Healthcare Trust, Inc. - Quarter Report: 2014 September (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2014
OR | |
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from _________ to __________
Commission file number: 000-55201
American Realty Capital Healthcare Trust II, Inc.
(Exact name of registrant as specified in its charter)
Maryland | 38-3888962 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
405 Park Ave., 14th Floor, New York, NY | 10022 | |
(Address of principal executive offices) | (Zip Code) | |
(212) 415-6500 | ||
(Registrant's telephone number, including area code) | ||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant submitted electronically and posted on its corporate Web Site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o | Accelerated filer o | |
Non-accelerated filer o | (Do not check if a smaller reporting company) | Smaller reporting company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
As of October 31, 2014, the registrant had 83,211,594 shares of common stock outstanding.
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
INDEX TO FINANCIAL STATEMENTS
Page | |
2
Part I — FINANCIAL INFORMATION
Item 1. Financial Statements.
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except for share and per share data)
September 30, 2014 | December 31, 2013 | |||||||
(Unaudited) | ||||||||
ASSETS | ||||||||
Real estate investments, at cost: | ||||||||
Land | $ | 65,640 | $ | 3,220 | ||||
Buildings, fixtures and improvements | 838,200 | 37,114 | ||||||
Acquired intangible lease assets | 103,443 | 5,952 | ||||||
Total real estate investments, at cost | 1,007,283 | 46,286 | ||||||
Less: accumulated depreciation and amortization | (11,786 | ) | (1,094 | ) | ||||
Total real estate investments, net | 995,497 | 45,192 | ||||||
Cash and cash equivalents | 766,061 | 111,833 | ||||||
Restricted cash | 1,902 | — | ||||||
Investment securities, at fair value | 18,544 | — | ||||||
Receivable for sale of common stock | 4,920 | 1,286 | ||||||
Prepaid expenses and other assets | 18,930 | 1,888 | ||||||
Deferred costs | 4,680 | 7 | ||||||
Total assets | $ | 1,810,534 | $ | 160,206 | ||||
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||
Mortgage notes payable | $ | 66,028 | $ | — | ||||
Mortgage premiums, net | 3,146 | — | ||||||
Below market lease liabilities, net | 339 | 57 | ||||||
Accounts payable and accrued expenses | 15,107 | 962 | ||||||
Deferred rent and other liabilities | 1,230 | 46 | ||||||
Distributions payable | 11,100 | 992 | ||||||
Total liabilities | 96,950 | 2,057 | ||||||
Preferred stock, $0.01 par value, 50,000,000 authorized, none issued and outstanding at September 30, 2014 and December 31, 2013 | — | — | ||||||
Common stock, $0.01 par value, 300,000,000 shares authorized, 81,457,445 and 7,529,789 shares issued and outstanding as of September 30, 2014 and December 31, 2013, respectively | 814 | 75 | ||||||
Additional paid-in capital | 1,793,520 | 161,952 | ||||||
Accumulated other comprehensive loss | (36 | ) | — | |||||
Accumulated deficit | (80,714 | ) | (3,878 | ) | ||||
Total stockholders' equity | 1,713,584 | 158,149 | ||||||
Total liabilities and stockholders' equity | $ | 1,810,534 | $ | 160,206 | ||||
The accompanying notes are an integral part of these statements.
3
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(In thousands, except for share and per share data)
(Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Revenues: | ||||||||||||||||
Rental income | $ | 10,620 | $ | 564 | $ | 14,061 | $ | 590 | ||||||||
Operating expense reimbursement | 1,034 | 88 | 1,849 | 89 | ||||||||||||
Resident services and fee income | 164 | — | 164 | — | ||||||||||||
Total revenues | 11,818 | 652 | 16,074 | 679 | ||||||||||||
Expenses: | ||||||||||||||||
Property operating | 4,202 | 88 | 5,231 | 89 | ||||||||||||
Acquisition and transaction related | 17,884 | 533 | 20,887 | 651 | ||||||||||||
General and administrative | 1,221 | 49 | 2,212 | 104 | ||||||||||||
Depreciation and amortization | 7,391 | 381 | 10,629 | 397 | ||||||||||||
Total expenses | 30,698 | 1,051 | 38,959 | 1,241 | ||||||||||||
Operating loss | (18,880 | ) | (399 | ) | (22,885 | ) | (562 | ) | ||||||||
Other income (expense): | ||||||||||||||||
Interest expense | (1,418 | ) | — | (2,163 | ) | — | ||||||||||
Income from investment securities and interest income | 275 | — | 296 | — | ||||||||||||
Total other expense | (1,143 | ) | — | (1,867 | ) | — | ||||||||||
Net loss | $ | (20,023 | ) | $ | (399 | ) | $ | (24,752 | ) | $ | (562 | ) | ||||
Other comprehensive loss: | ||||||||||||||||
Unrealized loss on investment securities, net | (36 | ) | — | (36 | ) | — | ||||||||||
Comprehensive loss | $ | (20,059 | ) | $ | (399 | ) | $ | (24,788 | ) | $ | (562 | ) | ||||
Basic and diluted weighted-average shares outstanding | 71,813,126 | 2,559,022 | 40,401,362 | 991,948 | ||||||||||||
Basic and diluted net loss per share | $ | (0.28 | ) | $ | (0.16 | ) | $ | (0.61 | ) | $ | (0.57 | ) | ||||
The accompanying notes are an integral part of these statements.
4
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
For the Nine Months Ended September 30, 2014
(In thousands, except for share data)
(Unaudited)
Common Stock | Accumulated Other Comprehensive Income | |||||||||||||||||||||
Number of Shares | Par Value | Additional Paid-in Capital | Accumulated Deficit | Total Stockholders' Equity | ||||||||||||||||||
Balance, December 31, 2013 | 7,529,789 | $ | 75 | $ | 161,952 | $ | — | $ | (3,878 | ) | $ | 158,149 | ||||||||||
Issuance of common stock | 72,993,267 | 730 | 1,813,838 | — | — | 1,814,568 | ||||||||||||||||
Common stock offering costs, commissions and dealer manager fees | — | — | (204,350 | ) | — | — | (204,350 | ) | ||||||||||||||
Common stock issued through distribution reinvestment plan | 947,382 | 9 | 22,491 | — | — | 22,500 | ||||||||||||||||
Common stock repurchases | (19,029 | ) | — | (475 | ) | — | — | (475 | ) | |||||||||||||
Equity-based compensation | 6,036 | — | 64 | — | — | 64 | ||||||||||||||||
Distributions declared | — | — | — | — | (52,084 | ) | (52,084 | ) | ||||||||||||||
Other comprehensive loss | — | — | — | (36 | ) | — | (36 | ) | ||||||||||||||
Net loss | — | — | — | — | (24,752 | ) | (24,752 | ) | ||||||||||||||
Balance, September 30, 2014 | 81,457,445 | $ | 814 | $ | 1,793,520 | $ | (36 | ) | $ | (80,714 | ) | $ | 1,713,584 | |||||||||
The accompanying notes are an integral part of this statement.
5
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended September 30, | |||||||
2014 | 2013 | ||||||
Cash flows from operating activities: | |||||||
Net loss | $ | (24,752 | ) | $ | (562 | ) | |
Adjustments to reconcile net loss to net cash used in operating activities: | |||||||
Depreciation | 6,515 | 306 | |||||
Amortization of intangibles | 4,114 | 91 | |||||
Amortization of deferred financing costs | 841 | — | |||||
Amortization of mortgage premiums | (387 | ) | — | ||||
Accretion of below-market lease liability and amortization of above-market lease assets, net | 51 | 3 | |||||
Equity-based compensation | 64 | 11 | |||||
Changes in assets and liabilities: | |||||||
Prepaid expenses and other assets | (6,222 | ) | (402 | ) | |||
Accounts payable and accrued expenses | 8,548 | 327 | |||||
Deferred rent and other liabilities | 1,184 | 50 | |||||
Net cash used in operating activities | (10,044 | ) | (176 | ) | |||
Cash flows from investing activities: | |||||||
Investment in real estate and other assets | (886,068 | ) | (41,834 | ) | |||
Deposits for real estate acquisitions | (10,451 | ) | (210 | ) | |||
Capital expenditures | (139 | ) | — | ||||
Purchase of investment securities | (18,580 | ) | — | ||||
Net cash used in investing activities | (915,238 | ) | (42,044 | ) | |||
Cash flows from financing activities: | |||||||
Payments of mortgage notes payable | (293 | ) | — | ||||
Payments of deferred financing costs | (5,408 | ) | — | ||||
Proceeds from issuance of common stock | 1,810,934 | 91,923 | |||||
Common stock repurchases | (294 | ) | — | ||||
Payments of offering costs and fees related to common stock issuances | (203,567 | ) | (11,002 | ) | |||
Distributions paid | (19,476 | ) | (380 | ) | |||
Payments to affiliate | (484 | ) | (399 | ) | |||
Restricted cash | (1,902 | ) | — | ||||
Net cash provided by financing activities | 1,579,510 | 80,142 | |||||
Net change in cash | 654,228 | 37,922 | |||||
Cash, beginning of period | 111,833 | 3 | |||||
Cash, end of period | $ | 766,061 | $ | 37,925 | |||
6
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended September 30, | |||||||
2014 | 2013 | ||||||
Supplemental Disclosures: | |||||||
Cash paid for interest | $ | 1,137 | $ | — | |||
Cash paid for taxes | 79 | — | |||||
Non-Cash Financing Activities: | |||||||
Proceeds from mortgage notes payable used to acquire investments in real estate | $ | 66,321 | $ | — | |||
Premiums on assumed mortgage notes payable | 3,533 | — | |||||
Liabilities assumed in real estate acquisitions | 4,633 | — | |||||
Common stock issued through distribution reinvestment plan | 22,500 | 385 | |||||
Reclassification of deferred offering costs to equity | — | 807 | |||||
The accompanying notes are an integral part of these statements.
7
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)
Note 1 — Organization
American Realty Capital Healthcare Trust II, Inc. (the "Company") was incorporated on October 15, 2012 as a Maryland corporation that elected and qualified to be taxed as a real estate investment trust ("REIT") for U.S. federal income tax purposes beginning with the taxable year ended December 31, 2013. On February 14, 2013, the Company commenced its ongoing initial public offering (the "IPO") on a "reasonable best efforts" basis of up to $1.7 billion of common stock, $0.01 par value per share, at a price of $25.00 per share, subject to certain volume and other discounts, pursuant to a registration statement on Form S-11, as amended (File No. 333-184677) (the "Registration Statement"), filed with the U.S. Securities and Exchange Commission (the "SEC") under the Securities Act of 1933, as amended. The Registration Statement also covers up to 14.7 million shares of common stock available pursuant to a distribution reinvestment plan (the "DRIP") under which common stockholders may elect to have their distributions reinvested in additional shares of common stock. The Company reserves the right to reallocate shares covered in the Registration Statement between the IPO and the DRIP. On July 23, 2014, the Company announced the reallocation of 13.9 million shares of the 14.2 million remaining unsold shares available pursuant to the DRIP. On August 1, 2014, the Company registered an additional 25.0 million shares to be issued under the DRIP pursuant to a registration statement on Form S-3 (File No. 333-197802).
As of September 30, 2014, the Company had 81.5 million shares of common stock outstanding, including unvested restricted shares and shares issued pursuant to the DRIP, and had received total gross proceeds from the IPO and the DRIP of $2.0 billion. As of September 30, 2014, the aggregate value of all share issuances and subscriptions of common stock outstanding was $2.0 billion based on a per share value of $25.00 (or $23.75 for shares issued under the DRIP). Until the NAV pricing date (as described below) the per share purchase price in the IPO will be up to $25.00 per share (including the maximum allowed to be charged for commissions and fees) and shares issued under the DRIP will be equal to $23.75 per share, which is equal to 95% of the offering price in the IPO. Beginning with the NAV pricing date (as described below), the per share price for shares in the IPO and under the DRIP will vary quarterly and will be equal to the Company’s per share net asset value (“NAV”), as determined by American Realty Capital Healthcare II Advisors, LLC (the “Advisor”), plus applicable commissions and fees, in the case of the primary offering, and the per share purchase price in the DRIP will be equal to the NAV per share. The NAV pricing date means the date on which the Company files its Quarterly Report on Form 10-Q (or Annual Report on Form 10-K should such filing constitute the applicable quarterly financial filing) with the SEC pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), for the second full fiscal quarter following the earlier of (i) the date on which the Company has invested all of the net proceeds of its primary offering, plus the net proceeds from debt financing equal to its target leverage ratio, but excluding working capital reserves and facilities and (ii) February 14, 2015, which is two years from the effective date of the IPO.
The Company was formed to acquire a diversified portfolio of healthcare-related real estate assets, including medical office buildings, seniors housing communities and other healthcare-related facilities. All such properties may be acquired and operated by the Company alone or jointly with another party. The Company may also originate or acquire first mortgage loans secured by real estate. The Company purchased its first property and commenced real estate operations in May 2013. As of September 30, 2014, the Company owned 88 properties consisting of 4.1 million rentable square feet, which were 97.3% leased, excluding seniors housing communities, with a weighted-average remaining lease term of 10.2 years.
Substantially all of the Company's business is conducted through American Realty Capital Healthcare Trust II Operating Partnership, LP (the "OP"), a Delaware limited partnership. The Company is the sole general partner and holds substantially all of the units of limited partner interests in the OP ("OP units"). American Realty Capital Healthcare II Special Limited Partnership, LLC (the "Special Limited Partner"), an entity controlled by the Company's sponsor, American Realty Capital VII, LLC (the "Sponsor"), contributed $2,020 to the OP in exchange for 90 OP units, which represents a nominal percentage of the aggregate OP ownership. A holder of OP units has the right to convert OP units for the cash value of a corresponding number of shares of the Company's common stock or, at the option of the OP, a corresponding number of shares of the Company's common stock, in accordance with the limited partnership agreement of the OP, provided, however, that such OP units must have been outstanding for at least one year. The remaining rights of the limited partners in the OP are limited, however, and do not include the ability to replace the general partner or to approve the sale, purchase or refinancing of the OP's assets.
8
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)
The Company has no direct employees. The Advisor has been retained by the Company to manage the Company's affairs on a day-to-day basis. The Company has retained American Realty Capital Healthcare II Properties, LLC (the "Property Manager") to serve as the Company's property manager. Realty Capital Securities, LLC (the "Dealer Manager") serves as the dealer manager of the IPO. The Advisor, the Property Manager and the Dealer Manager are under common control with the parent of the Sponsor, as a result of which, they are related parties, and each of which have or will receive compensation, fees and expense reimbursements for services related to the IPO and the investment and management of the Company's assets. The Advisor, Property Manager and Dealer Manager have or will also receive compensation, fees and expense reimbursements during the Company's offering, acquisition, operational and liquidation stages.
Note 2 — Summary of Significant Accounting Policies
The accompanying consolidated financial statements of the Company included herein were prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and with the instructions to this Quarterly Report on Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The information furnished includes all adjustments and accruals of a normal recurring nature, which, in the opinion of management, are necessary for a fair presentation of results for the interim periods. All intercompany accounts and transactions have been eliminated in consolidation. The results of operations for the three and nine months ended September 30, 2014 are not necessarily indicative of the results for the entire year or any subsequent interim period.
These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto as of, and for the year ended December 31, 2013, which are included in the Company's Annual Report on Form 10-K filed with the SEC on March 6, 2014. There have been no significant changes to Company's significant accounting policies during the nine months ended September 30, 2014 other than the updates described below.
Recent Accounting Pronouncements
In February 2013, the Financial Accounting Standards Board ("FASB") issued new accounting guidance clarifying the accounting and disclosure requirements for obligations resulting from joint and several liability arrangements for which the total amount under the arrangement is fixed at the reporting date. The new guidance was effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2013. The adoption of this guidance did not have a material impact on the Company's consolidated financial position, results of operations or cash flows.
In April 2014, the FASB amended the requirements for reporting discontinued operations. Under the revised guidance, in addition to other disclosure requirements, a disposal of a component of an entity or a group of components of an entity is required to be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity's operations and financial results when the component or group of components meets the criteria to be classified as held for sale, disposed of by sale or other than by sale. The Company has adopted the provisions of this guidance effective January 1, 2014 and have applied the provisions prospectively. The adoption of this guidance did not have a material impact on the Company's consolidated financial position, results of operations or cash flows.
In May 2014, the FASB issued revised guidance relating to revenue recognition. Under the revised guidance, an entity is required to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The revised guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is not permitted under GAAP. The revised guidance allows entities to apply the full retrospective or modified retrospective transition method upon adoption. The Company has not yet selected a transition method and is currently evaluating the impact of the new guidance.
9
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)
Note 3 — Real Estate Investments
The following table presents the allocation of the assets acquired during the nine months ended September 30, 2014 and 2013:
Nine Months Ended September 30, | ||||||||
(Dollar amounts in thousands) | 2014 | 2013 | ||||||
Real estate investments, at cost: | ||||||||
Land | $ | 62,420 | $ | 2,279 | ||||
Buildings, fixtures and improvements | 800,947 | 34,291 | ||||||
Total tangible assets | 863,367 | 36,570 | ||||||
Acquired intangibles: | ||||||||
In-place leases | 97,284 | 5,180 | ||||||
Above-market lease assets | 207 | 236 | ||||||
Below-market lease liabilities | (303 | ) | (61 | ) | ||||
Total assets acquired, net | 960,555 | 41,925 | ||||||
Mortgage notes payable assumed to acquire real estate investments | (66,321 | ) | — | |||||
Premiums on mortgages assumed | (3,533 | ) | — | |||||
Other liabilities assumed (1) | (4,633 | ) | (91 | ) | ||||
Cash paid for acquired real estate investments | $ | 886,068 | $ | 41,834 | ||||
Number of properties purchased | 81 | 6 | ||||||
___________________
(1) Other liabilities assumed includes $1.4 million in tenant security deposits assumed at acquisition of properties acquired and a $3.2 million capital lease obligation incurred in conjunction with the transaction described below during the nine months ended September 30, 2014.
During the nine months ended September 30, 2014, the Company acquired leasehold interests in six properties from Pinnacle Health Hospitals, a Pennsylvania nonprofit corporation ("PHH"), and has accounted for such interests as capital leases. The Company allocated $118.5 million and $16.3 million of assets at cost associated with the leasehold interests to buildings, fixtures and improvements and in-place leases, respectively, in the table above. Additionally, the Company entered into arrangements to sublease all or a portion of the six properties back to PHH, and assumed in-place subleases with other third-party tenants. Future minimum base rental payments due to the Company under subleases to PHH and other third-party tenants totaled $110.6 million. See Note 9 — Commitments and Contingencies for minimum base cash rental payments due from the Company to PHH under these leasehold interests.
The allocations to land, buildings, fixtures and improvements have been provisionally assigned to each class, pending receipt of additional information. The following table presents unaudited pro forma information as if the acquisitions during the nine months ended September 30, 2014 had been consummated on January 1, 2013. Additionally, the unaudited pro forma net loss was adjusted to exclude acquisition and transaction related expense of $20.9 million from the nine months ended September 30, 2014.
Nine Months Ended September 30, | ||||||||
(In thousands) | 2014 | 2013 | ||||||
Pro forma revenues | $ | 109,522 | $ | 106,590 | ||||
Pro forma net income (loss) | $ | (9,902 | ) | $ | 2,167 | |||
10
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)
The following table presents future minimum base rental cash payments due to the Company over the next five years and thereafter. These amounts exclude contingent rent payments, as applicable, that may be collected from certain tenants based on provisions related to sales thresholds and increases in annual rent based on exceeding certain economic indexes among other items.
(In thousands) | Future Minimum Base Rent Payments | |||
October 1, 2014 — December 31, 2014 | $ | 9,651 | ||
2015 | 38,371 | |||
2016 | 36,761 | |||
2017 | 35,659 | |||
2018 | 34,354 | |||
Thereafter | 278,851 | |||
$ | 433,647 | |||
The following table lists the tenants (including for this purpose, all affiliates of such tenants) whose annualized rental income on a straight-line basis represented 10% or more of consolidated annualized rental income for all properties on a straight-line basis as of September 30, 2014 and 2013:
September 30, | ||||
Tenant | 2014 | 2013 | ||
Adena Health System | * | 11.9% | ||
Advocate Health and Hospitals Corporation | * | 12.0% | ||
HH/Killeen Health System, LLC | * | 14.1% | ||
IASIS Healthcare, LLC | * | 16.9% | ||
Meridian Senior Living, LLC | 18.8% | * | ||
National Mentor Holdings, Inc. | * | 27.4% | ||
Pinnacle Health Hospitals | 21.4% | * | ||
Platinum Health Care, LLC | 12.6% | * | ||
_______________________________
* Tenant's annualized rental income on a straight-line bases was not greater than 10% of total annualized rental income for all portfolio properties as of the period specified
The following table lists the states where the Company has concentrations of properties where annualized rental income on a straight-line basis represented 10% or more of consolidated annualized rental income on a straight-line basis for all properties as of September 30, 2014 and 2013:
September 30, | ||||
State | 2014 | 2013 | ||
Colorado | * | 27.4% | ||
Florida | 32.0% | * | ||
Illinois | * | 25.3% | ||
Iowa | 20.9% | * | ||
Louisiana | * | 16.9% | ||
Michigan | 10.0% | * | ||
Ohio | * | 11.9% | ||
Texas | * | 14.1% | ||
_______________________________
* State's annualized rental income on a straight-line bases was not greater than 10% of total annualized rental income for all portfolio properties as of the period specified
11
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)
Note 4 — Investment Securities
As of September 30, 2014, the Company had investments in common stock, redeemable preferred stock, real estate income funds and a senior note with an aggregate fair value of $18.5 million. The real estate income funds are managed by an affiliate of the Sponsor (see Note 10 — Related Party Transactions and Arrangements). These investments are considered available-for-sale securities and, therefore, increases or decreases in the fair value of these investments are recorded in accumulated other comprehensive loss as a component of equity on the consolidated balance sheets unless the securities are considered to be other than temporarily impaired at which time the losses would be reclassified to expense.
The following table details the unrealized gains and losses on investment securities as of September 30, 2014. The Company had no such investments as of December 31, 2013.
(In thousands) | Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||
September 30, 2014 | ||||||||||||
Investment securities | 18,580 | 121 | (157 | ) | 18,544 | |||||||
Unrealized losses as of September 30, 2014 were considered temporary and, therefore, no impairment was recorded during the three and nine months ended September 30, 2014.
The Company's preferred stock investments are redeemable at the respective issuer's option five years after issuance. The senior note matures in 28.5 years and bears interest at 5.45% as of September 30, 2014.
Note 5 — Revolving Credit Facility
On March 21, 2014, the Company entered into a senior secured credit facility in the amount of $50.0 million (the "Credit Facility"). On April 15, 2014, the Company entered into an increase letter, increasing the amount available under the Credit Facility to $200.0 million. The Credit Facility contains an "accordion" feature to allow the Company, under certain circumstances, to increase the aggregate commitments under the Credit Facility to a maximum of $450.0 million.
The Company has the option, based upon its leverage, to have the Credit Facility priced at either: (a) LIBOR, plus an applicable margin that ranges from 1.60% to 2.20%; or (b) the Base Rate, plus an applicable margin that ranges from 0.35% to 0.95%. Base Rate is defined in the Credit Facility as the greatest of (i) the fluctuating annual rate of interest announced from time to time by the lender as its “prime rate,” (ii) 0.5% above the federal funds effective rate or (iii) the applicable one-month LIBOR plus 1.0%.
The Credit Facility provides for monthly interest payments for each Base Rate loan and periodic payments for each LIBOR loan, based upon the applicable LIBOR loan period, with all principal outstanding being due on the maturity date on March 21, 2017, subject to two one-year extension options. The Credit Facility may be prepaid at any time, in whole or in part, without premium or penalty (subject to standard breakage costs). In the event of a default, the lender has the right to terminate its obligations under the Credit Facility and to accelerate the payment on any unpaid principal amount of all outstanding loans.
Availability of borrowings is based on a pool of eligible unencumbered real estate assets. The Company did not have any borrowing capacity as there were no assets assigned to the borrowing base of the Credit Facility as of September 30, 2014. There were no advances outstanding as of September 30, 2014.
The Credit Facility requires the Company to meet certain financial covenants, including the maintenance of certain financial ratios (such as specified debt to equity and debt service coverage ratios) as well as the maintenance of a minimum net worth. As of September 30, 2014, the Company was in compliance with the financial covenants under the Credit Facility agreement.
12
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)
Note 6 — Mortgage Notes Payable
The following table reflects the Company's mortgage notes payable as of September 30, 2014. The Company had no mortgage notes payable as of December 31, 2013.
Outstanding Loan Amount as of | Effective Interest Rate | ||||||||||||
Portfolio | Encumbered Properties | September 30, 2014 | Interest Rate | Maturity | |||||||||
(In thousands) | |||||||||||||
Creekside Medical Office Building - Douglasville, GA | 1 | $ | 5,186 | 5.32 | % | Fixed | Sep. 2015 | ||||||
Bowie Gateway Medical Center - Bowie, MD | 1 | 6,076 | 6.18 | % | Fixed | Sep. 2016 | |||||||
Medical Center of New Windsor - New Windsor, NY | 1 | 8,859 | 6.39 | % | Fixed | Sep. 2017 | |||||||
Plank Medical Center - Clifton Park, NY | 1 | 3,516 | 6.39 | % | Fixed | Sep. 2017 | |||||||
Cushing Center - Schenectady, NY | 1 | 4,312 | 5.71 | % | Fixed | Feb. 2016 | |||||||
Countryside Medical Arts - Safety Harbor, FL | 1 | 6,097 | 6.07 | % | Fixed | (1) | Apr. 2019 | ||||||
St. Andrews Medical Park - Venice, FL | 3 | 6,739 | 6.07 | % | Fixed | (1) | Apr. 2019 | ||||||
Campus at Crooks & Auburn Building C - Rochester Hills, MI | 1 | 3,643 | 5.91 | % | Fixed | Apr. 2016 | |||||||
Slingerlands Crossing Phase I - Bethlehem, NY | 1 | 6,779 | 6.39 | % | Fixed | Sep. 2017 | |||||||
Slingerlands Crossing Phase II - Bethlehem, NY | 1 | 7,901 | 6.39 | % | Fixed | Sep. 2017 | |||||||
Benedictine Cancer Center - Kingston, NY | 1 | 6,920 | 6.39 | % | Fixed | Sep. 2017 | |||||||
Total | 13 | $ | 66,028 | 6.15 | % | (2) | |||||||
_______________________________
(1) Fixed interest rate through May 10, 2017. Interest rate changes to variable rate starting May 11, 2017.
(2) Calculated on a weighted average basis for all mortgages outstanding as of September 30, 2014.
The following table summarizes the scheduled aggregate principal payments on mortgage notes payable for the five years subsequent to September 30, 2014:
(In thousands) | Future Principal Payments | |||
October 1, 2014 — December 31, 2014 | $ | 235 | ||
2015 | 6,020 | |||
2016 | 14,347 | |||
2017 | 33,196 | |||
2018 | 212 | |||
Thereafter | 12,018 | |||
$ | 66,028 | |||
Some of the Company's mortgage notes payable agreements require the compliance of certain property-level financial covenants including debt service coverage ratios. As of September 30, 2014, the Company was in compliance with financial covenants under its mortgage notes payable agreements.
13
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)
Note 7 — Fair Value of Financial Instruments
The Company determines fair value based on quoted prices when available or through the use of alternative approaches, such as discounting the expected cash flows using market interest rates commensurate with the credit quality and duration of the investment. This alternative approach also reflects the contractual terms of the derivatives, if any, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The guidance defines three levels of inputs that may be used to measure fair value:
Level 1 — Quoted prices in active markets for identical assets and liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 — Inputs other than quoted prices included within Level 1 that are observable for the asset and liability or can be corroborated with observable market data for substantially the entire contractual term of the asset or liability.
Level 3 — Unobservable inputs that reflect the entity's own assumptions that market participants would use in the pricing of the asset or liability and are consequently not based on market activity, but rather through particular valuation techniques.
The determination of where an asset or liability falls in the hierarchy requires significant judgment and considers factors specific to the asset or liability. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company evaluates its hierarchy disclosures each quarter and depending on various factors, it is possible that an asset or liability may be classified differently from quarter to quarter. However, the Company expects that changes in classifications between levels will be rare.
The Company has investments in common stock, redeemable preferred stock, a real estate income fund and senior notes that are traded in active markets and therefore, due to the availability of quoted market prices in active markets, the Company has classified these investments as Level 1 in the fair value hierarchy.
The following table presents information about the Company's assets measured at fair value on a recurring basis as of September 30, 2014, aggregated by the level in the fair value hierarchy within which those instruments fall. The Company had no such assets as of December 31, 2013.
(In thousands) | Quoted Prices in Active Markets Level 1 | Significant Other Observable Inputs Level 2 | Significant Unobservable Inputs Level 3 | Total | ||||||||||||
September 30, 2014 | ||||||||||||||||
Investment securities | $ | 18,544 | $ | — | $ | — | $ | 18,544 | ||||||||
The Company is required to disclose the fair value of financial instruments for which it is practicable to estimate that value. The fair value of short-term financial instruments such as cash and cash equivalents, restricted cash, other receivables, due to affiliates, accounts payable and distributions payable approximates their carrying value on the consolidated balance sheets due to their short-term nature. The fair values of the Company's remaining financial instruments that are not reported at fair value on the consolidated balance sheets are reported below:
Carrying Amount(1) at | Fair Value at | Carrying Amount at | Fair Value at | |||||||||||||||
(In thousands) | Level | September 30, 2014 | September 30, 2014 | December 31, 2013 | December 31, 2013 | |||||||||||||
Mortgage notes payable and premiums, net | 3 | $ | 69,174 | $ | 69,561 | $ | — | $ | — | |||||||||
_______________________________
(1) Carrying value includes $66.0 million mortgage notes payable and $3.1 million mortgage premiums, net as of September 30, 2014.
The fair value of the mortgage notes payable are estimated using a discounted cash flow analysis, based on the Advisor's experience with similar types of borrowing arrangements.
14
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)
Note 8 — Common Stock
The Company had 81.5 million and 7.5 million shares of common stock outstanding, including unvested restricted shares and shares issued pursuant to the DRIP, and had received total proceeds of $2.0 billion and $186.8 million, including proceeds from shares issued pursuant to the DRIP, as of September 30, 2014 and December 31, 2013, respectively.
On April 9, 2013, the Company's board of directors authorized, and the Company declared, distributions payable to stockholders of record each day during the applicable period at a rate equal to $0.0046575343 per day, or 6.8% per annum, based on a price of $25.00 per share of common stock. Distributions began to accrue on May 24, 2013, 15 days following the Company's initial property acquisition. Distributions are payable by the 5th day following each month end to stockholders of record at the close of business each day during the prior month. Distribution payments are dependent on the availability of funds. The board of directors may reduce the amount of distributions paid or suspend distribution payments at any time and therefore distributions payments are not assured.
The Company has a Share Repurchase Program ("SRP") that enables stockholders, subject to certain conditions and limitations, to sell their shares to the Company. Under the SRP, stockholders may request that the Company repurchase all or any portion of their shares of common stock, if such repurchase does not impair the Company's capital or operations. The Company will fund repurchases from proceeds from the sale of common stock pursuant to the DRIP. The following table summarizes the number of shares repurchased under the SRP cumulatively through September 30, 2014:
Number of Requests | Number of Shares Repurchased | Average Price per Share | ||||||||
Cumulative repurchases as of December 31, 2013 | 2 | 1,600 | $ | 25.00 | ||||||
Nine months ended September 30, 2014 (1) | 19 | 19,029 | 24.97 | |||||||
Cumulative repurchases as of September 30, 2014 (1) | 21 | 20,629 | $ | 24.97 | ||||||
_____________________________
(1) Includes eight unfulfilled repurchase requests consisting of 8,866 shares at an average repurchase price per share of $24.97, which were approved for repurchase as of September 30, 2014 and are expected to be completed in November 2014.
Note 9 — Commitments and Contingencies
Future Minimum Lease Payments
The Company has entered into lease agreements related to certain acquisitions under leasehold interests arrangements. The following table reflects the minimum base cash rental payments due from the Company over the next five years and thereafter. These amounts exclude contingent rent payments, as applicable, that may be payable based on provisions related to increases in annual rent based on exceeding certain economic indexes among other items.
(In thousands) | Future Minimum Base Rent Payments(1) | |||
October 1, 2014 — December 31, 2014 | $ | 43 | ||
2015 | 172 | |||
2016 | 176 | |||
2017 | 179 | |||
2018 | 183 | |||
Thereafter | 11,629 | |||
$ | 12,382 | |||
_______________________________
(1) Future minimum base rental payments includes $2.3 million of imputed interest related to our capital lease obligations.
Litigation
In the ordinary course of business, the Company may become subject to litigation or claims. There are no material legal proceedings pending or known to be contemplated against the Company.
15
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)
Environmental Matters
In connection with the ownership and operation of real estate, the Company may potentially be liable for costs and damages related to environmental matters. As of September 30, 2014, the Company has not been notified by any governmental authority of any non-compliance, liability or other claim, and is not aware of any other environmental condition that it believes will have a material adverse effect on the results of operations.
Note 10 — Related Party Transactions and Arrangements
As of September 30, 2014 and December 31, 2013, the Special Limited Partner owned 8,888 shares of the Company's outstanding common stock. The Advisor and its affiliates may incur and pay costs and fees on behalf of the Company. As of December 31, 2013, the Company had $0.5 million payable to the Sponsor primarily related to funding the payment of third party professional fees and offering costs. There were no such amounts payable as of September 30, 2014.
During the nine months ended September 30, 2014, the Company invested $2.0 million in real estate income funds managed by an affiliate of the Sponsor (see Note 4 — Investment Securities). There is no obligation to purchase any additional shares and the shares can be sold at any time.
Fees Paid in Connection with the IPO
The Dealer Manager is paid fees in connection with the sale of the Company's common stock in the IPO. The Dealer Manager is paid a selling commission of up to 7.0% of the per share purchase price of offering proceeds before reallowance of commissions earned by participating broker-dealers. In addition, the Dealer Manager is paid up to 3.0% of the gross proceeds from the sale of shares, before reallowance to participating broker-dealers, as a dealer-manager fee. The Dealer Manager may reallow its dealer-manager fee to participating broker-dealers. A participating broker-dealer may elect to receive a fee equal to 7.5% of the gross proceeds from the sale of shares by such participating broker-dealer, with 2.5% thereof paid at the time of such sale and 1.0% thereof paid on each anniversary of the closing of such sale up to and including the fifth anniversary of the closing of such sale. If this option is elected, the dealer manager fee will be reduced to 2.5% of gross proceeds. The following table details total selling commissions and dealer manager fees incurred from and due to the Dealer Manager as of and for the periods presented:
Payable as of | ||||||||||||||||||||||||
Three Months Ended September 30, | Nine Months Ended September 30, | September 30, | December 31, | |||||||||||||||||||||
(In thousands) | 2014 | 2013 | 2014 | 2013 | 2014 | 2013 | ||||||||||||||||||
Total commissions and fees incurred from the Dealer Manager | $ | 67,004 | $ | 5,947 | $ | 172,201 | $ | 8,692 | $ | 465 | $ | 127 | ||||||||||||
The Advisor and its affiliates receive compensation and reimbursement for services relating to the IPO, including transfer agent services provided by an affiliate of the Dealer Manager. All offering costs incurred by the Company or its affiliated entities on behalf of the Company are charged to additional paid-in capital on the accompanying balance during the IPO. The following table details offering costs and reimbursements incurred from and due to the Advisor and Dealer Manager as of and for the periods presented:
Payable as of | ||||||||||||||||||||||||
Three Months Ended September 30, | Nine Months Ended September 30, | September 30, | December 31, | |||||||||||||||||||||
(In thousands) | 2014 | 2013 | 2014 | 2013 | 2014 | 2013 | ||||||||||||||||||
Fees and expense reimbursements from the Advisor and Dealer Manager | $ | 14,700 | $ | 538 | $ | 30,023 | $ | 1,253 | $ | 720 | $ | 192 | ||||||||||||
The Company is responsible for offering and related costs from the IPO, excluding commissions and dealer manager fees, up to a maximum of 2.0% of gross proceeds received from the IPO, measured at the end of the IPO. Offering costs in excess of the 2.0% cap as of the end of the IPO are the Advisor's responsibility. As of September 30, 2014, offering and related costs, excluding commissions and dealer manager fees, were lower than 2.0% of gross proceeds received from the IPO by $1.0 million.
16
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)
After the general escrow break, the Advisor and the Dealer Manager elected to cap cumulative offering costs for the IPO, including selling commissions and dealer manager fees, incurred by the Company, net of unpaid amounts, to 15% of gross common stock proceeds during the offering period of the IPO. As of September 30, 2014, cumulative offering costs were $229.1 million. Cumulative offering costs net of unpaid amounts were less than the 15% threshold as of September 30, 2014.
Fees Paid in Connection With the Operations of the Company
The Advisor is paid an acquisition fee equal to 1.0% of the contract purchase price of each acquired property and 1.0% of the amount advanced for a loan or other investment. The Advisor is also reimbursed for services provided for which it incurs investment-related expenses, or insourced expenses. Such insourced expenses may not exceed 0.5% of the contract purchase price of each acquired property and 0.5% of the amount advanced for a loan or other investment. Additionally, the Company reimburses the Advisor for third party acquisition expenses. Once the proceeds from the IPO have been fully invested, the aggregate amount of acquisition fees and financing coordination fees (as described below) may not exceed 1.5% of the contract purchase price and the amount advanced for a loan or other investment for all the assets acquired. In no event will the total of all acquisition fees, acquisition expenses and any financing coordination fees payable with respect to the Company's portfolio of investments or reinvestments exceed 4.5% of the contract purchase price of the Company's portfolio to be measured at the close of the acquisition phase or 4.5% of the amount advanced for all loans or other investments.
If the Advisor provides services in connection with the origination or refinancing of any debt that the Company obtains and uses to acquire properties or to make other permitted investments, or that is assumed, directly or indirectly, in connection with the acquisition of properties, the Company will pay the Advisor a financing coordination fee equal to 0.75% of the amount available and/or outstanding under such financing, subject to certain limitations.
For its asset management services, the Company causes the OP to issue (subject to periodic approval by the board of directors) to the Advisor performance-based restricted partnership units of the OP designated as "Class B units," which are intended to be profit interests and will vest, and no longer be subject to forfeiture, at such time as: (x) the value of the OP's assets plus all distributions made equals or exceeds the total amount of capital contributed by investors plus a 6% cumulative, pre-tax, non-compounded annual return thereon (the "economic hurdle"); (y) any one of the following occurs: (1) a listing; (2) an other liquidity event or (3) the termination of the advisory agreement by an affirmative vote of a majority of the Company's independent directors without cause; and (z) the Advisor is still providing advisory services to the Company (the "performance condition"). Such Class B units will be forfeited immediately if: (a) the advisory agreement is terminated for any reason other than a termination without cause; or (b) the advisory agreement is terminated by an affirmative vote of a majority of the Company's independent directors without cause before the economic hurdle has been met.
The asset management subordination is an amount equal to: (i) the excess of (A) the product of (y) the cost of assets (or the lower of the cost of assets and the applicable quarterly NAV once we begin calculating NAV) multiplied by (z) 0.1875% over (B) any amounts payable as an oversight fee (as described below) for such calendar quarter; divided by (ii) the value of one share of common stock as of the last day of such calendar quarter, which is equal initially to $22.50 (the IPO price minus the selling commissions and dealer manager fees). When and if approved by the board of directors, the Class B units are expected to be issued to the Advisor quarterly in arrears pursuant to the terms of the limited partnership agreement of the OP. The value of issued Class B units will be determined and expensed when the Company deems the achievement of the performance condition to be probable. As of September 30, 2014, the Company cannot determine the probability of achieving the performance condition. The Advisor receives distributions on vested and unvested Class B units equal to the distribution rate received on the Company's common stock. Such distributions on issued Class B units are included in general and administrative expenses in the consolidated statement of operations and comprehensive loss until the performance condition is considered probable to occur. As of September 30, 2014, the Company's board of directors approved the issuance of 27,418 Class B Units to the Advisor in connection with this arrangement.
Unless the Company contracts with a third party, the Company pays the Property Manager a property management fee of 1.5% of gross revenues from the Company's stand-alone single-tenant net leased properties and 2.5% of gross revenues from all other types of properties, respectively. The Company also reimburses the affiliate for property level expenses. If the Company contracts directly with third parties for such services, the Company will pay them customary market fees and will pay the Property Manager an oversight fee of up to 1.0% of the gross revenues of the property managed. In no event will the Company pay the Property Manager or any affiliate both a property management fee and an oversight fee with respect to any particular property.
17
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)
Effective June 1, 2013, the Company entered into an agreement with the Dealer Manager to provide strategic advisory services and investment banking services required in the ordinary course of the Company's business, such as performing financial analysis, evaluating publicly traded comparable companies and assisting in developing a portfolio composition strategy, a capitalization structure to optimize future liquidity options and structuring operations. Strategic advisory fees were amortized over the estimated remaining term of the IPO and, as such, have been fully amortized as of September 30, 2014. These fees are included in general and administrative expenses in the accompanying consolidated statement of operations and comprehensive loss.
The following table details amounts incurred, forgiven and payable in connection with the Company's operations-related services described above as of and for the periods presented:
Three Months Ended September 30, | Nine Months Ended September 30, | Payable as of | ||||||||||||||||||||||||||||||||||||||
2014 | 2013 | 2014 | 2013 | September 30, | December 31, | |||||||||||||||||||||||||||||||||||
(In thousands) | Incurred | Forgiven | Incurred | Forgiven | Incurred | Forgiven | Incurred | Forgiven | 2014 | 2013 | ||||||||||||||||||||||||||||||
One-time fees and reimbursements: | ||||||||||||||||||||||||||||||||||||||||
Acquisition fees and related cost reimbursements | $ | 12,280 | $ | — | $ | 457 | $ | — | $ | 14,333 | $ | — | $ | 541 | $ | — | $ | — | $ | — | ||||||||||||||||||||
Financing coordination fees | 52 | — | — | — | 1,997 | — | — | — | — | — | ||||||||||||||||||||||||||||||
Ongoing fees: | ||||||||||||||||||||||||||||||||||||||||
Property management and leasing fees | — | 124 | — | 9 | — | 171 | — | 9 | — | — | ||||||||||||||||||||||||||||||
Strategic advisory fees | 335 | — | 152 | — | 605 | — | 180 | — | — | — | ||||||||||||||||||||||||||||||
Distributions on Class B Units | 9 | — | — | — | 16 | — | — | — | — | 1 | ||||||||||||||||||||||||||||||
Total related party operation fees and reimbursements | $ | 12,676 | $ | 124 | $ | 609 | $ | 9 | $ | 16,951 | $ | 171 | $ | 721 | $ | 9 | $ | — | $ | 1 | ||||||||||||||||||||
The Company reimburses the Advisor's costs of providing administrative services, subject to the limitation that the Company will not reimburse the Advisor for any amount by which the Company's operating expenses at the end of the four preceding fiscal quarters exceeds the greater of (a) 2.0% of average invested assets and (b) 25.0% of net income other than any additions to reserves for depreciation, bad debt or other similar non-cash reserves and excluding any gain from the sale of assets for that period. Additionally, the Company reimburses the Advisor for personnel costs in connection with other services during the operational stage; however, the Company may not reimburse the Advisor for personnel costs in connection with services for which the Advisor receives acquisition fees, acquisition expenses or real estate commissions. No reimbursement was incurred from the Advisor for providing services during the three and nine months ended September 30, 2014 or 2013.
In order to improve operating cash flows and the ability to pay distributions from operating cash flows, the Advisor may elect to waive certain fees. Because the Advisor may waive certain fees, cash flow from operations that would have been paid to the Advisor may be available to pay distributions to stockholders. The fees that are forgiven are not deferrals and, accordingly, will not be paid to the Advisor. In certain instances, to improve the Company's working capital, the Advisor may elect to absorb a portion of the Company's property operating and general and administrative costs, which the Company will not repay. The following table reflects costs absorbed by the Advisor during the periods presented.
Three Months Ended September 30, | Nine Months Ended September 30, | Receivable as of | ||||||||||||||||||||||
(In thousands) | 2014 | 2013 | 2014 | 2013 | September 30, 2014 | December 31, 2013 | ||||||||||||||||||
Property operating expenses absorbed | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 150 | ||||||||||||
General and administrative expenses absorbed | — | 302 | — | 479 | — | 843 | ||||||||||||||||||
Total expenses absorbed | $ | — | $ | 302 | $ | — | $ | 479 | $ | — | $ | 993 | ||||||||||||
Fees Paid in Connection with the Liquidation or Listing of the Company's Real Estate Assets
The Company will pay the Advisor an annual subordinated performance fee calculated on the basis of the Company's total return to stockholders, payable annually in arrears, such that for any year in which the Company's total return on stockholders' capital exceeds 6.0% per annum, the Advisor will be entitled to 15.0% of the excess total return but not to exceed 10.0% of the aggregate total return for such year. This fee will be paid only upon the sale of assets, distributions or other event which results in the return on stockholders' capital exceeding 6.0% per annum. No subordinated performance fees were incurred during the three and nine months ended September 30, 2014 or 2013.
18
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)
The Company will pay a brokerage commission on the sale of property, not to exceed the lesser of 2.0% of the contract sale price of the property and 50.0% of the total brokerage commission paid if a third party broker is also involved; provided, however, that in no event may the real estate commissions paid to the Advisor, its affiliates and unaffiliated third parties exceed the lesser of 4.5% of the contract sales price and a reasonable, customary and competitive real estate commission, in each case, payable to the Advisor if the Advisor or its affiliates, as determined by a majority of the independent directors, provided a substantial amount of services are provided in connection with the sale. No such fees were incurred during the three and nine months ended September 30, 2014 or 2013.
The Company will pay the Special Limited Partner a subordinated participation in the net sales proceeds of the sale of real estate assets of 15.0% of remaining net sale proceeds after return of capital contributions to investors plus payment to investors of a 6.0% cumulative, pre-tax non-compounded return on the capital contributed by investors. The Special Limited Partner will not be entitled to the subordinated participation in net sale proceeds unless the Company's investors have received a 6.0% cumulative non-compounded return on their capital contributions. No such fees were incurred during the three and nine months ended September 30, 2014 or 2013.
If the common stock of the Company is listed on a national exchange, the Company will pay the Special Limited Partner a subordinated incentive listing distribution of 15.0% of the amount by which the adjusted market value of real estate assets plus distributions exceeds the aggregate capital contributed by investors plus an amount equal to a 6.0% cumulative, pre-tax non-compounded annual return to investors. The Special Limited Partner will not be entitled to the subordinated incentive listing distribution unless investors have received a 6.0% cumulative, pre-tax non-compounded return on their capital contributions. No such fees were incurred during the three and nine months ended September 30, 2014 or 2013. Neither the Special Limited Partner nor any of its affiliates can earn both the subordinated participation in the net sales proceeds and the subordinated incentive listing distribution.
Upon termination or non-renewal of the advisory agreement with the Advisor, with or without cause, the Special Limited Partner, through its controlling interest in the Advisor, will be entitled to receive distributions from the OP equal to 15% of the amount by which the sum of the Company's market value plus distributions exceeds the sum of the aggregate capital contributed by investors plus an amount equal to an annual 6% cumulative, pre-tax, non-compounded return to investors. The Special Limited Partner may elect to defer its right to receive a subordinated distribution upon termination until either a listing on a national securities exchange or other liquidity event occurs.
Note 11 — Economic Dependency
Under various agreements, the Company has engaged or will engage the Advisor, its affiliates and entities under common ownership with the Advisor to provide certain services that are essential to the Company, including asset management services, supervision of the management and leasing of properties owned by the Company, asset acquisition and disposition decisions, the sale of shares of the Company's common stock available for issue, transfer agency services, as well as other administrative responsibilities for the Company including accounting services, transaction management services and investor relations.
As a result of these relationships, the Company is dependent upon the Advisor and its affiliates. In the event that the Advisor and its affiliates are unable to provide the Company with the respective services, the Company will be required to find alternative providers of these services.
Note 12 — Share-Based Compensation
Restricted Share Plan
The Company has an employee and director incentive restricted share plan (the "RSP"), which provides for the automatic grant of 1,333 restricted shares of common stock to each of the independent directors, without any further action by the Company's board of directors or the stockholders, on the date of initial election to the board of directors and on the date of each annual stockholder meeting. Restricted stock issued to independent directors will vest over a five-year period following the first anniversary of the date of grant in increments of 20.0% per annum. The RSP provides the Company with the ability to grant awards of restricted shares to the Company's directors, officers and employees (if the Company ever has employees), employees of the Advisor and its affiliates, employees of entities that provide services to the Company, directors of the Advisor or of entities that provide services to the Company, certain consultants to the Company and the Advisor and its affiliates or to entities that provide services to the Company. The total number of common shares granted under the RSP may not exceed 5.0% of the Company's outstanding shares of common stock on a fully diluted basis at any time and in any event will not exceed 3.4 million shares (as such number may be adjusted for stock splits, stock dividends, combinations and similar events).
19
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)
Restricted share awards entitle the recipient to receive shares of common stock from the Company under terms that provide for vesting over a specified period of time. Such awards would typically be forfeited with respect to the unvested shares upon the termination of the recipient's employment or other relationship with the Company. Restricted shares may not, in general, be sold or otherwise transferred until restrictions are removed and the shares have vested. Holders of restricted shares may receive cash distributions prior to the time that the restrictions on the restricted shares have lapsed. Any distributions payable in shares of common stock shall be subject to the same restrictions as the underlying restricted shares. The following table reflects restricted share award activity for the nine months ended September 30, 2014:
Number of Common Shares | Weighted-Average Issue Price | ||||||
Unvested, December 31, 2013 | 3,999 | $ | 22.50 | ||||
Granted | 3,999 | 22.50 | |||||
Vested | (800 | ) | 22.50 | ||||
Unvested, September 30, 2014 | 7,198 | $ | 22.50 | ||||
As of September 30, 2014, the Company had $0.1 million of unrecognized compensation cost related to unvested restricted share awards granted under the Company's RSP. That cost is expected to be recognized over a weighted-average period of 4.1 years. The fair value of the restricted shares is being expensed over the vesting period of five years. Compensation expense related to restricted stock was approximately $8,000 and $4,000 during the three months ended September 30, 2014 and 2013, respectively. Compensation expense related to restricted stock was approximately $18,000 and $11,000 during the nine months ended September 30, 2014 and 2013, respectively. Compensation expense related to restricted stock is recorded as general and administrative expense in the accompanying consolidated statements of operations.
Other Share-Based Compensation
The Company may issue common stock in lieu of cash to pay fees earned by the Company's directors at the respective director's election. There are no restrictions on the shares issued since these payments in lieu of cash relate to fees earned for services performed. During the three and nine months ended September 30, 2014, the Company issued 1,433 and 2,036 shares in lieu of approximately $32,000 and $46,000 in cash, respectively. There were no shares issued in lieu of cash during the three and nine months ended September 30, 2013.
Note 13 — Net Loss Per Share
The following is a summary of the basic and diluted net loss per share computation for the three and nine months ended September 30, 2014 and 2013:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Net loss (in thousands) | $ | (20,023 | ) | $ | (399 | ) | $ | (24,752 | ) | $ | (562 | ) | ||||
Basic and diluted weighted-average shares outstanding | 71,813,126 | 2,559,022 | 40,401,362 | 991,948 | ||||||||||||
Basic and diluted net loss per share | $ | (0.28 | ) | $ | (0.16 | ) | $ | (0.61 | ) | $ | (0.57 | ) | ||||
The Company had the following common share equivalents as of September 30, 2014 and 2013, which were excluded from the calculation of diluted loss per share attributable to stockholders as the effect would have been antidilutive:
September 30, | ||||||
2014 | 2013 | |||||
Unvested restricted stock | 7,198 | 3,999 | ||||
OP Units | 90 | — | ||||
Class B units | 27,418 | 618 | ||||
Total common share equivalents | 34,706 | 4,617 | ||||
20
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)
Note 14 — Segment Reporting
During the three and nine months ended September 30, 2014, the Company operated in three reportable business segments for management and internal financial reporting purposes: medical office buildings; triple-net buildings; and seniors housing communities. During the three and nine months ended September 30, 2013, the Company did not own any seniors housing communities and therefore, operated in two reportable business segments.
These operating segments are the segments of the Company for which separate financial information is available and for which segment results are evaluated in deciding how to allocate resources and in assessing performance. The medical office buildings segment primarily consists of medical office buildings leased to healthcare-related tenants under long-term leases, which may require such tenants to pay a pro rata share of property-related expenses. The seniors housing communities segment primarily consists of investments in assisted living, independent living, memory care and skilled nursing facilities located in the United States which the Company operates through engaging independent third-party managers. The triple-net buildings segment primarily consists of investments in hospitals, inpatient rehabilitation facilities and seniors housing communities under long-term leases, under which tenants are generally responsible to directly pay property-related expenses. The Company evaluates performance of the combined properties in each segment based on net operating income. Net operating income is defined as total revenues less property operating and maintenance expenses. There are no intersegment sales or transfers. The Company uses net operating income to evaluate the operating performance of real estate investments and to make decisions concerning the operation of the properties. The Company believes that net operating income is useful to investors in understanding the value of income-producing real estate. Net income is the GAAP measure that is most directly comparable to net operating income; however, net operating income should not be considered as an alternative to net income as the primary indicator of operating performance as it excludes certain items such as operating fees to affiliates, acquisition and transaction related expenses, general and administrative expenses, depreciation and amortization expense and interest expense. Additionally, net operating income as defined by the Company may not be comparable to net operating income as defined by other REITs or companies.
For federal income tax purposes, the Company has qualified to be taxed as a REIT beginning with the taxable year ended December 31, 2013. REIT status imposes limitations related to seniors housing communities. Generally, to qualify as a REIT, the Company cannot directly operate seniors housing communities. However, such facilities may generally be operated by a taxable REIT subsidiary ("TRS") pursuant to a lease with the Company. Therefore, the Company has formed a TRS subsidiary under the OP to operate the seniors housing communities pursuant to contracts with unaffiliated management companies. The Company's TRS entity incurred $0.1 million in federal and state income taxes for the three and nine months ended September 30, 2014. The Company did not own any seniors housing communities and therefore did not have any TRS entities or incur any federal or state income tax expense during the three and nine months ended September 30, 2013. Federal and state income taxes are included in general and administrative expenses on the accompanying consolidated statements of operations and comprehensive loss.
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AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)
The following tables reconcile the segment activity to consolidated net income for the three and nine months ended September 30, 2014 and 2013.
Three Months Ended September 30, 2014 | Nine Months Ended September 30, 2014 | |||||||||||||||||||||||||||||||
(In thousands) | Medical Office Buildings | Triple-Net Buildings | Seniors Housing Communities | Consolidated | Medical Office Buildings | Triple-Net Buildings | Seniors Housing Communities | Consolidated | ||||||||||||||||||||||||
Revenues: | ||||||||||||||||||||||||||||||||
Rental income | $ | 4,044 | $ | 2,000 | $ | 4,576 | $ | 10,620 | $ | 6,684 | $ | 2,801 | $ | 4,576 | $ | 14,061 | ||||||||||||||||
Operating expense reimbursements | 1,022 | 12 | — | 1,034 | 1,808 | 41 | — | 1,849 | ||||||||||||||||||||||||
Resident services and fee income | — | — | 164 | 164 | — | — | 164 | 164 | ||||||||||||||||||||||||
Total revenues | 5,066 | 2,012 | 4,740 | 11,818 | 8,492 | 2,842 | 4,740 | 16,074 | ||||||||||||||||||||||||
Property operating and maintenance | 1,389 | 15 | 2,798 | 4,202 | 2,390 | 43 | 2,798 | 5,231 | ||||||||||||||||||||||||
Net operating income | $ | 3,677 | $ | 1,997 | $ | 1,942 | 7,616 | $ | 6,102 | $ | 2,799 | $ | 1,942 | 10,843 | ||||||||||||||||||
Acquisition and transaction related | (17,884 | ) | (20,887 | ) | ||||||||||||||||||||||||||||
General and administrative | (1,221 | ) | (2,212 | ) | ||||||||||||||||||||||||||||
Depreciation and amortization | (7,391 | ) | (10,629 | ) | ||||||||||||||||||||||||||||
Interest expense | (1,418 | ) | (2,163 | ) | ||||||||||||||||||||||||||||
Income from investment securities and other income | 275 | 296 | ||||||||||||||||||||||||||||||
Net loss attributable to stockholders | $ | (20,023 | ) | $ | (24,752 | ) | ||||||||||||||||||||||||||
Three Months Ended September 30, 2013 | Nine Months Ended September 30, 2013 | |||||||||||||||||||||||||||||||
(In thousands) | Medical Office Buildings | Triple-Net Buildings | Seniors Housing Communities | Consolidated | Medical Office Buildings | Triple-Net Buildings | Seniors Housing Communities | Consolidated | ||||||||||||||||||||||||
Revenues: | ||||||||||||||||||||||||||||||||
Rental income | $ | 288 | $ | 276 | $ | — | $ | 564 | $ | 314 | $ | 276 | $ | — | $ | 590 | ||||||||||||||||
Operating expense reimbursements | 77 | 11 | — | 88 | 78 | 11 | — | 89 | ||||||||||||||||||||||||
Resident services and fee income | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||
Total revenues | 365 | 287 | — | 652 | 392 | 287 | — | 679 | ||||||||||||||||||||||||
Property operating and maintenance | 77 | 11 | — | 88 | 78 | 11 | — | 89 | ||||||||||||||||||||||||
Net operating income | $ | 288 | $ | 276 | $ | — | 564 | $ | 314 | $ | 276 | $ | — | 590 | ||||||||||||||||||
Acquisition and transaction related | (533 | ) | (651 | ) | ||||||||||||||||||||||||||||
General and administrative | (49 | ) | (104 | ) | ||||||||||||||||||||||||||||
Depreciation and amortization | (381 | ) | (397 | ) | ||||||||||||||||||||||||||||
Net loss attributable to stockholders | $ | (399 | ) | $ | (562 | ) | ||||||||||||||||||||||||||
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AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)
The following table reconciles the segment activity to consolidated total assets as of September 30, 2014 and December 31, 2013:
September 30, | December 31, | |||||
(In thousands) | 2014 | 2013 | ||||
ASSETS | ||||||
Investments in real estate: | ||||||
Medical office buildings | 306,695 | 27,520 | ||||
Triple-net buildings | 201,628 | 17,672 | ||||
Seniors housing communities | 487,174 | — | ||||
Total reportable segments, net | 995,497 | 45,192 | ||||
Cash and cash equivalents | 766,061 | 111,833 | ||||
Restricted cash | 1,902 | — | ||||
Investment securities, at fair value | 18,544 | — | ||||
Receivable for sale of common stock | 4,920 | 1,286 | ||||
Prepaid expenses and other assets | 18,930 | 1,888 | ||||
Deferred costs | 4,680 | 7 | ||||
Total assets | 1,810,534 | 160,206 | ||||
Note 15 — Subsequent Events
The Company has evaluated subsequent events through the filing of this Quarterly Report on Form 10-Q, and determined that there have not been any events that have occurred that would require adjustments to disclosures in the consolidated financial statements except for the following transactions:
Sales of Common Stock
As of October 31, 2014, the Company had 83.2 million shares of common stock outstanding, including unvested restricted shares and shares issued pursuant to the DRIP from total gross proceeds from the IPO and the DRIP of $2.1 billion.
Total capital raised to date, including shares issued under the DRIP, is as follows:
Source of Capital (in thousands) | Inception to September 30, 2014 | October 1, 2014 to October 31, 2014 | Total | |||||||||
Common stock | $ | 2,023,455 | $ | 43,148 | $ | 2,066,603 | ||||||
Acquisitions
The following table presents certain information about the properties that the Company acquired from October 1, 2014 to October 31, 2014:
Number of Properties | Rentable Square Feet | Base Purchase Price (1) | ||||||||
(In thousands) | ||||||||||
Portfolio, September 30, 2014 | 88 | 4,091,547 | $ | 1,001,763 | ||||||
Acquisitions | 8 | 441,537 | 141,410 | |||||||
Portfolio, October 31, 2014 | 96 | 4,533,084 | $ | 1,143,173 | ||||||
________________________
(1) Contract purchase price, excluding acquisition related costs.
23
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)
Management Update
On November 10, 2014, in light of his recent appointment as chief executive officer of RCS Capital Corporation, Edward M. Weil, Jr. resigned from his roles as president, secretary and treasurer of the Company, effective as of that same date. Mr. Weil did not resign pursuant to any disagreement with the Company. Simultaneously with Mr. Weil’s resignation, the Company’s board of directors appointed Thomas P. D’Arcy, currently the chief executive officer of the Company, to serve as the Company’s president and secretary. Mr. D’Arcy will also continue to serve in his capacity as chief executive officer of the Company. Also simultaneously with Mr. Weil’s resignation, the Company’s board of directors appointed Edward F. Lange, Jr., currently the chief financial officer and chief operating officer of the Company, to serve as the Company’s treasurer. Mr. Lange will also continue to serve in his capacity as chief financial officer and chief operating officer of the Company.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis should be read in conjunction with the accompanying consolidated financial statements of American Realty Capital Healthcare Trust II, Inc. and the notes thereto. As used herein, the terms the "Company," "we," "our" and "us" refer to American Realty Capital Healthcare Trust II, Inc., a Maryland corporation, including, as required by context, American Realty Capital Healthcare Trust II Operating Partnership, LP, a Delaware limited partnership, which we refer to as the "OP," and its subsidiaries. The Company is externally managed by American Realty Capital Healthcare II Advisors, LLC (our "Advisor"), a Delaware limited liability company. Capitalized terms used herein, but not otherwise defined, have the meaning ascribed to those terms in "Part I — Financial Information" included in the notes to the consolidated financial statements and contained herein.
Forward-Looking Statements
Certain statements included in this Quarterly Report on Form 10-Q are forward-looking statements. Those statements include statements regarding the intent, belief or current expectations of us and members of our management team, as well as the assumptions on which such statements are based, and generally are identified by the use of words such as "may," "will," "seeks," "anticipates," "believes," "estimates," "expects," "plans," "intends," "should" or similar expressions. Actual results may differ materially from those contemplated by such forward-looking statements. Further, forward-looking statements speak only as of the date they are made, and we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time, unless required by law.
The following are some of the risks and uncertainties, although not all risks and uncertainties, that could cause our actual results to differ materially from those presented in our forward-looking statements:
• | All of our executive officers are also officers, managers and/or holders of a direct or indirect controlling interest in the Advisor, our dealer manager, Realty Capital Securities, LLC (the "Dealer Manager") and other AR Capital, LLC affiliated entities ("American Realty Capital"). As a result, our executive officers, our Advisor and its affiliates face conflicts of interest, including significant conflicts created by our Advisor's compensation arrangements with us and other investment programs advised by American Realty Capital affiliates and conflicts in allocating time among these investment programs and us. These conflicts could result in unanticipated actions. |
• | Because investment opportunities that are suitable for us may also be suitable for other American Realty Capital advised investment programs, our Advisor and its affiliates face conflicts of interest relating to the purchase of properties and other investments and such conflicts may not be resolved in our favor, meaning that we could invest in less attractive assets, which could reduce the investment return to our stockholders. |
• | No public market currently exists, or may ever exist, for shares of our common stock which are, and may continue to be, illiquid. |
• | We focus on acquiring a diversified portfolio of healthcare-related assets located in the United States and are subject to risks inherent in concentrating investments in the healthcare industry. |
• | The healthcare industry is heavily regulated, and new laws or regulations, changes to existing laws or regulations, loss of licensure or failure to obtain licensure could result in the inability of tenants to make lease payments to us. |
• | If we and our Advisor are unable to find suitable investments, then we may not be able to achieve our investment objectives or pay distributions. |
• | We may be unable to pay or maintain cash distributions or increase distributions over time. |
• | We are obligated to pay fees, which may be substantial, to our Advisor and its affiliates. |
• | We depend on tenants for our revenue and, accordingly, our revenue is dependent upon the success and economic viability of our tenants. |
• | Increases in interest rates could increase the amount of our debt payments and limit our ability to pay distributions. |
• | We are permitted to pay distributions from unlimited amounts of any source. Until substantially all of the proceeds from our initial public offering ("IPO") are invested, we may use proceeds from our IPO and financings to fund distributions until we have sufficient cash flows from operations. There are no established limits on the amount of net proceeds and borrowings that we may use to fund distribution payments, except in accordance with our organizational documents and Maryland law. |
• | Any distributions may reduce the amount of capital we ultimately invest in properties and other permitted investments and negatively impact the value of our stockholders' investment in us. |
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• | We have not and may not in the future generate cash flows sufficient to pay our distributions to stockholders, as such, we may be forced to borrow at higher rates or depend on our Advisor to waive reimbursement of certain expenses and fees to fund our operations. |
• | We are subject to risks associated with any dislocations or liquidity disruptions that may exist or occur in the credit markets of the United States from time to time. |
• | We may fail to continue to qualify to be treated as a real estate investment trust ("REIT") for United States federal income tax purposes, which would result in higher taxes, may adversely affect our operations and would reduce our NAV and cash available for distributions. |
• | We may be deemed to be an investment company under the Investment Company Act of 1940, as amended (the "Investment Company Act"), and thus subject to regulation under the Investment Company Act. |
Overview
We were incorporated on October 15, 2012 as a Maryland corporation that elected and qualified to be taxed as a REIT for U.S. federal income tax purposes beginning with the taxable year ended December 31, 2013. On February 14, 2013, we commenced our IPO on a "reasonable best efforts" basis of up to $1.7 billion of common stock, $0.01 par value per share, at a price of $25.00 per share, subject to certain volume and other discounts, pursuant to a registration statement on Form S-11, as amended (File No. 333-184677) (the "Registration Statement"), filed with the U.S. Securities and Exchange Commission (the "SEC") under the Securities Act of 1933, as amended (the "Securities Act"). The Registration Statement also covers up to 14.7 million shares of common stock available pursuant to a distribution reinvestment plan (the "DRIP") under which common stockholders may elect to have their distributions reinvested in additional shares of common stock. We reserve the right to reallocate shares covered in the Registration Statement between the IPO and the DRIP. On July 23, 2014, we announced the reallocation of 13.9 million shares of the 14.2 million remaining unsold shares available pursuant to the DRIP. On August 1, 2014, we registered an additional 25.0 million shares to be issued under the DRIP pursuant to a registration statement on Form S-3 (File No. 333-197802).
As of September 30, 2014, we had 81.5 million shares of common stock outstanding, including unvested restricted shares and shares issued pursuant to the DRIP, and had received total gross proceeds from the IPO and the DRIP of $2.0 billion. As of September 30, 2014, the aggregate value of all share issuances and subscriptions of common stock outstanding was $2.0 billion based on a per share value of $25.00 (or $23.75 for shares issued under the DRIP). Until the NAV pricing date (as described below) the per share purchase price in the IPO will be up to $25.00 per share (including the maximum allowed to be charged for commissions and fees) and shares issued under the DRIP will be equal to $23.75 per share, which is equal to 95% of the offering price in the IPO. Beginning with the NAV pricing date (as described below), the per share price for shares in the IPO and under the DRIP will vary quarterly and will be equal to our NAV, as determined by our Advisor, plus applicable commissions and fees, in the case of the primary offering, and the per share purchase price in the DRIP will be equal to the NAV per share. The NAV pricing date means the date on which we file our Quarterly Report on Form 10-Q (or Annual Report on Form 10-K should such filing constitute the applicable quarterly financial filing) with the SEC pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), for the second full fiscal quarter following the earlier of (i) the date on which we have invested all of the net proceeds of its primary offering, plus the net proceeds from debt financing equal to its target leverage ratio, but excluding working capital reserves and facilities and (ii) February 14, 2015, which is two years from the effective date of the IPO.
We were formed to acquire a diversified portfolio of healthcare-related assets, including medical office buildings, seniors housing communities and other healthcare-related facilities. All such properties may be acquired and operated by us alone or jointly with another party. We may also originate or acquire first mortgage loans secured by real estate. We purchased our first property and commenced real estate operations in May 2013. As of September 30, 2014, we owned 88 properties consisting of 4.1 million rentable square feet, which were 97.3% leased, excluding seniors housing communities, with a remaining lease term of 10.2 years.
Substantially all of our business is conducted through the OP. We are the sole general partner and hold substantially all of the units of limited partner interests in the OP ("OP units"). American Realty Capital Healthcare II Special Limited Partnership, LLC (the "Special Limited Partner"), an entity controlled by American Realty Capital VII, LLC (the "Sponsor"), contributed $2,020 to the OP in exchange for 90 OP units, which represents a nominal percentage of the aggregate OP ownership. A holder of OP units has the right to convert OP units for the cash value of a corresponding number of shares of our common stock or, at the option of the OP, a corresponding number of shares of our common stock, in accordance with the limited partnership agreement of the OP. The remaining rights of the limited partners are limited, however, and do not include the ability to replace the general partner or to approve the sale, purchase or refinancing of the OP's assets.
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We have no direct employees. The Advisor is our affiliated external advisor, which we have retained to manage our affairs on a day-to-day basis. We have retained American Realty Capital Healthcare II Properties, LLC (the "Property Manager") to serve as our property manager. The Dealer Manager serves as the dealer manager of the IPO. The Advisor, the Property Manager and the Dealer Manager are under common control with the parent of the Sponsor, as a result of which, they are related parties, and each of which have or will receive compensation, fees and expense reimbursements for services related to the IPO and the investment and management of our assets. The Advisor, Property Manager and Dealer Manager have or will also receive fees during our offering, acquisition, operational and liquidation stages.
Significant Accounting Estimates and Critical Accounting Policies
Set forth below is a summary of the significant accounting estimates and critical accounting policies that management believes are important to the preparation of our financial statements. Certain of our accounting estimates are particularly important for an understanding of our financial position and results of operations and require the application of significant judgment by our management. As a result, these estimates are subject to a degree of uncertainty. These significant accounting estimates and critical accounting policies include:
Offering and Related Costs
Offering and related costs include all expenses incurred in connection with our IPO. Offering costs (other than selling commissions and the dealer manager fees) include costs that may be paid by the Advisor, the Dealer Manager or their affiliates on our behalf. These costs include but are not limited to (i) legal, accounting, printing, mailing, and filing fees; (ii) escrow service related fees; (iii) reimbursement of the Dealer Manager for amounts it may pay to reimburse the bona fide diligence expenses of broker-dealers; and (iv) reimbursement to the Advisor for a portion of the costs of its employees and other costs in connection with preparing supplemental sales materials and related offering activities. We are obligated to reimburse the Advisor or its affiliates, as applicable, for organization and offering costs paid by them on our behalf, provided that the Advisor is obligated to reimburse us to the extent organization and offering costs (excluding selling commissions and the dealer manager fee) incurred by us in our IPO exceed 2.0% of gross offering proceeds in the IPO. As a result, these costs are only our liability to the extent aggregate selling commissions, the dealer manager fee and other organization and offering costs do not exceed 12.0% of the gross proceeds determined at the end of our IPO.
Revenue Recognition
Our rental income is primarily related to rent received from tenants, which are recorded in accordance with the terms of each lease on a straight-line basis over the initial term of the lease. Because many of the leases provide for rental increases at specified intervals, straight-line basis accounting requires us to record a receivable, and include in revenues, unbilled rent receivables that we will only receive if the tenant makes all rent payments required through the expiration of the initial term of the lease. When we acquire a property, the terms of existing leases are considered to commence as of the acquisition date for the purposes of this calculation. We defer the revenue related to lease payments received from tenants in advance of their due dates. Cost recoveries from tenants are included in operating expense reimbursement in the period the related costs are incurred, as applicable.
We continually review receivables related to rent and unbilled rent receivables and determine collectability by taking into consideration the tenant's payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area in which the property is located. In the event that the collectability of a receivable is in doubt, we will record an increase in the allowance for uncollectible accounts or record a direct write-off of the receivable in the consolidated statements of operations.
Investments in Real Estate
Investments in real estate are recorded at cost. Improvements and replacements are capitalized when they extend the useful life of the asset. Costs of repairs and maintenance are expensed as incurred. Depreciation is computed using the straight-line method over the estimated useful lives of up to 40 years for buildings, 15 years for land improvements, five years for fixtures and improvements and the shorter of the useful life or the remaining lease term for tenant improvements and leasehold interests.
We are required to make subjective assessments as to the useful lives of our properties for purposes of determining the amount of depreciation to record on an annual basis with respect to our investments in real estate. These assessments have a direct impact on our net income because if we were to shorten the expected useful lives of our investments in real estate, we would depreciate these investments over fewer years, resulting in more depreciation expense and lower net income on an annual basis. We are required to present the operations related to properties that have been sold or properties that are intended to be sold as discontinued operations in the statement of operations at fair value for all periods presented to the extent the disposal of a component represents a strategic shift that has or will have a major effect on our operations and financial results. Properties that are intended to be sold are to be designated as "held for sale" on the balance sheet.
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Long-lived assets are carried at cost and evaluated for impairment when events or changes in circumstances indicate such an evaluation is warranted or when they are designated as held for sale. Valuation of real estate is considered a "critical accounting estimate" because the evaluation of impairment and the determination of fair values involve a number of management assumptions relating to future economic events that could materially affect the determination of the ultimate value, and therefore, the carrying amounts of our real estate. Additionally, decisions regarding when a property should be classified as held for sale are also highly subjective and require significant management judgment.
Events or changes in circumstances that could cause an evaluation for impairment include the following:
• | a significant decrease in the market price of a long-lived asset; |
• | a significant adverse change in the extent or manner in which a long-lived asset is being used or in its physical condition; |
• | a significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset, including an adverse action or assessment by a regulator; |
• | an accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset; and |
• | a current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset. |
We review our portfolio on an ongoing basis to evaluate the existence of any of the aforementioned events or changes in circumstances that would require us to test for recoverability. In general, our review of recoverability is based on an estimate of the future undiscounted cash flows, excluding interest charges, expected to result from the property's use and eventual disposition. These estimates consider factors such as expected future operating income, market and other applicable trends and residual value expected, as well as the effects of leasing demand, competition and other factors. If impairment exists due to the inability to recover the carrying value of a property, an impairment loss is recorded to the extent that the carrying value exceeds the estimated fair value of the property. We are required to make subjective assessments as to whether there are impairments in the values of our investments in real estate. These assessments have a direct impact on our net income because recording an impairment loss results in an immediate negative adjustment to net income.
Purchase Price Allocation
We allocate the purchase price of acquired properties to tangible and identifiable intangible assets acquired based on their respective fair values. Tangible assets include land, land improvements, buildings, fixtures and tenant improvements on an as-if vacant basis. We utilize various estimates, processes and information to determine the as-if vacant property value. Estimates of value are made using customary methods, including data from appraisals, comparable sales, discounted cash flow analysis and other methods. Amounts allocated to land, land improvements, buildings and fixtures are based on cost segregation studies performed by independent third-parties or on our analysis of comparable properties in our portfolio. Identifiable intangible assets include amounts allocated to acquire leases for above- and below-market lease rates, the value of in-place leases, and the value of customer relationships, as applicable.
The aggregate value of intangible assets related to in-place leases is primarily the difference between the property valued with existing in-place leases adjusted to market rental rates and the property valued as if vacant. Factors considered by us in our analysis of the in-place lease intangibles include an estimate of carrying costs during the expected lease-up period for each property, taking into account current market conditions and costs to execute similar leases. In estimating carrying costs, we include real estate taxes, insurance and other operating expenses and estimates of lost rentals at contract rates during the expected lease-up period, which typically ranges from six to 12 months. We also estimate costs to execute similar leases including leasing commissions, legal and other related expenses.
Above-market and below-market in-place lease values for owned properties are recorded based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between the contractual amounts to be paid pursuant to the in-place leases and management's estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease. The capitalized above-market lease intangibles are amortized as a decrease to rental income over the remaining term of the lease. The capitalized below-market lease values are amortized as an increase to rental income over the remaining term and any fixed rate renewal periods provided within the respective leases. In determining the amortization period for below-market lease intangibles, we initially will consider, and periodically evaluate on a quarterly basis, the likelihood that a lessee will execute the renewal option. The likelihood that a lessee will execute the renewal option is determined by taking into consideration the tenant's payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area in which the property is located.
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The aggregate value of intangible assets related to customer relationship is measured based on our evaluation of the specific characteristics of each tenant's lease and our overall relationship with the tenant. Characteristics considered by us in determining these values include the nature and extent of our existing business relationships with the tenant, growth prospects for developing new business with the tenant, the tenant's credit quality and expectations of lease renewals, among other factors.
The value of in-place leases is amortized to expense over the initial term of the respective leases, which range primarily from one to 14 years. The value of customer relationship intangibles is amortized to expense over the initial term and any renewal periods in the respective leases, but in no event does the amortization period for intangible assets exceed the remaining depreciable life of the building. If a tenant terminates its lease, the unamortized portion of the in-place lease value and customer relationship intangibles is charged to expense.
In making estimates of fair values for purposes of allocating purchase price, we utilize a number of sources, including independent appraisals that may be obtained in connection with the acquisition or financing of the respective property and other market data. We also consider information obtained about each property as a result of our pre-acquisition due diligence, as well as subsequent marketing and leasing activities, in estimating the fair value of the tangible and intangible assets acquired and intangible liabilities assumed.
Derivative Instruments
We may use derivative financial instruments to hedge all or a portion of the interest rate risk associated with our borrowings. The principal objective of such agreements is to minimize the risks and/or costs associated with our operating and financial structure as well as to hedge specific anticipated transactions.
We record all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether we have elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that is attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. We may enter into derivative contracts that are intended to economically hedge certain risks, even though hedge accounting does not apply or we elect not to apply hedge accounting.
Recently Issued Accounting Pronouncements
In February 2013, the Financial Accounting Standards Board ("FASB") issued new accounting guidance clarifying the accounting and disclosure requirements for obligations resulting from joint and several liability arrangements for which the total amount under the arrangement is fixed at the reporting date. The new guidance was effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2013. The adoption of this guidance did not have a material impact on our consolidated financial position, results of operations or cash flows.
In April 2014, the FASB amended the requirements for reporting discontinued operations. Under the revised guidance, in addition to other disclosure requirements, a disposal of a component of an entity or a group of components of an entity is required to be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity's operations and financial results when the component or group of components meets the criteria to be classified as held for sale, disposed of by sale or other than by sale. We have adopted the provisions of this guidance effective January 1, 2014, and have applied the provisions prospectively. This adoption of this guidance did not have a material impact on our consolidated financial position, results of operations or cash flows.
In May 2014, the FASB issued revised guidance relating to revenue recognition. Under the revised guidance, an entity is required to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The revised guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is not permitted under GAAP. The revised guidance allows entities to apply the full retrospective or modified retrospective transition method upon adoption. We have not yet selected a transition method and are currently evaluating the impact of the new guidance.
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Properties
The following table presents certain additional information about the properties we own as of September 30, 2014:
Portfolio | Acquisition Date | Number of Properties | Rentable Square Feet | Occupancy | Remaining Lease Term (1) | Base Purchase Price (2) | |||||||||
(In thousands) | |||||||||||||||
Medical Office Buildings: | |||||||||||||||
Fresenius Medical Care - Winfield, AL | May 2013 | 1 | 5,564 | 100.0% | 8.4 | $ | 1,920 | ||||||||
Adena Health Center - Jackson, OH | Jun. 2013 | 1 | 24,924 | 100.0% | 9.4 | 5,446 | |||||||||
Oak Lawn Medical Center - Oak Lawn, IL | Aug. 2013 | 1 | 26,324 | 100.0% | 3.4 | 10,300 | |||||||||
Surgery Center of Temple - Temple, TX | Aug. 2013 | 1 | 10,400 | 100.0% | 12.4 | 6,150 | |||||||||
Greenville Health System - Greenville, SC | Oct. 2013 | 1 | 21,603 | 100.0% | 5.5 | 4,300 | |||||||||
Arrowhead Medical Plaza II - Glendale, AZ | Feb. 2014 | 1 | 45,366 | 94.0% | 3.2 | 11,170 | |||||||||
Village Center Parkway - Stockbridge, GA | Feb. 2014 | 1 | 25,051 | 72.1% | 5.8 | 4,100 | |||||||||
Stockbridge Family Medical - Stockbridge, GA | Feb. 2014 | 1 | 19,822 | 65.7% | 3.8 | 3,120 | |||||||||
Creekside Medical Office Building - Douglasville, GA | Apr. 2014 | 1 | 54,899 | 87.6% | 7.2 | 10,030 | |||||||||
Bowie Gateway Medical Center - Bowie, MD | May 2014 | 1 | 36,260 | 100.0% | 6.2 | 12,450 | |||||||||
Campus at Crooks & Auburn Building D - Rochester Hills, MI | May 2014 | 1 | 24,529 | 88.9% | 5.3 | 5,000 | |||||||||
Medical Center of New Windsor - New Windsor, NY | May 2014 | 1 | 48,377 | 80.8% | 4.6 | 11,590 | |||||||||
Plank Medical Center - Clifton Park, NY | May 2014 | 1 | 24,835 | 84.4% | 0.3 | 4,530 | |||||||||
Cushing Center - Schenectady, NY | May 2014 | 1 | 45,301 | 95.3% | 5.2 | 13,200 | |||||||||
Berwyn Medical Center - Berwyn, IL | May 2014 | 1 | 42,779 | 100.0% | 6.8 | 11,000 | |||||||||
Countryside Medical Arts - Safety Harbor, FL | May 2014 | 1 | 50,972 | 100.0% | 10.3 | 9,342 | |||||||||
St. Andrews Medical Park - Venice, FL. | May 2014 | 3 | 60,441 | 95.3% | 3.5 | 13,308 | |||||||||
Campus at Crooks & Auburn Building C - Rochester Hills, MI | Jun. 2014 | 1 | 24,224 | 100.0% | 7.5 | 5,250 | |||||||||
Slingerlands Crossing Phase I - Bethlehem, NY | Jun. 2014 | 1 | 43,173 | 93.1% | 6.6 | 10,600 | |||||||||
Slingerlands Crossing Phase II - Bethlehem, NY | Jun. 2014 | 1 | 47,696 | 100.0% | 6.5 | 12,175 | |||||||||
UC Davis Medical Office Building - Elk Grove, CA | Jul. 2014 | 1 | 25,861 | 100.0% | 8.6 | 10,049 | |||||||||
Laguna Professional Center - Elk Grove, CA | Jul. 2014 | 2 | 41,932 | 96.3% | 3.5 | 17,451 | |||||||||
Benedictine Cancer Center - Kingston, NY | Aug. 2014 | 1 | 36,479 | 100.0% | 15.2 | 11,200 | |||||||||
Arrowhead Medical Plaza I - Glendale, AZ | Sep. 2014 | 1 | 34,172 | 57.0% | 4.4 | 8,100 | |||||||||
Cardiovascular Consultants of Cape Girardeau Medical Office Building- Cape Girardeau, MO | Sep. 2014 | 1 | 28,634 | 100.0% | 4.3 | 8,500 | |||||||||
Fredericksen Outpatient Center Clinical Building - Mechanicsburg, PA | Sep. 2014 | 1 | 69,437 | 100.0% | 12.0 | 24,065 | |||||||||
Brady MOB - Harrisburg, PA | Sep. 2014 | 1 | 92,413 | 100.0% | 12.0 | 26,370 | |||||||||
Community Health MOB - Harrisburg, PA | Sep. 2014 | 1 | 48,212 | 100.0% | 12.0 | 7,020 | |||||||||
Fredericksen Outpatient Center I - Mechanicsburg, PA | Sep. 2014 | 1 | 56,057 | 100.0% | 4.7 | 11,255 | |||||||||
Fredericksen Outpatient Center II - Mechanicsburg, PA | Sep. 2014 | 1 | 64,259 | 100.0% | 9.4 | 20,585 | |||||||||
Total Medical Office Buildings | 33 | 1,179,996 | 94.6% | 7.3 | 309,576 | ||||||||||
Triple-Net Leased Buildings: | |||||||||||||||
Ouachita Community Hospital - West Monroe, LA | Jul. 2013 | 1 | 17,830 | 100.0% | 9.4 | 6,834 | |||||||||
CareMeridian - Littleton, CO | Aug. 2013 | 1 | 27,630 | 100.0% | 12.8 | 11,275 | |||||||||
Big Spring Care Center - Humansville, MO | Jul. 2014 | 1 | 19,832 | 100.0% | 14.8 | 6,761 | |||||||||
Buffalo Prairie Care Center - Buffalo, MO | Jul. 2014 | 1 | 20,070 | 100.0% | 14.8 | 3,778 | |||||||||
Cassville Health Care & Rehab - Cassville, MO | Jul. 2014 | 1 | 33,697 | 100.0% | 14.8 | 3,380 | |||||||||
Country Aire Retirement Estates - Lewistown, MO | Jul. 2014 | 1 | 23,034 | 100.0% | 14.8 | 5,568 | |||||||||
Edgewood Manor Nursing Home - Raytown, MO | Jul. 2014 | 1 | 34,160 | 100.0% | 14.8 | 2,585 | |||||||||
Georgian Gardens - Potosi, MO | Jul. 2014 | 1 | 33,682 | 100.0% | 14.8 | 4,872 | |||||||||
Gregory Ridge Living Center - Kansas City, MO | Jul. 2014 | 1 | 46,121 | 100.0% | 14.8 | 5,369 | |||||||||
Marshfield Care Center - Marshfield, MO | Jul. 2014 | 1 | 23,383 | 100.0% | 14.8 | 3,878 | |||||||||
Parkway Health Care Center - Kansas City, MO | Jul. 2014 | 1 | 30,673 | 100.0% | 14.8 | 6,164 | |||||||||
Buchanan Meadows - Buchanan, MI | Aug. 2014 | 1 | 25,577 | 100.0% | 14.9 | 7,384 | |||||||||
Crystal Springs - Kentwood, MI | Aug. 2014 | 1 | 36,756 | 100.0% | 14.9 | 15,377 | |||||||||
Golden Orchards - Fennville, MI | Aug. 2014 | 1 | 25,811 | 100.0% | 14.9 | 5,823 | |||||||||
Lakeside Vista - Holland, MI | Aug. 2014 | 1 | 110,401 | 100.0% | 14.9 | 12,742 | |||||||||
Liberty Court - Dixon, IL | Aug. 2014 | 1 | 19,541 | 100.0% | 14.9 | 2,123 | |||||||||
Prestige Centre - Buchanan, MI | Aug. 2014 | 1 | 14,800 | 100.0% | 14.9 | 2,552 | |||||||||
Prestige Commons - Chesterfield Twp, MI | Aug. 2014 | 1 | 39,995 | 100.0% | 14.9 | 5,752 | |||||||||
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Portfolio | Acquisition Date | Number of Properties | Rentable Square Feet | Occupancy | Remaining Lease Term (1) | Base Purchase Price (2) | |||||||||
(In thousands) | |||||||||||||||
Prestige Pines - Dewitt, MI | Aug. 2014 | 1 | 24,847 | 100.0% | 14.9 | 3,598 | |||||||||
Prestige Place - Clare, MI | Aug. 2014 | 1 | 10,760 | 100.0% | 14.9 | 1,266 | |||||||||
Prestige Point - Grand Blanc, MI | Aug. 2014 | 1 | 15,817 | 100.0% | 14.9 | 3,363 | |||||||||
Prestige Way - Holt, MI | Aug. 2014 | 1 | 15,185 | 100.0% | 14.9 | 5,883 | |||||||||
The Atrium - Rockford, IL | Aug. 2014 | 1 | 21,862 | 100.0% | 14.9 | 4,830 | |||||||||
Waldon Woods - Wyoming, MI | Aug. 2014 | 1 | 49,270 | 100.0% | 14.9 | 6,320 | |||||||||
Whispering Woods - Grand Rapids, MI | Aug. 2014 | 1 | 82,654 | 100.0% | 14.9 | 13,187 | |||||||||
Golden Years - Harrisonville, MO | Sep. 2014 | 1 | 47,670 | 100.0% | 14.8 | 9,644 | |||||||||
Landis Memorial - Harrisburg, PA | Sep. 2014 | 1 | 314,790 | 100.0% | 12.0 | 42,565 | |||||||||
Total Triple-Net Leased Buildings | 27 | 1,165,848 | 100.0% | 14.1 | 202,873 | ||||||||||
Seniors Housing Communities: | |||||||||||||||
Horizon Bay Memory Care by the Bay - Tampa, FL | Jul. 2014 | 1 | 56,996 | 99.3% | N/A | 24,200 | |||||||||
Autumn Ridge of Clarkston - Clarkston, MI | Aug. 2014 | 1 | 68,725 | 93.0% | N/A | 22,000 | |||||||||
Sunnybrook of Burlington - Burlington, IA | Aug. 2014 | 1 | 52,678 | 95.5% | N/A | 18,490 | |||||||||
Sunnybrook of Carroll - Carroll, IA | Aug. 2014 | 1 | 38,185 | 97.8% | N/A | 12,600 | |||||||||
Sunnybrook of Fairfield - Fairfield, IA | Aug. 2014 | 1 | 52,857 | 90.5% | N/A | 15,500 | |||||||||
Sunnybrook of Ft. Madison - Ft. Madison, IA | Aug. 2014 | 1 | 38,947 | 93.5% | N/A | 10,400 | |||||||||
Sunnybrook of Mt. Pleasant - Mt. Pleasant, IA | Aug. 2014 | 1 | 38,835 | 100.0% | N/A | 12,000 | |||||||||
Sunnybrook of Muscatine - Muscatine, IA | Aug. 2014 | 1 | 53,484 | 96.9% | N/A | 15,200 | |||||||||
Prairie Hills at Cedar Rapids - Cedar Rapids, IA | Aug. 2014 | 1 | 50,000 | 91.1% | N/A | 9,500 | |||||||||
Prairie Hills at Clinton - Clinton, IA | Aug. 2014 | 1 | 55,791 | 98.6% | N/A | 21,175 | |||||||||
Prairie Hills at Des Moines - Des Moines, IA | Aug. 2014 | 1 | 58,366 | 56.8% | N/A | 15,000 | |||||||||
Prairie Hills at Tipton - Tipton, IA | Aug. 2014 | 1 | 39,194 | 84.8% | N/A | 11,400 | |||||||||
Prairie Hills at Independence - Independence, IA | Aug. 2014 | 1 | 44,624 | 84.5% | N/A | 11,800 | |||||||||
Prairie Hills at Ottumwa - Ottumwa, IA | Aug. 2014 | 1 | 40,939 | 100.0% | N/A | 10,500 | |||||||||
Diamond View Assisted Living Community - Meridian, ID | Sep. 2014 | 1 | 55,846 | 92.5% | N/A | 8,700 | |||||||||
Benton House - Brunswick - Brunswick, GA | Sep. 2014 | 1 | 33,847 | 66.4% | N/A | 16,741 | |||||||||
Benton House - Dublin - Dublin, GA | Sep. 2014 | 1 | 40,944 | 87.3% | N/A | 10,685 | |||||||||
Benton House - Johns Creek - Johns Creek, GA | Sep. 2014 | 1 | 38,675 | 85.6% | N/A | 13,915 | |||||||||
Benton House - Lee's Summit - Lee's Summit, MO | Sep. 2014 | 1 | 48,008 | 98.6% | N/A | 29,584 | |||||||||
Benton House - Roswell - Roswell, GA | Sep. 2014 | 1 | 40,010 | 91.1% | N/A | 10,498 | |||||||||
Benton House - Titusville - Titusville, FL | Sep. 2014 | 1 | 45,933 | 75.4% | N/A | 16,317 | |||||||||
Allegro at Elizabethtown - Elizabethtown, KY | Sep. 2014 | 1 | 58,216 | 91.0% | N/A | 8,743 | |||||||||
Allegro at Jupiter - Jupiter, FL | Sep. 2014 | 1 | 174,860 | 98.6% | N/A | 57,255 | |||||||||
Allegro at St Petersburg - St Petersburg, FL | Sep. 2014 | 1 | 194,800 | 84.0% | N/A | 15,546 | |||||||||
Allegro at Stuart - Stuart, FL | Sep. 2014 | 1 | 218,892 | 92.8% | N/A | 70,223 | |||||||||
Allegro at Tarpon - Tarpon Springs, FL | Sep. 2014 | 1 | 106,051 | 97.8% | N/A | 17,732 | |||||||||
Total Seniors Housing Communities | 26 | 1,745,703 | 90.3% | N/A | 485,704 | ||||||||||
Land: | |||||||||||||||
Sunnybrook of Burlington - Land - Burlington, IA | Aug. 2014 | 1 | N/A | N/A | N/A | 610 | |||||||||
Allegro at St Petersburg - Land - St Petersburg, FL | Sep. 2014 | 1 | N/A | N/A | N/A | 3,000 | |||||||||
Total Land | 2 | N/A | N/A | N/A | 3,610 | ||||||||||
Portfolio, September 30, 2014 | 88 | 4,091,547 | 97.3% | 10.2 | $ | 1,001,763 | |||||||||
_______________________________
(1) | Remaining lease term in years as of September 30, 2014, calculated on a weighted-average basis, as applicable, excluding seniors housing communities. |
(2) | Contract purchase price, excluding acquisition related costs. |
Results of Operations
We purchased our first property and commenced our real estate operations in May 2013. As of September 30, 2014, we owned 88 properties with an aggregate purchase price of $1.0 billion, comprised of 4.1 million rentable square feet. As of September 30, 2013, we owned six properties with an aggregate purchase price of $41.9 million, comprised of 112,672 rentable square feet. Accordingly, our results of operations for the three and nine months ended September 30, 2014 as compared to the three and nine months ended September 30, 2013 reflect significant increases in most categories.
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Comparison of the Three Months Ended September 30, 2014 to the Three Months Ended September 30, 2013
Rental Income
Rental income was $10.6 million for the three months ended September 30, 2014, compared to approximately $0.6 million for the three months ended September 30, 2013. The increase in rental income was directly related to our acquisitions.
Operating Expense Reimbursements
Operating expense reimbursements were $1.0 million for the three months ended September 30, 2014, compared to $0.1 million for the three months ended September 30, 2013. Pursuant to many of our lease agreements, tenants are required to pay their pro rata share of property operating expenses, in addition to base rent, whereas under certain other lease agreements, the tenants are generally directly responsible for all operating costs of the respective properties. The increase in operating expense reimbursements was directly related to our acquisitions.
Resident Services and Fee Income
Resident services and fee income of $0.2 million for the three months ended September 30, 2014 relates to services offered to residents in our seniors housing communities depending on the level of care required, as well as fees associated with other ancillary services. We did not own any seniors housing communities and therefore did not have any resident services and fee income for the three months ended September 30, 2013.
Property operating expenses
Property operating expenses were $4.2 million for the three months ended September 30, 2014, compared to $0.1 million for the three months ended September 30, 2013. These costs primarily relate to the costs associated with maintaining our properties, including real estate taxes, utilities, repairs, maintenance and unaffiliated third party property management fees, as well as costs relating to caring for the residents in our seniors housing communities. The increase in property operating expenses was directly related to our acquisitions.
Acquisition and Transaction Related Expenses
Acquisition and transaction related expenses of $17.9 million for the three months ended September 30, 2014 related to our acquisition of 64 properties with an aggregate purchase price of $818.7 million. Acquisition and transaction related expenses of $0.5 million for the three months ended September 30, 2013, related to our acquisition of four properties for an aggregate purchase price of $34.6 million.
General and Administrative Expenses
General and administrative expenses were $1.2 million for the three months ended September 30, 2014, compared to approximately $49,000 for the three months ended September 30, 2013. Professional fees and federal and state taxes increased $0.9 million in order to support our larger real estate portfolio. In addition, the Advisor absorbed $0.3 million in general and administrative expenses during the three months ended September 30, 2013. No general and administrative expense was absorbed by the Advisor during the three months ended September 30, 2014.
Depreciation and Amortization Expenses
Depreciation and amortization expense was $7.4 million for the three months ended September 30, 2014, compared to $0.4 million for the three months ended September 30, 2013. The increase in depreciation and amortization expense related to our acquisitions. The purchase price of acquired properties is allocated to tangible and identifiable intangible assets and depreciated or amortized over the estimated useful lives of the properties.
Interest Expense
Interest expense of $1.4 million for the three months ended September 30, 2014 related to our mortgage notes payable balance of $66.0 million as of September 30, 2014, as well as non-usage fees on our senior secured credit facility and the related amortization of deferred financing costs. We did not have any debt and, therefore, did not have interest expense during the three months ended September 30, 2013.
Income From Investment Securities and Interest Income
Income from investment securities and interest income of $0.3 million for the three months ended September 30, 2014 includes income from our investment securities and interest income earned on cash and cash equivalents held during the period. We did not have any investment securities or interest bearing accounts during the three months ended September 30, 2013 and, therefore, had no income from our investment securities or interest income.
32
Comparison of the Nine Months Ended September 30, 2014 to the Nine Months Ended September 30, 2013
Rental Income
Rental income was $14.1 million for the nine months ended September 30, 2014, compared to $0.6 million for the nine months ended September 30, 2013. The increase in rental income was directly related to our acquisitions.
Operating Expense Reimbursements
Operating expense reimbursements were $1.8 million for the nine months ended September 30, 2014, compared to $0.1 million for the nine months ended September 30, 2013. Pursuant to many of our lease agreements, tenants are required to pay their pro rata share of property operating expenses, in addition to base rent, whereas under certain other lease agreements, the tenants are generally directly responsible for all operating costs of the respective properties. The increase in operating expense reimbursements was directly related to acquisitions.
Resident Services and Fee Income
Resident services and fee income of $0.2 million for the nine months ended September 30, 2014 relates to services offered to residents in our seniors housing communities depending on the level of care required, as well as fees associated with other ancillary services. We did not own any seniors housing communities and therefore did not have any resident services and fee income for the nine months ended September 30, 2013.
Property operating expenses
Property operating expenses were $5.2 million for the nine months ended September 30, 2014, compared to $0.1 million for the nine months ended September 30, 2013. These costs primarily relate to the costs associated with maintaining our properties, including real estate taxes, utilities, repairs, maintenance and unaffiliated third party property management fees, as well as costs relating to caring for the residents in our seniors housing communities. The increase in property operating expenses was directly related to acquisitions.
Acquisition and Transaction Related Expenses
Acquisition and transaction related expenses of $20.9 million for the nine months ended September 30, 2014, related to our acquisition of 81 properties with an aggregate purchase price of $955.5 million. Acquisition and transaction related expenses of $0.7 million for the nine months ended September 30, 2013, related to our acquisition of six properties for a aggregate purchase price of $41.9 million.
General and Administrative Expenses
General and administrative expenses were $2.2 million for the nine months ended September 30, 2014, compared to $0.1 million for the nine months ended September 30, 2013. Professional fees, federal and state taxes, board member compensation and insurance costs increased $1.7 million in order to support our larger real estate portfolio. In addition, the Advisor absorbed $0.5 million in general and administrative expenses during the nine months ended September 30, 2013. No general and administrative expense was absorbed by the Advisor during the nine months ended September 30, 2014.
Depreciation and Amortization Expenses
Depreciation and amortization expense was $10.6 million for the nine months ended September 30, 2014, compared to $0.4 million for the nine months ended September 30, 2013. The increase in depreciation and amortization expense related to our acquisitions. The purchase price of acquired properties is allocated to tangible and identifiable intangible assets and depreciated or amortized over the estimated useful lives of the properties.
Interest Expense
Interest expense of $2.2 million for the nine months ended September 30, 2014 related to our mortgage notes payable balance of $66.0 million as of September 30, 2014, as well as non-usage fees on our senior secured credit facility and the related amortization of deferred financing costs. We did not have any debt and, therefore, did not have interest expense during the nine months ended September 30, 2013.
Income From Investment Securities and Interest Income
Income from investment securities and interest income of $0.3 million for the nine months ended September 30, 2014 includes income from our investment securities and interest income earned on cash and cash equivalents held during the period. We did not have any investment securities or interest bearing accounts during the nine months ended September 30, 2013 and, therefore, had no income from our investment securities or interest income.
33
Cash Flows for the Nine Months Ended September 30, 2014
During the nine months ended September 30, 2014, net cash used in operating activities was $10.0 million. The level of cash flows used in or provided by operating activities is affected by the volume of acquisition activity, the timing of interest payments and the amount of borrowings outstanding during the period, as well as the receipt of scheduled rent payments and the level of operating expenses. Cash flows used in operating activities during the nine months ended September 30, 2014 included $20.9 million of acquisition and transaction costs. Cash outflows related to a net loss adjusted for non-cash items of $13.6 million (net loss of $24.8 million adjusted for non-cash items including depreciation and amortization of tangible and intangible real estate assets and mortgage premiums and share based compensation of $11.2 million) and an increase in prepaid and other assets of $6.2 million due to rent and other receivables, unbilled receivables recorded in accordance with straight-line basis accounting and prepaid real estate taxes and insurance. These cash outflows were partially offset by an increase in accounts payable and accrued expenses of $8.5 million primarily related to accrued real estate taxes and accrued property operating expenses for our medical office buildings and seniors housing communities and $1.2 million in deferred rent.
Net cash used in investing activities during the nine months ended September 30, 2014 was $915.2 million. The cash used in investing activities included $886.1 million to acquire 81 properties. Net cash used in investing activities also included $0.1 million of capital expenditures, $10.5 million for deposits on pending real estate acquisitions and $18.6 million for the purchase of investment securities.
Net cash provided by financing activities of $1.6 billion during the nine months ended September 30, 2014 related to proceeds, net of receivables, from the issuance of common stock of $1.8 billion, partially offset by payments made on mortgage notes payable of $0.3 million, payments of deferred financing costs of $5.4 million, payments for common stock repurchases of $0.3 million, payments related to offering costs of $203.6 million, distributions paid to stockholders of $19.5 million, payments to affiliates for advances to fund offering costs of $0.5 million and increases in restricted cash of $1.9 million.
Cash Flows for the Nine Months Ended September 30, 2013
During the nine months ended September 30, 2013, net cash used in operating activities was $0.2 million. The level of cash flows used in or provided by operating activities is affected by the volume of acquisition activity and the receipt of scheduled rent payments. Cash flows used in operating activities during the nine months ended September 30, 2013 included $0.7 million of acquisition and transaction costs. Cash outflows included a net loss adjusted for non-cash items of $0.2 million (net loss of $0.6 million adjusted for non-cash items including depreciation and amortization of tangible and intangible real estate assets and share based compensation of $0.4 million) and an increase in prepaid expenses of $0.4 million primarily related to real estate taxes, insurance, rent receivable and unbilled rent receivables recorded in accordance with accounting for rental income on a straight-line basis. These cash outflows were partially offset by cash inflows that consisted of an increase in accounts payable and accrued expenses of $0.3 million related to accrued real estate taxes and accrued professional fees, and deferred rent of $0.1 million.
The net cash used in investing activities during the nine months ended September 30, 2013 of $42.0 million related to the acquisition of six properties with an aggregate purchase price of $41.9 million. Net cash used in investing activities also included a deposit on an acquisition of $0.2 million, which closed in October 2013.
Net cash provided by financing activities of $80.1 million during the nine months ended September 30, 2013 related to proceeds, net of receivables, from the issuance of common stock of $91.9 million, partially offset by net advances from affiliates of $0.4 million, payments related to offering costs of $11.0 million and $0.4 million in distributions paid to stockholders.
Liquidity and Capital Resources
Pursuant to the IPO, we are offering and selling up to $1.7 billion in shares of our common stock to the public, until the NAV pricing date, at $25.00 per share (including the maximum allowed to be charged for commissions and fees). We are also offering up to 14.7 million shares of our common stock to be issued pursuant to our DRIP, under which our stockholders may elect to have distributions reinvested in additional shares. We reserve the right to reallocate shares covered in the Registration Statement between the IPO and the DRIP. On July 23, 2014, we announced the reallocation of 13.9 million of our approximately 14.2 million remaining unsold shares available pursuant to the DRIP. On August 1, 2014, we registered an additional 25.0 million shares to be issued under the DRIP pursuant to a registration statement on Form S-3. Commencing with the NAV pricing date, the per share purchase price in the IPO will vary quarterly and will be equal to the NAV per share, as determined by the Advisor, plus applicable commissions and fees and the per share purchase price in the DRIP will be equal to the NAV per share. As of September 30, 2014, we had 81.5 million shares of common stock outstanding, including unvested restricted shares and shares issued pursuant to the DRIP, and had received total gross proceeds from the IPO and the DRIP of $2.0 billion.
34
On March 21, 2014, we entered into a senior secured credit facility in the amount of $50.0 million (the "Credit Facility"). On April 15, 2014, we entered into an increase letter, increasing the amount available under the Credit Facility to $200.0 million. The Credit Facility contains an "accordion" feature to allow us, under certain circumstances, to increase the aggregate commitments under the Credit Facility to a maximum of $450.0 million. The Credit Facility matures on March 21, 2017, subject to two one-year extension options. There were no advances outstanding as of September 30, 2014. Availability of borrowings is based on a pool of eligible unencumbered real estate assets. We plan to add our unencumbered acquisitions to the borrowing base of the Credit Facility during the fourth quarter of 2014. As of September 30, 2014, we had no assets assigned to the Credit Facility.
As of September 30, 2014, we had cash of $766.1 million, which we expect to use to fund acquisitions. We expect cash flows from operations and the sale of common stock to be used primarily to invest in additional real estate, pay debt service, pay operating expenses and pay stockholder distributions. As of October 31, 2014, we had raised $2.1 billion in our IPO, which we expect to close during the fourth quarter of 2014. We expect to utilize the net proceeds from the sale of our common stock and proceeds from our Credit Facility and secured financings to fund future property acquisitions.
Generally, we will fund our acquisitions from the net proceeds of our IPO. We intend to acquire our assets with cash advances under our Credit Facility and mortgage or other debt proceeds, but we also may acquire assets free and clear of permanent mortgage or other indebtedness by paying the entire purchase price for the asset in cash or in OP Units. As of October 31, 2014, we owned 96 properties with an aggregate purchase price of $1.1 billion. We currently have $514.2 million of assets under contract and executed letters of intent. Pursuant to the terms of the purchase and sale agreements and letters of intent, our obligation to close upon these acquisitions is subject to certain conditions customary to closing, including the successful completion of due diligence and fully negotiated binding agreements. We may decide to temporarily invest any unused proceeds from common stock offerings in certain investments that could yield lower returns than the properties. These lower returns may affect our ability to make distributions.
We expect to fund our future short-term operating liquidity requirements through a combination of net cash provided by our current property operations and the operations of properties to be acquired in the future, proceeds from our Credit Facility and secured mortgage financings. Once we have used all the proceeds from the IPO to acquire properties, management expects that cash flow from our properties will be sufficient to fund operating expenses and the payment of our monthly distributions. Other potential future sources of capital include proceeds from secured and unsecured financings from banks or other lenders, proceeds from public and private offerings, proceeds from the sale of properties and undistributed funds from operations.
We expect to use debt financing as a source of capital. Under our charter, the maximum amount of our total indebtedness may not exceed 300% of our total "net assets" (as defined in our charter) as of the date of any borrowing, which is generally expected to be approximately 75% of the cost of our investments. We may exceed that limit if approved by a majority of our independent directors and disclosed to stockholders in our next quarterly report on Form 10-Q or annual report on Form 10-K, as applicable, following such borrowing along with justification for exceeding such limit. This charter limitation, however, does not apply to individual real estate assets or investments. In addition, it is currently our intention to limit our aggregate borrowings to 45% of the aggregate fair market value of our assets (calculated after the close of our IPO and once we have invested substantially all the proceeds of our IPO), unless borrowing a greater amount is approved by a majority of our independent directors and disclosed to stockholders in our next quarterly report following such borrowing along with justification for borrowing such a greater amount. This limitation, however, will not apply to individual real estate assets or investments. At the date of acquisition of each asset, we anticipate that the cost of investment for such asset will be substantially similar to its fair market value, which will enable us to satisfy our requirements under our charter. However, subsequent events, including changes in the fair market value of our assets, could result in our exceeding these limits.
Once our NAV exceeds $1.0 billion, in the aggregate, we intend to maintain 5% of the overall value of our portfolio in liquid assets. However, our stockholders should not expect that we will maintain liquid assets at or above this level. To the extent that we maintain borrowing capacity under our Credit Facility, such available amount will be included in calculating our liquid assets. Our Advisor will consider various factors in determining the amount of liquid assets we should maintain, including, but not limited to, our receipt of proceeds from sales of additional shares, our cash flow from operations, available borrowing capacity under our Credit Facility, if any, our receipt of proceeds from any asset sale, and the use of cash to fund repurchases. The board of directors will review the amount and sources of liquid assets on a quarterly basis.
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Our board of directors has adopted a Share Repurchase Program ("SRP") that enables our stockholders to sell their shares to us under limited circumstances. At the time a stockholder requests a repurchase, we may, subject to certain conditions, repurchase the shares presented for repurchase for cash to the extent we have sufficient funds available to fund such purchase. There are limits on the number of shares we may repurchase under this program during any 12-month period. Further, we are only authorized to repurchase shares using the proceeds secured from the DRIP in any given quarter. The following table reflects the number of shares repurchased under the Company's SRP cumulatively through September 30, 2014:
Number of Requests | Number of Shares Repurchased | Average Price per Share | ||||||||
Cumulative repurchases as of December 31, 2013 | 2 | 1,600 | $ | 25.00 | ||||||
Nine months ended September 30, 2014(1) | 19 | 19,029 | 24.97 | |||||||
Cumulative repurchases as of September 30, 2014(1) | 21 | 20,629 | $ | 24.97 | ||||||
_____________________________
(1) Includes eight unfulfilled repurchase requests consisting of 8,866 shares at an average repurchase price per share of $24.97, which were approved for repurchase as of September 30, 2014 and are expected to be completed in November 2014.
Acquisitions
As of October 31, 2014, we owned 96 properties with an aggregate purchase price of $1.1 billion. We currently have $514.2 million of assets under contract and executed letters of intent. Pursuant to the terms of the purchase and sale agreements and letters of intent, our obligation to close upon these acquisitions is subject to certain conditions customary to closing, including the successful completion of due diligence and fully negotiated binding agreements. There can be no assurance that we will complete these acquisitions.
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"), an industry trade group, has 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 accounting principles generally accepted in the United States ("GAAP").
We define FFO, a non-GAAP measure, consistent with the standards established by the White Paper on FFO approved by the Board of Governors of NAREIT, as revised in February 2004 (the "White Paper"). The White Paper defines FFO as net income or loss computed in accordance with GAAP, excluding gains or losses from sales of property and asset impairment writedowns, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures are calculated to reflect FFO. Our FFO calculation complies with NAREIT's policy described above.
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 disclosed. We believe that, since 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. Additionally, we believe it is appropriate to disregard impairment charges, as this is a fair value adjustment that is largely based on market fluctuations and assessments regarding general market conditions which can change over time. An asset will only be evaluated for impairment if certain impairment indicators exist and if the carrying, or book value, exceeds the total estimated undiscounted future cash flows (including net rental and lease revenues, net proceeds on the sale of the property, and any other ancillary cash flows at a property or group level under GAAP) from such asset. Determinations of whether impairment charges have been incurred are based partly on anticipated operating performance, because estimated undiscounted future cash flows from a property, including estimated future net rental and lease revenues, net proceeds on the sale of the property, and certain other ancillary cash flows, are taken into account in determining whether an impairment charge has been incurred. While impairment charges are excluded from the calculation of FFO as described above, because impairments are based on estimated undiscounted future cash flows and the relatively limited term of our operations, it could be difficult to recover any impairment charges.
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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 and impairments, 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. However, FFO and modified funds from operations ("MFFO"), as described below, should not be construed to be more relevant or accurate than the current GAAP methodology in calculating net income or in its applicability in evaluating our 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.
There have been changes in the accounting and reporting promulgations under GAAP that were put into effect in 2009 subsequent to the establishment of NAREIT's definition of FFO, such as the change to expense as incurred rather than capitalize and depreciate acquisition fees and expenses. 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. We are using the proceeds raised in our offering to, among other things, acquire properties. We intend to begin the process of achieving a liquidity event (i.e., listing of our common stock on a national stock exchange, a merger or sale or another similar transaction) within three to five years of the completion of the offering. Thus, unless we raise, or recycle, a significant amount of capital after we complete our offering, we will not be continuing to purchase assets at the same rate as during our offering. Due to the above factors and other unique features of publicly registered, non-listed REITs, the Investment Program Association ("IPA"), an industry trade group, has standardized a measure known as MFFO, which the IPA has recommended as a supplemental measure for publicly registered non-listed REITs and which we believe to be another appropriate supplemental measure to reflect the operating performance of a non-listed REIT having the characteristics described above. 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 purchase a significant amount of new assets after we complete our offering. 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 are acquiring our properties and once our portfolio is stabilized. 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 IPO has been completed and our portfolios have been stabilized. We also believe that MFFO is a recognized measure of sustainable operating performance by the non-listed REIT industry. Further, we believe MFFO is useful in comparing the sustainability of our operating performance after our IPO and acquisitions are completed with the sustainability of the operating performance of other real estate companies that are not as involved in acquisition activities. MFFO should only be used to assess the sustainability of our operating performance after our IPO has been completed and our portfolio has been stabilized because it excludes acquisition costs that have a negative effect on our operating performance during the periods in which properties are acquired.
We define MFFO, a non-GAAP measure, consistent with the IPA's Guideline 2010-01, Supplemental Performance Measure for Publicly Registered, Non-Listed REITs: Modified Funds from Operations ("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: acquisition fees and expenses; amounts relating to deferred rent receivables and amortization of above and below market leases and liabilities (which are adjusted in order to reflect such payments from a GAAP accrual basis to a cash basis of disclosing the rent and lease payments); accretion of discounts and amortization of premiums on debt investments; mark-to-market adjustments included in net income; gains or losses included in net income from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan, unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity accounting, and after adjustments for consolidated and unconsolidated partnerships and joint ventures, with such adjustments calculated to reflect MFFO on the same basis. The accretion of discounts and amortization of premiums on debt investments, gains and losses on hedges, foreign exchange, derivatives or securities holdings, unrealized gains and losses resulting from consolidations, as well as other listed cash flow adjustments are adjustments made to net income in calculating the cash flows provided by operating activities and, in some cases, reflect gains or losses which are unrealized and may not ultimately be realized.
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Our MFFO calculation complies with the IPA's Practice Guideline described above. In calculating MFFO, we exclude acquisition related expenses, amortization of above and below market leases, fair value adjustments of derivative financial instruments, deferred rent receivables and the adjustments of such items related to non-controlling interests. Under GAAP, acquisition fees and expenses are characterized as operating expenses in determining operating net income. These expenses are paid in cash by us, and therefore such funds will not be available to distribute to investors. All paid and accrued acquisition fees and expenses negatively impact our operating performance during the period in which properties are acquired and negatively impact the returns earned on an investment in our shares, 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, these fees and expenses and other costs related to such property. Therefore, MFFO may not be an accurate indicator of our operating performance, during periods in which properties are being acquired. MFFO that excludes such costs and expenses would only be comparable to that of non-listed REITs that have completed their acquisition activities and have similar operating characteristics as us. Further, under GAAP, certain contemplated non-cash fair value and other non-cash adjustments are considered operating non-cash adjustments to net income in determining cash flow from operating activities. In addition, we view fair value adjustments of derivatives as items which are unrealized. We view both gains and losses from dispositions of assets and fair value adjustments of derivatives as items which are not reflective of ongoing operations and are therefore typically adjusted for when assessing operating performance. The purchase of properties, and the corresponding expenses associated with that process, is a key operational feature of our business plan to generate operational income and cash flows in order to make distributions to our investors. Acquisition fees and expenses will not be reimbursed by our Advisor if there are no further proceeds from the sale of shares in our offering, and therefore such fees and expenses will need to be paid from either additional debt, operational earnings or cash flows, net proceeds from the sale of properties or from ancillary cash flows.
Our management uses MFFO and the adjustments used to calculate it in order to evaluate our performance against other non-listed REITs with similar acquisition periods and targeted exit strategies. 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 acquire and manage properties. 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 a limited and defined acquisition period. By excluding expensed acquisition costs, the use of MFFO provides information consistent with management's analysis of the operating performance of the properties. Additionally, fair value adjustments, which are based on the impact of current market fluctuations and underlying assessments of general market conditions, but can also result from operational factors such as rental and occupancy rates, may not be directly related or attributable to our current operating performance. By excluding such changes that may reflect anticipated and unrealized gains or losses, we believe MFFO provides useful supplemental information.
Presentation of this information is intended to provide useful information to investors as they compare the operating performance of different REITs, although it should be noted that not all REITs calculate FFO and MFFO the same way. Accordingly, comparisons with other REITs may not be meaningful. Furthermore, FFO and MFFO are not necessarily indicative of cash flow available to fund cash needs and should not be considered as an alternative to net income (loss) or income (loss) from continuing operations as an indication of our performance, as an alternative to cash flows from operations as an indication of our liquidity, or indicative of funds available to fund our cash needs including our ability to make distributions to our stockholders. FFO and MFFO should be reviewed in conjunction with GAAP measurements as an indication of our performance. MFFO has limitations as a performance measure while an offering is ongoing such as our offering where the price of a share of common stock is a stated value and there is no NAV determination during the offering stage and for a period thereafter. MFFO is useful in assisting management and investors in assessing the sustainability of operating performance in future operating periods, and in particular, after the offering and acquisition stages are complete 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 or MFFO.
Neither the SEC, NAREIT nor any other regulatory body has passed judgment on the acceptability of the adjustments that 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 table below reflects the items deducted or added to net loss in our calculation of FFO and MFFO for the period indicated:
Three Months Ended | Nine Months Ended | |||||||||||||||
(In thousands) | March 31, 2014 | June 30, 2014 | September 30, 2014 | September 30, 2014 | ||||||||||||
Net loss (in accordance with GAAP) | $ | (582 | ) | $ | (4,147 | ) | $ | (20,023 | ) | $ | (24,752 | ) | ||||
Depreciation and amortization | 857 | 2,381 | 7,391 | 10,629 | ||||||||||||
FFO | 275 | (1,766 | ) | (12,632 | ) | (14,123 | ) | |||||||||
Acquisition fees and expenses (1) | 404 | 2,599 | 17,884 | 20,887 | ||||||||||||
Amortization of above or accretion of below market leases and liabilities, net (2) | 15 | 22 | 14 | 51 | ||||||||||||
Straight-line rent (3) | (80 | ) | (117 | ) | (462 | ) | (659 | ) | ||||||||
Accretion of discount/amortization of premiums | — | (106 | ) | (281 | ) | (387 | ) | |||||||||
MFFO | $ | 614 | $ | 632 | $ | 4,523 | $ | 5,769 | ||||||||
______________________________
(1) In evaluating investments in real estate, management differentiates the costs to acquire the investment from the operations derived from the investment. Such information would be comparable only for non-listed REITs that have completed their acquisition activity and have other similar operating characteristics. By excluding expensed acquisition costs, management believes MFFO provides useful supplemental information that is comparable for each type of real estate investment and is consistent with management's analysis of the investing and operating performance of our properties. Acquisition fees and expenses include payments to our Advisor or third parties. Acquisition fees and expenses under GAAP are considered operating expenses and as expenses included in the determination of net income and income from continuing operations, both of which are performance measures under GAAP. 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 properties are generated to cover the purchase price of the property, these fees and expenses and other costs related to the property.
(2) Under GAAP, certain intangibles are accounted for at cost and reviewed at least annually for impairment, and certain intangibles are assumed to diminish predictably in value over time and amortized, similar to depreciation and amortization of other real estate related assets that are excluded from FFO. However, because real estate values and market lease rates historically rise or fall with market conditions, management believes that by excluding charges relating to amortization of these intangibles, MFFO provides useful supplemental information on the performance of the real estate.
(3) Under GAAP, rental receipts are allocated to periods using various methodologies. This may result in income recognition that is significantly different than underlying contract terms. By adjusting for these items (to reflect such payments from a GAAP accrual basis to a cash basis of disclosing the rent and lease payments), MFFO provides useful supplemental information on the realized economic impact of lease terms and debt investments, providing insight on the contractual cash flows of such lease terms and debt investments, and aligns results with management's analysis of operating performance.
Distributions
On April 9, 2013, our board of directors authorized, and we declared, distributions payable to stockholders of record each day during the applicable period at a rate equal to $0.0046575343 per day, or 6.8% per annum, based on a price of $25.00 per share of common stock. Distributions began to accrue on May 24, 2013, 15 days following our initial property acquisition. Distributions are payable by the 5th day following each month end to stockholders of record at the close of business each day during the prior month.
The amount of distributions payable to our stockholders is determined by our board of directors and is dependent on a number of factors, including funds available for distribution, our financial condition, capital expenditure requirements, as applicable, requirements of Maryland law and annual distribution requirements needed to qualify and maintain our status as a REIT under the Internal Revenue Code of 1986, as amended (the "Code"). Distribution payments are dependent on the availability of funds. Our board of directors may reduce the amount of distributions paid or suspend distribution payments at any time and therefore distribution payments are not assured.
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During the nine months ended September 30, 2014, distributions paid to common stockholders totaled $42.0 million, inclusive of $22.5 million of distributions reinvested through the DRIP. During the nine months ended September 2014, cash used to pay distributions was generated from net proceeds from our offering.
The following table shows the sources for the payment of distributions to common stockholders, including distributions on unvested restricted stock, for the periods indicated:
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||
March 31, 2014 | June 30, 2014 | September 30, 2014 | September 30, 2014 | |||||||||||||||||||||||||
(In thousands) | Percentage of Distributions | Percentage of Distributions | Percentage of Distributions | Percentage of Distributions | ||||||||||||||||||||||||
Distributions: | ||||||||||||||||||||||||||||
Distributions paid in cash | $ | 1,923 | $ | 5,481 | $ | 12,068 | $ | 19,472 | ||||||||||||||||||||
Distributions reinvested | 2,047 | 6,060 | 14,393 | 22,500 | ||||||||||||||||||||||||
Distributions on unvested restricted stock | 2 | 1 | 1 | 4 | ||||||||||||||||||||||||
Total distributions | $ | 3,972 | $ | 11,542 | $ | 26,462 | $ | 41,976 | ||||||||||||||||||||
Source of distribution coverage: | ||||||||||||||||||||||||||||
Cash flows provided by (used in) operations (1) | $ | 1,301 | 32.8 | % | $ | (163 | ) | (1.4 | )% | $ | (1,138 | ) | (4.3 | )% | $ | — | — | % | ||||||||||
Proceeds from issuance of common stock | 624 | 15.7 | % | 5,645 | 48.9 | % | 13,207 | 49.9 | % | 19,476 | 46.4 | % | ||||||||||||||||
Common stock issued under the DRIP / offering proceeds | 2,047 | 51.5 | % | 6,060 | 52.5 | % | 14,393 | 54.4 | % | 22,500 | 53.6 | % | ||||||||||||||||
Proceeds from financings | — | — | % | — | — | % | — | — | % | — | — | % | ||||||||||||||||
Total source of distribution coverage | $ | 3,972 | 100.0 | % | $ | 11,542 | 100.0 | % | $ | 26,462 | 100.0 | % | $ | 41,976 | 100.0 | % | ||||||||||||
Cash flows provided by operations (GAAP basis) (1) | $ | 1,301 | $ | (163 | ) | $ | (11,182 | ) | $ | (10,044 | ) | |||||||||||||||||
Net loss (in accordance with GAAP) | $ | (582 | ) | $ | (4,147 | ) | $ | (20,023 | ) | $ | (24,752 | ) | ||||||||||||||||
______________________________
(1) Cash flows used in operations for the three months ended March 31, 2014, June 30, 2014 and September 30, 2014 and for the nine months ended September 30, 2014 reflect acquisition and transaction related expenses of $0.4 million, $2.6 million, $17.9 million and $20.9 million, respectively.
For the nine months ended September 30, 2014, cash flows used in operations were $10.0 million. As shown in the table above, we funded distributions with proceeds from our IPO as well as proceeds from our IPO which were reinvested in common stock issued under our DRIP. To the extent we pay distributions in excess of cash flows provided by operations, our stockholders' investment may be adversely impacted. Since inception, our cumulative distributions have exceeded our cumulative FFO. See “Risk Factors - Distributions paid from sources other than our cash flows from operations, particularly from proceeds of our IPO, will result in us having fewer funds available for the acquisition of properties and other real estate-related investments and may dilute our stockholders' interests in us, which may adversely affect our ability to fund future distributions with cash flows from operations and may adversely affect our stockholders' overall return.” under Item 1A in this Quarterly Report on Form 10-Q.
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The following table compares cumulative distributions paid to cumulative net loss and cumulative cash flows provided by operations (in accordance with GAAP) for the period from October 15, 2012 (date of inception) through September 30, 2014:
For the Period from October 15, 2012 (date of inception) to | ||||
(In thousands) | September 30, 2014 | |||
Distributions paid: | ||||
Common stockholders in cash | $ | 20,775 | ||
Common stockholders pursuant to DRIP/offering proceeds | 23,845 | |||
Unvested restricted stock | 7 | |||
Total distributions paid | $ | 44,627 | ||
Reconciliation of net loss: | ||||
Revenues | $ | 17,891 | ||
Acquisition and transaction related | (21,617 | ) | ||
Depreciation and amortization | (11,706 | ) | ||
Other operating expenses | (7,689 | ) | ||
Other non-operating expenses | (1,867 | ) | ||
Net loss (in accordance with GAAP) (1) | $ | (24,988 | ) | |
Cash flows provided by operations | $ | (10,808 | ) | |
FFO | $ | (13,220 | ) | |
_____________________
(1) Net loss as defined by GAAP includes the non-cash impact of depreciation and amortization expense as well as costs incurred relating to acquisitions and related transactions.
Loan Obligations
The payment terms of our loan obligations require principal and interest amounts payable monthly with all unpaid principal and interest due at maturity. Our loan agreements stipulate that we comply with specific reporting covenants. As of September 30, 2014, we were in compliance with the debt covenants under our loan agreements.
Our Advisor may, with approval from our independent board of directors, seek to borrow short-term capital that, combined with secured mortgage financing, exceeds our targeted leverage ratio. Such short-term borrowings may be obtained from third-parties on a case-by-case basis as acquisition opportunities present themselves. We view the use of short-term borrowings, including advances under our credit facility, as an efficient and accretive means of acquiring real estate. Our secured debt leverage ratio (total secured debt, divided by the base purchase price of acquired real estate investments) was approximately 6.6% as of September 30, 2014.
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Contractual Obligations
The following table reflects contractual debt obligations under our mortgage notes payable and minimum base rental cash payments due for leasehold interests over the next five years and thereafter as of September 30, 2014. These minimum base rental cash payments due for leasehold interests amounts exclude contingent rent payments, as applicable, that may be payable based on provisions related to increases in annual rent based on exceeding certain economic indexes among other items. As of September 30, 2014, the outstanding mortgage notes payable had weighted average effective interest rates of 6.15%. As of September 30, 2014, we had no advances outstanding under the Credit Facility.
October 1, 2014 — December 31, 2014 | Years Ended December 31, | |||||||||||||||||||
(In thousands) | Total | 2015 — 2016 | 2017 — 2018 | Thereafter | ||||||||||||||||
Principal on mortgage notes payable | $ | 66,028 | $ | 235 | $ | 20,367 | $ | 33,408 | $ | 12,018 | ||||||||||
Interest on mortgage notes payable | 11,565 | 1,013 | 7,233 | 3,060 | 259 | |||||||||||||||
Lease rental payments due | 12,382 | 43 | 348 | 362 | 11,629 | |||||||||||||||
$ | 89,975 | $ | 1,291 | $ | 27,948 | $ | 36,830 | $ | 23,906 | |||||||||||
Election as a REIT
We elected and qualified to be taxed as a REIT under Sections 856 through 860 of the Code, effective for our taxable year ended December 31, 2013. We believe that, commencing with such taxable year, we are organized and operate in such a manner as to qualify for taxation as a REIT under the Code. We intend to continue to operate in such a manner to qualify for taxation as a REIT, but no assurance can be given that we will operate in a manner so as to qualify or remain qualified as a REIT. In order to qualify and continue to qualify, for taxation as a REIT, we must distribute annually at least 90% of our REIT taxable income. REITs are also subject to a number of other organizational and operational requirements. Even if we qualify for taxation as a REIT, we may be subject to certain state and local taxes on our income and properties as well as federal income and excise taxes on our undistributed income.
Inflation
We may be adversely impacted by inflation on any leases that do not contain indexed escalation provisions. In addition, we may be required to pay costs for maintenance and operation of properties which may adversely impact our results of operations due to potential increases in costs and operating expenses resulting from inflation.
Related-Party Transactions and Agreements
We have entered into agreements with affiliates of our Sponsor, under which we have paid or may in the future pay certain fees or reimbursements to our Advisor, its affiliates and entities under common control with our Advisor in connection with acquisition and financing activities, sales and maintenance of common stock under our IPO, transfer agency services, asset and property management services and reimbursement of operating and offering related costs. See Note 10 — Related Party Transactions and Arrangements to our consolidated financial statements included in this Quarterly Report on Form 10-Q for a discussion of the various related party transactions, agreements and fees.
In addition, the limited partnership agreement of the OP provides for a special allocation, solely for tax purposes, of excess depreciation deductions of up to $10.0 million to our Advisor, a limited partner of the OP. In connection with this special allocation, our Advisor has agreed to restore a deficit balance in its capital account in the event of a liquidation of the OP and has agreed to provide a guaranty or indemnity of indebtedness of the OP. Our Advisor is directly or indirectly controlled by certain of our officers and directors.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The market risk associated with financial instruments is the risk of loss from adverse changes in market prices or interest rates. Our long-term debt, which consists of secured financings and our Credit Facility (which had no advances outstanding as of September 30, 2014), bears interest at fixed rates and variable rates. Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives, from time to time, we may enter into interest rate hedge contracts such as swaps, collars, and treasury lock agreements in order to mitigate our interest rate risk with respect to various debt instruments. We do not hold or issue these derivative contracts for trading or speculative purposes. We do not have any foreign operations and thus we are not exposed to foreign currency fluctuations.
As of September 30, 2014, our debt included fixed-rate secured mortgage financings with a carrying value of $69.2 million and a fair value of $69.6 million. Changes in market interest rates on our fixed-rate debt impact the fair value of the notes, but it has no impact on interest due on the notes. For instance, if interest rates rise 100 basis points and our fixed rate debt balance remains constant, we expect the fair value of our obligation to decrease, the same way the price of a bond declines as interest rates rise. The sensitivity analysis related to our fixed–rate debt assumes an immediate 100 basis point move in interest rates from their September 30, 2014 levels, with all other variables held constant. A 100 basis point increase in market interest rates would result in a decrease in the fair value of our fixed-rate debt by $1.3 million. A 100 basis point decrease in market interest rates would result in an increase in the fair value of our fixed-rate debt by $1.1 million.
These amounts were determined by considering the impact of hypothetical interest rates changes on our borrowing costs, and assuming no other changes in our capital structure. The information presented above includes only those exposures that existed as of September 30, 2014 and does not consider exposures or positions arising after that date. The information represented herein has limited predictive value. Future actual realized gains or losses with respect to interest rate fluctuations will depend on cumulative exposures, hedging strategies employed and the magnitude of the fluctuations.
Item 4. Controls and Procedures.
In accordance with Rules 13a-15(b) and 15d-15(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), we, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q and determined that the disclosure controls and procedures are effective.
No change occurred in our internal controls over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the three months ended September 30, 2014 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
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PART II — OTHER INFORMATION
Item 1. Legal Proceedings.
We are not a party to, and none of our properties are subject to, any material pending legal proceedings.
Item 1A. Risk Factors.
Our potential risks and uncertainties are presented in the section entitled "Item 1A. Risk Factors," disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013. The following additional risk factors should be considered regarding our potential risks and uncertainties:
Recent disclosures made by American Realty Capital Properties, Inc., or ARCP, an entity previously sponsored by the parent of our Sponsor, regarding certain accounting errors may affect our ability to raise capital.
ARCP recently filed a Form 8-K announcing that its audit committee had concluded that the previously issued financial statements and other financial information contained in certain public filings should no longer be relied upon as a result of certain accounting errors that were identified but intentionally not corrected, and other AFFO and financial statement errors that were intentionally made. These accounting errors resulted in the resignations of ARCP’s former chief financial officer and its former chief accounting officer. ARCP has initiated an investigation into these matters that is ongoing; no assurance can be made regarding the outcome of the investigation. ARCP’s former chief financial officer is one of the non-controlling owners of the parent of our Sponsor. While ARCP’s former chief financial officer does not have a current role in the management of our Sponsor’s or our business, he did serve as our chief financial officer from October 2012 to December 2013.
As a result of this announcement, a number of broker-dealer firms that had been participating in the distribution of offerings of public, non-listed REITs sponsored directly or indirectly by the parent of our Sponsor have temporarily suspended their participation in the distribution of those offerings. Although we have substantially completed our initial public offering, we may seek to raise additional capital in connection with the operation of our business. Similarly to other entities sponsored directly or indirectly by the parent of our Sponsor, the recent announcement by ARCP, as well as any future announcements by ARCP, may have an adverse effect on our ability to access capital through, among other things, equity offerings or lending arrangements. If we are unable to access additional capital it may have a material adverse effect on our business including, among other things, our ability to achieve our investment objectives.
Our stockholders' interest in us may be diluted if the price we pay in respect of shares repurchased under our share repurchase program exceeds the net asset value, at such time as we calculate the NAV of our shares.
The prices we may pay for shares repurchased under our share repurchase program may exceed the NAV of such shares at the time of repurchase, which may reduce the NAV of the remaining shares.
Distributions paid from sources other than our cash flows from operations, particularly from proceeds of our IPO, will result in us having fewer funds available for the acquisition of properties and other real estate-related investments and may dilute our stockholders' interests in us, which may adversely affect our ability to fund future distributions with cash flows from operations and may adversely affect our stockholders' overall return.
Our cash flows used in operations were $10.0 million for the nine months ended September 30, 2014. During the nine months ended September 30, 2014, we paid distributions of $42.0 million, of which $19.5 million, or 46.4%, was funded from proceeds from the IPO and $22.5 million, or 53.6%, was funded from proceeds from our IPO which were reinvested in common stock issued under our DRIP. During the nine months ended September 30, 2014 cash flow from operations included an increase in accounts payable and accrued expenses of $8.5 million, as reflected on the statement of cash flows. Accordingly, if these accounts payable and accrued expenses had been paid during the nine months ended September 30, 2014, there would have been $8.5 million less in cash flow from operations available to pay distributions. Using offering proceeds to pay distributions, especially if the distributions are not reinvested through our DRIP, reduces cash available for investment in assets or other purposes, and reduces our per share stockholders' equity. We may continue to use net offering proceeds to fund distributions.
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We may not generate sufficient cash flows from operations to pay distributions. If we have not generated sufficient cash flows from our operations and other sources, such as from borrowings, the sale of additional securities, advances from our Advisor, and our Advisor's deferral, suspension or waiver of its fees and expense reimbursements, to fund distributions, we may use the proceeds from our IPO. Moreover, our board of directors may change our distribution policy, in its sole discretion, at any time. Distributions made from offering proceeds are a return of capital to stockholders, from which we will have already paid offering expenses in connection with our IPO. We have not established any limit on the amount of proceeds from our IPO that may be used to fund distributions, except that, in accordance with our organizational documents and Maryland law, we may not make distributions that would: (1) cause us to be unable to pay our debts as they become due in the usual course of business; (2) cause our total assets to be less than the sum of our total liabilities plus senior liquidation preferences, if any; or (3) jeopardize our ability to qualify as a REIT.
Funding distributions from borrowings could restrict the amount we can borrow for investments, which may affect our profitability. Funding distributions with the sale of assets or the proceeds of our IPO may affect our ability to generate additional operating cash flows. Funding distributions from the sale of additional securities could dilute each stockholder's interest in us if we sell shares of our common stock or securities that are convertible or exercisable into shares of our common stock to third-party investors. Payment of distributions from the mentioned sources could restrict our ability to generate sufficient cash flows from operations, affect our profitability or affect the distributions payable to stockholders upon a liquidity event, any or all of which may have an adverse effect on an investment in our shares.
We rely significantly on three major tenants (including, for this purpose, all affiliates of such tenants) and therefore, are subject to tenant credit concentrations that make us more susceptible to adverse events with respect to those tenants.
As of September 30, 2014, the following three major tenants represented annualized rental income on a straight-line basis, which represented 5% or more of our consolidated annualized rental income on a straight-line basis including for this purpose, all affiliates of such tenants:
Tenant | Percentage of Straight-Line Rental Income | |
Meridian Senior Living, LLC | 18.8% | |
Pinnacle Health Hospitals | 21.4% | |
Platinum Health Care, LLC | 12.6% | |
Therefore, the financial failure of any of these tenants could have a material adverse effect on our results of operations and our financial condition. In addition, the value of our investment is driven by the credit quality of the underlying tenant, and an adverse change in either the tenant's financial condition or a decline in the credit rating of such tenant may result in a decline in the value of our investments.
Our property portfolio has a high concentration of properties located in six states. Our properties may be adversely affected by economic cycles and risks inherent to those states.
As of September 30, 2014, the following six states represented annualized rental income on a straight-line basis, which represented 5% or more of our consolidated annualized rental income on a straight-line basis:
State | Percentage of Straight-Line Rental Income | |
Florida | 32.0% | |
Georgia | 8.0% | |
Iowa | 20.9% | |
Michigan | 10.0% | |
Missouri | 7.0% | |
Pennsylvania | 7.4% | |
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Any adverse situation that disproportionately affects the states listed above may have a magnified adverse effect on our portfolio. Real estate markets are subject to economic downturns, as they have been in the past, and we cannot predict how economic conditions will impact this market in both the short and long term. Declines in the economy or a decline in the real estate market in these states could hurt our financial performance and the value of our properties. Factors that may negatively affect economic conditions in these states include:
• | business layoffs or downsizing; |
• | industry slowdowns; |
• | relocations of businesses; |
• | changing demographics; |
• | increased telecommuting and use of alternative work places; |
• | infrastructure quality; |
• | any oversupply of, or reduced demand for, real estate; |
• | concessions or reduced rental rates under new leases for properties where tenants defaulted; and |
• | increased insurance premiums. |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds of Registered Securities.
Unregistered Sales of Equity Securities
We did not sell any equity securities that were not registered under the Securities Act during the nine months ended September 30, 2014.
Use of Proceeds of Registered Securities
On February 14, 2013 we commenced our IPO on a "reasonable best efforts" basis of up to a maximum of $1.7 billion of common stock, consisting of up to 68.0 million shares, pursuant to the Registration Statement (File No. 333-184677) initially filed on October 31, 2012 with the SEC under the Securities Act. The Registration Statement, which was declared effective by the SEC on February 14, 2013, also covers 14.7 million shares of common stock pursuant the DRIP under which common stockholders may elect to have their distributions reinvested in additional shares of common stock. We reserve the right to reallocate shares covered in the Registration Statement between the IPO and the DRIP. On July 23, 2014, we announced the reallocation of 13.9 million of our approximately 14.2 million remaining unsold shares available pursuant to the DRIP. On August 1, 2014, we registered an additional 25.0 million shares to be issued under the DRIP pursuant to a registration statement on Form S-3 (File No. 333-197802). As of September 30, 2014, we have issued 81.5 million shares of our common stock, including unvested restricted shares and shares issued pursuant to the DRIP, and received $2.0 billion of offering proceeds, including proceeds from shares issued pursuant to the DRIP.
The following table reflects the offering costs associated with the issuance of common stock:
Nine Months Ended | ||||
(In thousands) | September 30, 2014 | |||
Selling commissions and dealer manager fees | $ | 172,201 | ||
Other offering costs | 32,149 | |||
Total offering costs | $ | 204,350 | ||
The Dealer Manager may reallow the selling commissions and a portion of the dealer manager fees to participating broker-dealers. The following table details the selling commissions incurred and reallowed related to the sale of shares of common stock:
Nine Months Ended | ||||
(In thousands) | September 30, 2014 | |||
Total commissions paid to the Dealer Manager | $ | 172,201 | ||
Less: | ||||
Commissions to participating brokers | (117,636 | ) | ||
Reallowance to participating broker dealers | (19,782 | ) | ||
Net to the Dealer Manager | $ | 34,783 | ||
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As of September 30, 2014, we have incurred $229.1 million of cumulative offering costs in connection with the issuance and distribution of our shares in connection with our IPO. As of September 30, 2014, cumulative offering costs included $35.0 million of offering costs reimbursements incurred from the Advisor and Dealer Manager, excluding commission and dealer manager fees. The Advisor elected to cap cumulative offering costs incurred by us, net of unpaid amounts, to 15% of gross common stock proceeds during the offering period. Cumulative offering costs, net of unpaid amounts, were less than the 15% threshold as of September 30, 2014. Cumulative offering proceeds from the sale of common stock exceeded cumulative offering costs by $1.8 billion at September 30, 2014.
We have used and expect to continue to use substantially all of the net proceeds from our IPO to primarily acquire a diversified portfolio of income producing real estate properties, focusing predominantly on medical office buildings and healthcare-related facilities. We may also originate or acquire first mortgage loans secured by real estate. As of September 30, 2014, we have used the net proceeds from our IPO to purchase 88 properties with an aggregate contract purchase price of $1.0 billion. We have used and may continue to use net proceeds from our IPO to fund a portion of our distributions. Once we have used all the proceeds from the IPO to acquire properties, management expects that cash flow from our properties will be sufficient to fund operating expenses and the payment of our monthly distributions.
Issuer Purchases of Equity Securities
The following table reflects the number of shares repurchased under the Company's SRP cumulatively through September 30, 2014:
_____________________________
Number of Requests | Number of Shares Repurchased | Average Price per Share | ||||||||
Cumulative repurchases as of December 31, 2013 | 2 | 1,600 | $ | 25.00 | ||||||
Nine months ended September 30, 2014(1) | 19 | 19,029 | 24.97 | |||||||
Cumulative repurchases as of September 30, 2014(1) | 21 | 20,629 | $ | 24.97 | ||||||
(1) Includes eight unfulfilled repurchase requests consisting of 8,866 shares at an average repurchase price per share of $24.97, which were approved for repurchase as of September 30, 2014 and are expected to be completed in November 2014.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
None.
Item 6. Exhibits.
The exhibits listed on the Exhibit Index (following the signatures section of this report) are included, or incorporated by reference, in this Quarterly Report on Form 10-Q.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
AMERICAN REALTY CAPITAL HEALTHCARE TRUST II, INC. | ||
By: | /s/ Thomas P. D'Arcy | |
Thomas P. D'Arcy | ||
Chief Executive Officer (Principal Executive Officer) | ||
By: | /s/ Edward F. Lange | |
Edward F. Lange | ||
Chief Financial Officer and Chief Operating Officer (Principal Financial Officer and Principal Accounting Officer) | ||
Dated: November 14, 2014
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EXHIBITS INDEX
The following exhibits are included, or incorporated by reference, in this Quarterly Report on Form 10-Q for the quarter ended September 30, 2014 (and are numbered in accordance with Item 601 of Regulation S-K):
Exhibit No. | Description | |
10.28 * | Agreement for Lease of Real Property, dated as of June 14, 2014, by and between American Realty Capital VII, LLC and Pinnacle Health Hospitals | |
10.29* | First Amendment to Agreement for Lease of Real Property, dated as of July 16, 2014, by and between American Realty Capital VII, LLC and Pinnacle Health Hospitals | |
10.30* | Second Amendment to Agreement for Lease of Real Property, dated as of August 1, 2014, by and between American Realty Capital VII, LLC and Pinnacle Health Hospitals | |
10.31* | Third Amendment to Agreement for Lease of Real Property, dated as of September 26, 2014, by and between American Realty Capital VII, LLC and Pinnacle Health Hospitals | |
10.33* | Agreement of Sale, dated as of June 16, 2014, by and among American Realty Capital Healthcare Trust Operating Partnership, L.P., Leisure Living Properties - Holt, LLC, Leisure Living Properties - Dewitt, LLC, Lifehouse Crystal Manor Property, LLC, Lifehouse Waldon Woods Property, LLC, Lifehouse - Golden Acres Properties, LLC, Lifehouse - Golden Acres Properties II, LLC, Lifehouse Grand Blanc Properties, LLC, Lifehouse Clare Properties, LLC, Lifehouse Mt. Pleasant Properties, LLC, Lifehouse Mt. Pleasant Properties II, LLC, Lifehouse Prestige Commons Properties, LLC, Leisure Living Properties - Buchanan, LLC, Lifehouse Buchanan Property-II, LLC, Leisure Living Properties - Grand Rapids, LLC, Leisure Living Properties - Holland, LLC, Lifehouse - Oakridge Manor Dixon Properties, LLC, Lifehouse - Oakridge Manor Rockford Properties, LLC, (collectively, the “Lifehouse Sellers”), and Lifehouse Holdings, LLC, as representative of the Lifehouse Sellers | |
10.34* | First Amendment to Agreement of Sale, dated as of July 20, 2014, by and among American Realty Capital Healthcare Trust Operating Partnership, L.P., the Lifehouse Sellers and Lifehouse Holdings, LLC, as representative of the Lifehouse Sellers | |
10.35* | Second Amendment to Agreement of Sale, dated as of August 7, 2014, by and among American Realty Capital Healthcare Trust Operating Partnership, L.P., American Realty Capital Healthcare Trust II Operating Partnership, L.P., the Lifehouse Sellers and Lifehouse Holdings, LLC, as representative of the Lifehouse Sellers | |
10.36* | Asset Purchase Agreement, dated as of July 2, 2014, by and between American Realty Capital Healthcare Trust II Operating Partnership, LP and PHBS REALTY, LLC, PHGG REALTY, LLC, PHCA REALTY, LLC, PHKC SWOPE REALTY, LLC, PHKC CLEVELAND REALTY, LLC, PHMC REALTY, LLC, PHDC REALTY, LLC, PHBC REALTY, LLC, PHGY REALTY, LLC and PHEM REALTY, LLC | |
10.37* | First Amendment to Asset Purchase Agreement, dated as of July 30, 2014, by and between American Realty Capital Healthcare Trust II Operating Partnership, LP and PHBS REALTY, LLC, PHGG REALTY, LLC, PHCA REALTY, LLC, PHKC SWOPE REALTY, LLC, PHKC CLEVELAND REALTY, LLC, PHMC REALTY, LLC, PHDC REALTY, LLC, PHBC REALTY, LLC, PHGY REALTY, LLC and PHEM REALTY, LLC | |
10.38* | Asset Purchase Agreement, dated as of August 1, 2014, by and among American Realty Capital Healthcare Trust II Operating Partnership, LP and ECI Acquisition I, LLC, Village Assisted Living, LLC, Mt. Pleasant Assisted Living, LLC, Burlington Assisted Living, LLC, Muscatine Assisted Living, LLC, Carroll Assisted Living, LLC, Ft. Madison Assisted Living, LLC and Burlington Independent Living, LLC | |
10.39* | First Amendment to Asset Purchase Agreement, dated as of August 7, 2014, by and among American Realty Capital Healthcare Trust II Operating Partnership, LP and ECI Acquisition I, LLC, Village Assisted Living, LLC, Mt. Pleasant Assisted Living, LLC, Burlington Assisted Living, LLC, Muscatine Assisted Living, LLC, Carroll Assisted Living, LLC, Ft. Madison Assisted Living, LLC and Burlington Independent Living, LLC | |
10.40* | Second Amendment to Asset Purchase Agreement, dated as of August 8, 2014, by and among American Realty Capital Healthcare Trust II Operating Partnership, LP and ECI Acquisition I, LLC, Village Assisted Living, LLC, Mt. Pleasant Assisted Living, LLC, Burlington Assisted Living, LLC, Muscatine Assisted Living, LLC, Carroll Assisted Living, LLC, Ft. Madison Assisted Living, LLC and Burlington Independent Living, LLC | |
10.41* | Third Amendment to Asset Purchase Agreement, dated as of August 26 2014, by and among American Realty Capital Healthcare Trust II Operating Partnership, LP and ECI Acquisition I, LLC, Village Assisted Living, LLC, Mt. Pleasant Assisted Living, LLC, Burlington Assisted Living, LLC, Muscatine Assisted Living, LLC, Carroll Assisted Living, LLC, Ft. Madison Assisted Living, LLC and Burlington Independent Living, LLC | |
10.42* | Asset Purchase Agreement, dated as of August 25, 2014, by and among American Realty Capital VII, LLC, The Allegro at Abacoa, L.L.C., College Harbor Properties, L.L.C., The Allegro at Willoughby, L.L.C., The Allegro at East Lake, L.L.C. and Harbor Towers, L.L.C. and The Allegro at Helmwood, L.L.C. | |
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EXHIBITS INDEX
Exhibit No. | Description | |
10.43* | First Amendment to Senior Secured Revolving Credit Agreement, dated September 18, 2014, to the Senior Secured Revolving Credit Agreement dated as of March 21, 2014, between American Realty Capital Healthcare Trust II Operating Partnership, LP, American Realty Capital Healthcare Trust II, Inc. and KeyBank National Association, individually and as agent for itself and the other lenders party from time to time | |
31.1 * | Certification of the Principal Executive Officer of the Company pursuant to Securities Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 * | Certification of the Principal Financial Officer of the Company pursuant to Securities Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32 * | Written statements of the Principal Executive Officer and Principal Financial Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
101 * | XBRL (eXtensible Business Reporting Language). The following materials from American Realty Capital Healthcare Trust II, Inc.'s Quarterly Report on Form 10-Q for the three months ended September 30, 2014, formatted in XBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations and Comprehensive Loss, (iii) the Consolidated Statement of Changes in Equity, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to the Consolidated Financial Statements. As provided in Rule 406T of Regulation S-T, this information in furnished and not filed for purpose of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934 | |
____________________
* Filed herewith
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