UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

OR

 

Commission file number:  000-54685

 

  

 

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, 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 ☒

Securities registered pursuant to Section 12(b) of the Act:

 

The number of shares of common stock of the registrant outstanding as of November 5, 2020 was 173,960,540.

 

 

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

 

INDEX

 

 

 

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Item 1. Condensed Consolidated Financial Information

CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(in thousands, except per share data)

 

 

See accompanying notes to condensed consolidated financial statements

 

 

 

2

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(in thousands, except per share data)

 

 

See accompanying notes to condensed consolidated financial statements.

3

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

(in thousands)

 

 

See accompanying notes to condensed consolidated financial statements.

4

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND REDEEMABLE NONCONTROLLING INTEREST

QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 2020 (UNAUDITED)

(in thousands, except per share data)

 

 

See accompanying notes to condensed consolidated financial statements.

5

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND REDEEMABLE NONCONTROLLING INTEREST

QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 2019 (UNAUDITED)

(in thousands, except per share data)

 

 

See accompanying notes to condensed consolidated financial statements.

 

 

 

6

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands)

 

 

See accompanying notes to condensed consolidated financial statements.

 

 

7

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2020 (UNAUDITED)

 

CNL Healthcare Properties, Inc. (“Company”) is a Maryland corporation that incorporated on June 8, 2010 and elected to be taxed as a real estate investment trust (“REIT”) for United States (“U.S.”) federal income tax purposes beginning with the year ended December 31, 2012.  The Company’s intention is to be organized and operate in a manner that allows it to remain qualified as a REIT for U.S. federal income tax purposes.  The Company conducts substantially all of its operations either directly or indirectly through: (1) an operating partnership, CHP Partners, LP (“Operating Partnership”), in which the Company is the sole limited partner and its wholly-owned subsidiary, CHP GP, LLC, is the sole general partner; (2) a wholly-owned taxable REIT subsidiary (“TRS”), CHP TRS Holding, Inc.; (3) property owner and lender subsidiaries, which are single purpose entities; and (4) investments in joint ventures.

The Company is externally managed and advised by CNL Healthcare Corp. (“Advisor”), which is an affiliate of CNL Financial Group, LLC (“Sponsor”).  The Sponsor is an affiliate of CNL Financial Group, Inc. (“CNL”). The Advisor is responsible for managing the Company’s day-to-day operations, serving as a consultant in connection with policy decisions to be made by the board of directors, and for identifying, recommending and executing on possible strategic alternatives and dispositions on the Company’s behalf pursuant to an advisory agreement among the Company, the Operating Partnership and the Advisor.  Substantially all of the Company’s operating, administrative and certain property management services are, provided by affiliates of the Advisor.  In addition, certain property management services are provided by third-party property managers.  

On September 30, 2015, the Company completed its public offerings (“Offerings”) having received aggregate subscription proceeds of approximately $1.7 billion.  In October 2015, the Company deregistered the unsold shares of its common stock under its previous registration statement on Form S-11, except for 20 million shares that it registered on Form S-3 under the Securities Exchange Act of 1933 with the Securities and Exchange Commission (“SEC”) for the sale of additional shares of common stock through its distribution reinvestment plan (“Reinvestment Plan”).  Effective July 11, 2018, the Company suspended both its Reinvestment Plan and its stock redemption plan (“Redemption Plan”).

In 2017, the Company began evaluating possible strategic alternatives to provide liquidity to the Company’s stockholders.  In April 2018, the Company’s board of directors formed a special committee consisting solely of its independent directors (“Special Committee”) to consider possible strategic alternatives, including, but not limited to (i) the listing of the Company’s or one of its subsidiaries’ common stock on a national securities exchange, (ii) 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 (iii) a potential business combination or other transaction with a third party or parties that provides the stockholders of the Company with cash and/or securities of a publicly traded company (collectively, among other options, “Possible Strategic Alternatives”). During 2018, the Special Committee engaged HFF Securities L.P. (through June 2019) and KeyBanc Capital Markets Inc. to act as financial advisors to the aforementioned Special Committee.  As of December 2018, as part of executing on Possible Strategic Alternatives, the Company had committed to a plan to sell a total of 70 properties including the sale of 63 properties consisting of 53 medical office buildings (“MOBs”), five post-acute care facilities and five acute care hospitals across the US (collectively, the “MOB/Healthcare Portfolio”), a skilled nursing facility in Colorado (“Welbrook Senior Living Grand Junction”) and six skilled nursing facilities in Arkansas (the “Perennial Communities”).  During the year ended December 31, 2019, the Company sold 61 of the properties and during the nine months ended September 30, 2020, the Company sold seven additional properties.  In September 2020, the Company decided to discontinue marketing for sale one of its two remaining acute care properties and therefore only had one acute care property classified as assets held for sale as of September 30, 2020.

As of September 30, 2020, the Company’s healthcare investment portfolio was geographically diversified with properties in 27 states and consisted of interests in 74 properties, including 71 senior housing communities, one acute care hospital, one vacant land parcel and one acute care facility classified as held for sale.  The Company

8

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2020 (UNAUDITED)

 

has primarily leased its seniors housing properties to wholly-owned TRS entities and engaged independent third-party managers under management agreements to operate the properties under the REIT Investment Diversification and Empowerment Act of 2007 (“RIDEA”) structures; however, the Company has also leased its properties to third-party tenants under triple-net or similar lease structures, where the tenant bears all or substantially all of the costs (including cost increases, for real estate taxes, utilities, insurance and ordinary repairs).  In addition, although most of the Company’s investments are wholly owned, it has invested in properties through partnerships with other entities where it is believed to be appropriate and beneficial.

 

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 U.S. (“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 nine months ended September 30, 2020 may not be indicative of the results that may be expected for the year ending December 31, 2020.  Amounts as of December 31, 2019 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, 2019.

The accompanying unaudited condensed consolidated financial statements include the Company’s accounts, the accounts of wholly owned subsidiaries or subsidiaries for which the Company has a controlling interest, the accounts of two variable interest entities (“VIEs”) in which the Company is the primary beneficiary, and the accounts of other subsidiaries over which the Company has a controlling financial interest.  All material intercompany accounts and transactions have been eliminated in consolidation.

Assets Reclassified from Held for Sale to Held and Used — Upon management’s determination to discontinue marketing properties for sale, the properties will no longer meet the held for sale criteria and are required to be reclassified as held and used at the lower of adjusted carrying value (carrying value of the properties prior to being classified as held for sale adjusted for any depreciation and/or amortization expense that would have been recognized had the properties been continuously classified as held and used) or its fair value at the date of the subsequent decision not to sell. If adjusted carrying value is determined to be lower, a catch-up depreciation and/or amortization adjustment will be recorded. The depreciation and/or amortization expenses that would have been recognized had the properties been continuously classified as held and used and will be included as a component of depreciation and amortization expense in the accompanying unaudited condensed consolidated statements of operations. If fair value is determined to be lower, the Company will record a loss on reclassification which will be included in income or loss from continuing operations in the accompanying unaudited condensed consolidated statements of operations. 

Government Grant Income  — On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law which provided, among other things, for the establishment of a Provider Relief Fund under the direction of the Department of Health and Human Services (“HHS”). During the nine months ended September 30, 2020, the Company received $0.6 million in government grants under Phase 1 of the Provider Relief Fund primarily to cover increased expenses and lost revenue during the coronavirus pandemic. In September 2020, HHS announced that it expanded the eligibility to the Provider Relief Fund to include assisted living facilities as part of Phase 2 of the Provider Relief Fund.  The Company submitted an application for Phase 2 in September 2020 for approximately $5.5 million in government grants.  In October 2020, HHS announced that additional funds were made available for healthcare providers under Phase 3 of the Provider Relief Fund.  The Company submitted an application under Phase 3 in November 2020 and is awaiting specific guidance from HHS on how Phase 3 relief will be calculated. Grant income is recognized upon receipt of grant income and when all the conditions of the grant have been met. As of September 30, 2020, the

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2020 (UNAUDITED)

 

Company recorded $0.6 million of grant income related to the funding from Phase 1 of the Provider Relief Fund as all conditions had been met.

Risks and Uncertainties — The outbreak of the novel coronavirus (“COVID-19”) pandemic around the globe and the impact of the outbreak has been rapidly evolving.  Various of the states in which the Company owns properties have reacted by, among other things, instituting quarantines in many business sectors and instituting move-in restrictions to seniors housing communities.  The pandemic has also resulted in the incurrence of costs related to disease control and containment. Such actions are creating significant business disruption and adversely impacting a number of industries, including the senior housing sector.

The full impact of COVID-19 on the Company’s financial condition and results of operations is uncertain and cannot be predicted at the current time as it depends on several factors beyond the control of the Company including, but not limited to (i) the uncertainty around the severity and duration of the outbreak, (ii) the effectiveness of the United States public health response, (iii) the pandemic’s impact on the U.S. and global economies, (iv) the timing, scope and effectiveness of additional governmental responses to the pandemic and (v) the timing and speed of economic recovery, including the availability of a treatment or vaccination for COVID-19.

Use of Estimates — The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements, the reported amounts of revenues and expenses during the reporting periods and the disclosure of contingent liabilities. For example, significant assumptions are made in the analysis of real estate impairments, the valuation of contingent assets and liabilities, and the valuation of restricted common stock (“Restricted Stock”) shares issued to the Advisor.  The uncertainty surrounding the COVID-19 pandemic may materially impact the accuracy of the estimates and assumptions used in the financial statements and related footnotes and accordingly, actual results could differ from those estimates.

Adopted Accounting Pronouncements — In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-13, “Measurement of Credit Losses on Financial Instruments (Topic 326),” which requires a new forward-looking expected loss model to be used for receivables, held-to-maturity debt, loans and other financial instruments.  Previously, when credit losses were measured under current GAAP, an entity generally only considered past events and current conditions in measuring the incurred loss.  The amendments eliminate the probable initial threshold for recognition of credit losses in current GAAP and, instead, reflect an entity’s current estimate of all expected credit losses over the life of the financial instrument.  The ASU is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2019.  The Company adopted this ASU prospectively on January 1, 2020, the adoption of which did not have a material impact on the Company’s consolidated results of operations.

Impact of Recent Accounting Pronouncements - In Q1 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848). ASU 2020-04 contains practical expedients for reference rate reform related activities that impact debt, leases, derivatives and other contracts. The guidance in ASU 2020-04 is optional and may be elected over time as reference rate reform activities occur. During the nine months ended September 30, 2020, the Company has elected to apply the hedge accounting expedients related to probability and the assessments of effectiveness for future LIBOR-indexed cash flows to assume that the index upon which future hedged transactions will be based matches the index on the corresponding derivatives. Application of these expedients preserves the presentation of derivatives consistent with past presentation.  The Company continues to evaluate the impact of the guidance and may apply other elections as applicable as additional changes in the market occur.  

In April 2020, the FASB issued a Staff Question-and-Answer (“Q&A”) to clarify whether lease concessions related to the effects of COVID-19 require the application of the lease modification guidance under the new lease standard, which the Company adopted on January 1, 2019. Under the new leasing standard, an entity would have to determine, on a lease by lease basis, if a lease concession was the result of a new arrangement

10

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2020 (UNAUDITED)

 

reached with the tenant, which would be accounted for under the lease modification framework, or if the lease concession was under the enforceable rights and obligations that existed in the original lease, which would be accounted for outside the lease modification framework. The Q&A provides entities with the option to elect to account for lease concessions as though the enforceable rights and obligations existed in the original lease as long as the total cash flows from the modified lease are substantially similar to the cash flows in the original lease. We have elected this option and therefore, to the extent that a rent concession is granted as a deferral of payments, but total payments are substantially the same, we will account for the concession as if no change has been made to the original lease.

 

The following table presents disaggregated revenue related to the Company’s resident fees and services during the nine months ended September 30, 2020 and 2019:

 

 

 

The gross carrying amount and accumulated depreciation of the Company’s real estate assets as of September 30, 2020 and December 31, 2019 are as follows, excluding assets held for sale (in thousands):

 

 

In September 2020, the Company decided to discontinue marketing for sale one of its two remaining acute care properties that it had previously classified as assets held for sale.  As a result of discontinuing marketing efforts, this acute care property no longer met the assets held for sale criteria and the Company recorded an adjustment of $1.6 million during the quarter and nine months ended September 30, 2020, representing the catch up in depreciation expense that would have been recognized had this property been continuously classified as held and used. The property was reclassified as held and used at the adjusted carrying value, which was lower than its fair value, resulting in no loss on reclassification on this property. The Company recorded all operating results from this acute care property as income or loss from continuing operations for all periods presented.

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2020 (UNAUDITED)

 

Depreciation expense on the Company’s real estate investment properties, net was approximately $14.3 million and $39.1 million for the quarter and nine months ended September 30, 2020, respectively, and approximately $12.2 million and $36.7 million for the quarter and nine months ended September 30, 2019, respectively.  These amounts include the $1.6 million depreciation catch up adjustment described above and depreciation through the determination date on assets held for sale; refer to Note 6. “Assets and Associated Liabilities Held For Sale and Discontinued Operations” for additional information.

 

The gross carrying amount and accumulated amortization of the Company’s intangible assets as of September 30, 2020 and December 31, 2019 are as follows (in thousands):

 

 

For each of the quarter and nine months ended September 30, 2020 and 2019, amortization on the Company’s intangible assets was approximately $0.1 million and $0.3 million, respectively, all of which were included in depreciation and amortization.

 

As part of executing on Possible Strategic Alternatives, during 2018, the Company committed to a plan to sell a total of 70 properties, including: (1) the 63 property MOB/Healthcare Portfolio, (2) the six properties comprising the Perennial Communities and (3) Welbrook Senior Living Grand Junction.  As such, the Company classified the 70 properties as held for sale.  The Company believed the sale of the MOB/Healthcare Portfolio would cause a strategic shift in the Company’s operations and therefore classified the operations of those properties as discontinued operations.  The sale of the other seven properties would not cause a strategic shift in the Company’s operations and were not considered individually significant; therefore, those properties did not qualify as discontinued operations.

During the year ended December 31, 2019, the Company sold 61 of the 70 properties and as of December 31, 2019, had entered into purchase and sale agreements for its acute care property in New Orleans (the “New Orleans Sale Agreement”) and for the Perennial Communities (the “Perennial Sale Agreement”) with unrelated third party buyers.  During the nine months ended September 30, 2020, the Company sold the seven properties in accordance with the New Orleans Sale Agreement and the Perennial Sale Agreement and recorded gain on sale of $1.1 million for financial reporting purposes.  

As described in Note 4, “Real Estate Assets, Net”, in September 2020, the Company decided to discontinue marketing for sale one of its two remaining acute care properties that it had previously classified as assets held for sale.  As a result of discontinued marketing efforts, this acute care property no longer met the assets held for sale criteria.  The Company recorded all operating results from this acute care property as income or loss from continuing operations for all periods presented.

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2020 (UNAUDITED)

 

As of September 30, 2020 and December 31, 2019, the Company had one acute care property and eight properties, respectively, classified as assets held for sale. The one asset held for sale, and the liabilities associated with those assets held for sale, consisted of the following (in thousands):

 

 

As of December 31, 2019, the eight properties classified as assets held for sale, and the liabilities associated with those assets held for sale, consisted of the following (in thousands):

 

 

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2020 (UNAUDITED)

 

The Company classified the revenues and expenses related to the Company’s MOB/Healthcare Portfolio, which consisted of 62 properties, as discontinued operations in the accompanying condensed consolidated statements of operations, as it believed the sale of these properties represented a strategic shift in the Company’s operations.  The following table is a summary of the Company’s income from discontinued operations for the quarter and nine months ended September 30, 2020 and 2019 (in thousands):

 

 

FOOTNOTES:

 

 

As of September 30, 2020 and December 31, 2019, the Company had two subsidiaries classified as VIEs. These subsidiaries are joint ventures with completed real estate under development in which their equity interest consists of non-substantive protective voting rights.  Additionally, one of the subsidiaries has insufficient equity at risk due to the development nature of the joint venture. The Company determined it is the primary beneficiary and holds a controlling financial interest in each of these subsidiaries due to its power to direct the activities that most significantly impact the economic performance of the entities, as well as its obligation to absorb the losses and its right to receive benefits from these entities that could potentially be significant to these entities. As such, the transactions and accounts of these VIEs are included in the accompanying consolidated financial statements.  The Company’s maximum exposure to loss as a result of its involvement with these VIEs

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2020 (UNAUDITED)

 

is limited to its net investment in these entities which totaled approximately $13.0 million as of September 30, 2020. The Company’s exposure is limited because of the non-recourse nature of the borrowings of the VIEs.

 

During the nine months ended September 30, 2020, the Company repaid the Primrose II Communities outstanding mortgage loan balance of approximately $20.5 million, which matured in June 2020.  In April 2020, the Company borrowed $40 million under its Revolving Credit Facility as a precautionary measure to increase liquidity and preserve financial flexibility in light of COVID-19 and in September 2020 repaid $80 million under its Revolving Credit Facility.

The following table provides the details of the fair market value and carrying value of the Company’s indebtedness as of September 30, 2020 and December 31, 2019 (in millions):

 

 

These fair market values are 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 related to the Company’s mortgage notes payable is categorized as Level 3 on the three-level valuation hierarchy.  The estimated fair value of accounts payable and accrued liabilities approximates the carrying value as of September 30, 2020 and December 31, 2019 because of the relatively short maturities of the obligations.

All of the Company’s mortgage loans contain customary financial covenants and ratios, including (but not limited to) debt service coverage ratio, minimum occupancy levels, limitations on incurrence of additional indebtedness, etc.  

The credit facilities contain affirmative, negative, and financial covenants which are customary for loans of this type, including (but not limited to): (i) maximum leverage, (ii) minimum fixed charge coverage ratio, (iii) minimum consolidated net worth, (iv) restrictions on payments of cash distributions except if required by REIT requirements, (v) maximum secured indebtedness, (vi) maximum secured recourse debt, (vii) minimum unsecured interest coverage, (viii) maximum unsecured indebtedness ratio, and (ix) limitations on certain types of investments and with respect to the pool of properties supporting borrowings under the credit facilities, minimum weighted average occupancy, and remaining lease terms, as well as property type, MSA, operator, and asset value concentration limits.  The limitations on distributions generally include a limitation on the extent of allowable distributions, which are not to exceed the greater of 95% of adjusted FFO (as defined per the credit facilities) and the minimum amount of distributions required to maintain the Company’s REIT status.  As of September 30, 2020, the Company was in compliance with all financial covenants.

 

During the quarter and nine months ended September 30, 2020, the Company paid approximately $0.07 million and $0.20 million, respectively, of cash distributions on restricted stock issued through March 2017 pursuant to the Advisor expense support agreement.  During the quarter and nine months ended September 30, 2019, the Company paid approximately $0.07 million and $3.0 million, respectively, of cash distributions on restricted stock issued pursuant to the Advisor expense support agreement, which included a special cash distribution in May 2019 funded with sales proceeds from the sale of real estate.  These amounts have been recognized as

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2020 (UNAUDITED)

 

compensation expense and included in general and administrative expenses in the accompanying condensed consolidated statements of operations.

In May 2020, the Company’s board of directors approved the renewal of its advisory agreement with the Advisor through June 2021. The expenses and fees incurred by and reimbursable to the Company’s related parties, including amounts included in income from discontinued operations, for the quarter and nine months ended September 30, 2020 and 2019, and related amounts unpaid as of September 30, 2020 and December 31, 2019 are as follows (in thousands):

 

 

FOOTNOTES:

 

Stockholders’ Equity:

Distributions — During the quarter and nine months ended September 30, 2020, the Company declared cash distributions of approximately $8.9 million and $26.7 million, respectively. During the quarter and nine months ended September 30, 2019, the Company declared cash distributions of approximately $8.9 million and $386.0 million, respectively, which included a special cash distribution of $347.9 million funded in May 2019 with proceeds from the sale of real estate.

 

The accompanying condensed consolidated financial statements include an interim tax provision for the quarter and nine months ended September 30, 2020 and 2019.  The Company recorded a (benefit) expense for income taxes of approximately ($0.4) million and $0.9 million for the quarter and nine months ended September 30, 2020 respectively, and $0.7 million and $1.9 million for the quarter and nine months ended September 30, 2019, respectively.  Of the amounts recorded for the quarter and nine months ended September 30, 2020, approximately $0.1 million and $0.4 million, respectively, represented current income tax expense, and

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CNL HEALTHCARE PROPERTIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2020 (UNAUDITED)

 

approximately ($0.5) million and $0.5 million, respectively, represented a change to the Company’s net deferred tax assets which was primarily due to the addition to and utilization of a portion of the Company’s TRS’s federal and state net operating loss carry-forwards.  Of the total amounts recorded for the quarter and nine months ended September 30, 2019, approximately $0.1 million and $0.5 million, respectively, represented current income tax expense, and approximately $0.6 million and $1.4 million, respectively, represented a decrease to the Company’s net deferred tax assets which was primarily due to the utilization of a portion of the Company’s TRS’s federal and state net operating loss carry-forwards. 

 

On March 27, 2020, the CARES Act was enacted into law.  As required under U.S. GAAP, the effects of tax law changes are recognized in the period of enactment.

 

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.

As a result of the Company’s completed seniors housing developments continuing to move towards or achieving stabilization, the Company monitors the lease-up of these properties to determine whether the established performance metrics have been met as of each reporting period.  As of September 30, 2020, the Company had six promoted interest agreements with third-party developers pursuant to which certain operating targets have been established that, upon meeting such targets, result in the developer being entitled to additional payments based on enumerated percentages of the assumed net proceeds of a deemed sale, subject to achievement of an established internal rate of return on the Company’s investment in the development.   None of the established performance metrics were not met nor probable of being met as of September 30, 2020.

The Company’s Advisor has approximately 1.3 million contingently issuable Restricted Stock shares for financial reporting purposes that were issued pursuant to the Advisor expense support agreement.  Refer to Note 9. “Related Party Arrangements” for information on distributions declared related to these Restricted Stock shares.

In March 2020, the World Health Organization declared the outbreak of COVID-19 as a pandemic.  The COVID-19 pandemic has had a significant effect on global markets, supply chains, businesses and communities. It has impacted various parts of the Company’s operations and financial results, including but not limited to, loss of revenue from reductions in occupancy levels and the incurrence of additional costs for emergency preparedness, disease control and containment and additional labor costs of healthcare personnel.

The Company remains focused on maintaining a strong balance sheet, liquidity and financial flexibility and continues to monitor developments as it deals with the disruptions and uncertainties from a business and financial perspective relating to COVID-19.  However, the full impact of COVID-19 is unknown and cannot be reasonably estimated. The ultimate extent of the impact of COVID-19 on the financial performance of the Company will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the scope, severity and duration of the outbreak of the pandemic, the actions taken to contain the pandemic or mitigate its impact, and the direct and indirect economic effects of the pandemic and containment measures, among others.

 

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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 quarter and nine months ended September 30, 2020 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 (the “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,” and “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, estimated net asset value per share 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.  

Important factors that could cause the Company's actual results to vary materially from those expressed or implied in its forward-looking statements include, but are not limited to government regulation, economic, strategic, political and social conditions and the following:

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Given these uncertainties, the Company cautions you not to place undue reliance on forward-looking information.

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 factors listed and described in the Company’s  reports filed from time to time with the SEC, including, but not limited to, the Company’s quarterly reports on Form 10-Q and the Company’s annual reports on Form 10-K, copies of which may be obtained from the Company’s website at www.cnlhealthcareproperties.com.  One of the most significant factors is the ongoing and potential impact of the current outbreak of the COVID-19 pandemic on the economy and the broader financial markets, which may have a significant negative impact on the Company's financial condition, results of operations and cash flows. The Company is unable to predict whether the continuing effects of the COVID-19 pandemic will trigger a further economic slowdown or a recession and to what extent the Company will experience disruptions related to the COVID-19 pandemic during the remainder of 2020 or thereafter.

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

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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.

Introduction

The following discussion is based on the condensed consolidated financial statements of the Company as of September 30, 2020 (unaudited) and December 31, 2019.  Amounts as of December 31, 2019 included in the unaudited condensed consolidated balance sheets 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 balance sheets and the notes thereto, as well as the audited consolidated financial statements, notes and management’s discussion and analysis included in our Annual Report on Form 10-K for the year ended December 31, 2019.

Overview

CNL Healthcare Properties, Inc. is a Maryland corporation that incorporated on June 8, 2010.  We elected to be taxed as a REIT for U.S. federal income tax purposes beginning with the year ended December 31, 2012 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. The terms “us,” “we,” “our,” “Company” and “CNL Healthcare Properties” include CNL Healthcare Properties, Inc. and each of its subsidiaries.

Substantially all of our assets are held by, and all operations are conducted, either directly or indirectly, through: (1) the Operating Partnership in which we are the sole limited partner and our wholly owned subsidiary, CHP GP, LLC, is the sole general partner; (2) a wholly owned TRS, CHP TRS Holding, Inc.; (3) property owner subsidiaries and lender subsidiaries, which are single purpose entities; and (4) investments in joint ventures.

We are externally managed and advised by CNL Healthcare Corp. (the “Advisor”).  Our Advisor has responsibility for our day-to-day operations, serving as our consultant in connection with policy decisions to be made by our board of directors, and for identifying, recommending and executing on Possible Strategic Alternatives (as described below under “Possible Strategic Alternatives”) and dispositions on our behalf pursuant to an advisory agreement. In May 2020, we extended the advisory agreement with our Advisor through June 2021.  For additional information on our Advisor, its affiliates or other related parties, as well as the fees and reimbursements we pay, see Note 9. “Related Party Arrangements.”

On September 30, 2015, we completed our Offerings having received aggregate subscription proceeds of approximately $1.7 billion.  In October 2015, we deregistered the unsold shares of our common stock under our previous registration statement on Form S-11, except for 20 million shares that we registered on Form S-3 under the Securities Exchange Act of 1933 with the SEC for the sale of additional shares of common stock through our Reinvestment Plan.  As part of moving forward with the consideration of Possible Strategic Alternatives, effective July 11, 2018 we suspended our Reinvestment Plan, and stockholders who were participants in our Reinvestment Plan now receive cash distributions instead of additional shares of our common stock.

COVID-19

In March 2020, the World Health Organization declared the outbreak of COVID-19 as a pandemic which has resulted in significant effects on global markets, supply chains, businesses and communities. The outbreak of the COVID-19 pandemic around the globe continues to adversely impact global commercial activity and has contributed to significant volatility in financial markets. The global impact of the outbreak has been rapidly evolving and many countries, including the United States, have reacted by, among other things, instituting quarantines, mandating business and school closures and restricting travel. Such actions are creating significant disruption in global supply chains, and adversely impacting a number of industries.

The major disruption caused by COVID-19 brought to a halt most economic activity in most of the United States resulting in a significant increase in unemployment claims and will likely result in a significant decline in the U.S. Gross Domestic Product. COVID-19 could have a continued and prolonged adverse impact on economic and market

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conditions and trigger a period of global economic slowdown which could have a material adverse effect on our Company’s results and financial condition.

The full impact of COVID-19 on the financial and credit markets and consequently on our business, financial condition and results of operations is uncertain and cannot be predicted at the current time as it depends on several factors beyond our control including, but not limited to (i) the uncertainty around the severity and duration of the outbreak, (ii) the effectiveness of the United States public health response, (iii) the pandemic’s impact on the U.S. and global economies, (iv) the timing, scope and effectiveness of additional governmental responses to the pandemic and (v) the timing and speed of economic recovery, including the availability of a treatment or vaccination for COVID-19.

The Advisor began its contingency and process planning for the potential pandemic and transitioned swiftly to a remote working environment in early March for all the personnel that support our Company’s operations in advance of the issuance of stay at home orders from state and local governmental agencies.  In March, we proactively increased our engagement with our property managers and our communities.  Even though we already had influenza protocols at each of our seniors housing communities, we immediately enhanced the influenza protocols to incorporate new guidelines issued by the CDC to address the increased exposure from COVID-19.    

As of September 30, 2020, our healthcare investment portfolio consisted of interests in 74 properties, comprising 71 senior housing communities, one acute care hospital, one vacant land parcel and one acute care hospital classified as held for sale.  Of our 71 senior housing communities, we owned 15 properties leased to third party tenants under triple-net leases (“NNN”), and the remaining 56 properties were managed through third party operators, including five senior housing communities owned through our unconsolidated joint venture. While the average occupancy of our senior housing communities was not materially impacted as of the beginning of March 2020, occupancy began to decline starting in the second half of March.  Occupancy has continued to trend lower through October as a result of move-in restrictions, intensified screening and other measures enacted at our communities to address the spread of COVID-19.  While some of these restrictions have been relaxed or phased out, many of these or similar restrictions remain in place or continue to be implemented and in certain cases additional restrictions are being considered. We expect to continue to experience a negative impact in occupancy rates during the COVID-19 pandemic. Starting in the last half of March, we began incurring unanticipated COVID-19 related operating expenses, including higher labor costs, costs to obtain personal protective equipment and other costs related to disease control and containment. We expect to continue incurring higher operating expenses during the COVID-19 pandemic.

Our 71 seniors housing communities are located throughout the United States in 26 states with a population of nearly 7,000 residents and approximately 5,700 community-level staff.  As of November 11, 2020, as reported by our senior housing operators and tenants, we had 112 active, confirmed positive cases among our residents and staff members in 25 of our communities located in 15 states.  The number of confirmed cases in our senior housing communities may continue to increase depending on the duration, scope and depth of the COVID-19 pandemic as well as the timing and extent of ceasing stay at home and other social distancing restrictions from state and local governmental agencies.

As described below in “Liquidity and Capital Resources”, as of September 30, 2020, we had $240.0 million in liquidity, consisting of approximately $69.9 million in cash and cash equivalents and approximately $170.1 million of availability under our Revolving Credit Facility.  We remain focused on maintaining liquidity and financial flexibility and continue to monitor developments as we deal with the disruptions and uncertainties from a business and financial perspective relating to COVID-19.  

In May 2020, we granted a three-month rent payment deferral of approximately $2 million to one of our senior housing tenants relating to eight properties for the periods May, June and July of 2020. We did not provide any rent concessions to this tenant and repayment of the $2 million in deferred amounts is scheduled to be collected over twelve monthly installments beginning in January 2021. In August, we began collecting 100% of the rental amounts due in accordance with their lease agreements.  As of September 30, 2020, with the exception of the $2 million payment deferral, we had collected 100% of all rental amounts due through October 31, 2020 for all seniors housing properties leased to third party tenants under NNN leases.

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We believe we are taking appropriate actions to manage through the COVID-19 pandemic.  As described above, we began to see a reduction in our operating results in the last half of March which has continued through the date of this filing.  However, the full impact of COVID-19 is unknown and cannot be reasonably estimated. The ultimate extent of the impact of COVID-19 on the financial performance of our Company will depend on future developments, including the duration and spread of COVID-19 and its effects on the overall economy, all of which are highly uncertain and cannot be predicted. 

Since March 13, 2020, there have been a number of federal, state and local government initiatives to manage the spread of the virus and its impact on the economy, financial markets and continuity of businesses of all sizes and industries. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law which provided, among other things, for the establishment of a Provider Relief Fund under the direction of the Department of Health and Human Services (“HHS”). One of our communities that provided skilled nursing care services and received Medicare fee-for-service reimbursements for those services, received approximately $0.6 million in relief funds from Phase 1 of the Provider Relief Fund.  In September 2020, HHS announced that it had expanded the eligibility of the Provider Relief Fund to include assisted living facilities as part of Phase 2 of the Provider Relief Fund. We submitted our application for Phase 2 in September 2020 for approximately $5.5 million, and we anticipate receiving and recognizing these funds as an offset to property operating expenses and/or other income in the fourth quarter. In October 2020, HHS announced that additional funds would be made available for healthcare providers under Phase 3 of the Provider Relief Fund.  We submitted our application under Phase 3 in November and are awaiting specific guidance from HHS on how Phase 3 relief will be calculated.  

Possible Strategic Alternatives

In 2017, we began evaluating possible strategic alternatives to provide liquidity to the Company’s stockholders.  In April 2018, our board of directors formed a special committee consisting solely of our independent directors (“Special Committee”) to consider possible strategic alternatives, including, but not limited to (i) the listing of the Company’s or one of its subsidiaries’ common stock on a national securities exchange, (ii) 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 (iii) a potential business combination or other transaction with a third-party or parties that provides the stockholders of the Company with cash and/or securities of a publicly traded company (collectively, among other options, “Possible Strategic Alternatives”).  During 2018, the Special Committee engaged HFF Securities L.P. (through June 2019) and KeyBanc Capital Markets Inc. to act as financial advisors in connection with exploring our Possible Strategic Alternatives.  

In connection with our consideration of the Possible Strategic Alternatives, our board of directors suspended both our Reinvestment Plan and our Redemption Plan effective July 11, 2018.  As part of executing on Possible Strategic Alternatives, in September 2018, our board of directors committed to a plan to sell the MOB/Healthcare Portfolio, a portfolio of 63 properties consisting of 53 MOBs, five post-acute care facilities and five acute care hospitals across the US. In December 2018, we also committed to a plan to sell our Welbrook Senior Living Grand Junction property, our skilled nursing facility in Grand Junction, Colorado.  We had also previously committed to a plan to sell our six skilled nursing facilities in Arkansas.  As of December 31, 2018, we had a total of 70 properties classified as held for sale and had classified the operations of the 63 properties in the MOB/Healthcare Portfolio as discontinued operations because the sale of these properties represented a strategic shift in our operations.

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In April 2019, we completed the sale of four post-acute care properties (“IRF Sale”) to an unrelated third party. In May 2019, we completed the sale of 55 medical office buildings and related properties (“MOB Sale”), to a subsidiary of Welltower Inc. and received approximately $1,321.2 million in net sales proceeds.  Both the IRF Sale and the MOB Sale were in furtherance of our efforts to sell the MOB/Healthcare Portfolio.  We used the net sales proceeds to: (1) repay indebtedness secured by or allocated to the 59 properties comprising the MOB Sale and the IRF Sale; (2) strategically rebalance other corporate borrowings; (3) make a special cash distribution of $347.9 million ($2.00 per share) to our stockholders and (4) for other corporate purposes.  Additionally, as a result of the IRF Sale and the MOB Sale, our board of directors adjusted our regular quarterly cash distribution to an amount equal to $0.0512 per share, compared to $0.1164 per share that had been in effect since the third quarter of 2017.  The adjustment to our regular cash distributions was the result of a reduction in our remaining earnings base and operating cash flows given the associated impact of the sale of real estate on our operating cash flows.  In June 2019 subsequent to the consummation of the MOB Sale, we terminated our engagement of HFF Securities L.P., one of the financial advisors to our Special Committee in connection with exploring Possible Strategic Alternatives, subject to a 12-month tail of certain fees and obligations under the terminated engagement letter, which expired in June 2020. During the last half of 2019, we sold one acute care hospital from the MOB/Healthcare Portfolio plus the Welbrook Senior Living Grand Junction property to unrelated third parties and received net sales proceeds of $39.0 million.

In December 2019, we entered into a purchase and sale agreement for the sale of our six skilled nursing facilities in Arkansas (the “Perennial Communities Sale Agreement”) with an unrelated third party for a gross sales price of $55.0 million, subject to certain pro-rations and other adjustments, as described in the Perennial Communities Sale Agreement.  In addition, in December 2019, we entered into a purchase and sale agreement with an unrelated third party for our acute care hospital in New Orleans (the “New Orleans Sale Agreement”) for a gross sales price of $28.65 million.  During the nine months ended September 30, 2020, we sold the property related to the New Orleans Sale Agreement and the six properties related to the Perennial Communities Sale Agreement, respectively.

In September 2020, we decided to discontinue marketing for sale one of our two remaining acute care properties that we had previously classified as assets held for sale.  As a result of discontinued marketing efforts, this acute care property no longer met the assets held for sale criteria.  As of September 30, 2020, we had one remaining acute care property classified as held for sale.

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Portfolio Overview

As of September 30, 2020, our healthcare investment portfolio consisted of interests in 74 properties, comprising 71 senior housing communities, one acute care property, one vacant land parcel and one acute care hospital classified as held for sale.  Of our properties held as of September 30, 2020, five of our 71 seniors housing properties were owned through an unconsolidated joint venture.    

We believe demographic trends and compelling supply and demand indicators presented a strong case for an investment focus on healthcare real estate and real estate-related assets.  Including our one acute care property classified as held for sale, our remaining healthcare investment portfolio is geographically diversified with properties in 27 states. The map below shows our remaining healthcare investment portfolio across geographic regions as of November 5, 2020:

 

 

The following table summarizes our remaining healthcare investment portfolio by asset class and investment structure as of November 5, 2020:

 

 

FOOTNOTES:

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Portfolio Evaluation

While we are not directly impacted by the performance of the underlying properties leased to 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, managers or joint venture partners 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 managers are generally contractually required to provide this information to us in accordance with their respective lease, management and/or joint venture agreements.  Therefore, in order to mitigate the aforementioned risk, we monitor our investments through a variety of methods determined by the type of property.

We monitor the performance of our tenants and third-party operators to stay abreast of any material changes in the operations of the underlying properties by (1) reviewing the current, historical and prospective operating margins (measured by a tenant’s earnings before interest, taxes, depreciation, amortization and facility rent), (2) monitoring trends in the source of our tenants’ revenue, including the relative mix of public 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 tenants’ profitability and liquidity, and (4) reviewing the competition and demographics of the local and surrounding areas in which the tenants operate. As described above under COVID-19, we provided a $2 million three-month payment deferral to one of our tenants for May, June and July 2020.  Repayment of the $2 million in deferred amounts is scheduled to be collected over twelve monthly installments beginning in January 2021. We did not provide any rent concessions to the tenant and the tenant resumed paying full rents due under its lease agreement in August 2020.  We are proactively working closely with our tenants and third-party operators to monitor the impact from COVID-19 on the operations of our seniors housing communities.

We monitor the credit of our tenants to stay abreast of any material changes in credit quality.  We monitor credit quality by (1) reviewing financial statements that are publicly available or that are required to be delivered to us under the applicable lease, (2) direct interaction with onsite property managers, (3) monitoring news and rating agency reports regarding our tenants (or their parent companies) and their underlying businesses, (4) monitoring the timeliness of rent collections and (5) monitoring lease coverage. The tenant at one of our acute care properties began experiencing financial difficulties.  The tenant has been unable to remain current under its lease and had $0.6 million of past due rents outstanding (all of which were reserved) as of September 30, 2020.  We have not granted any rent concessions and are working with this tenant on the collection of past due amounts.  See further discussion below in “Tenant Financial Difficulties”.

When evaluating the performance of our senior housing portfolio, management reviews occupancy levels and monthly revenue per occupied unit, which we define as total revenue divided by average number of occupied units or beds and is considered a performance metric within these asset classes.  Similarly, when evaluating the performance of our third-party operators, management reviews monthly financial statements, property-level operating performance versus budgeted expectations, conducts periodic operational review calls with operators and conducts periodic property inspections or site visits.   All of the aforementioned operating and statistical metrics assist us in determining the ability of our properties or operators to achieve market rental rates, to assess the overall performance of our diversified healthcare portfolio, and to review compliance with leases, debt, licensure, real estate taxes, and other collateral.

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Significant Tenants and Operators

Our real estate portfolio is operated by a mix of national or regional operators and the following represent the significant tenants and operators that lease or manage 5% or more of our rentable space as of September 30, 2020, excluding the one acute property which was classified as discontinued operations:

 

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Tenant Lease Expirations

As of September 30, 2020, excluding the one property classified as held for sale, we owned 15 senior housing communities and one acute care property that were leased to third party tenants under NNN leases. During the nine months ended September 30, 2020, our rental income from continuing operations represented approximately 9% of our total revenues from continuing operations.  

Under the terms of our triple-net lease agreements, each tenant is responsible for payment of property taxes, general liability insurance, utilities, repairs and maintenance, including structural and roof expenses.  Each tenant is expected to pay real estate taxes directly to the taxing authorities. However, if the tenant does not pay the real estate taxes, we would be liable.  

Our asset management team collaborates with existing tenants to understand their current and anticipated space needs in advance of their lease term renewal date.  As of September 30, 2020, none of our rental income from continuing operations was scheduled to expire until 2022.  Therefore, we do not expect lease turnover to have a significant impact on our cash flows from operations in the near term.  We work with and begin lease-related negotiations well in advance of the lease expirations or renewal period options in order for us to maintain a balanced lease rollover schedule and high occupancy levels, as well as to enhance the value of our properties through extended lease terms. Lease extensions are likely to create an obligation to pay lease commissions, lease incentives and/or tenant improvements and may also provide our tenants with some periods of reduced and/or “free rent.” Certain amendments or modifications to the terms of existing leases could require lender approval.

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The following table lists, on an aggregate basis, scheduled expirations for the remainder of 2020, each of the next nine years and thereafter on our consolidated healthcare investment portfolio, excluding the one acute care property classified as assets held for sale, assuming that none of the tenants exercise any of their renewal options (in thousands, except for number of tenants and percentages) as of September 30, 2020:

 

FOOTNOTES:

Liquidity and Capital Resources

General

Our ongoing primary sources of capital include proceeds from collateralized or uncollateralized financings from banks or other lenders, other assets and undistributed operating cash flows, and as part of executing on Possible Strategic Alternatives as described above under “Possible Strategic Alternatives,” proceeds from the sales of real estate.  Our primary use of capital includes the payment of distributions, payment of operating expenses, funding capital improvements to existing properties and payment of debt service.  Our ongoing sources and uses of capital will be impacted by the COVID-19 pandemic as described above in “COVID-19”. As necessary, we may use financings or other sources of capital in the event of unforeseen significant capital expenditures or to cover periodic shortfalls between distributions paid and cash flows from operating activities.  

As of September 30, 2020, we had approximately $240.0 million of liquidity (consisting of approximately $69.9 million in cash and cash equivalents on hand and approximately $170.1 million of undrawn availability under our Revolving Credit Facility). In October 2020, we repaid $8.0 million of a debt obligation upon maturity and have approximately $2.8 million of debt obligations coming due during the remainder of 2020.   We remain focused on maintaining liquidity and financial flexibility and continue to monitor developments as we deal with the disruptions and uncertainties from a business and financial perspective relating to COVID-19.  However, the full impact of COVID-19 is unknown and cannot be reasonably estimated. The ultimate extent of the impact of COVID-19 on the financial performance of our Company will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the scope, severity and duration of the outbreak of the pandemic, the actions taken to contain the pandemic or mitigate its impact, and the direct and indirect economic effects of the pandemic and containment measures, among others.

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We have pledged certain of our properties in connection with our borrowings and may continue to strategically leverage our real estate and use debt financing as a means of providing additional funds for the payment of distributions to stockholders, working capital and for other corporate purposes.  Our ability to increase our borrowings could be adversely affected by credit market conditions, including the COVID-19 pandemic, which could result in lenders reducing or limiting funds available for loans, including loans collateralized by real estate.  We may also be negatively impacted by rising interest rates on our unhedged variable rate debt or the timing of when we seek to refinance existing debt. In addition, we continue to evaluate the need for additional interest rate protection in the form of interest rate swaps or caps on unhedged variable rate debt.

Our cash flows from operating and investing activities as described within “Sources of Liquidity and Capital Resources” and “Uses of Liquidity and Capital Resources” represent cash flows from continuing operations and exclude the results for the 62 properties from our MOB/Healthcare Portfolio classified as discontinued operations, of which 61 were sold through September 30, 2020 and of which one acute care property was classified as held for sale as of September 30, 2020.  

Sources of Liquidity and Capital Resources

Proceeds from Sale of Real Estate – Continuing Operations

During the nine months ended September 30, 2020, we closed on the sale of six properties under the Perennial Communities Sales Agreement and received net sales proceeds of $53.7 million. We retained the net sales proceeds for corporate purposes as we are focused on maintaining a strong balance sheet, liquidity and financial flexibility given the uncertainty relating to COVID-19.  In June 2019 we sold a small parcel of vacant land at our Brookridge Heights Assisted Living & Memory Care property and received net sales proceeds of approximately $0.2 million.  

Proceeds from Sale of Real Estate – Discontinued Operations

As part of executing under our Possible Strategic Alternatives, during the nine months ended September 30, 2020, we closed on the sale of our property under the New Orleans Sale Agreement and received net sales proceeds of $28.4 million.  We retained these net sales proceeds, along with the net sales proceeds received from the sale of an acute-care property during the last half of 2019, for corporate purposes as we are focused on maintaining a strong balance sheet, liquidity and financial flexibility given the uncertainty relating to COVID-19. During the nine months ended September 30, 2019, as part of executing under our Possible Strategic Alternatives, we sold 59 of the 62 properties in our MOB/Healthcare Portfolio and received net sales proceeds of approximately $1,312.5 million, which were used to: (1) repay indebtedness secured by the properties sold; (2) rebalance other corporate borrowings (3) make a special cash distribution to the Company’s stockholders and (4) for other corporate purposes.

Borrowings

On an ongoing basis, we monitor our debt maturities, engage in dialogue with third-party lenders about various financing scenarios and analyze our overall portfolio borrowings in advance of scheduled maturity dates of the debt obligations to determine the optimal borrowing strategy.  During the nine months ended September 30, 2019, we borrowed proceeds of approximately $55.2 million.  In May 2019, as part of executing under our Possible Strategic Alternatives, we completed the sale of 55 properties. In conjunction therewith, we refinanced our Credit Facilities (including the payment of amounts outstanding under our Credit Facilities as described further in “Uses of Liquidity and Capital Resources – Debt Repayments”) and entered into new financings, which were comprised of a 2019 Revolving Line of Credit Facility of approximately $250 million and a 2019 Term Loan Facility of approximately $265 million (collectively, the “2019 Credit Facilities”).

In April 2020, we borrowed $40 million from our 2019 Credit Facilities as a precautionary measure to increase liquidity and preserve financial flexibility in light of COVID-19, which we repaid in September 2020 as described further under “Uses of Liquidity and Capital Resources – Debt Repayments”.  We have borrowed money and intend to continue borrowing money, to fund other enhancements to our portfolio as well as to cover periodic shortfalls between distributions paid and cash flows from operating activities. Our principal demand for funds is expected to be for the payment of debt service on our outstanding indebtedness and the payment of distributions.  Generally, we expect to meet short-term working capital needs from our cash flows from operations.  

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The aggregate amount of long-term financing is not expected to exceed 60% of our gross asset values (as defined in our Credit Facilities) on an annual basis. As of September 30, 2020 and December 31, 2019, we had an aggregate debt leverage ratio of approximately 32.8% and 35.5%, respectively, of the aggregate carrying value of our assets.  As described above under “Possible Strategic Alternatives,” during 2019 and through the nine months ended September 30, 2020, we sold 68 of the 69 properties we had classified as held for sale, used a portion of the 2019 net sales proceeds to pay off indebtedness related to those properties and to pay down a portion of the amounts outstanding on our mortgages and notes payable and our Credit Facilities.  We retained a portion of the net sales proceeds to maintain liquidity and a strong balance sheet in light of COVID-19.  Refer to “Uses of Liquidity and Capital Resources – Debt Repayments” for additional information.

Net Cash Provided by Operating Activities – Continuing Operations

We experienced positive cash flow from operating activities for the nine months ended September 30, 2020 and 2019 of approximately $46.6 million and $36.2 million, respectively.  The increase in cash flows from operating activities for the nine months ended September 30, 2020 as compared to the same period in 2019 was primarily the result of the following:

Tenant Financial Difficulties

The tenant at one of our acute care properties began experiencing financial difficulties.  The tenant has been unable to remain current under its lease and had $0.6 million of past due rents outstanding (all of which were reserved) as of September 30, 2020.  We have not granted any rent concessions to this tenant, are recognizing rental income on a cash basis and are working with this tenant on the collection of past due amounts. We also paid approximately $0.2 million in past due real estate taxes related to this property during the nine months ended September 30, 2020.  

 

We had previously classified this acute care property as held for sale and classified the operations of this property as discontinued operations.  Due to the financial difficulties of the tenant, we decided to discontinue marketing this property for sale and determined that this acute care property no longer met the assets held for sale criteria.  In September 2020, we reclassified this property as held and used and recorded all operating results from this acute care property as income or loss from continuing operations for all periods presented.     

 

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Uses of Liquidity and Capital Resources

Capital Expenditures

We paid approximately $5.7 million and $4.3 million in capital expenditures during the nine months ended September 30, 2020 and 2019, respectively.  

Debt Repayments

During the nine months ended September 30, 2020, we paid approximately $29.0 million of debt obligations, which included approximately $20.5 million of debt obligations that were scheduled to mature in June 2020 and $8.5 million of scheduled repayments on our mortgages and other notes payable. In September 2020, we repaid the $80 million that was outstanding under our Revolving Credit Facility. In October, we paid $8 million in debt obligations that matured in October 2020 relating to one of our consolidated VIEs and have approximately $2.8 million of debt obligations coming due during the remainder of 2020.  We remain focused on maintaining liquidity and financial flexibility and continue to monitor developments as we deal with the disruptions and uncertainties from a business and financial perspective relating to COVID-19.  

During the nine months ended September 30, 2019, we paid approximately $1,044.9 million of total repayments, which was comprised of approximately $457.3 million of repayments in connection with indebtedness secured by the 59 properties that were part of the IRF Sale and the MOB Sale, approximately $83.7 million of indebtedness secured by other properties that we strategically paid down using net sales proceeds received in connection with the IRF Sale and MOB Sale, approximately $434.1 million in repayments related to the refinancing of our 2014 Credit Facilities, approximately $10.0 million in repayments on our 2019 Revolving Credit Facility, approximately $39.7 million repayments on certain construction loans prior to their scheduled maturities and approximately $20.1 million in scheduled repayments on our mortgages and other notes payable.  In connection with the refinancing of our 2014 Credit Facilities, we paid approximately $7.6 million in lender fees and other loan-related costs.

Distributions

In order to qualify as a REIT, we are 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.  While we generally expect to pay distributions from cash flows provided by operating activities, we have and may continue to cover periodic shortfalls between distributions paid and cash flows from operating activities with proceeds from other sources, such as from cash flows provided by financing activities (“Other Sources”), a component of which could include borrowings, whether collateralized by our properties or unsecured, or net sales proceeds from the sale of real estate.  We will continue to monitor the extent of the impact of the disruptions from the COVID-19 pandemic on our cash flows from operations in determining the level of distributions going forward. 

As part of executing our Possible Strategic Alternatives, in May 2019 we used a portion of the net sales proceeds received from the MOB Sale to pay a special cash distribution.  Our board of directors declared a special cash distribution of $2.00 per share to the holders of record of our common stock, for an aggregate total distribution of approximately $347.9 million.  Additionally, as a result of the sales of these properties, our board of directors adjusted our regular quarterly cash distribution to an amount equal to $0.0512 per share compared to $0.1164 per share in effect since the third quarter of 2017.  The adjustment to our regular cash distributions was the result of a reduction in our remaining earnings base and operating cash flows given the associated impact of the sale of real estate on our operating cash flows.  No amounts distributed to stockholders during the quarter and nine months ended September 30, 2020 and 2019 were required to be or have been treated as a return of capital for purposes of calculating the stockholders’ return on their invested capital as described in the advisory agreement.

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The following table represents total cash distributions declared and cash distributions per share for quarter and nine months ended September 30, 2020 and 2019 (in thousands, except per share data):    

 

FOOTNOTES:

Results of Operations

Except for the impact from the COVID-19 pandemic as described above in “COVID-19”, we are not aware of other material trends or uncertainties, favorable or unfavorable, that may be reasonably anticipated to have a material impact on either capital resources or the revenues or income to be derived from the  operation of properties, other than those referred to in the risk factors identified in “Part II, Item 1A” of this report and the “Risk Factors” section of our Annual Report.

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

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Quarter and nine months ended September 30, 2020 as compared to the quarter and nine months ended September 30, 2019

As of September 30, 2020 and 2019, excluding properties classified as discontinued operations, unconsolidated investments and unimproved land, we owned the following consolidated operating investment properties.

 

Rental Income and Related Revenues.  Rental income and related revenues were approximately $6.8 million and $21.8 million for the quarter and nine months ended September 30, 2020, respectively, as compared to approximately $10.5 million and $28.8 million for the quarter and nine months ended September 30, 2019, respectively.  This decrease was primarily due to sale of the Grand Junction property in December 2019 and the six skilled nursing facilities located in Arkansas (“Perennial Communities”), as well as rent reserves recorded for one post-acute care facility due to tenant financial difficulties.   

Resident Fees and Services. Resident fees and services income were approximately $69.4 million and $214.6 million for the quarter and nine months ended September 30, 2020, respectively, as compared to approximately $72.3 million and $215.5 million for the quarter and nine months ended September 30, 2019, respectively.  As described above in “Liquidity and Capital Resources - COVID-19”, resident fees and services were negatively impacted during the nine months ended September 30, 2020 as a result of declines in occupancy levels affected by move-in restrictions, intensified screening and other measures enacted at our communities to address the spread of COVID-19. As a result of the disruptions and uncertainty from COVID-19, we expect to experience reduced occupancy levels, resident fees and services during the remainder of 2020 as compared to levels experienced during 2019.

Property Operating Expenses. Property operating expenses were approximately $48.4 million and $145.5 million for the quarter and nine months ended September 30, 2020, respectively, as compared to approximately $47.6 million and $140.1 million for the quarter and nine months ended September 30, 2019, respectively.  The increase in property operating expenses is primarily a result of increases in COVID-19 related expenses.  We expect property operating expenses to continue at higher levels during the remainder of 2020 as compared to 2019 due to incurring additional costs for emergency preparedness, disease control and containment, and labor costs of healthcare personnel as a result of COVID-19.  

General and Administrative Expenses. General and administrative expenses were approximately $2.3 million and $7.0 million for the quarter and nine months ended September 30, 2020, respectively, as compared to approximately $2.2 million and $10.3 million for the quarter and nine months ended September 30, 2019, respectively.  General and administrative expenses during the nine months ended September 30, 2019 included expenses related to the execution of Possible Strategic Alternatives and stock compensation expense incurred related to the special cash distribution declared in May 2019 on restricted stock issued pursuant to the Advisor expense support agreement. No such expenses were incurred during the quarter and nine months ended September 30, 2020.

Asset Management Fees. We incurred asset management fees of approximately $4.5 million and $13.6 million for the quarter and nine months ended September 30, 2020, respectively, as compared to approximately $4.7 million and $14.0 million for the quarter and nine months ended September 30, 2019, respectively.  Monthly asset management fees equal to 0.08334% of invested assets are paid to our Advisor for the management of our real estate assets, including our pro rata share of investments in unconsolidated entities, loans and other permitted investments.

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Property Management Fees.  We incurred property management fees of approximately $3.8 million and $10.6 million for the quarter and nine months ended September 30, 2020, respectively, payable to our third-party property managers, as compared to approximately $2.6 million and $9.5 million for the quarter and nine months ended September 30, 2019, respectively. Property management fees were lower during the quarter and nine months ended September 30, 2019 because several third-party operators did not meet property performance targets and were required to subordinate a portion of their management fee in accordance with their property management agreements.  We amended and removed the subordination provision from their property management agreements subsequent to September 30, 2019. Property management fees for the quarter and nine months ended September 30, 2020 did not reflect subordination of management fees from these third-party operators.

Financing Coordination Fees.  No financing coordination fees were incurred during the quarter and nine months ended September 30, 2020.  We incurred financing coordination fees primarily related to the refinancing of our credit facilities of approximately $5.4 million, of which approximately $3.5 million, were capitalized in the accompanying condensed consolidated balance sheets for the nine months ended September 30, 2019.

Depreciation and Amortization. Depreciation and amortization expenses were approximately $14.4 million and $39.4 million for the quarter and nine months ended September 30, 2020, respectively, as compared to approximately $12.3 million and $37.0 million for the quarter and nine months ended September 30, 2019, respectively.  Depreciation and amortization expenses are comprised of depreciation and amortization of the buildings, equipment, land improvements and in-place leases related to our real estate portfolio. Depreciation and amortization expense for the quarter and nine months ended September 30, 2020 includes the catch-up adjustment of $1.6 million in depreciation expense related to the acute care property that was reclassified from assets held for sale to held and used as described further above in “Liquidity and Capital Resources - Tenant Financial Difficulties”.

Gain on Sale of Real Estate. Gain on the sale of real state was approximately $1.1 million and $0.2 million for the nine months ended September 30, 2020 and 2019.  In March 2020, we sold the Perennial Communities and in June 2019 we sold a small parcel of vacant land at our Brookridge Heights Assisted Living & Memory Care property.

Interest Expense and Loan Cost Amortization. Interest expense and loan cost amortization were approximately $5.7 million and $18.8 million for the quarter and nine months ended September 30, 2020, respectively, as compared to approximately $9.2 million and $32.0 million for the quarter and nine months ended September 30, 2019, respectively.  The decrease in interest expense and loan cost amortization was primarily the result of the reduction in average debt outstanding resulting from the repayment of approximately $1.1 billion of indebtedness from the refinancing of our credit facilities and the repayment of indebtedness using net sales proceeds from the sales of properties during the nine months ended September 30, 2019, as well as the repayment of approximately $29 million in debt obligations during the nine months ended September 30, 2020.

Income from Discontinued Operations. As discussed above under “Possible Strategic Alternatives,” we classified the revenues and expenses related to our MOB/Healthcare Portfolio, which consisted of 62 properties, as discontinued operations because we believed the sale of these properties would cause a strategic shift in our operations.  We had income from discontinued operations of approximately $0.2 million and $0.8 million for the quarter and nine months ended September 30, 2020, respectively, related to two properties, as compared to approximately $1.6 million and $344.6 million for the quarter and nine months ended September 30, 2019 related to 62 properties, respectively.  Income from discontinued operations included gain on sale of approximately $331.6 million during the nine months ended September 30, 2019 from the sale of 59 properties within our MOB/Healthcare Portfolio during April and May 2019. Refer to Note 6. “Assets and Associated Liabilities Held For Sale and Discontinued Operations” for additional information.

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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 less the property operating expenses and property management fees from managed properties.  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 from operating activities in accordance with GAAP and should not be considered to be an alternative to net income 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 NOI from a property that was sold in December 2019 and six properties that were sold in March 2020.  The chart below presents a reconciliation of net income to NOI for the quarter and nine months ended September 30, 2020 and 2019 (in thousands) and the amount invested in properties as of September 30, 2020 and 2019 (in millions), excluding the properties classified as discontinued operations:

 

 

The decrease in same-store NOI for the quarter and nine months ended September 30, 2020 and 2019, is due to decreased occupancy revenues and increased expenses related to the COVID-19 pandemic.    

Funds from Operations and Modified Funds from Operations

Due to certain unique operating characteristics of real estate companies, as discussed below, the National Association of Real Estate Investment Trusts, (“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 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, an industry trade group (“IPA”) has standardized a measure known as modified funds from operations (“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.

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 from a GAAP accrual basis in order to reflect such payments on a cash basis of amounts expected to be received for such lease and rental payments); contingent purchase price consideration adjustments; accretion of discounts and amortization of premiums on debt investments;  mark-to-market adjustments included in net income or loss; 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

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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 or loss 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 (or loss) or income (or 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, now that the offering and acquisition stages are complete and NAV is disclosed.  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 income to FFO and MFFO for the quarter and nine months ended September 30, 2020 and 2019 (in thousands, except per share data):

 

 

FOOTNOTES:

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Contractual Obligations

The following table presents our contractual obligations by payment periods as of September 30, 2020, including liabilities associated with assets held for sale (in thousands):

 

Off-Balance Sheet Arrangements

As of September 30, 2020, our off-balance sheet and other arrangements were not materially different from the amounts reported for the year ended December 31, 2019.  Refer to our annual report on Form 10-K for the year ended December 31, 2019 for a summary of our off-balance sheet and other arrangements.

Related-Party Transactions

See Item 1. “Condensed Consolidated Financial Information” in this Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2019 for a summary of our related party transactions.

Critical Accounting Policies and Estimates

See Item 1. “Condensed Consolidated Financial Information” in this Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2019 for a summary of our critical accounting policies and estimates.

Recent Accounting Pronouncements

See Item 1. “Condensed Consolidated Financial Information” in this Form 10-Q 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 interest rate changes primarily as a result of the long-term debt we used to acquire properties and other permitted investments. Our management objective related to interest rate risk is 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 borrow at fixed rates or variable rates with the lowest margins available, and in some cases, with the ability to convert from variable rates to fixed rates.  With regard to variable rate financing, we 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 hedging opportunities.

The following is a schedule as of September 30, 2020 of our fixed and variable rate debt maturities for the remainder of 2020, and each of the next four years and thereafter (principal maturities only), including liabilities associated with assets held for sale (in thousands):

 

_____________

FOOTNOTE:

Management estimates that a hypothetical one-percentage point increase in LIBOR compared to the LIBOR rate as of September 30, 2020, considering the impact of our interest rate caps, would increase interest expense by approximately $0.2 million and $0.7 million on our variable rate debt for the quarter and nine months ended September 30, 2020, respectively.  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 the effects of changes in LIBOR does not factor in a potential change in variable rate debt levels.

As of September 30, 2020, the Company’s debt is comprised of approximately 55.5% in fixed rate debt, approximately 43.2% in variable rate debt with current interest rate protection and approximately 1.3% of unhedged variable rate debt.  The remaining unhedged variable rate debt primarily relates to our construction loans and the Revolving Credit Facility.  Overall, we believe longer term fixed rate debt could be beneficial in a rising interest rate or rising inflation rate environment and as such we continue to evaluate the need for additional interest rate protection on unhedged variable rate debt or variable rate debt with interest rate protection scheduled to mature.

 

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Evaluation of Disclosure Controls and Procedures

Pursuant to Rule 13a-15(b) under the Exchange Act, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act) 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 as of the end of the period covered by this report to provide reasonable assurance that material information required to be included in our periodic SEC reports is recorded, processed, summarized and reported within the time periods specified in the relevant SEC rules and forms.

Changes in Internal Control 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.

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.

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, 2019.

Unregistered Sales of Equity Securities - None

Issuer Purchases of Equity Securities – None

Secondary Sales of Registered Shares between Investors

 

During the nine months ended September 30, 2020 and 2019, there were approximately 50,000 shares and 161,000 shares transferred between investors, respectively, at an average sales price per share of approximately $5.80 and $7.61, respectively.  We are not aware of any other trades of our shares.

The exhibits required by this item are set forth in the Exhibit Index attached hereto and are filed or incorporated as part of this report.

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EXHIBIT INDEX

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, 2020 (and are numbered in accordance with Item 601 of Regulation 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 12th day of November 2020.

 

 

 

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