NOTE 6. Net Investment in Direct Financing Leases

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


	December 31,
	2014		2013
Minimum lease payments receivable	$	24,182,525	$	24,808,386
Estimated residual values		4,126,426		4,134,405
Less unearned income		(21,028,617)		(21,789,392)
Net investment in direct financing leases	$	7,280,334	$	7,153,399
Properties subject to direct financing leases		363		364

The minimum lease payments receivable are primarily attributable to HCR ManorCare, Inc. (“HCRMC”) ($23.0 billion and $23.5 billion at December 31, 2014 and 2013, respectively). The triple-net master lease with HCRMC provides for annual rent of $524 million beginning April 1, 2014 (prior to April 1, 2014, annual rent was $506 million). The rent increases by 3.5% per year over the next two years and by a minimum of 3% for the remaining portion of the initial lease term. The properties are grouped into four pools, and HCRMC has extension options for each pool with rent increased for the first year of the extension option to the greater of fair market rent or a 3% increase over the rent for the prior year. Including the extension options, which the Company determined at inception to be bargain renewal options, the four leased pools had total initial terms ranging from 23 to 35 years. See Notes 8 and 17 for additional discussion on the Company’s 9.4% equity interest in HCRMC and related December 2014 impairment charge.

During the year ended December 31, 2014, the Company received a $13 million payoff from the HCRMC proceeds of the sale of a post-acute/skilled nursing facility that collateralized this DFL.

During the year ended December 31, 2013, the Company reached an agreement with Tenet Healthcare Corporation to modify and extend three acute care hospital leases. The leases were extended at then-current rent levels and contain annual CPI-based escalators under staggered terms from three to eight years with purchase options exercisable for a fixed price at the end of each term. As a result of these lease modifications, the Company reassessed the classification of the leases and accounted for the lease agreements as DFLs.

The following table summarizes the Company’s internal ratings for net investment in DFLs at December 31, 2014 (dollars in thousands):


	Carrying		Percentage of	Internal Ratings
Investment Type	Amount		DFL Portfolio	Performing DFLs		Watch List DFLs		Workout DFLs
Senior housing	$	1,497,136	20	$	1,127,043	$	370,093	$	—
Post-acute/skilled nursing		5,659,307	78		5,659,307		—		—
Hospital		123,891	2		123,891		—		—
	$	7,280,334	100	$	6,910,241	$	370,093	$	—

Beginning September 30, 2013, the Company placed a 14-property senior housing DFL (the “DFL Portfolio”) on non-accrual status. The Company determined that the collection of all rental payments was and continues to be no longer reasonably assured; therefore, rental revenue for the DFL Portfolio has been recognized on a cash basis. The Company re-assessed the DFL Portfolio for impairment on December 31, 2014 and determined that the DFL Portfolio was not impaired based on its belief that: (i) it was not probable that it will not collect all of the rental payments under the terms of the lease; and (ii) the fair value of the underlying collateral exceeded the DFL Portfolio’s $370 million carrying amount. The fair value of the DFL Portfolio was estimated based on a discounted cash flow model, the inputs to which are considered to be a Level 3 measurement within the fair value hierarchy. Inputs to this valuation model include real estate capitalization rates, industry growth rates and operating margins, some of which influence the Company’s expectation of future cash flows from the DFL Portfolio and, accordingly, the fair value of its investment. During the years ended December 31, 2014, 2013 and 2012, the Company recognized DFL income of $19 million, $24 million and $28 million, respectively, and received cash payments each year of $24 million from the DFL Portfolio. The carrying value of the DFL Portfolio was $370 million and $374 million at December 31, 2014 and 2013, respectively.

Certain leases contain provisions that allow the tenants to elect to purchase the properties during or at the end of the lease terms for the aggregate initial investment amount plus adjustments, if any, as defined in the lease agreements. Certain leases also permit the Company to require the tenants to purchase the properties at the end of the lease terms.

Future minimum lease payments contractually due under DFLs at December 31, 2014, were as follows (in thousands):


Year	Amount
2015	$	614,886
2016		625,637
2017		637,666
2018		655,121
2019		674,206
Thereafter		20,975,009
	$	24,182,525