UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

For the quarterly period ended September 30, 2018

OR

For the transition period from              to             

 

Commission file number:  000-55777

 

  

 

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 ☒  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 ☒    No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or 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.

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 ☒

The number of shares of the registrant’s outstanding common stock as of November 1, 2018 was 4,899,140 Class A shares.

 

 

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CNL HEALTHCARE PROPERTIES II, INC. AND SUBSIDIARIES

 

INDEX

 

 

 

 

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Item 1. Financial Statements

CNL HEALTHCARE PROPERTIES II, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

 

 

See accompanying notes to condensed consolidated financial statements.

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CNL HEALTHCARE PROPERTIES II, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

 

 

See accompanying notes to condensed consolidated financial statements.

 

 

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CNL HEALTHCARE PROPERTIES II, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017

 

 

See accompanying notes to condensed consolidated financial statements.

 

 

 

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CNL HEALTHCARE PROPERTIES II, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

 

See accompanying notes to condensed consolidated financial statements.

 

 

 

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CNL HEALTHCARE PROPERTIES II, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

CNL Healthcare Properties II, Inc. (“Company”) is a Maryland corporation organized on July 10, 2015 that elected to be taxed as a real estate investment trust (“REIT”) for U.S. federal income tax purposes beginning with the year ended December 31, 2017.  The Company is sponsored by CNL Financial Group, LLC (“Sponsor” or “CNL”) and is externally managed and advised by CHP II Advisors, LLC (“Advisor”), an affiliate of CNL.  The Advisor provides advisory services to the Company relating to substantially all aspects of its investments and operations, including real estate acquisitions, asset management and other operational matters.  

On March 2, 2016, pursuant to a registration statement on Form S-11 under the Securities Act of 1933, the Company commenced its initial public offering of up to $1.75 billion (“Primary Offering”), in any combination, of Class A, Class T and Class I shares of common stock on a “best efforts” basis, which meant that CNL Securities Corp. (“Dealer Manager”), an affiliate of the Sponsor, used its best efforts but was not required to sell any specific amount of shares.  The Company also offered up to $250 million, in any combination, of Class A, Class T and Class I shares pursuant to its distribution reinvestment plan (“Reinvestment Plan” and, together with the Primary Offering, the “Offering”).  

On August 31, 2018, the Company’s board of directors approved the termination of its Offering and the suspension of its Reinvestment Plan, effective October 1, 2018. The Company also suspended its share redemption plan (“Redemption Plan”) and discontinued its stock dividends concurrently.  In October 2018, the Company deregistered the unsold shares of its common stock under its previous registration statement on Form S-11.  In addition, the Company announced it had formed a special committee consisting solely of its independent directors (“Special Committee”) to consider possible strategic alternatives available to the Company, including, without limitation, (i) an orderly disposition of the Company’s assets or one or more of the Company’s asset classes and the distribution of the net sale proceeds thereof to the stockholders of the Company and (ii) a potential business combination or other transaction.  Although the Company has formed the Special Committee for the exploration of possible strategic alternatives, the Company is not obligated to enter into any particular transaction or any transaction at all.

 

As of September 30, 2018, the Company had received aggregate Offering proceeds of approximately $51.2 million (4.9 million shares), including approximately $1.2 million (0.1 million shares) of proceeds pursuant to the Reinvestment Plan.  The Company has contributed the net proceeds from its Offering to CHP II Partners, LP (“Operating Partnership”) in exchange for partnership interests.  The Company owns substantially all of its assets either directly or indirectly through the Operating Partnership in which the Company is the sole limited partner and its wholly-owned subsidiary, CHP II GP, LLC, is the sole general partner.  The Operating Partnership owns assets through: (1) a wholly-owned taxable REIT subsidiary (“TRS”), CHP II TRS Holding, Inc. (“TRS Holdings”) and (2) property owner subsidiaries, which are single purpose entities.

 

The Company has leased its two seniors housing properties to single member limited liability companies wholly-owned by TRS Holdings and engaged independent third-party managers under management agreements to operate the properties as permitted under the REIT Investment Diversification and Empowerment Act of 2007 (“RIDEA”) structures; whereas, its medical office building has been leased on a net or modified gross basis to third-party tenants.

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CNL HEALTHCARE PROPERTIES II, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

Basis of Presentation and Consolidation — The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and note disclosures required by generally accepted accounting principles in the United States (“GAAP”).  The unaudited condensed consolidated financial statements reflect all normal recurring adjustments, which, in the opinion of management, are necessary for the fair statement of the Company’s results for the interim period presented.  Operating results for the quarter and nine months ended September 30, 2018 may not be indicative of the results that may be expected for the year ending December 31, 2018.  Amounts as of December 31, 2017 included in the unaudited condensed consolidated financial statements have been derived from audited consolidated financial statements as of that date but do not include all disclosures required by GAAP.  These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

The accompanying condensed consolidated financial statements include the accounts of the Company, the Operating Partnership and its other subsidiaries.  All material intercompany accounts and transactions have been eliminated in consolidation.  

Use of Estimates — The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the Company’s condensed consolidated financial statements and accompanying notes.  Actual results could differ from those estimates.

Adopted Accounting Pronouncements — In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers,” as a new ASC topic (Topic 606).  The core principle of this ASU is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  The ASU further provides guidance for any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards (for example, lease contracts).  The FASB subsequently issued ASU 2015-14 to defer the effective date of ASU 2014-09 until annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, with earlier adoption permitted.  In addition, the FASB issued ASU 2017-05, "Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20)," which clarifies the scope of subtopic 610-20, that was issued as a part of ASU 2014-09, as it relates to in-substance nonfinancial assets and must be adopted concurrently with ASC 606.  Both ASUs can be adopted using one of two retrospective transition methods: (i) retrospectively to each prior reporting period presented or (ii) as a cumulative-effect adjustment as of the date of adoption.  The Company adopted these ASUs using the modified retrospective approach as its transition method on January 1, 2018; the adoption of which did not have a material impact to its consolidated financial statements.

In August 2017, the FASB issued ASU 2017-12 “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities,” which amended the hedge accounting model to better reflect an entity’s risk management activities. The ASU expands an entities ability to hedge nonfinancial and financial risk components as well as reduce the complexity related to fair value hedges of interest rate risk. The ASU further eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item. The ASU is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2018. The Company early adopted this ASU prospectively on January 1, 2018; the adoption of which did not have a material impact on the Company’s consolidated financial statements.

7

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CNL HEALTHCARE PROPERTIES II, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

Recent Accounting Pronouncements — In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842): Accounting for Leases,” which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e. lessees and lessors).  The ASU requires lessees to recognize assets and liabilities on the balance sheet for the rights and obligations created by all leases with terms of more than 12 months.  The ASU further modifies lessors’ classification criteria for leases and the accounting for sales-type and direct financing leases.  The ASU will also require qualitative and quantitative disclosures designed to give financial statement users additional information on the amount, timing, and uncertainty of cash flows arising from leases. In July 2018, the FASB issued ASU 2018-11, “Leases (Topic 842): Targeted Improvements,” which includes a practical expedient for lessors allowing them to elect to not separate lease and non-lease components in a contract for the purpose of revenue recognition and disclosure if certain criteria are met.  The Company plans to elect the practical expedient and apply to all leases that qualify under the established criteria.  The ASU is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2018 with early adoption permitted.  The ASU is to be applied using a modified retrospective approach.  The Company expects that adoption will impact the Company’s consolidated financial statements and related financial statement disclosures; specifically, the Company’s consolidated financial position as it relates to the required presentation for arrangements such as ground or other leases in which the Company is the lessee. However, the Company does not expect the adoption of this ASU to have a material impact on the Company’s consolidated results of operations or cash flows.

In June 2018, the FASB issued ASU 2018-07, “Compensation – Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting”, which expands the scope to include share-based payment transactions for acquiring goods and services from nonemployees. The amendments specify that Topic 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payments. The amendments also clarify that this topic does not apply to share-based payments used to provide financing to the issuer or awards granted in conjunction with selling of goods or services to customers as a part of a contract accounted for under Revenue from Contracts with Customers (Topic 606).  The ASU is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2018.  The Company does not expect of adoption of this ASU will have a material impact on the Company’s consolidated financial statements.

Resident fees and services are operating revenues relating to the Company’s managed seniors housing property, which is operated under a RIDEA structure.  Resident fees and services directly relate to the provision of monthly goods and services that are generally bundled together under a single resident agreement.   The Company accounts for its resident agreements as a single performance obligation under ASC 606 given the Company’s overall promise to provide a series of stand-ready goods and services to its residents each month.  Resident fees and services are recorded in the period in which the goods are provided and the services performed and generally consist of (1) monthly rent, which covers occupancy of the residents’ unit as well as basic services, such as utilities, meals and certain housekeeping services, and (2) service level charges, such as assisted living care, memory care and ancillary services.  Resident agreements are generally short-term in nature, billed monthly in advance and cancelable by the residents with a 30-day notice.  Resident agreements may require the payment of upfront fees prior to moving into the community with any non-refundable portion of such fees being recorded as deferred revenue and amortized over the estimated resident stay.

The following table represents the disaggregated revenue for resident fees and services during the nine months ended September 30, 2018 and 2017:

 

 

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CNL HEALTHCARE PROPERTIES II, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

During the nine months ended September 30, 2018, the Company acquired a seniors housing community in Riverview, Florida (“Riverview”) for a purchase price of approximately $24.3 million.  In connection therewith, the Company incurred approximately $0.7 million of acquisition fees and expenses, which were capitalized as a component of the cost of the assets acquired and allocated on a relative fair value basis.  The seniors housing community features 92 resident units (62 assisted living and 30 memory care units) and is operated under a RIDEA structure pursuant to a five-year property management agreement with Fosters Development, Inc. (“Fosters”).

During the nine months ended September 30, 2017, the Company acquired a seniors housing community in Pensacola, Florida (“Summer Vista”) for a purchase price of approximately $21.4 million.  In connection therewith, the Company incurred approximately $0.6 million of acquisition fees and expenses, which were capitalized as a component of the cost of the assets acquired and allocated on a relative fair value basis. The seniors housing community features 89 resident units (67 assisted living and 22 memory care units) and is operated under a RIDEA structure pursuant to a five-year property management agreement with SRI Management, LLC (“Superior Residences”).

The following summarizes the purchase price allocation for the above mentioned acquisitions, and the related assets acquired and liabilities assumed in connection with the acquisitions:

 

 

FOOTNOTE:

The gross carrying amount and accumulated depreciation of the Company’s real estate assets as of September 30, 2018 and December 31, 2017 are as follows:

 

 

Depreciation expense on the Company’s real estate assets, net was approximately $0.3 million and $0.9 million for the quarter and nine months ended September 30, 2018, respectively, and approximately $0.2 million and $0.4 million for the quarter and nine months ended September 30, 2017, respectively.

9

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CNL HEALTHCARE PROPERTIES II, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

The gross carrying amount and accumulated amortization of the Company’s intangible assets and liabilities as of September 30, 2018 and December 31, 2017 are as follows:

 

 

FOOTNOTE:

Amortization on the Company’s intangible assets was approximately $0.2 million and $0.6 million for the quarter and nine months ended September 30, 2018, respectively, of which approximately $10,000 and $30,000 was treated as an increase of property operating expenses and approximately $0.2 million and $0.6 million was included in depreciation and amortization.  Amortization on the Company’s intangible assets was approximately $0.1 million and $0.3 million for the quarter and nine months ended September 30, 2017, respectively, all of which was included in depreciation and amortization.

Amortization on the Company’s intangible liabilities was approximately $8,000 and $23,000 for the quarter and nine months ended September 30, 2018, respectively, all of which was treated as an increase in rental income and tenant reimbursements.  There was no amortization expense on the Company’s intangible liabilities for the quarter and nine months ended September 30, 2017.

The estimated future amortization on the Company’s intangibles for the remainder of 2018, each of the next four years and thereafter, in the aggregate, as of September 30, 2018 is as follows:

 

 

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CNL HEALTHCARE PROPERTIES II, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

In August 2018, in connection with the Riverview acquisition, the Company entered into a secured mortgage loan agreement with Florida Community Bank in the amount of approximately $5.0 million (“Riverview Loan”).  The Riverview loan matures on August 31, 2023.  The Riverview loan accrues interest at a rate of the sum of LIBOR plus 2.25%, with monthly payments of interest for the first 24 months, and monthly payments of interest and principal during the remaining months using a 30-year amortization period with the remaining balance payable at maturity.  The Company may prepay, without penalty, all or any part of the Riverview Loan at any time.

The following table provides details of the Company’s indebtedness as of September 30, 2018 and December 31, 2017:

 

 

FOOTNOTE:

The fair market value of the mortgage and notes payable was approximately $24.9 million as of September 30, 2018, which is based on current rates and spreads the Company would expect to obtain for similar borrowings.  Since this methodology includes inputs that are less observable by the public and are not necessarily reflected in active markets, the measurement of the estimated fair values is categorized as Level 3 on the three-level valuation hierarchy.

The following is a schedule of future principal payments and maturity for the Company’s indebtedness for the remainder of 2018, each of the next four years and thereafter, in the aggregate, as of September 30, 2018:

 

 

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CNL HEALTHCARE PROPERTIES II, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

The Company is externally advised and has no direct employees. All of the Company’s executive officers are executive officers, or on the board of managers of the Advisor. In addition, certain directors and officers hold similar positions with CNL Securities Corp., the Dealer Manager of the Offering and a wholly owned subsidiary of CNL. In connection with services provided to the Company, affiliates are entitled to the following fees:

Dealer Manager — In March 2017, the Company entered into an amended and restated dealer manager agreement pursuant to which the Dealer Manager received a combined selling commission and dealer manager fee of up to 8.5% of the sale price for each Class A share and up to 4.75% of the sale price for each Class T share sold in the Primary Offering, all or a portion of which could be reallowed to participating broker dealers.  In addition, for Class T shares sold in the Primary Offering, the Dealer Manager could choose the respective amounts of the commission and dealer manager fee, provided that the selling commission did not exceed 3.0% of the gross proceeds from the completed sale of such Class T shares.  

The Company has and will continue to pay a distribution and stockholder servicing fee, subject to certain underwriting compensation limits, with respect to the Class T and Class I shares sold in the Primary Offering in an annual amount equal to 1% and 0.50%, respectively, of the current gross offering price per Class T or Class I share, respectively.  The annual distribution and stockholder servicing fee will continue to be calculated as a percentage of the current gross offering price per Class T or Class I share until the Company reports an estimated per share value following the termination of the Primary Offering, at which point the distribution fee will be calculated based on the new estimated per share value, until such underwriting compensation limits are met or the shares are converted to Class A shares pursuant to the terms of the securities.  Refer to Note 12. “Subsequent Events” for additional information.

The Company recorded the annual distribution and stockholder servicing fees as a reduction to capital in excess of par value and measures the related liability in an amount equal to the maximum fees owed in relation to the Class T and Class I shares on the shares’ issuance date.  The liability is relieved over time, as the fees are paid to the Dealer Manager, or is adjusted if the fees are no longer owed on any Class T or Class I share that is redeemed or repurchased, as well as upon the earliest occurrence of: (i) a listing on a national securities exchange; (ii) a merger or consolidation of the Company with or into another entity, or the sale or other disposition of all or substantially all of the Company’s assets; (iii) after the termination of the Primary Offering in which the initial shares in the account were sold, the end of the month in which total underwriting compensation paid in the Primary Offering is not less than 10% of the gross proceeds from all share classes of the Primary Offering; (iv) the end of the month in which the total underwriting compensation paid in a Primary Offering with respect to shares purchased in a Primary Offering is not less than 8.5% of the gross offering price of those shares purchased in such Primary Offering (excluding shares purchased through the Reinvestment Plan and those received as stock dividends); or (v) any other conditions described in the Company’s prospectus.  The Company’s distribution and stockholder servicing fees liability was approximately $1.4 million as of September 30, 2018.  The Company’s obligation to pay the annual distribution and stockholder servicing fee ceased effective October 31, 2018 upon the conversion of the Class T and Class I shares into Class A Shares.  Refer to Note 12. “Subsequent Events” for additional information.  

CNL Capital Markets, LLC — The Company will pay CNL Capital Markets, LLC, an affiliate of CNL, an annual fee payable monthly based on the average number of total investor accounts that will be open during the term of the capital markets service agreement pursuant to which certain administrative services are provided to the Company.  These services may include, but are not limited to, the facilitation and coordination of the transfer agent’s activities, client services and administrative call center activities, financial advisor administrative correspondence services, material distribution services and various reporting and troubleshooting activities.

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CNL HEALTHCARE PROPERTIES II, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

Advisor — The Company will pay the Advisor a monthly asset management fee in an amount equal to 0.0667% of the monthly average of the sum of the Company’s and the Operating Partnership’s respective daily real estate asset value, without duplication, plus the outstanding principal amount of any loans made, plus the amount invested in other permitted investments.  For this purpose, “real estate asset value” equals the amount invested in wholly-owned properties, determined on the basis of cost, and in the case of properties owned by any joint venture or partnership in which the Company is a co-venturer or partner the portion of the cost of such properties paid by the Company, exclusive of acquisition fees and acquisition expenses and will not be reduced for any recognized impairment.  Any recognized impairment loss will not reduce the real estate asset value for the purposes of calculating the asset management fee.  The asset management fee, which will not exceed fees which are competitive for similar services in the same geographic area, may or may not be taken, in whole or in part as to any year, in the Advisor’s sole discretion.  All or any portion of the asset management fee not taken as to any fiscal year shall be deferred without interest and may be taken in such other fiscal year as the Advisor shall determine.

The Advisor received an investment services fee of 2.25% of the purchase price of properties for services in connection with the selection, evaluation, structure and purchase of assets.

The Advisor, its affiliates and related parties also are entitled to reimbursement of certain operating expenses in connection with their provision of services to the Company, including personnel costs, subject to the limitation that the Company will not reimburse the Advisor for any amount by which operating expenses exceed the greater of 2% of its average invested assets or 25% of its net income in any four consecutive fiscal quarters (“Expense Year”) unless approved by the independent directors.  For the Expense Year ended September 30, 2018, the Company’s total operating expenses were in excess of this limitation by approximately $0.4 million.  As of September 30, 2018, the Company had received cumulative approvals from its independent directors for total operating expenses in excess of this limitation of approximately $0.9 million.  The Company’s independent directors determined that the higher relationship of operating expenses to average invested assets was justified based on unattained capital raise expectations which limited the number of investments, and the cost of operating a public company.

The Advisor will pay all other organizational and offering expenses incurred in connection with the formation of the Company, without reimbursement by the Company.  These expenses include, but are not limited to, Security and Exchange Commission (“SEC”) registration fees, Financial Industry Regulatory Authority (“FINRA”) filing fees, printing and mailing expenses, blue sky fees and expenses, legal fees and expenses, accounting fees and expenses, advertising and sales literature, transfer agent fees, due diligence expenses, personnel costs associated with processing investor subscriptions, escrow fees and other administrative expenses of the Offering.

For the quarter and nine months ended September 30, 2018, the Company paid cash distributions of approximately $38,000 and $114,000, respectively, and issued stock dividends of approximately 1,000 shares and 2,000 shares, respectively, to the Advisor.  For the quarter and nine months ended September 30, 2017, the Company paid cash distributions of approximately $40,000 and $108,000, respectively, and issued stock dividends of approximately 800 shares and 3,000 shares, respectively.

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CNL HEALTHCARE PROPERTIES II, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

Pursuant to an expense support arrangement, the Advisor has agreed to accept payment in restricted stock in lieu of cash for services rendered, in the event that the Company does not achieve established distribution coverage targets (“Expense Support Agreement”).  Under the terms of the Expense Support Agreement, for each quarter within a calendar expense support year, the Company will record a proportional estimate of the cumulative year-to-date period based on an estimate of the annual expense support expected for the calendar expense support year.  In exchange for services rendered and in consideration of the expense support provided under this arrangement, the Company shall issue, following each determination date, a number of shares of restricted stock equal to the quotient of the expense support amount provided by the Advisor for the preceding year divided by the board of directors’ most recent determination of net asset value (“NAV”) per share of the Class A common shares, if the board has made such a determination, or otherwise the most recent public offering price per Class A common share, on the terms and conditions and subject to the restrictions set forth in the Expense Support Agreement.  The restricted stock is subordinated and forfeited to the extent that shareholders do not receive a Priority Return on their Invested Capital (as such terms are defined in the Company’s prospectus), excluding for the purposes of calculating this threshold any shares of restricted stock owned by the Advisor.

The following fees for services rendered are expected to be settled in the form of restricted stock pursuant to the Expense Support Agreement for the quarter and nine months ended September 30, 2018 and cumulatively as of September 30, 2018:

 

 

FOOTNOTES:

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CNL HEALTHCARE PROPERTIES II, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

The fees payable to the Dealer Manager for the quarter and nine months ended September 30, 2018 and 2017, and related amounts unpaid as of September 30, 2018 and December 31, 2017 are as follows:

 

 

The expenses incurred by and reimbursable to the Company’s related parties for the quarter and nine months ended September 30, 2018 and 2017, and related amounts unpaid as of September 30, 2018 and December 31, 2017 are as follows:

 

 

FOOTNOTES:

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CNL HEALTHCARE PROPERTIES II, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

Subscription Proceeds — As of September 30, 2018 and 2017, the Company had received aggregate subscription proceeds of approximately $51.2 million (4.9 million shares) and $23.3 million (2.2 million shares), respectively, both of which include $200,000 (20,000 shares) of subscription proceeds received from the Advisor prior to the commencement of the Offering, approximately $251,250 (25,125 shares) of subscription proceeds received in connection with a private placement made in 2016 and approximately $1.2 million (0.1 million shares) and $221,000 (22,100 shares), respectively, of subscription proceeds pursuant to the Reinvestment Plan.  The Company terminated and closed its Primary Offering effective October 1, 2018 and concurrently suspended the Reinvestment Plan.

Distributions — For the nine months ended September 30, 2018 and 2017, the Company declared and paid cash distributions of approximately $1.4 million and $0.5 million, respectively, which were net of class-specific expenses.  In addition, the Company declared and issued stock dividends of approximately 35,000 and 14,000 shares of common stock during the nine months ended September 30, 2018 and 2017, respectively.

For the nine months ended September 30, 2018 and 2017, 100.0% of the cash distributions paid to stockholders were considered a return of capital to stockholders for federal income tax purposes.  No amounts distributed to stockholders for the nine months ended September 30, 2018 and 2017 were required to be or have been treated by the Company as a return of capital for purposes of calculating the stockholders’ return on their invested capital as described in the Company’s advisory agreement.  The distribution of new common stock shares to recipients is non-taxable.

In September 2018, the Company’s board of directors declared a monthly cash distribution of $0.0480, less class-specific expenses, on each outstanding share of common stock on October 1, 2018, November 1, 2018 and December 1, 2018.  These distributions are to be paid and distributed by December 31, 2018.  In connection with the termination of the Offering effective October 1, 2018, the Company’s board of directors determined that it does not intend to authorize additional stock dividends at this time.  Refer to Note 12. “Subsequent Events” for additional information.

Redemptions — During the nine months ended September 30, 2018, the Company received requests for the redemption of common stock under its Redemption Plan of approximately $59,000 in Class T shares and $127,000 in Class A shares, which were approved for redemption at a weighted average price per share of $10.05 and paid in March 2018, June 2018, and September 2018, respectively.  There were no redemptions requested during the nine months ended September 30, 2017.  In connection with the termination of the Offering and the board of directors’ decision to consider possible strategic alternatives available to the Company, the Redemption Plan was suspended effective October 1, 2018 and the Company no longer accepts or processes any redemption requests received after such date.

The accompanying condensed consolidated financial statements include an interim tax provision for the quarter and nine months ended September 30, 2018 and 2017.  The Company recorded a total provision for income tax (benefit) expense of approximately ($10,000) and $35,000 for the quarter and nine months ended September 30, 2018, respectively, and approximately $12,000 and $42,000 for the quarter and nine months ended September 30, 2017, respectively.  Of the approximate $35,000 in income tax expense for the nine months ended September 30, 2018, approximately $32,000 represent current income tax expense, and approximately $3,000 represents a decrease to the Company’s net deferred tax assets which is primarily due to the reversal of the existing taxable temporary differences.  Of the approximate $42,000 in income tax expense for the nine months ended September 30, 2017, $73,000 represents current income tax expense offset by $31,000 of deferred tax benefit.

From time to time, the Company may be a party to legal proceedings in the ordinary course of, or incidental to the normal course of, its business, including proceedings to enforce its contractual or statutory rights.  While the Company cannot predict the outcome of these legal proceedings with certainty, based upon currently available information, the Company does not believe the final outcome of any pending or threatened legal proceeding will have a material adverse effect on its results of operations or financial condition.

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CNL HEALTHCARE PROPERTIES II, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SIX MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

In October 2018, the Company repaid approximately $0.3 million of promissory notes and redeemed approximately $0.3 million (26,000 shares) of shares, which were both previously issued in connection with a private placement offering in August 2016.

In connection with the close of the Offering effective October 1, 2018, certain underwriting compensation limits were met and, effective October 31, 2018, each Class T and Class I share automatically converted into a Class A share pursuant to the terms of the Company’s charter.  The Class T and Class I shares converted into Class A shares on a one-for-one basis because the most recent estimated NAV per share of $10.06, which was approved by the Company’s board of directors as of December 31, 2017, is the same for all share classes.  Stockholders who received Class A shares upon the conversion will no longer be subject to the class-specific expenses associated with Class T and Class I shares.  The Company’s obligation to pay the approximate $1.4 million distribution and stockholder servicing fees liability as of September 30, 2018 to the Dealer Manager ceased effective October 31, 2018 upon the conversion of the Class T and Class I shares into Class A Shares.

 

 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Caution Concerning Forward-Looking Statements

Statements contained under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Quarterly Report on Form 10-Q for the fiscal quarter and nine months ended September 30, 2018 (“Quarterly Report”) that are not statements of historical or current fact may constitute “forward-looking statements” within the meaning of the Federal Private Securities Litigation Reform Act of 1995.  The Company intends that such forward-looking statements be subject to the safe harbor created by Section 21E of the Securities Exchange Act of 1934, as amended (“Exchange Act”).  Forward-looking statements are statements that do not relate strictly to historical or current facts, but reflect management’s current understandings, intentions, beliefs, plans, expectations, assumptions and/or predictions regarding the future of the Company’s business and its performance, the economy, and other future conditions and forecasts of future events and circumstances.  Forward-looking statements are typically identified by words such as “believes,” “expects,” “anticipates,” “intends,” “estimates,” “plans,” “continues,” “pro forma,” “may,” “will,” “seeks,” “should,” “could” and words and terms of similar substance in connection with discussions of future operating or financial performance, business strategy and portfolios, projected growth prospects, cash flows, costs and financing needs, legal proceedings, amount and timing of anticipated future distributions, estimates of per share net asset value of the Company’s common stock, and/or other matters.  The Company’s forward-looking statements are not guarantees of future performance.  While the Company’s management believes its forward-looking statements are reasonable, such statements are inherently susceptible to uncertainty and changes in circumstances.  As with any projection or forecast, forward-looking statements are necessarily dependent on assumptions, data and/or methods that may be incorrect or imprecise, and may not be realized.  The Company’s forward-looking statements are based on management’s current expectations and a variety of risks, uncertainties and other factors, many of which are beyond the Company’s ability to control or accurately predict.  Although the Company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, the Company’s actual results could differ materially from those set forth in the forward-looking statements due to a variety of risks, uncertainties and other factors.  Given these uncertainties, the Company cautions you not to place undue reliance on such statements.  

For further information regarding risks and uncertainties associated with the Company’s business, and other important factors that could cause the Company’s actual results to vary materially from those expressed or implied in its forward-looking statements, please refer to the risk factors listed and described in the Company’s  Annual Report on Form 10-K for the year ended December 31, 2017, as well as Part II, Item 1A in our Quarterly Report on Form 10-Q for the quarter end March 31, 2018, copies of which may be obtained from the Company’s website at www.cnlhealthcarepropertiesii.com.

All written and oral forward-looking statements attributable to the Company or persons acting on its behalf are qualified in their entirety by this cautionary note.  Forward-looking statements speak only as of the date on which they are made, and the Company undertakes no obligation to, and expressly disclaims any obligation to, publicly release the results of any revisions to its forward-looking statements to reflect new information, changed assumptions, the occurrence of unanticipated subsequent events or circumstances, or changes to future operating results over time, except as otherwise required by law.

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Introduction

The following discussion is based on the condensed consolidated financial statements as of September 30, 2018 (unaudited) and December 31, 2017.  Amounts as of December 31, 2017, included in the unaudited condensed consolidated financial statements have been derived from the audited consolidated financial statements as of that date.  This information should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and the notes thereto, as well as the audited consolidated financial statements, notes thereto and management’s discussion and analysis included in our Annual Report on Form 10-K for the year ended December 31, 2017.

Overview

CNL Healthcare Properties II, Inc. (referred to herein as “we”, “us”, “our” or the “Company”) is a Maryland corporation that incorporated on July 10, 2015.  We elected to be taxed as a REIT for U.S. federal income tax purposes beginning with the year ended December 31, 2017 and our intention is to be organized and operate in a manner that allows us to remain qualified as a REIT for federal income tax purposes.

We are externally managed and advised by our Advisor, CHP II Advisors, LLC.  Our Advisor is responsible for managing our day-to-day affairs and for identifying and making acquisitions and investments on our behalf.  We had no operations prior to the commencement of our Primary Offering.  

We have leased our two seniors housing properties to single member limited liability companies wholly-owned by TRS Holdings and engaged independent third-party managers under management agreements to operate the properties as permitted under RIDEA structures; whereas, our medical office building has been leased on a net or modified gross basis to third-party tenants.  We view, manage and evaluate our portfolio homogeneously as one collection of healthcare assets with a common goal of maximizing revenues and property income regardless of the asset class or asset type.

From the commencement of our Offering until September 15, 2017, our net investment value per share for Class A, Class T and Class I shares was $10.00 per share, which was based on the “amount available for investment/net investment amount” percentage shown in the Estimated Use of Proceeds section of our prospectus.  From September 16, 2017 until March 13, 2018 our board of directors adopted an estimated NAV of $10.00 per share for each class of our common stock.  On March 14, 2018, our board of directors adopted an estimated NAV of $10.06 per share for each class of our common stock outstanding as of December 31, 2017.  For additional information on the determination of our estimated NAV, please refer to our Current Report on Form 8-K, filed with the SEC on March 15, 2018.

On August 31, 2018, our board of directors approved the termination of our Offering and the suspension of the Reinvestment Plan, effective October 1, 2018.  We also suspended our Redemption Plan and discontinued our stock dividends concurrently.  In addition, we announced the formation of a Special Committee to consider possible strategic alternatives available to the Company, including, without limitation, (i) an orderly disposition of our assets or one or more of our asset classes and the distribution of the net sale proceeds thereof to our stockholders and (ii) a potential business combination or other transaction.  Although we formed a Special Committee for the exploration of possible strategic alternatives, we are not obligated to enter into any particular transaction or any transaction at all.

Portfolio Overview

As of November 1, 2018, our healthcare investment portfolio consisted of interests in two seniors housing properties and one medical office building (“MOB”).  Our seniors housing properties consist of Summer Vista and Riverview, which are both operated under a RIDEA structure pursuant to property management agreements with third party property managers.  Our MOB, Mid America Surgery Institute, consisted of five tenants with the largest tenant, Mid America Surgery Institute, accounting for 50.6% of total rentable square feet.

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While we are not directly impacted by the performance of our third-party tenants, we believe that the financial and operational performance of our tenants provides an indication about the stability of our tenants and their ability to pay rent. To the extent that our tenants or property managers experience operating difficulties and become unable to generate sufficient cash to make rent payments to us, there could be a material adverse impact on our consolidated results of operations, liquidity and/or financial condition. Our tenants and property managers are generally contractually required to provide this information to us in accordance with their respective lease and/or management agreements. Therefore, in order to mitigate the aforementioned risk, we monitor our investments through a variety of methods determined by the type of property.

Management reviews certain operating and other statistical measures of the underlying property such as occupancy levels and revenue per occupied unit (“RevPOU”), which we define as total revenue before charges for ancillary and care services offered at the community divided by average number of occupied units. As of September 30, 2018, 99% and 78% of resident units were occupied at Summer Vista and Riverview, respectively.  The average monthly RevPOU as of September 30, 2018 and 2017 was $3,680 and $3,881 for assisted living units, respectively, and $4,072 and $4,278 for memory care units, respectively.  

Similarly, for our MOB, management reviews operating statistics of the underlying property, including occupancy levels and monthly rent per square foot.  As of September 30, 2018, Mid America Surgery was 100% leased to five tenants with a remaining weighted average lease term of approximately 8.4 years.  The average monthly rent per square foot as of September 30, 2018 was $2.19.

We monitor the performance of our third-party operator(s) to stay abreast of material changes in the operations of underlying property by (1) reviewing the current, historical and prospective operating margins (measured by earnings before interest, taxes, depreciation, amortization and facility rent), (2) monitoring trends in the source of our revenue, including relative mix of payors (including Medicare, Medicaid, etc.) and private payors (including commercial insurance and private pay patients), (3) evaluating the effect of evolving healthcare legislation and other regulations on our profitability and liquidity, and (4) reviewing the competition and demographics of the local and surrounding areas in which we operate.

Liquidity and Capital Resources

General

Through September 2018, we were in our offering and acquisition phase and, therefore, our primary sources of capital to date were proceeds from our Offering and debt financing.

To date, our principal demands for funds have been for:

Through the completion of our acquisition phase, we sought to strategically leverage our real estate assets and use debt as a means of providing additional funds for the acquisition of properties and the diversification of our portfolio.  We may be negatively impacted by rising interest rates on any unhedged variable rate debt or the timing of when we seek to refinance existing debt. As of September 30, 2018 and December 31, 2017, our debt leverage ratio was approximately 35.1% and 43.4% of the aggregate carrying value of our assets, respectively.

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Sources of Liquidity and Capital Resources

Common Stock Subscriptions

For the nine months ended September 30, 2018 and 2017, we received aggregate subscription proceeds of approximately $19.0 million (1.9 million shares) and $16.4 million (1.6 million shares), respectively, and approximately $0.8 million (0.08 million shares) and $0.2 million (0.02 million shares), respectively, of subscription proceeds received pursuant to our Reinvestment Plan.  We terminated and closed our Offering effective October 1, 2018 and concurrently suspended the Reinvestment Plan.  As a consequence of suspending the Reinvestment Plan, stockholders who were participants in the Reinvestment Plan will receive cash distributions instead of additional shares of our common stock.

As of September 30, 2018, we had received aggregate subscription proceeds of approximately $51.2 million.  

Net Cash Provided by Operating Activities

We experienced cash provided by operating activities for the nine months ended September 30, 2018 of approximately $0.2 million as compared to cash provided by operating activities of approximately $0.1 million for the nine months ended September 30, 2017. We generally expect to meet future cash needs for general and administrative expenses as well as debt service from the net operating income (“NOI”) from our three properties.

Indebtedness

During the nine months ended September 30, 2018, we borrowed approximately $5.0 million in connection with our acquisition of Riverview.  The Riverview Loan matures on August 31, 2023.  The Riverview Loan accrues interest at a rate of the sum of LIBOR plus 2.25%, with monthly payments of interest for the first 24 months, and monthly payments of interest and principal during the remaining months using a 30-year amortization period with the remaining balance payable at maturity.  We may prepay, without penalty, all or any part of the Riverview Loan at any time.

During the nine months ended September 30, 2017, we borrowed approximately $16.1 million in connection with our acquisition of Summer Vista.  In December 2017, we paid the sum of approximately $2.2 million of the original outstanding principal balance of the Summer Vista Loan, and as a result, interest payable on the Summer Vista Loan was reduced to a rate equal to the sum of LIBOR plus 2.70% in accordance with the terms of the Summer Vista Loan.  We may prepay, without a penalty, all or any part of the Summer Vista Loan at any time.  

Expense Support Agreement

During the quarter and nine months ended September 30, 2018 and 2017, our cash flows from operating activities was positively impacted by the Expense Support Agreement with our Advisor pursuant to which our Advisor has agreed to accept payment in restricted stock in lieu of cash for services rendered, in the event that the Company does not achieve established distribution coverage targets (as defined in the Expense Support Agreement).  For the quarter and nine months ended September 30, 2018, approximately $0.2 million and $0.6 million are expected to be settled in the form of restricted stock pursuant to the Expense Support Agreement.  For the quarter and nine months ended September 30, 2017, $0.1 million and $0.4 million, respectively, of asset management fees and Advisor personnel expenses have been settled in the form of restricted stock pursuant to the Expense Support Agreement.  Any amounts settled, and for which restricted stock shares will be issued, pursuant to the Expense Support Agreement are permanently settled and we have no further obligation to pay such amounts to our Advisor.

Refer to Note 8. “Related Party Arrangements” in Item 1. “Financial Statements” for additional information.

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Uses of Liquidity and Capital Resources

Real Estate Acquisition

We have completed our acquisition phase.  During the nine months ended September 30, 2018, we acquired Riverview for a total purchase price consideration of approximately $24.7 million.  Riverview consists of 92 resident units (62 assisted living and 30 memory care units).  During the nine months ended September 30, 2017, we acquired Summer Vista for a total purchase price consideration of approximately $21.9 million.

Underwriting Compensation

From the time we broke escrow through March 2017, we had a maximum combined sales commissions, dealer manager fees and ongoing annual distribution and stockholder servicing fees (“Maximum Underwriting Fees”) payable to the Dealer Manager and participating broker-dealers totaling 9.75% of the gross proceeds for each share class of common stock sold in the Primary Offering.  In March 2017, we entered into an amended and restated dealer manager agreement, which reduced the Maximum Underwriting Fees from 9.75% to 8.5% of the gross proceeds for each share class of common stock sold in the Primary Offering.  The aforementioned reduction to our Maximum Underwriting Fees resulted in a lower amount of commissions and fees being paid to the Dealer Manager and provided for increased net proceeds from our Primary Offering to be available for investment.

For the nine months ended September 30, 2018 and 2017, we paid approximately $1.0 million and $1.0 million, respectively, in underwriting compensation.  Under the terms of the Primary Offering, our Dealer Manager was entitled to receive selling commissions, dealer manager fees and/or annual distribution and stockholder servicing fees, which were based on the respective share class of our common stock sold, all or a portion of which could be reallowed to participating broker dealers.

In October 2018, we reached certain underwriting compensation limits and, effective October 31,2018, each Class T and Class I share automatically converted into a Class A share pursuant to the terms of our charter.  The Class T and Class I shares converted into Class A shares on a one-for-one basis because the most recent estimated NAV per share approved by our board of directors of $10.06 is the same for all share classes.  Stockholders who received Class A shares upon the conversion will no longer be subject to the class-specific expenses associated with Class T and Class I shares.  Our obligation to pay the approximate $1.4 million distribution and stockholder servicing fees liability as of September 30, 2018 to the Dealer Manager ceased effective October 31, 2018 upon the conversion of the Class T and Class I shares into Class A Shares.  

Distributions

In order to qualify as a REIT, we will be required to make distributions, other than capital gain distributions, to our stockholders each year in the amount of at least 90% of our taxable income.  We may make distributions in the form of cash or other property, including distributions of our own securities.  We expect to have little, if any, cash flows from operations available for distribution. Therefore, we have and may continue to pay some or all of our cash distributions from sources other than cash flows from operations, such as from cash flows provided by financing activities, a component of which may include the remaining proceeds of our Offering and/or borrowings, whether collateralized by our assets or unsecured.  We have not established any limit on the extent to which we may use borrowings or proceeds of our Offering to pay distributions, and there is no assurance we will be able to sustain distributions at any level.

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The following table details our cash distributions per share and our total cash distributions paid, including distribution reinvestments, for the nine months ended September 30, 2018 and 2017 (in thousands except per share data):

 

 

FOOTNOTES:

In September 2018, our board of directors declared a monthly cash distribution of $0.0480, less class-specific expenses, on each outstanding share of common stock on October 1, 2018, November 1, 2018 and December 1, 2018.  These distributions are to be paid and distributed by December 31, 2018.  We terminated and closed our Offering effective October 1, 2018. Concurrently, we suspended the Reinvestment Plan and determined not to authorize additional stock dividends. As a consequence of suspending the Reinvestment Plan, stockholders who were participants in the Reinvestment Plan will receive cash distributions instead of additional shares of our common stock.

As noted above, effective October 31, 2018, each Class T and Class I share automatically converted into a Class A share pursuant to the terms of the Company’s charter.  

Common Stock Redemptions

During the quarter and nine months ended September 30, 2018, we received requests for the redemption of common stock of approximately $33,000 and $185,000, respectively.  The redemptions were approved by our board of directors and paid in March 2018, June 2018 and September 2018, respectively.  No other redemption requests were made during quarter and nine months ended September 30, 2018 and 2017.

In October 2018, we redeemed approximately $0.3 million (26,000 shares) of shares, which were previously issued in connection with a private placement offering in August 2016.

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Our Redemption Plan was designed to provide eligible stockholders with limited interim liquidity by enabling them to sell shares back to us prior to any liquidity event.  Such redemptions were funded by proceeds from our Reinvestment Plan.  In connection with the termination of our Offering and our board of directors’ decision to consider possible strategic alternatives available to us, our Redemption Plan was suspended effective October 1, 2018 and we no longer accept or process any redemption requests received after such date.

Debt Repayments

In October 2018, we repaid approximately $0.3 million of promissory notes, which were previously issued in connection with a private placement offering in August 2016.

Results of Operations

The following discussion and analysis should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and the notes thereto.

Quarter and nine months ended September 30, 2018 as compared to quarter and nine months ended September 30, 2017

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We are not aware of any material trends or uncertainties, favorable or unfavorable, that may be reasonably anticipated to have a material impact on either capital resources or the revenues and income to be derived from the acquisition and operation of properties and other permitted investments, other than those referred to in the risk factors identified in Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017 as well as on Form 10-Q for the quarter end March 31, 2018.

Net Operating Income

We generally expect to meet future cash needs for general and administrative expenses, debt service and distributions from NOI.  We define NOI, a non-GAAP measure, as total revenues and services less property operating expenses and property management fees.  We use NOI as a key performance metric for internal monitoring and planning purposes, including the preparation of annual operating budgets and monthly operating reviews, as well as to facilitate analysis of future investment and business decisions.  It does not represent cash flows generated from operating activities in accordance with GAAP and should not be considered to be an alternative to net income or loss (determined in accordance with GAAP) as an indication of our operating performance or to be an alternative to cash flows from operating activities (determined in accordance with GAAP) as a measure of our liquidity.  We believe the presentation of this non-GAAP measure is important to the understanding of our operating results for the periods presented because it is an indicator of the return on property investment and provides a method of comparing property performance over time.  In addition, we have aggregated NOI on a “same-store” basis only for comparable properties that we have owned during the entirety of all periods presented.  Non-same-store NOI represents aggregated NOI from acquisitions after July 1, 2017 or January 1, 2017, which are excluded as we did not own those properties during the entirety of all periods presented.  In understanding our operating results in the accompanying condensed consolidated financial statements, it is important to understand how the growth in our assets has impacted our results.

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The chart below illustrates our net losses and NOI for the quarter and nine months ended September 30, 2018 and 2017 (in thousands) and the amount invested in properties as of September 30, 2018 and 2017 (in millions):

 

 

Overall, our NOI for the quarter and nine months ended September 30, 2018 increased by approximately $0.3 million and $1.2 million, respectively, as compared to the same period in the prior year.  Our non-same-store NOI of approximately $0.3 million for the quarter ended September 30, 2018 related to our acquisition of Mid America Surgery Institute in December 2017 and Riverview in August 2018.  Our same-store NOI for the quarter ended September 30, 2018 increased by approximately $14,000, or 3.5%, as compared to the same period in the prior year. The increase in same-store NOI related to our acquisition of Summer Vista Assisted Living in March 2017 and improved financial performance across periods.

Funds from Operations and Modified Funds from Operations

Due to certain unique operating characteristics of real estate companies, as discussed below, the North American Real Estate Investment Trust (“NAREIT”) promulgated a measure known as Funds From Operations (“FFO”), which we believe to be an appropriate supplemental measure to reflect the operating performance of a REIT.  The use of FFO is recommended by the REIT industry as a supplemental performance measure.  FFO is not equivalent to net income or loss as determined under GAAP.

We define FFO, a non-GAAP measure, consistent with the standards approved by the Board of Governors of NAREIT.  NAREIT defines FFO as net income or loss computed in accordance with GAAP, excluding gains or losses from sales of property, real estate asset impairment write-downs, plus depreciation and amortization of real estate related assets, and after adjustments for unconsolidated partnerships and joint ventures.  Our FFO calculation complies with NAREIT’s policy described above.

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The historical accounting convention used for real estate assets requires straight-line depreciation of buildings and improvements, which implies that the value of real estate assets diminishes predictably over time, especially if such assets are not adequately maintained or repaired and renovated as required by relevant circumstances and/or is requested or required by lessees for operational purposes in order to maintain the value of the property. We believe that, because real estate values historically rise and fall with market conditions, including inflation, interest rates, the business cycle, unemployment and consumer spending, presentations of operating results for a REIT using historical accounting for depreciation may be less informative.  Historical accounting for real estate involves the use of GAAP.  Any other method of accounting for real estate such as the fair value method cannot be construed to be any more accurate or relevant than the comparable methodologies of real estate valuation found in GAAP.  Nevertheless, we believe that the use of FFO, which excludes the impact of real estate related depreciation and amortization, provides a more complete understanding of our performance to investors and to management, and when compared year over year, reflects the impact on our operations from trends in occupancy rates, rental rates, operating costs, general and administrative expenses, and interest costs, which may not be immediately apparent from net income or loss. However, FFO and Modified Funds From Operations (“MFFO”), as described below, should not be construed to be more relevant or accurate than the current GAAP methodology in calculating net income or loss in its applicability in evaluating operating performance. The method utilized to evaluate the value and performance of real estate under GAAP should be construed as a more relevant measure of operational performance and considered more prominently than the non-GAAP FFO and MFFO measures and the adjustments to GAAP in calculating FFO and MFFO.

Changes in the accounting and reporting promulgations under GAAP (for acquisition fees and expenses for business combinations from a capitalization/depreciation model) to an expensed-as-incurred model that were put into effect in 2009, and other changes to GAAP accounting for real estate subsequent to the establishment of NAREIT’s definition of FFO, have prompted an increase in cash-settled expenses, specifically acquisition fees and expenses, as items that are expensed under GAAP and accounted for as operating expenses.  Our management believes these fees and expenses do not affect our overall long-term operating performance.  Publicly registered, non-listed REITs typically have a significant amount of acquisition activity and are substantially more dynamic during their initial years of investment and operation.  While other start up entities may also experience significant acquisition activity during their initial years, we believe that non-listed REITs are unique in that they have a limited life with targeted exit strategies within a relatively limited time frame after acquisition activity ceases.  Due to the above factors and other unique features of publicly registered, non-listed REITs, the Investment Program Association (“IPA”), an industry trade group, has standardized a measure known as MFFO which the IPA has recommended as a supplemental measure for publicly registered non-listed REITs and which we believe to be another appropriate supplemental measure to reflect the operating performance of a non-listed REIT.  MFFO is not equivalent to our net income or loss as determined under GAAP, and MFFO may not be a useful measure of the impact of long-term operating performance on value if we do not continue to operate with a limited life and targeted exit strategy, as currently intended.  We believe that because MFFO excludes costs that we consider more reflective of investing activities and other non-operating items included in FFO and also excludes acquisition fees and expenses that affect our operations only in periods in which properties are acquired, MFFO can provide, on a going forward basis, an indication of the sustainability (that is, the capacity to continue to be maintained) of our operating performance after the period in which we acquired our properties and once our portfolio is in place.  By providing MFFO, we believe we are presenting useful information that assists investors and analysts to better assess the sustainability of our operating performance after our properties have been acquired.  We also believe that MFFO is a recognized measure of sustainable operating performance by the non-listed REIT industry.

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We define MFFO, a non-GAAP measure, consistent with the IPA’s Guideline 2010-01, Supplemental Performance Measure for Publicly Registered, Non-Listed REITs: MFFO, or the Practice Guideline, issued by the IPA in November 2010. The Practice Guideline defines MFFO as FFO further adjusted for the following items, as applicable, included in the determination of GAAP net income or loss: acquisition fees and expenses; amounts relating to deferred rent receivables and amortization of above and below market leases and liabilities (which are adjusted in order to remove the impact of GAAP straight-line adjustments from rental revenues); accretion of discounts and amortization of premiums on debt investments,  mark-to-market adjustments included in net income; gains or losses included in net income from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan, and unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity accounting and after adjustments for consolidated and unconsolidated partnerships and joint ventures, with such adjustments calculated to reflect MFFO on the same basis. The accretion of discounts and amortization of premiums on debt investments, unrealized gains and losses on hedges, foreign exchange, derivatives or securities holdings, unrealized gains and losses resulting from consolidations, as well as other listed cash flow adjustments are adjustments made to net income in calculating the cash flows provided by operating activities and, in some cases, reflect gains or losses which are unrealized and may not ultimately be realized.

Our MFFO calculation complies with the IPA’s Practice Guideline described above. In calculating MFFO, we exclude acquisition related expenses. Under GAAP, acquisition fees and expenses are characterized as operating expenses in determining operating net income or loss. These expenses are paid in cash by us.  All paid and accrued acquisition fees and expenses will have negative effects on returns to investors, the potential for future distributions, and cash flows generated by us, unless earnings from operations or net sales proceeds from the disposition of other properties are generated to cover the purchase price of the property.

Our management uses MFFO and the adjustments used to calculate it in order to evaluate our performance against other non-listed REITs which have limited lives with short and defined acquisition periods and targeted exit strategies shortly thereafter. As noted above, MFFO may not be a useful measure of the impact of long-term operating performance on value if we do not continue to operate in this manner.  We believe that our use of MFFO and the adjustments used to calculate it allow us to present our performance in a manner that reflects certain characteristics that are unique to non-listed REITs, such as their limited life, limited and defined acquisition period and targeted exit strategy, and hence that the use of such measures is useful to investors.  For example, acquisition costs are funded from our subscription proceeds and other financing sources and not from operations.  By excluding expensed acquisition costs, the use of MFFO provides information consistent with management’s analysis of the operating performance of the properties.

Presentation of this information is intended to provide useful information to investors as they compare the operating performance of different non-listed REITs, although it should be noted that not all REITs calculate FFO and MFFO the same way and as such comparisons with other REITs may not be meaningful.  Furthermore, FFO and MFFO are not necessarily indicative of cash flows available to fund cash needs and should not be considered as an alternative to net income (loss) or income (loss) from continuing operations as an indication of our performance, as an alternative to cash flows from operations, as an indication of our liquidity, or indicative of funds available to fund our cash needs including our ability to make distributions to our stockholders.  FFO and MFFO should be reviewed in conjunction with other GAAP measurements as an indication of our performance.  MFFO is useful in assisting management and investors in assessing the sustainability of operating performance in future operating periods, and in particular, after the offering and acquisition stages are complete.  FFO and MFFO are not useful measures in evaluating NAV because impairments are taken into account in determining NAV but not in determining FFO and MFFO.

Neither the SEC, NAREIT nor any other regulatory body has passed judgment on the acceptability of the adjustments we use to calculate FFO or MFFO.  In the future, the SEC, NAREIT or another regulatory body may decide to standardize the allowable adjustments across the non-listed REIT industry and we would have to adjust our calculation and characterization of FFO or MFFO.

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The following table presents a reconciliation of net loss to FFO and MFFO for the quarter and nine months ended September 30, 2018 and 2017 (in thousands, except per share data):

 

 

FOOTNOTE:

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Related Party Transactions

We have entered into agreements with our Advisor and its affiliates, whereby we agree to pay certain fees to, or reimburse certain expenses of, our Advisor or its affiliates for acquisition and advisory services, selling commissions, dealer manager fees, asset management fees and reimbursement of operating costs.

Our Advisor and its affiliates and related parties also are entitled to reimbursement of certain operating expenses in connection with their provision of services to us, including personnel costs, subject to the limitation that, beginning on the earlier of the Expense Year after (i) we make our first investment or (ii) six months after the commencement of the Offering, we will not reimburse the Advisor for any amount by which operating expenses exceed the greater of 2% of our average invested assets or 25% of our net income in any Expense Year unless approved by the independent directors.

For the Expense Year ended September 30, 2018, our total operating expenses were in excess of this limitation by approximately $0.4 million.  As of September 30, 2018, we had received cumulative approvals by our independent directors for total operating expenses in excess of this limitation of approximately $0.9 million.  Our independent directors determined that the higher relationship of operating expenses to average invested assets was justified based on unattained capital raise expectations which limited the number of investments, and the cost of operating a public company.

As of September 30, 2018, our Advisor has incurred aggregate other organizational and offering expenses of approximately $6.9 million, which are not eligible for reimbursement by us.  These expenses include, but are not limited to, SEC registration fees, FINRA filing fees, printing and mailing expenses, blue sky fees and expenses, legal fees and expenses, accounting fees and expenses, advertising and sales literature, transfer agent fees, due diligence expenses, personnel costs associated with processing investor subscriptions, escrow fees and other administrative expenses of the Offering.  

See Item 1. “Financial Statements” – Note 8. “Related Party Arrangements” in the accompanying condensed consolidated financial statements for additional information.

Off-Balance Sheet Arrangements

We had no off-balance sheet arrangements as of September 30, 2018.

Contractual Obligations

The following table presents our contractual obligations by payment period as of September 30, 2018 (in thousands):

 

 

Critical Accounting Policies and Estimates

See Item 1. “Financial Statements” for a summary of our significant accounting policies.

Recent Accounting Pronouncements

See Item 1. “Financial Statements” for a summary of the impact of recent accounting pronouncements.

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Item 3. Quantitative and Qualitative Disclosures about Market Risks

We may be exposed to financial market risks, specifically changes in interest rates to the extent we borrow money to acquire properties or to make loans and other permitted investments.  Our management objectives related to interest rate risk will be to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs.  To achieve our objectives, we expect to borrow primarily at fixed rates or variable rates with the lowest margins available, and in some cases, with the ability to convert variable rates to fixed rates.  With regard to variable rate financing, we will assess interest rate cash flow risk by continually identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating interest rate protection opportunities through swaps or caps.

We expect to hold our fixed-rate note obligations to maturity (or prepayment) and the amounts due under such instruments would be limited to the outstanding principal balance, any accrued and unpaid interest and any prepayment premiums. Accordingly, we do not expect that fluctuations in interest rates, and the resulting change in fair value of our fixed-rate note obligations, would have a significant impact on our operations.  The fair market value of the Notes was approximately $0.3 million as of September 30, 2018, which was determined using discounted cash flows based on current rates and spreads we would expect to obtain for similar borrowings.

The following is a schedule as of September 30, 2018 of our variable rate debt maturities for the remainder of 2018 and each of the next four years and thereafter (principal maturities only) (in thousands):

 

 

FOOTNOTE:

Management estimates that a one-percentage point increase or decrease in LIBOR in 2018, compared to LIBOR rates as of September 30, 2018, would result in fluctuation of interest expense on our variable rate debt of approximately $0.2 million for the year ended December 31, 2018. This sensitivity analysis contains certain simplifying assumptions, and although it gives an indication of our exposure to changes in interest rates, it is not intended to predict future results and actual results will likely vary given that our sensitivity analysis on effects of changes in LIBOR does not factor in a potential change in variable rate debt levels, any offsetting gains on interest swap contracts, or the impact of any LIBOR floors or caps.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, including our principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, our management, including our principal executive officer and principal financial officer, concluded that our disclosure controls and procedures are effective at the reasonable assurance level as of the end of the period covered by this report to provide reasonable assurance that information required to be disclosed by us in the reports we filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the relevant SEC rules and forms.

Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file and submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Internal Controls Over Financial Reporting

During the most recent fiscal quarter, there were no changes in our internal controls over financial reporting (as defined under Rule 13a-15(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we may be a party to legal proceedings in the ordinary course of, or incidental to the normal course of, our business, including proceedings to enforce our contractual or statutory rights.  While we cannot predict the outcome of these legal proceedings with certainty, based upon currently available information, we do not believe the final outcome of any pending or threatened legal proceeding will have a material adverse effect on our results of operations or financial condition.

Item 1A. Risk Factors

There have been no material changes in our assessment of our risk factors from those set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017 as well as on Form 10-Q for the quarter end March 31, 2018.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Unregistered Sales of Equity Securities

During the period covered by this quarterly report, we did not sell any equity securities that were not registered under the Securities Act of 1933.

Use of Proceeds from Registered Securities

On March 2, 2016, our Registration Statement on Form S-11 (File No. 333-206017), covering a public offering of up to $2.0 billion shares of common stock, was initially declared effective under the Securities Act of 1933, as amended.  Our Primary Offering closed effective October 1, 2018 and was conducted on a “best efforts” basis wherein we offered, in any combination, three classes of our common stock: Class A shares, Class T shares and Class I shares.  There were differing selling fees and commissions for each class of common stock.  We also paid annual distribution and stockholder servicing fees, subject to certain underwriting compensation limits, on the Class T and Class I shares sold in the Primary Offering.  

The use of proceeds from our Primary Offering was as follows as of September 30, 2018 (in thousands):

 

 

FOOTNOTES:

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Issuer Purchases of Equity Securities

The following details our repurchases of securities between July 1, 2018 and September 30, 2018:

 

 

FOOTNOTE:

Item 3. Defaults Upon Senior Securities - None

Item 4. Mine Safety Disclosure – Not Applicable

Item 5. Other Information - None

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Item 6. Exhibits

The following exhibits are included, or incorporated by reference in this Quarterly Report on Form 10-Q for the quarter and nine months ended September 30, 2018 (and are numbered in accordance with Item 601 of Regular S-K).

 

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, on the 8th day of November 2018.

 

 

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