3. Real Estate and Lending Activities

Acquisitions

On March 31, 2014, we acquired a general acute care hospital and an adjacent parcel for an aggregate purchase price of $115 million from a joint venture of LHP Hospital Group, Inc. and Hackensack University Medical Center Mountainside. The facility was simultaneously leased back to the seller under a lease with a 15-year initial term with a 3-year extension option, followed by a further 12-year extension option at fair market value. The lease provides for consumer price-indexed annual rent increases, subject to a specified floor and ceiling. The lease includes a customary right of first refusal with respect to a subsequent proposed sale of the facility.

With this transaction we acquired the following assets:


	2014
Assets Acquired
Land	$	8,515
Building		99,602
Intangible lease assets — subject to amortization (weighted average useful life 15 years)		6,883

Total assets acquired	$	115,000
Total liabilities assumed		—

Net assets acquired	$	115,000

The purchase price allocation attributable to the facility acquired in the 2014 first quarter along with the facilities acquired from IASIS and RHM in the 2013 third and fourth quarters is preliminary as we are waiting on additional information to perform our final analysis. When all relevant information is obtained, and if changes to our provisional purchase price allocation are needed, we will retrospectively adjust to reflect the new information obtained about the facts and circumstances that existed as of the respective acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date.

Development Activities

During the 2014 first quarter, we completed construction and began recording rental income on the following three facilities:

•

Northern Utah Rehabilitation Hospital – This $19 million inpatient rehabilitation facility located in South Ogden, Utah is leased to Ernest pursuant to the 2012 master lease.

•

First Choice ER – Nacogdoches – This is a $5 million acute care facility located in San Antonio, Texas and is leased to First Choice ER pursuant to the master lease entered into in 2013.

•

First Choice ER – Alvin – This is a $5 million acute care facility located in Houston, Texas and is leased to First Choice ER pursuant to the master lease entered into in 2013.

In the first quarter of 2014, we began construction on 9 additional facilities pursuant to the master funding and development agreement with First Choice ER.

In regards to our Twelve Oaks facility, approximately 55% of this facility is being occupied, pursuant to a 15 year lease.

See table below for a status update on our current development projects (in thousands):

Property

Location

Property Type

Operator

Commitment

Costs Incurred
as of
March 31,
2014

Estimated
Completion
Date

Oakleaf Surgical Hospital

Altoona, WI

Acute Care Hospital

National Surgical Hospitals

33,500

22,780

3Q 2014

First Choice ER - Brodie

Austin, TX

Acute Care Hospital

First Choice ER, LLC

5,466

2,829

2Q 2014

First Choice ER - Briar Forest

Houston, TX

Acute Care Hospital

First Choice ER, LLC

5,844

1,595

3Q 2014

First Choice ER - Cedar Hill

Cedar Hill, TX

Acute Care Hospital

First Choice ER, LLC

5,769

1,710

3Q 2014

First Choice ER- Firestone

Firestone, CO

Acute Care Hospital

First Choice ER, LLC

5,173

1,699

3Q 2014

First Choice ER - Allen

Allen, TX

Acute Care Hospital

First Choice ER, LLC

6,187

2,042

3Q 2014

First Choice ER - Frisco

Frisco, TX

Acute Care Hospital

First Choice ER, LLC

5,893

2,060

3Q 2014

First Choice ER - Broomfield

Broomfield, CO

Acute Care Hospital

First Choice ER, LLC

5,238

1,118

3Q 2014

First Choice ER - Spring

Spring, TX

Acute Care Hospital

First Choice ER, LLC

5,804

1,804

3Q 2014

First Choice ER - North Gate

Colorado Springs, CO

Acute Care Hospital

First Choice ER, LLC

5,249

896

3Q 2014

First Choice ER - Fountain

Fountain, CO

Acute Care Hospital

First Choice ER, LLC

6,194

1,558

3Q 2014

First Choice ER - Missouri City (Sienna)

Houston, TX

Acute Care Hospital

First Choice ER, LLC

5,394

1,062

3Q 2014

First Choice ER - Pearland

Pearland, TX

Acute Care Hospital

First Choice ER, LLC

5,691

1,403

4Q 2014

First Choice ER - Thornton

Thornton, CO

Acute Care Hospital

First Choice ER, LLC

6,029

1,400

4Q 2014

First Choice - ER

Various

Acute Care Hospital

First Choice ER, LLC

10,615

—

118,046

43,956

Leasing Operations

All of our leases are accounted for as operating leases except for the master lease of 13 Ernest facilities and five Prime facilities which are accounted for as direct financing leases (“DFLs”). The components of our net investment in DFLs consisted of the following (dollars in thousands):


	As of March 31, 2014			As of December 31, 2013
Minimum lease payments receivable	$	1,637,092		$	1,647,567
Estimated residual values		211,888			211,863
Less: Unearned income		(1,416,323	)		(1,428,406	)

Net investment in direct financing leases	$	432,657		$	431,024

Monroe Facility

As of March 31, 2014 and December 31, 2013, our net investment (exclusive of the related real estate) in Monroe was as follows:


	As of March 31, 2014			As of December 31, 2013
Loans	$	33,726		$	31,341
Less: Loan impairment reserve		(32,354	)		(12,000	)
Loans, net		1,372			19,341

Interest, rent and other receivables*		20,992			20,972

Net investment	$	22,364		$	40,313

Includes approximately $ 6 million of interest receivables that are significantly more than 90 days past due

The operator of our Monroe facility has not made all payments required by the real estate lease agreement and working capital loan agreement, and we have deemed the loan to be impaired. During 2010, we recorded a $12 million impairment charge on the working capital loan and fully reserved for unbilled straight-line rent receivables as well. Since 2010, we have not recognized any interest income on the Monroe loan and have not recorded any unbilled rent revenue. In addition, we stopped recording billed rental revenue on April 1, 2013, until we begin receiving cash payments.

During the first quarter of 2014, we commenced and have recently executed a non-binding letter of intent with a third party with respect to a restructuring of our investment in the form of a new joint venture that would acquire the real estate of our Monroe facility and related assets in exchange for a combination of cash and promissory notes. We will also be entitled to additional cash, if any, generated from our share in the new joint venture’s operations (but not be liable to fund any losses or other cash needs) during its first five years of operations. While we expect the transaction to close during the second half of 2014, the transaction is contingent upon, among other things, the negotiation and execution of definitive agreements and the completion of satisfactory due diligence, and we cannot assure you that it will be consummated on the terms described above or at all. Based on these new developments and the current fair value of the loan’s underlying collateral (using Level 2 inputs), we believe an additional reserve on our loan is needed and as a result we recorded an approximate $20.5 million impairment charge in the 2014 first quarter. If the transaction is not completed as currently expected or if the terms of such anticipated transaction change, further impairment charges could be incurred.

Florence facility

On March 6, 2013, the tenant of our facility in Phoenix, Arizona filed for Chapter 11 bankruptcy; but continues to pay rent. We have a letter of credit for approximately $1.2 million to cover any rent and other monetary payments not made. Although no assurances can be made that we will not have any impairment charges in the future, we believe our real estate investment in Florence of approximately $28 million at March 31, 2014, is fully recoverable.

Gilbert facility

In the first quarter of 2014, the tenant of our facility in Gilbert, Arizona filed for Chapter 11 bankruptcy; we sent notice of termination of the lease prior to the bankruptcy filing. As a result of the lease terminating, we recorded an accrual charge of approximately $1 million to reserve against the straight-line rent receivables. In addition, we accelerated the amortization of the related lease intangible asset resulting in $1.1 million of additional expense in the 2014 first quarter. At March 31, 2014, we have $0.1 million of outstanding receivables, which we believe are collectible. Although no assurances can be made that we will not have any impairment charges or write-offs of receivables in the future, we believe our real estate investment in Gilbert of approximately $14 million at March 31, 2014, is fully recoverable.

Loans

The following is a summary of our loans (in thousands):


	As of March 31, 2014		As of December 31, 2013
Mortgage loans	$	388,650	$	388,650
Acquisition loans		103,016		103,266
Working capital and other loans		35,184		54,372
Convertible loan		3,352		3,352

	$	530,202	$	549,640

The decrease in our working capital and other loans is due to the $20 million impairment charge incurred on our Monroe loan during the 2014 first quarter – see Note 3 for further discussion.

On March 1, 2012, pursuant to our convertible note agreement, we converted $1.7 million of our $5.0 million convertible note into a 9.9% equity interest in the operator of our Hoboken University Medical Center facility. At March 31, 2014, $3.3 million remains outstanding on the convertible note, and we retain the option, subject to regulatory approvals, to convert this remainder into 15.1% of equity interest in the operator.

Concentrations of Credit Risk

For the three months ended March 31, 2014 and 2013, revenue from affiliates of Ernest (including rent and interest from mortgage and acquisition loans) accounted for 19.5% and 20.5% of total revenue, respectively. From an investment concentration perspective, Ernest represented 15.8% and 15.9% of our total assets at March 31, 2014 and December 31, 2013, respectively.

For the three months ended March 31, 2014 and 2013, revenue from affiliates of Prime (including rent and interest from mortgage loans) accounted for 29.1% and 31.4%, respectively, of total revenue. From an investment concentration perspective, Prime represented 23.5% and 24.5% of our total assets at March 31, 2014 and December 31, 2013, respectively.

On an individual property basis, we had no investment of any single property greater than 4% of our total assets as of March 31, 2014.

From a geographic perspective, investments located in California represented 17.9% of our total assets at March 31, 2014, down from 18.7% at December 31, 2013. Investments located in Texas represented 22.0% of our total assets at March 31, 2014, down slightly from 22.7% at December 31, 2013. In addition, we further expanded our portfolio into Europe with the RHM portfolio acquisition in 2013, which represents less than 8% of total assets at March 31, 2014.