NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2020
(unaudited)
(1) General
This Quarterly Report on Form 10-Q is for the quarter ended March 31, 2020. In this Quarterly Report, “we,” “us,” “our” and the “Trust” refer to Universal Health Realty Income Trust and its subsidiaries.
In this Quarterly Report on Form 10-Q, the term “revenues” does not include the revenues of the unconsolidated LLCs in which we have various non-controlling equity interests ranging from 33% to 95%. As of March 31, 2020, we had investments in five jointly-owned LLCs/LPs (including one under construction which is scheduled to be completed in late 2020). We currently account for our share of the income/loss from these investments by the equity method (see Note 5). These LLCs are included in our consolidated financial statements for all periods presented on an unconsolidated basis since they are not variable interest entities for which we are the primary beneficiary, nor do we hold a controlling voting interest.
The condensed consolidated financial statements included herein have been prepared by us, without audit, pursuant to the rules and regulations of the SEC and reflect all normal and recurring adjustments which, in our opinion, are necessary to fairly present results for the interim periods. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America (U.S. GAAP) have been condensed or omitted pursuant to such rules and regulations, although we believe that the accompanying disclosures are adequate to make the information presented not misleading. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements, the notes thereto and accounting policies included in our Annual Report on Form 10-K for the year ended December 31, 2019.
In March 2020, the World Health Organization declared the COVID-19 outbreak a pandemic and the federal government declared COVID-19 a national emergency. Patient volumes at our three acute care hospitals, and likely at our other healthcare properties including the MOBs and ambulatory care centers, were significantly reduced during the second half of March as a result of COVID-19. These significant reductions to patient volumes experienced at our three acute care hospitals, and likely at our other healthcare facilities, have continued through April, 2020.
We believe that the adverse impact that COVID-19 will have on the future operations and financial results of our tenants, and in turn ours, will depend upon many factors, most of which are beyond our, or our tenants’, ability to control or predict. Such factors and developments include, but are not limited to, the length of time and severity of the spread of the pandemic; the volume of cancelled or rescheduled elective procedures and the volume of COVID-19 patients treated by the operators of our hospitals and other healthcare facilities; measures our tenants are taking to respond to the COVID-19 pandemic; the impact of government and administrative regulation, including travel bans and restrictions, shelter-in-place or stay-at-home orders, quarantines, the promotion of social distancing, business shutdowns and limitations on business activity; changes in patient volumes at our tenants’ hospitals and other healthcare facilities due to patients’ general concerns related to the risk of contracting COVID-19 from interacting with the healthcare system; the impact of stimulus on the health care industry and our tenants; changes in patient volumes and payer mix caused by deteriorating macroeconomic conditions (including increases in uninsured and underinsured patients as the result of business closings and layoffs); potential disruptions to clinical staffing and shortages and disruptions related to supplies required for our tenants’ employees and patients, including equipment, pharmaceuticals and medical supplies, particularly personal protective equipment, or PPE; potential increases to expenses incurred by our tenants related to staffing, supply chain or other expenditures; the impact of our indebtedness and the ability to refinance such indebtedness on acceptable terms; disruptions in the financial markets and the business of financial institutions as the result of the COVID-19 pandemic which could impact our ability to access capital or increase associated borrowing costs; and changes in general economic conditions nationally and regionally in the markets our properties are located resulting from the COVID-19 pandemic, including increased unemployment and underemployment levels and reduced consumer spending and confidence.
There may be significant declines in future bonus rental revenue earned on our hospital properties leased to subsidiaries UHS to the extent that each hospital continues to experience significant decline in patient volumes and revenues which continued through April, 2020. We believe that the underlying businesses operated by certain of our other tenants are either temporarily closed entirely or operating at substantially reduced hours. These factors may result in the inability or unwillingness on the part of some of our tenants to make timely payment of their rent to us at current levels or to seek to amend or terminate their leases which, in turn, would have an adverse effect on our occupancy levels and our revenue and cash flow and the value of our properties, and potentially, our ability to maintain our dividend at current levels. Due to COVID-19 restrictions and its impact on the economy, we may experience a decrease in prospective tenants which could unfavorably impact the volume of new leases, as well as the renewal rate of existing leases. The
8
COVID-19 pandemic could also impact our indebtedness and the ability to refinance such indebtedness on acceptable terms, as well as risks associated with disruptions in the financial markets and the business of financial institutions as the result of the COVID-19 pandemic which could impact us from a financing perspective; and changes in general economic conditions nationally and regionally in the markets our properties are located resulting from the COVID-19 pandemic. Decreases in cash flows and results of operations may have an impact on the inputs and assumptions used in significant accounting estimates, including potential impairments of intangible and long-lived assets.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes.
(2) Relationship with Universal Health Services, Inc. (“UHS”) and Related Party Transactions
Leases: We commenced operations in 1986 by purchasing properties from certain subsidiaries of UHS and immediately leasing the properties back to the respective subsidiaries. Most of the leases were entered into at the time we commenced operations and provided for initial terms of 13 to 15 years with up to six additional 5-year renewal terms. The current base rentals and lease and renewal terms for each of the three hospital facilities leased to subsidiaries of UHS are provided below. The base rents are paid monthly and each lease also provides for additional or bonus rents which are computed and paid on a quarterly basis based upon a computation that compares current quarter revenue to a corresponding quarter in the base year. The three hospital leases with subsidiaries of UHS are unconditionally guaranteed by UHS and are cross-defaulted with one another.
The combined revenues generated from the leases on the UHS hospital facilities accounted for approximately 22% of our consolidated revenues for each of the three months ended March 31, 2020 and 2019. In addition, we have seventeen medical office buildings (“MOBs”), or free-standing emergency departments (“FEDs”), that are either wholly or jointly-owned by us (excluding new construction), that include tenants which are subsidiaries of UHS. The aggregate revenues generated from UHS-related tenants comprised approximately 32% and 31% of our consolidated revenues during the three-month periods ended March 31, 2020 and 2019, respectively.
Pursuant to the Master Lease Document by and among us and certain subsidiaries of UHS, dated December 24, 1986 (the “Master Lease”), which governs the leases of all hospital properties with subsidiaries of UHS, UHS has the option to renew the leases at the lease terms described below by providing notice to us at least 90 days prior to the termination of the then current term. UHS also has the right to purchase the respective leased facilities at the end of the lease terms or any renewal terms at the appraised fair market value. In addition, the Master Lease, as amended in 2006, includes a change of control provision whereby UHS has the right, upon one month’s notice should a change of control of the Trust occur, to purchase any or all of the three leased hospital properties listed below at their appraised fair market value. Additionally, UHS has rights of first refusal to: (i) purchase the respective leased facilities during and for 180 days after the lease terms at the same price, terms and conditions of any third-party offer, or; (ii) renew the lease on the respective leased facility at the end of, and for 180 days after, the lease term at the same terms and conditions pursuant to any third-party offer.
The table below details the existing lease terms and renewal options for our three acute care hospitals operated by wholly-owned subsidiaries of UHS:
Hospital Name
|
|
Annual
Minimum
Rent
|
|
|
End of
Lease Term
|
|
Renewal
Term
(years)
|
|
|
McAllen Medical Center
|
|
$
|
5,485,000
|
|
|
December, 2026
|
|
|
5
|
|
(a.)
|
Wellington Regional Medical Center
|
|
$
|
3,030,000
|
|
|
December, 2021
|
|
|
10
|
|
(b.)
|
Southwest Healthcare System, Inland Valley Campus
|
|
$
|
2,648,000
|
|
|
December, 2021
|
|
|
10
|
|
(b.)
|
(a.)
|
UHS has one 5-year renewal option at the existing lease rate (through 2031).
|
(b.)
|
UHS has two 5-year renewal options at fair market value lease rates (2022 through 2031).
|
Management cannot predict whether the leases with subsidiaries of UHS, which have renewal options at existing lease rates or fair market value lease rates, or any of our other leases, will be renewed at the end of their lease term. If the leases are not renewed at their current rates or the fair market value lease rates, we would be required to find other operators for those facilities and/or enter into leases on terms potentially less favorable to us than the current leases. In addition, if subsidiaries of UHS exercise their options to purchase the respective leased hospital or FED facilities upon expiration of the lease terms, our future revenues could decrease if we were unable to earn a favorable rate of return on the sale proceeds received, as compared to the lease revenue currently earned pursuant to these leases.
9
We are the lessee on eleven ground leases with subsidiaries of UHS (for consolidated and unconsolidated investments). The remaining lease terms on the ground leases with subsidiaries of UHS range from approximately 29 years to approximately 79 years. The annual aggregate lease payments on these properties are approximately $482,000 for the year ended 2020 and $482,000 for each of the years ended 2021, 2022, 2023 and 2024, and an aggregate of $27.7 million thereafter. See Note 7 for further disclosure around our lease accounting.
In late July, 2019 and September, 2019 we entered into two separate agreements with entities that are each related to wholly-owned subsidiaries of UHS in connection with newly constructed properties located in Clive, Iowa and Denison, Texas. Please see additional disclosure in Note 4, “New Construction, Acquisitions and Dispositions”.
Officers and Employees: Our officers are all employees of a wholly-owned subsidiary of UHS and although as of March 31, 2020 we had no salaried employees, our officers do typically receive annual stock-based compensation awards in the form of restricted stock. In special circumstances, if warranted and deemed appropriate by the Compensation Committee of the Board of Trustees, our officers may also receive one-time special compensation awards in the form of restricted stock and/or cash bonuses.
Advisory Agreement: UHS of Delaware, Inc. (the “Advisor”), a wholly-owned subsidiary of UHS, serves as Advisor to us under an advisory agreement dated December 24, 1986, and as amended and restated as of January 1, 2019 (the “Advisory Agreement”). Pursuant to the Advisory Agreement, the Advisor is obligated to present an investment program to us, to use its best efforts to obtain investments suitable for such program (although it is not obligated to present any particular investment opportunity to us), to provide administrative services to us and to conduct our day-to-day affairs. All transactions between us and UHS must be approved by the Trustees who are unaffiliated with UHS (the “Independent Trustees”). In performing its services under the Advisory Agreement, the Advisor may utilize independent professional services, including accounting, legal, tax and other services, for which the Advisor is reimbursed directly by us. The Advisory Agreement may be terminated for any reason upon sixty days written notice by us or the Advisor. The Advisory Agreement expires on December 31 of each year; however, it is renewable by us, subject to a determination by the Independent Trustees, that the Advisor’s performance has been satisfactory.
Our advisory fee for the three months ended March 31, 2020 and 2019, was computed at 0.70% of our average invested real estate assets, as derived from our condensed consolidated balance sheets. Based upon a review of our advisory fee and other general and administrative expenses, as compared to an industry peer group, the advisory fee computation remained unchanged for 2020, as compared to the last three years. The average real estate assets for advisory fee calculation purposes exclude certain items from our condensed consolidated balance sheet such as, among other things, accumulated depreciation, cash and cash equivalents, lease receivables, deferred charges and other assets. The advisory fee is payable quarterly, subject to adjustment at year-end based upon our audited financial statements. Advisory fees incurred and paid (or payable) to UHS amounted to approximately $1.0 million for each of the three months ended March 31, 2020 and 2019 and were based upon average invested real estate assets of $581 million and $554 million, respectively.
Share Ownership: As of March 31, 2020 and December 31, 2019, UHS owned 5.7% of our outstanding shares of beneficial interest.
SEC reporting requirements of UHS: UHS is subject to the reporting requirements of the SEC and is required to file annual reports containing audited financial information and quarterly reports containing unaudited financial information. Since the aggregate revenues generated from the UHS-related tenants comprised 32% and 31% of our consolidated revenues during the three-month periods ended March 31, 2020 and 2019, respectively, and since a subsidiary of UHS is our Advisor, you are encouraged to obtain the publicly available filings for Universal Health Services, Inc. from the SEC’s website. These filings are the sole responsibility of UHS and are not incorporated by reference herein.
(3) Dividends
Dividends:
During the first quarter of 2020, we declared and paid dividends of approximately $9.4 million, or $.685 per share, which were paid on March 31, 2020. We declared and paid dividends of approximately $9.3 million, or $.675 per share, during the first quarter of 2019.
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(4) New Construction, Acquisitions and Dispositions
Three Months Ended March 31, 2020:
New Construction:
In September, 2019, we entered into an agreement whereby we will own a 95% non-controlling ownership interest in Grayson Properties II L.P., which will develop, construct, own and operate the Texoma Medical Plaza II, an MOB located in Denison, Texas. This MOB, which is scheduled to be completed in late 2020, will be located on the campus of Texoma Medical Center, a hospital that is owned and operated by a wholly-owned subsidiary of UHS. A 10-year master flex lease was executed with the wholly-owned subsidiary of UHS for 40,000 rentable square feet, representing over 50% of the rentable square feet of the MOB. The master flex lease commitment is subject to reduction upon the execution of third-party leases on up to 20,000 rentable square feet of the first and second floors of the three-story MOB, and 20,000 rentable square feet on the third floor. In April, 2020, a new, 122-month lease was fully executed with a third-party tenant for approximately 26,000 rentable square feet on the first floor of the MOB. As a result, the master flex lease commitment was reduced to 20,000 of rentable square feet on the third floor of the MOB. After giving effect to this new lease, 61% of the rentable square feet of the MOB is under lease agreements (including the remaining master lease space). We have committed to invest up to $17.9 million in equity or member loans on the development and construction of this MOB, which may be reduced if a third-party construction loan is placed on the property, and have invested approximately $4.0 million as of March 31, 2020 (including accrued costs at March 31, 2020). We account for this LP on an unconsolidated basis pursuant to the equity method since it is not a variable interest entity and we do not have a controlling voting interest.
In July, 2019, Des Moines Medical Properties, LLC, a wholly-owned subsidiary of ours, entered into an agreement to build and lease a newly constructed behavioral health care hospital located in Clive, Iowa. The lease on this facility, which is triple net and has an initial term of 20-years with five 10-year renewal options, was executed with Clive Behavioral Health, LLC, a joint venture between UHS and Catholic Health Initiatives - Iowa, Corp. (d/b/a Mercy One Des Moines Medical Center). Construction of this hospital, for which we have engaged a wholly-owned subsidiary of UHS to act as project manager for an aggregate fee of approximately $750,000, is expected to be completed in late 2020 or early 2021. The hospital lease will commence upon issuance of the certificate of occupancy. The approximate cost of the project is estimated to be $37.5 million and the initial annual rent is estimated to be approximately $2.7 million. We have invested approximately $11.5 million for land and the development and construction costs of this hospital as of March 31, 2020 (including accrued costs at March 31, 2020).
Acquisitions:
There were no acquisitions during the first three months of 2020.
Dispositions:
There were no dispositions during the first three months of 2020.
Three Months Ended March 31, 2019:
Acquisitions:
There were no acquisitions during the first three months of 2019.
Dispositions:
There were no dispositions during the first three months of 2019.
(5) Summarized Financial Information of Equity Affiliates
In accordance with U.S. GAAP and guidance relating to accounting for investments and real estate ventures, we account for our unconsolidated investments in LLCs/LPs which we do not control using the equity method of accounting. The third-party members in these investments have equal voting rights with regards to issues such as, but not limited to: (i) divestiture of property; (ii) annual budget approval, and; (iii) financing commitments. These investments, which represent 33% to 95% non-controlling ownership interests, are recorded initially at our cost and subsequently adjusted for our net equity in the net income, cash contributions to, and distributions from, the investments. Pursuant to certain agreements, allocations of sales proceeds and profits and losses of some of the LLC investments may be allocated disproportionately as compared to ownership interests after specified preferred return rate thresholds have been satisfied.
Distributions received from equity method investees in the consolidated statements of cash flows are classified based upon the nature of the distribution. Returns on investments are presented net of equity in income from unconsolidated investments as cash flows from operating activities. Returns of investments are classified as cash flows from investing activities.
11
At March 31, 2020, we have non-controlling equity investments or commitments in five jointly-owned LLCs/LPs which own MOBs (including one currently under construction which is scheduled to be completed in late 2020). As of March 31, 2020, we accounted for these LLCs/LPs on an unconsolidated basis pursuant to the equity method since they are not variable interest entities which we are the primary beneficiary nor do we have a controlling voting interest. The majority of these entities are joint-ventures between us and non-related parties that hold minority ownership interests in the entities. Each entity is generally self-sustained from a cash flow perspective and generates sufficient cash flow to meet its operating cash flow requirements and service the third-party debt (if applicable) that is non-recourse to us. Although there is typically no ongoing financial support required from us to these entities since they are cash-flow sufficient, we may, from time to time, provide funding for certain purposes such as, but not limited to, significant capital expenditures, leasehold improvements and debt financing. Although we are not obligated to do so, if approved by us at our sole discretion, additional cash funding is typically advanced as equity or member loans. These entities maintain property insurance on the properties.
The following property table represents the five LLCs/LPs in which we own a non-controlling interest (including one that is currently under construction) and were accounted for under the equity method as of March 31, 2020:
|
|
|
|
|
|
|
Name of LLC/LP
|
|
Ownership
|
|
|
Property Owned by LLC/LP
|
Suburban Properties
|
|
|
33
|
%
|
|
St. Matthews Medical Plaza II
|
Brunswick Associates (a.)(e.)
|
|
|
74
|
%
|
|
Mid Coast Hospital MOB
|
Grayson Properties (b.)(f.)
|
|
|
95
|
%
|
|
Texoma Medical Plaza
|
FTX MOB Phase II (c.)
|
|
|
95
|
%
|
|
Forney Medical Plaza II
|
Grayson Properties II (d.)(f.)
|
|
|
95
|
%
|
|
Texoma Medical Plaza II
|
(a.)
|
This LLC has a third-party term loan of $8.0 million, which is non-recourse to us, outstanding as of March 31, 2020.
|
(b.)
|
This building is on the campus of a UHS hospital and has tenants that include subsidiaries of UHS. This LP has a third-party term loan, which is non-recourse to us, of $13.6 million, outstanding as of March 31, 2020.
|
(c.)
|
We have committed to invest up to $2.5 million in equity and debt financing, of which $2.1 million has been funded as of March 31, 2020. This LP has a third-party term loan, which is non-recourse to us, of $4.9 million, outstanding as of March 31, 2020.
|
(d.)
|
This MOB, currently under construction, will be located in Denison, Texas on the campus of a hospital owned and operated by a wholly-owned subsidiary of UHS. We have committed to invest up to $17.9 million in equity and debt financing, which may be reduced if a third-party construction loan is placed on the property. We have incurred approximately $4.0 million of costs as of March 31, 2020 in connection with this property and our related commitment. The LP will develop, construct, own and operate the Texoma Medical Plaza II which is expected to open in late 2020.
|
(e.)
|
We are the lessee with a third party lessor under a ground lease for land.
|
(f.)
|
We are the lessee, or have committed to a lease, with a UHS-related party for the land related to this property.
|
Below are the condensed combined statements of income (unaudited) for the four LLCs/LPs (excluding one that owns an MOB that is currently under construction) accounted for under the equity method at March 31, 2020 and 2019.
|
|
Three Months Ended
March 31,
|
|
|
|
2020
|
|
|
2019
|
|
|
|
(amounts in thousands)
|
|
Revenues
|
|
$
|
2,516
|
|
|
$
|
2,460
|
|
Operating expenses
|
|
|
1,028
|
|
|
|
1,012
|
|
Depreciation and amortization
|
|
|
442
|
|
|
|
398
|
|
Interest, net
|
|
|
318
|
|
|
|
322
|
|
Net income
|
|
$
|
728
|
|
|
$
|
728
|
|
Our share of net income
|
|
$
|
435
|
|
|
$
|
430
|
|
12
Below are the condensed combined balance sheets (unaudited) for the five above-mentioned LLCs/LPs (including one LP that currently owns an MOB under construction) that were accounted for under the equity method as of March 31, 2020 and December 31, 2019:
|
|
March 31,
2020
|
|
|
December 31,
2019
|
|
|
|
(amounts in thousands)
|
|
Net property, including construction in progress
|
|
$
|
34,357
|
|
|
$
|
33,207
|
|
Other assets (a.)
|
|
|
7,488
|
|
|
|
7,452
|
|
Total assets
|
|
$
|
41,845
|
|
|
$
|
40,659
|
|
|
|
|
|
|
|
|
|
|
Other liabilities (a.)
|
|
$
|
6,528
|
|
|
$
|
6,785
|
|
Mortgage notes payable, non-recourse to us
|
|
|
26,493
|
|
|
|
26,650
|
|
Equity
|
|
|
8,824
|
|
|
|
7,224
|
|
Total liabilities and equity
|
|
$
|
41,845
|
|
|
$
|
40,659
|
|
|
|
|
|
|
|
|
|
|
Investments in LLCs before amounts included in
|
|
|
|
|
|
|
|
|
accrued expenses and other liabilities
|
|
$
|
8,411
|
|
|
$
|
6,918
|
|
Amounts included in accrued expenses and other liabilities
|
|
|
(1,753
|
)
|
|
|
(1,856
|
)
|
Our share of equity in LLCs, net
|
|
$
|
6,658
|
|
|
$
|
5,062
|
|
(a.) Other assets and other liabilities as of both March 31, 2020 and December 31, 2019 includes approximately $3.7 million of right-of-use land assets and right-of-use land liabilities related to ground leases whereby the LLC/LP is the lessee, with third party lessors, including subsidiaries of UHS.
13
As of March 31, 2020, and December 31, 2019, aggregate principal amounts due on mortgage notes payable by unconsolidated LLCs/LPs, which are accounted for under the equity method and are non-recourse to us, are as follows (amounts in thousands):
|
|
Mortgage Loan Balance (a.)
|
|
|
|
Name of LLC/LP
|
|
3/31/2020
|
|
|
12/31/2019
|
|
|
Maturity Date
|
FTX MOB Phase II (5.00% fixed rate mortgage loan) (b.)
|
|
$
|
4,889
|
|
|
$
|
4,926
|
|
|
October, 2020
|
Grayson Properties (5.034% fixed rate mortgage loan)
|
|
|
13,587
|
|
|
|
13,658
|
|
|
September, 2021
|
Brunswick Associates (3.64% fixed rate mortgage loan)
|
|
|
8,017
|
|
|
|
8,066
|
|
|
December, 2024
|
|
|
$
|
26,493
|
|
|
$
|
26,650
|
|
|
|
|
(a.)
|
All mortgage loans require monthly principal payments through maturity and include a balloon principal payment upon maturity.
|
|
(b.)
|
This loan is scheduled to mature within the next twelve months, at which time we intend to refinance pursuant to a new mortgage loan.
|
Pursuant to the operating and/or partnership agreements of the five LLCs/LPs in which we continue to hold non-controlling ownership interests, the third-party member and/or the Trust, at any time, potentially subject to certain conditions, have the right to make an offer (“Offering Member”) to the other member(s) (“Non-Offering Member”) in which it either agrees to: (i) sell the entire ownership interest of the Offering Member to the Non-Offering Member (“Offer to Sell”) at a price as determined by the Offering Member (“Transfer Price”), or; (ii) purchase the entire ownership interest of the Non-Offering Member (“Offer to Purchase”) at the equivalent proportionate Transfer Price. The Non-Offering Member has 60 to 90 days to either: (i) purchase the entire ownership interest of the Offering Member at the Transfer Price, or; (ii) sell its entire ownership interest to the Offering Member at the equivalent proportionate Transfer Price. The closing of the transfer must occur within 60 to 90 days of the acceptance by the Non-Offering Member.
(6) Recent Accounting Pronouncements
Accounting for Lease Concessions Granted in Connection with the COVID-19 Outbreak
On April 8, 2020, the Financial Accounting Standard Board ("FASB") held a public meeting and shortly afterwards issued a question-and-answer ("Q&A") document which was intended to provide accounting relief for lease concessions related to the COVID-19 pandemic. The accounting relief permits an entity to choose to forgo the evaluation of the enforceable rights and obligations of a lease contract, which is a requirement of Accounting Standards Codification Topic 842, Leases, as long as the total rent payments after the lease concessions are substantially the same, or less than, the total payments previously required by the lease. An entity may account for COVID-19 related lease concessions either (i) as if they were part of the enforceable rights and obligations of the parties under the existing lease contract; or (ii) as a lease modification. To the extent that a rent concession is granted as a deferral of payments, but the total lease payments are substantially the same, lessors are allowed to account for the concession as if no change had been made to the original lease contract.
Based on the Q&A, an entity is not required to account for all lease concessions related to the effects of the COVID-19 pandemic under one elected option, however, the entity is required to apply the elected option consistently to leases with similar characteristics and in similar circumstances. Since the COVID-19 pandemic did not start to adversely impact the economic conditions in the United States until late March 2020, COVID-19 did not have a material effect on our operations or financial results during the three months ended March 31, 2020.
We have received short-term rent deferral requests from a portion of tenants under lease at our MOBs. These requests are under review on a request-by-request basis based upon each tenant’s specific circumstances as well as consideration of potential economic benefit available and received by tenants through governmental assistance programs. At this time, we cannot estimate the magnitude of short-term rent deferral requests that we may ultimately agree to provide, or the magnitude of additional short-term rent deferral requests that we may receive in the future.
Reference Rate Reform
In March 2020, the FASB issued an accounting standard classified under FASB ASC Topic 848, “Reference Rate Reform.” The amendments in this update contain practical expedients for reference rate reform related activities that impact debt, leases, derivatives and other contracts. The guidance in ASC 848 is optional and may be elected over time as reference rate reform activities occur. We will evaluate the impact of the guidance and may apply elections as applicable as additional changes in the market occur.
Financial Instruments – Credit Losses
In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses," which introduced new guidance for an approach based on expected losses to estimate credit losses on certain types of financial instruments. Instruments in scope include
14
loans, held-to-maturity debt securities, and net investments in leases as well as reinsurance and trade receivables. In November 2018, the FASB issued ASU 2018-19, which clarifies that operating lease receivables are outside the scope of the new standard. The standard was effective for us in fiscal years beginning after December 15, 2019. The adoption of this guidance did not have a material impact on our consolidated financial statements.
(7) Lease Accounting
As Lessor:
We lease our operating properties to customers under agreements that are classified as operating leases. We recognize the total minimum lease payments provided for under the leases on a straight-line basis over the lease term. Generally, under the terms of our leases, the majority of our rental expenses, including common area maintenance, real estate taxes and insurance, are recovered from our customers. We record amounts reimbursed by customers in the period that the applicable expenses are incurred, which is generally ratably throughout the term of the lease. We have elected the package of practical expedients that allows lessors to not separate lease and non-lease components by class of underlying asset. This practical expedient allowed us to not separate expenses reimbursed by our customers (“tenant reimbursements”) from the associated rental revenue if certain criteria were met. We assessed these criteria and concluded that the timing and pattern of transfer for rental revenue and the associated tenant reimbursements are the same, and as our leases qualify as operating leases, we accounted for and presented rental revenue and tenant reimbursements as a single component under Lease revenue in our condensed consolidated statements of income for the three months ended March 31, 2020 and 2019.
The components of the “Lease revenue – UHS facilities” and “Lease revenue – Non-related parties” captions for the three month periods ended March 31, 2020 and 2019 are disaggregated below (in thousands). Base rents are primarily stated rent amounts provided for under the leases that are recognized on a straight-line basis over the lease term. Bonus rents and tenant reimbursements represent amounts where tenants are contractually obligated to pay an amount that is variable in nature.
|
March 31, 2020
|
|
|
March 31, 2019
|
|
UHS facilities:
|
|
|
|
|
|
|
|
Base rents
|
$
|
4,244
|
|
|
$
|
4,174
|
|
Bonus rents
|
|
1,380
|
|
|
|
1,394
|
|
Tenant reimbursements
|
|
257
|
|
|
|
225
|
|
Lease revenue - UHS facilities
|
$
|
5,881
|
|
|
$
|
5,793
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2020
|
|
|
March 31, 2019
|
|
Non-related parties:
|
|
|
|
|
|
|
|
Base rents
|
|
10,378
|
|
|
|
10,360
|
|
Tenant reimbursements
|
|
2,464
|
|
|
|
2,371
|
|
Lease revenue - Non-related parties
|
$
|
12,842
|
|
|
$
|
12,731
|
|
As Lessee:
We are the lessee with various third parties, including subsidiaries of UHS, in connection with ground leases for land at fourteen of our consolidated properties. Our right-of-use land assets represent our right to use the land for the lease term and our lease liabilities represent our obligation to make lease payments arising from the leases. Right-of-use assets and lease liabilities were recognized upon adoption of Topic 842 based on the present value of lease payments over the lease term. We utilized our estimated incremental borrowing rate, which was derived from information available as of January 1, 2019, in determining the present value of lease payments. A right-of-use asset and lease liability are not recognized for leases with an initial term of 12 months or less, as these short-term leases are accounted for similar to previous guidance for operating leases. We do not currently have any ground leases with an initial term of 12 months or less. As of March 31, 2020, our condensed consolidated balance sheet includes right-of-use land assets of approximately $8.9 million and ground lease liabilities of approximately $8.9 million. There were no newly leased assets for which a right-of-use asset was recorded in exchange for a new lease liability during the three months ended March 31, 2020.
15
(8) Debt and Financial Instruments
Debt:
Management routinely monitors and analyzes the Trust’s capital structure in an effort to maintain the targeted balance among capital resources including the level of borrowings pursuant to our $300 million revolving credit facility, the level of borrowings pursuant to non-recourse mortgage debt secured by the real property of our properties and our level of equity including consideration of additional equity issuances. This ongoing analysis considers factors such as the current debt market and interest rate environment, the current/projected occupancy and financial performance of our properties, the current loan-to-value ratio of our properties, the Trust’s current stock price, the capital resources required for anticipated acquisitions and the expected capital to be generated by anticipated divestitures. This analysis, together with consideration of the Trust’s current balance of revolving credit agreement borrowings, non-recourse mortgage borrowings and equity, assists management in deciding which capital resource to utilize when events such as refinancing of specific debt components occur or additional funds are required to finance the Trust’s growth.
On March 27, 2018, we entered into a revolving credit agreement (“Credit Agreement”) which, among other things, increased our borrowing capacity by $50 million to $300 million and extended the maturity date from our previously existing facility. The replacement Credit Agreement, which is scheduled to mature in March 2022, includes a $40 million sublimit for letters of credit and a $30 million sublimit for swingline/short-term loans. The Credit Agreement also provides for options to extend the maturity date for two additional six month periods. Additionally, the Credit Agreement includes an option to increase the total facility borrowing capacity up to an additional $50 million, subject to lender agreement. Borrowings under the Credit Agreement are guaranteed by certain subsidiaries of the Trust. In addition, borrowings under the Credit Agreement are secured by first priority security interests in and liens on all equity interests in certain of the Trust’s wholly-owned subsidiaries. Borrowings made pursuant to the Credit Agreement will bear interest, at our option, at one, two, three, or six-month LIBOR plus an applicable margin ranging from 1.10% to 1.35% or at the Base Rate plus an applicable margin ranging from 0.10% to 0.35%. The Credit Agreement defines “Base Rate” as the greater of: (a) the administrative agent’s prime rate; (b) the federal funds effective rate plus 1/2 of 1%, and; (c) one month LIBOR plus 1%. A facility fee of 0.15% to 0.35% will be charged on the total commitment of the Credit Agreement. The margins over LIBOR, Base Rate and the facility fee are based upon our total leverage ratio. At March 31, 2020, the applicable margin over the LIBOR rate was 1.20%, the margin over the Base Rate was 0.20%, and the facility fee was 0.20%.
At March 31, 2020, we had $219.2 million of outstanding borrowings against our Credit Agreement and $80.8 million of available borrowing capacity. At December 31, 2019, we had $213.0 million of outstanding borrowings outstanding against our revolving credit agreement and $87.0 million of available borrowing capacity. There are no compensating balance requirements.
The Credit Agreement contains customary affirmative and negative covenants, including limitations on certain indebtedness, liens, acquisitions and other investments, fundamental changes, asset dispositions and dividends and other distributions. The Credit Agreement also contains restrictive covenants regarding the Trust’s ratio of total debt to total assets, the fixed charge coverage ratio, the ratio of total secured debt to total asset value, the ratio of total unsecured debt to total unencumbered asset value, and minimum tangible net worth, as well as customary events of default, the occurrence of which may trigger an acceleration of amounts outstanding under the Credit Agreement. We are in compliance with all of the covenants at March 31, 2020 and December 31, 2019. We also believe that we would remain in compliance if the full amount of our commitment was borrowed.
The following table includes a summary of the required compliance ratios, giving effect to the covenants contained in the Credit Agreement (dollar amounts in thousands):
|
|
Covenant
|
|
March 31,
2020
|
|
December 31,
2019
|
|
Tangible net worth
|
|
> =$125,000
|
|
$
|
158,691
|
|
$
|
167,181
|
|
Total leverage
|
|
< 60%
|
|
|
42.6
|
%
|
|
42.3
|
%
|
Secured leverage
|
|
< 30%
|
|
|
9.0
|
%
|
|
9.1
|
%
|
Unencumbered leverage
|
|
< 60%
|
|
|
40.1
|
%
|
|
38.5
|
%
|
Fixed charge coverage
|
|
> 1.50x
|
|
4.1x
|
|
4.0x
|
|
16
As indicated on the following table, we have various mortgages, all of which are non-recourse to us, included on our condensed consolidated balance sheet as of March 31, 2020 (amounts in thousands):
Facility Name
|
|
Outstanding
Balance
(in thousands) (a.)
|
|
|
Interest
Rate
|
|
|
Maturity
Date
|
700 Shadow Lane and Goldring MOBs fixed rate
mortgage loan
|
|
$
|
5,601
|
|
|
|
4.54
|
%
|
|
June, 2022
|
BRB Medical Office Building fixed rate mortgage loan
|
|
|
5,668
|
|
|
|
4.27
|
%
|
|
December, 2022
|
Desert Valley Medical Center fixed rate mortgage loan
|
|
|
4,624
|
|
|
|
3.62
|
%
|
|
January, 2023
|
2704 North Tenaya Way fixed rate mortgage loan
|
|
|
6,690
|
|
|
|
4.95
|
%
|
|
November, 2023
|
Summerlin Hospital Medical Office Building III fixed
rate mortgage loan
|
|
|
13,196
|
|
|
|
4.03
|
%
|
|
April, 2024
|
Tuscan Professional Building fixed rate mortgage loan
|
|
|
3,355
|
|
|
|
5.56
|
%
|
|
June, 2025
|
Phoenix Children’s East Valley Care Center fixed rate
mortgage loan
|
|
|
8,901
|
|
|
|
3.95
|
%
|
|
January, 2030
|
Rosenberg Children's Medical Plaza fixed rate mortgage loan
|
|
|
12,677
|
|
|
|
4.42
|
%
|
|
September, 2033
|
Total, excluding net debt premium and net financing fees
|
|
|
60,712
|
|
|
|
|
|
|
|
Less net financing fees
|
|
|
(566
|
)
|
|
|
|
|
|
|
Plus net debt premium
|
|
|
180
|
|
|
|
|
|
|
|
Total mortgages notes payable, non-recourse to us, net
|
|
$
|
60,326
|
|
|
|
|
|
|
|
|
(a.)
|
All mortgage loans require monthly principal payments through maturity and either fully amortize or include a balloon principal payment upon maturity.
|
The mortgages are secured by the real property of the buildings as well as property leases and rents. The mortgages outstanding as of March 31, 2020 had a combined fair value of approximately $61.7 million. At December 31, 2019, we had various mortgages, all of which were non-recourse to us, included in our condensed consolidated balance sheet. The combined outstanding balance of these various mortgages was $61.1 million and had a combined fair value of approximately $63.1 million. The fair value of our debt was computed based upon quotes received from financial institutions. We consider these to be “level 2” in the fair value hierarchy as outlined in the authoritative guidance for disclosure in connection with debt instruments. Changes in market rates on our fixed rate debt impacts the fair value of debt, but it has no impact on interest incurred or cash flow.
Financial Instruments:
In March 2020, we entered into an interest rate swap agreement on a total notional amount of $55 million with a fixed interest rate of a 0.565%. that we designated as a cash flow hedge. The interest rate swap became effective on March 25, 2020 and is scheduled to mature on March 25, 2027. If the one-month LIBOR is above 0.565%, the counterparty pays us, and if the one-month LIBOR is less than 0.565%, we pay the counterparty, the difference between the fixed rate of 0.565% and one-month LIBOR.
In January 2020, we entered into an interest rate swap agreement on a total notional amount of $35 million with a fixed interest rate of a 1.4975% that we designated as a cash flow hedge. The interest rate swap became effective on January 15, 2020 and is scheduled to mature on September 16, 2024. If the one-month LIBOR is above 1.4975%, the counterparty pays us, and if the one-month LIBOR is less than 1.4975%, we pay the counterparty, the difference between the fixed rate of 1.4975% and one-month LIBOR.
During the third quarter of 2019, we entered into an interest rate swap agreement on a total notional amount of $50 million with a fixed interest rate of a 1.144% that we designated as a cash flow hedge. The interest rate swap became effective on September 16, 2019 and is scheduled to mature on September 16, 2024. If the one-month LIBOR is above 1.144%, the counterparty pays us, and if the one-month LIBOR is less than 1.144%, we pay the counterparty, the difference between the fixed rate of 1.144% and one-month LIBOR.
We measure our interest rate swaps at fair value on a recurring basis. The fair value of our interest rate swaps is based on quotes from third parties. We consider those inputs to be “level 2” in the fair value hierarchy as outlined in the authoritative guidance for disclosures in connection with derivative instruments and hedging activities. At March 31, 2020, the fair value of our interest rate swaps was a net liability of $3.7 million which is included in accrued expenses and other liabilities on the accompanying condensed consolidated balance sheet. During the first quarter of 2020, we received or accrued approximately $50,000 in net payments made to us by the counterparty, adjusted for the previous quarter accrual, pursuant to the terms of the swaps (consisting of approximately $71,000 in payments, adjusted for the previous quarter accrual, or accruals made to us by the counterparty, offset by approximately $21,000 due to the counterparty from us). From inception of the swap agreements through March 31, 2020 we received or accrued approximately $158,000 in net payments made to us by the counterparty pursuant to the terms of the swap (consisting of approximately $179,000 in payments or accruals made to us by the counterparty, offset by approximately $21,000 of payments due to
17
the counterparty from us). Cash flow hedges are accounted for by recording the fair value of the derivative instrument on the balance sheet as either an asset or a liability, with a corresponding amount recorded in accumulated other comprehensive income (“AOCI”) within shareholders’ equity. Amounts are classified from AOCI to the income statement in the period or periods the hedged transaction affects earnings.
During the third quarter of 2016, we entered into an additional interest rate cap agreement on a total notional amount of $30 million whereby we paid a premium of $55,000. This interest rate cap became effective in October, 2016 and expired in March, 2019. In exchange for the premium payment, the counterparties agreed to pay us the difference between 1.5% and one-month LIBOR if one-month LIBOR rises above 1.5% during the term of the cap. From inception through the March, 2019 expiration, we received approximately $205,000 in payments made to us by the counterparties ($61,000 of which was received during the first three months of 2019 and $144,000 of which was received during 2018) pursuant to the terms of this cap.
During the second quarter of 2016, we entered into an interest rate cap on the total notional amount of $30 million whereby we paid a premium of $115,000. This interest rate cap became effective in January, 2017 and expired in March 2019. In exchange for the premium payment, the counterparties agreed to pay us the difference between 1.50% and one-month LIBOR if one-month LIBOR rises above 1.50% during the term of the cap. From inception through the March, 2019 expiration, we received approximately $205,000 in payments made to us by the counterparties ($61,000 of which was received during the first three months of 2019 and $144,000 of which was received during 2018) pursuant to the terms of this cap.
(9) Segment Reporting
Our primary business is investing in and leasing healthcare and human service facilities through direct ownership or through joint ventures, which aggregate into a single reportable segment. We actively manage our portfolio of healthcare and human service facilities and may from time to time make decisions to sell lower performing properties not meeting our long-term investment objectives. The proceeds of sales are typically reinvested in new developments or acquisitions, which we believe will meet our planned rate of return. It is our intent that all healthcare and human service facilities will be owned or developed for investment purposes. Our revenue and net income are generated from the operation of our investment portfolio.
Our portfolio is located throughout the United States, however, we do not distinguish or group our operations on a geographical basis for purposes of allocating resources or measuring performance. We review operating and financial data for each property on an individual basis; therefore, we define an operating segment as our individual properties. Individual properties have been aggregated into one reportable segment based upon their similarities with regard to both the nature and economics of the facilities, tenants and operational processes, as well as long-term average financial performance. No individual property meets the requirements necessary to be considered its own segment.
18