UNIVERSAL HEALTH REALTY INCOME TRUST – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
We are a real estate investment trust ("REIT") that commenced operations in
1986. We invest in healthcare and human service related facilities currently
including acute care hospitals, behavioral health care hospitals, specialty
facilities, free-standing emergency departments, childcare centers and
medical/office buildings. As of
investments or commitments located in twenty-one states consisting of:
• six hospital facilities consisting of three acute care hospitals and three behavioral health care hospitals; • four free-standing emergency departments ("FEDs"); • fifty-nine medical/office buildings, including four owned by unconsolidated limited liability companies ("LLCs")/limited liability partnerships ("LPs"); • four preschool and childcare centers, and; • three specialty facilities that are currently vacant.
Forward Looking Statements and Certain Risk Factors
You should carefully review all of the information contained in this Quarterly
Report, and should particularly consider any risk factors that we set forth in
our Annual Report on Form 10-K for the year ended
Quarterly Report and in other reports or documents that we file from time to
time with the
Report, we state our beliefs of future events and of our future financial
performance. This Quarterly Report contains "forward-looking statements" that
reflect our current estimates, expectations and projections about our future
results, performance, prospects and opportunities. Words such as "may," "will,"
"should," "could," "would," "predicts," "potential," "continue," "expects,"
"anticipates," "future," "intends," "plans," "believes," "estimates," "appears,"
"projects" and similar expressions, as well as statements in future tense,
identify forward-looking statements. You should be aware that those statements
are only our predictions. Actual events or results may differ materially. In
evaluating those statements, you should specifically consider various factors,
including the risks described elsewhere herein and in our Annual Report on Form
10-K for the year ended
Management's Discussion and Analysis of Financial Condition and Results of
Operations-Forward Looking Statements and in Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations-Forward Looking
Statements and Risk Factors, as included herein. Those factors may cause our
actual results to differ materially from any of our forward-looking statements.
Forward-looking statements should not be read as a guarantee of future
performance or results and will not necessarily be accurate indications of the
times at, or by which, such performance or results will be achieved.
Forward-looking information is based on information available at the time and/or
our good faith belief with respect to future events and is subject to risks and
uncertainties that could cause actual performance or results to differ
materially from those expressed in the statements. Such factors include, among
other things, the following:
• Future operations and financial results of our tenants, and in turn ours, will likely be materially impacted by numerous factors and future developments related to COVID-19. Such factors and developments include, but are not limited to, the length of time and severity of the spread of the pandemic; the volume of cancelled or rescheduled elective procedures and the volume of COVID-19 patients treated by the operators of our hospitals and other healthcare facilities; measures our tenants are taking to respond to the COVID-19 pandemic; the impact of government and administrative regulation, including travel bans and restrictions, shelter-in-place or stay-at-home orders, quarantines, the promotion of social distancing, business shutdowns and limitations on business activity; vaccine requirements; changes in patient volumes at our tenants' hospitals and other healthcare facilities due to patients' general concerns related to the risk of contracting COVID-19 from interacting with the healthcare system; changes in patient volumes and payer mix caused by deteriorating macroeconomic conditions (including increases in uninsured and underinsured patients as the result of business closings and layoffs); potential disruptions to clinical staffing and shortages and disruptions related to supplies required for our tenants' employees and patients, including equipment, pharmaceuticals and medical supplies, potential increases to expenses incurred by our tenants related to staffing, supply chain or other expenditures; the impact of our indebtedness and the ability to refinance such indebtedness on acceptable terms; disruptions in the financial markets and the business of financial institutions as the result of the COVID-19 pandemic which could impact our ability to access capital or increase associated borrowing costs; and changes in general economic conditions nationally and regionally in the markets our properties are located resulting from the COVID-19 pandemic, including higher sustained rates of unemployment and underemployment levels and reduced consumer spending and confidence. The nationwide shortage of nurses and other clinical staff and support personnel has been a significant operating issues facing our healthcare provider tenants, including UHS. In some areas, the labor scarcity is putting a strain on the resources of our tenants and their staff, which has required them to utilize higher-cost temporary labor and pay premiums 22
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above standard compensation for essential workers. In addition to significantly increasing the labor cost of our tenants, the healthcare staffing shortage could also require the operators of our hospital facilities to limit the services provided which would have an adverse effect on their operating revenues. There may be significant declines in future bonus rental revenue earned on one acute care hospital leased to a subsidiary of UHS to the extent that the hospital experiences significant declines in patient volumes and revenues. These factors may result in the inability or unwillingness on the part of some of our tenants to make timely payment of their rent to us at current levels or to seek to amend or terminate their leases which, in turn, would have an adverse effect on our occupancy levels and our revenue and cash flow and the value of our properties, and potentially, our ability to maintain our dividend at current levels. • Due to COVID-19 restrictions and its impact on the economy, we may experience a decrease in prospective tenants which could unfavorably impact the volume of new leases, as well as the renewal rate of existing leases. The COVID-19 pandemic may delay our construction projects which could result in increased costs and delay the timing of opening and rental payments from those projects, although no such delays have yet occurred. The COVID-19 pandemic could also impact our indebtedness and the ability to refinance such indebtedness on acceptable terms, as well as risks associated with disruptions in the financial markets and the business of financial institutions as the result of the COVID-19 pandemic which could impact us from a financing perspective; and changes in general economic conditions nationally and regionally in the markets our properties are located resulting from the COVID-19 pandemic. Although COVID-19 has not previously had a material adverse impact on our financial results, we are not able to quantify the impact that these factors could have on our future financial results and therefore can provide no assurance that developments related to the COVID-19 pandemic will not have a material adverse impact on our future financial results. • TheCenters for Medicare and Medicaid Services ("CMS") issued an Interim Final Rule ("IFR") effectiveNovember 5, 2021 mandating COVID-19 vaccinations for all applicable staff at all Medicare and Medicaid certified facilities. Under the IFR, facilities covered by this regulation must establish a policy ensuring all eligible staff have received the first dose of a two-dose COVID-19 vaccine or a one-dose COVID-19 vaccine prior to providing any care, treatment, or other services byDecember 5, 2021 . All eligible staff must have received the necessary shots to be fully vaccinated - either two doses of Pfizer or Moderna or one dose of Johnson & Johnson - byJanuary 4, 2022 . The regulation also provides for exemptions based on recognized medical conditions or religious beliefs, observances, or practices. Under the IFR, facilities must develop a similar process or plan for permitting exemptions in alignment with federal law. If facilities fail to comply with the IFR by the deadlines established, they are subject to potential termination from the Medicare and Medicaid program for non-compliance. In addition, theOccupational Safety and Health Administration also issued an Emergency Temporary Standard ("ETS") requiring all businesses with 100 or more employees to be vaccinated byJanuary 4, 2022 . Pursuant to the ETS, those employees not vaccinated by that date will need to show a negative COVID-19 test weekly and wear a face mask in the workplace. Legal challenges to these rules ensued, and theU.S. Supreme Court has upheld a stay of the ETS requirements but permitted the IFR vaccination requirements to go into effect pending additional litigation. CMS has indicated that hospitals in states not involved in theSupreme Court litigation are expected to be in compliance with IFR vaccination requirements consistent with the dates referenced above. Hospitals in states that were involved in theSupreme Court litigation must now come into compliance with second dose requirements byMarch 15, 2022 . Hospitals inTexas must come into compliance with second dose requirements byMarch 21, 2022 due to the recent termination of separate litigation there. We cannot predict at this time the potential viability or impact of any such additional litigation on us or the operators of our facilities. Implementation of these rules could have an impact on staffing at the operators of our facilities for those employees that are not vaccinated in accordance with IFR and ETS requirements, and associated loss of revenues and increased costs resulting from staffing issues could have a material adverse effect on our financial results or those of the operators. • Recent legislation, including the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"), the Paycheck Protection Program and Health Care Enhancement Act ("PPPHCE Act") and the American Rescue Plan Act of 2021 ("ARPA"), has provided grant funding to hospitals and other healthcare providers to assist them during the COVID-19 pandemic. There is a high degree of uncertainty surrounding the implementation of the CARES Act, the PPPHCE Act and ARPA, and the federal government may consider additional stimulus and relief efforts, but we are unable to predict whether additional stimulus measures will be enacted or their impact. There can be no assurance as to the total amount of financial and other types of assistance our tenants will receive under the CARES Act, the PPPHCE Act and the ARPA, and it is difficult to predict the impact of such legislation on our tenants' operations or how they will affect operations of our tenants' competitors. There can be no assurance as to whether our tenants would be required to repay any previously granted funding, due to noncompliance with grant terms or otherwise. Moreover, we are unable to assess the extent to which anticipated negative impacts on our tenants (and, in turn, us) arising from the COVID-19 pandemic will be offset by amounts or benefits received or to be received under the CARES Act, the PPPHCE Act and the ARPA. • A substantial portion of our revenues are dependent upon one operator, UHS, which comprised approximately 41% and 36% of our consolidated revenues for the three-month periods endedMarch 31, 2022 and 2021, respectively. As previously disclosed, onDecember 31, 2021 , a wholly-owned subsidiary of UHS purchased the real estate assets ofInland Valley 23
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Campus ofSouthwest Healthcare System from us and in exchange, transferred the real estate assets ofAiken Regional Medical Center and Canyon Creek Behavioral Health to us. These transactions were approved by the Independent Trustees of our Board, as well as the UHS Board of Directors. The aggregate annual rental revenue during 2022 pursuant to the leases for the two facilities transferred to us is approximately$5.7 million ; there is no bonus rent component applicable to either of these leases. Pursuant to the terms of the lease on the Inland Valley Campus, we earned$4.5 million of lease revenue during year endedDecember 31, 2021 ($2.6 million in base rental and$1.9 million in bonus rental). Please see Note 7 to the condensed consolidated financial statements - Lease Accounting, for additional information related to this asset purchase and sale transaction between us and UHS. • We cannot assure you that subsidiaries of UHS will renew the leases on the hospital facilities and free-standing emergency departments, upon the scheduled expirations of the existing lease terms. In addition, if subsidiaries of UHS exercise their options to purchase the respective leased hospital facilities and FEDs, and do not enter into a substitution arrangement upon expiration of the lease terms or otherwise, our future revenues and results of operations could decrease if we were unable to earn a favorable rate of return on the sale proceeds received, as compared to the rental revenue currently earned pursuant to these leases. Please see Note 7 to the consolidated financial statements - Lease Accounting, for additional information related to a lease renewal between us andWellington Regional Medical Center , a wholly-owned subsidiary of UHS. • In certain of our markets, the general real estate market has been unfavorably impacted by increased competition/capacity and decreases in occupancy and rental rates which may adversely impact our operating results and the underlying value of our properties. • A number of legislative initiatives have recently been passed into law that may result in major changes in the health care delivery system on a national or state level to the operators of our facilities, including UHS. No assurances can be given that the implementation of these new laws will not have a material adverse effect on the business, financial condition or results of operations of our operators. • The potential indirect impact of the Tax Cuts and Jobs Act of 2017, signed into law onDecember 22, 2017 , which makes significant changes to corporate and individual tax rates and calculation of taxes, which could potentially impact our tenants and jurisdictions, both positively and negatively, in which we do business, as well as the overall investment thesis for REITs. • A subsidiary of UHS is our Advisor and our officers are all employees of a wholly-owned subsidiary of UHS, which may create the potential for conflicts of interest. • Lost revenues resulting from the exercise of purchase options, lease expirations and renewals and other transactions (see Note 7 to the condensed consolidated financial statements - Lease Accounting for additional disclosure related to lease expirations and subsequent vacancies that occurred during the second and third quarters of 2019 and the fourth quarter of 2021 on three specialty hospital facilities). • Potential unfavorable tax consequences and reduced income resulting from an inability to complete, within the statutory timeframes, anticipated tax deferred like-kind exchange transactions pursuant to Section 1031 of the Internal Revenue Code, if, and as, applicable from time-to-time. • Our ability to continue to obtain capital on acceptable terms, including borrowed funds, to fund future growth of our business. • The outcome and effects of known and unknown litigation, government investigations, and liabilities and other claims asserted against us, UHS or the other operators of our facilities. UHS and its subsidiaries are subject to legal actions, purported shareholder class actions and shareholder derivative cases, governmental investigations and regulatory actions and the effects of adverse publicity relating to such matters. Since UHS comprised approximately 41% of our consolidated revenues during the three months endedMarch 31, 2022 , and since a subsidiary of UHS is our Advisor, you are encouraged to obtain and review the disclosures contained in the Legal Proceedings section of Universal Health Services, Inc.'s Forms 10-Q and 10-K, as publicly filed with theSecurities and Exchange Commission . Those filings are the sole responsibility of UHS and are not incorporated by reference herein. • Failure of UHS or the other operators of our hospital facilities to comply with governmental regulations related to the Medicare and Medicaid licensing and certification requirements could have a material adverse impact on our future revenues and the underlying value of the property. • The potential unfavorable impact on our business of the deterioration in national, regional and local economic and business conditions, including a worsening of credit and/or capital market conditions, which may adversely affect our ability to obtain capital which may be required to fund the future growth of our business and refinance existing debt with near term maturities. • A continuation in the deterioration in general economic conditions which has resulted in increases in the number of people unemployed and/or insured and likely increase the number of individuals without health insurance. Under these 24
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circumstances, the operators of our facilities may experience declines in patient volumes which could result in decreased occupancy rates at our medical office buildings. • A continuation of the worsening of the economic and employment conditions inthe United States would likely materially affect the business of our operators, including UHS, which would likely unfavorably impact our future bonus rental revenue (on one UHS hospital facility) and may potentially have a negative impact on the future lease renewal terms and the underlying value of the hospital properties. • Real estate market factors, including without limitation, the supply and demand of office space and market rental rates, changes in interest rates as well as an increase in the development of medical office condominiums in certain markets. • The impact of property values and results of operations of severe weather conditions, including the effects of hurricanes. • Government regulations, including changes in the reimbursement levels under the Medicare and Medicaid programs. • The issues facing the health care industry that affect the operators of our facilities, including UHS, such as: changes in, or the ability to comply with, existing laws and government regulations; unfavorable changes in the levels and terms of reimbursement by third party payors or government programs, including Medicare (including, but not limited to, the potential unfavorable impact of future reductions to Medicare reimbursements resulting from the Budget Control Act of 2011, as discussed in the next bullet point below) and Medicaid (most states have reported significant budget deficits that have, in the past, resulted in the reduction of Medicaid funding to the operators of our facilities, including UHS); demographic changes; the ability to enter into managed care provider agreements on acceptable terms; an increase in uninsured and self-pay patients which unfavorably impacts the collectability of patient accounts; decreasing in-patient admission trends; technological and pharmaceutical improvements that may increase the cost of providing, or reduce the demand for, health care, and; the ability to attract and retain qualified medical personnel, including physicians. • The Budget Control Act of 2011 imposed annual spending limits for most federal agencies and programs aimed at reducing budget deficits by$917 billion between 2012 and 2021, according to a report released by theCongressional Budget Office . Among its other provisions, the law established a bipartisan Congressional committee, known as theJoint Select Committee on Deficit Reduction (the "Joint Committee "), which was tasked with making recommendations aimed at reducing future federal budget deficits by an additional$1.5 trillion over 10 years.The Joint Committee was unable to reach an agreement by theNovember 23, 2011 deadline and, as a result, across-the-board cuts to discretionary, national defense and Medicare spending were implemented onMarch 1, 2013 resulting in Medicare payment reductions of up to 2% per fiscal year with a uniform percentage reduction across all Medicare programs. The Bipartisan Budget Act of 2015, enacted onNovember 2, 2015 , continued the 2% reductions to Medicare reimbursement imposed under the Budget Control Act of 2011. Recent legislation has suspended payment reductions throughDecember 31, 2021 in exchange for extended cuts through 2030. Subsequent legislation extended the payment reduction suspension throughMarch 31, 2022 , with a 1% payment reduction from then untilJune 30, 2022 and the full 2% payment reduction thereafter. We cannot predict whetherCongress will restructure the implemented Medicare payment reductions or what other federal budget deficit reduction initiatives may be proposed byCongress going forward. We also cannot predict the effect these enactments will have on the operators of our properties (including UHS), and thus, our business. • An increasing number of legislative initiatives have been passed into law that may result in major changes in the health care delivery system on a national or state level. Legislation has already been enacted that has eliminated the penalty for failing to maintain health coverage that was part of the original Patient Protection and Affordable Care Act (the "ACA").President Biden is expected to undertake executive actions that will strengthen the ACA and may reverse the policies of the prior administration. To date, the Biden administration has issued executive orders implementing a special enrollment period permitting individuals to enroll in health plans outside of the annual open enrollment period and reexamining policies that may undermine the ACA or the Medicaid program. The ARPA's expansion of subsidies to purchase coverage through an exchange is anticipated to increase exchange enrollment.The Trump Administration had directed the issuance of final rules: (i) enabling the formation of association health plans that would be exempt from certain ACA requirements such as the provision of essential health benefits; (ii) expanding the availability of short-term, limited duration health insurance, (iii) eliminating cost-sharing reduction payments to insurers that would otherwise offset deductibles and other out-of-pocket expenses for health plan enrollees at or below 250 percent of the federal poverty level; (iv) relaxing requirements for state innovation waivers that could reduce enrollment in the individual and small group markets and lead to additional enrollment in short-term, limited duration insurance and association health plans; and (v) incentivizing the use of health reimbursement arrangements by employers to permit employees to purchase health insurance in the individual market. The uncertainty resulting from these Executive Branch policies had led to reduced Exchange enrollment in 2018, 2019 and 2020, and is expected to further worsen the individual and small group market risk pools in future years. It is also anticipated that these policies, to the extent that they remain as implemented, may create additional cost and reimbursement pressures on hospitals, including ours. In addition, while attempts to repeal the entirety of the ACA have not been successful to date, a key provision of the ACA was eliminated as part of the Tax Cuts and Jobs Act and onDecember 14, 2018 , a federalU.S. District Court 25
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Judge inTexas ruled the entire ACA is unconstitutional. That ruling was appealed and onDecember 18, 2019 , theFifth Circuit Court of Appeals voted 2-1 to strike down the ACA individual mandate as unconstitutional. The case was ultimately appealed to theUnited States Supreme Court , which decided in California v. Texas that the plaintiffs in the matter lacked standing to bring their constitutionality claims. As a result, the Legislation will continue to remain law, in its entirety, likely for the foreseeable future. • There can be no assurance that if any of the announced or proposed changes described above are implemented there will not be negative financial impact on the operators of our hospitals, which material effects may include a potential decrease in the market for health care services or a decrease in the ability of the operators of our hospitals to receive reimbursement for health care services provided which could result in a material adverse effect on the financial condition or results of operations of the operators of our properties, and, thus, our business. • Competition for properties includes, but is not limited to, other REITs, private investors and firms, banks and other companies, including UHS. In addition, we may face competition from other REITs for our tenants. • The operators of our facilities face competition from other health care providers, including physician owned facilities and other competing facilities, including certain facilities operated by UHS but the real property of which is not owned by us. Such competition is experienced in markets including, but not limited to,McAllen, Texas , the site of ourMcAllen Medical Center , a 370-bed acute care hospital. • Changes in, or inadvertent violations of, tax laws and regulations and other factors that can affect REITs and our status as a REIT, including possible future changes to federal tax laws that could materially impact our ability to defer gains on divestitures through like-kind property exchanges. • The individual and collective impact of the changes made by the CARES Act on REITs and their security holders are uncertain and may not become evident for some period of time; it is also possible additional legislation could be enacted in the future as a result of the COVID-19 pandemic which may affect the holders of our securities. • Should we be unable to comply with the strict income distribution requirements applicable to REITs, utilizing only cash generated by operating activities, we would be required to generate cash from other sources which could adversely affect our financial condition. • Our ownership interest in four LLCs/LPs in which we hold non-controlling equity interests. In addition, pursuant to the operating and/or partnership agreements of the four LLCs/LPs in which we continue to hold non-controlling ownership interests, the third-party member and the Trust, at any time, potentially subject to certain conditions, have the right to make an offer ("Offering Member") to the other member(s) ("Non-Offering Member") in which it either agrees to: (i) sell the entire ownership interest of the Offering Member to the Non-Offering Member ("Offer to Sell") at a price as determined by the Offering Member ("Transfer Price"), or; (ii) purchase the entire ownership interest of the Non-Offering Member ("Offer to Purchase") at the equivalent proportionate Transfer Price. The Non-Offering Member has 60 to 90 days to either: (i) purchase the entire ownership interest of the Offering Member at the Transfer Price, or; (ii) sell its entire ownership interest to the Offering Member at the equivalent proportionate Transfer Price. The closing of the transfer must occur within 60 to 90 days of the acceptance by the Non-Offering Member. Please see Note 5 to the condensed consolidated financial statements - Summarized Financial Information of Equity Affiliates for additional disclosure related to a fourth quarter, 2021 transaction between us and the minority partner inGrayson Properties, LP . • Fluctuations in the value of our common stock. • Other factors referenced herein or in our other filings with the Securities andExchange Commission .
Given these uncertainties, risks and assumptions, you are cautioned not to place
undue reliance on such forward-looking statements. Our actual results and
financial condition, including the operating results of our lessees and the
facilities leased to subsidiaries of UHS, could differ materially from those
expressed in, or implied by, the forward-looking statements.
Forward-looking statements speak only as of the date the statements are made. We
assume no obligation to publicly update any forward-looking statements to
reflect actual results, changes in assumptions or changes in other factors
affecting forward-looking information, except as may be required by law. All
forward-looking statements attributable to us or persons acting on our behalf
are expressly qualified in their entirety by this cautionary statement.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in
and assumptions that affect the amounts reported in our consolidated financial
statements and accompanying notes.
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We consider our critical accounting policies to be those that require us to make
significant judgments and estimates when we prepare our financial statements,
including the following:
Purchase Accounting for Acquisition of Investments in Real Estate: Purchase
accounting is applied to the assets and liabilities related to most real estate
investments acquired from third parties. In accordance with current accounting
guidance, we account for most of our property acquisitions as acquisitions of
assets, which requires the capitalization of acquisition costs to the underlying
assets and prohibits the recognition of goodwill or bargain purchase gains. The
fair value of most of the real estate acquired is allocated to the acquired
tangible assets, consisting primarily of land, building and tenant improvements,
and identified intangible assets and liabilities, consisting of the value of
above-market and below-market leases, and acquired ground leases, based in each
case on their fair values. Loan premiums, in the case of above market rate
assumed loans, or loan discounts, in the case of below market assumed loans, are
recorded based on the fair value of any loans assumed in connection with
acquiring the real estate. Please see additional disclosure below regarding
"Financing Assets".
The fair values of the tangible assets of an acquired property are determined
based on comparable land sales for land and replacement costs adjusted for
physical and market obsolescence for the improvements. The fair values of the
tangible assets of an acquired property are also determined by valuing the
property as if it were vacant, and the "as-if-vacant" value is then allocated to
land, building and tenant improvements based on management's determination of
the relative fair values of these assets. Management determines the as-if-vacant
fair value of a property based on assumptions that a market participant would
use, which is similar to methods used by independent appraisers. In addition,
there is intangible value related to having tenants leasing space in the
purchased property, which is referred to as in-place lease value. Such value
results primarily from the buyer of a leased property avoiding the costs
associated with leasing the property and also avoiding rent losses and
unreimbursed operating expenses during the hypothetical lease-up period. Factors
considered by management in performing these analyses include an estimate of
carrying costs during the expected lease-up periods considering current market
conditions and costs to execute similar leases. In estimating carrying costs,
management includes real estate taxes, insurance and other operating expenses
and estimates of lost rental revenue during the expected lease-up periods based
on current market demand. Management also estimates costs to execute similar
leases including leasing commissions, tenant improvements, legal and other
related costs. The value of in-place leases are amortized to expense over the
remaining initial terms of the respective leases.
In allocating the fair value of the identified intangible assets and liabilities
of an acquired property, above-market and below-market in-place lease values are
recorded based on the present value (using an interest rate which reflects the
risks associated with the leases acquired) of the difference between (i) the
contractual amounts to be paid pursuant to the in-place leases and
(ii) estimated fair market lease rates from the perspective of a market
participant for the corresponding in-place leases, measured, for above-market
leases, over a period equal to the remaining non-cancelable term of the lease
and, for below-market leases, over a period equal to the initial term plus any
below market fixed rate renewal periods. The capitalized above-market lease
values are amortized as a reduction of rental income over the remaining
non-cancelable terms of the respective leases. The capitalized below-market
lease values, also referred to as acquired lease obligations, are amortized as
an increase to rental income over the initial terms of the respective leases.
Financing Assets: As discussed in Note 2 - Relationship with UHS and Related
Party Transactions, on
sale agreement with UHS and certain of its affiliates. Pursuant to the
agreement, which was amended during the first quarter of 2022, UHS purchased
from us the real estate assets of the Inland Valley Campus of
Healthcare System
of
("Canyon Creek"). In connection with this transaction, Aiken and Canyon Creek
(as lessees), entered into a master lease and individual property leases (with
us as lessor), as amended during the first quarter of 2022, for initial lease
terms of approximately twelve years, ending on
UHS' purchase option within the lease agreements of Aiken and Canyon Creek, the
transaction is accounted for as a failed sale leaseback in accordance with
GAAP and we have accounted for the transaction with UHS as a financing
arrangement. A portion of the monthly lease payment to us from UHS will be
recorded to interest income based upon an imputed interest rate and the
remainder will reduce the outstanding financing receivable. In connection with
this transaction, our Consolidated Balance Sheets at
31, 2021
respectively. As of
financing receivable will be assessed for recoverability in accordance with our
asset impairment policy.
Asset Impairment: We review each of our properties for indicators that its
carrying amount may not be recoverable. Examples of such indicators may include
a significant decrease in the market price of the property, a change in the
expected holding period for the property, a significant adverse change in how
the property is being used or expected to be used based on the underwriting at
the time of acquisition, an accumulation of costs significantly in excess of the
amount originally expected for the acquisition or development of the property,
or a history of operating or cash flow losses of the property. When such
impairment indicators exist, we review an estimate of the future undiscounted
net cash flows (excluding interest charges) expected to result from the real
estate investment's use and eventual disposition and compare that estimate to
the carrying value of the property. We consider factors such as future operating
income, trends and prospects, as well as the effects of leasing demand,
competition and other factors. If our future undiscounted net
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cash flow evaluation indicates that we are unable to recover the carrying value
of a real estate investment, an impairment loss is recorded to the extent that
the carrying value exceeds the estimated fair value of the property. The
evaluation of anticipated cash flows is highly subjective and is based in part
on assumptions regarding future occupancy, rental rates and capital requirements
that could differ materially from actual results in future periods. Since cash
flows on properties considered to be long-lived assets to be held and used are
considered on an undiscounted basis to determine whether the carrying value of a
property is recoverable, our strategy of holding properties over the long-term
directly decreases the likelihood of their carrying values not being recoverable
and therefore requiring the recording of an impairment loss. If our strategy
changes or market conditions otherwise dictate an earlier sale date, an
impairment loss may be recognized and such loss could be material. If we
determine that the asset fails the recoverability test, the affected assets must
be reduced to their fair value.
We generally estimate the fair value of rental properties utilizing a discounted
cash flow analysis that includes projections of future revenues, expenses and
capital improvement costs that a market participant would use based on the
highest and best use of the asset, which is similar to the income approach that
is commonly utilized by appraisers. In certain cases, we may supplement this
analysis by obtaining outside broker opinions of value or third party
appraisals.
In considering whether to classify a property as held for sale, we consider
factors such as whether management has committed to a plan to sell the property,
the property is available for immediate sale in its present condition for a
price that is reasonable in relation to its current value, the sale of the
property is probable, and actions required for management to complete the plan
indicate that it is unlikely that any significant changes will made to the
plan. If all the criteria are met, we classify the property as held for sale.
Upon being classified as held for sale, depreciation and amortization related to
the property ceases and it is recorded at the lower of its carrying amount or
fair value less cost to sell. The assets and related liabilities of the property
are classified separately on the consolidated balance sheets for the most recent
reporting period. Only those assets held for sale that constitute a strategic
shift or that will have a major effect on our operations are classified as
discontinued operations.
An other than temporary impairment of an investment in an unconsolidated LLC is
recognized when the carrying value of the investment is not considered
recoverable based on evaluation of the severity and duration of the decline in
value, including projected declines in cash flow. To the extent impairment has
occurred, the excess carrying value of the asset over its estimated fair value
is charged to income.
Federal Income Taxes: No provision has been made for federal income tax
purposes since we qualify as a REIT under Sections 856 to 860 of the Internal
Revenue Code of 1986, and intend to continue to remain so qualified. To qualify
as a REIT, we must meet certain organizational and operational requirements,
including a requirement to distribute at least 90% of our annual REIT taxable
income to shareholders. As a REIT, we generally will not be subject to federal,
state or local income tax on income that we distribute as dividends to our
shareholders.
We are subject to a federal excise tax computed on a calendar year basis. The
excise tax equals 4% of the amount by which 85% of our ordinary income plus 95%
of any capital gain income for the calendar year exceeds cash distributions
during the calendar year, as defined. No provision for excise tax has been
reflected in the financial statements as no tax was due.
Earnings and profits, which determine the taxability of dividends to
shareholders, will differ from net income reported for financial reporting
purposes due to the differences for federal tax purposes in the cost basis of
assets and in the estimated useful lives used to compute depreciation and the
recording of provision for investment losses.
Results of Operations
During the three-month period ended
as compared to
decrease was attributable to:
• a decrease of$884,000 related to a vacant specialty hospital located inChicago, Illinois , on which, as discussed in Note 7 to the consolidated financial statements, the lease expired onDecember 31, 2021 ; • a net increase of$431,000 resulting from the asset purchase and sale agreement with UHS that occurred onDecember 31, 2021 , as discussed in Note 7 to the consolidated financial statements; • an increase of$335,000 resulting from the impact of the fair market value lease renewal onWellington Regional Medical Center , which became effective onJanuary 1, 2022 , as discussed in Note 7 to the consolidated financial statements, and; •$63,000 of other combined net decreases. 28
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Revenues increased
ended
2021. The increase during the first quarter of 2022, as compared to the first
quarter of 2021, was due to: (i) a
consolidated basis of
as discussed in Note 5 to the consolidated financial statements), resulting from
our purchase of the 5% minority ownership interest in the entity; (ii) a
(iii) a
purchase and sale agreement with UHS whereby we divested the real estate assets
of the Inland Valley Campus of
estate assets of
Health
including the impact of acquisitions and divestitures, partially offset by; (v)
a
specialty hospital located in
expenses increased during the first quarter of 2022, as compared to the first
quarter of 2021, resulting from the recording of
consolidated basis effective as of
impact on our net income resulting from the change from the
unconsolidated/equity method basis.
Included in our other operating expenses are expenses related to the
consolidated medical office buildings and three vacant specialty facilities.
Other operating expenses totaled
three-month periods ended
million
2022, as compared to the first quarter of 2021, was due primarily to
operating expenses incurred during the first quarter of 2022 at a vacant
specialty facility located in
responsibility through the lease expiration date) and
operating expenses recorded during the first quarter of 2022 in connection with
basis effective as of
associated with our consolidated medical office buildings is passed on directly
to the tenants either directly as tenant reimbursements of common area
maintenance expenses or included in base rental amounts. Tenant reimbursements
for operating expenses are accrued as revenue in the same period the related
expenses are incurred and are included as lease revenue in our condensed
consolidated statements of income.
Funds from operations ("FFO") is a widely recognized measure of performance for
Real Estate Investment Trusts ("REITs"). We believe that FFO and FFO per diluted
share, which are non-GAAP financial measures, are helpful to our investors as
measures of our operating performance. We compute FFO in accordance with
standards established by the
Trusts
that do not compute FFO in accordance with the NAREIT definition, or that
interpret the NAREIT definition differently than we interpret the definition.
FFO adjusts for the effects of certain items, such as gains on transactions that
occurred during the periods presented. To the extent a REIT recognizes a gain or
loss with respect to the sale of incidental assets, the REIT has the option to
exclude or include such gains and losses in the calculation of FFO. We have
opted to exclude gains and losses from sales of incidental assets in our
calculation of FFO. FFO does not represent cash generated from operating
activities in accordance with GAAP and should not be considered to be an
alternative to net income determined in accordance with GAAP. In addition, FFO
should not be used as: (i) an indication of our financial performance determined
in accordance with GAAP; (ii) an alternative to cash flow from operating
activities determined in accordance with GAAP; (iii) a measure of our liquidity,
or; (iv) an indicator of funds available for our cash needs, including our
ability to make cash distributions to shareholders.
Below is a reconciliation of our reported net income to FFO for the three-month
periods ended
Three Months Ended March 31, 2022 2021 Net income$ 5,405 $ 5,586
Depreciation and amortization expense on consolidated
Investments 6,709 6,787
Depreciation and amortization expense on unconsolidated
Affiliates 295 362 Funds From Operations$ 12,409 $ 12,735
Weighted average number of shares outstanding - Diluted 13,785 13,771
Funds From Operations per diluted share
$ 0.90 $ 0.92
Our FFO decreased
of 2022, as compared to the first quarter of 2021. The net decrease was
primarily due to: (i) the decrease in net income of
diluted share, as discussed above, and; (ii) a
and amortization expense incurred on our consolidated and unconsolidated
affiliates.
29
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Other Operating Results Interest Expense:
As reflected in the schedule below, interest expense was
million
respectively (amounts in thousands):
Three Months Three Months Ended Ended March 31, March 31, 2022 2021 Revolving credit agreement$ 1,168 $ 967 Mortgage interest 612 635 Interest rate swaps expense, net (a.) 287 309 Amortization of financing fees 178 216 Amortization of fair value of debt (13 ) (13 ) Capitalized interest on major projects (21 ) - Other interest 11 19 Interest expense, net$ 2,222 $ 2,133 (a.) Represents interest paid by us to the counterparties pursuant to three interest rate SWAPs with a combined notional amount of$140 million .
Interest expense increased by
31, 2022
primarily resulting from an increase in our average outstanding borrowings
(
average cost of borrowings pursuant to our revolving credit agreement (1.76%
average effective rate during the first quarter of 2022, as compared to 1.64%
average effective rate during the comparable quarter of 2021), partially offset
by; (ii) a
debt; (iii) a
decrease due to an increase in capitalized interest on a major project; (v) a
combined net decreases in interest expense.
Disclosures Related to Certain Facilities
Please refer to Note 7 to the consolidated financial statements - Lease
Accounting, for additional information regarding certain of our hospital
facilities including
Center
Texas
Liquidity and Capital Resources
Net cash provided by operating activities
Net cash provided by operating activities was$11.7 million during the three-month period endedMarch 31, 2022 as compared to$11.3 million during the comparable period of 2021. The$454,000 million net increase was attributable to: • an unfavorable change of$312,000 due to a decrease in net income plus/minus the adjustments to reconcile net income to net cash provided by operating activities (depreciation and amortization, amortization related to above/below market leases, amortization of debt premium, amortization of deferred financing costs and stock-based compensation), as discussed above; • an unfavorable change of$81,000 in lease receivable; • a favorable change of$489,000 in tenant reserves, deposits and deferred and prepaid rents; • an unfavorable change of$117,000 in leasing costs paid, and; • other combined net favorable change of$475,000 , resulting primarily from the timing of deposits made on acquisitions and prepaid expense payments.
Net cash used in investing activities
Net cash used in investing activities was
months of 2022 as compared to
2021.
30
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During the three-month period ended
including transaction costs, on the acquisitions of the Beaumont Heart and
Vascular Center in March, 2022, and; the
building in January, 2022, as discussed in Note 4 to the consolidated financial
statements-Acquisitions and Divestitures; (ii)
estate investments including construction costs related to the Sierra Medical
completed during the first quarter of 2023, as well as tenant improvements at
various MOBs, and; (iii)
agreement with UHS, as discussed in Note 2 to the consolidated financial
statements-Relationship with UHS and Related Party Transactions. In addition,
during the three-months ended
of cash in excess of income from LLCs.
During the three-month period ended
in additions to real estate investments including construction costs related to
substantially completed in late December, 2020, as well as tenant improvements
at various MOBs; (ii)
(iii)
equity investments in unconsolidated LLCs.
Net cash (used in)/ provided by financing activities
Net cash used in financing activities was
ended
activities during the three months ended
During the three-month period ended
mortgage notes payable that are non-recourse to us; (ii)
costs related to the revolving credit agreement, and; (iii)
dividends. Additionally, during the three months ended
received: (i)
and; (ii)
interest.
During the three-month period ended
mortgage notes payable that are non-recourse to us; (ii)
costs related to the revolving credit agreement, and; (iii)
dividends. Additionally, during the three months ended
received: (i)
and; (ii)
interest.
During 2020, we commenced an at-the-market ("ATM") equity issuance program,
pursuant to the terms of which we may sell, from time-to-time, common shares of
our beneficial interest up to an aggregate sales price of
through our agent banks. No shares were issued pursuant to this ATM equity
program during the first three months of 2022 and no shares were issued pursuant
to this ATM equity program during the year ended
Additional cash flow and dividends paid information for the three-month periods
ended
As indicated on our condensed consolidated statement of cash flows, we generated
net cash provided by operating activities of
during the three-month periods ended
also indicated on our statement of cash flows, non-cash expenses including
depreciation and amortization expense, amortization related to above/below
market leases, amortization of debt premium, amortization of deferred financing
costs and stock-based compensation expense are the primary differences between
our net income and net cash provided by operating activities during each period.
We declared and paid dividends of
three-month periods ended
first three months of 2022, the
activities was approximately
dividends paid during the first three months of 2022. During the first three
months of 2021, the
was approximately
during the first three months of 2021.
As indicated in the cash flows from investing activities and cash flows from
financing activities sections of the statements of cash flows, there were
various other sources and uses of cash during the three months ended
2022
include items such as investments and advances made to/from LLCs, additions to
real estate investments, acquisitions/divestiture of properties, net
borrowings/repayments of debt, and proceeds generated from the issuance of
equity. Therefore, in any given period, the funding source for our dividend
payments is not wholly dependent on the operating cash flow generated by our
properties. Rather, our dividends as well as our capital reinvestments into our
existing properties, acquisitions of real property and other investments are
funded based upon the aggregate net cash inflows or outflows from all sources
and uses of cash from the properties we own either in whole or through LLCs, as
outlined above.
In determining and monitoring our dividend level on a quarterly basis, our
management and
of dividends to be paid each period. These considerations primarily include:
(i) the minimum required amount of dividends to be paid in order to maintain our
REIT status; (ii) the current and projected operating results of our properties,
31
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including those owned in LLCs, and; (iii) our future capital commitments and
debt repayments, including those of our LLCs. Based upon the information
discussed above, as well as consideration of projections and forecasts of our
future operating cash flows, management and the
determined that our operating cash flows have been sufficient to fund our
dividend payments. Future dividend levels will be determined based upon the
factors outlined above with consideration given to our projected future results
of operations.
We expect to finance all capital expenditures and acquisitions and pay dividends
utilizing internally generated and additional funds. Additional funds may be
obtained through: (i) borrowings under our
agreement (which had
outstanding borrowings and letters of credit as of
(ii) borrowings under or refinancing of existing third-party debt pursuant to
mortgage loan agreements entered into by our consolidated and unconsolidated
LLCs/LPs; (iii) the issuance of equity pursuant to our ATM program, and/or;
(iv) the issuance of other long-term debt.
We believe that our operating cash flows, cash and cash equivalents, available
borrowing capacity under our revolving credit agreement and access to the
capital markets provide us with sufficient capital resources to fund our
operating, investing and financing requirements for the next twelve months,
including providing sufficient capital to allow us to make distributions
necessary to enable us to continue to qualify as a REIT under Sections 856 to
860 of the Internal Revenue Code of 1986. In the event we need to access the
capital markets or other sources of financing, there can be no assurance that we
will be able to obtain financing on acceptable terms or within an acceptable
time. Our inability to obtain financing on terms acceptable to us could have a
material unfavorable impact on our results of operations, financial condition
and liquidity.
Credit facilities and mortgage debt
Management routinely monitors and analyzes the Trust's capital structure in an
effort to maintain the targeted balance among capital resources including the
level of borrowings pursuant to our revolving credit facility, the level of
borrowings pursuant to non-recourse mortgage debt secured by the real property
of our properties and our level of equity including consideration of additional
equity issuances pursuant to our ATM equity issuance program. This ongoing
analysis considers factors such as the current debt market and interest rate
environment, the current/projected occupancy and financial performance of our
properties, the current loan-to-value ratio of our properties, the Trust's
current stock price, the capital resources required for anticipated acquisitions
and the expected capital to be generated by anticipated divestitures. This
analysis, together with consideration of the Trust's current balance of
revolving credit agreement borrowings, non-recourse mortgage borrowings and
equity, assists management in deciding which capital resource to utilize when
events such as refinancing of specific debt components occur or additional funds
are required to finance the Trust's growth.
On
agreement ("Credit Agreement") to amend and restate the previously existing
million
Agreement"). Among other things, under the Credit Agreement, our aggregate
revolving credit commitment was increased to
Credit Agreement, which is scheduled to mature on
revolving credit facility in an aggregate principal amount of
including a
sublimit for swingline/short-term loans. Under the terms of the Credit
Agreement, we may request that the revolving line of credit be increased by up
to an additional
by certain subsidiaries of the Trust. In addition, borrowings under the new
facility are secured by first priority security interests in and liens on all
equity interests in most of the Trust's wholly-owned subsidiaries.
Borrowings under the Credit Agreement will bear interest annually at a rate
equal to, at our option, at either LIBOR (for one, three, or six months) or the
Base Rate, plus in either case, a specified margin depending on our ratio of
debt to total capital, as determined by the formula set forth in the Credit
Agreement. The applicable margin ranges from 1.10% to 1.35% for LIBOR loans and
0.10% to 0.35% for Base Rate loans. The initial applicable margin is 1.25% for
LIBOR loans and 0.25% for Base Rate loans. The Credit Agreement defines "Base
Rate" as the greatest of (a) the Administrative Agent's prime rate, (b) the
federal funds effective rate plus 1/2 of 1% and (c) one month LIBOR plus 1%. The
Trust will also pay a quarterly revolving facility fee ranging from 0.15% to
0.35% (depending on the Trust's ratio of debt to asset value) on the revolving
committed amount of the Credit Agreement. The Credit Agreement also provides for
options to extend the maturity date and borrowing availability for two
additional six-month periods.
The margins over LIBOR, Base Rate and the facility fee are based upon our total
leverage ratio. At
1.20%, the margin over the Base Rate was 0.20% and the facility fee was 0.20%.
At
million
and letters of credit outstanding as of
compensating balance requirements. At
of outstanding borrowings,
The Credit Agreement contains customary affirmative and negative covenants,
including limitations on certain indebtedness, liens, acquisitions and other
investments, fundamental changes, asset dispositions and dividends and other
distributions. The Credit
32
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Agreement also contains restrictive covenants regarding the Trust's ratio of
total debt to total assets, the fixed charge coverage ratio, the ratio of total
secured debt to total asset value, the ratio of total unsecured debt to total
unencumbered asset value, and minimum tangible net worth, as well as customary
events of default, the occurrence of which may trigger an acceleration of
amounts then outstanding under the Credit Agreement. We are in compliance with
all of the covenants in the Credit Agreement at
compliance with all of the covenants in the Credit Agreement at
2021
assumption that the majority of the potential new borrowings will be used to
fund investments, the full amount of our commitment was borrowed.
The following table includes a summary of the required compliance ratios, giving effect to the covenants contained in the Credit Agreement (dollar amounts in thousands): March 31, December 31, Covenant 2022 2021 Tangible net worth > =$125,000 $ 225,799 $ 225,355 Total leverage < 60% 42.4 % 43.1 % Secured leverage < 30% 7.2 % 7.4 % Unencumbered leverage < 60% 41.3 % 41.9 % Fixed charge coverage > 1.50x 4.8x 4.8x
As indicated on the following table, we have various mortgages, all of which are
non-recourse to us, included on our condensed consolidated balance sheet as of
Outstanding Balance Interest Maturity Facility Name (in thousands) (a.) Rate Date700 Shadow Lane and Goldring MOBs fixed rate mortgage loan (b.) $ 5,152 4.54 % June, 2022BRB Medical Office Building fixed rate mortgage loan (c.) 5,222 4.27 % December, 2022Desert Valley Medical Center fixed rate mortgage loan (c.) 4,316 3.62 % January, 20232704 North Tenaya Way fixed rate mortgage loan 6,377 4.95 % November, 2023 Summerlin Hospital Medical Office Building III fixed rate mortgage loan 12,745 4.03 % April, 2024Tuscan Professional Building fixed rate mortgage loan 2,190 5.56 % June, 2025 Phoenix Children's East Valley Care Center fixed rate mortgage loan 8,401 3.95 % January, 2030Rosenberg Children's Medical Plaza fixed rate mortgage loan 12,213 4.42 % September, 2033 Total, excluding net debt premium and net financing fees 56,616 Less net financing fees (348 ) Plus net debt premium 78 Total mortgages notes payable, non-recourse to us, net $ 56,346 (a.) All mortgage loans require monthly principal payments through maturity and either fully amortize or include a balloon principal payment upon maturity. (b.) This loan is scheduled to mature in the second quarter of 2022, at which time we intend on paying off the remaining principal balance utilizing borrowings under our Credit Agreement. (c.) This loan is scheduled to mature within the next twelve months, at which time we will decide whether to refinance pursuant to a new mortgage loan or by utilizing borrowings under our Credit Agreement.
The mortgages are secured by the real property of the buildings as well as
property leases and rents. The mortgages outstanding as of
combined fair value of approximately
various mortgages, all of which were non-recourse to us, included in our
condensed consolidated balance sheet. The combined outstanding balance of these
various mortgages at
value of approximately
Changes in market rates on our fixed rate debt impacts the fair value of debt,
but it has no impact on interest incurred or cash flow.
Off Balance Sheet Arrangements
As of
consisting of standby letters of credit and equity and debt financing
commitments. Our outstanding letters of credit at
million
33
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As of
standby letters of credit and equity and debt financing commitments. Our
outstanding letters of credit at
to Grayson Properties II.
Acquisition and Divestiture Activity
Please see Note 4 to the consolidated financial statements for completed
transactions.
MANAGEMENT ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS Quarters Ended March 31, 2022 and 2021 ($ in Millions, Except Share Data)
ELEPHANT INSURANCE PROVIDES NOTICE OF DATA EVENT
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