our behalf under the terms of the Advisory Agreement. Our Advisor has contractual and fiduciary responsibilities to us and our stockholders. Under the terms of the Advisory Agreement, our Advisor will use commercially reasonable efforts to present to us investment opportunities and to provide a continuing and suitable investment program consistent with the investment policies and objectives adopted by our board of directors.
On February 10, 2013, we entered into a series of agreements, which have been amended at various points after February 10, 2013, with the Investor for the purpose of obtaining up to $158.7 million of equity funding to be used to finance future real estate investments (such investments and the related agreements are referred to herein collectively as “the KKR Equity Commitment”). Pursuant to the KKR Equity Commitment, we may issue and sell to the Investor and its affiliates on a private placement basis from time to time over a period of up to three years, up to $158.7 million in aggregate issuance amount of preferred securities in the Company and the Operating Partnership.
As of December 31, 2014, we had issued and outstanding 11,472,765 shares of common stock, and 1,000 shares of Series C Preferred Stock. All 1,000 shares of the Series C Preferred Stock were issued to the Investor pursuant to the KKR Equity Commitment. In addition, as of December 31, 2014 the Operating Partnership had issued and outstanding 20,000 Common Units, 1,000 Series A Preferred Units, and 946,560 Series B Preferred Units.
In connection with the KKR Equity Commitment, we entered into the Transition Agreement with our Advisor and the Investor which sets forth the terms for a transition to an internal management structure for the Company. The Transition Agreement, as amended, requires that the existing external advisory structure will remain in place upon substantially the same terms as currently in effect until February 10, 2017, upon which time the advisory function will be internalized in accordance with procedures set forth in the Transition Agreement.
We commenced our initial public offering of our common stock on June 20, 2008. We stopped making offers under our initial public offering on February 3, 2011 after raising gross offering proceeds of $123.9 million from the sale of approximately 12.4 million shares, including shares sold under the distribution reinvestment plan. On February 4, 2011, we commenced a follow-on offering of our common stock. We suspended primary offering sales in our follow-on offering on April 29, 2011 and completed the final sale of shares under the distribution reinvestment plan on May 10, 2011. We raised gross offering proceeds under the follow-on offering of $8.4 million from the sale of approximately 800,000 shares, including shares sold under the distribution reinvestment plan.
On June 19, 2013, we filed a registration statement on Form S-3 to register up to $99,000,000 of shares of common stock to be offered to our existing stockholders pursuant to the DRIP offering. The DRIP offering shares were initially offered at a purchase price of $10.02 per share, which was the current estimated per-share value of our common stock. Effective February 28, 2014, the offering price of the DRIP shares was adjusted to $11.63 per share, which is our updated estimated per-share value of common stock as of February 28, 2014.
Our revenues, which are comprised largely of rental income, include rents reported on a straight-line basis over the initial term of each lease. Our growth depends, in part, on our ability to (i) increase rental income and other earned income from leases by increasing rental rates and occupancy levels; and (ii) control operating and other expenses, including maximizing tenant recoveries as provided for in lease structures. Our operations are impacted by property specific, market specific, general economic and other conditions.
Market Outlook - Real Estate and Real Estate Finance Markets
In recent years, both the national and most global economies have experienced increased unemployment and a downturn in economic activity, as well as significant market fluctuations. Despite certain recent more positive economic indicators and improved stock market performance, the economic environment continues to be unpredictable and to present challenges that may delay the implementation of our business strategy or force us to modify it.
Despite the economic conditions discussed above, the demand for health care services is projected to continue to grow for the foreseeable future. According to The National Coalition on Healthcare, by 2016 nearly $1 in every $5 in the United States will be spent on healthcare, and the aging US population is expected to continue to fuel the need for healthcare services. The over age 65 population of the United States is projected to grow 36% between 2010 and 2020, compared with 9% for the general population, according to the US Census Bureau. Presently, the healthcare real estate market is fragmented, with a local or regional focus, offering opportunities for consolidation and market dominance. We believe that a diversified portfolio of healthcare property types minimizes risks associated with third-party payors, such as Medicare and Medicaid, while also allowing us to capitalize on the favorable demographic trends described above.
Highlights for the Twelve Months Ended December 31, 2014
·We purchased 1,113,213 shares of our common stock for an aggregate cost of approximately $10.0 million.
·We made the following investments during the year:
·We acquired a 25% joint venture interest that will develop Buffalo Crossing, a senior housing facility, for approximately $1.1 million;
·We acquired a 95% joint venture interest in Compass on the Bay, a senior housing facility, for approximately $11.7 million;
·We acquired St. Andrews Village, a senior housing facility, accounted for under a triple net lease arrangement, for approximately $42.5 million;
·We acquired a 65% joint venture interest in Blue Springs Senior Living Community, LLC that will develop The Parkway, a senior housing facility, for approximately $3.5 million;
·We acquired Live Oaks Village of Hammond and Slidell, two senior housing facilities, for approximately $12.7 million;
·We acquired Spring Village at Wildewood, a senior housing facility, for approximately $9.65 million;
·We acquired Gables of Hudson, a senior housing facility, for approximately $16.75 million;
·We acquired Sumter Place, a senior housing facility, for approximately $48.5 million.
Results of Operations
As of December 31, 2014, we operated in three reportable business segments: senior living operations, triple-net leased properties, and medical office building (“MOB”) properties. Our senior living operations segment invests in and operates assisted living, memory care and other senior housing communities located in the United States. We engage independent third party managers to operate these properties. Our triple-net leased properties segment invests in healthcare properties in the United States leased under long term “triple-net” or “absolute-net” leases, which require the tenants to pay all property-related expenses. Our MOB segment invests in medical office buildings and leases those properties to healthcare providers under long term “full service” leases which may require tenants to reimburse property related expenses to us.
We purchased our first property in January 2009, and as of December 31, 2014, we owned interests in 30 properties. For the years ended December 31, 2014, 2013 and 2012, our investments by segment were as follows:
(1)In addition to our three reportable business segments, which reflect the operations of our consolidated investments, we also have investments in unconsolidated joint ventures. For the years ended December 31, 2014, 2013, and 2012 we had three, one and two investments in unconsolidated joint ventures, respectively.
In January 2014, we acquired a 25% interest in a joint venture entity that will develop Buffalo Crossing, a senior living facility. In April 2014, we acquired a 95% joint venture interest in Compass on the Bay, a senior living facility. In August 2014, we acquired St. Andrews Village, a senior living facility, accounted for under a triple net lease arrangement. In October 2014, we acquired a 65% interest in a joint venture entity that will develop The Parkway. In November 2014, we acquired Spring Village at Wildewood and Live Oaks Village of Hammond and Slidell, senior living facilities. In December 2014, we acquired Gables of Hudson and Sumter Place, senior living facilities. Buffalo Crossing and The Parkway are accounted for as unconsolidated joint ventures.
In October 2013, we acquired Woodbury Mews, a two facility senior living campus, and in December 2013, we acquired a 95% joint venture interest in Standish Village, a senior living facility. In August 2013, we sold our joint venture interest in an unconsolidated property, Littleton Specialty Rehabilitation Facility.
The results of our operations for the twelve months ended December 31, 2014, 2013 and 2012 are affected by our acquisitions that have occurred during the periods.
Year Ended December 31, 2014 Compared to Year Ended December 31, 2013
(1)Net operating income, a non-GAAP supplemental measure, is defined as total revenue less property operating and maintenance expenses. We use net operating income to evaluate the operating performance of our real estate investments and to make decisions concerning the operation of the property. We believe that net operating income is useful to investors in understanding the value of income-producing real estate. Net income is the GAAP measure that is most directly comparable to net operating income; however, net operating income should not be considered as an alternative to net income as the primary indicator of operating performance as it excludes certain items such as depreciation and amortization, interest expense and corporate general and administrative expenses. Additionally, net operating income as we define it may not be comparable to net operating income as defined by other REITs or companies.
Senior Living Operations
Total revenue for senior living operations includes rental revenue and resident fees and service income. Property operating and maintenance expenses include labor, food, utilities, marketing, management and other property operating costs. Net operating income for the year ended December 31, 2014 increased to $23.2 million from $18.1 million for the year ended December 31, 2013. The increase is primarily due to the inclusion of the operations of Compass on the Bay in the second quarter of 2014 and The Villages at Wildewood, Live Oaks Village of Hammond and Slidell, and Gables of Hudson in the fourth quarter of 2014.
Triple-Net Leased Properties
Total revenue for triple-net leased properties includes rental revenue and expense reimbursements from tenants. Property operating and maintenance expenses include insurance and property taxes and other operating expenses reimbursed by our tenants. Net operating income increased to $6.7 million for the year ended December 31, 2014 compared to $5.3 million for the year ended December 31, 2013, primarily as a result of the acquisition of St. Andrews Village in the third quarter of 2014.
Medical Office Buildings
Total revenue for medical office buildings includes rental revenue and expense reimbursements from tenants. Property operating and maintenance expenses include utilities, repairs and maintenance, insurance and property taxes. Net operating income in 2014 was comparable to net operating income in 2013.
Unallocated (expenses) income
General and administrative expenses decreased to $1.3 million for the year ended December 31, 2014 from $1.6 million for the year ended December 31, 2013. The decrease is primarily the result of a $0.3 million higher income tax benefit in 2014 as compared to 2013.
Asset management fees and expenses increased to $4.1 million for the year ended December 31, 2014 from $2.9 million for the year ended December 31, 2013, as a result of a higher asset base. Real estate acquisition costs increased to $2.7 million for the year ended December 31, 2014 from $1.5 million for the year ended December 31, 2013, primarily as a result of the increase of acquisitions in 2014. The increase in depreciation and amortization to $11.8 million for the year ended December 31, 2014 from $8.7 million for the year ended December 31, 2013 reflects the effect of 2014 and 2013 real estate acquisitions.
Interest expense, net, for the year ended December 31, 2014 increased to $9.9 million from $8.3 million for the year ended December 31, 2013, primarily as a result of the debt incurred for acquisitions that occurred throughout 2014.
The 2014 equity in loss from unconsolidated joint ventures relates to the operations of Physicians Center MOB. The 2013 equity in loss from unconsolidated joint ventures relates to the operations of Physicians Center MOB and is partially offset by income from the Littleton Specialty Rehabilitation Facility that was sold in August of 2013.
Year Ended December 31, 2013 Compared to Year Ended December 31, 2012
(1) Net operating income, a non-GAAP supplemental measure, is defined as total revenue less property operating and maintenance expenses. We use net operating income to evaluate the operating performance of our real estate investments and to make decisions concerning the operation of the property. We believe that net operating income is useful to investors in understanding the value of income-producing real estate. Net income is the GAAP measure that is most directly comparable to net operating income; however, net operating income should not be considered as an alternative to net income as the primary indicator of operating performance as it excludes certain items such as depreciation and amortization, interest expense and corporate general and administrative expenses. Additionally, net operating income as we define it may not be comparable to net operating income as defined by other REITs or companies.
Senior Living Operations
Total revenue for senior living operations includes rental revenue and resident fees and service income. Property operating and maintenance expenses include labor, food, utilities, marketing, management and other property operating costs. Net operating income for the year ended December 31, 2013 increased to $18.1 million from $13.1 million for the year ended December 31, 2012. The increase is primarily due to the inclusion of the operations of the four Leah Bay joint venture properties for a full year in 2013 and the operations of Woodbury Mews and Standish Village properties after their acquisitions during the fourth quarter of 2013. In addition, net operating income from properties acquired prior to 2012 increased approximately 4.5% in 2013.
Triple-Net Leased Properties
Total revenue for triple-net leased properties includes rental revenue and expense reimbursements from tenants. Property operating and maintenance expenses include insurance and property taxes and other operating expenses reimbursed by our tenants. Net operating income increased to $5.3 million for the year ended December 31, 2013 compared to $4.7 million for the year ended December 31, 2012, primarily due to the ownership of a controlling interest in the Rome LTACH for a full year in 2013. The operations of Rome LTACH were included in our consolidated triple-net leased segment for a full year in 2013 and for the period after the date of the acquisition in April 2012 when we began consolidating Rome LTACH.
Medical Office Buildings
Total revenue for medical office buildings includes rental revenue and expense reimbursements from tenants. Property operating and maintenance expenses include utilities, repairs and maintenance, insurance and property taxes. Net operating income in 2013 was comparable to 2012 with only normal operating variances in income and recoverable expenses.
Unallocated (expenses) income
General and administrative expenses decreased to $1.6 million for the year ended December 31, 2013 from $1.8 million for the year ended December 31, 2012. The decrease is primarily the result of lower non-recurring professional fees, partially offset by a lower 2013 income tax benefit. Non-recurring expenses incurred in 2012 included consulting, legal and accounting charges incurred in the transition to a new advisor and corporate relocation.
Asset management fees and expenses increased to $2.9 million for the year ended December 31, 2013 from $2.2 million in 2012, as a result of the increase in net asset value of the December 31, 2012 portfolio and acquisition of two properties in 2013. Real estate acquisition costs and contingent considerations were comparable between years reflecting respective acquisition activity. The increase in depreciation and amortization to $8.7 million for the year ended December 31, 2013 from $7.1 million for the year ended December 31, 2012 reflects the effect of 2013 and 2012 real estate acquisitions.
Interest expense, net, for the year ended December 31, 2013 increased to $8.3 million from $7.0 million for the year ended December 31, 2012, due to real estate acquisitions in 2013 and 2012 and higher balances on refinanced loans, primarily during 2012, partially offset by lower interest rates on the refinanced debt. Other expense in 2013 consists of a gain of $1.7 on the disposition of our interest in an unconsolidated subsidiary, partially offset by an approximate $0.4 million loss on debt extinguishment. Other expense of $1.2 million in 2012 represents the loss associated with the refinancing of the loan on the Carriage Court at Hilliard property that was completed in October 2012.
The 2013 equity in loss from unconsolidated joint ventures relates to the operations of Physicians Center MOB, partially offset by income from the Littleton Specialty Rehabilitation Facility that was sold in August of 2013. The 2012 equity in loss from unconsolidated joint ventures includes the operations of the Rome LTACH joint venture until we acquired a controlling interest in the property in April 2012, after which it was consolidated, the operations of the Physicians Centre MOB joint venture, purchased in April 2012, and the operations of the Littleton Specialty Rehabilitation facility from its completion in July 2012.
Our equity interest in the Rome LTACH joint venture was revalued in connection with the acquisition of our partners’ joint venture interests resulting in a $1.3 million gain on remeasurement.
Liquidity and Capital Resources
On June 19, 2013, we filed a registration statement on Form S-3 to register up to $99,000,000 of shares of common stock to be offered to our existing stockholders pursuant to an amended and restated distribution reinvestment plan (the “DRIP Offering”). The DRIP Offering shares were initially offered at a purchase price of $10.02, which was the then-current estimated per-share value of our common stock. Effective February 28, 2014, DRIP offering price for the shares was adjusted to $11.63 per share, which is our estimated per-share value of our common stock as of February 28, 2014.
On February 10, 2013, we entered into the KKR Equity Commitment for the purpose of obtaining up to $158.7 million of equity funding to be used to finance future investment opportunities. Pursuant to the KKR Equity Commitment, we may issue and sell to the Investor and its affiliates on a private placement basis from time to time over a period of up to three years, up to $158.7 million in aggregate issuance amount of shares of newly issued Series C Preferred Stock and newly issued Series B Preferred Units. As of December 31, 2014, we had issued 1,000 shares of our Series C Preferred Stock and 946,560 Series B Preferred Units to the Investor (See Note 13 to the accompanying condensed consolidated financial statements) and approximately $63.9 million of this commitment is available for investments. Based on acquisition activity we anticipate, provided we can secure necessary lender amounts per a “change of control”, that we will draw all funds available from the KKR Equity Commitment by March 31, 2015.
We expect that primary sources of capital will include debt financing, net cash flows from operations and net proceeds from the sale of preferred units of partnership interest in our Operating Partnership in accordance with the terms of the KKR Equity Commitment to the extent we have funds available to draw. We expect that our primary uses of capital will be for property acquisitions, including promote monetization payments for other real estate-related investments, for the payment of tenant improvements and capital improvements and operating expenses, including interest expense on any outstanding indebtedness, reducing outstanding indebtedness and for the payment of distributions.
We intend to own our stabilized properties with low to moderate levels of debt financing. We will incur moderate to high levels of indebtedness when acquiring development or value-added properties and possibly other real estate investments. For our stabilized core plus properties, our long-term goal will be to use low to moderate levels of debt financing with leverage ranging from 50% to 65% of the value of the asset. For development and value-added properties, our goal will be to acquire and develop or redevelop these properties using moderate to high levels of debt financing with leverage ranging from 65% to 75% of the cost of the asset. Once these properties are developed, redeveloped and stabilized with tenants, we plan to reduce the levels of debt to fall within target debt ranges appropriate for core properties. While we seek to fall within the outlined targets on a portfolio basis, for any specific property we may exceed these estimates. To the extent sufficient proceeds from public offerings, debt financing, the KKR Equity Commitment or a combination of these are unavailable to repay debt financing down to the target ranges within a reasonable time as determined by our board of directors, we will endeavor to raise additional equity or sell properties to repay such debt so that we will own our properties with low to moderate levels of permanent financing. In the event that we are unable to raise additional equity, our ability to diversify our investments may be diminished.
As of December 31, 2014, we had approximately $35.6 million in cash and cash equivalents on hand. Our liquidity will increase from the sale of common stock pursuant to our DRIP Offering, the sale of preferred units of partnership interest in our Operating Partnership pursuant to the KKR Equity Commitment, if refinancing results in excess loan proceeds, and increased cash flows from operations. The Company’s liquidity will decrease as net offering proceeds are expended in connection with acquisitions and if distributions are made in excess of cash available from operating cash flows.
In addition, one of our principal liquidity requirements includes debt service payments and the repayment of maturing debt. As of December 31, 2014, our notes payable were $276.4 million ($276.5 million, including premium).
We are required by the terms of the applicable loan documents to meet certain financial covenants, such as debt service coverage ratios, rent coverage ratios and reporting requirements. As of December 31, 2014, we were in compliance with all such covenants and requirements, with the exception of Woodbury Mews. As of December 31, 2014, the average occupancy level at our Woodbury Mews property was below the minimum required under the financial covenants in our loan documents, violating a covenant of this loan. The lender has waived compliance with this covenant for the quarter ended December 31, 2014, but we can provide no assurances that the lender will continue to waive compliance with this covenant in future quarters. Any such violation constitutes an event of default under the loan agreement, and if we do not secure a waiver of this covenant in future quarters in which the property does not satisfy the minimum occupancy level, the lender could, in its discretion, declare the loan to be immediately due and payable, take possession of the Woodbury Mews property, enforce the Company’s guarantee of up to 25% of the loan balance, or exercise other remedies available to it under law. If the lender were to declare the loan to be immediately due and payable, we expect to refinance the loan in satisfaction of the debt. Any such refinancing may be on terms and conditions less favorable than the terms currently available under the loan.
Cash flows provided by operating activities for the years ended December 31, 2014 and 2013 were $13.2 million and $8.9 million, respectively. The increase in cash flows from operations was primarily due to an increase in net operating income of $6.6 million, partially offset by the timing of cash receipts and payments.
Cash flows used in investing activities for the years ended December 31, 2014 and 2013 were $141.7 million and $50.2, respectively. The 2014 increase was due primarily to a higher level of property acquisition activity in 2014, including: the investment in Buffalo Crossing and the acquisition of Compass on the Bay, St. Andrews Village, Spring Village at Wildewood, Live Oaks Village of Hammond and Slidell, Gables of Hudson and Sumter Place. The 2013 amount was comprised of the acquisitions of Woodbury Mews and Standish Village and capital expenditures related to existing properties which were offset by proceeds from the disposition of the investment in the Littleton Specialty Rehabilitation Facility.
Cash flows provided by financing activities for the years ended December 31, 2014 and 2013 were $142.3 million and $41.6 million, respectively. The change was due primarily to activity related to the KKR Equity Commitment and redemption of the Company’s common shares in 2014. During the year ended December 31, 2014, the Company received $75.1 million of net proceeds from the issuance of Series B Preferred Units, redeemed $10.6 million off its common shares, paid $5.8 million of distributions to stockholders, and paid $2.8 million of distributions to noncontrolling interests, principally to the investor in the Series B Preferred Units. During the year ended December 31, 2013, the Company received $15.1 million of net proceeds from the issuance of Series B Preferred Units, redeemed $2.0 million of its common shares, paid $6.2 million of distributions to stockholders, paid $1.2 million of distributions to noncontrolling interests and paid $4.1 million of fees and expenses in connection with the KKR Equity Commitment. During the year ended December 31, 2014, the Company received proceeds from notes payable related to the acquisitions of St. Andrews Village, Spring Village at Wildewood, Live Oaks Village of Hammond and Slidell, Gables of Hudson, and Sumter Place as well as the debt refinancing of Woodland Terrace at the Oaks and Mesa Vista Inn of $104.0 million. These proceeds were offset by the Company’s repayment of notes payable of $15.5 million. During the year ended December 31, 2013, the Company received proceeds, net of related costs of $15.1 million in connection with the KKR Equity Commitment, and proceeds from notes payable related to Woodbury Mews, Standish Village, and the refinance on Oakleaf in the amount of $55.9 million. These proceeds were offset by the Company’s repayment of notes payable of $19.5 million.
We expect to have sufficient cash available from cash on hand and operations to fund capital improvements and principal payments due on our borrowings in the next twelve months. We expect to fund stockholder distributions from cash on hand and from the excess of cash provided by operations over required capital improvements and debt payments. This excess may be insufficient to make distributions at the current level or at all.
There may be a delay between the generation of cash available for investment and the purchase of properties. During this period, proceeds from sales of securities may be temporarily invested in short-term, liquid investments that could yield lower returns than investments in real estate.
Potential future sources of capital include proceeds from future equity offerings, proceeds from secured or unsecured financings from banks or other lenders, proceeds from the sale of properties and undistributed funds from operations.
Funds from Operations and Modified Funds from Operations
Funds from operations (“FFO”) is a non-GAAP financial measure that is widely recognized as a measure of REIT operating performance. We compute FFO in accordance with the definition outlined by the National Association of Real Estate Investment Trusts (“NAREIT”). NAREIT defines FFO as net income (loss), computed in accordance with GAAP, excluding extraordinary items, as defined by the accounting principles generally accepted in the United States of America (“GAAP”) , and gains (or losses) from sales of property, plus depreciation and amortization on real estate assets, and after adjustments for unconsolidated partnerships, joint ventures, noncontrolling interests and subsidiaries. Our FFO may not be comparable to FFO reported by other REITs that do not define the term in accordance with the current NAREIT definition or that interpret the current NAREIT definition differently than we do. We believe that FFO is helpful to investors and our management as a measure of operating performance because it excludes depreciation and amortization, gains and losses from property dispositions, and extraordinary items, and as a result, when compared year to year, reflects the impact on operations from trends in occupancy rates, rental rates, operating costs, development activities, general and administrative expenses, and interest costs, which is not immediately apparent from net income. Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting alone to be insufficient. As a result, our management believes that the use of FFO, together with the required GAAP presentations, provide a more complete understanding of our performance. Factors that impact FFO include start-up costs, fixed costs, delay in buying assets, lower yields on cash held in accounts pending investment, income from portfolio properties and other portfolio assets, interest rates on acquisition financing and operating expenses. FFO should not be considered as an alternative to net income (loss), as an indication of our performance, nor is it indicative of funds available to fund our cash needs, including our ability to make distributions, as well as dividend sustainability.
Changes in the accounting and reporting rules under GAAP have prompted a significant increase in the amount of non-cash and non-operating items included in FFO, as defined. Therefore, we use modified funds from operations (“MFFO”), which excludes from FFO real estate acquisition expenses, and non-cash amounts related to straight line rent to further evaluate our operating performance. We compute MFFO in accordance with the definition suggested by the Investment Program Association (the “IPA”), the trade association for direct investment programs (including non-listed REITs). However, certain adjustments included in the IPA’s definition are not applicable to us and are therefore not included in the foregoing definition.
We believe that MFFO is a helpful measure of operating performance because it excludes costs that management considers more reflective of investing activities or non-operating changes. Accordingly, we believe that MFFO can be a useful metric to assist management, investors and analysts in assessing the sustainability of our operating performance. As explained below, management’s evaluation of our operating performance excludes the items considered in the calculation based on the following considerations:
·Adjustments for straight line rents. Under GAAP, rental income recognition can be significantly different than underlying contract terms. By adjusting for these items, MFFO provides useful supplemental information on the economic impact of our lease terms and presents results in a manner more consistent with management’s analysis of our operating performance.
·Real estate acquisition costs. In evaluating investments in real estate, including both business combinations and investments accounted for under the equity method of accounting, management’s investment models and analysis differentiate costs to acquire the investment from the operations derived from the investment. These acquisition costs have been funded from the proceeds of our initial public offering and other financing sources and not from operations. We believe by excluding expensed acquisition costs, MFFO provides useful supplemental information that is comparable for each type of our real estate investments and is consistent with management’s analysis of the investing and operating performance of our properties. Real estate acquisition expenses include those paid to our Advisor and to third parties.
·Non-recurring gains or losses included in net income from the extinguishment or sale of debt.
·Unrealized gains or losses resulting from consolidation from, or deconsolidation to equity accounting.
FFO or MFFO should not be considered as an alternative to net income (loss) nor as an indication of our liquidity. Nor is either indicative of funds available to fund our cash needs, including our ability to make distributions. Both FFO and MFFO should be reviewed along with other GAAP measurements. Our FFO and MFFO as presented may not be comparable to amounts calculated by other REITs. In addition, FFO and MFFO presented for different periods may not be directly comparable.
We believe that MFFO is helpful as a measure of operating performance because it excludes costs that management considers more reflective of investing activities or non-operating changes.
Our calculations of FFO and MFFO for the years ended December 31, 2014, 2013, and 2012 are presented below:
Election as a REIT
For federal income tax purposes, we have elected to be taxed as a REIT, under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Code”) beginning with our taxable year ending December 31, 2008. Under the Internal Revenue Code of 1986, we are not subject to federal income tax on income that we distribute to our stockholders. REITs are subject to numerous organizational and operational requirements in order to avoid taxation as a regular corporation, including a requirement that they generally distribute at least 90% of their annual ordinary taxable income to their stockholders. If we fail to qualify for taxation as a REIT in any year, our income will be taxed at regular corporate rates, and we may be precluded from qualifying for treatment as a REIT for the four-year period following our failure to qualify. Our failure to qualify as a REIT could result in us having a significant liability for taxes.
REIT status imposes limitations related to operating assisted-living properties. Generally, to qualify as a REIT, we cannot directly operate assisted-living facilities. However, such facilities may generally be operated by a taxable REIT subsidiary (“TRS”) pursuant to a lease with the REIT. Therefore, we have formed a TRS to lease any assisted-living properties we acquire and to operate the assisted-living properties pursuant to contracts with qualified unaffiliated management companies. The TRS and the REIT have made the applicable election for the TRS to qualify as a TRS. Under the management contracts, the unaffiliated management companies will have direct control of the daily operations of these assisted-living properties.
Off-Balance Sheet Arrangements
Other than outstanding notes payable on the Company’s unconsolidated joint ventures, there are no off-balance sheet transactions, arrangements or obligations (including contingent obligations) that have, or are reasonably likely to have, a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.
Inflation
Although the real estate market has not been affected significantly by inflation in the recent past due to the relatively low inflation rate, we expect that the majority of our tenant leases will include provisions that would protect us to some extent from the impact of inflation. Where possible, our leases will include provisions for rent escalations and partial reimbursement to us of expenses. Our ability to include provisions in the leases that protect us against inflation is subject to competitive conditions that vary from market to market.
Critical Accounting Policies
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, or GAAP, requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We believe that our critical accounting policies are those that require significant judgments and estimates such as those related to fair value, real estate purchase price allocation, evaluation of possible impairment of real property assets, revenue recognition and valuation of receivables, income taxes, and uncertain tax positions. These estimates are made and evaluated on an on-going basis using information that is currently available as well as various other assumptions believed to be reasonable under the circumstances. Actual results could vary from those estimates, perhaps in material adverse ways, and those estimates could be different under different assumptions or conditions.
Investments in Real Estate
Upon acquisition of a property, we allocate the purchase price of the property based upon the fair value of the assets acquired, which generally consist of land, buildings, site improvements, tenant improvements, intangible lease assets or liabilities including in-place leases, above market and below market leases, tenant relationships and goodwill. We allocated the purchase price to the fair value of the tangible assets of an acquired property by valuing the property as if it were vacant. The value of the building and improvements are depreciated over an estimated useful life of 15 to 39 years.
In-place lease values are calculated based on management’s evaluation of the specific characteristics of each tenant’s lease and our overall relationship with the respective tenant.
Acquired above and below market leases are valued based on the present value of the difference between prevailing market rates and the in-place rates over the remaining lease term. The value of acquired above and below market leases is amortized over the remaining non-cancelable terms of the respective leases as an adjustment to rental revenue on our consolidated statements of operations.
We consider any bargain periods in our calculation of fair value of below-market leases and to amortize our below-market leases over the remaining non-cancelable lease term plus any bargain renewal periods in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 840-20-20, as determined by our management at the time we acquire real property with an in-place lease. The renewal option rates for our acquired leases do not include any fixed rate options and, instead, contain renewal options that are based on fair value terms at the time of renewal. Accordingly, no fixed rate renewal options were included in the fair value of below-market leases acquired and the amortization period is based on the acquired non-cancelable lease term.
Should a significant tenant terminate their lease, the unamortized portion of intangible assets or liabilities is charged to revenue.
Fair Value of Financial Instruments
FASB ASC 825-10, “Financial Instruments,” requires the disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practical to estimate that value.
Fair value represents the estimate of the proceeds to be received, or paid in the case of a liability, in a current transaction between willing parties. ASC 820, Fair Value Measurement (“ASC 820”) establishes a fair value hierarchy to categorize the inputs used in valuation techniques to measure fair value. Inputs are either observable or unobservable in the marketplace. Observable inputs are based on market data from independent sources and unobservable inputs reflect the reporting entity’s assumptions about market participant assumptions used to value an asset or liability.
Financial assets and liabilities recorded at fair value on the consolidated balance sheets are categorized based on the inputs to the valuation techniques as follows:
Level 1. Quoted prices in active markets for identical instruments.
Level 2. Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3. Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Assets and liabilities measured at fair value are classified according to the lowest level input that is significant to their valuation. A financial instrument that has a significant unobservable input along with significant observable inputs may still be classified as a Level 3 instrument.
We generally determine or calculate the fair value of financial instruments using present value or other valuation techniques, such as discounted cash flow analyses, incorporating available market discount rate information for similar types of instruments and our estimates for non-performance and liquidity risk. These techniques are significantly affected by the assumptions used, including the discount rate, credit spreads, and estimates of future cash flow.
Impairment of Real Estate Assets and Goodwill
Real Estate Assets
Rental properties, properties undergoing development and redevelopment, land held for development and intangibles are individually evaluated for impairment in accordance with ASC 360-10, “ Property, Plant & Equipment ” when conditions exist which may indicate that it is probable that the sum of expected future undiscounted cash flows is less than the carrying amount. We assess the expected undiscounted cash flows based upon numerous factors, including, but not limited to, appropriate capitalization rates, construction costs, available market information, historical operating results, known trends and market/economic conditions that may affect the property and our assumptions about the use of the asset, including, if necessary, a probability-weighted approach if multiple outcomes are under consideration. Upon determination that impairment has occurred, a write-down will be recorded to reduce the carrying amount to its estimated fair value.
In accordance with ASC 360 “Accounting for the Impairment or Disposal of Long-lived Assets,” we assess whether there has been impairment in the value of our investments in real estate whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Our portfolio is evaluated for impairment on a property-by-property basis. Indicators of potential impairment include the following:
·Change in strategy resulting in a decreased holding period;
·Decreased occupancy levels;
·Deterioration of the rental market as evidenced by rent decreases over numerous quarters;
·Properties adjacent to or located in the same submarket as those with recent impairment issues; and/or
·Tenant financial problems.
During 2014, 2013 and 2012, we did not record any impairment charges related to our investments in real estate.
Goodwill
We review goodwill for impairment annually and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. The guidance on goodwill impairment requires us to annually test goodwill for impairment under a two-step impairment test or under a qualitative assessment which became optional in 2011. In the first step of the two-step test, we compare the fair value of each reporting unit to its carrying value. We determine the fair value of our reporting unit based on the income approach. Under the income approach, we calculate the fair value of a reporting unit based on the present value of estimated future cash flows. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not impaired. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then the second step of the impairment test is performed in order to determine the implied fair value of the reporting unit’s goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then the company records an impairment loss equal to the difference.
For the years ended December 31, 2014 and 2013, the Company elected to perform Step 1 in its evaluation of goodwill. The Company did not record any impairment charges related to our goodwill.
Revenue Recognition
Revenue is recognized when four basic criteria are met: persuasive evidence of an arrangement exists, services have been delivered, the amount of revenue is fixed or determinable, and collection is reasonably assured. Leases with fixed annual rental escalators are generally recognized on a straight-line basis over the initial lease period, subject to a collectability assessment. Rental income related to leases with contingent rental escalators is generally recorded based on the contractual cash rental payments due for the period. Because our leases may provide for free rent, lease incentives, or other rental increases at specified intervals, we straight-line the recognition of revenue, which results in the recording of a receivable for rent not yet due under the lease terms. Our revenues are comprised largely of rental income and other income collected from tenants.
Investments in Unconsolidated Entities
We account for our investments in unconsolidated joint ventures under the equity method of accounting. We exercise significant influence, but do not control these entities or direct the activities that most significantly impact the venture’s performance. Investments in unconsolidated entities are recorded initially at cost and subsequently adjusted for cash contributions and distributions. We recognize our allocable share of the equity in earnings of our unconsolidated entities based on the respective venture’s structure and preferences.
Consolidation Considerations for Our Investments in Joint Ventures
ASC 810-10, “Consolidation,” addresses how a business enterprise should evaluate whether it has a controlling interest in an entity through means other than voting rights and, accordingly, should consolidate the entity. We analyze our joint ventures in accordance with this accounting standard to determine whether they are variable interest entities and, if so, whether we are the primary beneficiary. Our judgment with respect to our level of influence or control over an entity and whether we are the primary beneficiary of a variable interest entity involves consideration of various factors including the form of our ownership interest, our voting interest, the size of our investment (including loans) and our ability to participate in major policy-making decisions. Our ability to correctly assess our influence or control over an entity affects the presentation of these investments in our consolidated financial statements. Please refer to Note 6, Investments in Unconsolidated Entities of the accompanying consolidated financial statements.
Income Taxes
As part of the process of preparing our consolidated financial statements, significant management judgment is required to evaluate our compliance with REIT requirements. Our determinations are based on interpretation of tax laws, and our conclusions may have an impact on the income tax expense recognized. Adjustments to income tax expense may be required as a result of: (i) audits conducted by federal and state tax authorities, (ii) our ability to qualify as a REIT and (iii) changes in tax laws.
For federal income tax purposes, we have elected to be taxed as a REIT, under Sections 856 through 860 of the Code beginning with our taxable year ended December 31, 2008, which imposes limitations related to operating assisted-living properties. As of December 31, 2014, we had acquired fourteen assisted-living facilities and formed twenty-four wholly owned taxable REIT subsidiaries, or TRSs, which includes a Master TRS that consolidates our wholly owned TRSs. The properties are operated pursuant to leases with our TRSs. Our TRSs have engaged qualified unaffiliated management companies to operate the assisted-living facilities. Under the management contracts, the managers have direct control of the daily operations of the properties.
We are subject to state and local income taxes in some jurisdictions, and in certain circumstances we may also be subject to federal excise taxes on undistributed income. In addition, certain of our activities must be conducted by subsidiaries which elect to be treated as TRSs. TRSs are subject to both federal and state income taxes. We recognize tax penalties relating to unrecognized tax benefits as additional tax expense. Interest relating to unrecognized tax benefits is recognized as interest expense. Under section 857(b), an excise tax of 100% is imposed on any excessive amount of rental income received by the REIT in connection with services performed by its TRS to a tenant of the REIT and the deductions of the TRS for payments made to the REIT if rental income and deductions are not at arms’ length. Several safe harbors are provided for rental income received by the REIT, any of which, if met, prohibit the imposition of the 100% excise tax.
Subsequent Events
Georgetown Loan
On January 15, 2015, the Company, through an indirect wholly owned subsidiary, originated a development loan in the amount of $41.9 million for The Delaney at Georgetown Village development project located in Georgetown, Texas (the “Georgetown Loan”). The borrower, Westminster-LCS Georgetown LLC, is not affiliated with the Company or the Advisor. The borrower is a joint venture between Life Care Companies, LLC (“LCS”) and a fund sponsored by Westminster Capital (“Westminster”), and will use the proceeds of the Georgetown Loan to develop a senior living facility with 207 units including independent living, assisted living and memory care.
The Georgetown Loan is secured by a first mortgage lien on the land, building, and all improvements made thereon. The Georgetown Loan matures on January 15, 2020 with one 12-month option to extend at the Company’s option, and bears interest at a fixed rate of 7.9% per annum for the term of the loan. Advances will be made periodically during the construction period to cover documented hard and soft costs of construction and interest, commencing after the borrower has expended its required equity contribution, and subject to customary construction draw conditions. The borrower paid a loan origination fee equal to 1% of the loan amount. Monthly payments are interest only for the term of the loan. The Company has the option to purchase the property at fair market value upon stabilization or 48 months. Fair market value is determined by the average asset value of independent appraisals obtained by the lender and borrower. Regardless of whether the Company exercises the option to purchase the property, the Company will be entitled to participate in the value creation which is the difference between the fair market value and the total development cost. The Georgetown Loan is non-recourse to LCS and Westminster, but LCS has provided cost and completion guarantees as well as a guaranty of customary “bad boy” carve-outs.
The Company expects to fund the Georgetown Loan with proceeds from the sale of Series B Preferred Units to the Investor. Upon funding of the Georgetown Loan, interest income on the loan receivable will be recognized as earned based upon the principal amount outstanding subject to an evaluation of collectability risks.
Sale of Preferred Units in the Operating Partnership
On January 16, 2015, a purchase of securities related to the Georgetown Loan (the “Georgetown Put Exercise”) was completed by the Investor pursuant to the KKR Equity Commitment.
Pursuant to the Georgetown Put Exercise, the Investor agreed to fund $41.9 million related to the Georgetown Loan and was issued the following securities:
·155,000 newly-issued Series B Preferred Units, which are convertible into approximately 1,546,906 shares of the Company’s common stock at the currently effective conversion price.
After giving effect to the 155,000 Series B Preferred Units issued upon the closing of the Georgetown Put Exercise and the Series B Preferred Units relating to the Georgetown Put Exercise remaining to be issued, 220,580 Series B Preferred Units remain issuable under the Purchase Agreement.
Sumter Grand
On February 6, 2015, through a wholly-owned subsidiary, we acquired real estate property (“Sumter Grand”) from Retirement Two, LLC, which is not affiliated with us, for a purchase price of $31.5 million. Sumter Grand consists of a 150-unit independent living facility located in The Villages, Florida. We funded the purchase of Sumter Grand with proceeds from the sale to the Investor of Series B Preferred Units pursuant to the KKR Equity Commitment on December 30, 2014 and with proceeds from a mortgage loan from KeyBank National Association, Inc.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk includes risks that arise from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market sensitive instruments. We invest our cash and cash equivalents in government backed securities and FDIC insured savings account which, by their nature, are subject to interest rate fluctuations. However, we believe that the primary market risk to which we will be exposed to is interest rate risk relating to the variable portion of our debt financing. As of December 31, 2014, we had approximately $120.0 million of variable rate debt, the majority of which is at a rate tied to short term LIBOR rates. A 1.0% change in 3-Month LIBOR would result in a change in annual interest expense of approximately $1.2 million per year. Our interest rate risk management objectives will be to monitor and manage the impact of interest rate changes on earnings and cash flows by using certain derivative financial instruments such as interest rate swaps and caps in order to mitigate our interest rate risk on variable rate debt. We will not enter into derivative or interest rate transactions for speculative purposes.
In addition to changes in interest rates, the fair value of our real estate is subject to fluctuations based on changes in the real estate capital markets, market rental rates for office space, local, regional and national economic conditions and changes in the credit worthiness of tenants. All of these factors may also affect our ability to refinance our debt if necessary.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See the index included at Item 15. Exhibits, Financial Statement Schedules.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports we file or submit under the Securities and Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our senior management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Our Chief Executive Officer and Chief Financial Officer have reviewed the effectiveness of our disclosure controls and procedures and have concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report.
In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Management’s Report on Internal Control Over Financial Reporting
Our Chief Executive Officer and Chief Financial Officer are responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities and Exchange Act of 1934. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on their evaluation as of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer have concluded that we maintained effective internal control over financial reporting as of December 31, 2014.
There have been no changes in our internal control over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
This annual report does not include an attestation report of our independent registered public accounting firm regarding control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to the Dodd-Frank Wall Street and Consumer Protection Act, which exempts non-accelerated filers from the auditor attestation requirement of Section 404 (b) of the Sarbanes-Oxley Act.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Our board of directors amended our Second Amended and Restated Bylaws (the “Bylaws”) as of March 20, 2015. The amendment is effective immediately. Section 2.2 of the Bylaws was amended to provide that the annual meeting of stockholders be held on any date determined by our board of directors. Prior to adoption of the amendment, the Bylaws provided that the annual meeting of stockholders would be held during the month of May.
PART III
ITEM 10.
ITEM 10.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The Board of Directors
The names, ages, principal occupations and certain other information about the members of our board of directors are set forth below.
Billy Butcher, age 34, is one of our KKR-selected Directors as he was elected to be one of our directors, and a member of our investment committee, on March 12, 2013 in connection with, and as a condition to, the execution of the KKR Equity Commitment. Mr. Butcher is an executive officer of Sentinel RE Investment Holdings GP LLC, which is the general partner of the Investor. Mr. Butcher is currently employed by KKR as a Director in its real estate investment business. Mr. Butcher joined KKR in 2004, and prior to KKR’s establishment of a dedicated real estate investment effort, Mr. Butcher worked in KKR’s corporate private equity business, both in the United States and internationally.
Prior to joining KKR, Mr. Butcher was employed with Goldman, Sachs & Co. He holds an A.B. from Princeton University and an M.B.A. from the Stanford University Graduate School of Business.
Romeo Cefalo, age 65, has served as one of our independent directors since August 2008. From 2004 to 2006, Mr. Cefalo was Executive Vice President of Real Estate, Construction and New Store Development for Albertsons, Inc. He was responsible for managing Albertson’s real estate operation and $1.5 billion annual capital budget. From 2001 to 2004, Mr. Cefalo was Executive Vice President of Operations for Albertsons. His responsibilities included managing growth planning and capital budgets. From 1995 to 2001, Mr. Cefalo was President of Lucky Stores in Buena Park, California, and was responsible for $6.0 billion in sales and $400.0 million in earnings. Mr. Cefalo received his Master of Business Administration from New Hampshire College in 1984.
For the following reasons, the board concluded that Mr. Cefalo should serve as a director. In addition to his management experience, Mr. Cefalo’s specific knowledge of commercial real estate and related investment and financing activities position him very well to provide the board of directors with valuable industry-specific insight and experience.
Barry Chase, age 59, has served as one of our independent directors since September 2007. He has been actively involved in the real estate industry since 1980. Mr. Chase is the Co-Founder and Managing Principal of AVP advisors, a real estate investment management firm for institutional investors. From 2004 to present, Mr. Chase has worked for AVP advisors. From 2002 to 2003, Mr. Chase was a Principal of Platinum Capital advisors, and from 1998 to 2002, he was the Executive Vice President and the President of Koll Development Company’s Western Division, where he developed more than nine million square feet of office, industrial, retail and mixed-use projects.
Prior to joining the Koll Development Company, Mr. Chase held executive level positions with several nationally recognized real estate companies. He served as the President of Cushman Investment and Development Company, and the Executive Vice President, General Counsel and member of the board of directors of Cushman Realty Corporation and as the Executive Vice President - Acquisitions of CT Realty Corporation. Mr. Chase began his real estate career with Sunrise Investment, Inc. As Executive Vice President and General Counsel of Sunrise, Mr. Chase was in charge of property acquisitions/dispositions and capital raising for the firm’s real estate private placements. Mr. Chase attended California State University, Northridge and received his J.D. Degree from the University of San Fernando. He is an inactive member of the California State Bar.
For the following reasons, the board concluded that Mr. Chase should serve as a director. Mr. Chase brings to the board of directors demonstrated management ability at senior levels as well as extensive relevant experience in the commercial real estate industry. Mr. Chase’s legal background provides our board with leadership and consensus-building skills on a variety of matters, including corporate governance.
Daniel A. Decker, age 62, is one of our KKR-selected Directors. He is the President and an owner of CoastWood Senior Housing Partners, LLC (“CW”), an investment firm specializing in senior housing and related services, which he founded in 2005. In January 2013, CW joined with KKR and Beecken Petty O'Keefe & Company to acquire 100% of the operations of Sunrise Senior Living (NYSE:SRZ), one of the leading operators of assisted living properties in the United States.
Prior to forming CW, Mr. Decker was a partner from 1990 to 2005 at The Hampstead Group, LLC, a private equity firm specializing in real estate operating companies. Mr. Decker was an attorney at the law firm of Munsch, Hardt, Kopf & Harr from 1985 to 1990, which he co-founded in 1985. Mr. Decker was an attorney at Winstead, Sechrest & Minick P.C. from 1980 to 1985. Mr. Decker served as a Director of Health Care REIT, Inc. (NYSE:HCN) from October 2011 through August 2012, during which time he served as a member of the Audit, Investment, Nominating/Corporate Governance and Planning Committees. Mr. Decker earned his Bachelor of Business Administration degree in economics in 1979 and his J.D. in 1980, both from the University of Missouri.
Mr. Decker has been investing in the senior housing industry for nearly 20 years. During that period he has been involved in the investment, made through three different public companies, of approximately $2 billion of assets across a spectrum of independent living, assisted living, memory care, and skilled nursing facilities. Mr. Decker’s experience with investment and private equity firms brings a new point of view and base of experience to the board of directors. Mr. Decker was elected to be one of our directors, and a member of our investment committee, on March 12, 2013 in connection with, and as a condition to, the execution of the KKR Equity Commitment. Mr. Decker, through an affiliate of KKR, is a co-investor with the Investor in us in connection with the KKR Equity Commitment.
Steven Pearson, age 67, has served as one of our independent directors since September 2007. He is the Executive Vice President, Chief Strategy Officer and a director for DAUM Commercial Real Estate. Mr. Pearson has been with DAUM since June 1997 and serves as a key executive responsible for the planning and execution of the company’s growth initiatives. Prior to his affiliation with DAUM, from July 1991 through May 1997, Mr. Pearson served as Senior Vice President of Coldwell Banker Commercial Affiliates, where he oversaw the design, development, and delivery of all commercial resources for Coldwell Banker.
Mr. Pearson’s background includes 15 years with CB Commercial in Denver, San Francisco and Newport Beach. During his tenure in Denver he was active in the local chapter of the National Association of Industrial and Office Parks (NAIOP) and served as a market expert for several Urban Land Institute (ULI) functions. In San Francisco, Mr. Pearson was a vice president for Coldwell Banker Investment Banking Services. In this capacity, he focused on the analysis of recapitalization or disposition of larger real estate assets or asset portfolios of institutional owners - primarily industrial and office portfolios in Denver and Southern California. In Newport Beach, Mr. Pearson worked as an investment specialist focusing primarily on the analysis and sale of mid-sized institutional property for insurance companies, Savings and Loans, and the RTC. Mr. Pearson earned his Bachelor of Arts in Psychology from Stanford University and earned his MBA in Marketing and Finance from the University of Colorado.
For the following reasons, the board concluded that Mr. Pearson should serve as a director. Mr. Pearson brings to the board over 37 years of diverse experience in commercial real estate, including experience in the areas of investment banking, brokerage, management and financing. His extensive understanding of these aspects of industry provide the board with an invaluable resource for assessing and managing risks and planning corporate strategy. In addition, Mr. Pearson provides an important perspective for the board’s discussions regarding our capital and liquidity needs.
John Mark Ramsey, age 44, is our Chief Executive Officer, President and a member of our board of directors, positions he has held since December 2011. Mr. Ramsey is also Chief Executive Officer and majority owner of our Advisor, Sentio Investments, LLC, positions he has held since its formation in December 2011. Between May 2007 and December 2011, Mr. Ramsey was an owner of, and served as the Chief Executive Officer of Servant Healthcare Investments, LLC (“SHI”), which served as our sub-advisor from May 2008 through July 2011 and as our Advisor from July 2011 through December 2011. During his tenures with Sentio Investments and SHI, Mr. Ramsey has overseen all investment activity for these entities while also developing and maintaining relationships with leaders in the healthcare industry.
Prior to his role with SHI, Mr. Ramsey served for four years at CNL Retirement Properties, Inc. (“CNL”), now Health Care Property Investors, Inc., (NYSE: HCP), the nation’s largest real estate investment trust focusing exclusively on properties serving the healthcare industry. During his four years as an executive at CNL, Mr. Ramsey served as a senior vice president and executive committee member. In this capacity, Mr. Ramsey managed the Investment Group, and was responsible for implementing and executing the investment strategy in the senior housing and medical facilities’ sectors. During his tenure, CNL closed on over 18,000,000 square feet and $3.1 billion, positioning it as the third largest healthcare REIT in the United States, which proved to be a key factor in CNL’s successful merger with HCP.
Before joining CNL in 2003, Mr. Ramsey was co-founder and Senior Vice President of Development and Acquisitions for Superior Residences, Inc., a regional developer and owner/operator of Senior Housing projects with responsibilities for all company development and acquisition activities. He also has extensive investment advising experience, having been a Principal and Co-Founder of Weaver, Ramsey & Hershiser, a financial advisory firm specializing in financial management. Prior to that, he served as an Investment Advisor to A.G. Edwards, where he implemented a total financial planning approach with his clients. Mr. Ramsey is a Magna Cum Laude graduate of Florida State University, having earned dual degrees in finance and real estate.
For the following reasons, the board concluded that Mr. Ramsey should serve as a director. As the Chief Executive Officer and President of the Company, Mr. Ramsey is the only officer of the Company to sit on the board of directors. As such, Mr. Ramsey is well positioned to provide essential insight and guidance to the board of directors from an inside perspective of the day-to-day operations of the Company. Furthermore, his experience and expertise in the healthcare real estate sector and with the acquisition, ownership and operation of senior living facilities and medical facilities are key assets to our board of directors.
Ronald Shuck, age 66, has served as one of our independent directors since September 2008. Mr. Shuck was a shareholder with Moore Stephens Lovelace, P.A, (MSL), an accounting firm, for 25 years until his retirement as a shareholder in July 2013. He continues to serve as an advisor to MSL in relation to its senior housing practice. Mr. Shuck also helped to form Windermere Strategic Partners, LLC, an organization that provides services to developers and owners of senior housing properties. Mr. Shuck has been providing services to the senior housing and care industry for over 30 years. His comprehensive financial experience in the healthcare industry includes consulting with clients on corporate governance, strategic planning, market risk and compiling and examining financial forecasts and projections. Mr. Shuck has written articles pertaining to senior housing and care that have been published in various publications including The Wall Street Journal and Forbes Magazine. Mr. Shuck received his Bachelor of Science in Accounting from Kent State University and his Masters in Accounting from the University of Central Florida. Mr. Shuck also serves on the board of directors for the Florida Retirement Housing Council.
For the following reasons, the board concluded that Mr. Shuck should serve as a director. Mr. Shuck brings a key combination of skills overlapping the healthcare and real estate industries. His background and expert knowledge in the areas of corporate governance, risk assessment and strategic planning are key assets to the board of directors. In addition, Mr. Shuck’s strong accounting credentials provide him with the skills and knowledge to serve effectively on our audit committee.
James Skorheim, age 63, has served as one of our independent directors since September 2007. He is a CPA, an attorney at law, a Certified Valuation Analyst, a Certified Fraud Examiner and a Certified Forensic Accountant. Since 2005, he has served as a Principal of the firm Skorheim & Associates, an accountancy corporation specializing in financial analysis and valuation in relation to commercial damages and losses. From 2000 to 2005, Mr. Skorheim was a partner in the certified public accounting and business consulting firm of Moss Adams, LLP. Prior to that, he was a partner of Coleman & Grant and Deloitte & Touche LLP.
Mr. Skorheim has testified in over one hundred business litigation cases at both the federal and state levels on a variety of business and financial issues. He has also served as a mediator, arbitrator and accounting neutral in numerous matters. His professional background and experience includes the handling of accounting, tax, financial and estate planning, business consulting, business valuation, risk management and commercial insurance claims services for both small and Fortune 500 companies and their owners and executives. Mr. Skorheim serves as chairman of our audit committee.
For the following reasons, the board concluded that Mr. Skorheim should serve as a director. Mr. Skorheim is an experienced forensic accountant and certified valuation analyst with the requisite skills necessary to lead our audit committee. His background in financial analysis and his substantial experience in commercial real estate investment and operations make him a critical asset, both on our board of directors in general and as the chairman of our audit committee. Mr. Skorheim’s positions have provided him with a wealth of knowledge in dealing with a broad range of financial and accounting matters.
Executive Officers
The following individuals serve as of our executive officers:
John Mark Ramsey is our Chief Executive Officer and President. Biographical information for Mr. Ramsey is set forth above.
Sharon Kaiser, age 70, is our Chief Financial Officer, Treasurer and Secretary, positions she has held since October 2006, November, 2011 and July 2010, respectively. Ms. Kaiser has overall responsibility for our finance and accounting. Ms. Kaiser served as our President from May 25, 2011 to December 16, 2011. Effective January 1, 2012, Ms. Kaiser was also appointed Chief Financial Officer of Sentio Investments, LLC, our Advisor.
From July 2005 to December 2011, Ms. Kaiser served as the Chief Financial Officer for a number of entities affiliated with Cornerstone Ventures, Inc., the sponsor of our former advisor, including three publicly registered, non-traded real estate funds. Prior to joining the Cornerstone group, Ms. Kaiser was Director of Financial Operations for Westfield America, Inc., an owner, manager and developer of regional shopping centers and the American subsidiary of a large retail REIT listed on the Australian stock exchange. From 1999 to 2002, Ms. Kaiser served as Chief Financial Officer of The StayWell Company, then a subsidiary of Vivendi Universal, and from 1995 to 1999 she served as Chief Financial Officer and Senior Vice President of HemaCare Corporation, a publicly traded biomedical company. Her responsibilities included financial accounting and reporting, information technology, investor relations and human resources, as well as strategic planning and acquisition due diligence and integration. Before joining HemaCare Corporation, Ms. Kaiser served as the Chief Financial Officer of a publicly-traded (AMEX) REIT sponsored by The Koll Company. She started her career with Arthur Andersen and Co., leaving as a senior manager. Ms. Kaiser holds a Bachelor of Science degree in Business Administration from the University of Southern California and has been a Certified Public Accountant since 1981.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), requires each director, officer and individual beneficially owning more than 10% of a registered security of us to file initial statements of beneficial ownership (Form 3) and statements of changes in beneficial ownership (Forms 4 and 5) of common stock of us with the SEC. Based solely upon our review of copies of these reports filed with the SEC and written representations furnished to us by our officers and directors, we believe that all of the persons subject to the Section 16(a) reporting requirements filed the required reports on a timely basis with respect to the year ended December 31, 2014.
Code of Business Conduct and Ethics
Our board of directors has adopted a Code of Business Conduct and Ethics that is applicable to all members of our board of directors and our executive officers. The Code of Business Conduct and Ethics can be accessed through our website: www.sentiohealthcareproperties.com. If, in the future, we amend, modify or waive a provision in the Code of Business Conduct and Ethics, we may, rather than filing a Current Report on Form 8-K, satisfy the disclosure requirement by posting such information on our website.
Audit Committee Financial Expert
The Audit Committee consists of independent directors James Skorheim (Chairman), Steven Pearson and Ronald Shuck. Our board of directors has determined that Mr. Skorheim is an “audit committee financial expert,” as defined by the rules of the SEC. The biography of Mr. Skorheim, including his relevant qualifications, is previously described in this Item 10. Our shares are not listed for trading on any national securities exchange and therefore our audit committee members are not subject to the independence requirements of any national securities exchange. However, each member of our audit committee is “independent” under the rules of the NASDAQ stock market.
ITEM 11.
ITEM 11.EXECUTIVE COMPENSATION
Executive Officer Compensation
We have no employees and our executive officers do not receive compensation directly from us for services rendered to us. During 2014 and 2013, John Mark Ramsey and Sharon Kaiser served as our executive officers and were also officers and employees of Sentio Investments, LLC, our Advisor. Mr. Ramsey and Ms. Kaiser were compensated by our Advisor, in part, for services that they provided to us. Pursuant to the terms of the Advisory Agreements in effect with our Advisor during 2014 and 2013, we were not required to reimburse our Advisor for any personnel costs incurred by our Advisor related to its employees, including any compensation paid by our Advisor to Mr. Ramsey and Ms. Kaiser. A description of the nature and amounts of fees that we paid to our Advisor during 2014 and 2013 is found below under Item 13. “Certain Relationships and Related Transactions, and Director Independence.”
Director Compensation
If a director is also one of our executive officers, we do not pay any compensation for services rendered as a director. The amount and form of compensation payable to directors who are neither our executive officers nor affiliates of our Advisor (such directors are “outside directors”) for their service to us is determined by our board of directors, based upon information provided by our Advisor. Mr. Ramsey, who manages and controls our Advisor, is involved in advising on the compensation to be paid to our outside directors.
We have provided below certain information regarding compensation paid to our directors for the year ended December 31, 2014.
(1)Includes fees paid in 2015 for services rendered in 2014.
(2)William Bloomer retired from the board of directors effective May 8, 2014.
(3)Directors who are either (i) our executive officers, or (ii) affiliated with our Advisor, do not receive compensation for services rendered as a director.
We pay each of our outside directors for attending board and committee meetings as follows:
·$3,000 per regular board meeting attended in person or by teleconference. Effective commencing with the first regular board meeting of 2015 we increased the cash compensation for attendance at a regular board meeting to $4,500 per meeting attended in person or by teleconference. We expect to hold four regular meetings per year.
·$750 per special board meeting attended in person or by teleconference. The special board meeting fee will apply to any board meeting called by our officers that is not a regular board meeting.
·$1,000 per committee meeting attended.
·An additional committee chair fee of $500 per meeting for the chair of the audit committee.
·An additional committee chair fee of $250 per meeting for the respective chairs of the compensation, investment and independent directors committees.
All directors receive reimbursement of reasonable out-of-pocket expenses incurred in connection with attendance at meetings of the board of directors and committees.
Equity-Based Compensation
We have adopted an Employee and Director Long-Term Incentive Plan to (i) provide incentives to individuals chosen to receive share-based awards because of their ability to improve operations and increase our profits; (ii) encourage selected persons to accept or continue employment with us or our Advisor or one of our other affiliates; and (iii) increase the interest of our independent directors in our welfare through their participation in the growth in the value of our common stock. The total number of shares of common stock we have reserved for issuance under the Employee and Director Long-Term Incentive Plan is equal to 10% of our outstanding shares at any time. No awards have been granted under the plan. Our Employee and Director Long-Term Incentive Plan was approved prior to the commencement of our public offering by our board of directors and initial stockholder.
ITEM 12.
ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Equity Compensation Plan Information
The following table provides summary information about securities issuable under our equity compensation plans as of December 31, 2014.
(1) The number of shares authorized for issuance pursuant to the Employee and Director Long-Term Incentive Plan is equal to 10% of our outstanding stock at any time. As discussed above under the heading “Equity-based Compensation,” no awards have been granted under the Employee and Director Long-Term Incentive Plan.
Ownership of Equity Securities by Directors and Executive Officers
The following table sets forth information as of March 15, 2015, regarding the beneficial ownership of our common stock by each of our directors, each of our named executive officers, and our directors and executive officers as a group. The percentage of beneficial ownership is calculated based on 11,480,620 shares of common stock outstanding as of March 15, 2015.
*Less than 1%.
(1)Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities and shares issuable pursuant to options, warrants and similar rights held by the respective person or group that may be exercised within 60 days following March 15, 2015. Except as otherwise indicated by footnote, and subject to community property laws where applicable, the persons named in the table above have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them. None of the securities listed are pledged as security.
Ownership of Equity Securities by Certain Beneficial Owners
The following table sets forth information as of March 15, 2015, regarding the beneficial ownership of the persons that are known to us to be the beneficial owners of more than 5% of our common stock and Series C Preferred Stock, which constitute our two classes of voting securities. The percentage of beneficial ownership is calculated based on 11,480,620 shares of common stock and 1,000 shares of Series C Preferred Stock outstanding as of March 15, 2015.
*Less than 1%.
(1)Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities and shares issuable pursuant to options, warrants and similar rights held by the respective person or group that may be exercised within 60 days following March 15, 2015. None of the securities listed are pledged as security.
(2)These securities are held directly by Sentinel RE Investment Holdings LP. Sentinel RE Investment Holdings GP LLC is the general partner of Sentinel RE Investment Holdings LP. KKR REPA AIV-1 L.P. is the managing member of Sentinel RE Investment Holdings GP LLC. KKR Associates REPA L.P. is the general partner of KKR REPA AIV-1 L.P. KKR REPA GP LLC is the general partner of KKR Associates REPA L.P. KKR Fund Holdings L.P. is the sole member of KKR REPA GP LLC. KKR Fund Holdings GP Limited is a general partner KKR Fund Holdings L.P. KKR Group Holdings L.P. is the sole shareholder of KKR Fund Holdings GP Limited and a general partner of KKR Fund Holdings L.P. KKR Group Limited is the general partner of KKR Group Holdings L.P. KKR & Co. L.P. is the sole shareholder of KKR Group Limited. KKR Management LLC is the general partner of KKR & Co. L.P. Messrs. Henry R. Kravis and George R. Roberts are the designated members of KKR Management LLC. Each of Sentinel RE Investment Holdings GP LLC, KKR REPA AIV-1 L.P., KKR Associates REPA L.P., KKR REPA GP LLC, KKR Fund Holdings L.P., KKR Fund Holdings GP Limited, KKR Group Holdings L.P., KKR Group Limited, KKR & Co. L.P., KKR Management LLC, and Messrs. Kravis and Roberts may be deemed to be the beneficial owner of the securities held by Sentinel RE Investment Holdings LP.
(3)Represents Series B Preferred Units of our operating partnership. Subject to the terms of the Second Amended and Restated Limited Partnership Agreement of our operating partnership, dated as of August 5, 2013, entered into by and among the Company, HPC LP TRS, LLC, and Sentinel RE Investment Holdings LP, Sentinel RE Investment Holdings LP has the right to convert 1,101,560 Series B Preferred Units into 10,993,613 common units of our operating partnership, which are then exchangeable for shares of our common stock on a one-for-one basis.
Potential Change of Control
The KKR Equity Commitment and the transactions contemplated thereby may result in a change of control of the Company. Based on the capitalization of the Company as of March 15, 2015, if the maximum amount of $158.7 million is drawn by us under the KKR Equity Commitment, then the Investor and its affiliates would hold approximately 58% of our voting capital stock as well as the same percentage of our as-converted common stock by virtue of their combined interests in the Series C Preferred Stock and Series B Preferred Units.
ITEM 13.
ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The independent directors committee has reviewed the material transactions between our related persons and us during our two most recently completed fiscal years, as well as any such currently proposed transactions. Based upon the independent directors committee’s review of these transactions and of the fees paid to affiliates of the company during this period, the independent directors committee believes that all of the transactions have been fair and reasonable to the company and on terms and conditions not less favorable to us than those available from unaffiliated third parties. Set forth below is a description of such transactions and our policy regarding the review and approval of transactions involving affiliates.
Advisory Relationship with Sentio Investments
Throughout 2013 we were party to an Advisory Agreement with our external Advisor, Sentio Investments, LLC (referred to herein as our Advisor or “Sentio Investments”), which became effective on January 1, 2012 for a one year term ending December 31, 2012. The Advisory Agreement was renewed for additional one-year terms commencing on January 1, 2013, January 1, 2014, and January 1, 2015, however, as discussed below under the heading “Transition Agreement” certain provisions of the Advisory Agreement have been amended as a result of the execution on February 10, 2013 of a Transition to Internal Management Agreement which was subsequently amended in April 2014 and February 2015 (as amended, the “Transition Agreement”) with Sentio Investments.
John Mark Ramsey, our Chief Executive Officer, President and a member of our board of directors, is also the Chief Executive Officer and majority owner of Sentio Investments. Sharon Kaiser, our Chief Financial Officer, Treasurer and Secretary, is also an executive officer and an employee of Sentio Investments.
Pursuant to the provisions of the Advisory Agreement, Sentio Investments, as Advisor, is responsible for managing, operating, directing and supervising the operation of our company and its assets. Generally, Sentio Investments is responsible for providing us with (i) property acquisition, disposition and financing services, (ii) asset management and operational services, including real estate services and financial and administrative services, (iii) stockholder services, and (iv) in the event we conduct a public offering of our securities, offering-related services. Sentio Investments is subject to the supervision and ultimate authority of our board of directors and has a fiduciary duty to our company and its stockholders.
The fees and expense reimbursements payable or paid to Sentio Investments under the Advisory Agreement, and subject to the terms of the Transition Agreement, as discussed below under the heading “Transition Agreement,” are described below.
Offering Stage Fees and Expenses:
·If our board of directors determines that it is advisable and in our best interests to conduct an offering of our securities, Sentio Investments will be responsible for managing and supervising such offering activities and will be entitled to be reimbursed for organizational and offering costs paid by Sentio Investments on our behalf from the proceeds of such offering. Organizational and offering costs consist of all expenses (other than sales commissions and the dealer manager fees) to be paid by us in connection with our offerings, including our legal, accounting, printing, mailing and filing fees, charges of our escrow holder and other accountable offering expenses. However, Sentio Investments would be required to reimburse us to the extent that our organization and offering expenses are in excess of 15% of gross offering proceeds at the conclusion of such offering. During the years ended December 31, 2013 and 2014, Sentio Investments incurred no organization and offering expenses on our behalf.
Acquisition and Operating Stage Fees and Expenses:
·Subject to the limitation on fees agreed to in the Transition Agreement, we are obligated to pay Sentio Investments acquisition fees in an amount equal to 1.0% of the sum of the amount actually paid or allocated to the purchase, development, construction or improvement of an investment, inclusive of the acquisition expenses associated with such investment, and the amount of any debt attributable to such investment. With respect to acquisitions made through a joint venture in which the Company is a co-venturer, the acquisition fee payable to Sentio Investments will be equal to 1.0% of the Company’s allocable portion of the amount actually paid or allocated to the purchase, development, construction or improvement of the investment, inclusive of the acquisition expenses associated with such investment, and the Company’s allocable portion of any debt attributable to such investment. An acquisition fee will be payable to Sentio Investments at the time we acquire the related investment. In addition, we are required to reimburse Sentio Investments for direct costs Sentio Investments incurs and pays to third parties in connection with the selection and acquisition of potential investments, whether or not we ultimately acquire them. During the years ended December 31, 2013 and 2014, Sentio Investments earned approximately $0.5 million and $1.6 million, respectively, of acquisition fees from us and incurred no acquisition expenses on our behalf.
·We are not required to reimburse Sentio Investments or its affiliates for any of their costs or expenses that are not directly attributable to our business, including without limitation (i) any personnel costs incurred by Sentio Investments to its employees, and (ii) any costs related to Sentio Investments’ rent, utilities and general overhead. We are responsible for paying directly or reimbursing Sentio Investments for costs that are directly attributable to our business.
·Under the Advisory Agreement, Sentio Investments must restrict total operating expenses for the preceding four consecutive fiscal quarters, as determined at the end of each fiscal quarter, to the greater of 2% of the Company’s Average Invested Assets (as defined in the Advisory Agreement) or 25% of the Company’s net income for such period (the “2%/25% Guidelines”), unless the independent directors committee determines that a higher level of expenses is justified, based on unusual and non-recurring factors which it deems sufficient. If the independent directors committee does not approve such excess as being so justified, the Advisory Agreement and our charter require that any amount in excess of the 2%/25 Guidelines (an “Excess Amount”) paid to Sentio Investments during a fiscal quarter shall be repaid to us. For the four quarters ended December 31, 2013 and December 31, 2014, our management fees and expenses and operating expenses totaled $4.6 million and $5.8 million, respectively. These amounts did not exceed the greater of 2% of our average invested assets and 25% of our net income.
·Subject to compliance with the 2%/25% Guidelines and the limitation on fees agreed to in the Transition Agreement, we are obligated to pay Sentio Investments a financing coordination fee for services rendered by Sentio Investments in connection with the refinancing of any of our debt obligations in an amount equal to 0.5% of the gross amount of any such refinancing, provided however, that Sentio Investments will not be entitled to a financing coordination fee in connection with the refinancing of debt obligations secured by any particular asset that was subject to a refinancing in connection with which Sentio Investments received a financing coordination fee within the immediately preceding three year period. Any such financing coordination fee is payable to Sentio Investments upon the closing of the related refinancing. During the years ended December 31, 2013 and 2014, Sentio Investments earned approximately $0.1 million and $0.1 million of financing coordination fees from us, respectively.
·Subject to compliance with the 2%/25% Guidelines and the limitation on fees agreed to in the Transition Agreement, we are obligated to pay Sentio Investments a monthly asset management fee in an amount equal to one-twelfth of 1.0% of our assets under management, calculated on a monthly basis as of the last day of each month. Additionally, subject to compliance with the 2%/25% Guidelines and the limitation on fees agreed to in the Transition Agreement, with respect to fiscal quarters in which distributions declared to stockholders and cash available for distribution for such fiscal quarter are each at least $0.125 per share, we are also obligated to pay Sentio Investments a quarterly bonus asset management fee equal to the lesser of (i) one-fourth of 0.15% of our assets under management, calculated on a quarterly basis as of the last day of the quarter, or (ii) $150,000. During the years ended December 31, 2013 and 2014, Sentio Investments earned approximately $2.9 million and $4.1 million, respectively, of asset management fees from us.
·Subject to the limitation on fees agreed to in the Transition Agreement, if we retain Sentio Investments or one of its affiliates to manage or lease any of our properties, we will pay Sentio Investments or such affiliate a market-based fee in accordance with a separately negotiated property management, leasing and development agreement to be approved by the independent directors committee, which agreement may provide for fees similar to what other management or leasing companies generally charge for the management or leasing of similar properties, and which may include reimbursement for the costs and expenses Sentio Investments or its affiliates incurs in managing or leasing our properties. During the years ended December 31, 2013 and 2014, we did not pay any property management, leasing or development fees to Sentio Investments.
Listing/ Liquidation Stage Fees and Expenses:
·Subject to the limitation on fees agreed to in the Transition Agreement, if Sentio Investments or one of its affiliates provides a substantial amount of the services (as determined by a majority of our directors, including a majority of our independent directors committee) in connection with the sale of one or more of our properties, other than a sale in connection with a transaction in which we sell, grant, convey or relinquish our ownership of all or substantially all of our assets, we would be required to pay Sentio Investments or such affiliate at closing a disposition fee equal to the lesser of (i) 1.0% of the sales price of such property or properties, or (ii) one-half of the competitive real estate commission in light of the size, type and location of the property. The disposition fee may be paid in addition to real estate commissions paid to non-affiliates, provided that the total real estate commissions (including such disposition fee) paid to all persons by us for each property shall not exceed an amount equal to the lesser of (i) 6.0% of the aggregate contract sales price of each property or (ii) the competitive real estate commission for each property. During the years ended December 31, 2013 and 2014, Sentio Investments earned approximately $0.1 million and $0.0 million, respectively, of disposition fees from us.
·As described in further detail below under “Transition Agreement” under certain circumstances, Sentio Investments may be entitled to incentive fee amounts upon a listing or liquidation of the Company, or upon a termination of the Advisory Agreement. During the years ended December 31, 2013 and 2014, we did not pay any incentive fees to Sentio Investments related to listing or liquidation of the Company, or a termination of the Advisory Agreement.
Fee Credit
Sentio Investments may advise other owners or prospective owners of assets in the healthcare sector and earn fees for such efforts. However, in the event that a third party owner contracts with Sentio Investments for the provision of advisory services, Sentio Investments will be required to reduce the fees that we pay pursuant to the Advisory Agreement as follows: (A) if the contractual fees to be paid by such third party owner to Sentio Investments are, on a percentage basis, greater than or equal to 90% of the corresponding or analogous fees charged to us, then Sentio Investments will reduce the amount of fees charged to us by a dollar amount equal to 50% of the corresponding or analogous fees actually paid to Sentio Investments by such third party owner; and (B) if the contractual fees to be paid by such third party owner to Sentio Investments are, on a percentage basis, less than 90% of the corresponding or analogous fees charged to us, then Sentio Investments will reduce the dollar amount of fees charged to us by an amount equal to 25% of the corresponding or analogous fees actually paid to Sentio Investments to such third party owner.
Term and Termination
The Advisory Agreement with Sentio Investments has a one-year term, which may be renewed for an unlimited number of successive one-year terms upon mutual consent of the parties. The Advisory Agreement may be terminated by us or by Sentio Investments without cause and without penalty upon 60 days written notice to the other party. Either party may terminate the agreement immediately in the event that the other party (i) commences bankruptcy or similar insolvency proceedings, or (ii) commits a material breach of the agreement which is not cured within 30 days after written notice from the non-breaching party, or which the non-breaching party reasonably determines cannot be cured within 30 days.
Transition Agreement
In connection with entering into the KKR Equity Commitment on February 10, 2013 (the “Commitment Effective Date”), we entered into the Transition Agreement with Sentio Investments and the Investor. The Transition Agreement sets forth the terms for our transition from our current externally-advised structure to an internal management structure. The Transition Agreement provides that the existing external advisory structure will remain in place upon substantially the same terms as currently in effect until February 10, 2017, subject to annual renewals of the Advisory Agreement in accordance with the requirements of the Company’s governing documents, at the end of which time the advisory function will be internalized in accordance with the Transition Agreement.
As noted above, Mr. Ramsey is the Chief Executive Officer and majority owner of Sentio Investments, and Ms. Kaiser is an executive officer and an employee of Sentio Investments.
The Transition Agreement limits the amount of the fees payable under our existing Advisory Agreement with Sentio Investments. Specifically, notwithstanding the provisions of the Advisory Agreement, acquisition fees, financing coordination fees, asset management fees, property management and leasing fees, and disposition fees payable under the Advisory Agreement are limited to an amount no more than (1) $3.2 million plus an excess amount of $3.2 million (the “Excess Fee Amount”) during the one-year period following the Commitment Effective Date, and (2) $3.2 million plus any remaining portion of the Excess Fee Amount during the period from the first to the second anniversary of the Commitment Effective Date. The maximum aggregate amount of such fees payable to the Advisor from the Commitment Effective Date through the second anniversary of the Commitment Effective Date under these limits was $9.6 million (the “Maximum Fee Amount”). Solely with respect to any fees earned by the Advisor during the period from the first to the second anniversary of the Commitment Effective Date in excess of the Maximum Fee Amount, such fees will be included in fees payable during the one-year period following the second anniversary of the Commitment Effective Date, subject to a maximum amount of $1.0 million. For the one-year period from the second to the third anniversary of the Commitment Effective Date, as well as for the one-year period from the third to the fourth anniversary of the Commitment Effective Date, the same limits will apply to the aggregate fees the Advisor can earn such that the aggregate amount of such fees payable to the Advisor from the second anniversary to the fourth anniversary of the Commitment Effective Date is equal to the Maximum Fee Amount.
The Transition Agreement also amends the Advisory Agreement to modify the terms of the subordinated incentive fees to which our Advisor may be entitled under certain circumstances. Specifically, the Transition Agreement provides for the following possible incentive amounts to be payable to our Advisor:
·Subordinated Sales and Financings Promote. A subordinated sales and financings promote may be payable to the Advisor upon a distribution to holders of shares of our common stock outstanding as of the Commitment Effective Date (the “Legacy Common Shares”) resulting from a sale and financing of one or more of our assets, which will be determined and paid as an amount of shares of common stock equal to the ratio of:
o10% of the amount, if any, by which (A) the sum of (i) the number of Legacy Common Shares times the per share cash distributions to the holders of the Legacy Common Shares in respect of cash from sales and financings, plus (ii) the total amount of all previous dividends or distributions paid on the Legacy Common Shares since the date of the inception of the Company’s initial public offering; exceeds (B) the sum of (x) the total invested capital for the Legacy Common Shares and (y) the amount required to pay stockholders a 7% cumulative, non-compounded return from inception of the Company’s initial public offering through the date of the closing of the applicable sale or financing on the Legacy Common Shares;
over:
othe net asset value per share of common stock as of the closing of the applicable sale or financing (as defined in the Transition Agreement).
However, if the subordinated sales and financings promote is payable as the result of a sale of all or substantially all of the assets of the Company, then the promote will be paid in cash rather than shares of common stock.
·Subordinated Internalization Promote. In connection with a termination of the Advisory Agreement upon consummation of an internalization, the Advisor may be entitled to a subordinated internalization promote determined and paid on the third anniversary of the Commitment Effective Date (unless delayed in accordance with the Transition Agreement), in an amount consisting of the sum of:
oa cash payment equal to 40% of:
§10% of the amount, if any, by which (A) the sum of (i) the number of Legacy Common Shares times the per share net asset value on the determination date, plus (ii) the total amount of dividends or distributions paid on the Legacy Common Shares from date from inception of the Company’s initial public offering through the determination date; exceeds (B) the sum of (x) the total invested capital for the Legacy Common Shares and (y) the amount required to pay stockholders a 7% cumulative, non-compounded return from inception of the Company’s initial public offering through the determination date on the Legacy Common Shares (such amount, the “Subordinated Internalization Cash Amount”); and
an amount of shares of common stock equal to the ratio of:
§60% of the Subordinated Internalization Cash Amount;
over:
§the net asset value per share of common stock as of the determination date (as defined in the Transition Agreement).
However, in the event the common stock is listed on a national stock exchange as of the determination date, the amount of the subordinated internalization promote will be determined by reference to the market value of a share of common stock (as defined in the Transition Agreement), rather than the net asset value. Furthermore, the amount of the subordinated internalization promote will be reduced by the amount of any subordinated sales and financings promote previously earned by our Advisor.
·Subordinated Performance Fee Due Upon Termination. If (1) we terminate the Advisory Agreement prior to an internalization for any reason other than a material breach by the Advisor, (2) the Advisory Agreement is not renewed (other than in connection with an internalization) because we are unwilling to renew the agreement on substantially similar terms, or (3) the Advisor terminates the Advisory Agreement prior to an internalization because of a material breach by us, then, we will pay the Advisor a subordinated performance fee due upon termination, payable in the form of a promissory note bearing simple interest at a rate of 5% per annum, in a principal amount equal to:
o10% the amount, if any, by which (A) the sum of (i) the product of the Legacy Common Shares times the per share net asset value at the termination date and (ii) total distributions (excluding any stock dividend and distributions paid on shares of common stock redeemed by the Company) paid on the Legacy Common Shares through the termination date, exceeds (B) the sum of (i) the total invested capital for the Legacy Common Shares and (ii) the total distributions required to be made to the Legacy Common Shares in order to pay stockholders a 7% cumulative, non-compounded return from inception of the Company’s initial public offering through the termination date;
oless any prior payment to our Advisor of a subordinated sales and financings promote.
Upon the internalization date established pursuant to the Transition Agreement, we will acquire all of the Advisor’s assets that are reasonably necessary for the management and operation of our business (we refer to such a transaction as an internalization). On or prior to the internalization date, our Advisor will facilitate our efforts to hire the employees of the Advisor. With respect to certain key persons, we will be required to enter into employment agreements based upon market terms established in consultation with an independent compensation consultant. The Investor will have the right to consent to our hiring of all key personnel. Upon an internalization or a Liquidation Event (as defined in the investor rights agreement entered in connection with the KKR Equity Commitment), then our Advisor will receive a fee in an amount that is the lesser of (i) $4.0 million or $3.0 million (depending on when the event occurs), and (ii) the remaining portion of the $9.6 million maximum fee amount, if any, not previously paid to our Advisor.
In connection with entering into the Transition Agreement, we and our Advisor have generally agreed not to terminate the Advisory Agreement without the prior consent of the Investor.
KKR Equity Commitment
Pursuant to the KKR Equity Commitment, we may issue and sell to the Investor and its affiliates on a private placement basis from time to time over a period of three years, up to $158.7 million in aggregate issuance amount of shares of newly issued Series C Preferred Stock and newly issued Series B Preferred Units of our operating partnership. The terms of the KKR Equity Commitment and the related agreements and securities are described in detail in our Current Report on Form 8-K filed with the SEC on February 12, 2013.
Billy Butcher, who has served as one of our directors since March 12, 2013 and was elected to be one of our directors in connection with, and as a condition to, the execution of KKR Equity Commitment is an executive officer of Sentinel RE Investment Holdings GP LLC, which is the general partner of the Investor. Mr. Butcher is also employed by KKR as a Director in its Real Estate business.
Daniel Decker who has also served as one of our directors since March 12, 2013 and was elected to be one of our directors in connection with, and as a condition to, the execution of KKR Equity Commitment. Mr. Decker is associated with the Investor and KKR. Mr. Decker, through an entity that he owns, is a co-investor with the Investor in us in connection with the KKR Equity Commitment.
As a result of the transactions contemplated by the KKR Equity Commitment, the Investor currently beneficially owns an aggregate of 10,993,613 shares of common stock of the Company, which represent, in the aggregate, approximately, 48.9% of the outstanding shares of common stock.
Amendments to Securities Purchase Agreement
Effective April 8, 2014, the Securities Purchase Agreement was amended to allow the operating partnership to issue up to $29 million of additional Series B Preferred Units to the Investor for the purpose of funding a repurchase of the Company’s stock under the tender offer discussed below under the heading “Tender Offer” (the “Second Amendment Agreement”). As a result of the Second Amendment Agreement, the Securities Purchase Agreement was also amended to delay and potentially reduce the unused capital fee payable by the Company to the Investor during the first year of the term of the Securities Purchase Agreement, depending on the success of the tender offer.
On December 22, 2014, the Securities Purchase Agreement was amended again (the “Third Amendment Agreement”) to permit us to use the KKR Equity Commitment to finance the origination and funding of non-recourse loans to third-party borrowers for the development, construction and leasing of health care properties (each a “Construction Loan”). Previously, the KKR Equity Commitment only contemplated the financing of real estate acquisitions.
Pursuant to the Third Amendment Agreement, the procedures for the delivery and review of a put exercise notice were revised to account for the potential financing by the Company, via the KKR Equity Commitment, of a Construction Loan. Under the Third Amendment Agreement, we may deliver a put exercise notice related to a Construction Loan (a “Construction Loan Put Exercise”) that the Investor may then approve or disapprove in its discretion. If the Investor accepts the Construction Loan Put Exercise, the Investor is then committed to fund the full put exercise amount included in the related notice. However, the Investor shall fund the put exercise amount in installments (commencing on the closing of the Construction Loan Put Exercise) pursuant to a draw schedule provided by us, which draw schedule we may adjust by no more than 10% without further approval by the Investor. Notwithstanding the fact that at the closing of the Construction Loan Put Exercise the Investor will not contribute cash to the operating partnership in the full put exercise amount, the operating partnership will issue Series B Preferred Units to the Investor in an amount that reflects the full amount of the Construction Loan Put Exercise. In the event the Company experiences a liquidation event (as defined in the Investor Rights Agreement), the Investor is required to immediately advance to us all Construction Loan Put Exercise amounts remaining to be funded. Finally, the term of the Securities Purchase Agreement was revised to provide that if the draw schedule of a Construction Loan Put Exercise extends beyond the initially contemplated term of the Securities Purchase Agreement, the Securities Purchase Agreement shall continue, solely with respect to the obligation of the Investor to continue funding amounts under a Construction Loan Put Exercise and any rights and obligations of the parties with respect thereto, beyond the initially contemplated term and shall terminate automatically on the date the unfunded amount of a Construction Loan Put Exercise equals zero dollars.
Amendment to Second Amended and Restated Operating Partnership Agreement
On December 22, 2014, the Company, HPC LP TRS, LLC and the Investor entered the First Amendment to the Second Amended and Restated Limited Partnership Agreement (the “Partnership Amendment”) to revise certain terms of the Series B Preferred Units included in the Second Amended and Restated Limited Partnership Agreement to be consistent with the changes effected in the Third Amendment Agreement.
Pursuant to the Partnership Amendment, any Series B Preferred Units issued in connection with a Construction Loan Put Exercise related to the Georgetown transaction would receive cash distributions at a reduced annual rate equal to 6.0% in preference to any distributions paid to common units. In addition, in consideration of the fact that at any closing of a Construction Loan Put Exercise, the operating partnership will issue Series B Preferred Units in the full amount of the exercise put amount committed by the Investor notwithstanding the fact that the Investor will contribute the cash to the operating partnership in installments pursuant to a draw schedule as described above, the preferred return for a Construction Loan Put Exercise will be calculated based solely on the exercise put amount related to the Construction Loan Put Exercise that has been funded as opposed to the full amount of Series B Preferred Units outstanding. The Partnership Amendment further adjusts the “catch-up” return common stockholders must receive to a weighted average of 7.5% and 6.0% to account for the different rate of return on any Series B Preferred Units issued in connection with a Construction Loan Put Exercise for the Georgetown transaction. For additional information regarding the Georgetown Transaction see below under the heading “Georgetown Transaction.”
The Partnership Amendment also permits the operating partnership to engage in a sale of the assets or equity of the operating partnership without the consent of the Investor, which would otherwise be required under the Second Amended and Restated Limited Partnership Agreement, provided the following conditions are met: (i) the sale is cash only, and (ii) the Company or the operating partnership, as applicable, has issued to the Investor $100,000 in aggregate liquidation preference amount of Series C Preferred Shares and $149,900,000 in aggregate liquidation preference amount of Series B Preferred Units. Finally, the Partnership Amendment requires prior Investor approval for any material changes to the transaction documents related to the Georgetown transaction.
Amendment to Investor Rights Agreement
On December 22, 2014, the Company and the Investor entered into the First Amendment to Investor Rights Agreement to amend the Investor Rights Agreement to permit the Company to engage in a sale of the assets or equity of the operating partnership and the Company without the consent of the Investor, which would otherwise be required under the Investor Rights Agreement, provided the following conditions are met: (i) the sale is cash only, and (ii) the Company or the operating partnership, as applicable, has issued to the Investor $100,000 in aggregate liquidation preference amount of Series C Preferred Shares and $149,900,000 in aggregate liquidation preference amount of Series B Preferred Units.
Real Estate Acquisitions
On October 18, 2013, in connection with our acquisition of the Woodbury Mews property in Woodbury, New Jersey, the Investor completed the first put exercise under the KKR Equity Commitment, purchasing 1,000 shares of newly issued Series C Preferred Stock and 142,000 newly-issued Series B Preferred Units in our operating partnership for an aggregate purchase price of $14.3 million. In addition, on December 5, 2013, in connection with our acquisition of an interest in the Standish Village property in Dorchester, Massachusetts the Investor completed a second put exercise under the KKR Equity Commitment, purchasing 51,000 newly-issued Series B Preferred Units for an aggregate purchase price of $5.1 million.
On April 4, 2014, in connection with our acquisition of an interest in the Compass on the Bay property in Boston, Massachusetts the Investor completed a put exercise under the KKR Equity Commitment, purchasing 54,000 newly-issued Series B Preferred Units for an aggregate purchase price of $5.4 million. On August 13, 2014, in connection with our acquisition of the St. Andrew’s Village property in Aurora, Colorado, the Investor completed a put exercise under the KKR Equity Commitment, purchasing 127,310 newly-issued Series B Preferred Units for an aggregate purchase price of $12.7 million. On November 14, 2014, in connection with our acquisition of the Wildewood property in California, Maryland and the Live Oaks Portfolio in Louisiana, the Investor completed a put exercise under the KKR Equity Commitment, purchasing 86,710 newly-issued Series B Preferred Units for an aggregate purchase price of $8.67 million. On December 15, 2014, in connection with our acquisition of the Gables Portfolio in Ohio, the Investor completed a put exercise under the KKR Equity Commitment, purchasing 56,880 newly-issued Series B Preferred Units for an aggregate purchase price of $5.69 million. On December 30, 2014, in connection with our acquisition of the Sumter Place and Sumter Grand properties in The Villages, Florida, the Investor completed a put exercise under the KKR Equity Commitment, purchasing 341,400 newly-issued Series B Preferred Units for an aggregate purchase price of $34.1 million.
Tender Offer
On April 10, 2014, we announced the commencement of an issuer tender offer to purchase for cash up to $35 million of our issued and outstanding shares of common stock from stockholders at a price of $8.50 per share. On May 22, 2014, we amended the tender offer to increase the purchase price to $9.00 per share and to extend the tender offer expiration date. The tender offer expired on June 12, 2014. We purchased 1,113,213 shares of our common stock pursuant to the tender offer for an aggregate cost of approximately $10.0 million, excluding fees and expenses related to the tender offer paid by the Company. The tender offer was funded by a sale of 87,260 newly-issued Series B Preferred Units to the Investor for an aggregate purchase price of $8.7 million on June 18, 2014, and the remainder from the Company’s existing cash.
Georgetown Transaction
On January 15, 2015, we originated a development loan in the amount of $41.9 million for The Delaney at Georgetown Village development project located in Georgetown, Texas (the “Georgetown Loan”). On January 16, 2015, in connection with our origination of the Georgetown Loan, the Investor completed a put exercise under the KKR Equity Commitment, purchasing 155,000 newly-issued Series B Preferred Units for an aggregate purchase price of $41.9 million (the “Georgetown Put Exercise”). On January 16, 2015, we entered a letter agreement with the Investor (the “Letter Agreement”) to divide the issuance of Series B Preferred Units related to the Georgetown Put Exercise into two issuances in recognition of the fact that if Series B Preferred Units were issued for the full Georgetown Put Exercise amount of $41.9 million certain “change-of-control” provisions would be triggered in our loan documents, which, without consents from the lenders thereto, would have caused us to be in default under such loan documents.
After giving effect to the 155,000 Series B Preferred Units issued upon the closing of the Georgetown Put Exercise and the Series B Preferred Units relating to the Georgetown Put Exercise remaining to be issued pursuant to the Letter Agreement, 220,580 Series B Preferred Units remained issuable under the Securities Purchase Agreement. The obligation of the Investor to purchase additional Series B Preferred Units under the Securities Purchase Agreement is conditioned upon, among other things, the receipt of notice from us of the intention to sell a specified amount of securities to the Investor to finance a proposed real estate acquisition or construction loan.
Policy regarding Transactions with Affiliates
Our charter requires our independent directors committee to review and approve all transactions involving our affiliates and us. Prior to entering into a transaction with an affiliate that is not covered by our Advisory Agreement with our Advisor, a majority of the independent directors committee must conclude that the transaction is fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties. Furthermore, our independent directors committee must review at least annually our fees and expenses to determine that the expenses incurred are reasonable in light of our investment performance, our net asset value, our net income and the fees and expenses of other comparable unaffiliated REITs. In addition, our Code of Business Conduct and Ethics sets forth examples of types of transactions with related parties that would create conflicts of interest between the interests of our stockholders and the private interests of the parties involved in such transactions. Our directors and officers are required to take all reasonable action to avoid such conflicts of interest or the appearance of conflicts of interest. If a conflict of interest becomes unavoidable, our directors and officers are required to report the conflict to a designated ethics contact, which, depending on the circumstances of the transaction, would be either our chief executive officer, chief financial officer, or the chairman of our audit committee. The appropriate ethics contact is then responsible for working with the reporting director or officer to monitor and resolve the conflict of interest in accordance with our Code of Business Conduct and Ethics.
Director Independence
Our charter contains detailed criteria for determining the independence of our directors and requires a majority of the members of our board of directors to qualify as independent. The board of directors consults with our legal counsel to ensure that the board’s independence determinations are consistent with our charter and applicable securities and other laws and regulations. Consistent with these considerations, after review of all relevant transactions or relationships between each director, or any of his family members, and Sentio Healthcare Properties, our senior management and our independent registered public accounting firm, the board of directors has determined that Romeo Cefalo, Barry Chase, Steven Pearson, Ronald Shuck and James Skorheim are independent, and consequently the majority of our board of directors is comprised of independent directors. In addition, Mr. William Bloomer, who served as a director until his resignation in May 2014 was also independent. Furthermore, although our shares are not listed on a national securities exchange, a majority of the members of our board of directors, and all of the members of our audit committee, independent directors committee and compensation committee are independent under the rules of the NASDAQ stock market.
ITEM 14.
ITEM 14.PRINCIPAL ACCOUNTANT FEES AND SERVICES
Independent Registered Public Accounting Firm
KPMG LLP (“KPMG”) has served as our independent registered public accounting firm since September 11, 2012. Our management believes that KPMG is knowledgeable about our operations and accounting practices and is well qualified to act as our independent registered public accounting firm.
Audit, Audit-Related, Tax and Other Fees
The audit committee reviewed the audit and nonaudit services performed by KPMG, as well as the fees charged by KPMG for such services. In its review of the nonaudit service fees, the audit committee considered whether the provision of such services was compatible with maintaining the independence of KPMG.
The following table presents the aggregate fees billed to us for the years ended December 31, 2014 and 2013 by our principal accounting firm:
(1)Audit fees billed in 2014 and 2013 consisted of the audit of our annual consolidated financial statements, a review of our quarterly consolidated financial statements, and statutory and regulatory audits, consents and other services related to filings with the SEC.
(2)Tax services billed in 2014 and 2013 consisted of tax compliance and tax planning and advice.
Pre-Approval Polices
The audit committee pre-approves all auditing services and permitted non-audit services (including the fees and terms thereof) to be performed for us by our independent auditor, subject to the de minimis exceptions for non-audit services described in Section 10A(i)(1)(B) of the Exchange Act and the rules and regulations of the SEC which are approved by the audit committee prior to the completion of the audit. All services rendered by our independent registered public accounting firms for the years ended December 31, 2014 and 2013 were pre-approved in accordance with the policies and procedures described above.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1) Financial Statements
The following financial statements are included in a separate section of this Annual Report on Form 10-K commencing on the page numbers specified below:
Report of Independent Registered Public Accounting Firm (KPMG LLP)
Consolidated Balance Sheets as of December 31, 2014 and December 31, 2013
Consolidated Statements of Operations for the Years Ended December 31, 2014, 2013 and 2012
Consolidated Statements of Equity for the Years Ended December 31, 2014, 2013, and 2012
Consolidated Statements of Cash Flows for the Years Ended December 31, 2014, 2013 and 2012
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules
Schedule III - Real Estate and Accumulated Depreciation
(3) Exhibits
The exhibits listed on the Exhibit Index (following the signatures section of this report) are included, or incorporated by reference, in this annual report.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Sentio Healthcare Properties, Inc.:
We have audited the accompanying consolidated balance sheets of Sentio Healthcare Properties, Inc. and subsidiaries as of December 31, 2014 and 2013, and the related consolidated statements of operations, equity, and cash flows for each of the years in the three-year period ended December 31, 2014. In connection with our audits of the consolidated financial statements, we also have audited financial statement schedule III. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule III based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sentio Healthcare Properties, Inc. and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule III, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ KPMG LLP
Orlando, Florida
March 20, 2015
Certified Public Accountants
SENTIO HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2014 and 2013
The accompanying notes are an integral part of these consolidated financial statements.
SENTIO HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31, 2014, 2013 and 2012
The accompanying notes are an integral part of these consolidated financial statements.
SENTIO HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EQUITY
For the Years Ended December 31, 2014, 2013 and 2012
The accompanying notes are an integral part of these consolidated financial statements.
SENTIO HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2014, 2013 and 2012
The accompanying notes are an integral part of these consolidated figures
SENTIO HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2014, 2013 and 2012
1. Organization
Sentio Healthcare Properties, Inc., a Maryland corporation, was formed on October 16, 2006 under the Maryland General Corporation Law for the purpose of engaging in the business of investing in and owning commercial real estate. As used in this report, the “Company”, “we”, “us” and “our” refer to Sentio Healthcare Properties, Inc. and its consolidated subsidiaries, except where context otherwise requires. Effective January 1, 2012, subject to certain restrictions and limitations, our business is managed by Sentio Investments, LLC, a Florida limited liability company that was formed on December 20, 2011 (the “Advisor”). Prior to January 1, 2012, we were externally advised by Cornerstone Leveraged Realty Advisors, LLC.
Sentio Healthcare Properties OP, LP., a Delaware limited partnership (the “Operating Partnership”), was formed on October 17, 2006. At December 31, 2014, we owned 100% of the outstanding common units in the Operating Partnership and the HC Operating Partnership, LP, a subsidiary of the Operating Partnership. Pursuant to the terms of the KKR Equity Commitment (as described in Note 2), we have issued Series B Convertible Preferred Units in the Operating Partnership (“Series B Preferred Units”) to the Investor (as described in Note 2), the terms of which provide that the Investor may convert its preferred units into common units in its discretion. On an as-converted basis, the Investor owns 45% and we own the remaining interest in the Operating Partnership and the HC Operating Partnership, LP. We anticipate that we will conduct all or a portion of our operations through the Operating Partnership. Our financial statements and the financial statements of the Operating Partnership are consolidated in the accompanying consolidated financial statements. All intercompany accounts and transactions have been eliminated in consolidation.
2. Equity Issuances
Our charter authorizes the issuance of up to 580,000,000 shares of common stock with a par value of $0.01 per share and 20,000,000 shares of preferred stock with a par value of $0.01 per share.
From June 2008 until May 2011, we conducted public offerings of our shares of common stock. Our initial public offering terminated on February 3, 2011, immediately prior to commencement of our follow-on public offering on February 4, 2011. As of December 31, 2014, we had sold a total of 12.7 million shares of our common stock pursuant to our initial and follow-on public offerings for aggregate gross proceeds of $127.0 million.
On February 10, 2013, we entered into a series of agreements, which have been amended at various times after February 10, 2013, with the Sentinel RE Investment Holdings LP (the “Investor”), an affiliate of Kohlberg Kravis Roberts & Co. L.P. (together with its affiliates, “KKR”) for the purpose of obtaining up to a $158.7 million equity commitment to be used to finance future investment opportunities (such investment and the related agreements, are referred to herein collectively as the “KKR Equity Commitment”). Pursuant to the KKR Equity Commitment, the Company authorized and issued 1,000 shares of Senior Cumulative Preferred Stock, Series C, $0.01 par value per share (the “Series C Preferred Stock”), representing an aggregate issuance amount of $100,000. The Operating Partnership may issue Series B Preferred Units up to an aggregate issuance amount of $158.6 million. Subject to certain limitations, the Series B Preferred Units may be converted into common stock of the Company. The obligations of KKR to fund and of the Company to draw funds under the KKR Equity Commitment are subject to various conditions, limitations and penalties.
On June 19, 2013, we filed a registration statement on Form S-3 to register up to $99,000,000 of shares of common stock to be offered to our existing stockholders pursuant to our distribution reinvestment plan. The distribution reinvestment plan offering shares were initially offered at a purchase price of $10.02 per share, which was the then-current estimated per-share value of our common stock. Effective February 28, 2014, the distribution reinvestment plan offering shares are being offered at a purchase price of $11.63 per share, which is our updated estimated per-share value of our common stock as of February 28, 2014. As of December 31, 2014, we had sold a total of 583,611 shares of our common stock pursuant to our distribution reinvestment plan offering for aggregate gross proceeds of $5.6 million.
3. Summary of Significant Accounting Policies
The summary of significant accounting policies presented below is designed to assist in understanding our consolidated financial statements. These accounting policies conform to accounting principles generally accepted in the United States of America, or GAAP, in all material respects, and have been consistently applied in preparing the accompanying consolidated financial statements.
Cash and Cash Equivalents
We consider all short-term, highly liquid investments that are readily convertible to cash with a maturity of three months or less at the time of purchase to be cash equivalents.
Restricted Cash
Restricted cash represents cash held in interest bearing accounts and amounts related to impound reserve accounts for property taxes and insurance as required under the terms of mortgage loan agreements. Based on the intended use of the restricted cash, we have classified changes in restricted cash within the statements of cash flows as operating or investing activities.
Principles of Consolidation and Basis of Presentation
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. In accordance with the guidance for the consolidation of variable interest entities (“VIEs”), we analyze our variable interests, including investments in partnerships and joint ventures, to determine if the entity in which we have a variable interest is a variable interest entity. Our analysis includes both quantitative and qualitative reviews, based on our review of the design of the entity, its organizational structure including decision-making ability, risk and reward sharing experience and financial condition of other partner(s), voting rights, involvement in day-to-day capital and operating decisions and financial agreements. We also use quantitative and qualitative analyses to determine if we must consolidate a variable interest entity as the primary beneficiary.
Investments in Unconsolidated Entities
We account for our investments in unconsolidated joint ventures under the equity method of accounting. We exercise significant influence, but do not control these entities or direct the activities that most significantly impact the venture’s performance. Investments in unconsolidated entities are recorded initially at cost and subsequently adjusted for cash contributions and distributions. We recognize our allocable share of the equity in earnings of our unconsolidated entities based on the respective venture’s structure and preferences.
Real Estate Purchase Price Allocation
We allocate the purchase price of our properties in accordance with ASC 805-10, “Business Combinations.” Upon acquisition of a property, we allocate the purchase price of the property based upon the fair value of the assets acquired, which generally consist of land, buildings, site improvements, tenant improvements, intangible lease assets or liabilities including in-place leases, above market and below market leases, tenant relationships and goodwill. We allocated the purchase price to the fair value of the tangible assets of an acquired property by valuing the property as if it were vacant. We are required to make subjective assessments as to the useful lives of our depreciable assets. We consider the period of future benefit of the asset to determine the appropriate useful lives. Depreciation of our assets is being charged to expense on a straight-line basis over the assigned useful lives. The value of the building and improvements are depreciated over an estimated useful life of 15 to 39 years.
In-place lease values are calculated based on management’s evaluation of the specific characteristics of each tenant’s lease and our overall relationship with the respective tenant.
Acquired above and below market leases are valued based on the present value of the difference between prevailing market rates and the in-place rates over the remaining lease term. The value of acquired above and below market leases is amortized over the remaining non-cancelable terms of the respective leases as an adjustment to rental revenue on our consolidated statements of operations.
We amortize the value of in-place leases and above and below market leases over the initial term of the respective leases. Should a tenant terminate its lease, the unamortized portion of the tenant improvements, intangible lease assets or liabilities and the in-place lease value will be immediately charged to expense.
Goodwill represents the excess of acquisition cost over the fair value of identifiable net assets of the business acquired.
Impairment of Real Estate Assets and Goodwill
Real Estate Assets
We assess whether there has been impairment in the value of our investments in real estate whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Our portfolio is evaluated for impairment on a property-by-property basis. Indicators of potential impairment include the following:
·Change in strategy resulting in a decreased holding period;
·Decreased occupancy levels;
·Deterioration of the rental market as evidenced by rent decreases over numerous quarters;
·Properties adjacent to or located in the same submarket as those with recent impairment issues; and/or
·Tenant financial problems.
During 2014, 2013 and 2012, we did not record any impairment charges related to our investments in real estate. The assessment as to whether our investments in real estate are impaired is highly subjective. The calculations, which are primarily based on discounted cash flow analyses, involve management’s best estimate of the holding period, market comparables, future occupancy levels, rental rates, capitalization rates, lease-up periods and capital requirements for each property. A change in any one or more of these factors could materially impact whether a property is impaired as of any given valuation date.
Goodwill
We review goodwill for impairment annually and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. The guidance on goodwill impairment requires us to annually test goodwill for impairment under a two-step impairment test or under a qualitative assessment which became optional in 2011. In Step 1 of the two-step test, we compare the fair value of each reporting unit to its carrying value. We determine the fair value of our reporting unit based on the income approach. Under the income approach, we calculate the fair value of a reporting unit based on the present value of estimated future cash flows. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not impaired. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then the second step of the impairment test is performed in order to determine the implied fair value of the reporting unit’s goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then the company records an impairment loss equal to the difference.
For the years ended December 31, 2014 and 2013, the Company performed Step 1 in its evaluation of goodwill. The Company did not record any impairment charges related to our goodwill.
Income Taxes
For federal income tax purposes, we have elected to be taxed as a REIT, under Sections 856 through 860 of the Code beginning with our taxable year ended December 31, 2008, which imposes limitations related to operating assisted-living properties.
Each taxable REIT subsidiary (“TRS”) is a tax paying component for purposes of classifying deferred tax assets and liabilities. We record net deferred tax assets to the extent we believe these assets will more likely than not be realized. In making such determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations. In the event we were to determine that we would not be able to realize our deferred income tax assets in the future in excess of their net recorded amount, we would make an adjustment to the valuation allowance which would reduce the provision for income taxes.
Uncertain Tax Positions
In accordance with the requirements of ASC 740-10, “Income Taxes,” favorable tax positions are included in the calculation of tax liabilities if it is more likely than not that the Company’s adopted tax position will prevail if challenged by tax authorities. As a result of our REIT status, we are able to claim a dividends-paid deduction on our tax return to deduct the full amount of common dividends paid to stockholders when computing our annual taxable income. A REIT is subject to a 100% tax on the net income from prohibited transactions. A “prohibited transaction” is the sale or other disposition of property held primarily for sale to customers in the ordinary course of a trade or business. There is a safe harbor which, if met, expressly prevents the Internal Revenue Service (the “IRS”) from asserting the prohibited transaction test. As we have not had any sales of properties to date, the prohibited transaction tax is not applicable. We have no income tax expense, deferred tax assets or deferred tax liabilities associated with any such uncertain tax positions for the operations of any entity included in the consolidated results of operations.
Tenant and Other Receivables
Tenant and other receivables are comprised of rental and reimbursement billings due from tenants. Tenant receivables are recorded at the original amount earned, less an allowance for any doubtful accounts. Management assesses the realizability of tenant receivables on an ongoing tenant by tenant basis and provides for allowances as such balances, or portions thereof, become uncollectible. For the years ended December 31, 2014 and December 31, 2013 provisions for bad debts amounted to approximately $276,000 and $50,000, respectively. The allowance for tenant receivables is included in property operating and maintenance expenses in the accompanying consolidated statements of operations.
Deferred Financing Costs
Costs incurred in connection with debt financing are recorded as deferred financing costs. Deferred financing costs are amortized using a method which approximates the effective interest rate method over the contractual terms of the respective financings.
Revenue Recognition
Revenue is recognized when four basic criteria are met: persuasive evidence of an arrangement, the rendering of service, fixed and determinable income and reasonably assured collectability. Leases with fixed annual rental escalators are generally recognized on a straight-line basis over the initial lease period, subject to a collectability assessment. Rental income related to leases with contingent rental escalators is generally recorded based on the contractual cash rental payments due for the period. Because our leases may provide for free rent, lease incentives, or other rental increases at specified intervals, we straight-line the recognition of revenue, which results in the recording of a receivable for rent not yet due under the lease terms. Our revenues are comprised largely of rental income and other income collected from tenants.
Noncontrolling Interest in Consolidated Subsidiaries
Noncontrolling interests include the portion of consolidated entities that are not owned by the Company, and the KKR net investment of $94.7 million in Series B Preferred Units. The Series B Preferred Units have a liquidation preference that is determined as the greater of: (i) $ 100 per unit, plus accrued and unpaid distributions or (ii) the distribution that would be made on number of common shares into which shares of Series B Preferred Units could be converted.
ASC 810-10-65 Consolidation clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. ASC 810-10-65 also requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest and requires disclosure, on the face of the consolidated statement of income, of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest.
We periodically evaluate individual noncontrolling interests for the ability to continue to recognize the noncontrolling interest as permanent equity in the consolidated balance sheets. Any noncontrolling interest that fails to qualify as permanent equity will be reclassified as temporary equity and adjusted to the greater of (a) the carrying amount, or (b) its redemption value as of the end of the period in which the determination is made.
Fair Value of Financial Instruments
FASB ASC 825-10, “Financial Instruments,” requires the disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practical to estimate that value.
Fair value represents the estimate of the proceeds to be received, or paid in the case of a liability, in a current transaction between willing parties. ASC 820, Fair Value Measurement establishes a fair value hierarchy to categorize the inputs used in valuation techniques to measure fair value. Inputs are either observable or unobservable in the marketplace. Observable inputs are based on market data from independent sources and unobservable inputs reflect the reporting entity’s assumptions about market participant assumptions used to value an asset or liability.
Financial assets and liabilities recorded at fair value on the consolidated balance sheets are categorized based on the inputs to the valuation techniques as follows:
Level 1. Quoted prices in active markets for identical instruments.
Level 2. Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3. Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Assets and liabilities measured at fair value are classified according to the lowest level input that is significant to their valuation. A financial instrument that has a significant unobservable input along with significant observable inputs may still be classified as a Level 3 instrument.
We generally determine or calculate the fair value of financial instruments using present value or other valuation techniques, such as discounted cash flow analyses, incorporating available market discount rate information for similar types of instruments and our estimates for non-performance and liquidity risk. These techniques are significantly affected by the assumptions used, including the discount rate, credit spreads, and estimates of future cash flow.
Our balance sheets include the following financial instruments: cash and cash equivalents, tenant and other receivables, restricted cash, security deposits, accounts payable and accrued liabilities, distributions payable, and notes payable. With the exception of notes payable, we consider the carrying values of our financial instruments to approximate fair value because they generally expose the Company to limited credit risk and because of the short period of time between origination of the financial assets and liabilities and their expected settlement.
Use of Estimates
The preparation of our consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of the assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the reporting period. Actual results could materially differ from those estimates.
New Accounting Standards
In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”). The standard is a comprehensive new revenue recognition model that requires revenue to be recognized in a manner to depict the transfer of goods or services to a customer at an amount that reflects the consideration expected to be received in exchange for those goods or services. ASU 2014-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early adoption is not permitted. Accordingly, the standard is effective for us on January 1, 2017. We are currently evaluating the impact that the standard will have on our consolidated financial statements and have not yet determined the method by which we will adopt the standard.
4. Acquisitions
2014 Acquisitions
Compass on the Bay
On April 4, 2014, through wholly-owned subsidiaries, we acquired a 95% interest in a joint venture entity that will own Compass on the Bay, located in Boston, MA. Compass on the Bay has a total of 56 beds in 39 units, which are dedicated to both assisted living and memory care. Senior Living Residences, LLC and its affiliates (collectively, “SLR”), which is not affiliated with us, is our joint venture partner in the $11.7 million transaction. Prior to the completion of this transaction, Compass on the Bay was owned by SLR and a third-party entity. SLR specializes in the acquisition, development and management of senior housing communities.
St. Andrews Village
On August 20, 2014, through a wholly-owned subsidiary, we acquired real estate property (“St. Andrews Village”) from ERB PROPCO SAV, LLC, which is not affiliated with us, for a purchase price of $42.5 million plus closing costs and expenses. St. Andrews Village is a senior living community that consists of 146 independent living units, 60 assisted living units, and 40 skilled nursing facility units in Aurora, Colorado. St. Andrews Village is leased to ERB OPCO SAV, LLC under the terms of a net lease with an initial term of 10 years.
Live Oaks Village of Hammond and Slidell
On November 14, 2014, through a wholly-owned subsidiary, we acquired real estate property (“Live Oaks”) from CBC Slidell, LLC, CBC Hammond, LLC, Slidell Senior Living, LLC and Hammond Senior Living, LLC (collectively, the “Sellers”), none of which are affiliated with us or our Advisor, for an approximate purchase price of $12.7 million. The Live Oak Portfolio consists of two assisted living and memory care facilities (“Hammond” and “Slidell”) with a total of 94 units, located in Louisiana. After the transaction occurred, we transitioned the Portfolio management to SRI Management, LLC (“Superior Residences” or “Superior”), which is not affiliated with us.
Spring Village at Wildewood
On November 24, 2014, through a wholly-owned subsidiary, we acquired real estate property (“Spring Village at Wildewood” or “Wildewood”) from Wildewood Operating Company, LLC, which is not affiliated with us, for a purchase price of $9.65 million. Wildewood received its Certificate of Occupancy in May 2014 and opened later that month in California, Maryland. The senior housing facility has a total of 48 units dedicated to both assisted living and memory care. We entered into a management agreement with Woodbine Senior Living (“Woodbine”) to operate Wildewood. Woodbine currently manages Floral Vale and Forestview, and the properties have been full for the past several years.
Gables of Hudson
On December 18, 2014, through wholly owned subsidiaries, we acquired real estate property (“Gables of Hudson”) from Great-Hudson, LLC, and Gables-Hudson, LLC (collectively, the “Sellers”), none of which are affiliated with us or our Advisor, for a net approximate purchase price of $16.75 million. Gables of Hudson has a total of 114 beds in 112 units, which are dedicated to both assisted living and memory care located in Hudson, Ohio. Prior to the completion of this transaction, Gables of Hudson was owned and operated by Gables Management Company, Inc. (“Gables Management”). We will retain Gables Management on a fee basis to operate Gables of Hudson, which will result in a new operator relationship for the REIT.
Sumter Place
On December 31, 2014, through a wholly-owned subsidiary, we acquired real estate (“Sumter Place”) from Retirement One, LLC, which is not affiliated with us, for a purchase price of $48.5 million. Sumter Place is a senior living community that consists of 148 units dedicated to both assisted living and memory care in The Villages, Florida. The current manager of the Portfolio is KR Management.
The following summary provides the allocation of the acquired assets and liabilities for the above acquisitions as of the acquisition date. We have accounted for the acquisitions as business combinations under GAAP. Under business combination accounting, the assets and liabilities of the acquired properties were recorded as of the acquisition date, at their respective fair values, and consolidated in our financial statements. The details of the purchase prices of the acquired properties are set forth below:
(1)This balance represents the fair value of the above market ground lease associated with the land in the Sumter Place acquisition.
(2)This balance represents an earnout liability the sellers of Gables of Hudson are entitled to based on a net operating income threshold. The earliest period of the earnout will be twelve months after the acquisition date and will expire (if not achieved) 36 months after close.
The following unaudited pro forma information for the years ended December 31, 2014 and 2013 have been prepared to reflect the incremental effect of the 2014 acquisitions as if such acquisitions had occurred on January 1, 2013. We have not adjusted the pro forma information for any items that may be directly attributable to the business combination or non-recurring in nature.
The Company recorded revenues of $2.5 million and a net loss of $0.6 million for the twelve month period ended December 31, 2014 for the Compass on the Bay acquisition.
The Company recorded revenues of $1.6 million and a net loss of $0.1 million for the twelve month period ended December 31, 2014 for the St. Andrews Village acquisition.
The remaining five entities that were acquired in the fourth quarter of 2014 recorded net revenues of $0.9 million and a net loss of $0.3 million for the twelve month period ended December 31, 2014.
2013 Acquisitions
Woodbury Mews
On October 21, 2013, through wholly-owned subsidiaries, we acquired real estate property (“Woodbury Mews”) from Three WM Real Estate, LLC, Three WM Operating, LLC, Four WM Real Estate, LLC and Four WM Operating, none of which are affiliated with us, for a purchase price of $38.1 million. Woodbury Mews consists of a 129-unit independent living facility, a 98-unit assisted living facility, and four undeveloped land parcels located in Woodbury, New Jersey. We funded the purchase of Woodbury Mews with proceeds from the sale of Series C Preferred Stock and Series B Preferred Units to the Investor, as described in Note 13, and with proceeds from a mortgage loan from KeyBank National Association, Inc., as described in Note 7.
Standish Village Joint Venture
On December 6, 2013, through wholly-owned subsidiaries, we invested approximately $5.1 million to acquire 95% of the respective equity interests in Sentio SLR Boston Portfolio, LLC (“Landlord LLC”) and Sentio SLR Boston TRS Portfolio, LLC (“Tenant LLC”) (collectively, we refer to the Landlord LLC and the Tenant LLC as the “SLR Joint Venture”). Landlord LLC, through its wholly-owned subsidiary, indirectly owns 100% of Standish Village. Standish Village has a total of 108 beds in 85 units, which are dedicated to both assisted living and memory care. Tenant LLC owns 100% of the tenant entity that operates the Standish Village licensed community residential care facility. Oaktree SLR, LLC, a Senior Living Residences (“SLR”) affiliate, invested approximately $0.3 million to acquire the remaining 5% equity interests in Landlord LLC and Tenant LLC. As a result of the structure described above, the Company controls Landlord LLC and Tenant LLC and consolidates these entities. We funded the purchase of our interest in the SLR Joint Venture with proceeds from the sale of Series B Preferred Units to the Investor as described in Note 13, and with proceeds from a mortgage loan from CBRE Capital Markets, Inc. as described in Note 7.
The following summary provides the allocation of the acquired assets and liabilities as of the acquisition date. We have accounted for the acquisitions as business combinations under GAAP. Under business combination accounting, the assets and liabilities of the acquired properties were recorded as of the acquisition date, at their respective fair values, and consolidated in our financial statements. The details of the purchase prices of the acquired properties are set forth below:
The following unaudited pro forma information for the years ended December 31, 2013 and 2012 have been prepared to reflect the incremental effect of the Woodbury Mews and the Standish Village acquisitions as if such acquisitions had occurred on January 1, 2012. We have not adjusted the pro forma information for any items that may be directly attributable to the business combination or non-recurring in nature.
The Company recorded revenues of $1.7 million and net loss of $1.5 million for the year ended December 31, 2013, for the Woodbury Mews acquisition.
The Company recorded revenues of $0.3 million and a net loss of $0.4 million for the year ended December 31, 2013, for the Standish Village acquisition.
5. Investments in Real Estate
The following table provides summary information regarding our property portfolio of consolidated investments as of December 31, 2014:
As of December 31, 2014, cost and accumulated depreciation and amortization related to real estate assets and related lease intangibles were as follows:
As of December 31, 2013, accumulated depreciation and amortization related to investments in real estate and related lease intangibles were as follows:
Depreciation expense associated with buildings and improvements, site improvements and furniture, fixtures and equipment for the years ended December 31, 2014, 2013, and 2012 was approximately $8.2 million, $5.9 million, and $4.5 million, respectively. Amortization associated with the intangible assets for the years ended December 31, 2014, 2013 and 2012 was $3.6 million, $2.8 million, and $2.6 million, respectively.
The estimated useful lives for intangible assets range from one to 20 years. As of December 31, 2014, the weighted-average amortization period for intangible assets was approximately 11 years.
Estimated amortization for each of the five following years ended December 31 is as follows:
6. Investments in Unconsolidated Entities
As of December 31, 2014, the Company owned an interest in the following entities that are accounted for under the equity method of accounting:
As of December 31, 2013, the Company owned interests in the following entity that was accounted for under the equity method of accounting:
(1) These entities are not consolidated because the Company exercises significant influence, but does not control or direct the activities that most significantly impact each entity’s performance.
(2) Represents the carrying value of the Company’s investment in each unconsolidated entity.
Summarized combined financial information for the Company’s unconsolidated entities is as follows:
(1) Littleton Specialty Rehabilitation Facility was completed in April 2012 and the single tenant began paying rent in July 2012, in accordance with the lease. Tenant operations commenced upon licensure of the facility in July 2012 and Littleton Specialty Rehabilitation Facility was accounted for under the equity method of accounting. On December 17, 2012, our joint venture partner notified the Company of their intent to exercise their promote monetization right. The Company elected to satisfy the monetization provision through a sale of the property. The property was sold on August 8, 2013 for $11.3 million, which resulted in the Company receiving cash proceeds, net of debt repayment, of approximately $3.5 million. The Company recorded a gain of $1.7 million in the quarter ended September 30, 2013. The Company’s equity in income from the Littleton Specialty Rehabilitation Facility is included in the statement of operations through the date of the sale.
(2) The Physicians Centre MOB joint venture was acquired in April 2012 and was accounted for under the equity method of accounting beginning with the second quarter of 2012.
(3) The Company acquired the controlling interest in the operations of Rome LTACH in April 2012 and as a result, Rome LTACH was consolidated in the second quarter of 2012. Prior to April 2012, Rome LTACH was accounted for under the equity method of accounting for the year ended December 31, 2011 and the three months ended March 31, 2012.
(4) On January 28, 2014, through a wholly-owned subsidiary, we acquired a 25% interest in a joint venture entity that will develop Buffalo Crossing, a 108-unit, assisted living community. Buffalo Crossing was accounted for under the entity method of accounting beginning with the first quarter of 2014.
(5) On October 2, 2014, through a wholly-owned subsidiary, we acquired a 65% interest in a joint venture entity that will develop the Parkway, a 142-unit, senior housing facility. The Parkway was accounted for under the equity method accounting beginning with the fourth quarter of 2014.
7. Notes Payable
Notes payable were $276.4 million ($276.5 million, including premium) and $181.3 million ($181.7 million, including premium) as of December 31, 2014 and 2013, respectively. As of December 31, 2014, we had total secured mortgage loans with effective interest rates ranging from 2.80% to 6.43% per annum and a weighted-average effective interest rate of 4.13% per annum. As of December 31, 2014, we had $156.4 million of fixed rate debt, or 57% of notes payable, at a weighted average interest rate of 4.89% per annum and $120.0 million of variable rate debt, or 43% of notes payable, at a weighted average interest rate of 3.15% per annum. As of December 31, 2013, we had fixed and variable rate mortgage loans with effective interest rates ranging from 2.80% to 6.50% per annum and a weighted average effective interest rate of 4.91% per annum.
On April 4, 2014, the Company acquired a 95% interest in the SLR Joint Venture subject to existing indebtedness of two loans that totaled approximately $6.6 million ($6.3 million, net of discount). The Company assumed one note payable in the amount of approximately $3.9 million with a fixed 3.32% rate of interest and a 35 year term. In addition, the Company assumed a second note payable in the amount of approximately $2.7 million with a fixed 5.65% rate of interest and a 35 year term. These notes payable are secured by the underlying real estate.
On August 19, 2014, in connection with the acquisition of St. Andrews Village, we entered into a mortgage agreement with CBRE Capital Markets, Inc. (“CBRE“), an unaffiliated lender, with an outstanding principal balance of approximately $30.2 million, which is secured by St. Andrews Village. The note has a term of nine years with the first two years at a floating interest rate of the one month LIBOR plus 3.07% and the remaining seven years at a fixed rate of interest of 4.64%. Loan payments are interest only for the first four years and thereafter include principal amortization based on a 30-year amortization period.
On November 14, 2014, the company entered into a secured loan agreement with KeyBank National Association, Inc. (“KeyBank”), an unaffiliated lender, in the aggregate amount of $38.035 million. The loan represents a refinancing of the loan on Mesa Vista Inn Health Center (“MVI”) as well as a loan in connection with the acquisition of Live Oaks of Hammond, Live Oaks of Slidell, Spring Village at Wildewood, and Gables of Hudson. As of December 31, 2014, a total of $36.035 million was drawn on the loan where the outstanding principal related to MVI is $10.0 million, Live Oaks of Hammond is $4.55 million, Live Oaks of Slidell is $3.7 million, Spring Village at Wildewood is $6.41 million, and Gables of Hudson is $11.375 million. The loan has an initial term of three years with an option to extend the maturity date one year and a floating interest rate of one-month LIBOR plus 2.75% subject to increase in certain circumstances. Loan payments are interest only until the maturity date.
On December 31, 2014, in connection with the acquisition of a senior living community in The Villages, Florida (“Sumter Place”), we entered into a mortgage agreement with KeyBank with an outstanding principal balance of approximately $28.9 million, which is secured by Sumter Place. The loan has a term of three years at a floating interest rate of one month LIBOR plus 3.15% subject to increase in certain circumstances. Loan payments are interest only for the initial three year term. We have the right to make prepayments on the loan, in whole or in part, without prepayment penalty provided that the minimum repayment is in increments of at least $500,000. We have an extension option for a single one-year term in which the payments would include principal amortization based on a 30-year amortization period.	
On December 5, 2013, in connection with our acquisition of an interest in Standish Village, we entered into a mortgage agreement with CBRE with an outstanding principal balance of approximately $10.9 million, which is secured by Standish Village. The loan has an initial term of ten years, and bears interest at a fixed rate of 5.76%. Payments on the loan are due monthly and consist of accrued interest-only during the initial 48 months, and the remaining payments will consist of interest plus principal amortization payments based upon a 25-year amortization schedule.
On November 26, 2013, the Company completed a refinancing of the Oakleaf Village Portfolio. Proceeds from the refinancing of $20.0 million exceeded the debt repaid and loan fees and expenses by approximately $2.0 million. The loan is secured by first priority liens on the refinanced properties. The loan has a five-year term with the rate of interest fixed at 4.0% and payments of principal on a 25-year amortization rate. In connection with the closing of the loan, the Company recognized a loss on debt extinguishment in the amount of $0.4 million, which is included in loss on debt extinguishment and other expense in the accompanying consolidated statements of operations.
On October 21, 2013, in connection with our acquisition of Woodbury Mews, we entered into a mortgage agreement with KeyBank with an outstanding principal balance of approximately $25.0 million, which is secured by Woodbury Mews. The loan had an initial term of twelve months with two twelve-month extensions available assuming certain criteria are met, and bears interest at a rate of one month LIBOR plus 3.0%. Payments on the loans are due monthly and consist of accrued interest-only during the initial term. If the extension option is exercised, payments will consist of interest plus principal amortization payments based upon a 25-year amortization schedule. This loan has been extended for an additional twelve month term.
We are required by the terms of the applicable loan documents to meet certain financial covenants, such as debt service coverage ratios, rent coverage ratios and reporting requirements. As of December 31, 2014, we were in compliance with all such covenants and requirements, with the exception of Woodbury Mews.
At December 31, 2014, the average Woodbury Mews occupancy was below the minimum loan requirement, violating a covenant of this loan. Our lender has waived compliance with this covenant for the quarter ended December 31, 2014. In the event that the Company is not in compliance with this covenant in future periods and is unable to obtain a consent or waiver, KeyBank may choose to pursue remedies under the loan which could include foreclosure of the Woodbury Mews Property and enforcement of the Company’s guarantee of up to 25% of the loan balance.
The following table summarizes the debt terms and our outstanding principal loan balances as of December 31, 2014 and December 31, 2013:
(1)As of December 31, 2014 and December 31, 2013, all notes payable are secured by the underlying real estate.
(2)On October 22, 2013, this loan was modified to reduce the interest rate from a variable rate of 6.25% to a fixed rate of 4.75%.
(3)On September 19, 2014, this loan was refinanced with BB&T Real Estate Funding LLC.
(4)On November 14, 2014 this loan was refinanced with KeyBank.
(5)Part of the November 14, 2014 KeyBank secured term loan agreement that totals $38.035 Million
Principal payments due on our notes payable as of December 31, 2014 and each of the five subsequent years are as follows:
8. Future Minimum Lease Payments
All resident leases in our senior operations living segment are on a month to month basis and are excluded from the following schedule. Future minimum lease payments to be received from leases under the triple-net leased segment and medical office building segment as of December 31, 2014 are as follows:
9. Concentration of Risks
Financial instruments that potentially subject the Company to a concentration of credit risk are primarily cash investments; cash is generally invested in investment-grade short-term instruments. As of December 31, 2014, we had cash accounts in excess of Federal Deposit Insurance Corporation insured limits.
Concentrations of credit risks arise when a number of operators, tenants or obligors related to our investments are engaged in similar business activities, located in the same geographic region, or have similar economic features that would cause their ability to meet contractual obligations, including those to the Company, to be similarly affected by changes in economic conditions. We regularly monitor various segments of our portfolio to assess potential concentration of risks. Management believes the current portfolio is reasonably diversified across healthcare-related real estate and does not contain any other significant concentration of credit risks, except as presented below.
For the year ended December 31, 2014, the senior living segment generated 89% of the Company’s total revenues. Included in the senior living segment, we owned or had joint venture interests in properties in 13 states of which the properties in five states accounted for 10% or more of our total revenue. The following table provides information about our geographic risk related to each of the five states and their economies for the three years ended December 31, 2014:
The Company utilizes third-party operators to provide property management and accounting services for our senior living operations, for which we pay annual management fees. As operators, the Company is not directly exposed to their credit risk. However, we rely on our operators to operate our senior housing operations in compliance with the terms of our management agreements and all applicable laws and regulations. The operators’ inability to satisfy their obligations under the management agreements could have a material adverse effect on us.
The following table provides information about our senior living operators which accounted for 10% or more of our total revenue for the three years ended December 31, 2014:
10. Segment Reporting
As of December 31, 2014, we operated in three reportable business segments for management and internal financial reporting purposes: senior living operations, triple-net leased properties, and medical office building (“MOB”) properties. These operating segments are the segments of the Company for which separate financial information is available and for which segment results are evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Our senior living operations segment primarily consists of investments in senior housing communities located in the United States for which we engage independent third-party managers. Our triple-net leased properties segment consists of investments in skilled nursing and hospital facilities in the United States. These facilities are leased to healthcare operating companies under long-term “triple-net” or “absolute-net” leases, which require the tenants to pay all property-related expenses. Our MOB operations segment primarily consists of investing in medical office buildings and leasing those properties to healthcare providers under long-term leases, which may require tenants to pay property-related expenses.
We evaluate performance of the combined properties in each segment based on net operating income. Net operating income is defined as total revenue less property operating and maintenance expenses. There are no intersegment sales or transfers. We use net operating income to evaluate the operating performance of our real estate investments and to make decisions concerning the operation of the property. We believe that net operating income is useful to investors in understanding the value of income-producing real estate. Net income is the GAAP measure that is most directly comparable to net operating income; however, net operating income should not be considered as an alternative to net income as the primary indicator of operating performance as it excludes certain items such as depreciation and amortization, asset management fees and expenses, real estate acquisition costs, interest expense and corporate general and administrative expenses. Additionally, net operating income as we define it may not be comparable to net operating income as defined by other REITs or companies.
The following tables reconcile the segment activity to consolidated net income for the years ended December 31, 2014, 2013 and 2012:
The following table reconciles the segment activity to Consolidated Total Assets as of December 31, 2014 and December 31, 2013:
As of December 31, 2014 and 2013, goodwill had a balance of approximately $6.0 million all related to our senior living operations segment.
11. Fair Value Measurements
Our balance sheets include the following financial instruments: cash and cash equivalents, tenant and other receivables, restricted cash, security deposits, accounts payable and accrued liabilities, distributions payable, and notes payable. With the exception of an equity method investment the Company obtained control of in April 2012 and notes payable discussed below, we consider the carrying values of our financial instruments to approximate fair value because they generally expose the Company to limited credit risk and because of the short period of time between origination of the financial assets and liabilities and their expected settlement.
The fair market value of the Company’s notes payable is estimated by discounting future cash flows of each instrument at rates that reflect the current market rates available to the Company for debt of the same terms and maturities. The fair value of the notes payable was determined using Level 2 inputs of the fair value hierarchy. Based on the estimates used by the Company, the fair value of notes payable was $275.8 million and $178.4 million, compared to the carrying values of $276.4 million ($276.5 million, including premium) and $181.3 million ($181.7 million, including premium) at December 31, 2014 and 2013, respectively.
Upon acquiring control of a previously unconsolidated entity in April 2012, the Company recorded its equity method investment at fair value of $6.0 million, and recorded a gain of approximately $1.3 million. The fair value of the equity method investment was estimated using a direct capitalization approach and was measured using Level 3 inputs. The capitalization rate used was 8.25% and a change in this input could result in a significant change in the valuation of our original joint venture investment and a change in the gain from remeasurement recognized during the period.
There were no transfers between Levels 1 or 2 during the year ended December 31, 2014. There were no assets or liabilities measured at fair value on a non-recurring basis included in the consolidated balance sheets as of December 31, 2014 or December 31, 2013.
12. Income Taxes
For federal income tax purposes, we have elected to be taxed as a REIT, under Sections 856 through 860 of the Code beginning with our taxable year ended December 31, 2008. REIT status imposes limitations related to operating assisted-living properties. Generally, to qualify as a REIT, we cannot directly operate assisted-living facilities. However, such facilities may generally be operated by a TRS pursuant to a lease with the Company. Therefore, we have formed Master HC TRS, LLC (“Master TRS”), a wholly owned subsidiary of HC Operating Partnership, LP, to lease any assisted-living properties we acquire and to operate the assisted-living properties pursuant to contracts with unaffiliated management companies. Master TRS and the Company made the applicable election for Master TRS to qualify as a TRS. Under the management contracts, the management companies direct control of the daily operations of these assisted-living properties.
As of December 31, 2014, we had acquired 14 wholly-owned assisted-living facilities and formed 24 wholly-owned TRSs, which includes a Master TRS that consolidates our wholly-owned TRSs.
Each TRS is a tax paying component for purposes of classifying deferred tax assets and liabilities. We record net deferred tax assets to the extent we believe these assets will more likely than not be realized. In making such determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations. In the event we were to determine that we would not be able to realize our deferred income tax assets in the future in excess of their net recorded amount, we would establish a valuation allowance which would reduce the provision for income taxes.
For the years ended December 31, 2014, 2013 and 2012, our TRS reported net taxable income of approximately $0.8 million, $0.7 million, and $0.7 million, respectively. The TRS recognized a $0.4 million, a $0.1 million and a $0.2 million benefit for federal and state income taxes in 2014, 2013 and 2012, respectively, which have been recorded in general and administrative expenses. Net deferred tax assets related to the TRS entities totaled $2.8 million and $1.9 million at December 31, 2014 and 2013, respectively, related primarily to book and tax basis differences for straight-line rent and accrued liabilities. Realization of these deferred tax assets is dependent in part upon generating sufficient taxable income in future periods. Deferred tax assets are included in deferred costs and other assets in our consolidated balance sheets. We have not recorded a valuation allowance against our deferred tax assets as of December 31, 2014, as we have determined the future taxable income from the operations of the TRS entities are expected to be sufficient to cover the additional future expenses resulting from these book tax differences.
13. Stockholders’ Equity
Our charter authorizes the issuance of 580,000,000 shares of common stock with a par value of $0.01 per share and 20,000,000 shares of preferred stock with a par value of $0.01 per share, of which 1,000 shares are designated as Series C Preferred Stock.
Common Stock
As of December 31, 2014 and 2013 including distributions reinvested, we had issued 13.3 million shares of common stock for a total of $132.3 million of gross proceeds, respectively, in our public offerings.
On April 10, 2014, we announced the commencement of an issuer tender offer to purchase for cash up to $35.0 million of our issued and outstanding shares of common stock from stockholders at a price of $8.50 per share. On May 22, 2014, we amended the tender offer to increase the purchase price to $9.00 per share and to extend the tender offer expiration date. The tender offer expired on June 12, 2014. We purchased 1,113,213 shares of our common stock pursuant to the tender offer for an aggregate cost of approximately $10.0 million, excluding fees and expenses related to the tender offer paid by the Company. The tender offer was funded by a sale of Series B Preferred Units to the Investor on June 18, 2014, and the remainder from the Company’s existing cash.
Preferred Stock and OP Units
As of December 31, 2014 we had issued 1,000 shares of Series C Preferred Stock and 946,560 Series B Preferred Units for gross proceeds of $94.8 million. The Series B Preferred Units outstanding are convertible into approximately 9,446,707 shares of the Company’s common stock and are classified as non-controlling interests in the accompanying consolidated balance sheets.
The Series C Preferred Stock ranks senior to the Company’s common stock with respect to dividend rights and rights on liquidation. The holders of the Series C Preferred Stock are entitled to receive dividends, as and if authorized by our board of directors out of funds legally available for that purpose, at an annual rate equal to 3% of the liquidation preference for each share. Dividends on the Series C Preferred Stock are payable annually in arrears.
The Series B Preferred Units rank senior to the Operating Partnership’s common units with respect to distribution rights and rights on liquidation. The Series B Preferred Units are entitled to receive cash distributions at an annual rate equal to 7.5% (with respect to put exercises associated with real property acquisitions) and 6.0% (with respect to put exercises associated with construction loan originations) of the Series B liquidation preference prior to any distributions paid to common units of the Operating Partnership. If the Operating Partnership is unable to pay cash distributions, distributions will be paid in kind at an annual rate of 10% of the Series B liquidation preference. After payment of the preferred distributions, additional distributions will be paid first to the common units until they have received an aggregate blended return equal to a weighted average interest rate determined taking into account the Series B Preferred Units receiving a 6.0% return and the Series B Preferred Units receiving a 7.5% return per unit in annual distributions commencing from February 10, 2013, and thereafter to the common units and Series B Preferred Units pro rata.
After giving effect to the Series C Preferred Stock and Series B Preferred Units issued at December 31, 2014, 639,700 Series B Preferred Units remain issuable under the Purchase Agreement. The obligation of the Investor to purchase additional Series B Preferred Units under the Purchase Agreement is conditioned upon, among other things, the receipt of notice from us of the intention to sell a specified amount of securities to the Investor to finance a proposed real estate acquisition.
Distributions
In 2007, we adopted a distribution reinvestment plan that allows our stockholders to have dividends and other distributions otherwise distributable to them, invested in additional shares of our common stock at their election. We registered 10,000,000 shares of our common stock for sale pursuant to the distribution reinvestment plan.
Effective as of May 10, 2011, we suspended our distribution reinvestment plan.
On June 19, 2013, we filed a registration statement on Form S-3 to register up to $99,000,000 of shares of common stock to be offered to our existing stockholders pursuant to an amended and restated distribution reinvestment plan (the “DRIP offering”). The DRIP offering shares were initially offered at a purchase price of $10.02, which was the then-current estimated per-share value of our common stock. Effective February 28, 2014, the DRIP offering shares are being offered at a purchase price of $11.63 per share, which is our updated estimated per-share value of common stock as of February 28, 2014. As of December 31, 2014 and December 31, 2013, 583,611 and 556,204 shares, respectively, had been issued under the distribution reinvestment plan.
The following are the distributions declared on our common stock during the years ended December 31, 2014, 2013, and 2012:
(1) In order to meet the requirements for being treated as a REIT under the Internal Revenue Code, we must pay distributions to our stockholders each taxable year equal to at least 90 % of our net ordinary taxable income. Some of our distributions have been paid from sources other than operating cash flow, such as offering proceeds. Until proceeds from equity issuances are fully invested and generating operating cash flow sufficient to fully cover distributions to stockholders, we intend to pay all or a portion of our distributions from the proceeds of equity issuances or from borrowings in anticipation of future cash flow.
The declaration of distributions is at the discretion of our board of directors. Our board will determine the amount of distributions on a regular basis. The amount of distributions will depend on our funds from operations, financial condition, capital requirements, annual distribution requirements under the REIT provisions of the Code and other factors our board of directors deems relevant. The rate and frequency of distributions is subject to the discretion of our board of directors and may change from time to time based on our operating results and cash flow.
Stock Repurchase Program
In 2007, we adopted a stock repurchase program for investors who have held their shares for at least one year, unless the shares are being repurchased in connection with a stockholder’s death. Under our stock repurchase program, the repurchase price varies depending on the purchase price paid by the stockholder and the number of years the shares are held. Our board of directors may amend, suspend or terminate the program at any time with 30 days prior notice to stockholders. We have no obligation to repurchase our stockholders’ shares. In 2009, our board of directors waived the one-year holding period in the event of the death of a stockholder and adjusted the repurchase price to 100% of such stockholders purchase price irrespective of how long the stockholder held the shares.
Our stock repurchase program has been suspended since May 29, 2011 for all repurchases, except repurchases due to death of a stockholder. On March 31, 2014, we informed our stockholders of the suspension of the share repurchase program following the March 2014 redemption date. The Company redeemed all stock repurchase requests received prior to March 31, 2014 due to death. Thereafter no shares will be repurchased until the repurchase program is reinstated.
During the years ended December 31, 2014, 2013 and 2012, we redeemed shares pursuant to our stock repurchase program as follows:
Employee and Director Incentive Stock Plan
We have adopted an Employee and Director Incentive Stock Plan (the “Plan”) which provides for the grant of awards to our directors and full-time employees, as well as other eligible participants that provide services to us. We have no employees, and we currently do not have plans to grant awards under the Plan to persons who are not directors. Awards granted under the Plan may consist of nonqualified stock options, incentive stock options, restricted stock, share appreciation rights, and dividend equivalent rights. The term of the Plan is 10 years. The total number of shares of common stock reserved for issuance under the Plan is equal to 10% of our outstanding shares of stock at any time. As of December 31, 2014 and 2013, we have not granted any awards under the Plan.
Tax Treatment of Distributions
For tax purposes, our distributions are comprised of taxable ordinary dividend and return of capital. The return of capital for the distributions per share to common stockholders reportable for the years ended December 31, 2014, 2013, and 2012 were as follows:
14. Earnings Per Share
We report earnings (loss) per share pursuant to ASC Topic 260, “Earnings per Share.” Basic earnings (loss) per share attributable for all periods presented are computed by dividing net income (loss) attributable to common stockholders by the weighted average number of shares of our common stock outstanding during the period. Diluted earnings (loss) per share are computed based on the weighted average number of shares of our common stock and all potentially dilutive securities, if any. The Series B Preferred Units give rise to potentially dilutive securities of our common stock. As of December 31, 2014, 2013, and 2012, there were 946,560, 193,000, and 0, respectively, Series B Preferred Units outstanding, but such units were excluded from the computation of diluted earnings per share because such shares were anti-dilutive during these periods.
15. Related Party Transactions
Advisory Relationship with the Advisor
Throughout 2013 and 2014 we were party to an Advisory Agreement with the Advisor, which became effective on January 1, 2012 for a one-year term ending December 31, 2012. The Advisory Agreement was renewed for additional one-year terms commencing on January 1, 2013, January 1, 2014, and January 1, 2015, however, as discussed below under the heading “Transition to Internal Management Agreement” certain provisions of the Advisory Agreement have been amended as a result of the execution on February 10, 2013 of a Transition to Internal Management Agreement which was subsequently amended in April 2014 and February 2015 (as amended, the “Transition Agreement”) with the Advisor.
Pursuant to the provisions of the Advisory Agreement, the Advisor is responsible for managing, operating, directing and supervising the operation of our company and its assets. Generally, the Advisor is responsible for providing us with (i) property acquisition, disposition and financing services, (ii) asset management and operational services, including real estate services and financial and administrative services, (iii) stockholder services, and (iv) in the event we conduct a public offering of our securities, offering-related services. The Advisor is subject to the supervision and ultimate authority of our board of directors and has a fiduciary duty to us and our stockholders.
The fees and expense reimbursements payable or paid to the Advisor under the Advisory Agreement, and subject to the terms of the Transition Agreement, as discussed below under the heading “Transition to Internal Management Agreement,” are described below.
Offering Stage Fees and Expenses:
·If our board of directors determines that it is advisable and in our best interests to conduct an offering of our securities, the Advisor will be entitled to be reimbursed for organizational and offering costs paid by the Advisor on our behalf. Organizational and offering costs consist of all expenses (other than sales commissions and the dealer manager fees) to be paid by us in connection with our offerings, including our legal, accounting, printing, mailing and filing fees, charges of our escrow holder and other accountable offering expenses. However, the Advisor would be required to reimburse us to the extent that our organization and offering expenses are in excess of 15% of gross offering proceeds at the conclusion of such offering. During the years ended December 31, 2014 and 2013, the Advisor incurred no organization and offering expenses on our behalf.
Acquisition and Operating Stage Fees and Expenses:
·Subject to the limitation on fees agreed to in the Transition Agreement, we are obligated to pay the Advisor acquisition fees in an amount equal to 1.0% of the sum of the amount actually paid or allocated to the purchase, development, construction or improvement of an investment, inclusive of the acquisition expenses associated with such investment, and the amount of any debt attributable to such investment. With respect to acquisitions made through a joint venture in which the Company is a co-venturer, the acquisition fee payable to the Advisor will be equal to 1.0% of the Company’s allocable portion of the amount actually paid or allocated to the purchase, development, construction or improvement of the investment, inclusive of the acquisition expenses associated with such investment, and the Company’s allocable portion of any debt attributable to such investment. An acquisition fee will be payable to the Advisor at the time we acquire the related investment. In addition, we are required to reimburse the Advisor for direct costs the Advisor incurs and pays to third parties in connection with the selection and acquisition of potential investments, whether or not we ultimately acquire them. During the years ended December 31, 2014 and 2013, the Advisor earned approximately $1.6 million and $0.5 million, respectively, of acquisition fees from us and incurred no acquisition expenses on our behalf.
·We are not required to reimburse the Advisor or its affiliates for any of their costs or expenses that are not directly attributable to our business, including without limitation (i) any personnel costs incurred by the Advisor to its employees, and (ii) any costs related to the Advisor’ rent, utilities and general overhead. We are responsible for paying directly or reimbursing the Advisor for costs that are directly attributable to our business.
·Under the Advisory Agreement, the Advisor must restrict total operating expenses for the preceding four consecutive fiscal quarters, as determined at the end of each fiscal quarter, to the greater of 2% of the Company’s Average Invested Assets (as defined in the Advisory Agreement) or 25% of the Company’s net income for such period (the “2%/25% Guidelines”), unless the independent directors committee determines that a higher level of expenses is justified, based on unusual and non-recurring factors which it deems sufficient. If the independent directors committee does not approve such excess as being so justified, the Advisory Agreement and our charter require that any amount in excess of the 2%/25 Guidelines (an “Excess Amount”) paid to the Advisor during a fiscal quarter shall be repaid to us. For the four quarters ended December 31, 2014 and December 31, 2013, our management fees and expenses and operating expenses totaled $5.8 million and $4.6 million, respectively. These amounts did not exceed the greater of 2% of our average invested assets and 25% of our net income.
·Subject to compliance with the 2%/25% Guidelines and the limitation on fees agreed to in the Transition Agreement, we are obligated to pay the Advisor a financing coordination fee for services rendered by the Advisor in connection with the refinancing of any of our debt obligations in an amount equal to 0.5% of the gross amount of any such refinancing, provided however, that the Advisor will not be entitled to a financing coordination fee in connection with the refinancing of debt obligations secured by any particular asset that was subject to a refinancing in connection with which the Advisor received a financing coordination fee within the immediately preceding three year period. Any such financing coordination fee is payable to the Advisor upon the closing of the related refinancing. During the years ended December 31, 2014 and 2013, the Advisor earned approximately $0.1 million of financing coordination fees from us.
·Subject to compliance with the 2%/25% Guidelines and the limitation on fees agreed to in the Transition Agreement, we are obligated to pay the Advisor a monthly asset management fee in an amount equal to one-twelfth of 1.0% of our assets under management, calculated on a monthly basis as of the last day of each month. Additionally, subject to compliance with the 2%/25% Guidelines and the limitation on fees agreed to in the Transition Agreement, with respect to fiscal quarters in which distributions declared to stockholders and cash available for distribution for such fiscal quarter are each at least $0.125 per share, we are also obligated to pay the Advisor a quarterly bonus asset management fee equal to the lesser of (i) one-fourth of 0.15% of our assets under management, calculated on a quarterly basis as of the last day of the quarter, or (ii) $150,000. During the years ended December 31, 2014 and 2013, the Advisor earned approximately $4.1 million and $2.9 million, respectively, of asset management fees from us.
·Subject to the limitation on fees agreed to in the Transition Agreement, if we retain the Advisor or one of its affiliates to manage or lease any of our properties, we will pay the Advisor or such affiliate a market-based fee in accordance with a separately negotiated property management, leasing and development agreement to be approved by the independent directors committee, which agreement may provide for fees similar to what other management or leasing companies generally charge for the management or leasing of similar properties, and which may include reimbursement for the costs and expenses the Advisor or its affiliates incurs in managing or leasing our properties. During the years ended December 31, 2014 and 2013, we did not pay any property management, leasing or development fees to the Advisor.
Listing/ Liquidation Stage Fees and Expenses:
·Subject to the limitation on fees agreed to in the Transition Agreement, if the Advisor or one of its affiliates provides a substantial amount of the services (as determined by a majority of our directors, including a majority of our independent directors committee) in connection with the sale of one or more of our properties, other than a sale in connection with a transaction in which we sell, grant, convey or relinquish our ownership of all or substantially all of our assets, we would be required to pay the Advisor or such affiliate at closing a disposition fee equal to the lesser of (i) 1.0% of the sales price of such property or properties, or (ii) one-half of the competitive real estate commission in light of the size, type and location of the property. The disposition fee may be paid in addition to real estate commissions paid to non-affiliates, provided that the total real estate commissions (including such disposition fee) paid to all persons by us for each property shall not exceed an amount equal to the lesser of (i) 6.0% of the aggregate contract sales price of each property or (ii) the competitive real estate commission for each property. During the years ended December 31, 2014 and 2013, the Advisor earned approximately $0.0 million and $0.1 million, respectively, of disposition fees from us.
·As described in further detail below under “Transition to Internal Management Agreement” under certain circumstances, the Advisor may be entitled to incentive fee amounts upon a listing or liquidation of the Company, or upon a termination of the Advisory Agreement. During the years ended December 31, 2014 and 2013, we did not pay any incentive fees to the Advisor related to a listing or liquidation of the Company, or a termination of the Advisory Agreement.
Transition to Internal Management Agreement
In connection with entering into the KKR Equity Commitment, we entered into the Transition Agreement with the Advisor and the Investor. The Transition Agreement sets forth the terms for our transition from our current externally-advised structure to an internal management structure. The Transition Agreement provides that the existing external advisory structure will remain in place upon substantially the same terms as currently in effect until February 10, 2017, subject to annual renewals of the Advisory Agreement in accordance with the requirements of the Company’s governing documents, at the end of which time the advisory function will be internalized in accordance with the Transition Agreement.
The Transition Agreement limits the amount of the fees payable under our existing Advisory Agreement with the Advisor. Specifically, notwithstanding the provisions of the Advisory Agreement, acquisition fees, financing coordination fees, asset management fees, property management and leasing fees, and disposition fees payable under the Advisory Agreement are limited to an amount no more than (1) $3.2 million plus an excess amount of $3.2 million (the “Excess Fee Amount”) from February 10, 2013 to February 10, 2014, and (2) $3.2 million plus any remaining portion of the Excess Fee Amount during the period from the February 11, 2014 to February 10, 2015. The maximum aggregate amount of such fees payable to the Advisor from February 10, 2013 through February 10, 2015 under these limits was $9.6 million (the “Maximum Fee Amount”). Solely with respect to any fees earned by the Advisor during the period from February 11, 2014 to February 10, 2015 in excess of the Maximum Fee Amount, such fees will be included in fees payable during the one-year period from February 11, 2015 to February 10, 2016, subject to a maximum amount of $1.0 million. For the one-year period from February 11, 2015 to February 10, 2016, as well as for the one-year period from February 11, 2016 to February 10, 2017, the same limits will apply to the aggregate fees the Advisor can earn such that the aggregate amount of such fees payable to the Advisor from February 11, 2015 to February 10, 2017 is equal to the Maximum Fee Amount.
The Transition Agreement also amends the Advisory Agreement to modify the terms of the subordinated incentive fees to which the Advisor may be entitled under certain circumstances. Specifically, the Transition Agreement provides for the following possible incentive amounts to be payable to the Advisor:
● Subordinated Sales and Financings Promote. A subordinated sales and financings promote may be payable to the Advisor upon a distribution to holders of shares of our common stock outstanding as of February 10, 2013 (the “Legacy Common Shares”) resulting from a sale and financing of one or more of our assets, which will be determined and paid as an amount of shares of common stock equal to the ratio of:
o 10% of the amount, if any, by which (A) the sum of (i) the number of Legacy Common Shares times the per share cash distributions to the holders of the Legacy Common Shares in respect of cash from sales and financings, plus (ii) the total amount of all previous dividends or distributions paid on the Legacy Common Shares since the date of the inception of the Company’s initial public offering; exceeds (B) the sum of (x) the total invested capital for the Legacy Common Shares and (y) the amount required to pay stockholders a 7% cumulative, non-compounded return from inception of the Company’s initial public offering through the date of the closing of the applicable sale or financing on the Legacy Common Shares;
over:
o the net asset value per share of common stock as of the closing of the applicable sale or financing (as defined in the Transition Agreement).
However, if the subordinated sales and financings promote is payable as the result of a sale of all or substantially all of the assets of the Company, then the promote will be paid in cash rather than shares of common stock.
● Subordinated Internalization Promote. In connection with a termination of the Advisory Agreement upon consummation of an internalization, the Advisor may be entitled to a subordinated internalization promote determined and paid on one-year anniversary of the termination of the Advisor Agreement, in an amount consisting of the sum of:
o a cash payment equal to 40% of:
● 10% of the amount, if any, by which (A) the sum of (i) the number of Legacy Common Shares times the per share net asset value on the determination date, plus (ii) the total amount of dividends or distributions paid on the Legacy Common Shares from date from inception of the Company’s initial public offering through the determination date; exceeds (B) the sum of (x) the total invested capital for the Legacy Common Shares and (y) the amount required to pay stockholders a 7% cumulative, non-compounded return from inception of the Company’s initial public offering through the determination date on the Legacy Common Shares (such amount, the “Subordinated Internalization Cash Amount”); and
an amount of shares of common stock equal to the ratio of:
● 60% of the Subordinated Internalization Cash Amount;
over:
● the net asset value per share of common stock as of the determination date (as defined in the Transition Agreement).
However, in the event the common stock is listed on a national stock exchange as of the determination date, the amount of the subordinated internalization promote will be determined by reference to the market value of a share of common stock (as defined in the Transition Agreement), rather than the net asset value. Furthermore, the amount of the subordinated internalization promote will be reduced by the amount of any subordinated sales and financings promote previously earned by our Advisor.
● Subordinated Performance Fee Due Upon Termination. If (1) we terminate the Advisory Agreement prior to an internalization for any reason other than a material breach by the Advisor, (2) the Advisory Agreement is not renewed (other than in connection with an internalization) because we are unwilling to renew the agreement on substantially similar terms, or (3) the Advisor terminates the Advisory Agreement prior to an internalization because of a material breach by us, then, we will pay the Advisor a subordinated performance fee due upon termination, payable in the form of a promissory note bearing simple interest at a rate of 5% per annum, in a principal amount equal to:
o 10% of the amount, if any, by which (A) the sum of (i) the product of the Legacy Common Shares times the per share net asset value at the termination date and (ii) total distributions (excluding any stock dividends and distributions paid on shares of common stock redeemed by the Company) paid on the Legacy Common Shares through the termination date, exceeds (B) the sum of (i) the total invested capital for the Legacy Common Shares and (ii) the total distributions required to be made to the Legacy Common Shares in order to pay stockholders a 7% cumulative, non-compounded return from inception of the Company’s initial public offering through the termination date;
oless any prior payment to our Advisor of a subordinated sales and financings promote.
Upon the internalization date established pursuant to the Transition Agreement, we will acquire all of the Advisor’s assets that are reasonably necessary for the management and operation of our business (we refer to such a transaction as an internalization). On or prior to the internalization date, our Advisor will facilitate our efforts to hire the employees of the Advisor. With respect to certain key persons, we will be required to enter into employment agreements based upon market terms established in consultation with an independent compensation consultant. The Investor will have the right to consent to our hiring of all key personnel. Upon an internalization or a Liquidation Event (as defined in the investor rights agreement entered into in connection with the KKR Equity Commitment), then our Advisor will receive a fee in an amount that is the lesser of (i) $4.0 million or $3.0 million (depending on when the event occurs), and (ii) the remaining portion of the $9.6 million Maximum Fee Amount, if any, not previously paid to our Advisor.
In connection with entering into the Transition Agreement, we and the Advisor have generally agreed not to terminate the Advisory Agreement without the prior consent of the Investor.
KKR Equity Commitment
Pursuant to the KKR Equity Commitment, we may issue and sell to the Investor and its affiliates on a private placement basis from time to time over a period of three years, up to $158.7 million in aggregate issuance amount of shares of newly issued Series C Preferred Stock and newly issued Series B Preferred Units to fund real estate acquisitions, a self-tender offer and the origination of a development loan. As a result of the transactions contemplated by the KKR Equity Commitment, the Investor currently beneficially owns an aggregate of 10,993,613 shares of common stock of the Company, which represent, in the aggregate, approximately, 48.9% of the outstanding shares of common stock as of March 15, 2015.
As of December 31, 2014, pursuant to the terms of the KKR Equity Commitment, the Investor has purchased 1,000 newly issued Series C Preferred Stock and 946,560 newly issued Series B Preferred Units for an aggregate purchase price of $94.8 million. As of December 31, 2014, 639,700 Series B Preferred Units remain issuable under the Securities Purchase Agreement. The obligation of the Investor to purchase additional Series B Preferred Units under the Securities Purchase Agreement is conditioned upon, among other things, the receipt of notice from us of the intention to sell a specified amount of securities to the Investor to finance a proposed investment opportunity.
Securities Purchase Agreement
On February 10, 2013, the Company, and the Operating Partnership (as used herein, the Company and the Operating Partnership are referred to as the “Sentio Parties”) and the Investor entered into a Securities Purchase Agreement which was subsequently amended in April 2014 and December 2014 (as amended, the “Purchase Agreement”). Under the Purchase Agreement, the Sentio Parties may issue and sell to the Investor on a private placement basis from time to time over a period of up to three years, newly issued Series C Preferred Stock and newly issued Series B Preferred Units in an amount up to $158.7 million.
In conjunction with the execution of the Purchase Agreement, the Sentio Parties paid to Investor a transaction fee of $2.0 million and were obligated to reimburse the Investor for up to $1.0 million of its expenses incurred in connection with the Purchase Agreement. With limited exceptions, the Sentio Parties are restricted from issuing securities other than in accordance with the Purchase Agreement while the put rights under the Purchase Agreement are in effect.
To the extent the minimum purchase obligation is not exercised during the term of the commitment, the Sentio Parties are required to pay a premium to the Investor calculated and payable annually as a percentage of the unexercised amount under the commitment. For the years ended December 31, 2014 and 2013, we paid the Investor an unused fee of $0.1 million and $0.0 million, respectively.
Pursuant to the Purchase Agreement, our board of directors increased the size of the board from seven to nine members and filled the vacancies created thereby with two directors selected by the Investor. We will also, at the Investor’s sole election, add one additional director (for a total of ten directors), which director will also be selected by the Investor.
Series C Preferred Stock
The Series C Preferred Stock issued to the Investor pursuant to the Purchase Agreement ranks senior to the Company’s common stock with respect to dividend rights and rights on liquidation. The holders of the Series C Preferred Shares will be entitled to receive dividends, as and if authorized by the board out of funds legally available for that purpose, at an annual rate equal to 3%.
The holder of each share of Series C Preferred Stock has the right to one vote for each share of As-Converted Common Stock (defined below) held by such holder and its affiliates and with respect to such vote, such holder will have full voting rights and powers equal to the voting rights and powers of the holders of the Company’s common stock, and will be entitled to notice of any shareholders’ meeting in accordance with the bylaws of the Company, and shall be entitled to vote, together with holders of common stock as a single class, with respect to any question upon which holders of common stock have the right to vote, with certain limited exceptions. “As-Converted Common Stock” means, as of any determination date and with respect to any holder, the number of shares of Common Stock then held by such holder and its affiliates after giving effect to the conversion or exchange, in accordance with their terms, of any and all securities then convertible or exchangeable, directly or indirectly, into common stock.
Amended Partnership Agreement
On April 5, 2013, the Company, HPC LP TRS, LLC and the Investor entered a Second Amended and Restated Limited Partnership Agreement of the Operating Partnership which was subsequently amended on December 22, 2014 (as amended, the “Amended Partnership Agreement”). The Amended Partnership Agreement authorizes the issuance of the Series B Preferred Units to the Investor. The Series B Preferred Units rank senior to the Partnership’s common units with respect to distribution rights and rights on liquidation. The Series B Preferred Units related to the acquisition of an Approved Acquisition (as defined in the Purchase Agreement) will receive cash distributions at an annual rate equal to 7.5% in preference to any distributions paid to common units. Provided, however, that any Series B Preferred Units issued in connection with a put exercise for a construction loan will receive cash distributions at a reduced annual rate equal to 6.0% in preference to any distributions paid to common units. In addition, the preferred return for a put exercise for a construction loan will be calculated based solely on the exercise put amount related to the construction loan put exercise that has been funded as opposed to the full amount of Series B Preferred Units outstanding. If the Partnership is unable to pay cash distributions, distributions will be paid in kind at an annual rate of 10%. After payment of the preferred distributions, additional distributions will be paid first to the common units until they have received an aggregate blended return equal to the weighted average of the return being paid to Series B Preferred Units in annual distributions from the Effective Date, and thereafter to the common units and Series B Preferred Units pro rata. In the event of a liquidation of the Operating Partnership, the Investor would receive an amount equal to the greater of (a) the amount paid to acquire securities under the Purchase Agreement plus all accrued and unpaid distributions or (b) the amount the Investor would be entitled to receive in the transaction if the Series B Preferred Units were converted into common units of the Partnership (excluding any unpaid distribution to holders of common units, to which the holders of common units alone are entitled).
Each Series B Preferred Unit has an initial issuance value of $100.00 per unit and is convertible into a number of common units of Partnership interest equal to the issuance value of such Series B Preferred Unit divided by the applicable conversion price as determined in accordance with the terms of the Amended Partnership Agreement. The initial conversion price is $10.02. The Investor may exchange common units for shares of the Company’s common stock, at an initial exchange factor of 1 to 1, subject to proportional adjustment for stock splits, stock dividends, cash dividends, merger, recapitalizations and other similar events by the Company or the Partnership. The Partnership Agreement requires that the Company and the Partnership receive the Investor’s consent before taking certain actions.
The Amended Partnership Agreement permits the Operating Partnership to engage in a sale of the assets or equity of the Operating Partnership without the consent of the Investor, which would otherwise be required under the Second Amended and Restated Limited Partnership Agreement, provided the following conditions are met: (i) the sale is cash only, and (ii) the Company or the Operating Partnership, as applicable, has issued to the Investor $100,000 in aggregate liquidation preference amount of Series C Preferred Stock and $149,900,000 in aggregate liquidation preference amount of Series B Preferred Units.
Investor Rights Agreement
On February 10, 2013, the Company, the Operating Partnership, and the Investor entered into an Investor Rights Agreement, which was subsequently amended in December 2014 (as amended, the “Investor Rights Agreement”) that provides the Investor, its affiliates and their respective permitted transferees with certain rights as a holder of Series C Preferred Stock and Series B Preferred Units. More specifically, the Investor Rights Agreement provides such holders with preemptive rights to participate in future equity issuances by the Company, subject to customary exceptions. Additionally, the Investor Rights Agreement contains certain significant minority protections that require the Investor’s consent before taking certain actions. Under the Investor Rights Agreement, the Sentio Parties are also prohibited from incurring indebtedness other than property-level mortgage refinancing, subject to certain limitations.
The Investor Rights Agreement includes standstill provisions prohibiting the Investor from acquiring additional securities of the Company or the Partnership other than in accordance with the Purchase Agreement (subject to the pre-emptive rights described above) until February 10, 2016. The Investor Rights Agreement contains customary registration rights requiring the Company to register the shares of Series C Preferred Stock and common stock held by the Investor as a result of exchange of its Series B Preferred Units for resale to the public from time to time, in defined circumstances and within defined deadlines as set forth in the Investor Rights Agreement. The Company is also required, upon demand by the Investor in accordance with the Investor Rights Agreement, to register one or more primary offerings of newly issued common stock and to use the proceeds from such offerings to redeem partnership units held by the Investor. Beginning on July 1, 2017, the Investor, at its sole option, will have the ability to cause us to initiate a listing of the Company’s common stock, a sale of the Company, or a process to sell all or substantially all of our assets subject to specific terms and conditions.
The Investor Rights Agreement permits the Company to engage in a sale of the assets or equity of the Operating Partnership and the Company without the consent of the Investor, which would otherwise be required under the Investor Rights Agreement, provided the following conditions are met: (i) the sale is cash only, and (ii) the Company or the operating partnership, as applicable, has issued to the Investor $100,000 in aggregate liquidation preference amount of Series C Preferred Stock and $149,900,000 in aggregate liquidation preference amount of Series B Preferred Units.
16. Commitments and Contingencies
We monitor our properties for the presence of hazardous or toxic substances. While there can be no assurance that a material environmental liability does not exist, we are not currently aware of any environmental liability with respect to the properties that we believe would have a material effect on our financial condition, results of operations and cash flows. Further, we are not aware of any environmental liability or any unasserted claim or assessment with respect to an environmental liability that we believe would require additional disclosure or the recording of a loss contingency.
Our commitments and contingencies include the usual obligations of real estate owners and operators in the normal course of business. In the opinion of management, these matters are not expected to have a material impact on our consolidated financial position, cash flows and results of operations. We are not presently subject to any material litigation nor, to our knowledge, is any material litigation threatened against the Company which if determined unfavorably to us would have a material adverse effect on our cash flows, financial condition or results of operations.
17. Selected Quarterly Data (unaudited)
Set forth below is certain unaudited quarterly financial information. We believe that all necessary adjustments, consisting only of normal recurring adjustments, have been included in the amounts stated below to present fairly, and in accordance with generally accepted accounting principles, the selected quarterly information when read in conjunction with the consolidated financial statements.
18. Subsequent Events
Georgetown Loan
On January 15, 2015, the Company, through an indirect wholly owned subsidiary, originated a development loan in the amount of $41.9 million for The Delaney at Georgetown Village development project located in Georgetown, Texas (the “Georgetown Loan”). The borrower, Westminster-LCS Georgetown LLC, is not affiliated with the Company or the Advisor. The borrower is a joint venture between Life Care Companies, LLC (“LCS”) and a fund sponsored by Westminster Capital (“Westminster”), and will use the proceeds of the Georgetown Loan to develop a senior living facility with 207 units including independent living, assisted living and memory care.
The Georgetown Loan is secured by a first mortgage lien on the land, building, and all improvements made thereon. The Georgetown Loan matures on January 15, 2020 with one 12-month option to extend at the Company’s option, and bears interest at a fixed rate of 7.9% per annum for the term of the loan. Advances will be made periodically during the construction period to cover documented hard and soft costs of construction and interest, commencing after the borrower has expended its required equity contribution, and subject to customary construction draw conditions. The borrower paid a loan origination fee equal to 1% of the loan amount. Monthly payments are interest only for the term of the loan. The Company has the option to purchase the property at fair market value upon stabilization or 48 months. Fair market value is determined by the average asset value of independent appraisals obtained by the lender and borrower. Regardless of whether the Company exercises the option to purchase the property, the Company will be entitled to participate in the value creation which is the difference between the fair market value and the total development cost. The Georgetown Loan is non-recourse to LCS and Westminster, but LCS has provided cost and completion guarantees as well as a guaranty of customary “bad boy” carve-outs.
The Company expects to fund the Georgetown Loan with proceeds from the sale of Series B Preferred Units to the Investor. Upon funding of the Georgetown Loan, interest income on the loan receivable will be recognized as earned based upon the principal amount outstanding subject to an evaluation of collectability risks.
Sale of Preferred Units in the Operating Partnership
On January 16, 2015, a purchase of securities related to the Georgetown Loan (the “Georgetown Put Exercise”) was completed by the Investor pursuant to the KKR Equity Commitment.
Pursuant to the Georgetown Put Exercise, the Investor agreed to fund $41.9 million related to the Georgetown Loan and was issued the following securities:
·155,000 newly-issued Series B Preferred Units, which are convertible into approximately 1,546,906 shares of the Company’s common stock at the currently effective conversion price.
After giving effect to the 155,000 Series B Preferred Units issued upon the closing of the Georgetown Put Exercise and the Series B Preferred Units relating to the Georgetown Put Exercise remaining to be issued, 220,580 Series B Preferred Units remain issuable under the Purchase Agreement.
Sumter Grand
On February 6, 2015, through a wholly-owned subsidiary, we acquired real estate property (“Sumter Grand”) from Retirement Two, LLC, which is not affiliated with us, for a purchase price of $31.5 million. Sumter Grand consists of a 150-unit independent living facility located in The Villages, Florida. We funded the purchase of Sumter Grand with proceeds from the sale to the Investor of Series B Preferred Units pursuant to the KKR Equity Commitment on December 30, 2014 and with proceeds from a mortgage loan from KeyBank National Association, Inc.
SENTIO HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES
Schedule III
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2014
(1)The aggregate cost of real estate for federal income tax purposes was $390.0 million.
(2)Please see Note 3 to our consolidated financial statements for information regarding useful lives used for depreciation and amortization.
The changes in total real estate for the three years ended December 31, 2014 are as follows.
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SENTIO HEALTHCARE PROPERTIES, INC.
By: /s/ SHARON C. KAISER
SHARON C. KAISER
Chief Financial Officer, Treasurer and Secretary
March 20, 2015
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 20, 2015.
Name
Title
/s/ John Mark Ramsey
President, Chief Executive Officer and Director
John Mark Ramsey
(Principal Executive Officer)
/s/ Sharon C. Kaiser
Chief Financial Officer Treasurer and Secretary
Sharon C. Kaiser
(Principal Financial and Accounting Officer)
/s/ Steven M. Pearson
Director
Steven M. Pearson
/s/ James M. Skorheim
Director
James M. Skorheim
/s/ Barry A. Chase
Director
Barry A. Chase
/s/ Romeo Cefalo
Director
Romeo Cefalo
/s/ Ronald Shuck
Director
Ronald Shuck
/s/ Billy Butcher
Director
Billy Butcher
/s/ Daniel Decker
Director
Daniel Decker
Ex.
Description
3.1
Articles of Amendment and Restatement of the Registrant, as amended on December 29, 2009 and January 24, 2012 (incorporated by reference to Exhibit 3.1 to the Registrant’s annual report on Form 10-K for the year ended December 31, 2011).
3.2
Articles of Amendment of the Registrant, dated August 6, 2013 (incorporated by reference to Exhibit 3.2 to the Registrant’s quarterly report on Form 10-Q for the quarterly period ended June 30, 2013).
3.3
Articles Supplementary, 3% Senior Cumulative Preferred Stock, Series A, dated August 6, 2013 (incorporated by reference to Exhibit 3.3 to the Registrant’s quarterly report on Form 10-Q for the quarterly period ended June 30, 2013).
3.4
Articles Supplementary, 3% Senior Cumulative Preferred Stock, Series C, dated August 6, 2013 (incorporated by reference to Exhibit 3.4 to the Registrant’s quarterly report on Form 10-Q for the quarterly period ended June 30, 2013).
3.5
Second Amended and Restated Bylaws of the Registrant as adopted on August 6, 2013 as amended by Amendment no. 1 to the Second Amended and Restate Bylaws of the Registrant, effective as of March 20, 2015. (filed herewith).
3.6
Second Amended and Restated Limited Partnership Agreement of Sentio Healthcare Properties OP, L.P., dated August 5, 2013 (incorporated by reference to Exhibit 3.6 to the Registrant’s quarterly report on Form 10-Q for the quarterly period ended June 30, 2013).
3.7
First Amendment dated December 22, 2014 to the Second Amended and Restated Limited Partnership Agreement of Sentio Healthcare Properties OP, L.P., dated August 5, 2013 (incorporated by reference to Exhibit 3.1 to the Registrant’s current report on Form 8-K filed on December 30, 2014).
4.1
Form of Distribution Reinvestment Enrollment Form (incorporated by reference to Appendix A to the Registrant’s prospectus filed on June 19, 2013).
4.2
Statement regarding restrictions on transferability of the Registrant’s shares of common stock (to appear on stock certificate or to be sent upon request and without charge to stockholders issued shares without certificates) (incorporated by reference to Exhibit 4.2 to Pre-Effective Amendment No. 2 to the Registration Statement on Form S-11 (No. 333-139704) filed on June 15, 2007).
4.3
Second Amended and Restated Distribution Reinvestment Plan (incorporated by reference to Appendix B to the Registrant’s prospectus filed on June 19, 2013).
10.1
Fourth Amendment dated February 26, 2014 to Purchase and Sale Agreement dated as of September 18, 2013 by and between Sentio - SLR Boston Portfolio, LLC and Bay View of Boston Associates Limited Partnership (incorporated by reference to Exhibit 10.26 to the Registrant’s annual report on Form 10-K for the year ended December 31, 2013).
10.2
Fifth Amendment dated March 31, 2014 to Purchase and Sale Agreement dated as of September 18, 2013 by and between Sentio - SLR Boston Portfolio, LLC and Bay View of Boston Associates Limited Partnership (incorporated by reference to Exhibit 10.1 to the Registrant’s current report on Form 8-K filed April 8, 2014).
10.3
Second Amendment Agreement dated April 8, 2014, by and among Sentinel RE Investment Holdings LP, the Registrant and Sentio Healthcare Properties OP, L.P. (incorporated by reference to Exhibit 10.1 to the Registrant’s current report on Form 8-K filed on April 10, 2014).
10.4
Amendment No. 1 dated April 8, 2014 to the Transition to Internal Management Agreement, dated February 10, 2013, by and among the Registrant, Sentio Healthcare Properties OP, L.P., Sentinel RE Investment Holdings LP and Sentio Investments, LLC (incorporated by reference to Exhibit 10.2 to the Registrant’s current report on Form 8-K filed on April 10, 2014).
10.5
Amendment No. 2 dated April 8, 2014 to the Transition to Internal Management Agreement, dated February 10, 2013, by and among the Registrant, Sentio Healthcare Properties OP, L.P., Sentinel RE Investment Holdings LP and Sentio Investments, LLC (incorporated by reference to Exhibit 10.3 to the Registrant’s current report on Form 8-K filed on April 10, 2014).
10.6
Purchase and Sale Agreement dated May 22, 2014 by and among Sentio STAV Landlord, LLC, and ERB Propco SAV LLC (incorporated by reference to Exhibit 10.4 to the Registrant’s quarterly report on Form 10-Q for the quarterly period ended June 30, 2014).
10.7
First Amendment dated July 6, 2014 to Purchase and Sale Agreement dated May 22, 2014 by and among Sentio STAV Landlord, LLC, ERB Propco SAV LLC and Stewart Title Guaranty Company (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K/A filed October 29, 2014).
10.8
Second Amendment dated July 7, 2014 to Purchase and Sale Agreement dated May 22, 2014 by and among Sentio STAV Landlord, LLC, ERB Propco SAV LLC and Stewart Title Guaranty Company (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K/A filed October 29, 2014).
10.9
Third Amendment dated July 14, 2014 to Purchase and Sale Agreement dated May 22, 2014 by and among Sentio STAV Landlord, LLC, ERB Propco SAV LLC and Stewart Title Guaranty Company (incorporated by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K/A filed October 29, 2014).
10.10
Fourth Amendment dated July 21, 2014 to Purchase and Sale Agreement dated May 22, 2014 by and among Sentio STAV Landlord, LLC, ERB Propco SAV LLC and Stewart Title Guaranty Company (incorporated by reference to Exhibit 10.4 to the Registrant’s Current Report on Form 8-K/A filed October 29, 2014).
10.11
Lease Agreement by and between Sentio STAV Landlord, LLC, a Delaware Limited Liability Company as Lessor and ERB Opco SAV LLC, a Delaware Limited Liability Company as Lessee, dated as of August 20, 2014 (incorporated by reference to Exhibit 10.5 to the Registrant’s Current Report on Form 8-K/A filed October 29, 2014).
10.12
Multifamily Loan and Security Agreement by and between Sentio STAV Landlord, LLC, and CBRE Capital Markets, Inc. dated as of August 19, 2014 (incorporated by reference to Exhibit 10.6 to the Registrant’s Current Report on Form 8-K/A filed October 29, 2014).
10.13
Multifamily Note by and between Sentio STAV Landlord, LLC, and CBRE Capital Markets, Inc. dated as of August 19, 2014 (incorporated by reference to Exhibit 10.7 to the Registrant’s Current Report on Form 8-K/A filed October 29, 2014).
10.14
Purchase and Sale Agreement dated September 11, 2014 by and between Gables of Kentridge, LLC, Kentridge at Golden Pond, Ltd., and Great-Kent, LLC (filed herewith).
10.15
First Amendment dated October 22, 2014 to Purchase and Sale Agreement dated September 11, 2014 by and between Gables of Kentridge, LLC, Kentridge at Golden Pond, Ltd., and Great-Kent, LLC (filed herewith).
10.16
Second Amendment dated November 19, 2014 to Purchase and Sale Agreement dated September 11, 2014 by and between Gables of Kentridge, LLC, Kentridge at Golden Pond, Ltd., and Great-Kent, LLC (filed herewith).
10.17
Secured Loan, by and between the Registrant and KeyBank National Association dated November 14, 2014 (filed herewith).
10.18
Promissory Note, by Maker for the benefit of KeyBank National Association dated November 14, 2014 (filed herewith).
10.19
Guaranty Agreement, by Sentio Healthcare Properties, Inc. for the benefit of KeyBank National Association dated November 14, 2014 (filed herewith).
10.20
Deed of Trust, Assignment of Rents, Security Agreement and Fixture Filing, by MVI Health Center, LP for the benefit of KeyBank National Association dated November 14, 2014 (filed herewith).
10.21
Third Amendment Agreement dated December 22, 2014 by and among Sentinel RE Investment Holdings LP, the Registrant and Sentio Healthcare Properties OP, L.P. (incorporated by reference to Exhibit 10.1 to the Registrant’s current report on Form 8-K filed on December 30, 2014).
10.22
First Amendment dated December 22, 2014 to Investor Rights Agreement dated as of February 10, 2013 by and among Sentinel RE Investment Holdings LP, the Registrant and Sentio Healthcare Properties OP, L.P. (incorporated by reference to Exhibit 10.2 to the Registrant’s current report on Form 8-K filed on December 30, 2014).
10.23
Renewal Agreement dated December 22, 2014 between the Registrant and Sentio Investments, LLC (incorporated by reference to Exhibit 10.3 to the Registrant’s current report on Form 8-K filed on December 30, 2014).
10.24
Secured Loan, by and between the Registrant and KeyBank National Association dated December 31, 2014 (filed herewith).
10.25
Amended and Restated Promissory Note, by Sumter Place Owner for the benefit of KeyBank National Associations dated December 31, 2014 (filed herewith).
10.26
Security Agreement, by Sumter Place TRS, LLC for the benefit of KeyBank National Association dated December 31, 2014 (filed herewith).
10.27
Guaranty Agreement, by Sentio Healthcare Properties, Inc. for the benefit of KeyBank National Association dated December 31, 2014 (filed herewith).
10.28
Payment Guaranty, by Sumter Place TRS, LLC for the benefit of KeyBank National Association dated December 31, 2014 (filed herewith).
10.29
Purchase and Sale Agreement dated September 11, 2014 by and between Gables of Hudson, LLC, Great-Hudson, LLC, and Gables-Hudson, LLC (filed herewith).
10.30
First Amendment dated October 22, 2014 to Purchase and Sale Agreement dated September 11, 2014 by and between Gables of Hudson, LLC, Gables-Hudson, LLC and Great-Hudson, LLC (filed herewith).
10.31
Second Amendment dated December 17, 2014 to Purchase and Sale Agreement dated September 11, 2014 by and between Gables of Hudson, LLC, Gables-Hudson, LLC and Great-Hudson, LLC (filed herewith).
21.1
List of Subsidiaries (filed herewith).
23.1
Consent of KPMG LLP (filed herewith).
31.1
Certification of Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
31.2
Certification of Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
32.1
Certification of Chief Executive Officer and Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document