Summary of Significant Accounting Policies

12 Months Ended

Dec. 31, 2011

Summary of Significant Accounting Policies [Abstract]

Summary of Significant Accounting Policies

1. Summary of Significant Accounting Policies

Business Overview

Healthcare Realty Trust Incorporated (the “Company”) is a real estate investment trust that owns, acquires, manages, finances, and develops income-producing real estate properties associated primarily with the delivery of outpatient healthcare services throughout the United States. As of December 31, 2011, excluding assets classified as held for sale and including an investment in one unconsolidated joint venture, the Company had investments of approximately $2.9 billion in 209 real estate properties and mortgages. The Company’s 201 owned real estate properties, excluding assets classified as held for sale, are located in 28 states, totaling approximately 13.7 million square feet. In addition, the Company provided property management services to approximately 10.3 million square feet nationwide. Square footage disclosures in this Annual Report on Form 10-K are unaudited.

Principles of Consolidation

The Consolidated Financial Statements include the accounts of the Company, its wholly-owned subsidiaries, joint ventures, partnerships and variable interest entities (“VIEs”) where the Company controls the operating activities.

In accordance with the consolidations accounting standards, the Company must evaluate each contractual relationship it has with its lessees, borrowers, or others to determine whether or not the contractual arrangement creates a variable interest in those entities. If the Company determines that it has a variable interest and the entity is a VIE, then management must determine whether or not the Company is the primary beneficiary of the VIE, resulting in consolidation of the VIE. A primary beneficiary has the power to direct the activities of the VIE that most significantly impacts the VIE’s economic performance and has the obligation to absorb the losses of, or receive the benefits from, the VIE. During the third quarter of 2011, the Company began overseeing and managing a construction project that it was funding through a mortgage loan. As a result, the Company concluded that it was the primary beneficiary of the VIE, resulting in the Company consolidating the VIE which held the mortgage note payable to the Company. Upon consolidation, the Company eliminated the VIE’s mortgage note payable and interest against the Company’s mortgage note receivable and interest and reclassified the costs incurred on the project to construction in progress at fair value, which the Company determined to approximate the carrying value of the mortgage note plus accrued but unpaid construction-related invoices. The mortgage note receivable/payable eliminated on the Company’s Consolidated Financial Statements was approximately $34.9 million at December 31, 2011, and the construction in progress asset (including accrued invoices) totaled approximately $38.0 million at December 31, 2011. The creditors of the VIE have no recourse against the general credit of the Company.

The Company also had two construction mortgage loans aggregating approximately $40.5 million at December 31, 2011 in which each borrower has been identified as a VIE, but management had determined that the Company was not the primary beneficiary in either case. The Company’s maximum exposure to loss related to these two unconsolidated VIEs at December 31, 2011 equaled the Company’s related aggregate loan investment.

During the first quarter of 2011, the Company purchased the remaining noncontrolling equity interest in two previously consolidated joint ventures, in which the noncontrolling interest holder in both joint ventures was an affiliate of Ladco. Prior to the purchase in the first quarter of 2011, the noncontrolling interests were reported as equity and the related net income (loss) attributable to the noncontrolling interests as part of consolidated net income in the Company’s Condensed Consolidated Financial Statements.

The Company also had a $1.3 million investment in one unconsolidated joint venture at December 31, 2011, 2010 and 2009. The Company’s investment in its unconsolidated joint ventures is included in other assets, and the related equity income is recognized in other income (expense) on the Company’s Consolidated Financial Statements.

All significant intercompany accounts, transactions and balances have been eliminated in the Consolidated Financial Statements.

Use of Estimates in the Consolidated Financial Statements

Preparation of the Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect amounts reported in the Consolidated Financial Statements and accompanying notes. Actual results may differ from those estimates.

Segment Reporting

The Company owns, acquires, manages, finances and develops outpatient and other healthcare-related properties. The Company is managed as one reporting unit, rather than multiple reporting units, for internal reporting purposes and for internal decision-making. Therefore, the Company discloses its operating results in a single segment.

Reclassifications

Certain reclassifications for discontinued operations have been made to the Consolidated Financial Statements for the years ended December 31, 2011, 2010 and 2009 to conform to the 2011 presentation. The operating results for assets classified as held for sale as of December 31, 2011 or sold during 2011 have been reclassified from continuing operations to discontinued operations on the Consolidated Financial Statements for the years ended December 31, 2010 and 2009. Also during 2011, one property was reclassified from discontinued operations to continuing operations, including the reclassification of an impairment charge on the property in 2010, as discussed in Note 5.

Real Estate Properties

Real estate properties are recorded at cost or fair value, if acquired. Cost or fair value at the time of acquisition is allocated between land, buildings, tenant improvements, lease and other intangibles, and personal property. The Company’s gross real estate assets, on a book-basis, totaled approximately $2.8 billion and $2.6 billion, respectively, as of December 31, 2011 and 2010.

Periodically, the Company will eliminate fully depreciated assets that are no longer in use against the respective accumulated depreciation balances. During 2011, the Company eliminated against accumulated depreciation approximately $40.0 million of fully amortized real estate intangibles that were initially recorded as part of certain real estate acquisitions and approximately $1.1 million of personal property and equipment.

Depreciation and amortization of real estate assets and liabilities in place as of December 31, 2011, is provided for on a straight-line basis over the asset’s estimated useful life:

Land improvements	15.0 to 39.0 years
Buildings and improvements	3.3 to 39.0 years
Lease intangibles (including ground lease intangibles)	0.8 to 93.1 years
Personal property	3.0 to 15.8 years

Land Held for Development

Land held for development, which is included in construction in progress (CIP), on the Company’s Consolidated Balance Sheets, includes parcels of land owned by the Company, upon which the Company intends to develop and own outpatient healthcare facilities. As of December 31, 2011 and 2010, the Company’s investment in land held for development totaled approximately $25.2 million and $20.8 million, respectively.

Accounting for Acquisitions of Real Estate Properties with In-Place Leases

When a building is acquired with in-place leases, the cost of the acquisition must be allocated between the tangible real estate assets and the intangible real estate assets related to in-place leases based on their estimated fair values. Where appropriate, the intangible assets recorded could include goodwill or customer relationship assets. The values related to above- or below-market in-place lease intangibles are amortized to rental income where the Company is the lessor, are amortized to property operating expense where the Company is the lessee, and are amortized over the average remaining term of the leases upon acquisition. The values of at-market in-place leases and other intangible assets, such as customer relationship assets, are amortized and reflected in amortization expense in the Company’s Consolidated Statements of Operations. See Note 8 for more details on the Company’s intangible assets.

The Company’s approach to estimating the value of in-place leases is a multi-step process:

• First, the Company considers whether any of the in-place lease rental rates are above- or below-market. An asset (if the actual rental rate is above-market) or a liability (if the actual rental rate is below-market) is calculated and recorded in an amount equal to the present value of the future cash flows that represent the difference between the actual lease rate and the average market rate.

• Second, the Company estimates an absorption period assuming the building is vacant and must be leased up to the actual level of occupancy when acquired. During that absorption period the owner would incur direct costs, such as tenant improvements, and would suffer lost rental income. Likewise, the owner would have acquired a measurable asset in that, assuming the building was vacant, certain fixed costs would be avoided because the actual in-place lessees would reimburse a certain portion of fixed costs through expense reimbursements during the absorption period. All of these assets (tenant improvement costs avoided, rental income lost, and fixed costs recovered through in-place lessee reimbursements) are estimated and recorded in amounts equal to the present value of future cash flows.

• Third, the Company estimates the value of the building “as if vacant.” The Company uses the same absorption period and occupancy assumptions used in step two, adding to those the future cash flows expected in a fully occupied building. The net present value of these future cash flows, discounted at a market rate of return, becomes the estimated “as if vacant” value of the building.

• Fourth, the actual purchase price is allocated based on the various asset fair values described above. The building and tenant improvement components of the purchase price are depreciated over the estimated useful life of the building or the average remaining term of the in-places leases. The above- or below-market rental rate assets or liabilities are amortized to rental income or property operating expense over the remaining term of the leases. The at-market, in-place leases are amortized to amortization expense over the average remaining term of the leases, customer relationship assets are amortized to amortization expense over terms applicable to each acquisition, and any goodwill recorded would be reviewed for impairment at least annually.

Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants. In calculating fair value, a company must maximize the use of observable market inputs, minimize the use of unobservable market inputs and disclose in the form of an outlined hierarchy the details of such fair value measurements.

A hierarchy of valuation techniques is defined to determine whether the inputs to a fair value measurement are considered to be observable or unobservable in a marketplace. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. This hierarchy requires the use of observable market data when available. These inputs have created the following fair value hierarchy:

• Level 1 – quoted prices for identical instruments in active markets;

• Level 2 – quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and

• Level 3 – fair value measurements derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

Executed purchase and sale agreements, since they are binding agreements, are categorized as level 1 inputs. Brokerage estimates, letters of intent, or unexecuted purchase and sale agreements are considered to be level 3 as they are nonbinding in nature.

During 2011, in connection with the sale of two medical office buildings, the Company recorded impairment charges totaling approximately $1.7 million based on the contractual sales price, a level one input. During 2011, the Company also recorded impairment charges totaling $5.0 million related to five properties that are classified as held for sale at December 31, 2011, reducing the Company’s carrying values to the estimated fair values of the properties less costs to sell. The Company used level three inputs in determining the fair value of the five properties classified as held for sale at December 31, 2011.

Cash and Cash Equivalents

Cash and cash equivalents includes short-term investments with original maturities of three months or less when purchased.

Allowance for Doubtful Accounts and Credit Losses

Accounts Receivable

Management monitors the aging and collectibility of its accounts receivable balances on an ongoing basis. Whenever deterioration in the timeliness of payment from a tenant or sponsor is noted, management investigates and determines the reason(s) for the delay. Considering all information gathered, management’s judgment is exercised in determining whether a receivable is potentially uncollectible and, if so, how much or what percentage may be uncollectible. Among the factors management considers in determining collectibility are: the type of contractual arrangement under which the receivable was recorded (e.g., a triple net lease, a gross lease, a sponsor guaranty agreement, or some other type of agreement); the tenant’s reason for slow payment; industry influences under which the tenant operates; evidence of willingness and ability of the tenant to pay the receivable; credit-worthiness of the tenant; collateral, security deposit, letters of credit or other monies held as security; tenant’s historical payment pattern; other contractual agreements between the tenant and the Company; relationship between the tenant and the Company; the state in which the tenant operates; and the existence of a guarantor and the willingness and ability of the guarantor to pay the receivable. Considering these factors and others, management concludes whether all or some of the aged receivable balance is likely uncollectible. Upon determining that some portion of the receivable is likely uncollectible, the Company records a provision for bad debts for the amount it expects will be uncollectible. When efforts to collect a receivable are exhausted, the receivable amount is charged off against the allowance. The Company does not hold any accounts receivable for sale.

Mortgage Notes and Notes Receivable

The Company had seven mortgage notes receivable outstanding as of December 31, 2011 and 2010 with aggregate principal balances totaling $97.4 million and $36.6 million, respectively. The weighted average maturity of the notes was approximately 2.1 years and 3.9 years, respectively, with interest rates ranging from 6.75% to 11.0% and 6.5% to 11.0%, respectively, as of December 31, 2011 and 2010.

The Company also had notes receivable outstanding as of December 31, 2011 and 2010 of approximately $0.3 million and $3.8 million, respectively. Interest rates on the notes were fixed, ranging from 8.0% to 13.5% with maturity dates ranging from 2013 through 2015 as of December 31, 2011 and 8.0% to 11.6% with maturity dates ranging from 2011 through 2016 as of December 31, 2010.

During 2011, the Company recorded an allowance of approximately $0.1 million on one of its notes receivable. No other allowances were recorded on the Company’s mortgage notes and notes receivable during 2011 or 2010. The Company evaluates collectibility of its mortgage notes and notes receivable and records allowances on the notes as necessary. A loan is impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan as scheduled, including both contractual interest and principal payments. If a mortgage loan or note receivable becomes past due, the Company will review the specific circumstances and may discontinue the accrual of interest on the loan. The loan is not returned to accrual status until the debtor has demonstrated the ability to continue debt service in accordance with the contractual terms. Loans placed on non-accrual status will be accounted for either on a cash basis, in which income is recognized only upon receipt of cash, or on a cost-recovery basis, in which all cash receipts reduce the carrying value of the loan, based on the Company’s expectation of future collectibility. As of December 31, 2011 and 2010, there were no recorded investments in mortgage notes or notes receivable that were either on non-accrual status or were past due more than ninety days and continued to accrue interest. Also, as of December 31, 2011, the Company did not hold any of its mortgage notes or notes receivable available for sale.

Goodwill and Other Intangible Assets

Goodwill and intangible assets with indefinite lives are not amortized, but are tested at least annually for impairment. Intangible assets with finite lives are amortized over their respective lives to their estimated residual values and are reviewed for impairment only when impairment indicators are present.

Identifiable intangible assets of the Company are comprised of enterprise goodwill, in-place lease intangible assets, customer relationship intangible assets, and deferred financing costs. In-place lease and customer relationship intangible assets are amortized on a straight-line basis over the applicable lives of the assets. Deferred financing costs are amortized over the term of the related credit facility or other debt instrument under the straight-line method, which approximates amortization under the effective interest method. Goodwill is not amortized but is evaluated annually on December 31 for impairment. The 2011 and 2010 impairment evaluations each indicated that no impairment had occurred with respect to the $3.5 million goodwill asset. See Note 8 for more detail on the Company’s intangible assets.

Contingent Liabilities

From time to time, the Company may be subject to loss contingencies arising from legal proceedings. Additionally, while the Company maintains comprehensive liability and property insurance with respect to each of its properties, the Company may be exposed to unforeseen losses related to uninsured or underinsured damages.

The Company continually monitors any matters that may present a contingent liability, and, on a quarterly basis, management reviews the Company’s reserves and accruals in relation to each of them, adjusting provisions as necessary in view of changes in available information. Liabilities for contingencies are first recorded when a loss is determined to be both probable and can be reasonably estimated. Changes in estimates regarding the exposure to a contingent loss are reflected as adjustments to the related liability in the periods when they occur.

Because of uncertainties inherent in the estimation of contingent liabilities, it is possible that the Company’s provision for contingent losses could change materially in the near term. To the extent that any losses, in addition to amounts recognized, are at least reasonably possible, such amounts will be disclosed in the notes to the Consolidated Financial Statements.

Accounting for Defined Benefit Pension Plans

The Company has a pension plan under which three of the Company’s founding officers may receive retirement benefits upon retirement (the “Executive Retirement Plan”). The plan is unfunded and benefits will be paid from cash flows of the Company. The Company recognizes pension expense on an accrual basis over an estimated service period. The Company calculates pension expense and the corresponding liability annually on the measurement date (December 31) which requires certain assumptions, such as a discount rate and the recognition of actuarial gains and losses. The maximum annual benefits payable to each individual under the plan have been frozen at $896,000, subject to cost-of-living adjustments.

The Company historically has also had a pension plan for its non-employee outside directors. The plan was terminated in 2009 and lump sum payments totaling approximately $2.6 million were made during 2010 to the directors who participated in the plan. See Note 11 for further discussion.

Incentive Plans

The Company has various employee stock-based awards outstanding. These awards include common stock issued to employees pursuant to the 2007 Employees Stock Incentive Plan and its predecessor plan (the “Incentive Plan”) and the 2000 Employee Stock Purchase Plan (the “Employee Stock Purchase Plan”). See Note 12 for details on the Company’s stock-based awards. The Employee Stock Purchase Plan features a “look-back” provision which enables the employee to purchase a fixed number of common shares at the lesser of 85% of the market price on the date of grant or 85% of the market price on the date of exercise, with optional purchase dates occurring once each quarter for 27 months.

The Company accounts for awards to its employees based on fair value, using the Black-Scholes model, and generally recognizes expense over the award’s vesting period, net of estimated forfeitures. Since the options granted under the Employee Stock Purchase Plan immediately vest, the Company records compensation expense for those options when they are granted in the first quarter of each year. In each of the first quarters of 2011, 2010 and 2009, the Company recognized in general and administrative expenses approximately $0.2 million, $0.2 million and $0.3 million of compensation expense, respectively, related to the annual grant of options to its employees to purchase shares under the Employee Stock Purchase Plan.

Accumulated Other Comprehensive Loss

Certain items must be included in comprehensive income, including items such as foreign currency translation adjustments, minimum pension liability adjustments, and unrealized gains or losses on available-for-sale securities. The Company’s accumulated other comprehensive loss includes the cumulative pension liability adjustments, which are generally recognized in the fourth quarter of each year.

Revenue Recognition

The Company recognizes revenue when it is realized or realizable and earned. There are four criteria that must all be met before a Company may recognize revenue, including persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered (i.e., the tenant has taken possession of and controls the physical use of the leased asset), the price has been fixed or is determinable, and collectibility is reasonably assured. Income received but not yet earned is deferred until such time it is earned. Deferred revenue, included in other liabilities on the Consolidated Balance Sheets, was $24.3 million and $17.3 million, respectively, at December 31, 2011 and 2010.

The Company derives most of its revenues from its real estate property and mortgage notes receivable portfolio. The Company’s rental and mortgage interest income is recognized based on contractual arrangements with its tenants, sponsors or borrowers. These contractual arrangements fall into three categories: leases, mortgage notes receivable, and property operating agreements as described in the following paragraphs. The Company may accrue late fees based on the contractual terms of a lease or note. Such fees, if accrued, are included in master lease income, property operating income, or mortgage interest income on the Company’s Consolidated Statements of Operations, based on the type of contractual agreement.

Rental Income

Rental income related to non-cancelable operating leases is recognized as earned over the life of the lease agreements on a straight-line basis. Rental income from properties under a master lease arrangement with the tenant is included in master lease rental income and rental income from properties under various tenant lease arrangements, including operating expense recoveries, is included in property operating income on the Company’s Consolidated Statements of Operations. Included in income from continuing operations were operating expense recoveries of approximately $31.8 million, $23.0 million and $20.8 million, respectively, for the years ended December 31, 2011, 2010 and 2009.

Additional rent, generally defined in most lease agreements as the cumulative increase in a Consumer Price Index (“CPI”) from the lease start date to the CPI as of the end of the previous year, is calculated as of the beginning of each year, and is then billed and recognized as income during the year as provided for in the lease. Included in income from continuing operations was additional rental income, net of reserves, of approximately $1.2 million, $2.3 million and $2.5 million, respectively, for the years ended December 31, 2011, 2010 and 2009.

Mortgage Interest Income

Interest income on the Company’s mortgage notes receivable is recognized based on the interest rates, maturity dates and amortization periods in accordance with each note agreement. Interest rates on its seven mortgage notes receivable outstanding as of December 31, 2011 were fixed. The Company amortizes any fees paid related to its mortgage notes receivable to mortgage interest income over the term of the loan on a straight-line basis.

Other Operating Income

Other operating income on the Company’s Consolidated Statements of Operations for 2011 generally included lease guaranty revenue recognized under its property operating agreements, interest income on notes receivable, and management fee income.

Applicable to six of the Company’s 201 owned real estate properties as of December 31, 2011, property operating agreements between the Company and sponsoring health systems contractually obligate the sponsoring health system to provide to the Company a minimum return on the Company’s investment in the property in exchange for the right to be involved in the operating decisions of the property, including tenancy. If the minimum return is not achieved through normal operations of the property, the Company will calculate and accrue any shortfalls as income that the sponsor is responsible to pay to the Company under the terms of the property operating agreement.

The Company also receives management fees related to property management services it provides to third parties. Management fees related to the Company’s owned properties are eliminated in consolidation. Management fees are generally calculated, accrued and billed monthly based on a percentage of cash collections of tenant receivables for the month.

Other operating income for the years ended December 31, 2011, 2010 and 2009 is detailed in the table below:

	Year Ended December 31,
(Dollars in millions)	2011		2010		2009
Property lease guaranty revenue	$	6.9	$	7.5	$	8.2
Interest income on notes receivable		0.6		0.8		0.6
Management fee income		0.2		0.2		0.2
Replacement rent		—		—		1.3
Other		0.2		0.1		0.6
	$	7.9	$	8.6	$	10.9

Federal Income Taxes

No provision has been made for federal income taxes. The Company intends at all times to qualify as a real estate investment trust under Sections 856 through 860 of the Internal Revenue Code of 1986 (the “Code”), as amended. The Company must distribute at least 90% per annum of its real estate investment trust taxable income to its stockholders and meet other requirements to continue to qualify as a real estate investment trust. See Note 15 for further discussion.

The Company classifies interest and penalties related to uncertain tax positions, if any, in the Consolidated Financial Statements as a component of general and administrative expenses. No such amounts were recognized during the three years ended December 31, 2011.

Federal tax returns for the years 2008, 2009 and 2010 are currently subject to examination by taxing authorities.

State Income Taxes

The Company must pay certain state income taxes and the provisions are generally included in general and administrative expense on the Company’s Consolidated Statements of Operations. See Note 15 for further discussion.

Sales and Use Taxes

The Company must pay sales and use taxes to certain state tax authorities based on rents collected from tenants in properties located in those states. The Company is generally reimbursed for these taxes by the tenant. The Company accounts for the payments to the taxing authority and subsequent reimbursement from the tenant on a net basis in revenues in the Company’s Consolidated Statements of Operations.

Discontinued Operations

The Company sells properties from time to time due to a variety of factors, such as market conditions or the exercise of purchase options by tenants. The operating results of properties that have been sold or are held for sale are reported as discontinued operations in the Company’s Consolidated Statements of Operations. A company must report discontinued operations when a component of an entity has either been disposed of or is deemed to be held for sale if (i) both the operations and cash flows of the component have been or will be eliminated from ongoing operations as a result of the disposal transaction, and (ii) the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction. Long-lived assets held for sale are reported at the lower of their carrying amount or their fair value less cost to sell. Further, depreciation of these assets ceases at the time the assets are classified as discontinued operations. Losses resulting from the sale of such properties are characterized as impairment losses relating to discontinued operations in the Consolidated Statements of Operations.

In the Company’s Consolidated Statements of Operations for the years ended December 31, 2011, 2010 and 2009, income related to properties sold or held for sale as of December 31, 2011 was included in discontinued operations for each of the three years totaling approximately $2.9 million, $6.2 million, and $27.9 million, respectively.

Assets held for sale at December 31, 2011 and 2010 included 15 and 11 properties, respectively.

See Note 5 for more detail on discontinued operations.

Earnings per Share

Basic earnings per common share is calculated using weighted average shares outstanding less issued and outstanding but unvested restricted shares of common stock. Diluted earnings per common share is calculated using weighted average shares outstanding plus the dilutive effect of the outstanding stock options from the Employee Stock Purchase Plan and restricted shares of common stock, using the treasury stock method and the average stock price during the period. See Note 13 for the calculations of earnings per share.

New Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-05, “Presentation of Comprehensive Income.” This standard requires companies to retrospectively present comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements, and eliminates the current option of presenting components of comprehensive income as part of the statement of changes in stockholders’ equity. The Company adopted this standard as of December 31, 2011 and presents comprehensive income in a separate statement. The adoption did not have a material impact on the Company’s results of operations or financial position.

In September 2011, the FASB issued ASU 2011-08, “Intangibles – Goodwill and Other (Topic 350), Testing Goodwill for Impairment.” This standard simplifies the process a company must go through to test goodwill for impairment. Companies will have an option to first assess qualitative factors of a reporting unit being tested before having to assess quantitative factors. If a company believes no impairment exists based on qualitative factors, then it will no longer be required to perform the two-step quantitative impairment test. The standard is effective for the Company on January 1, 2012 although early adoption is permitted. The adoption will not have a material impact on the Company’s results of operations or financial position.