3. Real Estate and Lending Activities

Acquisitions

2014 Activity

On September 19, 2014, we acquired an acute care hospital in Fairmont, West Virginia for an aggregate purchase price of $15 million from Alecto Healthcare Services. The facility was simultaneously leased back to the seller under a 15-year initial term with three five-year extension options. In addition, we made a $5 million working capital loan to the tenant with a five year term and a commitment to fund up to $5 million in capital improvements.

On July 1, 2014, we acquired an acute care hospital in Peasedown St. John, United Kingdom from Circle Health Ltd., through its subsidiary Circle Hospital (Bath) Ltd. The sale/leaseback transaction, excluding any transfer taxes, is valued at approximately £28.3 million (approximately $48.0 million). The lease has an initial term of 15-years with a tenant option to extend the lease for an additional 15 years. The lease includes annual rent increases, which will equal the year-over-year change in the retail price index with a floor of 2% and a cap of 5%. With the transaction, we incurred approximately £1.1 (approximately $1.9 million) million of transfer and other taxes that have been expensed as acquisition costs.

On March 31, 2014, we acquired a general acute care hospital and an adjacent parcel of land 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.

2013 Activity

On September 26, 2013, we acquired three general acute care hospitals from affiliates of IASIS Healthcare LLC (“IASIS”) for a combined purchase price of $281.3 million. Each of the facilities were leased back to IASIS under leases with initial 15-year terms plus two renewal options of five years each, and consumer price-indexed rent increases limited to a 2.5% ceiling annually. The lessees have a right of first refusal option with respect to subsequent proposed sales of the facilities. All of our leases with affiliates of IASIS are cross-defaulted with each other. In addition to the IASIS acquisitions transactions, we amended our lease with IASIS for the Pioneer Valley Hospital in West Valley City, Utah, which extended the lease to 2028 from 2019 and adjusted the rent.

On July 18, 2013, we acquired the real estate of Esplanade Rehab Hospital in Corpus Christi, Texas (now operating as Corpus Christi Rehabilitation Hospital). The total purchase price was $10.5 million including $0.5 million for adjacent land. The facility is leased to an affiliate of Ernest Health Inc. (“Ernest”) under the master lease agreement entered into with Ernest in 2012 that initially provided for a 20-year term with three five-year extension options, plus consumer price-indexed rent increases, limited to a 2% floor and 5% ceiling annually. This lease is accounted for as a direct financing lease (“DFL”). In addition, we made a $5.3 million loan on this property with terms similar to the lease terms.

On June 11, 2013, we acquired the real estate of two acute care hospitals in Kansas from affiliates of Prime Healthcare Services, Inc. (“Prime”) for a combined purchase price of $75 million and leased the facilities to the operator under a master lease agreement. The master lease is for 10 years and contains two renewal options of five years each, and the rent increases annually based on the greater of the consumer price-index or 2%. This lease is accounted for as a DFL.

As part of these acquisitions, we acquired the following assets during the first nine months:


	2014		2013
Assets Acquired
Land	$	13,058	$	16,220
Building		152,096		265,030
Intangible lease assets — subject to amortization (weighted average useful life 15 years)		12,828		—
Net investments in direct financing leases		—		85,000
Other loans		5,000		5,250

Total assets acquired	$	182,982	$	371,500

The purchase price allocation attributable to the facilities acquired in 2014 along with the facilities acquired from RHM Klinik-und Altenheimbetriebe GmbH & Co. KG (“RHM”) in the 2013 fourth quarter 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 allocations 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 first nine months of 2014, we completed construction and began recording rental income on the following 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.

•

Oakleaf Surgical Hospital – This $30.5 million acute care facility located in Altoona, Wisconsin. This facility is leased to National Surgical Hospitals for 15 years and contains two renewal options of five years each plus additional option for nearly another five years, and the rent increases annually based on changes in the consumer price-index.

•

First Choice ER (a subsidiary of Adeptus Health) – We completed 16 acute care facilities for this tenant during 2014 totaling approximately $73.7 million. These facilities are leased pursuant to the master lease entered into in 2013.

On August 15, 2014 we executed a binding $8.7 million agreement with Health Care Authority for University of Alabama Birmingham (UAB) Medical West, an Affiliate of UAB Health System for the development of a freestanding emergency department and medical office building. The facilities will be leased to Medical West under 15 year initial lease terms with four extension options of five years each. We began construction on this facility in September 2014 and expect the facility to be completed in the second quarter of 2015.

On July 29, 2014, we executed a binding $150 million agreement with Adeptus Health for the development of acute care hospitals and free-standing emergency departments. These facilities will be leased to Adeptus Health pursuant to a new master lease agreement that has a 15-year initial term with three extension options of five years each that provides for annual rent increases based on changes in the consumer price index with a 2% minimum. This new master lease agreement is cross-defaulted with the original master lease executed with First Choice ER in 2013. We began construction on one of these facilities in the 2014 third quarter pursuant to the master funding and development agreement.

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
September 30,
2014

Estimated
Completion
Date

First Choice ER—Commerce City

Denver, CO

Acute Care Hospital

Adeptus Health

5,372

1,924

4Q 2014

UAB Medical West

Hoover, AL

Acute Care Hospital & Medical Office Building

Medical West, an affiliate of UAB

8,653

257

2Q 2015

First Choice ER—Summerwood

Houston, TX

Acute Care Hospital

Adeptus Health

6,015

1,535

2Q 2015

First Choice – Various

Various

Acute Care Hospital

Adeptus Health

143,985

—

Various

164,025

3,716

Disposals

On May 20, 2014, the tenant of our Bucks facility gave notice of their intent to exercise the lease’s purchase option. Pursuant to this purchase option, the tenant acquired the facility on August 6, 2014 for $35 million. We wrote down this facility to fair market value less cost to sell, resulting in a $3.1 million real estate impairment charge in the 2014 second quarter. The sale of the Bucks facility is not a strategic shift in our operations, and therefore the results of the Bucks operations have not been reclassified as discontinued operations.

In April 2013, we sold two long-term acute care hospitals, Summit Hospital of Southeast Arizona and Summit Hospital of Southeast Texas, for total proceeds of $18.5 million, resulting in a gain of $2.1 million.

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 DFLs. The components of our net investment in DFLs consisted of the following (dollars in thousands):


	As of September 30, 2014			As of December 31, 2013
Minimum lease payments receivable	$	1,615,867		$	1,647,567
Estimated residual values		212,266			211,863
Less: Unearned income		(1,391,747	)		(1,428,406	)

Net investment in direct financing leases	$	436,386		$	431,024

Monroe Facility

As of September 30, 2014 and December 31, 2013, our net investment (exclusive of the related real estate) in Monroe was as follows:


	As of September 30, 2014			As of December 31, 2013
Loans	$	35,443		$	31,341
Less: Loan impairment reserve		(32,943	)		(12,000	)

Loans, net		2,500			19,341
Interest, rent and other receivables		—			20,972

Net investment	$	2,500		$	40,313

The current 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 these assets 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.

During the first quarter of 2014, we 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 along with the potential of additional cash, if any, to be generated from our share in this new joint venture’s operations. Based on those new developments and the fair value of the loan’s underlying collateral at that time (using Level 2 inputs), we recorded an approximate $20.5 million impairment charge in the 2014 first quarter. Subsequent to the 2014 first quarter, we terminated this non-binding letter of intent.

In July 2014, we entered into an agreement with Prime to manage the Monroe Hospital. In addition, we entered into a non-binding letter of intent with Prime to lease the facility for initial cash rents of $2.1 million. These agreements contemplate a bankruptcy filing by the existing tenant and do not provide us with any recovery on the past due receivables. Based on these new developments and the fair value of our real estate and the underlying collateral of our loan (using Level 2 inputs), we recorded a $26.5 million impairment charge in the 2014 second quarter. As of September 30, 2014, the bankruptcy of the existing tenant is progressing as planned. In July 2014, the new third party, Prime, was awarded the operations of the Monroe facility, and we expect for them to take over operations and begin leasing the facility from us in the near term. As part of the bankruptcy process, we agreed to provide up to $5 million in debtor-in-possession financing of which we have provided $2.5 million as of September 30, 2014 and another $1 million on October 31, 2014. At September 30, 2014, our investment in Monroe is $27.5 million which we believe is fully recoverable. However, no assurances can be made that we will not have additional impairment charges in the future.

Florence facility

On March 6, 2013, the tenant of our facility in Phoenix, Arizona filed for Chapter 11 bankruptcy. At September 30, 2014, we have approximately $1 million of outstanding receivables but the tenant continues to pay us in accordance with bankruptcy orders. 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 $27.6 million at September 30, 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; however, we sent notice of termination of the lease prior to the bankruptcy filing. As a result of the lease terminating, we recorded a 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 September 30, 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 $14.2 million at September 30, 2014, is fully recoverable.

Loans

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


	As of September 30, 2014		As of December 31, 2013
Mortgage loans	$	385,093	$	388,756
Acquisition loans		108,028		109,655
Working capital and other loans		36,038		47,983
Convertible loan		3,352		3,352

	$	532,511	$	549,746

The decrease in our working capital and other loans is primarily due to the impairment charge incurred on our Monroe loan during 2014 (– see Note 3, Leasing Operations for further discussion) partially offset by new loans or advances made.

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 September 30, 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 September 30, 2014 and 2013, revenue from affiliates of Prime (including rent and interest from mortgage loans) accounted for 26.4% and 33.9%, respectively, of total revenue. For the nine months ended September 30, 2014 and 2013, revenue from affiliates of Prime (including rent and interest from mortgage loans) accounted for 27.8% and 32.6%, respectively, of total revenue. From an investment concentration perspective, Prime represented 22.5% and 24.5% of our total assets at September 30, 2014 and December 31, 2013, respectively.

For the three months ended September 30, 2014 and 2013, revenue from affiliates of Ernest (including rent and interest from mortgage and acquisition loans) accounted for 18.3% and 20.8%, respectively, of total revenue. For the nine months ended September 30, 2014 and 2013, revenue from affiliates of Ernest (including rent and interest from mortgage and acquisition loans) accounted for 18.7% and 20.6%, respectively, of total revenue. From an investment concentration perspective, Ernest represented 15.3% and 15.9% of our total assets at September 30, 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 September 30, 2014.

From a geographic perspective, investments located in California represented 17.2% of our total assets at September 30, 2014, down from 18.7% at December 31, 2013. Investments located in Texas represented 22.5% of our total assets at September 30, 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 and the Circle (Bath) acquisition this quarter, which represents less than 9% of total assets at September 30, 2014.