REAL ESTATE

As of June 30, 2016, we owned 194 health care real estate properties located in 32 states and consisting of 122 senior housing communities, 67 skilled nursing facilities, 3 hospitals and 2 medical office buildings. Our senior housing properties include assisted living facilities, senior living campuses, independent living facilities, and entrance-fee communities. These investments (excluding our corporate office of $1,118,000) consisted of properties with an original cost of approximately $2,346,903,000, rented under triple-net leases to 26 lessees.

During the six months ended June 30, 2016, we made investments and commitments related to real estate as described below (dollars in thousands):



Operator	Properties	Asset Class	Amount
Watermark Retirement Communities / East Lake Capital Mgmt.	2	SHO	$	66,300
The Ensign Group	8	SNF	118,500
Woodland Village	1	SHO	9,813
Bickford Senior Living	5	SHO	89,900
			$	284,513

Watermark Retirement / East Lake Capital

On June 1, 2016, NHI acquired two entrance fee continuing care retirement communities (“CCRCs”) from funds managed by certain affiliates of East Lake Capital Management (“East Lake”) for $56,300,000 in cash, inclusive of a $4,500,000 regulatory deposit, and entered into a lease transaction with affiliates of East Lake. The CCRCs consist of 460 units and are located in Bridgeport and Southbury, Connecticut. The communities are sub-leased to affiliates of Watermark Retirement Communities (“Watermark”), the current manager. The lease has a term of 15 years, with an initial lease rate to East Lake of 7% with escalators of 3.5% in years two through four, and 3% annually thereafter. NHI has committed up to an additional $10,000,000 for capital improvements and potential expansion of the communities over the next two years, of which $747,000 was drawn at June 30, 2016. Because the facilities had no history as rental operations, we accounted for the purchase as an asset acquisition.

In conjunction with the lease, East Lake acquired a variable-rate purchase option on the properties as a whole, exercisable beginning in year six of the lease. The option will be based on our initial acquisition cost, our funding of capital improvements and expansions, other additional funding that may then be in place, or further rent escalations during the remaining duration of the option window.

East Lake’s June 2016 lease represents an expansion of its relationship with NHI, which began in July 2015, with our acquisition and lease to East Lake of two senior living campuses and one assisted living/memory care facility. East Lake’s relationship to NHI consists of its leasehold interests and purchase options and is considered a variable interest, analogous to a financing arrangement. Because we neither control East Lake nor have any role in its day-to-day management, we have no material input into activities that most significantly impact the entity’s economic performance, and we account for our transactions with East Lake at amortized cost. We are not obligated to provide further support to East Lake, and accordingly the maximum extent of our exposure to loss is limited to our investment in the facilities.

The Ensign Group

On April 1, 2016, we purchased eight skilled nursing facilities in Texas totaling 931 beds for $118,500,000 in cash. The facilities were owned and operated by NHI’s existing tenant, Legend Healthcare (“Legend”), and we accounted for the purchase as an asset acquisition. Concurrent with the acquisition, we amended in-place leases covering the nine existing skilled nursing facilities we leased to Legend, extending their provisions to the new facilities. The amendment also replaced purchase options that provided for equal sharing of any appreciation in value, within a specified range, with purchase options having a price determined at fair value, exercisable at the end of the lease term. Based on our analysis of the in-place rights, benefits and obligations, $6,400,000 of the consideration in the acquisition was allocated to the canceled provisions related to the in-place leases.

On May 1, 2016, Legend and NHI agreed to transition Legend’s skilled nursing operations under it’s lease with NHI to a new operator, and NHI entered into a new 15-year master lease with affiliates of The Ensign Group, Inc. (“Ensign”) on 15 of the former Legend facilities for an initial annual amount of $17,750,000, plus an annual escalator based on inflation. NHI’s total original investment in the 15 facilities leased to Ensign is approximately $211,000,000. The Ensign lease has two 5-year renewal options. Upon entering the new lease, NHI sold to Ensign for $24,600,000 two remaining skilled nursing facilities in Texas totaling 245 beds previously under lease to Legend. The Ensign lease, secured in part by the operator’s corporate guaranty, replaces the amended Legend lease, and, accordingly, the rights, benefits and obligations held by Legend have terminated. In recording the transition of our leases to Ensign, we wrote off the fair value assigned to the former Legend leases and $8,326,000 of accumulated straight-line rent receivable, leaving a preliminary allocation of $6,252,000 to land and $105,848,000 to depreciable assets.

As part of this transaction, NHI has committed to purchase, from a developer, four skilled nursing facilities under Legend management in Texas for $56,000,000. The option to purchase would occur at stabilization. On exercise of the option, NHI has committed to lease the facilities to Ensign. The buildings are in various stages of development, and the purchase window for the first facility is expected to open in 2017.

The fixed-price nature of the option creates a variable interest for NHI in the developer, whom NHI considers to lack sufficient equity to finance its operations without recourse to additional subordinated debt. The presence of these conditions causes the developer to be considered a VIE. However, because NHI lacks both the power to direct the activities of the VIE that most significantly impact the entity’s economic performance and the obligation to absorb losses or the right to receive benefits of the VIE that could be significant to the entity, NHI is not its primary beneficiary. We therefore account for our transactions with the developer at historical cost. Our exposure to loss as a result of our relationship with the VIE is limited to the amount of our commitments.

Woodland Village

On January 15, 2016, we acquired a 98-unit independent living community in Chehalis, Washington, for $9,463,000 in cash inclusive of closing costs of $213,000 plus an additional commitment to fund $350,000 in specified capital improvements, of which $125,000 has been funded at June 30, 2016. We leased the facility to a partnership between Marathon Development and Village Concepts Retirement Communities for an initial lease term of 15 years. The lease provides for an initial annual lease rate of 7.25% plus annual escalators. Because the facility was owner-occupied, the acquisition was accounted for as an asset purchase.

Bickford

On June 1, 2016, in an asset acquisition, we acquired five assisted living and memory care facilities owned and operated by Bickford Senior Living (“Bickford”) for $87,500,000, including $77,747,000 in cash and cancellation of notes and accrued interest receivable totaling $9,753,000 (Note 4). Additionally, we have committed $2,400,000 for capital expenditures and expansion of the existing facilities, the funding of which will be added to the lease base. The lease provides for an initial rate of 7.25% and term of 15 years plus two five-year renewal options. The annual lease escalator is 3%. NHI’s purchase option on an additional Bickford facility was relinquished. The facilities, consisting of 277 total units, are located in Iowa (2), Missouri, Illinois, and Nebraska. We recognized $849,000 in revenues from this lease through June 30, 2016. The facilities are not included in the existing RIDEA joint venture between the parties.

As of June 30, 2016, we owned an 85% equity interest and Sycamore Street, LLC (“Sycamore”), an affiliate of Bickford Senior Living (“Bickford”), owned a 15% equity interest in our consolidated subsidiary (“PropCo”) which owns 32 assisted living/memory care facilities plus 5 facilities in pre-development and development. The facilities are leased to an operating company (“OpCo”), in which we retain a non-controlling 85% ownership interest. The facilities are managed by Bickford. Our joint venture is structured to comply with the provisions of RIDEA. See Note 12 for a discussion of our decision to convert the RIDEA portfolio to a triple-net tenancy.

As of June 30, 2016, the annual contractual rent from OpCo to PropCo is $25,359,000, plus annual escalators of 3%. NHI has an exclusive right to Bickford’s future acquisitions, development projects and refinancing transactions. Of our total revenues, $6,315,000 (10%) and $5,890,000 (10%) were recognized as rental income from the RIDEA joint venture for the three months ended June 30, 2016 and 2015, respectively, and $12,622,000 (10%) and $11,695,000 (10%) for the six months ended June 30, 2016 and 2015, respectively.

Holiday

As of June 30, 2016, we leased 25 independent living facilities to an affiliate of Holiday Retirement (“Holiday”). The master lease term of 17 years began in December 2013 and provides for an escalator of 4.5% in 2017 and a minimum of 3.5% each year thereafter.

Of our total revenues, $10,954,000 (18%) and $10,954,000 (19%) were derived from Holiday for the three months ended June 30, 2016 and 2015, including $2,241,000 and $2,616,000 in straight-line rent, respectively. Of our total revenues, $21,908,000 (18%) and $21,908,000 (20%) were derived from Holiday for the six months ended June 30, 2016 and 2015, including $4,482,000 and $5,233,000 in straight-line rent, respectively. Our tenant operates the facilities pursuant to a management agreement with a Holiday-affiliated manager.

NHC

As of June 30, 2016, we leased 42 facilities under two master leases to National HealthCare Corporation (“NHC”), a publicly-held company and the lessee of our legacy properties. The facilities leased to NHC consist of 3 independent living facilities and 39 skilled nursing facilities (4 of which are subleased to other parties for whom the lease payments are guaranteed to us by NHC). These facilities are leased to NHC under the terms of an amended master lease agreement originally dated October 17, 1991 (“the 1991 lease”) which includes our 35 remaining legacy properties and a master lease agreement dated August 30, 2013 (“the 2013 lease”) which includes 7 skilled nursing facilities acquired from a third party.

The 1991 lease has been amended to extend the lease expiration to December 31, 2026. There are two additional 5-year renewal options, each at fair rental value of such leased property as negotiated between the parties and determined without including the value attributable to any improvements to the leased property voluntarily made by NHC at its expense. Under the terms of the lease, the base annual rental is $30,750,000 and rent escalates by 4% of the increase, if any, in each facility’s revenue over a 2007 base year. The 2013 lease provides for a base annual rental of $3,450,000 and has a lease expiration of August 2028. Under the terms of the 2013 lease, rent escalates 4% of the increase in each facility’s revenue over the 2014 base year. For both the 1991 lease and the 2013 lease, we refer to this additional rent component as “percentage rent.” During the last three years of the 2013 lease, NHC will have the option to purchase the facilities for $49,000,000.

The following table summarizes the percentage rent income from NHC (in thousands):



	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2016		2015		2016		2015
Current year	$	733	$	596	$	1,466	$	1,192
Prior year final certification¹	—		—		547		94
Total percentage rent income	$	733	$	596	$	2,013	$	1,286

¹For purposes of the percentage rent calculation described in the master lease Agreement, NHC’s annual revenue by facility for a given year is certified to NHI by March 31st of the following year.

Of our total revenues, $9,270,000 (15%) and $9,133,000 (16%) were derived from NHC for the three months ended June 30, 2016 and 2015, respectively and $19,087,000 (16%) and $18,360,000 (16%) for the six months ended June 30, 2016 and 2015, respectively.

The chairman of our board of directors is also a director on NHC’s board of directors. As of June 30, 2016, NHC owned 1,630,462 shares of our common stock.

Senior Living Communities

Beginning in December 2014 we leased eight retirement communities with 1,671 units to Senior Living Communities, LLC (“Senior Living”). The 15-year master lease contains two 5-year renewal options and provides for annual escalators of 4% in years two through four and 3% thereafter.

Of our total revenue, $9,855,000 (16%) and $9,855,000 (18%) in lease revenues were derived from Senior Living for the three months ended June 30, 2016 and 2015, respectively, including $1,795,000 and $2,105,000, respectively, in straight-line rent. For the six months ended June 30, 2016 and 2015, of our total revenues, $19,711,000 (16%) and $19,711,000 (18%) were derived from Senior Living including $3,591,000 and $4,211,000, respectively, in straight-line rent.

Disposition of Assets

On March 22, 2016, we sold a skilled nursing facility in Idaho for cash consideration of $3,000,000. The carrying value of the facility was $1,346,000, and we recorded a gain of $1,654,000. As discussed above in connection with The Ensign Group, we sold two skilled nursing facilities in May 2016 for total consideration of $24,600,000 and realized a gain of $2,805,000 on the disposal. In June 2016, we recognized a gain of $123,000 on the sale of a vacant land parcel.