National Health Investors Earnings 2018-12-31
NHI 10K Annual Report
| Balance Sheet | Income Statement | Cash Flow |
|---|---|---|
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One) | |
[ x ] | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2018 | |
[ ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from _____________ to _____________ | |
Commission File Number 001-10822
National Health Investors, Inc.
(Exact name of registrant as specified in its charter)
Maryland | 62-1470956 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
222 Robert Rose Drive, Murfreesboro, Tennessee | 37129 | |
(Address of principal executive offices) | (Zip Code) | |
(615) 890-9100 |
(Registrant’s telephone number, including area code) |
Securities registered pursuant to Section 12(b) of the Act:
Title of each Class | Name of each exchange on which registered | |
Common stock, $.01 par value | New York Stock Exchange | |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ x ] No [ ]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [ x ]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ x ] No [ ]
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files) Yes [ x ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§292.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [ x ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ x ] | Accelerated filer [ ] | |
Non-accelerated filer [ ] | Smaller reporting company [ ] | |
Emerging growth company [ ] | ||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [ x ]
The aggregate market value of shares of common stock held by non-affiliates on June 30, 2018 (based on the closing price of these shares on the New York Stock Exchange) was approximately $2,986,872,000. There were 42,735,034 shares of the registrant’s common stock outstanding as of February 15, 2019.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s definitive proxy statement for its 2019 annual meeting of stockholders are incorporated by reference into Part III, Items 10, 11, 12, 13, and 14 of this Form 10-K.
Table of Contents
Page | |
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PART I.
Forward Looking Statements
References throughout this document to NHI or the Company include National Health Investors, Inc., and its consolidated subsidiaries. In accordance with the Securities and Exchange Commission’s “Plain English” guidelines, this Annual Report on Form 10-K has been written in the first person. In this document, the words “we”, “our”, “ours” and “us” refer only to National Health Investors, Inc. and its consolidated subsidiaries and not any other person. Unless the context indicates otherwise, references herein to “the Company” include all of our consolidated subsidiaries.
This Annual Report on Form 10-K and other materials we have filed or may file with the Securities and Exchange Commission (the “SEC”), as well as information included in oral statements made, or to be made, by our senior management contain certain “forward-looking” statements as that term is defined by the Private Securities Litigation Reform Act of 1995. All statements regarding our expected future financial position, results of operations, cash flows, funds from operations, continued performance improvements, ability to service and refinance our debt obligations, ability to finance growth opportunities, and similar statements including, without limitation, those containing words such as “may”, “will”, “believes”, “anticipates”, “expects”, “intends”, “estimates”, “plans”, and other similar expressions are forward-looking statements.
Forward-looking statements involve known and unknown risks and uncertainties that may cause our actual results in future periods to differ materially from those projected or contemplated in the forward-looking statements as a result of factors including, but not limited to, the following:
* | We depend on the operating success of our tenants and borrowers for collection of our lease and note payments; |
* | We depend on the success of property development and construction activities, which may fail to achieve the operating results we expect; |
* | We are exposed to the risk that our tenants and borrowers may become subject to bankruptcy or insolvency proceedings; |
* | Certain tenants in our portfolio account for a significant percentage of the rent we expect to generate from our portfolio, and the failure of any of these tenants to meet their obligations to us could materially and adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders. |
* | We are exposed to the risk that the illiquidity of real estate investments could impede our ability to respond to adverse changes in the performance of our properties; |
* | We are exposed to risks related to governmental regulations and payors, principally Medicare and Medicaid, and the effect that lower reimbursement rates would have on our tenants’ and borrowers’ business; |
* | Legislative, regulatory, or administrative changes could adversely affect us or our security holders. |
* | We are exposed to the risk that the cash flows of our tenants and borrowers would be adversely affected by increased liability claims and liability insurance costs; |
* | We are exposed to risks related to environmental laws and the costs associated with liabilities related to hazardous substances; |
* | We are exposed to the risk that we may not be fully indemnified by our lessees and borrowers against future litigation; |
* | We depend on the success of our future acquisitions and investments; |
* | We depend on our ability to reinvest cash in real estate investments in a timely manner and on acceptable terms; |
* | We may need to refinance existing debt or incur additional debt in the future, which may not be available on terms acceptable to us; |
* | We have covenants related to our indebtedness which impose certain operational limitations and a breach of those covenants could materially adversely affect our financial condition and results of operations; |
* | When interest rates increase, our common stock may decline in price; |
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* | We depend on revenues derived mainly from fixed rate investments in real estate assets, while a portion of our debt capital used to finance those investments bears interest at variable rates; |
* | We are exposed to the risk that our assets may be subject to impairment charges; |
* | We depend on the ability to continue to qualify for taxation as a Real Estate Investment Trust; |
* | Complying with REIT requirements may cause us to forego otherwise attractive acquisition opportunities or liquidate otherwise attractive investments, which could materially hinder our performance; |
* | We have ownership limits in our charter with respect to our common stock and other classes of capital stock which may delay, defer or prevent a transaction or a change of control that might involve a premium price for our common stock or might otherwise be in the best interests of our stockholders; |
* | We are subject to certain provisions of Maryland law and our charter and bylaws that could hinder, delay or prevent a change in control transaction, even if the transaction involves a premium price for our common stock or our stockholders believe such transaction to be otherwise in their best interests. |
* | If our efforts to maintain the privacy and security of Company information are not successful, we could incur substantial costs and reputational damage, and could become subject to litigation and enforcement actions. |
See the notes to the annual audited consolidated financial statements, and “Business” and “Risk Factors” under Item 1 and Item 1A therein for a further discussion of these and of various governmental regulations and other operating factors relating to the healthcare industry and the risk factors inherent in them. You should carefully consider these risks before making any investment decisions in the Company. These risks and uncertainties are not the only ones we face. There may be additional risks that we do not presently know of or that we currently deem immaterial. If any of the risks actually occur, our business, financial condition, results of operations, or cash flows could be materially adversely affected. In that case, the trading price of our shares of stock could decline and you may lose part or all of your investment. Given these risks and uncertainties, we can give no assurance that these forward-looking statements will, in fact, occur and, therefore, caution investors not to place undue reliance on them.
ITEM 1. BUSINESS
General
National Health Investors, Inc., established in 1991 as a Maryland corporation, is a self-managed real estate investment trust (“REIT”) specializing in sale-leaseback, joint-venture, mortgage and mezzanine financing of need-driven and discretionary senior housing and medical investments. Our portfolio consists of lease, mortgage and other note investments in independent living facilities, assisted living facilities, entrance-fee communities, senior living campuses, skilled nursing facilities, specialty hospitals and medical office buildings. Other investments have included marketable securities and, until 2016, a joint venture structured to comply with the provisions of the REIT Investment Diversification Empowerment Act of 2007 (“RIDEA”) through which we invested in facility operations managed by an independent third-party. We have funded our real estate investments primarily through: (1) operating cash flow, (2) debt offerings, including bank lines of credit and term debt, both unsecured and secured, and (3) the sale of equity securities.
At December 31, 2018, we had investments in real estate, mortgage and other notes receivable involving 232 facilities located in 33 states. These investments involve 151 senior housing properties, 76 skilled nursing facilities, 3 hospitals, 2 medical office buildings and other notes receivable. These investments (excluding our corporate office of $2,471,000) consisted of properties with an original cost of $2,815,894,000, rented under triple-net leases to 30 lessees, and $246,111,000 aggregate carrying value of mortgage and other notes receivable due from 10 borrowers.
Our investments in real estate and mortgage loans are secured by real estate located within the United States. We are managed as one reporting unit, rather than multiple reporting units, for internal reporting purposes and for internal decision making. Therefore, we have concluded that we operate as a single segment. Information about revenues from our tenants and borrowers, our net income, cash flows and balance sheet can be found in Item 8 of this Form 10-K.
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Classification of Properties in our Portfolio
Senior Housing
As of December 31, 2018, our portfolio included 143 senior housing properties (“SHO”) leased to operators and mortgage loans secured by 8 SHOs. The SHOs in our portfolio are either need-driven or discretionary for end users and consist of independent living facilities, assisted living facilities, senior living campuses, and entrance-fee communities which are more fully described below.
Need-Driven Senior Housing
Assisted Living Facilities. As of December 31, 2018, our portfolio included 93 assisted living facilities (“ALF”) leased to operators and mortgage loans secured by 6 ALFs. ALFs are free-standing facilities that provide basic room and board functions for elderly residents. As residents typically receive assistance with activities of daily living such as bathing, grooming, administering medication and memory care services, we consider these facilities to be need-driven senior housing. On-site staff personnel are available to assist in minor medical needs on an as-needed basis. Operators of ALFs are typically paid from private sources without assistance from government. ALFs may be licensed and regulated in some states, but generally do not require the issuance of a Certificate of Need (“CON”) as required for skilled nursing facilities.
Senior Living Campuses. As of December 31, 2018, our portfolio included 10 senior living campuses (“SLC”) leased to operators. SLCs contain one or more buildings that include skilled nursing beds combined with an independent or assisted living facility that provides basic room and board functions for elderly residents. They may also provide assistance to residents with activities of daily living such as bathing, grooming and administering medication. On-site staff personnel are available to assist in minor medical needs on an as-needed basis. As the decision to transition to a senior living campus is typically more than a lifestyle choice and is usually driven by the need to receive some moderate level of care, we consider this facility type to be need-driven. Operators of SLCs are typically paid from private sources and from government programs such as Medicare and Medicaid for skilled nursing residents.
Discretionary Senior Housing
Independent Living Facilities. As of December 31, 2018, our portfolio included 30 independent living facilities (“ILF”) leased to operators. ILFs offer specially designed residential units for active senior adults and provide various ancillary services for their residents including restaurants, activity rooms and social areas. Services provided by ILF operators are generally paid from private sources without assistance from government payors. ILFs may be licensed and regulated in some states, but generally do not require the issuance of a CON as required for skilled nursing facilities. As ILFs typically do not provide assistance with activities of daily living, we consider the decision to transition to an ILF facility to be discretionary.
Entrance-Fee Communities. As of December 31, 2018, our portfolio included 10 entrance-fee communities (“EFC”) leased to operators and two mortgage loans secured by EFCs. Entrance-fee communities, frequently referred to as continuing care retirement communities, or CCRCs, typically include a combination of detached cottages, an independent living facility, an assisted living facility and a skilled nursing facility on one campus. These communities appeal to residents because there is no need to relocate when health and medical needs change. EFCs are classified as either Type A, B, or C depending upon the amount of healthcare benefits included in the entrance fee. “Type A” EFCs, or “Lifecare” communities, include substantially all future healthcare costs. Communities providing a modified healthcare contract offering access to skilled nursing care but only paying for a maximum number of days are referred to as “Type B” EFCs. Finally, “Type C” EFCs, the type in our lease portfolio, are fee-for-service communities which do not provide any healthcare benefits and correspondingly have the lowest entrance fees. However, monthly fees may be higher to reflect the current healthcare components delivered to each resident. EFC licensure is state-specific, but generally the skilled nursing beds included in our EFC portfolio are subject to state licensure and regulation. As the decision to transition to an EFC is typically made as a lifestyle choice and not as the result of a pressing medical concern, we consider the decision to transition to an EFC to be discretionary. Accordingly, the predominant source of revenue for operators of EFCs is from private payor sources.
Medical
As of December 31, 2018, our portfolio included 77 medical facilities leased to operators and mortgage loans secured by 4 medical facilities. The medical facilities within our portfolio consist of skilled nursing facilities, hospitals and medical office buildings, which are more fully described below.
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Skilled Nursing Facilities. As of December 31, 2018, our portfolio included 72 skilled nursing facilities (“SNF”) leased to operators and mortgage loans secured by 4 SNFs. SNFs provide some combination of skilled and intermediate nursing and rehabilitative care, including speech, physical and occupational therapy. As the decision to utilize the services of a SNF is typically made as the result of a pressing medical concern, we consider this to be a need-driven medical facility. The operators of the SNFs receive payment from a combination of private pay sources and government payors such as Medicaid and Medicare. SNFs are required to obtain state licenses and are highly regulated at the federal, state and local level. Most SNFs must obtain a CON from the state before opening or expanding such facilities. Some SNFs also include assisted living beds.
Hospitals. As of December 31, 2018, our portfolio included 3 hospitals (“HOSP”) leased to operators. Hospitals provide a wide range of inpatient and outpatient services, including acute psychiatric and rehabilitation services, and are subject to extensive federal, state and local legislation and regulation. Hospitals undergo periodic inspections regarding standards of medical care, equipment and hygiene as a condition of licensure. Services provided by hospitals are generally paid for by a combination of private pay sources and government payors. As the decision to utilize the services of a hospital is typically made as the result of a pressing medical concern, we consider this to be a need-driven medical facility.
Medical Office Buildings. As of December 31, 2018, our portfolio included 2 medical office buildings (“MOB”) leased to operators. MOBs are specifically configured office buildings whose tenants are primarily physicians and other medical practitioners. As the decision to utilize the services of an MOB is typically made as a the result of a pressing medical concern, we consider this to be a need-driven medical facility. MOBs differ from conventional office buildings due to the special requirements of the tenants. Each of our MOBs is leased to one lessee and is either physically attached to or located on an acute care hospital campus. The lessee sub-leases individual office space to the physicians or other medical practitioners. The lessee is responsible to us for the lease obligations of the entire building, regardless of their ability to sub-lease the individual office space.
Nature of Investments
Our investments are typically structured as acquisitions of properties through purchase-leaseback transactions, acquisitions of properties from other real estate investors, loans or operations through structures allowed by RIDEA. We have provided construction loans for facilities for which we were already committed to provide long-term financing or for which the operator agreed to enter into a purchase option and lease with us upon completion of construction or after the facility is stabilized. The annual lease rates on our leases and the annual interest rates on our mortgage, construction and mezzanine loans ranged between 6.75% and 10% during 2018. We believe our lease and loan terms are competitive within our peer group. Typical characteristics of these transactions are as follows:
Leases. Our leases generally have an initial leasehold term of 10 to 15 years with one or more 5-year tenant renewal options. The leases are “triple net leases” under which the tenant is responsible for the payment of all taxes, utilities, insurance premiums, repairs and other charges relating to the operation of the properties, including required levels of capital expenditures each year. The tenant is obligated at its expense to keep all improvements, fixtures and other components of the properties covered by “all risk” insurance in an amount equal to at least the full replacement cost thereof, and to maintain specified minimal personal injury and property damage insurance, protecting us as well as the tenant. The leases also require the tenant to indemnify and hold us harmless from all claims resulting from the use, occupancy and related activities of each property by the tenant, and to indemnify us against all costs related to any release, discovery, clean-up and removal of hazardous substances or materials, or other environmental responsibility with respect to each facility.
Most of our existing leases contain annual escalators in rent payments. For financial statement purposes, rental income is recognized on a straight-line basis over the term of the lease where the lease contains fixed escalators. Certain of our operators hold purchase options allowing them to acquire properties they currently lease from NHI. When present, tenant purchase options generally give the lessee an option to purchase the underlying property for consideration determined by i) a sliding base dependent upon the extent of appreciation in the property plus a specified proportion of any appreciation; ii) our acquisition costs plus a specified proportion of any appreciation; iii) an agreed capitalization rate applied to the current rental; or iv) our acquisition costs plus a profit floor plus a specified proportion of any appreciation. Where stipulated above, appreciation may be established by independent appraisal.
Some of the obligations under the leases are guaranteed by the parent corporation of the lessee, if any, or affiliates or individual principals of the lessee. In some leases, the third-party operator will also guarantee some portion of the lease obligations. Some obligations are backed further by other collateral such as security deposits, equipment, furnishings and other personal property.
We monitor our triple-net lessee tenant credit quality and identify any material changes by performing the following activities:
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• | Obtaining financial statements on a monthly, quarterly and annual basis to assess the operational trends of our tenants and the financial position and capability of those tenants |
• | Calculating the operating cash flow for each of our tenants |
• | Calculating the lease service coverage ratio and other ratios pertinent to our tenants |
• | Obtaining property-level occupancy rates for our tenants |
• | Verifying the payment of real estate taxes by our tenants |
• | Obtaining certificates of insurance for each tenant |
• | Obtaining financial statements of our lessee guarantors on an annual basis |
• | Conducting a periodic inspection of our properties to ascertain proper maintenance, repair and upkeep |
• | Monitoring those tenants with indications of continuing and material deteriorating credit quality through discussions with our executive management and Board of Directors |
RIDEA Transactions. Our arrangement with an affiliate of Bickford Senior Living (“Bickford”) was structured to be compliant with the provisions of RIDEA which permitted NHI to receive rent payments through a triple-net lease between a property company and an operating company and gave NHI the opportunity to capture additional value on the improving performance of the operating company through distributions to a Taxable REIT Subsidiary (“TRS”). Accordingly, the TRS held our 85% equity interest in an unconsolidated operating company, which we did not control, and provided an organizational structure that allowed the TRS to engage in a broad range of activities and share in revenues that would otherwise be non-qualifying income under the REIT gross income tests. The TRS is subject to state and federal income taxes. Our RIDEA arrangement ended on September 30, 2016, upon mutual agreement for NHI and Bickford to convert the buildings in the RIDEA to a traditional triple-net lease structure.
Mortgage loans. We have first mortgage loans with maturities of at least 5 years from inception, with varying amortization schedules from interest-only to fully-amortizing. Most of the loans are at a fixed interest rate; however, some interest rates increase based on a fixed schedule. In most cases, the owner of the facility is committed to make minimum annual capital expenditures for the purpose of maintaining or upgrading their respective facility. Additionally, most of our loans are collateralized by first mortgage liens and corporate or personal guarantees. Currently, our first mortgage loans carry interest rates which range from 6.75% to 9%.
We have made mortgage loans to borrowers secured by a second deed-of-trust where there is a process in place for the borrower to obtain long-term financing, primarily with a U.S. government agency, and where the historical financial performance of the underlying facility meets our loan underwriting criteria.
Mezzanine loans. Frequently in situations calling for temporary financing or when our borrowers’ in-place lending arrangements prohibit the extension of first mortgage security, we typically accept a second mortgage position or extend credit based on corporate and/or personal guarantees. These mezzanine loans often combine with an NHI purchase option covering the subject property. Our mezzanine loans currently carry an interest rate of 10%.
Construction loans. From time to time, we also provide construction loans that convert to mortgage loans upon the completion of the construction of the subject facility. We may also obtain a purchase option to acquire the facility at a future date and lease the facility back to the operator. During the term of the construction loan, funds are usually advanced pursuant to draw requests made by the borrower in accordance with the terms and conditions of the loan. Interest is typically assessed on these loans at rates equivalent to the eventual mortgage rate upon conversion. In addition to the security of the lien against the property, we will generally require additional security and collateral in the form of either payment and performance completion bonds or completion guarantees by the borrower’s parent, affiliates of the borrower or one or more of the individuals who control the borrower. We currently have construction loans bearing interest ranging from 6.75% to 9%.
Other notes receivable. We have provided a revolving credit facility to a borrower whose business is to provide bridge loans to owner-operators who are qualifying for long-term HUD financing secured by real estate. Our interest rate on the credit facility is 10%. We have provided loans to borrowers involved in the skilled nursing and senior housing industries who have pledged personal and business guarantees as security for the loans. The interest rates on these loans typically range from 8.25% to 10%.
Investment in marketable securities. From time to time we have invested a portion of our funds in various marketable securities with quoted market prices, including the common shares of other publicly-held REITs. We classify these highly-liquid securities as available-for-sale and carry the investments at their then quoted fair market value at the balance sheet date. We may choose to liquidate these investments to invest the proceeds into real estate assets. We currently have no investments in marketable securities.
Competition and Market Conditions
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We compete primarily with other REITs, private equity funds, banks and insurance companies in the acquisition, leasing and financing of health care real estate.
Operators of our facilities compete on a local and regional basis with operators of facilities that provide comparable services. Operators compete for residents and/or patients and staff based on quality of care, reputation, physical appearance of facilities, services offered, family preference, physicians, staff and price. Competition is with other operators as well as companies managing multiple facilities, some of which are substantially larger and have greater resources than the operators of our facilities. Some of these facilities are operated for profit, while others are owned by governmental agencies or tax exempt not-for-profit entities.
The SNFs which either secure our mortgage loans or we lease to third-party operators receive the majority of their revenues from Medicare, Medicaid and other government payors. From time to time, these facilities have experienced revenue reductions brought about by the enactment of legislation to reduce government costs. In particular, the establishment of a Medicare Prospective Payment System (“PPS”) for SNF services, to replace the cost-based reimbursement system, significantly reduced Medicare reimbursement to SNF providers. While Congress subsequently took steps to mitigate the impact of PPS on SNFs, other federal legislative policies have been adopted and continue to be proposed that would reduce the growth rate of Medicare and/or Medicaid payments to SNFs. Effective October 1, 2019, a Patient Driven Payment Model (PDPM) was adopted as a case-mix system for classifying patient information payment groups under PPS. State Medicaid funding is not expected to keep pace with inflation according to industry studies. Any changes in government reimbursement methodology that reduce reimbursement to levels that are insufficient to cover the operating costs of our lessees and borrowers could indirectly and adversely impact us.
Our senior housing properties generally rely on private-pay residents who may be negatively impacted in an economic downturn. For example, a resident may intend to sell his or her house in order to afford the cost of residing in an ILF or ALF. In addition, the success of these properties is often impacted by the existence of comparable, competing facilities in a local market.
Operator Diversification
For the year ended December 31, 2018, approximately 25% of our portfolio revenue was from publicly-owned operators, 56% was from regional operators, 17% from privately owned national chains which are privately owned and 2% was from smaller operators. We consider the creditworthiness of the operator to be an important factor in underwriting the lease or loan investment, and we generally have the right to approve any changes in operators.
For the year ended December 31, 2018, tenants which provided more than 3% of our total revenues were (in alphabetical order): Bickford Senior Living; Chancellor Health Care; The Ensign Group; Health Services Management; Holiday Retirement; National HealthCare Corporation; and Senior Living Communities. We will make reference to the parent company whenever we describe our business with these tenants, their subsidiaries and/or affiliates.
Major Customers
We have four operators, Holiday Retirement (“Holiday”), Senior Living Communities, LLC (“Senior Living”), National HealthCare Corporation (“NHC”) and Bickford, from whom we individually derive at least 10% of our total revenues, and 62% collectively.
Holiday
As of December 31, 2018, we leased 25 independent living facilities to an affiliate of Holiday. The 17-year master lease began in December 2013 and provided for a minimum escalator of 3.5% after 2017. Of our total revenues, $43,311,000 (15%), $43,817,000 (16%) and $43,817,000 (18%) were derived from Holiday for the years ended December 31, 2018, 2017 and 2016, respectively, including $5,616,000, $7,397,000 and $8,965,000 in straight-line rent, respectively. Our tenant operates the facilities pursuant to a management agreement with a Holiday-affiliated manager.
On November 5, 2018, we executed an Amendment to Master Lease and Termination of Guaranty with Holiday that significantly altered the master lease and extended its maturity to December 31, 2035. Apart from certain credit enhancements provided by our tenant, we agreed to decrease the annual rent under the existing master lease from approximately $39,000,000 scheduled in 2019 to $31,500,000 for the 25 facilities under the lease effective January 1, 2019. Annual lease escalators will go into effect on November 1, 2020 with a floor of 2% and a ceiling of 3%, such lease being secured by one-half of the original cash deposit of $21,275,000, with the other half of the deposit, or $10,637,000, being released to NHI. Further modifications of the existing master lease with NHI called for cash or a combination of cash and real estate equaling $55,125,000, at NHI’s option in 2019, for total consideration of $65,762,000. Accordingly, on January 31, 2019, we acquired a facility from Holiday in Vero Beach, Florida at a cost of
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$38,000,000 with a first year lease amount of $2,550,000 plus annual escalators as described above. Holiday settled the remaining payable to NHI with cash of $17,125,000 at closing.
Senior Living Communities
As of December 31, 2018, we leased nine retirement communities to Senior Living Communities (“Senior Living”) totaling 1,970 units under a 15-year master lease which began in December 2014, contains two 5-year renewal options and provides for an annual escalator of 4% in 2018 and 3% thereafter.
Of our total revenues, $45,868,000 (16%), $45,735,000 (16%) and $40,332,000 (16%) were derived from the Senior Living lease for the years ending December 31, 2018, 2017 and 2016, respectively, including $5,436,000, $6,984,000 and $7,369,000, respectively, in straight-line rent.
In December 2014, we provided a $15,000,000 revolving line of credit to Senior Living, the maturity of which mirrors the term of the master lease, but subject to reduction to $5,000,000 in 2019 and going forward. Borrowings are used primarily to finance construction projects within the Senior Living portfolio, including building additional units. Amounts outstanding under the facility, $1,900,000 at December 31, 2018, bear interest at an annual rate equal to the 10-year U.S. Treasury rate, 2.69% at December 31, 2018, plus 6%.
In March 2016, we extended two mezzanine loans of up to $12,000,000 and $2,000,000, respectively, to affiliates of Senior Living, to partially fund construction of a 186-unit senior living campus on Daniel Island in South Carolina. The loans bear interest payable monthly at a 10% annual rate and mature in March 2021. The loans were fully drawn as of December 31, 2018, and provide NHI with a purchase option on the campus upon its meeting certain operational metrics. The option is to remain open during the term of the loans, plus any extensions.
NHC
We lease 42 facilities to NHC comprised 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 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. Under the terms of the 1991 lease, base annual rental of $30,750,000 escalates by 4% of the increase, if any, in each facility’s revenue over a 2007 base year. Similarly, the 2013 lease provides for base annual rental of $3,450,000 plus percentage rent equal to 4% of the increase, if any, in each facility’s annual patient housing revenue over a 2014 base year. The NHC escalator is contingent upon future facility revenue increases and therefore does not give rise to straight-line revenues.
Of our total revenues, $37,843,000 (13%), $37,467,000 (13%) and $37,626,000 (15%) in 2018, 2017 and 2016, respectively, were derived from NHC.
NHC owned 1,630,462 shares of our common stock at December 31, 2018. The chairman of our board of directors is also a director on NHC’s board.
Bickford
As of December 31, 2018 our Bickford lease portfolio is structured as follows (in thousands):
June 2023 | September 2024 | September 2027 | May 2031 | April 2033 | Total | |||||||||||||
Number of Properties | 13 | 10 | 4 | 20 | 5 | 52 | ||||||||||||
2018 Annual Contractual Rent | $ | 11,133 | $ | 9,264 | $ | 1,515 | $ | 19,988 | $ | 3,165 | $ | 45,065 | ||||||
Straight Line Rent Adjustment | 588 | (260 | ) | 221 | 3,865 | 614 | 5,028 | |||||||||||
Total Revenues | $ | 11,721 | $ | 9,004 | $ | 1,736 | $ | 23,853 | $ | 3,779 | $ | 50,093 | ||||||
On April 30, 2018, we acquired an assisted living/memory-care portfolio in Ohio and Pennsylvania totaling 320 units and comprising five facilities, one of which is subject to a ground lease with remaining term, including extensions, of 50 years. The purchase price was $69,750,000, inclusive of $500,000 in closing costs and $1,750,000 in specified capital improvements, which
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will be added to the lease base upon funding. We included this portfolio in a separate master lease with Bickford which provides for a lease rate of 6.85%, with annual fixed escalators over a term of 15 years plus renewal options, subject to a fair market value rent reset feature available to NHI between years three and five.
Of our total revenues, $50,093,000 (17%), $41,606,000 (15%) and $30,732,000 (12%) were recognized as rental income from Bickford for the years ended December 31, 2018, 2017 and 2016, including $5,028,000, $5,102,000, and $858,000 in straight-line rent income, respectively.
At December 31, 2018, our ALF construction loans to Bickford are summarized as follows:
Commencement | Rate | Maturity | Commitment | Drawn | Location | |||||||||
July 2016 | 9% | 5 years | $ | 14,000,000 | $ | (13,047,000 | ) | Illinois | ||||||
January 2017 | 9% | 5 years | 14,000,000 | (11,931,000 | ) | Michigan | ||||||||
January 2018 | 9% | 5 years | 14,000,000 | (4,515,000 | ) | Virginia | ||||||||
July 2018 | 9% | 5 years | 14,700,000 | (2,978,000 | ) | Michigan | ||||||||
$ | 56,700,000 | $ | (32,471,000 | ) | ||||||||||
The promissory notes are secured by first mortgage liens on substantially all real and personal property as well as a pledge of any and all leases or agreements which may grant a right of use to the subject property. Usual and customary covenants extend to the agreements, including the borrower’s obligation for payment of insurance and taxes. NHI has a purchase option on the properties at stabilization, whereby annual rent will be set with a floor of 9.55%, based on NHI’s total investment, plus fixed annual escalators.
Commitments and Contingencies
The following tables summarize information as of December 31, 2018 related to our outstanding commitments and contingencies which are more fully described in the notes to the consolidated financial statements, included herein.
Asset Class | Type | Total | Funded | Remaining | |||||||||||
Loan Commitments: | |||||||||||||||
LCS Sagewood Note A | SHO | Construction | $ | 118,800,000 | $ | (76,653,000 | ) | $ | 42,147,000 | ||||||
LCS Sagewood Note B | SHO | Construction | 61,200,000 | (10,165,000 | ) | 51,035,000 | |||||||||
LCS Timber Ridge Note A | SHO | Construction | 60,000,000 | (58,158,000 | ) | 1,842,000 | |||||||||
Bickford Senior Living | SHO | Construction | 56,700,000 | (32,471,000 | ) | 24,229,000 | |||||||||
Senior Living Communities | SHO | Revolving Credit | 15,000,000 | (1,900,000 | ) | 13,100,000 | |||||||||
$ | 311,700,000 | $ | (179,347,000 | ) | $ | 132,353,000 | |||||||||
Asset Class | Type | Total | Funded | Remaining | |||||||||||
Development Commitments: | |||||||||||||||
Ignite Medical Resorts | SNF | Construction | 25,350,000 | (4,674,000 | ) | 20,676,000 | |||||||||
Woodland Village | SHO | Renovation | 7,450,000 | (6,867,000 | ) | 583,000 | |||||||||
Senior Living Communities | SHO | Renovation | 6,830,000 | (4,772,000 | ) | 2,058,000 | |||||||||
Bickford Senior Living | SHO | Renovation | 1,750,000 | (1,597,000 | ) | 153,000 | |||||||||
Navion Senior Solutions | SHO | Construction | 650,000 | — | 650,000 | ||||||||||
Discovery Senior Living | SHO | Renovation | 500,000 | (289,000 | ) | 211,000 | |||||||||
$ | 42,530,000 | $ | (18,199,000 | ) | $ | 24,331,000 | |||||||||
Asset Class | Type | Total | Funded | Remaining | |||||||||||
Contingencies: | |||||||||||||||
Bickford Senior Living | SHO | Lease Inducement | $ | 10,000,000 | $ | (7,500,000 | ) | $ | 2,500,000 | ||||||
Bickford Senior Living | SHO | Incentive Loan Draws | 8,000,000 | (250,000 | ) | 7,750,000 | |||||||||
Navion Senior Solutions | SHO | Lease Inducement | 4,850,000 | — | 4,850,000 | ||||||||||
Ignite Medical Resorts | SNF | Lease Inducement | 2,000,000 | — | 2,000,000 | ||||||||||
$ | 24,850,000 | $ | (7,750,000 | ) | $ | 17,100,000 | |||||||||
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Sources of Revenues
General. Our revenues are derived primarily from rental income, mortgage and other note interest income and income from our other investments, substantially all of which were in marketable securities, including the common stock of other healthcare REITs. During 2018, rental income was $280,813,000 (95.3%), interest income from mortgages and other notes was $13,220,000 (4.6%) and other income was $579,000 (0.1%) of total revenue of $294,612,000, an increase of 5.7% over 2017. Our revenues depend on the operating success of our tenants and borrowers whose source and amount of revenues are determined by (i) the licensed beds or other capacity of the facility, (ii) their occupancy rate, (iii) the extent to which the services provided at each facility are utilized by the residents and patients, (iv) the mix of private pay, Medicare and Medicaid patients, and (v) the rates paid by private payors and by the Medicare and Medicaid programs.
Government Regulation
Medicare and Medicaid. A significant portion of the revenue of our SNF lessees and borrowers is derived from government funded reimbursement programs, such as Medicare and Medicaid. Reimbursement under these programs is subject to periodic payment review and other audits by federal and state authorities. Medicare is uniform nationwide and reimburses skilled nursing facilities under PPS which is based on a predetermined, fixed amount. PPS is an acuity based classification system that uses nursing and therapy indexes adjusted by geographical wage indexes to calculate per diem rates for each Medicare patient. Payment rates are updated annually and are generally adjusted each October when the federal fiscal year begins. The current acuity classification system is named Resource Utilization Groups IV (“RUGs IV”) and was effective October 1, 2010. Federal legislative policies have been adopted and continue to be proposed that would provide small increases in annual Medicare payments to skilled nursing facilities. For example, the Centers for Medicare and Medicaid Services (“CMS”) announced the Skilled Nursing Facilities – PPS final rule for fiscal year 2019 which increased Medicare payments to SNF operators by only 2.4% beginning October 1, 2018.
Most notably, the new Patient Driven Payment Model (“PDPM”), which will replace the existing RUGs IV model beginning in FY 2020 (effective October 1, 2019), focuses on a resident’s clinical condition and care needs, rather than the volume of care provided. PDPM is characterized as a value-based, unified post-acute care payment system that prioritizes the unique care needs of patients and reduces the administrative burden associated with the system. PDPM is a case-mix classifications system for classifying SNF patients in a Medicare Part A covered stay into payment groups under the SNF PPS.
Medicaid is a joint federal and state program designed to provide medical assistance to “eligible needy persons.” Medicaid programs are operated by state agencies that adopt their own medical reimbursement methodology and standards. Payment rates and covered services vary from state to state. In many instances, revenues from Medicaid programs are insufficient to cover the actual costs incurred in providing care to those patients. With regard to Medicaid payment increases to skilled nursing operators, changes in federal funding coupled with state budget problems have produced uncertainty. States will more than likely be unable to keep pace with SNF inflation. States are under pressure to pursue other alternatives to long term care such as community and home-based services. Furthermore, several of the states in which we have investments have actively sought to reduce or slow the increase of Medicaid spending for SNF care.
Medicare and Medicaid programs are highly regulated and subject to frequent and substantial changes resulting from legislation, adoption of rules and regulations and administrative and judicial interpretations of existing law. Moreover, as health care facilities have experienced increasing pressure from private payors attempting to control health care costs, reimbursement from private payors has in many cases effectively been reduced to levels approaching those of government payors. Healthcare reimbursement will likely continue to be of significant importance to federal and state programs. We cannot make any assessment as to the ultimate timing or the effect that any future legislative reforms may have on our lessees’ and borrowers’ costs of doing business and on the amount of reimbursement by government and other third-party payors. There can be no assurance that future payment rates for either government or private payors will be sufficient to cover cost increases in providing services to patients. Any changes in government or private payor reimbursement policies which reduce payments to levels that are insufficient to cover the cost of providing patient care could adversely affect the operating revenues of tenants and borrowers in our properties that rely on such payments, and thereby adversely affect their ability to make their lease or debt payments to us.
Licensure and Certification. The health care industry is highly regulated by federal, state and local law and is directly affected by state and local licensing requirements, facility inspections, state and federal reimbursement policies, regulations concerning capital and other expenditures, certification requirements and other such laws, regulations and rules. Sanctions for failure to comply with these regulations and laws include (but are not limited to) loss of licensure, fines and loss of certification to participate in the Medicare and Medicaid programs, as well as potential criminal penalties. The failure of any tenant or borrower to comply with such laws, requirements and regulations could affect their ability to operate the facility or facilities and could adversely affect such tenant’s or borrower’s ability to make lease or debt payments to us.
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In the past several years, due to rising health care costs, there has been an increased emphasis on detecting and eliminating fraud and abuse in the Medicare and Medicaid programs. Payment of any consideration in exchange for referral of Medicare and Medicaid patients is generally prohibited by federal statute, which subjects violators to severe penalties, including exclusion from the Medicare and Medicaid programs, fines and even prison sentences. In recent years, both federal and state governments have significantly increased investigation and enforcement activity to detect and punish wrongdoers. In addition, legislation has been adopted at both state and federal levels which severely restrict the ability of physicians to refer patients to entities in which they have a financial interest.
It is anticipated that the trend toward increased investigation and enforcement activity in the area of fraud and abuse, as well as self-referral, will continue in future years. Certain of our investments are with lessees or borrowers which are partially or wholly owned by physicians. In the event that any lessee or borrower were to be found in violation of laws regarding fraud and abuse or self-referral, that lessee’s or borrower’s ability to operate the facility could be jeopardized, which could adversely affect the lessee’s or borrower’s ability to make lease or debt payments to us and could thereby adversely affect us.
Certificates of Need . The SNFs and hospitals in which we invest are also generally subject to state statutes which may require regulatory approval in the form of a CON prior to the construction or expansion of facilities to accommodate new beds (or addition of new beds to existing facilities), the addition of services or certain capital expenditures. CON requirements are not uniform throughout the United States and are subject to change. We cannot predict the impact of regulatory changes with respect to CONs on the operations of our lessees and borrowers; however, in our primary market areas, a significant reduction in new construction of long-term care beds has occurred.
Investment Policies
Our investment objectives are (i) to provide consistent and growing current income for distribution to our stockholders through investments primarily in health care related facilities or in the operations thereof through independent third-party management, (ii) to provide the opportunity to realize capital growth resulting from appreciation, if any, in the residual value of our portfolio properties, and (iii) to preserve and protect stockholders’ capital through a balance of diversity, flexibility and liquidity. There can be no assurance that these objectives will be realized. Our investment policies include making investments in real estate, mortgage and other notes receivable, marketable securities (including the common stock of other REITs) and joint ventures structured to comply with the provisions of RIDEA.
During 2018, we made commitments to fund new investments in real estate and loans totaling approximately $364,344,000. In making new investments, we consider such factors as (i) the geographic area and type of property, (ii) the location, construction quality, condition and design of the property, (iii) the current and anticipated cash flow and its adequacy to meet operational needs, and lease or mortgage obligations to provide a competitive income return to our investors, (iv) the growth, tax and regulatory environments of the communities in which the properties are located, (v) occupancy and demand for similar facilities in the same or nearby communities, (vi) the quality, experience and creditworthiness of the management operating the facilities located on the property and (vii) the mix of private and government-sponsored residents. There can be no assurances that investments meeting our standards regarding these attributes will be found or closed.
We will not, without the approval of a majority of the Board of Directors and review of a committee comprised of independent directors, enter into any joint venture relationships with or acquire from or sell to any director, officer or employee of NHI, or any affiliate thereof, as the case may be, any of our assets or other property.
The Board of Directors, without the approval of the stockholders, may alter our investment policies if it determines that such a change is in our best interests and our stockholders’ best interests. The methods of implementing our investment policies may vary as new investment and financing techniques are developed or for other reasons. Management may recommend changes in investment criteria from time to time.
Future investments in healthcare related facilities may utilize borrowed funds or issuance of equity when it is advisable in the opinion of the Board of Directors. We may negotiate lines of credit or arrange for other short or long-term borrowings from lenders. We may arrange for long-term borrowings from institutional investors or through public offerings. We have previously invested, and may in the future invest, in properties subject to existing loans or secured by mortgages, deeds of trust or similar liens with favorable terms or in mortgage investment pools.
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Executive Officers of the Company
The table below sets forth the name, position and age of each of our executive officers. Each executive officer is appointed by the Board of Directors, serves at its pleasure and holds office for a term of one year. There is no “family relationship” among any of the named executive officers or with any director. All information is given as of February 15, 2019:
Name | Position | Age |
Eric Mendelsohn | President and Chief Executive Officer | 57 |
Roger R. Hopkins | Chief Accounting Officer | 57 |
Kristin S. Gaines | Chief Credit Officer | 47 |
Kevin Pascoe | Chief Investment Officer | 38 |
John Spaid | Executive Vice President Finance | 59 |
Eric Mendelsohn joined NHI in January 2015. He has over 15 years of healthcare real estate and financing experience. Previously, Mr. Mendelsohn was with Emeritus Senior Living for 9 years, most recently as a Senior Vice President of Corporate Development where he was responsible for the financing and acquisition of assisted living properties, home health care companies, administration of joint venture relationships and executing corporate finance strategies. Prior to Emeritus, he was with the University of Washington as a Transaction Officer where he worked on the development, acquisition and financing of research, clinical and medical properties and has been a practicing transaction attorney, representing lenders and landlords. Mr. Mendelsohn holds a Bachelor of Science from American University in International Relations, a Law Degree from Pepperdine University, and a Masters (LLM) in Banking and Finance from Boston University. Mr. Mendelsohn is a member of the Florida and Washington State Bar Associations.
Roger R. Hopkins joined the former management advisor of NHI in July 2006 and was named Chief Accounting Officer for NHI in December 2006. With over 35 years of combined financial experience in public accounting and the real estate industry, he positioned companies to access public and private capital markets for equity and debt. Mr. Hopkins is responsible for the development of financial and tax strategies, reporting metrics, supplemental data reports and NHI’s internal control system. He has accounted for significant acquisitions and financings by NHI, including the successful executions of convertible debt and follow-on equity offerings, private debt placements and bank financing arrangements. Mr. Hopkins was an Audit Partner in the Nashville office of Rodefer Moss & Co, a regional accounting firm with eight offices in Tennessee, Indiana and Kentucky, where he brought extensive experience in SEC filing requirements and compliance issues. He was previously a Senior Manager in the Nashville office of Deloitte. Mr. Hopkins received his Bachelor of Science in Accounting from Tennessee Technological University in 1982 and is a CPA licensed in Tennessee.
Kristin S. Gaines was appointed NHI’s Chief Credit Officer in February 2010. She joined NHI in 1998 as a Credit Analyst. During her tenure with NHI, Ms. Gaines has had a progressive career in the areas of finance and operations. Her experience has resulted in a breadth of expertise in underwriting, portfolio oversight and real estate finance. Ms. Gaines holds an MBA and a Bachelor of Business Administration in Accounting from Middle Tennessee State University.
Kevin Pascoe joined NHI in June 2010. Mr. Pascoe oversees NHI’s portfolio of assets, relationship management with existing tenants and conducts operational due diligence on NHI’s existing investments and new investment opportunities. He has over 10 years of health care real estate background including his experience with General Electric - Healthcare Financial Services (“GE HFS”) (2006 – 2010) where he most recently served as a Vice President. With GE HFS, he moved up through the organization while working on various assignments including relationship management, deal restructuring, and special assets. He also was awarded an assignment in the GE Capital Global Risk Rotation Program. Mr. Pascoe holds an MBA and a Bachelor of Business Administration in Economics from Middle Tennessee State University.
John Spaid joined NHI in March 2016. He oversees the Company’s banking relationships and financial transactions. Mr. Spaid has nearly 30 years of experience in real estate, finance and senior housing. Previously, he was with Emeritus Senior Living as a Senior Vice President whose responsibilities included budget and forecasting, debt and lease obligation underwriting, merger and acquisition processes, financial modeling, due diligence, board and investor presentations, employee development and Sarbanes-Oxley compliance. Mr. Spaid has been an independent financial consultant and has also served as the CFO of a regional assisted living and memory care provider in Redmond, Washington. Mr. Spaid holds an MBA from the University of Michigan and a Bachelor of Business Administration from the University of Texas.
We have a staff of 16, all reporting to our corporate office in Murfreesboro, TN. Essential services such as internal audit, tax compliance, information technology and legal services are outsourced to third-party professional firms.
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Investor Information
We publish our annual report on Form 10-K, quarterly reports on Form 10-Q, quarterly Supplemental Information, current reports on Form 8-K, and press releases to our website at www.nhireit.com. We have a policy of publishing these on the website within two (2) business days after public release or filing with the SEC.
We also maintain the following documents on our web site:
▪ | The NHI Code of Business Conduct and Ethics which has been adopted for all employees, officers and directors of the Company. |
▪ | Information on our “NHI Valuesline” which allows all interested parties to communicate with NHI executive officers and directors. The toll free number is 877-880-2974 and the communications may be made anonymously, if desired. |
▪ | The NHI Restated Audit Committee Charter. |
▪ | The NHI Revised Compensation Committee Charter. |
▪ | The NHI Revised Nominating and Corporate Governance Committee Charter. |
▪ | The NHI Corporate Governance Guidelines. |
We will furnish, free of charge, a copy of any of the above documents to any interested investor upon receipt of a written request.
Our transfer agent is Computershare. Computershare will assist registered owners with the NHI Dividend Reinvestment plan, change of address, transfer of ownership, payment of dividends, replacement of lost checks or stock certificates. Computershare’s contact information is: Computershare Trust Company, N.A., P.O. Box 43078, Providence, RI 02940-3078. The toll free number is 800-942-5909 and the website is www.computershare.com.
The Annual Stockholders’ meeting will be held at 12:00 p.m. local time on Friday, May 3, 2019 at Embassy Suites, 1200 Conference Center Boulevard, Murfreesboro, TN.
ITEM 1A. RISK FACTORS
We depend on the operating success of our tenants and borrowers for collection of our lease and note payments.
Revenues to operators of our properties are primarily driven by occupancy, Medicare and Medicaid reimbursement and private pay rates. Revenues from government reimbursement have, and may continue to, come under pressure due to reimbursement cuts and from widely-publicized federal and state budget shortfalls and constraints. Periods of weak economic growth in the U.S. which affect housing sales, investment returns and personal incomes may adversely affect senior housing occupancy rates. Expenses for the facilities are driven by the costs of labor, food, utilities, taxes, insurance and rent or debt service. Liability insurance and staffing costs continue to increase for our operators. To the extent any decrease in revenues and/or any increase in operating expenses results in a property not generating enough cash to make scheduled payments to us, our revenues, net income and funds from operations would be adversely affected. Such events and circumstances would cause us to evaluate whether there was an impairment of the real estate or mortgage loan that should be charged to earnings. Such impairment would be measured as the amount by which the carrying amount of the asset exceeded its fair value. Consequently, we might be unable to maintain or increase our current dividend and the market price of our stock may decline.
We depend on the success of property development and construction activities, which may fail to achieve the operating results we expect.
When we decide to invest in the renovation of an existing property or in the development of a new property, we make assumptions about the future potential cash flows of that property. We estimate our return based on expected occupancy, rental rates and future capital costs. If our projections prove to be inaccurate due to increased capital costs, lower occupancy or other factors, our investment in that property may not generate the cash flow we expected. Recently developed properties may take longer than expected to achieve stabilized operating levels, if at all. To the extent such facilities fail to reach stabilized operating levels or achieve stabilization later than expected, it could materially adversely affect our tenants’ abilities to make payments to us under their leases and thus adversely affect our business and results of operations.
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We are exposed to the risk that our tenants and borrowers may become subject to bankruptcy or insolvency proceedings for other reasons.
Although our lease agreements provide us the right to evict a tenant/operator and demand immediate payment of rent and exercise other remedies, and our mortgage loans provide us the right to terminate any funding obligations, demand immediate repayment of principal and unpaid interest, foreclose on the collateral and exercise other remedies, the bankruptcy laws afford certain rights to a party that has filed for bankruptcy or reorganization. A tenant or borrower in bankruptcy may be able to limit or delay our ability to collect unpaid rent in the case of a lease or to receive unpaid principal and/or interest in the case of a mortgage loan and to exercise other rights and remedies. For example, a lessee may reject its lease with us in a bankruptcy proceeding. In such a case, our claim against the lessee for unpaid and future rents would be limited by the statutory cap of the U.S. Bankruptcy Code. This statutory cap could be substantially less than the remaining rent owed under the lease, and any claim we have for unpaid rent might not be paid in full. In addition, a lessee may assert in a bankruptcy proceeding that its lease should be re-characterized as a financing agreement. If such a claim is successful, our rights and remedies as a lender, compared to a landlord, are generally more limited. We may be required to fund certain expenses (e.g. real estate taxes, maintenance and capital improvements) to preserve the value of a property, avoid the imposition of liens on a property and/or transition a property to a new tenant or borrower. In some instances, we have terminated our lease with a tenant and leased the facility to another tenant. In some of those situations, we provided working capital loans to, and limited indemnification of, the new tenant. If we cannot transition a leased facility to a new tenant, we may take possession of that property, which may expose us to certain successor liabilities. Should such events occur, our revenue and operating cash flow may be adversely affected.
Certain tenants in our portfolio account for a significant percentage of the rent we expect to generate from our portfolio, and the failure of any of these tenants to meet their obligations to us could materially and adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders.
The successful performance of our real estate investments is materially dependent on the financial stability of our tenants/operators. As of December 31, 2018, approximately 62% of our total revenue is generated by Holiday (15%), Senior Living (16%), Bickford (17%), and NHC (13%). Payment defaults or declines in the operating performance by these or other tenants/operators could materially and adversely affect our business, financial condition and results of operations and our ability to pay expected dividends to our stockholders. In the event of a tenant default, we may experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment and re-leasing our property. Further, we may not be able to re-lease the property for the rent previously received, or at all, or that lease terminations will not cause us to sell the property at a loss. The result of any of the foregoing risks could materially and adversely affect our business, financial conditions and results of operations and our ability to make distributions to our stockholders.
We are exposed to the risk that the illiquidity of real estate investments could impede our ability to respond to adverse changes in the performance of our properties.
Real estate investments are relatively illiquid and, therefore, our ability to quickly sell or exchange any of our properties in response to changes in economic and other conditions may be limited. All of our properties are "special purpose" properties that cannot be readily converted to general residential, retail or office use. Facilities that participate in Medicare or Medicaid must meet extensive program requirements, including physical plant and operational requirements. Transfers of operations of facilities are subject to regulatory approvals not required for transfers of other types of real estate. Thus, if the operation of any of our properties becomes unprofitable due to competition, age of improvements or other factors such that our lessee or borrower becomes unable to meet its obligations on the lease or mortgage loan, the liquidation value of the property may be less than the net book value or the amount owed on any related mortgage loan, because the property may not be readily adaptable to other uses. The sale of the property or the replacement of an operator that has defaulted on its lease or loan could also be delayed by the approval process of any federal, state or local agency necessary for the transfer of the property or the replacement of the operator with a new operator licensed to manage the facility. No assurances can be given that we will recognize full value for any property that we are required to sell for liquidity reasons. Should such events occur, our results of operations and cash flows could be adversely affected.
We are exposed to risks related to governmental regulations and payors, principally Medicare and Medicaid, and the effect that lower reimbursement rates would have on our tenants’ and borrowers’ business.
Our tenants’ and borrowers’ businesses are affected by government reimbursement and the rates paid by private pay sources. To the extent that any of our facilities receive a significant portion of their revenues from governmental payors, primarily Medicare and Medicaid, such revenues may be subject to statutory and regulatory changes, retroactive rate adjustments, recovery of program overpayments or set-offs, administrative rulings, policy interpretations, payment or other delays by fiscal intermediaries, government funding restrictions (at a program level or with respect to specific facilities) and interruption or delays in payments
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due to any ongoing governmental investigations and audits at such facilities. In recent years, governmental payors have frozen or reduced payments to health care providers due to budgetary pressures. Such reductions in Medicare reimbursement will have an adverse effect on the financial operations of our borrowers and lessees who operate SNFs. Changes in health care reimbursement will likely continue to be of paramount importance to federal and state programs. The President and members of the U.S. Congress may approve or propose various spending cuts and tax reform initiatives that could result in changes (including substantial reductions in funding) to Medicare, Medicaid or Medicare Advantage Plans. In addition, a number of states are currently managing budget deficits, which may put pressure on states to decrease reimbursement rates for our tenants and operators with a goal of decreasing state expenditures under their state Medicaid programs. We cannot make any assessment as to the ultimate timing or effect any future legislative reforms may have on the financial condition of the health care industry. There can be no assurance that adequate reimbursement levels will continue to be available for services provided by any facility operator, whether the facility receives reimbursement from Medicare, Medicaid or private pay sources. Significant limits on the scope of services reimbursed and on reimbursement rates and fees could have a material adverse effect on an operator’s liquidity, financial condition and results of operations, which could adversely affect the ability of an operator to meet its obligations to us. In addition, the replacement of an operator that has defaulted on its lease or loan could be delayed by the approval process of any federal, state or local agency necessary for the transfer of the facility or the replacement of the operator licensed to manage the facility.
Legislative, regulatory, or administrative changes could adversely affect us or our security holders.
The tax laws or regulations governing REITs or the administrative interpretations thereof may be amended at any time. We cannot predict if or when any new or amended law, regulation, or administrative interpretation will be adopted, promulgated, or become effective, and any such change may apply retroactively. We and our security holders may be adversely affected by any new or amended law, regulation, or administrative interpretation.
On December 22, 2017, the Tax Cuts and Jobs Act was enacted. The Tax Cuts and Jobs Act makes significant changes to the U.S. federal income tax rules related to the taxation of individuals and corporations, generally effective for taxable years beginning after December 31, 2017. In addition to reducing corporate and non-corporate tax rates, the Tax Cuts and Jobs Act eliminates and restricts various deductions and limits the ability to utilize net operating losses. Most of the changes applicable to individuals are temporary and apply only to taxable years beginning after December 31, 2017, and before January 1, 2026. The Tax Cuts and Jobs Act makes numerous large and small changes to the tax rules that do not affect REITs directly but may affect our security holders and may indirectly affect us.
Prospective investors are urged to consult with their tax advisors with respect to the status of the Tax Cuts and Jobs Act and any other regulatory or administrative developments and proposals and their potential effect on investment in our securities.
We are exposed to the risk that the cash flows of our tenants and borrowers would be adversely affected by increased liability claims and liability insurance costs.
ALF and SNF operators have experienced substantial increases in both the number and size of patient care liability claims in recent years, particularly in the states of Texas and Florida. As a result, general and professional liability costs have increased and may continue to increase. Nationwide, long-term care liability insurance rates are increasing because of large jury awards in states like Texas and Florida. Both Texas and Florida have now adopted SNF liability laws that modify or limit tort damages. Despite some of these reforms, the long-term care industry overall continues to experience very high general and professional liability costs. Insurance companies have responded to this claims crisis by severely restricting their capacity to write long-term care general and professional liability policies. No assurance can be given that the climate for long-term care general and professional liability insurance will improve in any of the foregoing states or any other states where the facility operators conduct business. Insurance companies may continue to reduce or stop writing general and professional liability policies for ALFs and SNFs. Thus, general and professional liability insurance coverage may be restricted, very costly or not available, which may adversely affect the facility operators’ future operations, cash flows and financial condition and may have a material adverse effect on the facility operators’ ability to meet their obligations to us.
We are exposed to risks related to environmental laws and the costs associated with liabilities related to hazardous substances.
Under various federal and state laws, owners or operators of real property may be required to respond to the release of hazardous substances on the property and may be held liable for property damage, personal injuries or penalties that result from environmental contamination. These laws also expose us to the possibility that we may become liable to reimburse the government for damages and costs it incurs in connection with the contamination. Generally, such liability attaches to a person based on the person’s relationship to the property. Our tenants or borrowers are primarily responsible for the condition of the property they occupy. Moreover, we review environmental site assessment of the properties that we purchase or encumber prior to taking an interest in them. Those assessments are designed to meet the “all appropriate inquiry” standard, which qualifies us for the innocent purchaser
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defense if environmental liabilities arise. Based upon such assessments, we do not believe that any of our properties are subject to material environmental contamination. However, environmental liabilities, including mold, may be present in our properties and we may incur costs to remediate contamination, which could have a material adverse effect on our business or financial condition.
We are exposed to the risk that we may not be fully indemnified by our lessees and borrowers against future litigation.
Our leases and notes require that the tenant/borrowers name us as an additional insured party on their insurance policies covering professional liability or personal injury claims. These instruments also require the tenant/borrower to indemnify and hold us harmless for all claims arising out of or incidental to the occupancy and use of each facility. We cannot give any assurance that these protective measures will completely eliminate any risk to us related to future litigation, the costs of which could have a material adverse impact on us.
We depend on the success of our future acquisitions and investments.
We are exposed to the risk that our future acquisitions may not prove to be successful. We could encounter unanticipated difficulties and expenditures relating to any acquired properties, including contingent liabilities, and newly acquired properties might require significant attention of NHI’s management that would otherwise be devoted to our existing business. If we agree to provide construction funding to a borrower and the project is not completed, we may need to take steps to ensure completion of the project. Moreover, if we issue equity securities or incur additional debt, or both, to finance future acquisitions, it may reduce our per share financial results.
We depend on our ability to reinvest cash in real estate investments in a timely manner and on acceptable terms.
From time to time, we will have cash available from (1) the proceeds of sales of our securities, (2) principal payments on our notes receivable and (3) the sale of properties, including tenant purchase option exercises, under the terms of master leases or similar financial support arrangements. We must reinvest these proceeds, on a timely basis, in health care investments or in qualified short-term investments. We compete for real estate investments with a broad variety of potential investors. This competition for attractive investments may negatively affect our ability to make timely investments on terms acceptable to us. Delays in acquiring properties may negatively impact revenues and the amount of distributions to stockholders.
We may need to refinance existing debt or incur additional debt in the future, which may not be available on terms acceptable to us.
We operate with a policy of incurring debt when, in the opinion of our Board of Directors, it is advisable. Currently, we believe that our current liquidity, availability under our unsecured credit facility, and our capacity to service additional debt will enable us to meet our obligations, including dividends, and continue to make investments in healthcare real estate. While we currently have a low debt ratio, in the future, we may increase our borrowings. We may incur additional debt by borrowing under our unsecured credit facility, mortgaging properties we own and/or issuing debt securities in a public offering or in a private transaction. We believe we will be able to raise additional debt and equity capital at reasonable costs to refinance our existing indebtedness at or prior to its maturity. Our ability to raise reasonably priced capital is not guaranteed; we may be unable to raise reasonably priced capital because of reasons related to our business or for reasons beyond our control, such as market conditions. If our access to capital becomes limited, it could have an impact on our ability to refinance our debt obligations, fund dividend payments, acquire properties and fund acquisition activities.
We have covenants related to our indebtedness which impose certain operational limitations and a breach of those covenants could materially adversely affect our financial condition and results of operations.
The terms of our current indebtedness as well as debt instruments that the Company may enter into in the future are subject to customary financial and operational covenants. Among other things, these provisions require us to maintain certain financial ratios and minimum net worth and impose certain limits on our ability to incur indebtedness, create liens and make investments or acquisitions. Our continued ability to incur debt and operate our business is subject to compliance with these covenants, which limit operational flexibility. Breaches of these covenants could result in a default under applicable debt instruments, even if payment obligations are satisfied. Financial and other covenants that limit our operational flexibility, as well as defaults resulting from a breach of any of these covenants in our debt instruments, could have a material adverse effect on our financial condition and results of operations.
When interest rates increase, our common stock may decline in price.
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Our common stock, like other dividend stocks, is sensitive to changes in market interest rates. In response to changing interest rates the market price of our common stock may adjust like a long-term fixed-income security and, compared to shorter-term instruments, may have more volatility. A wide variety of market factors can cause interest rates to rise, including central bank monetary policy, an uptick in inflation and changes in general economic conditions. The risks associated with increasing rates are intensified given that interest rates have increased from historic lows and are expected to increase in the future, with unpredictable effects on capital markets and on the price of our common stock. Consequential effects of a general rise in interest rates may hamper our access to capital markets, affect the liquidity of our underlying investments in real estate, and, by extension, limit management’s effective range of responses to changing tenant circumstances or in answer to investment opportunities. Limited operational alternatives may further hinder our ability to maintain or increase our dividend, and the market price of our common stock may decline as the result.
We depend on revenues derived mainly from fixed rate investments in real estate assets, while a portion of our debt used to finance those investments bears interest at variable rates.
Our business model assumes that we can earn a spread between the returns earned from our investments in real estate as compared to our cost of debt and/or equity capital. Current interest rates on our debt are at low levels, and, as a result, the spread and our profitability on our investments have been at high levels. We are exposed to interest rate risk in the potential for a narrowing of our spread and profitability if interest rates increase in the future. Certain of our debt obligations are floating rate obligations with interest rates that vary with the movement of LIBOR or other indexes. Our revenues are derived mainly from fixed rate investments in real estate assets. Although our leases generally contain escalating rent clauses that provide a partial hedge against interest rate fluctuations, if interest rates rise, our interest costs for our existing floating rate debt and any new debt we incur would also increase. This increasing cost of debt could reduce our profitability by increasing the cost of financing our existing portfolio and our investment activity. Rising interest rates could limit our ability to refinance existing debt upon maturity or cause us to pay higher rates upon refinancing. We manage a portion of our exposure to interest rate risk by accessing debt with staggered maturities and through the use of derivative instruments, such as interest rate swap agreements with major financial institutions. Increased interest rates may also negatively affect the market price of our common stock and increase the cost of new equity capital.
We are exposed to the risk that our assets may be subject to impairment charges.
We regularly evaluate our real estate investments and other assets for impairment indicators. The judgment regarding the existence of impairment indicators is based on factors such as market conditions, operator performance and legal structure. If we determine that a significant impairment has occurred, we would be required to make an adjustment to the net carrying value of the asset, which could have a material adverse effect on our reported results of operations in the period in which the impairment charge occurs.
We depend on the ability to continue to qualify for taxation as a Real Estate Investment Trust.
We intend to operate as a REIT under the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”) and believe we have and will continue to operate in such a manner. Since REIT qualification requires us to meet a number of complex requirements, it is possible that we may fail to fulfill them. If we fail to qualify as a REIT:
• | we will not be allowed a deduction for distributions to stockholders in computing our taxable income; |
• | we will be subject to corporate-level income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates; |
• | we could be subject to increased state and local income taxes; and • unless we are entitled to relief under relevant statutory provisions, we will be disqualified from taxation as a REIT for the four taxable years following the year during which we fail to qualify as a REIT. |
Because of all these factors, our failure to qualify as a REIT could also impair our ability to expand our business and could materially adversely affect the value of our common stock. The present federal income tax treatment of REITs may be modified, possibly with retroactive effect, by legislative, judicial or administrative action at any time, which could affect the federal income tax treatment of an investment in us. The federal income tax rules dealing with REITs constantly are under review by persons involved in the legislative process, the U.S. Internal Revenue Service (the “IRS”) and the U.S. Treasury Department, which results in statutory changes as well as frequent revisions to regulations and interpretations. Revisions in federal tax laws and interpretations thereof could affect or cause us to change our investments and commitments and affect the tax considerations of an investment in us.
Complying with REIT requirements may cause us to forego otherwise attractive acquisition opportunities or liquidate otherwise attractive investments, which could materially hinder our performance.
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To qualify as a REIT for U.S. federal income tax purposes, we must continually satisfy certain tests, including tests concerning the sources of our income, the nature and diversification of our assets, the amounts we distribute to our stockholders and the ownership of our stock. To meet these tests, we may be required to forego investments or acquisitions we might otherwise make. Thus, compliance with the REIT requirements may materially hinder our performance.
We have ownership limits in our charter with respect to our common stock and other classes of capital stock which may delay, defer or prevent a transaction or a change of control that might involve a premium price for our common stock or might otherwise be in the best interests of our stockholders.
Our charter, subject to certain exceptions, contains restrictions on the ownership and transfer of our common and preferred stock that are intended to assist us in preserving our qualification as a REIT. Our charter provides that any transfer that would cause NHI to be beneficially owned by fewer than 100 persons or would cause NHI to be “closely held” under the Internal Revenue Code would be void, which, subject to certain exceptions, results in no person or entity being allowed to own, actually or constructively, more than 9.9% of the outstanding shares of our stock. Our Board of Directors, in its sole discretion, may exempt a proposed transferee from the ownership limit and such an exemption has been granted through Excepted Holder Agreements to members of the Carl E. Adams family. Based on the Excepted Holder Agreements currently outstanding, the individual ownership limit for all other stockholders is approximately 7.5%. Our charter gives our Board of Directors broad powers to prohibit and rescind any attempted transfer in violation of the ownership limits. These ownership limits may delay, defer or prevent a transaction or a change of control that might involve a premium price for our common stock or might otherwise be in the best interests of our stockholders.
We are subject to certain provisions of Maryland law and our charter and bylaws that could hinder, delay or prevent a change in control transaction, even if the transaction involves a premium price for our common stock or our stockholders believe such transaction to be otherwise in their best interests.
The Maryland Business Combination Act provides that, unless exempted, a Maryland corporation may not engage in business combinations, including mergers, dispositions of 10% or more of its assets, issuances of shares of stock and other specified transactions with an “interested stockholder” or an affiliate of an interested stockholder for five years after the most recent date on which the interested stockholder became an interested stockholder, and thereafter, unless specified criteria are met. An interested stockholder is generally a person owning or controlling, directly or indirectly, 10% or more of the voting power of the outstanding stock of a Maryland corporation. Unless our Board of Directors takes action to exempt us, generally or with respect to certain transactions, from this statute in the future, the Maryland Business Combination Act will be applicable to business combinations between us and other persons. The Company’s charter and bylaws also contain certain provisions that could have the effect of making it more difficult for a third party to acquire, or discouraging a third party from attempting to acquire, control of the Company. Such provisions could limit the price that certain investors might be willing to pay in the future for the common stock. These provisions include a staggered board of directors, blank check preferred stock, and the application of Maryland corporate law provisions on business combinations and control shares. The foregoing matters may, together or separately, have the effect of discouraging or making more difficult an acquisition or change of control of the Company.
If our efforts to maintain the privacy and security of Company information are not successful, we could incur substantial costs and reputational damage, and could become subject to litigation and enforcement actions.
Our business, like that of other REITs, involves the receipt, storage and transmission of information about our Company, our tenants and borrowers, and our employees, some of which is entrusted to third-party service providers and vendors. We also work with third-party service providers and vendors to provide technology, systems and services that we use in connection with the receipt, storage and transmission of this information.
Our information systems, and those of our third-party service providers and vendors, may be vulnerable to continually evolving cybersecurity risks. Unauthorized parties may attempt to gain access to these systems or our information through fraud or deception of our associates, third-party service providers or vendors. Hardware, software or applications we obtain from third parties may contain defects in design or manufacture or other problems that could unexpectedly compromise information security. The methods used to obtain unauthorized access, disable or degrade service or sabotage systems are also constantly changing and evolving and may be difficult to anticipate or detect for long periods of time. We have implemented and regularly review and update processes and procedures to protect against unauthorized access to or use of secured data and to prevent data loss. However, the ever-evolving threats mean we and our third-party service providers and vendors must continually evaluate and adapt our respective systems and processes, and there is no guarantee that they will be adequate to safeguard against all data security breaches or misuses of data. Any significant compromise or breach of our data security, whether external or internal, or misuse of our data, could result in significant costs, fines, lawsuits, and damage to our reputation. In addition, as the regulatory environment related to information
19
security, data collection and use, and privacy becomes increasingly rigorous, with new and constantly changing requirements applicable to our business, compliance with those requirements could also result in significant additional costs.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
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ITEM 2. PROPERTIES OWNED OR ASSOCIATED WITH MORTGAGE LOAN INVESTMENTS AS OF DECEMBER 31, 2018
PROPERTIES OWNED | ||||||||||
Location | SHO | SNF | HOSP & MOB | Investment | ||||||
Alabama | 1 | 2 | — | $ | 17,260,000 | |||||
Arkansas | 2 | — | — | 49,789,000 | ||||||
Arizona | 4 | 1 | — | 22,835,000 | ||||||
California | 9 | — | 1 | 183,723,000 | ||||||
Connecticut | 3 | — | — | 132,494,000 | ||||||
Florida | 7 | 10 | 1 | 212,506,000 | ||||||
Georgia | 5 | — | — | 112,753,000 | ||||||
Iowa | 10 | — | — | 63,593,000 | ||||||
Idaho | 4 | — | — | 29,373,000 | ||||||
Illinois | 14 | — | — | 206,545,000 | ||||||
Indiana | 8 | — | — | 74,311,000 | ||||||
Kansas | 2 | — | — | 42,072,000 | ||||||
Kentucky | — | 1 | 1 | 20,746,000 | ||||||
Louisiana | 5 | — | — | 39,569,000 | ||||||
Massachusetts | — | 4 | — | 13,730,000 | ||||||
Maryland | 1 | — | — | 9,472,000 | ||||||
Michigan | 8 | — | — | 58,077,000 | ||||||
Minnesota | 4 | — | — | 21,400,000 | ||||||
Missouri | 1 | 5 | — | 27,757,000 | ||||||
North Carolina | 6 | — | — | 133,643,000 | ||||||
Nebraska | 4 | — | — | 34,277,000 | ||||||
New Hampshire | — | 3 | — | 23,688,000 | ||||||
New Jersey | 1 | — | — | 24,380,000 | ||||||
Ohio | 8 | — | — | 130,537,000 | ||||||
Oklahoma | 2 | — | — | 56,025,000 | ||||||
Oregon | 8 | 3 | — | 134,571,000 | ||||||
Pennsylvania | 1 | — | — | 16,237,000 | ||||||
South Carolina | 7 | 4 | — | 338,780,000 | ||||||
Tennessee | 6 | 16 | 1 | 99,925,000 | ||||||
Texas | 2 | 21 | 1 | 322,390,000 | ||||||
Virginia | 3 | 1 | — | 34,196,000 | ||||||
Washington | 6 | — | — | 103,252,000 | ||||||
Wisconsin | 1 | 1 | — | 25,988,000 | ||||||
143 | 72 | 5 | $ | 2,815,894,000 | ||||||
Corporate Office | 2,471,000 | |||||||||
$ | 2,818,365,000 | |||||||||
ASSOCIATED WITH MORTGAGE LOAN INVESTMENTS | ||||||||
Location | SHO | SNF | Investment | |||||
Arizona | 1 | — | $ | 85,018,000 | ||||
Florida | 1 | — | 10,000,000 | |||||
Illinois | 1 | — | 13,047,000 | |||||
Michigan | 2 | — | 14,909,000 | |||||
New Hampshire | 1 | — | 9,928,000 | |||||
Virginia | 1 | 4 | 12,036,000 | |||||
Washington | 1 | — | 57,939,000 | |||||
8 | 4 | $ | 202,877,000 | |||||
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10-YEAR LEASE EXPIRATIONS
The following table provides additional information on our leases which are scheduled to expire based on the maturity date contained in the most recent lease agreement or extension. We expect that, prior to maturity, we will negotiate new terms of a lease to either the current tenant or another qualified operator.
Annualized | Percentage of | ||||||||||||
Leases | Rentable | Number | Gross Rent** | Annualized | |||||||||
Year | Expiring | Square Feet* | of Units/Beds | (in thousands) | Gross Rent | ||||||||
2019 | — | — | — | $ | — | — | % | ||||||
2020 | 6 | 27,017 | 224 | $ | 3,082 | 1.2 | % | ||||||
2021 | 2 | — | 344 | 2,044 | 0.8 | % | |||||||
2022 | 4 | — | 156 | 4,249 | 1.7 | % | |||||||
2023 | 15 | — | 852 | 14,139 | 5.7 | % | |||||||
2024 | 10 | — | 674 | 7,232 | 2.9 | % | |||||||
2025 | 6 | 61,500 | 521 | 6,707 | 2.7 | % | |||||||
2026 | 32 | — | 4,624 | 32,714 | 13.1 | % | |||||||
2027 | 10 | — | 717 | 8,267 | 3.3 | % | |||||||
2028 | 12 | — | 1,170 | 7,615 | 3.0 | % | |||||||
Thereafter | 113 | — | 11,487 | 163,598 | 65.6 | % | |||||||
100.0 | % | ||||||||||||
*Rentable Square Feet represents total square footage in two MOB investments.
**Annualized Gross Rent refers to the amount of lease revenue that our portfolio would have generated in 2018 if all leases were in effect for the twelve-month calendar year, regardless of the commencement date, maturity date, or renewals. The table excludes leases that auto-renew.
ITEM 3. LEGAL PROCEEDINGS
On June 15, 2018, East Lake Capital Management LLC and certain related entities, including Regency, filed suit against NHI and NHI-REIT of Axel, LLC, in the District Court of Dallas County, Texas; 95th Judicial District for injunctive and declaratory relief and unspecified monetary damages, including attorney’s fees. The suit sought, among other things, to enjoin NHI from making certain references to East Lake in NHI’s public filings. In response to this lawsuit, related litigation, and other circumstances, we entered motions calling for the immediate appointment of a receiver and for pre-judgment possession, hearing, and bond.
Resulting from these claims and counterclaims, on December 6, 2018, the plaintiff parties entered into an agreement with NHI under Texas Rule of Civil Procedure 11, which rule ensures the enforceability of an agreement between lawyers in a case when the agreement is in writing and filed in the papers of the court. The agreement provided that Regency vacate our facilities in Indiana and North Carolina on December 7, 2018 and in Tennessee on December 14, 2018. Further, Regency agreed to provide minimal levels of cooperation in transitioning the facilities.
The original libel action of the East Lake affiliated entities survives the Rule 11 agreement and is set to continue in January 2019. NHI is not precluded from further action in damages under terms of the lease.
Our facilities are subject to claims and suits in the ordinary course of business. Our lessees and borrowers have indemnified, and are obligated to continue to indemnify us, against all liabilities arising from the operation of the facilities, and are further obligated to indemnify us against environmental or title problems affecting the real estate underlying such facilities. While there may be lawsuits pending against certain of the owners and/or lessees of the facilities, management believes that the ultimate resolution of all such pending proceedings will have no material effect on our financial statements.
ITEM 4. MINE SAFETY DISCLOSURES
Not Applicable
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PART II.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
The Company’s charter contains certain provisions which are designed to ensure that the Company’s status as a REIT is protected for federal income tax purposes. One of the provisions ensures that any transfer (of shares) which would cause NHI to be beneficially owned by fewer than 100 persons or would cause NHI to be “closely-held” under the Internal Revenue Code would be void which, subject to certain exceptions, result in no stockholder being allowed to own, either directly or indirectly pursuant to certain tax attribution rules, more than 9.9% of the Company’s common stock with the exception of prior agreements in 1991 which were confirmed in writing in 2008 with the Company’s founders Dr. Carl E. Adams and Jennie Mae Adams and their lineal descendants. Based on these agreement, the ownership limit for all other stockholders is approximately 7.5%. If a stockholder’s stock ownership exceeds the limit, then such shares over the limit become Excess Stock within the meaning in the Company’s charter whose rights to vote and receive dividends in certain situations. Our charter gives our Board of Directors broad powers to prohibit and rescind any attempted transfer in violation of the ownership limits. In addition, W. Andrew Adams’ Excess Holder Agreement also provides that he will not own shares of stock in any tenant of the Company if such ownership would cause the Company to constructively own more than a 9.9% interest in such tenant. The purpose of these provisions is to protect the Company’s status as a REIT for tax purposes.
In order to qualify for the beneficial tax treatment accorded to a REIT, we must make distributions to holders of our common stock equal on an annual basis to at least 90% of our REIT taxable income (excluding net capital gains), as defined in the Internal Revenue Code. Cash available for distribution to our stockholders is primarily derived from interest payments received on our notes and from rental payments received under our leases. All distributions will be made by us at the discretion of the Board of Directors and will depend on our cash flow and earnings, our financial condition, bank covenants contained in our financing documents and such other factors as the Board of Directors deems relevant. Our REIT taxable income is calculated without reference to our cash flow. Therefore, under certain circumstances, we may not have received cash sufficient to pay our required distributions.
Our common stock is traded on the New York Stock Exchange under the symbol “NHI”. As of February 15, 2019, there were 712 holders of record of shares and 45,618 beneficial owners of shares.
We currently maintain two equity compensation plans: the 2005 Stock Option, Restricted Stock and Stock Appreciation Rights Plan (the “2005 Plan”) and the 2012 Stock Incentive Plan (the “2012 Plan”). These plans, as amended, have been approved by our stockholders. The following table provides information as of December 31, 2018 about our common stock that may be issued upon the exercise of options under our existing equity compensation plans.
Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted-average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in the first column) | ||||
Equity compensation plans approved | ||||||
by security holders | 920,346 | $69.24 | 921,6691 | |||
The following graph demonstrates the performance of the cumulative total return to the stockholders of our common stock during the previous five years in comparison to the cumulative total return on the MSCI US REIT Index and the Standard & Poor’s 500 Stock Index. The MSCI US REIT Index is a free float-adjusted market capitalization weighted index that is comprised of Equity REIT securities. The MSCI US REIT Index includes securities with exposure to core real estate (e.g. residential and retail properties) as well as securities with exposure to other types of real estate (e.g. casinos, theaters).
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2013 | 2014 | 2015 | 2016 | 2017 | 2018 | |
NHI | $100.00 | $130.79 | $119.77 | $153.57 | $166.03 | $177.84 |
MSCI | $100.00 | $130.38 | $133.67 | $145.16 | $152.52 | $145.55 |
S&P 500 | $100.00 | $113.69 | $115.26 | $129.05 | $157.22 | $150.33 |
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ITEM 6. SELECTED FINANCIAL DATA.
The following table represents our financial information for the five years ended December 31, 2018. This financial information has been derived from our historical financial statements including those for the most recent three years included elsewhere in this Annual Report on Form 10-K and should be read in conjunction with those consolidated financial statements, accompanying footnotes and Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7.
(in thousands, except share and per share amounts) | |||||||||||||||||||
Years Ended December 31, | |||||||||||||||||||
STATEMENT OF INCOME DATA: | 2018 | 2017 | 2016 | 2015 | 2014 | ||||||||||||||
Revenues | $ | 294,612 | $ | 278,659 | $ | 248,460 | $ | 228,948 | $ | 177,469 | |||||||||
Income from continuing operations | $ | 154,333 | $ | 159,365 | $ | 152,716 | $ | 150,314 | $ | 103,052 | |||||||||
Net income | $ | 154,333 | $ | 159,365 | $ | 152,716 | $ | 150,314 | $ | 103,052 | |||||||||
Net income attributable to noncontrolling interest | — | — | (1,176 | ) | (1,452 | ) | (1,443 | ) | |||||||||||
Net income attributable to common stockholders | $ | 154,333 | $ | 159,365 | $ | 151,540 | $ | 148,862 | $ | 101,609 | |||||||||
PER SHARE DATA: | |||||||||||||||||||
Basic earnings per common share: | |||||||||||||||||||
Net income attributable to common stockholders | $ | 3.68 | $ | 3.90 | $ | 3.88 | $ | 3.96 | $ | 3.04 | |||||||||
Diluted earnings per common share: | |||||||||||||||||||
Net income attributable to common stockholders | $ | 3.67 | $ | 3.87 | $ | 3.87 | $ | 3.95 | $ | 3.04 | |||||||||
OTHER DATA: | |||||||||||||||||||
Common shares outstanding, end of year | 42,700,411 | 41,532,154 | 39,847,860 | 38,396,727 | 37,485,902 | ||||||||||||||
Weighted average common shares: | |||||||||||||||||||
Basic | 41,943,873 | 40,894,219 | 39,013,412 | 37,604,594 | 33,375,966 | ||||||||||||||
Diluted | 42,091,731 | 41,151,453 | 39,155,380 | 37,644,171 | 33,416,014 | ||||||||||||||
Regular dividends declared per common share | $ | 4.00 | $ | 3.80 | $ | 3.60 | $ | 3.40 | $ | 3.08 | |||||||||
BALANCE SHEET DATA: (at year end) | |||||||||||||||||||
Real estate properties, net | $ | 2,366,882 | $ | 2,285,701 | $ | 2,159,774 | $ | 1,836,807 | $ | 1,776,549 | |||||||||
Mortgages and other notes receivable, net | $ | 246,111 | $ | 141,486 | $ | 133,493 | $ | 133,714 | $ | 63,630 | |||||||||
Investments in preferred stock and marketable securities | $ | — | $ | — | $ | — | $ | 72,744 | $ | 53,635 | |||||||||
Assets held for sale, net | $ | — | $ | — | $ | — | $ | 1,346 | $ | — | |||||||||
Total assets | $ | 2,750,570 | $ | 2,545,821 | $ | 2,403,633 | $ | 2,133,218 | $ | 1,982,960 | |||||||||
Debt | $ | 1,281,675 | $ | 1,145,497 | $ | 1,115,981 | $ | 914,443 | $ | 862,726 | |||||||||
Total liabilities | $ | 1,360,857 | $ | 1,223,704 | $ | 1,194,043 | $ | 990,758 | $ | 933,027 | |||||||||
Total equity | $ | 1,389,713 | $ | 1,322,117 | $ | 1,209,590 | $ | 1,142,460 | $ | 1,049,933 | |||||||||
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion and analysis is based primarily on the consolidated financial statements of National Health Investors, Inc. for the periods presented and should be read together with the notes thereto contained in this Annual Report on Form 10-K. Other important factors are identified in “Item 1. Business” and “Item 1A. Risk Factors” above.
Executive Overview
National Health Investors, Inc., established in 1991 as a Maryland corporation, is a self-managed REIT specializing in sale-leaseback, joint-venture, mortgage and mezzanine financing of need-driven and discretionary senior housing and medical investments. Our portfolio consists of lease, mortgage and other note investments in independent living facilities, assisted living facilities, entrance-fee communities, senior living campuses, skilled nursing facilities, specialty hospitals and medical office buildings. Other investments have included marketable securities and, until 2016, a joint venture structured to comply with the provisions of the REIT Investment Diversification Empowerment Act of 2007 (“RIDEA”) through which we invested in facility operations managed by an independent third-party. We have funded our real estate investments primarily through: (1) operating cash flow, (2) debt offerings, including bank lines of credit and term debt, both unsecured and secured, and (3) the sale of equity securities.
Portfolio
At December 31, 2018, we had investments in real estate, mortgage and other notes receivable involving 232 facilities located in 33 states. These investments involve 151 senior housing properties, 76 skilled nursing facilities, 3 hospitals, 2 medical office buildings and other notes receivable. These investments (excluding our corporate office of $2,471,000) consisted of properties with an original cost of $2,815,894,000, rented under triple-net leases to 30 lessees, and $246,111,000 aggregate carrying value of mortgage and other notes receivable due from 10 borrowers.
We classify the properties in our portfolio as either senior housing or medical properties. We further classify our senior housing properties as either need-driven (assisted living facilities and senior living campuses) or discretionary (independent living facilities and entrance-fee communities). Medical properties within our portfolio include skilled nursing facilities, medical office buildings and specialty hospitals.
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The following tables summarize our investments in real estate and mortgage and other notes receivable as of December 31, 2018 (dollars in thousands):
Real Estate Properties | Properties | Beds/Sq. Ft.* | Revenue | % | Investment | |||||||||||||
Senior Housing - Need-Driven | ||||||||||||||||||
Assisted Living | 93 | 4,618 | $ | 78,628 | 26.7 | % | $ | 854,018 | ||||||||||
Senior Living Campus | 10 | 1,323 | 16,372 | 5.6 | % | 161,611 | ||||||||||||
Total Senior Housing - Need-Driven | 103 | 5,941 | 95,000 | 32.3 | % | 1,015,629 | ||||||||||||
Senior Housing - Discretionary | ||||||||||||||||||
Independent Living | 30 | 3,412 | 48,683 | 16.6 | % | 553,727 | ||||||||||||
Entrance-Fee Communities | 10 | 2,363 | 50,869 | 17.3 | % | 603,234 | ||||||||||||
Total Senior Housing - Discretionary | 40 | 5,775 | 99,552 | 33.9 | % | 1,156,961 | ||||||||||||
Total Senior Housing | 143 | 11,716 | 194,552 | 66.2 | % | 2,172,590 | ||||||||||||
Medical Facilities | ||||||||||||||||||
Skilled Nursing Facilities | 72 | 9,342 | 77,603 | 26.4 | % | 576,847 | ||||||||||||
Hospitals | 3 | 181 | 7,991 | 2.7 | % | 55,971 | ||||||||||||
Medical Office Buildings | 2 | 88,517 | * | 667 | 0.2 | % | 10,486 | |||||||||||
Total Medical Facilities | 77 | 86,261 | 29.3 | % | 643,304 | |||||||||||||
Total Real Estate Properties | 220 | $ | 280,813 | 95.5 | % | $ | 2,815,894 | |||||||||||
Mortgage and Other Notes Receivable | ||||||||||||||||||
Senior Housing - Need-Driven | 6 | 376 | $ | 3,845 | 1.3 | % | $ | 52,400 | ||||||||||
Senior Housing - Discretionary | 2 | 967 | 4,592 | 1.6 | % | 142,956 | ||||||||||||
Medical Facilities | 4 | 270 | 689 | 0.2 | % | 7,521 | ||||||||||||
Other Notes Receivable | — | — | 4,094 | 1.4 | % | 43,234 | ||||||||||||
Total Mortgage and Other Notes Receivable | 12 | 1,613 | 13,220 | 4.5 | % | 246,111 | ||||||||||||
Total Portfolio | 232 | $ | 294,033 | 100.0 | % | $ | 3,062,005 | |||||||||||
Portfolio Summary | Properties | Beds/Sq. Ft.* | Revenue | % | Investment | |||||||||||||
Real Estate Properties | 220 | $ | 280,813 | 95.5 | % | $ | 2,815,894 | |||||||||||
Mortgage and Other Notes Receivable | 12 | 13,220 | 4.5 | % | 246,111 | |||||||||||||
Total Portfolio | 232 | $ | 294,033 | 100.0 | % | $ | 3,062,005 | |||||||||||
Summary of Facilities by Type | ||||||||||||||||||
Senior Housing - Need-Driven | ||||||||||||||||||
Assisted Living | 99 | 4,994 | $ | 82,473 | 28.0 | % | $ | 906,417 | ||||||||||
Senior Living Campus | 10 | 1,323 | 16,372 | 5.6 | % | 161,611 | ||||||||||||
Total Senior Housing - Need-Driven | 109 | 6,317 | 98,845 | 33.6 | % | 1,068,028 | ||||||||||||
Senior Housing - Discretionary | ||||||||||||||||||
Entrance-Fee Communities | 12 | 3,330 | 55,461 | 18.9 | % | 746,190 | ||||||||||||
Independent Living | 30 | 3,412 | 48,683 | 16.6 | % | 553,727 | ||||||||||||
Total Senior Housing - Discretionary | 42 | 6,742 | 104,144 | 35.5 | % | 1,299,917 | ||||||||||||
Total Senior Housing | 151 | 13,059 | 202,989 | 69.1 | % | 2,367,945 | ||||||||||||
Medical Facilities | ||||||||||||||||||
Skilled Nursing Facilities | 76 | 9,612 | 78,292 | 26.6 | % | 584,369 | ||||||||||||
Hospitals | 3 | 181 | 7,991 | 2.7 | % | 55,971 | ||||||||||||
Medical Office Buildings | 2 | 88,517 | * | 667 | 0.2 | % | 10,486 | |||||||||||
Total Medical Facilities | 81 | 86,950 | 29.5 | % | 650,826 | |||||||||||||
Other Notes Receivable | — | 4,094 | 1.4 | % | 43,234 | |||||||||||||
Total Portfolio | 232 | $ | 294,033 | 100.0 | % | $ | 3,062,005 | |||||||||||
Portfolio by Operator Type | ||||||||||||||||||
Public | 73 | $ | 72,625 | 24.7 | % | $ | 531,456 | |||||||||||
National Chain (Privately-Owned) | 29 | 50,467 | 17.2 | % | 664,095 | |||||||||||||
Regional | 121 | 165,762 | 56.4 | % | 1,799,858 | |||||||||||||
Small | 9 | 5,179 | 1.7 | % | 66,596 | |||||||||||||
Total Portfolio | 232 | $ | 294,033 | 100.0 | % | $ | 3,062,005 | |||||||||||
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For the year ended December 31, 2018, our tenants who provided more than 3% of our total revenues were (parent company, in alphabetical order): Bickford Senior Living; Chancellor Health Care; The Ensign Group; Health Services Management; Holiday Retirement; National HealthCare Corporation; and Senior Living Communities.
As of December 31, 2018, our average effective annualized rental income was $8,421 per bed for SNFs, $17,105 per unit for ALFs, $13,883 per unit for ILFs, $21,573 per unit for EFCs, $44,150 per bed for hospitals, and $8 per square foot for MOBs.
Areas of Focus
We are evaluating and will likely make real estate and note investments in 2019 while we continue to monitor and improve our existing properties. We seek tenants who will become mission-oriented partners in relationships where our business goals are aligned. This approach aims to fuel steady, and thus, enduring growth for those partners and for NHI. Within the context of our growth model, we rely on a cost-effective access to debt and equity capital to finance acquisitions that will drive our earnings. There is significant competition for healthcare assets from other REITs, both public and private, and from private equity sources. Large-scale portfolios continue to command premium pricing, due to the continued abundance of private and foreign buyers seeking to invest in healthcare real estate. This combination of circumstances places a premium on our ability to execute acquisitions and negotiate leases that will generate meaningful earnings growth for our shareholders. We emphasize growth with our existing tenants and borrowers as a way to insulate us from other competition.
With lower capitalization rates for existing healthcare facilities, there has been increased interest in constructing new facilities in hopes of generating better returns on invested capital. Using our relationship-driven model, we continue to look for opportunities to support new and existing tenants and borrowers with the capital needed to expand existing facilities and to initiate ground-up development of new facilities. We concentrate our efforts in those markets where there is both a demonstrated demand for a particular product type and where we perceive we have a competitive advantage. The projects we agree to finance have attractive upside potential and are expected to provide above-average returns to our shareholders to mitigate the risks inherent with property development and construction.
Following three 25 basis-point increases in 2017, the Federal Open Market Committee of the Federal Reserve announced four further increases during 2018. As inflation is expected to rise, officials have forecast a total of two increases in 2019. However, the actual path the federal funds rate takes will depend on the changing economic outlook as informed by incoming data. The anticipation of past and further increases in the federal funds rate in 2018 and beyond has been a primary source of much volatility in REIT equity markets. As a result, there will be pressure on the spread between our cost of capital and the returns we earn. We expect that pressure to be partially mitigated by market forces that would tend to result in higher capitalization rates for healthcare assets and higher lease rates indicative of historical levels. Our cost of capital has increased over the past year as we transition some of our short term revolving borrowings into debt instruments with longer maturities and fixed interest rates. Managing long-term risk involves trade-offs with the competing alternative goal of maximizing short-term profitability. Our intention is to strike an appropriate balance between these competing interests within the context of our investor profile. As interest rates rise, our share price may decline as investors adjust prices to reflect a dividend yield that is sufficiently in excess of a risk-free rate.
For the year ended December 31, 2018, approximately 27% of our revenue was derived from operators of our skilled nursing facilities that receive a significant portion of their revenue from governmental payors, primarily Medicare and Medicaid. Such revenues are subject annually to statutory and regulatory changes and in recent years have been reduced due to federal and state budgetary pressures. Over the past five years, we have selectively diversified our portfolio by directing a significant portion of our investments into properties which do not rely primarily on Medicare and Medicaid reimbursement, but rather on private pay sources (assisted living and memory care facilities, senior living campuses, independent living facilities and entrance-fee communities). We will occasionally acquire skilled nursing facilities in good physical condition with a proven operator and strong local market fundamentals, because diversification implies a periodic rebalancing, but our recent investment focus has been on acquiring need-driven and discretionary senior housing assets.
For individual tenant revenue as a percentage of total lease revenue, Bickford is our largest assisted living tenant, an affiliate of Holiday is our largest independent living tenant, NHC is our largest skilled nursing tenant and Senior Living Communities is our largest entrance-fee community tenant. Our shift toward private payor facilities, as well as our expansion into the discretionary senior housing market, has further resulted in a portfolio whose current composition is relatively balanced between medical facilities, need-driven and discretionary senior housing.
We manage our business with a goal of increasing the regular annual dividends paid to shareholders. Our Board of Directors approves a regular quarterly dividend which is reflective of expected taxable income on a recurring basis. Our transactions that are infrequent and non-recurring that generate additional taxable income have been distributed to shareholders in the form of special dividends. Taxable income is determined in accordance with the Internal Revenue Code and differs from net income for
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financial statements purposes determined in accordance with U.S. generally accepted accounting principles. Our goal of increasing annual dividends requires a careful balance between identification of high-quality lease and mortgage assets in which to invest and the cost of our capital with which to fund such investments. We consider the competing interests of short and long-term debt (interest rates, maturities and other terms) versus the higher cost of new equity. We accept some level of risk associated with leveraging our investments. We intend to continue to make new investments that meet our underwriting criteria and where the spreads over our cost of capital will generate sufficient returns to our shareholders.
Our dividends per share for the last three years are as follows:
2018 | 2017 | 2016 | ||||||||
$ | 4.00 | $ | 3.80 | $ | 3.60 | |||||
Our investments in healthcare real estate have been partially accomplished by our ability to effectively leverage our balance sheet. However, we continue to maintain a relatively low-leverage balance sheet compared with many in our peer group. We believe that our fixed charge coverage ratio, which is the ratio of Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization, including amounts in discontinued operations, excluding real estate asset impairments and gains on dispositions) to fixed charges (interest expense at contractual rates net of capitalized interest and principal payments on debt), and the ratio of consolidated net debt to Adjusted EBITDA are meaningful measures of our ability to service our debt. We use these two measures as a useful basis to compare the strength of our balance sheet with those in our peer group. We also believe this gives us a competitive advantage when accessing debt markets.
We calculate our fixed charge coverage ratio as approximately 6.0x for the year ended December 31, 2018 (see our discussion of Adjusted EBITDA and a reconciliation to our net income on page 52). Giving effect to our acquisitions and financings on an annualized basis, our consolidated net debt-to Adjusted EBITDA ratio is approximately 4.5x for the year ended December 31, 2018 (in thousands):
Consolidated Total Debt | $ | 1,281,675 | |
Less: cash and cash equivalents | (4,659 | ) | |
Consolidated Net Debt | $ | 1,277,016 | |
Adjusted EBITDA | $ | 280,190 | |
Annualized impact of recent investments | 2,175 | ||
$ | 282,365 | ||
Consolidated Net Debt to Adjusted EBITDA | 4.5 | x | |
According to the Administration on Aging (“AoA”) of the US Department of Health and Human Services, in 2016, the latest year for which data is available, 49.2 million people were age 65 or older in the United States (a 33% increase over the last ten years). Census estimates showed that, by 2040, those 65 or older are expected to constitute 21.7% of the population. The population aged 85 and above is projected to rise from 6.4 million in 2016 to 14.6 million in the US by 2040 (a 129% increase).
Per the AoA, in 2015, the median value of homes owned by older homeowners age 75 and over was $150,000 (with a median purchase price of $53,000). In comparison, the median home value of all homeowners was $180,000. Of the 11.9 million households headed by persons age 75 and over in 2015, 76% were owners. About 78% of these older homeowners in 2015 owned their homes free and clear. Home ownership provides the elderly with greater freedom to choose their lifestyles.
Equipped with the basics of financial security, many will be economically able to enter the market for senior housing. These strong demographic trends provide the context for continued growth in senior housing in 2019 and the years ahead. We plan to fund any new real estate and mortgage investments during 2019 using our liquid assets and debt financing. As the weight of additional debt resulting from new acquisitions suggests the need to rebalance our capital structure, we would then expect to access the capital markets through an at-the-market (“ATM”) or other equity offering. Our disciplined investment strategy implemented through measured increments of debt and equity sets the stage for access to capital at the lowest possible rates, annual dividend growth, continued low leverage, a portfolio of diversified, high-quality assets, and business relationships with experienced operators whom we make our priority, continue to be the key drivers of our business plan.
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Critical Accounting Policies
Estimates
We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. These accounting principles require us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. If actual experience differs from the assumptions and other considerations used in estimating amounts reflected in our consolidated financial statements, the resulting changes could have a material adverse effect on our consolidated results of operations, liquidity and/or financial condition.
We consider an accounting estimate or assumption critical if:
1. | the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change; and |
2. | the impact of the estimates and assumptions on financial condition or operating performance is material. |
Valuations and Impairments
Our tenants and borrowers who operate SNFs derive their revenues primarily from Medicare, Medicaid and other government programs. Amounts paid under these government programs are subject to legislative and government budget constraints. From time to time, there may be material changes in government reimbursement. In the past, SNFs have experienced material reductions in government reimbursement.
The long-term health care industry has experienced significant professional liability claims which have resulted in an increase in the cost of insurance to cover potential claims. In previous years, these factors have combined to cause a number of bankruptcy filings, bankruptcy court rulings and court judgments affecting our lessees and borrowers. In prior years, we have determined that impairment of certain of our loan investments had occurred as a result of these events.
We evaluate the recoverability of the carrying values of our properties on a property-by-property basis. On a quarterly basis, we review our properties for recoverability when events or circumstances, including significant physical changes in the property, significant adverse changes in general economic conditions and significant deteriorations of the underlying cash flows of the property, indicate that the carrying amount of the property may not be recoverable. The need to recognize an impairment charge is based on estimated undiscounted future cash flows from a property compared to the carrying value of that property. If recognition of an impairment charge is necessary, it is measured as the amount by which the carrying amount of the property exceeds the fair value of the property.
For our mortgage and other notes receivable, we evaluate the estimated collectibility of contractual loan payments and general economic conditions on an instrument-by-instrument basis. On a quarterly basis, we review our notes receivable for ability to realize on such notes when events or circumstances, including the non-receipt of contractual principal and interest payments, significant deteriorations of the financial condition of the borrower and significant adverse changes in general economic conditions, indicate that the carrying amount of the note receivable may not be recoverable. If necessary, impairment is measured as the amount by which the carrying amount exceeds the fair value as measured by the discounted cash flows expected to be received under the note receivable or, if foreclosure is probable, the fair value of the collateral securing the note receivable.
The determination of fair value and whether a shortfall in operating revenues or the existence of operating losses is indicative of a loss in value that is other than temporary involves significant judgment. Our estimates consider all available evidence including, as appropriate, the present value of the expected future cash flows discounted at market rates, general economic conditions and trends, the duration of the fair value deficiency, and any other relevant factors. While we believe our assumptions are reasonable, changes in these assumptions may have a material impact on our financial results.
While we believe that the carrying amounts of our properties are recoverable and our notes receivable and other investments are realizable, it is possible that future events could require us to make significant adjustments or revisions to these estimates.
Revenue Recognition
We collect rent and interest from our tenants and borrowers. Generally, our policy is to recognize income on an accrual basis as earned. However, when we determine, based on current collections and the lack of expected future collections, that rent or
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interest is not probable of collection until received, our policy is to recognize rental or interest income when assured, which we consider to be the period in which cash is received or accrued on the basis of tenant security deposits available to us for the recognition of lease revenue in the period in which it was earned. We identify investments as nonperforming if a required payment is not received within 30 days of the date it is due. This policy could cause our revenues to vary significantly from period to period. Rental income from minimum lease payments under our leases is recognized on a straight-line basis to the extent that future lease payments are considered collectible. Lease payments that depend on a factor directly related to future use of the property, such as an increase in annual revenues over base year revenues, are considered to be contingent rentals and are included in rental income when they are determinable and earned.
REIT Qualification
As part of the process of preparing our consolidated financial statements, significant management judgment is required to evaluate our compliance with REIT requirements. Our determinations are based on interpretation of tax laws, and our conclusions may have an impact on the income tax expense recognized. We believe that we have operated our business so as to qualify as a REIT under Sections 856 through 860 of the Internal Revenue Code, and we intend to continue to operate in such a manner, but no assurance can be given that we will be able to so qualify at all times. Until September 30, 2016, we operated a taxable REIT subsidiary under a joint venture structured to comply with the provisions of the RIDEA through which we invested in facility operations managed by independent third-parties. On September 30, 2016, NHI and Bickford entered into a definitive agreement terminating the joint venture. In the past we recorded income tax expense or benefit with respect to the subsidiary which was taxed under provisions similar to those applicable to regular corporations. Aside from such income taxes that may have been applicable to the taxable income in our taxable REIT subsidiary, we are not subject to U.S. federal income tax, provided that we continue to qualify as a REIT and make distributions to stockholders equal to or in excess of our taxable income. This treatment substantially eliminates the “double taxation” (at the corporate and stockholder levels) that typically applies to corporate dividends. Our failure to continue to qualify under the applicable REIT qualification rules and regulations would cause us to owe state and federal income taxes and would have a material adverse impact on our financial position, results of operations and cash flows.
Principles of Consolidation
The consolidated financial statements include our accounts, the accounts of our wholly-owned subsidiaries and the accounts of joint ventures in which we own a majority voting interest with the ability to control operations and where no substantive participating rights or substantive kick-out rights have been granted to the noncontrolling interests. In addition, we consolidate a legal entity deemed to be a variable interest entity (“VIE”) when we determine that we are the VIE’s primary beneficiary. All material inter-company transactions and balances have been eliminated in consolidation.
We apply Financial Accounting Standards Board (“FASB”) guidance for our arrangements with VIEs which requires us to identify entities for which control is achieved through means other than voting rights and to determine which business enterprise is the primary beneficiary of the VIE. A VIE is broadly defined as an entity with one or more of the following characteristics: (a) the total equity investment at risk is insufficient to finance the entity’s activities without additional subordinated financial support; (b) as a group, the holders of the equity investment at risk lack (i) the ability to make decisions about the entity’s activities through voting or similar rights, (ii) the obligation to absorb the expected losses of the entity, or (iii) the right to receive the expected residual returns of the entity; or (c) the equity investors have voting rights that are not proportional to their economic interests, and substantially all of the entity’s activities either involve, or are conducted on behalf of, an investor that has disproportionately few voting rights. We may change our assessment of a VIE due to events such as modifications of contractual arrangements that affect the characteristics or adequacy of the entity’s equity investments at risk and the disposal of all or a portion of an interest held by the primary beneficiary.
Real Estate Properties
Real property we develop is recorded at cost, including the capitalization of interest during construction. The cost of real property investments we acquire is allocated to net tangible and identifiable intangible assets based on their relative fair values. We make estimates as part of our allocation of the purchase price of acquisitions to the various components of the acquisition based upon the fair value of each component. For properties acquired in transactions accounted for as asset purchases, the purchase price allocation is based on the relative fair values of the assets acquired. Cost includes the amount of contingent consideration, if any, deemed to be probable at the acquisition date. Contingent consideration is deemed to be probable to the extent that a significant reversal in amounts recognized is not likely to occur when the uncertainty associated with the contingent consideration is subsequently resolved. The most significant components of our allocations are typically the allocation of fair value to land, equipment, buildings and other improvements, and intangible assets, if any. Our estimates of the values of these components will affect the amount of depreciation and amortization we record over the estimated useful life of the property acquired or the remaining lease term.
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Our leases are typically structured as “triple net leases” on single-tenant properties having an initial leasehold term of 10 to 15 years with one or more 5-year renewal options. As such, there may be reporting periods in which we experience few, if any, lease renewals or expirations. During the year ended December 31, 2018, we did not have any renewing or expiring leases.
Most of our existing leases contain annual escalators in rent payments. For financial statement purposes, rental income is recognized on a straight-line basis over the term of the lease. Certain of our operators hold purchase options allowing them to acquire properties they currently lease from NHI. For options open or coming open in the short term, we are engaged in negotiations to continue as lessor or in some other capacity.
We adjust rental income for the amortization of payments recorded as the result of the eventual settlement of commitments and contingencies listed later in Item 7 as lease inducements. Amortization of these payments against revenues was $387,000, $119,000 and $40,000 for the years ended December 31, 2018, 2017 and 2016, respectively.
Major Tenants
As discussed in Note 2 to the consolidated financial statements, we have four lessees (including their affiliated entities, which are the legal tenants) from whom we individually derive at least 10% of our rental income as follows (dollars in thousands):
Original | Rental Income | ||||||||||||||||
Investment | Year Ended December 31, | Lease | |||||||||||||||
Asset Class | Amount | 2018 | 2017 | Renewal | |||||||||||||
Senior Living Communities | EFC | $ | 551,459 | $ | 45,868 | 16% | $ | 45,735 | 17% | 2029 | |||||||
Bickford Senior Living | ALF | 531,918 | 50,093 | 18% | 41,606 | 16% | Various | ||||||||||
Holiday Retirement | ILF | 493,378 | 43,311 | 15% | 43,817 | 17% | 2035 | ||||||||||
National HealthCare Corporation | SNF | 171,297 | 37,843 | 13% | 37,467 | 14% | 2026 | ||||||||||
All others | Various | 1,067,842 | 103,698 | 38% | 96,544 | 36% | Various | ||||||||||
$ | 2,815,894 | $ | 280,813 | $ | 265,169 | ||||||||||||
Straight-line rent of $5,436,000 and $6,984,000 was recognized from the Senior Living lease for the years ended December 31, 2018 and 2017, respectively. Straight-line rent of $5,028,000 and $5,102,000 was recognized from the Bickford leases for the years ended December 31, 2018 and 2017, respectively. Straight-line rent of $5,616,000 and $7,397,000 was recognized from the Holiday lease for the years ended December 31, 2018 and 2017, respectively. In November 2018, we announced an agreement with Holiday to receive approximately $65,762,000 in specified cash and other consideration in exchange for a reduced annual rental payment for the existing 25 properties, beginning at $31,500,000 for 2019, as discussed below under the heading Other Portfolio Activity. For NHC, rent escalations are based on a percentage increase in revenue over a base year and do not give rise to non-cash, straight-line rental income.
Our operators report to us the results of their operations on a periodic basis, which we in turn subject to further analysis as a means of monitoring potential concerns within our portfolio. We have identified EBITDARM (earnings before interest, taxes, depreciation, amortization, rent and management fees) as the most elemental barometer of success for our tenants, based on results they have reported to us. We believe EBITDARM is useful in our most fundamental analyses, as it is a property level measure of our operators’ success, by eliminating the effects of the operator’s method of acquiring the use of its assets (interest and rent), its non-cash expenses (depreciation and amortization), expenses that are dependent on its level of success (income taxes), and also excluding the effect of the operator’s payment of its management fees, as typically those fees are contractually subordinate to our lease payment. For operators of our entrance-fee communities, our calculation of EBITDARM includes other cash flow adjustments typical of the industry which may include, but are not limited to, net cash flows from entrance fees; amortization of deferred entrance fees; adjustments for tenant rent obligations, depreciation and amortization; and management fee true-ups. The eliminations and adjustments reflect covenants in our leases and provide a comparable basis for assessing our various relationships
We believe that EBITDARM is a useful way to analyze the cash potential of a group of assets. From EBITDARM we calculate a lease coverage ratio (EBITDARM/Cash Rent), measuring the ability of the operator to meet its monthly rental obligation. In addition to EBITDARM and the lease coverage ratio, we rely on, a careful balance sheet analysis, and other analytical procedures to help us identify potential areas of concern relative to our operators’ ability to generate sufficient liquidity to meet their obligations, including their obligation to continue to pay the rent due to us. Typical among our operators is a varying lag in reporting to us the results of their operations. Across our portfolio, however, our operators report their results, at the latest, within ninety days of month’s end. For computational purposes, we exclude development and lease-up properties that have been in operation less than
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24 months and selected immaterial properties identified in 2019 as available for sale.For stabilized acquisitions in the portfolio less than 24 months and renewing leases with changes in scheduled rent, we include pro forma cash rent. For this reporting period, we have excluded results from SH Regency Leasing, LLC, as noted below under the heading Other Portfolio Activity.
The results by asset type are presented below on a trailing twelve-month basis, as of September 30, 2018 and 2017 (the most recent periods available):
EBITDARM / Cash Rent Twelve Months Ended September 30, 2018 | ||||||||||||
Bickford | Senior Living | Holiday | NHC | All Other | Total | |||||||
Discretionary | — | 1.28 | x | 1.17 | x | — | 2.24 | x | 1.29 | x | ||
Need-Driven | 1.10 | x | — | — | — | 1.09 | x | 1.09 | x | |||
Total SHO | 1.10 | x | 1.28 | x | 1.17 | x | — | 1.23 | x | 1.19 | x | |
Skilled Nursing | — | — | — | 3.66 | x | 1.54 | x | 2.58 | x | |||
Hospitals | — | — | — | — | 1.82 | x | 1.82 | x | ||||
Medical Office | — | — | — | — | 4.12 | x | 4.12 | x | ||||
Total Lease Portfolio | 1.10 | x | 1.28 | x | 1.17 | x | 3.66 | x | 1.43 | x | 1.64 | x |
EBITDARM / Cash Rent Twelve Months Ended September 30, 2017 | ||||||||||||
Bickford | Senior Living | Holiday | NHC | All Other | Total | |||||||
Discretionary | — | 1.26 | x | 1.16 | x | — | 1.92 | x | 1.26 | x | ||
Need-Driven | 1.20 | x | — | — | — | 1.19 | x | 1.19 | x | |||
Total SHO | 1.20 | x | 1.26 | x | 1.16 | x | — | 1.27 | x | 1.22 | x | |
Skilled Nursing | — | — | — | 3.61 | x | 1.40 | x | 2.49 | x | |||
Hospitals | — | — | — | — | 2.11 | x | 2.11 | x | ||||
Medical Office | — | — | — | — | 4.79 | x | 4.79 | x | ||||
Total Lease Portfolio | 1.20 | x | 1.26 | x | 1.16 | x | 3.61 | x | 1.43 | x | 1.65 | x |
Number of Properties | ||||||||||||
Bickford | Senior Living | Holiday | NHC1 | All Other | Total | |||||||
Discretionary | — | 9 | 25 | — | 3 | 37 | ||||||
Need-Driven | 46 | — | — | — | 48 | 94 | ||||||
Total SHO | 46 | 9 | 25 | — | 51 | 131 | ||||||
Skilled Nursing | — | — | — | 42 | 30 | 72 | ||||||
Hospitals | — | — | — | — | 3 | 3 | ||||||
Medical Office | — | — | — | — | 2 | 2 | ||||||
Total Lease Portfolio | 46 | 9 | 25 | 42 | 86 | 208 | ||||||
1 NHC based on corporate-level fixed-charge coverage and includes 3 independent living facilities
Fluctuations in portfolio coverage are a result of market and economic trends, local market competition, and regulatory factors as well as the operational success of our tenants. We use the results of individual leases to inform our decision making with respect to specific tenants, but trends described above by property type and operator bear analysis. Our Need-Driven SHO portfolio shows a decline brought about primarily by a softening in occupancy within particular markets, as well as rising wage pressures. For many of the affected operators, as is typical of our portfolio in general, NHI has significant security deposits in place and/or corporate guarantees should actual cash rental shortfalls eventually materialize. In certain instances, our operators may elect to increase their security deposits with us in an amount equal to the coverage shortfall, and, upon subsequent compliance with the required lease coverage ratio, the operator would then be entitled to a full refund. The metrics presented in the tables above give no effect to the presence of these security deposits. For Skilled Nursing, coverage in the All Other segment of our portfolio has improved due to a better operating environment for the segment, as a whole, and for the Ensign portfolio transition, in particular. Each MOB’s coverage is driven by the underlying performance of its on-campus hospital as the tenant or guarantor under the lease. In Texas, the aftermath of Hurricane Harvey in 2017 witnessed the shut-down of the guarantor hospital for a few days resulting in lost revenue, overtime and other one-time charges, negatively impacting the hospital’s bottom-line and
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resultant coverage ratios for that MOB. Within the context of this event-specific occurrence, it is also typical of MOB operations that there may be other large fluctuations in coverage resulting from hospital operations.
RIDEA
On September 30, 2016, NHI and Sycamore Street, LLC (“Sycamore”), an affiliate of Bickford, entered into a definitive agreement terminating our joint venture which consisted of the ownership and operation of 40 properties and converting Bickford’s participation to a triple-net tenancy with assumption of existing leases and terms. Through September 30, 2016, NHI owned an 85% equity interest and Sycamore owned a 15% equity interest in our consolidated subsidiary, PropCo which owned 40 assisted living/memory care facilities, three new facilities and two facilities in development. The facilities had been leased to OpCo, in which NHI previously held a non-controlling 85% ownership interest. The facilities are managed by Bickford. The joint venture was structured to comply with the provisions of RIDEA. For the combined transaction, we recognized a gain of $1,657,000 on the sale of OpCo; we recognized $462,000 of income tax expense in applying a full valuation allowance to our state net operating loss carry-forwards on our Taxable REIT Subsidiary; Bickford’s non-controlling interest was de-recognized; and the difference between the fair value of NHI’s cost allocated to the redemption and the carrying amount of the 15% non-controlling interest was recorded as an adjustment to equity through additional-paid-in capital.
Potential Effects of Medicare Reimbursement
Our SNF operators receive a significant portion of their revenues from governmental payors, primarily Medicare (federal) and Medicaid (states). Changes in reimbursement rates and limits on the scope of services reimbursed to skilled nursing facilities could have a material impact on the operators’ liquidity and financial condition. On August 1, 2018, the Centers for Medicare and Medicaid Services (“CMS”) announced the CMS Skilled Nursing Prospective Payment System (“PPS”) final rule whereby, effective October 1, 2019, its Patient-Driven Payment Model (“PDPM”) will replace Resource Utilization Groups (“RUGs”)-IV. Facilities will have one year to transition to PDPM from RUGs-IV by the October 1, 2019 implementation date. PDPM is designed as a more simplified payment model than RUGs-IV and is projected to reduce administrative costs and foster innovation to improve care to patients. Regulators forecast a $2 billion reduction in provider costs over 10 years as a result of simplified paperwork requirements for resident assessments. The new model shifts care delivery under Medicare away from fee-for-service, which in the past has based reimbursement on the amount of care provided, to focus on value-based care, which will base reimbursement on clinical complexity and the resident’s conditions and care needs. The final rule also established a 2.4% market basket increase beginning October 1, 2018.
We currently estimate that our borrowers and lessees will find these Medicare increases to be adequate in the near term due to their credit quality, profitability and their debt or lease coverage ratios, although no assurances can be given as to what the ultimate effect that PDPM increases on an annual basis will have on each of our borrowers and lessees. According to industry studies, state Medicaid funding is not expected to keep pace with inflation. Any future acquisitions by NHI of skilled nursing facilities are planned on a selective basis, with emphasis on operator quality and newer construction.
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Investment Highlights
Since January 1, 2018, we have made or announced the following real estate and note investments ($ in thousands):
Date | Properties | Asset Class | Amount | |||||||
2018 | ||||||||||
Lease Investments | ||||||||||
The Ensign Group | January / May 2018 | 3 | SNF | $ | 43,404 | |||||
Bickford Senior Living | April 2018 | 5 | SHO | 69,750 | ||||||
Comfort Care Senior Living | May 2018 | 2 | SHO | 17,140 | ||||||
Ignite Medical Resorts | December 2018 | 1 | SNF | 25,350 | ||||||
Note Investments | ||||||||||