UNIVERSAL HEALTH REALTY INCOME TRUST - Quarter Report: 2020 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(MARK ONE)


☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2020


☐	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 1-9321

UNIVERSAL HEALTH REALTY INCOME TRUST

(Exact name of registrant as specified in its charter)

Maryland		23-6858580
(State or other jurisdiction of incorporation or organization)		(I. R. S. Employer Identification No.)

UNIVERSAL CORPORATE CENTER 367 SOUTH GULPH ROAD KING OF PRUSSIA, Pennsylvania		19406
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code (610) 265-0688

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

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Shares of beneficial interest, $0.01 par value

UHT

New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.


Large accelerated filer	☒	Accelerated Filer	☐

Non-accelerated filer	☐	Smaller reporting company	☐
		Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Number of common shares of beneficial interest outstanding at October 31, 2020—13,770,519.

UNIVERSAL HEALTH REALTY INCOME TRUST

INDEX

		PAGE NO.
PART I. FINANCIAL INFORMATION (unaudited)
Item 1.	Financial Statements
	Condensed Consolidated Statements of Income—Three and Nine Months Ended September 30, 2020 and 2019	4
	Condensed Consolidated Statements of Comprehensive Income—Three and Nine Months Ended September 30, 2020 and 2019	5
	Condensed Consolidated Balance Sheets—September 30, 2020 and December 31, 2019	6
	Condensed Consolidated Statements of Changes in Equity—Three and Nine Months Ended September 30, 2020 and 2019	7 through 8
	Condensed Consolidated Statements of Cash Flows—Nine Months Ended September 30, 2020 and 2019	9
	Notes to Condensed Consolidated Financial Statements	10 through 21
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22 through 34
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	34 through 36
Item 4.	Controls and Procedures	36
PART II. OTHER INFORMATION		37
Item 1A. Risk Factors		37
Item 6.	Exhibits	37

SIGNATURES		38

This Quarterly Report on Form 10-Q is for the quarter ended September 30, 2020. In this Quarterly Report, “we,” “us,” “our” and the “Trust” refer to Universal Health Realty Income Trust and its subsidiaries.

As disclosed in this Quarterly Report, including in Note 2 to the condensed consolidated financial statements—Relationship with Universal Health Services, Inc. (“UHS”) and Related Party Transactions, a wholly-owned subsidiary of UHS (UHS of Delaware, Inc.) serves as our Advisor pursuant to the terms of an annually renewable Advisory Agreement dated December 24, 1986, and as amended and restated as of January 1, 2019. Our officers are all employees of UHS through its wholly-owned subsidiary, UHS of Delaware, Inc. In addition, three of our hospital facilities are leased to subsidiaries of UHS, and subsidiaries of UHS are tenants of seventeen medical office buildings or free-standing emergency departments, that are either wholly or jointly-owned by us (excluding new construction). Any reference to “UHS” or “UHS facilities” in this report is referring to Universal Health Services, Inc.’s subsidiaries, including UHS of Delaware, Inc.

In this Quarterly Report, the term “revenues” does not include the revenues of the unconsolidated limited liability companies (“LLCs”) in which we have various non-controlling equity interests ranging from 33% to 95%. As of September 30, 2020, we had investments in five jointly-owned LLCs/LPs (including one currently under construction which is scheduled to be completed in late 2020). We currently account for our share of the income/loss from these investments by the equity method (see Note 5 to the condensed consolidated financial statements included herein).

Part I. Financial Information

Item I. Financial Statements

Universal Health Realty Income Trust

Condensed Consolidated Statements of Income

For the Three and Nine Months Ended September 30, 2020 and 2019

(amounts in thousands, except share information)

(unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2020			2019			2020			2019
Revenues:
Lease revenue - UHS facilities (a.)	$	6,381		$	5,821		$	18,243		$	17,265
Lease revenue - Non-related parties		12,841			13,555			38,526			39,464
Other revenue - UHS facilities		232			230			667			652
Other revenue - Non-related parties		238			260			744			923
		19,692			19,866			58,180			58,304
Expenses:
Depreciation and amortization		6,399			6,430			19,160			19,564
Advisory fees to UHS		1,039			1,011			3,082			2,963
Other operating expenses		5,614			5,566			16,573			16,106
		13,052			13,007			38,815			38,633
Income before equity in income of unconsolidated limited liability companies ("LLCs"), interest expense and gain on sale		6,640			6,859			19,365			19,671
Equity in income of unconsolidated LLCs		517			453			1,371			1,337
Gain on sale of land		-			-			-			250
Interest expense, net		(1,964	)		(2,659	)		(6,289	)		(8,132	)
Net income	$	5,193		$	4,653		$	14,447		$	13,126
Basic earnings per share	$	0.38		$	0.34		$	1.05		$	0.96
Diluted earnings per share	$	0.38		$	0.34		$	1.05		$	0.95

Weighted average number of shares outstanding - Basic		13,748			13,735			13,741			13,731
Weighted average number of shares outstanding - Diluted		13,770			13,757			13,763			13,751

(a.) Includes bonus rental on UHS hospital facilities of $1,680 and $1,428 for the three-month periods ended September 30, 2020 and 2019, respectively, and $4,477 and $4,174 for the nine-month periods ended September 30, 2020 and 2019, respectively.

See accompanying notes to these condensed consolidated financial statements.

Universal Health Realty Income Trust

Condensed Consolidated Statements of Comprehensive Income

For the Three and Nine Months Ended September 30, 2020 and 2019

(amounts in thousands)

(unaudited)

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020			2019
Net income	$	5,193	$	4,653	$	14,447		$	13,126
Other comprehensive gain/(loss):
Unrealized derivative gains/(losses) on cash flow hedges		234		561		(5,709	)		429
Total other comprehensive gain/(loss):		234		561		(5,709	)		429
Total comprehensive income	$	5,427	$	5,214	$	8,738		$	13,555

See accompanying notes to these condensed consolidated financial statements.

Universal Health Realty Income Trust

Condensed Consolidated Balance Sheets

(amounts in thousands, except share information)

(unaudited)

	September 30,			December 31,
	2020			2019
Assets:
Real Estate Investments:
Buildings and improvements and construction in progress	$	595,462		$	572,503
Accumulated depreciation		(211,155	)		(194,888	)
		384,307			377,615
Land		54,892			54,892
Net Real Estate Investments		439,199			432,507
Investments in limited liability companies ("LLCs")		4,366			6,918
Other Assets:
Cash and cash equivalents		6,320			6,110
Lease and other receivables from UHS		3,270			2,963
Lease receivable - other		7,306			7,640
Intangible assets (net of accumulated amortization of $19.2 million and $26.5 million, respectively)		12,147			14,553
Right-of-use land assets, net		8,922			8,944
Deferred charges and other assets, net		9,091			9,154
Total Assets	$	490,621		$	488,789
Liabilities:
Line of credit borrowings	$	227,100		$	212,950
Mortgage notes payable, non-recourse to us, net		59,387			60,744
Accrued interest		533			374
Accrued expenses and other liabilities		21,316			12,888
Ground lease liabilities, net		8,922			8,944
Tenant reserves, deposits and deferred and prepaid rents		10,969			11,155
Total Liabilities		328,227			307,055
Equity:
Preferred shares of beneficial interest, $.01 par value; 5,000,000 shares authorized; none issued and outstanding		-			-
Common shares, $.01 par value; 95,000,000 shares authorized; issued and outstanding: 2020 - 13,770,510; 2019 - 13,757,498		138			138
Capital in excess of par value		267,071			266,723
Cumulative net income		675,727			661,280
Cumulative dividends		(775,843	)		(747,417	)
Accumulated other comprehensive (loss)/income		(4,699	)		1,010
Total Equity		162,394			181,734
Total Liabilities and Equity	$	490,621		$	488,789

See accompanying notes to these condensed consolidated financial statements.

Universal Health Realty Income Trust

Condensed Consolidated Statements of Changes in Equity

For the Nine Months Ended September 30, 2020

(amounts in thousands)

(unaudited)

	Common Shares
					Capital in								Accumulated other
	Number				excess of			Cumulative		Cumulative			comprehensive			Total
	of Shares		Amount		par value			net income		dividends			income/(loss)			Equity

January 1, 2020		13,757	$	138	$	266,723		$	661,280	$	(747,417	)	$	1,010		$	181,734
Shares of Beneficial Interest:
Issued, net		14		—		(317	)		—		—			—			(317	)
Restricted stock-based compensation expense		—		—		665			—		—			—			665
Dividends ($2.065/share)		—		—		—			—		(28,426	)		—			(28,426	)
Comprehensive income:
Net income		—		—		—			14,447		—			—			14,447
Unrealized loss on cash flow hedges		—		—		—			—		—			(5,709	)		(5,709	)
Subtotal - comprehensive income									14,447					(5,709	)		8,738
September 30, 2020		13,771	$	138	$	267,071		$	675,727	$	(775,843	)	$	(4,699	)	$	162,394

Universal Health Realty Income Trust

Condensed Consolidated Statements of Changes in Equity

For the Three Months Ended September 30, 2020

(amounts in thousands)

(unaudited)

	Common Shares
					Capital in								Accumulated other
	Number				excess of			Cumulative		Cumulative			comprehensive			Total
	of Shares		Amount		par value			net income		dividends			income/(loss)			Equity

July 1, 2020		13,770	$	138	$	266,843		$	670,534	$	(766,342	)	$	(4,933	)	$	166,240
Shares of Beneficial Interest:
Issued		1		—		(20	)		—		—			—			(20	)
Restricted stock-based compensation expense		—		—		248			—		—			—			248
Dividends ($.69/share)		—		—		—			—		(9,501	)		—			(9,501	)
Comprehensive income:
Net income		—		—		—			5,193		—			—			5,193
Unrealized gain on cash flow hedges		—		—		—			—		—			234			234
Subtotal - comprehensive income									5,193					234			5,427
September 30, 2020		13,771	$	138	$	267,071		$	675,727	$	(775,843	)	$	(4,699	)	$	162,394

See accompanying notes to these condensed consolidated financial statements.

Universal Health Realty Income Trust

Condensed Consolidated Statements of Changes in Equity

For the Nine Months Ended September 30, 2019

(amounts in thousands)

(unaudited)

	Common Shares
					Capital in								Accumulated other
	Number				excess of			Cumulative		Cumulative			comprehensive		Total
	of Shares		Amount		par value			net income		dividends			income/(loss)		Equity

January 1, 2019		13,747	$	137	$	266,031		$	642,316	$	(710,006	)	$	132	$	198,610
Shares of Beneficial Interest:
Issued, net		10		1		(57	)		—		—			—		(56	)
Restricted stock-based compensation expense		—		—		504			—		—			—		504
Dividends ($2.035/share)		—		—		—			—		(27,988	)		—		(27,988	)
Comprehensive income:
Net income		—		—		—			13,126		—			—		13,126
Unrealized gain on cash flow hedges		—		—		—			—		—			429		429
Subtotal - comprehensive income									13,126					429		13,555
September 30, 2019		13,757	$	138	$	266,478		$	655,442	$	(737,994	)	$	561	$	184,625

Universal Health Realty Income Trust

Condensed Consolidated Statements of Changes in Equity

For the Three Months Ended September 30, 2019

(amounts in thousands)

(unaudited)

	Common Shares
					Capital in							Accumulated other
	Number				excess of		Cumulative		Cumulative			comprehensive		Total
	of Shares		Amount		par value		net income		dividends			income/(loss)		Equity

July 1, 2019		13,757	$	138	$	266,252	$	650,789	$	(728,639	)	$	-	$	188,540
Shares of Beneficial Interest:
Issued		—		—		53		—		—			—		53
Restricted stock-based compensation expense		—		—		173		—		—			—		173
Dividends ($.68/share)		—		—		—		—		(9,355	)		—		(9,355	)
Comprehensive income:
Net income		—		—		—		4,653		—			—		4,653
Unrealized gain on cash flow hedges		—		—		—		—		—			561		561
Subtotal - comprehensive income								4,653					561		5,214
September 30, 2019		13,757	$	138	$	266,478	$	655,442	$	(737,994	)	$	561	$	184,625

See accompanying notes to these condensed consolidated financial statements.

Universal Health Realty Income Trust

Condensed Consolidated Statements of Cash Flows

(amounts in thousands)

(unaudited)

	Nine months ended September 30,
	2020			2019
Cash flows from operating activities:
Net income	$	14,447		$	13,126
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		19,160			19,564
Amortization related to below market leases, net		(140	)		(152	)
Amortization of debt premium		(39	)		(40	)
Amortization of deferred financing costs		549			481
Stock-based compensation expense		665			504
Gain on sale of land		—			(250	)
Changes in assets and liabilities:
Lease receivable		27			117
Accrued expenses and other liabilities		49			96
Tenant reserves, deposits and deferred and prepaid rents		(186	)		(676	)
Accrued interest		159			(80	)
Leasing costs paid		(745	)		(824	)
Other, net		(1,171	)		(135	)
Net cash provided by operating activities		32,775			31,731
Cash flows from investing activities:
Investments in LLCs		(3,204	)		(798	)
Cash distributions from LLCs		5,196			343
Additions to real estate investments, net		(18,784	)		(7,459	)
Deposit on real estate assets		—			(200	)
Cash proceeds received from divestiture of property, net		—			245
Net cash used in investing activities		(16,792	)		(7,869	)
Cash flows from financing activities:
Net borrowings on line of credit		14,150			9,250
Repayments of mortgage notes payable		(1,406	)		(3,775	)
Financing costs paid		(372	)		(35	)
Dividends paid		(28,411	)		(27,988	)
Issuance of shares of beneficial interest, net		266			165
Net cash used in financing activities		(15,773	)		(22,383	)
Increase in cash and cash equivalents		210			1,479
Cash and cash equivalents, beginning of period		6,110			5,036
Cash and cash equivalents, end of period	$	6,320		$	6,515
Supplemental disclosures of cash flow information:
Interest paid	$	5,620		$	7,771
Invoices accrued for construction and improvements	$	5,660		$	1,520

See accompanying notes to these condensed consolidated financial statements.

UNIVERSAL HEALTH REALTY INCOME TRUST

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(unaudited)

(1) General

In this Quarterly Report on Form 10-Q, the term “revenues” does not include the revenues of the unconsolidated LLCs in which we have various non-controlling equity interests ranging from 33% to 95%. As of September 30, 2020, we had investments in five jointly-owned LLCs/LPs (including one under construction which is scheduled to be completed in late 2020). We currently account for our share of the income/loss from these investments by the equity method (see Note 5). These LLCs are included in our consolidated financial statements for all periods presented on an unconsolidated basis since they are not variable interest entities for which we are the primary beneficiary, nor do we hold a controlling voting interest.

The condensed consolidated financial statements included herein have been prepared by us, without audit, pursuant to the rules and regulations of the SEC and reflect all normal and recurring adjustments which, in our opinion, are necessary to fairly present results for the interim periods. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America (U.S. GAAP) have been condensed or omitted pursuant to such rules and regulations, although we believe that the accompanying disclosures are adequate to make the information presented not misleading. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements, the notes thereto and accounting policies included in our Annual Report on Form 10-K for the year ended December 31, 2019.

In March 2020, the World Health Organization declared the COVID-19 outbreak a pandemic and the federal government declared COVID-19 a national emergency. As a result of various policies implemented by the federal and state governments, and varying by individual state, many non-essential businesses in the nation were closed for varying time periods. We believe that by June 30, 2020, substantially all of our tenants had resumed operations of their businesses.

Although COVID-19 has not had a material adverse impact on our results of operations through September 30, 2020, we believe that the potentially adverse impact that the pandemic may have on the future operations and financial results of our tenants, and in turn ours, will depend upon many factors, most of which are beyond our, or our tenants’, ability to control or predict. Such factors include, but are not limited to, the length of time and severity of the spread of the pandemic; the volume of cancelled or rescheduled elective procedures and the volume of COVID-19 patients treated by the operators of our hospitals and other healthcare facilities; measures our tenants are taking to respond to the COVID-19 pandemic; the impact of government and administrative regulation, including travel bans and restrictions, shelter-in-place or stay-at-home orders, quarantines, the promotion of social distancing, business shutdowns and limitations on business activity; changes in patient volumes at our tenants’ hospitals and other healthcare facilities due to patients’ general concerns related to the risk of contracting COVID-19 from interacting with the healthcare system; the impact of stimulus on the health care industry and our tenants; changes in patient volumes and payer mix caused by deteriorating macroeconomic conditions (including increases in uninsured and underinsured patients as the result of business closings and layoffs); potential disruptions to clinical staffing and shortages and disruptions related to supplies required for our tenants’ employees and patients, including equipment, pharmaceuticals and medical supplies, particularly personal protective equipment, or PPE; potential increases to expenses incurred by our tenants related to staffing, supply chain or other expenditures; the impact of our indebtedness and the ability to refinance such indebtedness on acceptable terms; disruptions in the financial markets and the business of financial institutions as the result of the COVID-19 pandemic which could impact our ability to access capital or increase associated borrowing costs; and changes in general economic conditions nationally and regionally in the markets our properties are located resulting from the COVID-19 pandemic, including increased unemployment and underemployment levels and reduced consumer spending and confidence. Since the underlying businesses in each of our properties are operated by the tenants, we can provide no assurance that the businesses will continue to operate in the future, or stay current with their lease obligations.

Bonus rents earned by us on the three acute care hospitals leased to wholly-owned subsidiaries of Universal Health Services, Inc., are computed based upon a computation that compares each hospital’s current quarter revenue to the corresponding quarter in the base year, we could therefore experience significant declines in future bonus rental revenue earned on these properties should those hospitals experience significant declines in patient volumes and revenues. These hospitals believe that, to the extent that they experience revenue declines and increased expenses resulting from the COVID-19 pandemic, as ultimately measured over the life of the pandemic, they are eligible for emergency fund grants as provided for by the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”).

Certain factors may result in the inability or unwillingness on the part of some of our tenants to make timely payment of their rent to us at current levels or to seek to amend or terminate their leases which, in turn, would have an adverse effect on our occupancy levels and our revenue and cash flow and the value of our properties, and potentially, our ability to maintain our dividend at current levels. Due to COVID-19 restrictions and its impact on the economy, we may experience a decrease in prospective tenants which could unfavorably impact the volume of new leases, as well as the renewal rate of existing leases. The COVID-19 pandemic could also impact our indebtedness and the ability to refinance such indebtedness on acceptable terms, as well as risks associated with disruptions in the financial markets and the business of financial institutions as the result of the COVID-19 pandemic which could impact us from a financing perspective; and changes in general economic conditions nationally and regionally in the markets our properties are located resulting from the COVID-19 pandemic. Decreases in cash flows and results of operations may have an impact on the inputs and assumptions used in significant accounting estimates, including potential impairments of intangible and long-lived assets.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes.

(2) Relationship with Universal Health Services, Inc. (“UHS”) and Related Party Transactions

Leases: We commenced operations in 1986 by purchasing properties from certain subsidiaries of UHS and immediately leasing the properties back to the respective subsidiaries. Most of the leases were entered into at the time we commenced operations and provided for initial terms of 13 to 15 years with up to six additional 5-year renewal terms. The current base rentals and lease and renewal terms for each of the three hospital facilities leased to subsidiaries of UHS are provided below. The base rents are paid monthly and each lease also provides for additional or bonus rents which are computed and paid on a quarterly basis based upon a computation that compares current quarter revenue to a corresponding quarter in the base year. The three hospital leases with subsidiaries of UHS are unconditionally guaranteed by UHS and are cross-defaulted with one another.

The combined revenues generated from the leases on the UHS hospital facilities accounted for approximately 23% and 21% of our consolidated revenues for the three months ended September 30, 2020 and 2019, respectively, and approximately 22% of our consolidated revenues for each of the nine months ended September 30, 2020 and 2019. In addition, we have seventeen medical office buildings (“MOBs”), or free-standing emergency departments (“FEDs”), that are either wholly or jointly-owned by us (excluding new construction), that include tenants which are subsidiaries of UHS. The aggregate revenues generated from UHS-related tenants comprised approximately 34% and 30% of our consolidated revenues during the three-month periods ended September 30, 2020 and 2019, respectively, and approximately 33% and 31% of our consolidated revenues during the nine-month periods ended September 30, 2020 and 2019, respectively.

Pursuant to the Master Lease Document by and among us and certain subsidiaries of UHS, dated December 24, 1986 (the “Master Lease”), which governs the leases of all hospital properties with subsidiaries of UHS, UHS has the option, among other things, to renew the leases at the lease terms described below by providing notice to us at least 90 days prior to the termination of the then current term. UHS also has the right to purchase the respective leased facilities at the end of the lease terms or any renewal terms at the appraised fair market value. In addition, the Master Lease, as amended in 2006, includes a change of control provision whereby UHS has the right, upon one month’s notice should a change of control of the Trust occur, to purchase any or all of the three leased hospital properties listed below at their appraised fair market value. Additionally, UHS has rights of first refusal to: (i) purchase the respective leased facilities during and for 180 days after the lease terms at the same price, terms and conditions of any third-party offer, or; (ii) renew the lease on the respective leased facility at the end of, and for 180 days after, the lease term at the same terms and conditions pursuant to any third-party offer.

The table below details the existing lease terms and renewal options for our three acute care hospitals operated by wholly-owned subsidiaries of UHS:

Hospital Name	Annual Minimum Rent		End of Lease Term	Renewal Term (years)
McAllen Medical Center	$	5,485,000	December, 2026		5	(a.)
Wellington Regional Medical Center	$	3,030,000	December, 2021		10	(b.)
Southwest Healthcare System, Inland Valley Campus	$	2,648,000	December, 2021		10	(b.)

(a.)	UHS has one 5-year renewal option at the existing lease rate (through 2031).

(b.)	UHS has two 5-year renewal options at fair market value lease rates (2022 through 2031).

A wholly-owned subsidiary of UHS has notified us that they are considering termination of the existing lease on Southwest Healthcare System, Inland Valley Campus, prior to the scheduled expiration of the current term on December 31, 2021. As permitted pursuant to

the terms of the lease, UHS has the right, subject to certain conditions, to propose substitution property with a fair market value substantially equal to that of the existing leased property. UHS is currently evaluating potential substitution properties and is expected to submit their proposal to us by December 31, 2020. Upon receipt, the proposal will be reviewed and evaluated by management of the Trust as well as by our Board of Trustees. All transactions with UHS must be approved by a majority of our Independent Trustees. We can provide no assurance that we will ultimately agree on a property substitution with UHS in connection with the Inland Valley Campus property, in which case, UHS has the right to purchase the property for its fair market value. Pursuant to the terms of the lease on the Inland Valley Campus, we earned $3.3 million of lease revenue during the nine-month period ended September 30, 2020 ($2.0 million in base rental and $1.3 million in bonus rental) and $4.3 million during the year ended December 31, 2019 ($2.6 million in base rental and $1.7 million in bonus rental).

Management cannot predict whether the leases with subsidiaries of UHS, which have renewal options at existing lease rates or fair market value lease rates, or any of our other leases, will be renewed at the end of their lease term. If the leases are not renewed at their current rates or the fair market value lease rates, we would be required to find other operators for those facilities and/or enter into leases on terms potentially less favorable to us than the current leases. In addition, if subsidiaries of UHS exercise their options to purchase the respective leased hospital or FED facilities upon expiration of the lease terms, our future revenues could decrease if we were unable to earn a favorable rate of return on the sale proceeds received, as compared to the lease revenue currently earned pursuant to these leases.

We are the lessee on eleven ground leases with subsidiaries of UHS (for consolidated and unconsolidated investments). The remaining lease terms on the ground leases with subsidiaries of UHS range from approximately 29 years to approximately 79 years. The annual aggregate lease payments on these properties are approximately $482,000 for the year ended 2020 and $482,000 for each of the years ended 2021, 2022, 2023 and 2024, and an aggregate of $27.5 million thereafter. See Note 7 for further disclosure around our lease accounting.

In late July, 2019 and September, 2019 we entered into two separate agreements with entities that are each related to wholly-owned subsidiaries of UHS in connection with newly constructed properties located in Clive, Iowa and Denison, Texas. Please see additional disclosure in Note 4, “New Construction, Acquisitions and Dispositions”.

Officers and Employees: Our officers are all employees of a wholly-owned subsidiary of UHS and although as of September 30, 2020 we had no salaried employees, our officers do typically receive annual stock-based compensation awards in the form of restricted stock. In special circumstances, if warranted and deemed appropriate by the Compensation Committee of the Board of Trustees, our officers may also receive one-time special compensation awards in the form of restricted stock and/or cash bonuses.

Advisory Agreement: UHS of Delaware, Inc. (the “Advisor”), a wholly-owned subsidiary of UHS, serves as Advisor to us under an advisory agreement dated December 24, 1986, and as amended and restated as of January 1, 2019 (the “Advisory Agreement”). Pursuant to the Advisory Agreement, the Advisor is obligated to present an investment program to us, to use its best efforts to obtain investments suitable for such program (although it is not obligated to present any particular investment opportunity to us), to provide administrative services to us and to conduct our day-to-day affairs. All transactions between us and UHS must be approved by the Trustees who are unaffiliated with UHS (the “Independent Trustees”). In performing its services under the Advisory Agreement, the Advisor may utilize independent professional services, including accounting, legal, tax and other services, for which the Advisor is reimbursed directly by us. The Advisory Agreement may be terminated for any reason upon sixty days written notice by us or the Advisor. The Advisory Agreement expires on December 31 of each year; however, it is renewable by us, subject to a determination by the Independent Trustees, that the Advisor’s performance has been satisfactory.

Our advisory fee for the three and nine months ended September 30, 2020 and 2019, was computed at 0.70% of our average invested real estate assets, as derived from our condensed consolidated balance sheets. Based upon a review of our advisory fee and other general and administrative expenses, as compared to an industry peer group, the advisory fee computation remained unchanged for 2020, as compared to the last three years. The average real estate assets for advisory fee calculation purposes exclude certain items from our condensed consolidated balance sheet such as, among other things, accumulated depreciation, cash and cash equivalents, lease receivables, deferred charges and other assets. The advisory fee is payable quarterly, subject to adjustment at year-end based upon our audited financial statements. Advisory fees incurred and paid (or payable) to UHS amounted to approximately $1.0 million for each of the three months ended September 30, 2020 and 2019, and were based upon average invested real estate assets of $594 million and $578 million, respectively. Advisory fees incurred and paid (or payable) to UHS were approximately $3.1 million and $3.0 million for the nine months ended September 30, 2020 and 2019, respectively, and were based upon average invested real estate assets of $587 million and $564 million, respectively.

Share Ownership: As of September 30, 2020 and December 31, 2019, UHS owned 5.7% of our outstanding shares of beneficial interest.

SEC reporting requirements of UHS: UHS is subject to the reporting requirements of the SEC and is required to file annual reports containing audited financial information and quarterly reports containing unaudited financial information. Since the aggregate revenues generated from the UHS-related tenants comprised 34% and 30% of our consolidated revenues during the three-month periods ended September 30, 2020 and 2019, respectively, and 33% and 31% of our consolidated revenues during the nine-month periods ended September 30, 2020 and 2019, respectively, and since a subsidiary of UHS is our Advisor, you are encouraged to obtain the publicly available filings for Universal Health Services, Inc. from the SEC’s website. These filings are the sole responsibility of UHS and are not incorporated by reference herein.

(3) Dividends and Equity Issuance Program

Dividends and dividend equivalents:

During the third quarter of 2020, we declared dividend and dividend equivalents of approximately $9.5 million, or $.69 per share and we paid dividends of approximately $9.5 million, or $.69 per share, on September 30, 2020. We declared and paid dividends of approximately $9.4 million, or $.68 per share, during the third quarter of 2019. During the nine-month period ended September 30, 2020, we declared dividend and dividend equivalents of approximately $28.4 million, or $2.065 per share and we paid dividends of $28.4 million, or $2.065 per share. During the nine-month period ended September 30, 2019, we declared and paid dividends of $28.0 million, or $2.035 per share. Dividend equivalents which were accrued during the three and nine-month periods of 2020 will be paid out upon the vesting of the related restricted stock award.

Equity Issuance Program:

No shares were issued pursuant to this ATM equity program during the third quarter of 2020. During the second quarter of 2020, pursuant to this ATM equity program, we have issued 2,704 shares at an average price of $101.30 per share, which generated approximately $270,000 of net proceeds (net of approximately $4,000, consisting of compensation to BofA Securities, Inc.). Additionally, as of September 30, 2020, we have paid or incurred approximately $507,000 in various fees and expenses related to the commencement of our ATM program.

(4) New Construction, Acquisitions and Dispositions

Nine Months Ended September 30, 2020:

New Construction:

In September, 2019, we entered into an agreement whereby we will own a 95% non-controlling ownership interest in Grayson Properties II L.P., which will develop, construct, own and operate the Texoma Medical Plaza II, an MOB located in Denison, Texas. This MOB, which is scheduled to be completed in late 2020, will be located on the campus of Texoma Medical Center, a hospital that is owned and operated by a wholly-owned subsidiary of UHS. A 10-year master flex lease was executed with the wholly-owned subsidiary of UHS for 40,000 rentable square feet, representing over 50% of the rentable square feet of the MOB. The master flex lease commitment is subject to reduction upon the execution of third-party leases on up to 20,000 rentable square feet of the first and second floors of the three-story MOB, and 20,000 rentable square feet on the third floor. In April, 2020, a new, 122-month lease was fully executed with a third-party tenant for approximately 26,000 rentable square feet on the first floor of the MOB. As a result, the master flex lease commitment was reduced to 20,000 of rentable square feet on the third floor of the MOB. After giving effect to this new lease, 61% of the rentable square feet of the MOB is under lease agreements (including the remaining master lease space). Effective June 1, 2020, a $13.1 million third-party construction loan (non-recourse to us) was obtained by the LP, which is scheduled to mature on June 1, 2025 and has an outstanding loan balance of $10.4 million as of September 30, 2020. Additionally, we have committed to invest up to $4.8 million in equity or member loans in the development and construction of this MOB, none of which has been invested as of September 30, 2020. We account for this LP on an unconsolidated basis pursuant to the equity method since it is not a variable interest entity and we do not have a controlling voting interest.

In July, 2019, Des Moines Medical Properties, LLC, a wholly-owned subsidiary of ours, entered into an agreement to build and lease a newly constructed behavioral health care hospital located in Clive, Iowa. The lease on this facility, which is triple net and has an initial term of 20-years with five 10-year renewal options, was executed with Clive Behavioral Health, LLC, a joint venture between UHS and Catholic Health Initiatives - Iowa, Corp. (d/b/a Mercy One Des Moines Medical Center). Construction of this hospital, for which we have engaged a wholly-owned subsidiary of UHS to act as project manager for an aggregate fee of approximately $750,000, is expected to be completed in late 2020 or early 2021. The hospital lease will commence upon issuance of the certificate of occupancy. The approximate cost of the project is estimated to be $37.5 million and the initial annual rent is estimated to be

approximately $2.7 million. We have invested approximately $25.0 million for land and the development and construction costs of this hospital as of September 30, 2020 (including accrued costs at September 30, 2020).

Acquisitions:

There were no acquisitions during the first nine months of 2020.

Dispositions:

There were no dispositions during the first nine months of 2020.

Nine Months Ended September 30, 2019:

Acquisitions:

There were no acquisitions during the first nine months of 2019.

Dispositions:

There were no dispositions during the first nine months of 2019.

(5) Summarized Financial Information of Equity Affiliates

In accordance with U.S. GAAP and guidance relating to accounting for investments and real estate ventures, we account for our unconsolidated investments in LLCs/LPs which we do not control using the equity method of accounting. The third-party members in these investments have equal voting rights with regards to issues such as, but not limited to: (i) divestiture of property; (ii) annual budget approval, and; (iii) financing commitments. These investments, which represent 33% to 95% non-controlling ownership interests, are recorded initially at our cost and subsequently adjusted for our net equity in the net income, cash contributions to, and distributions from, the investments. Pursuant to certain agreements, allocations of sales proceeds and profits and losses of some of the LLC investments may be allocated disproportionately as compared to ownership interests after specified preferred return rate thresholds have been satisfied.

Distributions received from equity method investees in the consolidated statements of cash flows are classified based upon the nature of the distribution. Returns on investments are presented net of equity in income from unconsolidated investments as cash flows from operating activities. Returns of investments are classified as cash flows from investing activities.

At September 30, 2020, we have non-controlling equity investments or commitments in five jointly-owned LLCs/LPs which own MOBs (including one currently under construction which is scheduled to be completed in late 2020). As of September 30, 2020, we accounted for these LLCs/LPs on an unconsolidated basis pursuant to the equity method since they are not variable interest entities which we are the primary beneficiary nor do we have a controlling voting interest. The majority of these entities are joint-ventures between us and non-related parties that hold minority ownership interests in the entities. Each entity is generally self-sustained from a cash flow perspective and generates sufficient cash flow to meet its operating cash flow requirements and service the third-party debt (if applicable) that is non-recourse to us. Although there is typically no ongoing financial support required from us to these entities since they are cash-flow sufficient, we may, from time to time, provide funding for certain purposes such as, but not limited to, significant capital expenditures, leasehold improvements and debt financing. Although we are not obligated to do so, if approved by us at our sole discretion, additional cash funding is typically advanced as equity or member loans. These entities maintain property insurance on the properties.

The following property table represents the five LLCs/LPs in which we own a non-controlling interest (including one that is currently under construction) and were accounted for under the equity method as of September 30, 2020:


Name of LLC/LP	Ownership			Property Owned by LLC/LP
Suburban Properties		33	%	St. Matthews Medical Plaza II
Brunswick Associates (a.)(e.)		74	%	Mid Coast Hospital MOB
Grayson Properties (b.)(f.)		95	%	Texoma Medical Plaza
FTX MOB Phase II (c.)		95	%	Forney Medical Plaza II
Grayson Properties II (d.)(f.)		95	%	Texoma Medical Plaza II

(a.)	This LLC has a third-party term loan of $7.9 million, which is non-recourse to us, outstanding as of September 30, 2020.

(b.)	This building is on the campus of a UHS hospital and has tenants that include subsidiaries of UHS. This LP has a third-party term loan, which is non-recourse to us, of $13.4 million, outstanding as of September 30, 2020.

(c.)

We have committed to invest up to $2.5 million in equity and debt financing, of which $2.1 million has been funded as of September 30, 2020. This LP has a third-party term loan, which is non-recourse to us, of $4.8 million, outstanding as of September 30, 2020. This loan, originally scheduled to mature on October 1, 2020, was extended with a new maturity date of February 1, 2021.

(d.)

This MOB, currently under construction, will be located in Denison, Texas on the campus of a hospital owned and operated by a wholly-owned subsidiary of UHS. We have committed to invest up to $4.8 million in equity and debt financing, none of which has been funded as of September 30, 2020. This LP entered into a $13.1 million third-party construction loan, which is non-recourse to us and has an outstanding balance of $10.4 million as of September 30, 2020. The LP will develop, construct, own and operate the Texoma Medical Plaza II which is expected to open in late 2020.

(e.)	The LLC is the lessee with a third party lessor under a ground lease for land.

(f.)	The LPs are the lessee, or have committed to a lease, with a UHS-related party for the land related to this property.

Below are the condensed combined statements of income (unaudited) for the four LLCs/LPs (excluding one that owns an MOB that is currently under construction) accounted for under the equity method at September 30, 2020 and 2019.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
	(amounts in thousands)				(amounts in thousands)
Revenues	$	2,624	$	2,441	$	7,637	$	7,432
Operating expenses		1,047		927		3,094		2,933
Depreciation and amortization		444		434		1,333		1,317
Interest, net		315		325		949		969
Net income	$	818	$	755	$	2,261	$	2,213
Our share of net income	$	517	$	453	$	1,371	$	1,337

Below are the condensed combined balance sheets (unaudited) for the five above-mentioned LLCs/LPs (including one LP that currently owns an MOB under construction) that were accounted for under the equity method as of September 30, 2020 and December 31, 2019:

	September 30, 2020			December 31, 2019
	(amounts in thousands)
Net property, including construction in progress	$	40,979		$	33,207
Other assets (a.)		8,275			7,452
Total assets	$	49,254		$	40,659

Other liabilities (a.)	$	7,384		$	6,785
Mortgage notes payable, non-recourse to us		36,525			26,650
Equity		5,345			7,224
Total liabilities and equity	$	49,254		$	40,659

Investments in LLCs before amounts included in
accrued expenses and other liabilities	$	4,366		$	6,918
Amounts included in accrued expenses and other liabilities		(1,544	)		(1,856	)
Our share of equity in LLCs, net	$	2,822		$	5,062

(a.) Other assets and other liabilities as of both September 30, 2020 and December 31, 2019 includes approximately $3.7 million of right-of-use land assets and right-of-use land liabilities related to ground leases whereby the LLC/LP is the lessee, with third party lessors, including subsidiaries of UHS.

As of September 30, 2020, and December 31, 2019, aggregate principal amounts due on mortgage notes payable by unconsolidated LLCs/LPs, which are accounted for under the equity method and are non-recourse to us, are as follows (amounts in thousands):

	Mortgage Loan Balance (a.)
Name of LLC/LP	9/30/2020		12/31/2019		Maturity Date
FTX MOB Phase II (5.00% fixed rate mortgage loan) (b.)	$	4,814	$	4,926	February, 2021
Grayson Properties (5.034% fixed rate mortgage loan) (c.)		13,442		13,658	September, 2021
Brunswick Associates (3.64% fixed rate mortgage loan)		7,917		8,066	December, 2024
Grayson Properties II (3.70% fixed rate construction loan) (d.)		10,352		-	June, 2025
	$	36,525	$	26,650

(a.)

All mortgage loans require monthly principal payments through maturity and include a balloon principal payment upon maturity.

(b.)

This loan, originally scheduled to mature on October 1, 2020, was extended with a new maturity date of February 1, 2021, at which time the venture intends to refinance pursuant to a new mortgage loan.

(c.)

This loan is scheduled to mature within the next twelve months, at which time the venture intends to refinance pursuant to a new mortgage loan.

(d.)

This construction loan has a maximum balance of $13.1 million and requires unpaid interest on the outstanding principal balance to be paid on a monthly basis through December 1, 2022. Principal and accrued interest monthly payments will commence on January 1, 2023.

Pursuant to the operating and/or partnership agreements of the five LLCs/LPs in which we continue to hold non-controlling ownership interests, the third-party member and/or the Trust, at any time, potentially subject to certain conditions, have the right to make an offer (“Offering Member”) to the other member(s) (“Non-Offering Member”) in which it either agrees to: (i) sell the entire ownership interest of the Offering Member to the Non-Offering Member (“Offer to Sell”) at a price as determined by the Offering Member (“Transfer Price”), or; (ii) purchase the entire ownership interest of the Non-Offering Member (“Offer to Purchase”) at the equivalent proportionate Transfer Price. The Non-Offering Member has 60 to 90 days to either: (i) purchase the entire ownership interest of the Offering Member at the Transfer Price, or; (ii) sell its entire ownership interest to the Offering Member at the equivalent proportionate Transfer Price. The closing of the transfer must occur within 60 to 90 days of the acceptance by the Non-Offering Member.

(6) Recent Accounting Pronouncements

Accounting for Lease Concessions Granted in Connection with the COVID-19 Pandemic

On April 8, 2020, the Financial Accounting Standards Board ("FASB") held a public meeting and shortly afterwards issued a question-and-answer ("Q&A") document which was intended to provide accounting relief for lease concessions related to the COVID-19 pandemic. The accounting relief permits an entity to choose to forgo the evaluation of the enforceable rights and obligations of a lease contract, which is a requirement of Accounting Standards Codification Topic 842, Leases, as long as the total rent payments after the lease concessions are substantially the same, or less than, the total payments previously required by the lease. An entity may account for COVID-19 related lease concessions either (i) as if they were part of the enforceable rights and obligations of the parties under the existing lease contract; or (ii) as a lease modification. To the extent that a rent concession is granted as a deferral of payments, but the total lease payments are substantially the same, lessors are allowed to account for the concession as if no change had been made to the original lease contract.

Based on the Q&A, an entity is not required to account for all lease concessions related to the effects of the COVID-19 pandemic under one elected option, however, the entity is required to apply the elected option consistently to leases with similar characteristics and in similar circumstances. The COVID-19 pandemic did not start to adversely impact the economic conditions in the United States until late March 2020 and did not have a material effect on our operations or financial results during the three or nine months ended September 30, 2020.

We have received short-term rent deferral requests from a portion of tenants under lease at our MOBs. These requests are under review on a request-by-request basis based upon each tenant’s specific circumstances as well as consideration of potential economic benefit available and received by tenants through governmental assistance programs. At this time, we cannot estimate the magnitude of short-term rent deferral requests that we may ultimately agree to provide, or the magnitude of additional short-term rent deferral requests that we may receive in the future.

Reference Rate Reform

In March 2020, the FASB issued an accounting standard classified under FASB ASC Topic 848, “Reference Rate Reform.” The amendments in this update contain practical expedients for reference rate reform related activities that impact debt, leases, derivatives

and other contracts. The guidance in ASC 848 is optional and may be elected over time as reference rate reform activities occur. We will evaluate the impact of the guidance and may apply elections as applicable as additional changes in the market occur.

Financial Instruments – Credit Losses

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses," which introduced new guidance for an approach based on expected losses to estimate credit losses on certain types of financial instruments. Instruments in scope include loans, held-to-maturity debt securities, and net investments in leases as well as reinsurance and trade receivables. In November 2018, the FASB issued ASU 2018-19, which clarifies that operating lease receivables are outside the scope of the new standard. The standard was effective for us in fiscal years beginning after December 15, 2019. The adoption of this guidance did not have a material impact on our consolidated financial statements.

(7) Lease Accounting

As Lessor:

We lease our operating properties to customers under agreements that are classified as operating leases. We recognize the total minimum lease payments provided for under the leases on a straight-line basis over the lease term. Generally, under the terms of our leases, the majority of our rental expenses, including common area maintenance, real estate taxes and insurance, are recovered from our customers. We record amounts reimbursed by customers in the period that the applicable expenses are incurred, which is generally ratably throughout the term of the lease. We have elected the package of practical expedients that allows lessors to not separate lease and non-lease components by class of underlying asset. This practical expedient allowed us to not separate expenses reimbursed by our customers (“tenant reimbursements”) from the associated rental revenue if certain criteria were met. We assessed these criteria and concluded that the timing and pattern of transfer for rental revenue and the associated tenant reimbursements are the same, and as our leases qualify as operating leases, we accounted for and presented rental revenue and tenant reimbursements as a single component under Lease revenue in our condensed consolidated statements of income for the three and nine months ended September 30, 2020 and 2019.

The components of the “Lease revenue – UHS facilities” and “Lease revenue – Non-related parties” captions for the three and nine month periods ended September 30, 2020 and 2019 are disaggregated below (in thousands). Base rents are primarily stated rent amounts provided for under the leases that are recognized on a straight-line basis over the lease term. Bonus rents and tenant reimbursements represent amounts where tenants are contractually obligated to pay an amount that is variable in nature.

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019
UHS facilities:
Base rents	$	4,402	$	4,159	$	12,940	$	12,448
Bonus rents		1,680		1,428		4,477		4,174
Tenant reimbursements		299		234		826		643
Lease revenue - UHS facilities	$	6,381	$	5,821	$	18,243	$	17,265



Non-related parties:
Base rents		10,390		10,979		31,155		31,999
Tenant reimbursements		2,451		2,576		7,371		7,465
Lease revenue - Non-related parties	$	12,841	$	13,555	$	38,526	$	39,464

Disclosures Related to Certain Hospital Facilities:

Southwest Healthcare System, Inland Valley Campus:

A wholly-owned subsidiary of UHS has notified us that they are considering termination of the existing lease on Southwest Healthcare System, Inland Valley Campus prior to the scheduled expiration of the current term on December 31, 2021. As permitted pursuant to the terms of the lease, UHS has the right, subject to certain conditions, to propose substitution property with a fair market value substantially equal to that of the existing leased property. UHS is currently evaluating potential substitution properties and is expected to submit their proposal to us by December 31, 2020. Upon receipt, the proposal will be reviewed and evaluated by management of

the Trust as well as by our Board of Trustees. All transactions with UHS must be approved by a majority of our Independent Trustees. We can provide no assurance that we will ultimately agree on a property substitution with UHS in connection with the Inland Valley Campus property, in which case, UHS has the right to purchase the property for its fair market value. Pursuant to the terms of the lease on the Inland Valley Campus, we earned $3.3 million of lease revenue during the nine-month period ended September 30, 2020 ($2.0 million in base rental and $1.3 million in bonus rental) and $4.3 million during the year ended December 31, 2019 ($2.6 million in base rental and $1.7 million in bonus rental).

Vacancies - Evansville, Indiana and Corpus Christi, Texas:

The leases on two hospital facilities, located in Evansville, Indiana, and Corpus Christi, Texas, expired on May 31, 2019 and June 1, 2019, respectively. The former tenant of the hospital located in Evansville, Indiana, entered into a short-term lease with us, which covered the period of June 1, 2019 through September 30, 2019, at a substantially increased lease rate as compared to the original lease rate.

The combined lease revenue generated at these facilities amounted to approximately $842,000 and $1.7 million during the three and nine-month periods ended September 30, 2019, respectively. The hospital located in Evansville, Indiana, has remained vacant since September 30, 2019 and the hospital located in Corpus Christi, Texas, has remained vacant since June 1, 2019.

We continue to market each property for lease to new tenants. However, should these properties continue to remain owned and vacant for an extended period of time, or should we experience decreased lease rates on future leases, as compared to prior/expired lease rates, or incur substantial renovation costs to make the properties suitable for other operators/tenants, our future results of operations could be materially unfavorably impacted.

Kindred Hospital Chicago Central:

The existing lease with Kindred Hospital Chicago Central is scheduled to expire on December 31, 2021. Pursuant to the terms of the lease, we earned approximately $1.2 million of lease revenue during the nine-month period ended September 30, 2020, and approximately $1.5 million during the year ended December 31, 2019. We can provide no assurance that the lease on this facility, which during the year ended December 31, 2019 did not generate sufficient operating income to cover its rent due to us, will be renewed, or renewed at existing lease rates, upon maturity.

As Lessee:

We are the lessee with various third parties, including subsidiaries of UHS, in connection with ground leases for land at fourteen of our consolidated properties. Our right-of-use land assets represent our right to use the land for the lease term and our lease liabilities represent our obligation to make lease payments arising from the leases. Right-of-use assets and lease liabilities were recognized upon adoption of Topic 842 based on the present value of lease payments over the lease term. We utilized our estimated incremental borrowing rate, which was derived from information available as of January 1, 2019, in determining the present value of lease payments. A right-of-use asset and lease liability are not recognized for leases with an initial term of 12 months or less, as these short-term leases are accounted for similar to previous guidance for operating leases. We do not currently have any ground leases with an initial term of 12 months or less. As of September 30, 2020, our condensed consolidated balance sheet includes right-of-use land assets of approximately $8.9 million and ground lease liabilities of approximately $8.9 million. There were no newly leased assets for which a right-of-use asset was recorded in exchange for a new lease liability during the nine months ended September 30, 2020.

(8) Debt and Financial Instruments

Debt:

Management routinely monitors and analyzes the Trust’s capital structure in an effort to maintain the targeted balance among capital resources including the level of borrowings pursuant to our $350 million revolving credit facility, the level of borrowings pursuant to non-recourse mortgage debt secured by the real property of our properties and our level of equity including consideration of additional equity issuances pursuant to our ATM equity issuance program. This ongoing analysis considers factors such as the current debt market and interest rate environment, the current/projected occupancy and financial performance of our properties, the current loan-to-value ratio of our properties, the Trust’s current stock price, the capital resources required for anticipated acquisitions and the expected capital to be generated by anticipated divestitures. This analysis, together with consideration of the Trust’s current balance of revolving credit agreement borrowings, non-recourse mortgage borrowings and equity, assists management in deciding which capital resource to utilize when events such as refinancing of specific debt components occur or additional funds are required to finance the Trust’s growth.

designated as the “Revolving B Facility”, was established thereby increasing the aggregate revolving credit commitment to $350 million from $300 million. The Credit Agreement, as amended, which is scheduled to mature in March 2022, provides for a revolving credit facility in an aggregate principal amount of $350 million, including a $40 million sublimit for letters of credit and a $30 million sublimit for swingline/short-term loans. Borrowings under the Credit Agreement are guaranteed by certain subsidiaries of the Trust. In addition, borrowings under the Credit Agreement are secured by first priority security interests in and liens on all equity interests in certain of the Trust’s wholly-owned subsidiaries. The remainder of the revolving credit commitments provided under the Credit Agreement that were in effect prior to giving effect to the First Amendment, has been designated as the “Revolving A Facility”.

Borrowings made pursuant to the Revolving A Facility will bear interest, at our option, at one, two, three, or six-month LIBOR plus an applicable margin ranging from 1.10% to 1.35% or at the Base Rate plus an applicable margin ranging from 0.10% to 0.35%. The Credit Agreement defines “Base Rate” as the greater of: (a) the administrative agent’s prime rate; (b) the federal funds effective rate plus 1/2 of 1%, and; (c) one month LIBOR plus 1%. A facility fee of 0.15% to 0.35% will be charged on the total commitment of the Revolving A Facility of the Credit Agreement. The margins over LIBOR, Base Rate and the facility fee are based upon our total leverage ratio. At September 30, 2020, the applicable margin over the LIBOR rate was 1.20%, the margin over the Base Rate was 0.20%, and the facility fee was 0.20%. The Credit Agreement also provides for options to extend the maturity date and borrowing availability for two additional six-month periods for the Revolving A Facility.

Borrowings made pursuant to the Revolving B Facility will bear interest, at our option, at one, two, three, or six months LIBOR plus an applicable margin ranging from 1.85% to 2.10% or at the Base Rate plus an applicable margin ranging from 0.85% to 1.10%. The Credit Agreement defines “Base Rate” as the greatest of (a) the Administrative Agent’s prime rate, (b) the federal funds effective rate plus 1/2 of 1% and (c) one month LIBOR plus 1%. The initial applicable margin is 1.95% for LIBOR loans and 0.95% for Base Rate loans. A facility fee of 0.15% to 0.35% will be charged on the total commitment of the Revolving B Facility of the Credit Agreement. The margins over LIBOR, Base Rate and the facility fee are based upon our total leverage ratio. At September 30, 2020, the applicable margin over the LIBOR rate was 1.95%, the margin over the Base Rate was 0.95% and the facility fee was 0.20%.

At September 30, 2020, we had $227.1 million of outstanding borrowings and $5.6 million of letters of credit outstanding under our Credit Agreement. We had $117.3 million of available borrowing capacity, net of the outstanding borrowings and letters of credit outstanding as of September 30, 2020. There are no compensating balance requirements. At December 31, 2019, we had $213.0 million of outstanding borrowings outstanding against our revolving credit agreement and $87.0 million of available borrowing capacity.

The Credit Agreement contains customary affirmative and negative covenants, including limitations on certain indebtedness, liens, acquisitions and other investments, fundamental changes, asset dispositions and dividends and other distributions. The Credit Agreement also contains restrictive covenants regarding the Trust’s ratio of total debt to total assets, the fixed charge coverage ratio, the ratio of total secured debt to total asset value, the ratio of total unsecured debt to total unencumbered asset value, and minimum tangible net worth, as well as customary events of default, the occurrence of which may trigger an acceleration of amounts outstanding under the Credit Agreement. We are in compliance with all of the covenants at September 30, 2020 and December 31, 2019. We also believe that we would remain in compliance if, based on the assumption that the majority of the potential new borrowings will be used to fund investments, the full amount of our commitment was borrowed.

The following table includes a summary of the required compliance ratios, giving effect to the covenants contained in the Credit Agreement (dollar amounts in thousands):

	Covenant	September 30, 2020			December 31, 2019
Tangible net worth	> =$125,000	$	150,247		$	167,181
Total leverage	< 60%		44.0	%		42.3	%
Secured leverage	< 30%		8.8	%		9.1	%
Unencumbered leverage	< 60%		40.6	%		38.5	%
Fixed charge coverage	> 1.50x	4.5x			4.0x

As indicated on the following table, we have various mortgages, all of which are non-recourse to us, included on our condensed consolidated balance sheet as of September 30, 2020 (amounts in thousands):

Facility Name	Outstanding Balance (in thousands) (a.)			Interest Rate			Maturity Date
700 Shadow Lane and Goldring MOBs fixed rate mortgage loan	$	5,492			4.54	%	June, 2022
BRB Medical Office Building fixed rate mortgage loan		5,560			4.27	%	December, 2022
Desert Valley Medical Center fixed rate mortgage loan		4,549			3.62	%	January, 2023
2704 North Tenaya Way fixed rate mortgage loan		6,615			4.95	%	November, 2023
Summerlin Hospital Medical Office Building III fixed rate mortgage loan		13,101			4.03	%	April, 2024
Tuscan Professional Building fixed rate mortgage loan		3,076			5.56	%	June, 2025
Phoenix Children’s East Valley Care Center fixed rate mortgage loan		8,780			3.95	%	January, 2030
Rosenberg Children's Medical Plaza fixed rate mortgage loan		12,565			4.42	%	September, 2033
Total, excluding net debt premium and net financing fees		59,738
Less net financing fees		(505	)
Plus net debt premium		154
Total mortgages notes payable, non-recourse to us, net	$	59,387

(a.)

All mortgage loans require monthly principal payments through maturity and either fully amortize or include a balloon principal payment upon maturity.

The mortgages are secured by the real property of the buildings as well as property leases and rents. The mortgages outstanding as of September 30, 2020 had a combined fair value of approximately $63.1 million. At December 31, 2019, we had various mortgages, all of which were non-recourse to us, included in our condensed consolidated balance sheet. The combined outstanding balance of these various mortgages at December 31, 2019 was $61.1 million and had a combined fair value of approximately $63.1 million. The fair value of our debt was computed based upon quotes received from financial institutions. We consider these to be “level 2” in the fair value hierarchy as outlined in the authoritative guidance for disclosure in connection with debt instruments. Changes in market rates on our fixed rate debt impacts the fair value of debt, but it has no impact on interest incurred or cash flow.

Financial Instruments:

In March 2020, we entered into an interest rate swap agreement on a total notional amount of $55 million with a fixed interest rate of 0.565% that we designated as a cash flow hedge. The interest rate swap became effective on March 25, 2020 and is scheduled to mature on March 25, 2027. If the one-month LIBOR is above 0.565%, the counterparty pays us, and if the one-month LIBOR is less than 0.565%, we pay the counterparty, the difference between the fixed rate of 0.565% and one-month LIBOR.

In January 2020, we entered into an interest rate swap agreement on a total notional amount of $35 million with a fixed interest rate of 1.4975% that we designated as a cash flow hedge. The interest rate swap became effective on January 15, 2020 and is scheduled to mature on September 16, 2024. If the one-month LIBOR is above 1.4975%, the counterparty pays us, and if the one-month LIBOR is less than 1.4975%, we pay the counterparty, the difference between the fixed rate of 1.4975% and one-month LIBOR.

During the third quarter of 2019, we entered into an interest rate swap agreement on a total notional amount of $50 million with a fixed interest rate of 1.144% that we designated as a cash flow hedge. The interest rate swap became effective on September 16, 2019 and is scheduled to mature on September 16, 2024. If the one-month LIBOR is above 1.144%, the counterparty pays us, and if the one-month LIBOR is less than 1.144%, we pay the counterparty, the difference between the fixed rate of 1.144% and one-month LIBOR.

pursuant to the terms of the swap (consisting of approximately $199,000 in payments or accruals made to us by the counterparty, offset by approximately $521,000 of payments due to the counterparty from us). Cash flow hedges are accounted for by recording the fair value of the derivative instrument on the balance sheet as either an asset or a liability, with a corresponding amount recorded in accumulated other comprehensive income (“AOCI”) within shareholders’ equity. Amounts are classified from AOCI to the income statement in the period or periods the hedged transaction affects earnings.

During the third quarter of 2016, we entered into an additional interest rate cap agreement on a total notional amount of $30 million whereby we paid a premium of $55,000. This interest rate cap became effective in October, 2016 and expired in March, 2019. In exchange for the premium payment, the counterparties agreed to pay us the difference between 1.5% and one-month LIBOR if one-month LIBOR rises above 1.5% during the term of the cap. From inception through the March, 2019 expiration, we received approximately $205,000 in payments made to us by the counterparties ($61,000 of which was received during the first three months of 2019 and $144,000 of which was received during 2018) pursuant to the terms of this cap.

During the second quarter of 2016, we entered into an interest rate cap on the total notional amount of $30 million whereby we paid a premium of $115,000. This interest rate cap became effective in January, 2017 and expired in March 2019. In exchange for the premium payment, the counterparties agreed to pay us the difference between 1.50% and one-month LIBOR if one-month LIBOR rises above 1.50% during the term of the cap. From inception through the March, 2019 expiration, we received approximately $205,000 in payments made to us by the counterparties ($61,000 of which was received during the first three months of 2019 and $144,000 of which was received during 2018) pursuant to the terms of this cap.

(9) Segment Reporting

Our primary business is investing in and leasing healthcare and human service facilities through direct ownership or through joint ventures, which aggregate into a single reportable segment. We actively manage our portfolio of healthcare and human service facilities and may from time to time make decisions to sell lower performing properties not meeting our long-term investment objectives. The proceeds of sales are typically reinvested in new developments or acquisitions, which we believe will meet our planned rate of return. It is our intent that all healthcare and human service facilities will be owned or developed for investment purposes. Our revenue and net income are generated from the operation of our investment portfolio.

Our portfolio is located throughout the United States, however, we do not distinguish or group our operations on a geographical basis for purposes of allocating resources or measuring performance. We review operating and financial data for each property on an individual basis; therefore, we define an operating segment as our individual properties. Individual properties have been aggregated into one reportable segment based upon their similarities with regard to both the nature and economics of the facilities, tenants and operational processes, as well as long-term average financial performance. No individual property meets the requirements necessary to be considered its own segment.

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

Overview

We are a real estate investment trust (“REIT”) that commenced operations in 1986. We invest in healthcare and human service related facilities currently including acute care hospitals, behavioral health care hospitals, specialty hospitals, free-standing emergency departments, childcare centers and medical/office buildings. As of October 31, 2020, we have seventy-one real estate investments or commitments located in twenty states consisting of:

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seven hospital facilities consisting of three acute care, one behavioral health care (currently under construction), one rehabilitation (currently vacant) and two sub-acute (one of which is currently vacant);

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four free-standing emergency departments (“FEDs”);

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fifty-six medical/office buildings, including five owned by unconsolidated limited liability companies (“LLCs”)/limited liability partnerships (“LPs”), (one of which is currently under construction), and;

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four preschool and childcare centers.

Forward Looking Statements and Certain Risk Factors

You should carefully review all of the information contained in this Quarterly Report, and should particularly consider any risk factors that we set forth in this Quarterly Report and in other reports or documents that we file from time to time with the Securities and Exchange Commission (the “SEC”). In this Quarterly Report, we state our beliefs of future events and of our future financial performance. In some cases, you can identify those so-called “forward-looking statements” by words such as “may,” “will,” “should,” “could,” “would,” “predicts,” “potential,” “continue,” “expects,” “anticipates,” “future,” “intends,” “plans,” “believes,” “estimates,” “appears,” “projects” and similar expressions, as well as statements in future tense. You should be aware that those statements are only our predictions. Actual events or results may differ materially. In evaluating those statements, you should specifically consider various factors, including the risks incorporated by reference in Item 1A Risk Factors and described elsewhere herein and in our Annual Report on Form 10-K for the year ended December 31, 2019 in Item 1A Risk Factors and in Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations—Forward Looking Statements. Those factors may cause our actual results to differ materially from any of our forward-looking statements.

Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of the times at, or by which, such performance or results will be achieved. Forward-looking information is based on information available at the time and/or our good faith belief with respect to future events, and is subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in the statements. Such factors include, among other things, the following:

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Future operations and financial results of our tenants, and in turn ours, will likely be materially impacted by numerous factors and future developments related to COVID-19. Such factors and developments include, but are not limited to, the length of time and severity of the spread of the pandemic; the volume of cancelled or rescheduled elective procedures and the volume of COVID-19 patients treated by the operators of our hospitals and other healthcare facilities; measures our tenants are taking to respond to the COVID-19 pandemic; the impact of government and administrative regulation, including travel bans and restrictions, shelter-in-place or stay-at-home orders, quarantines, the promotion of social distancing, business shutdowns and limitations on business activity; changes in patient volumes at our tenants’ hospitals and other healthcare facilities due to patients’ general concerns related to the risk of contracting COVID-19 from interacting with the healthcare system; the impact of stimulus on the health care industry and our tenants; changes in patient volumes and payer mix caused by deteriorating macroeconomic conditions (including increases in uninsured and underinsured patients as the result of business closings and layoffs); potential disruptions to clinical staffing and shortages and disruptions related to supplies required for our tenants’ employees and patients, including equipment, pharmaceuticals and medical supplies, particularly personal protective equipment, or PPE; potential increases to expenses incurred by our tenants related to staffing, supply chain or other expenditures; the impact of our indebtedness and the ability to refinance such indebtedness on acceptable terms; disruptions in the financial markets and the business of financial institutions as the result of the COVID-19 pandemic which could impact our ability to access capital or increase associated borrowing costs; and changes in general economic conditions nationally and regionally in the markets our properties are located resulting from the COVID-19 pandemic, including higher sustained rates of unemployment and underemployment levels and reduced consumer spending and confidence. There may be significant declines in future bonus rental revenue earned on our hospital properties leased to subsidiaries of UHS to the extent that each hospital continues to experience significant decline in patient volumes and revenues. These factors may result in the inability or unwillingness on the part of some of our tenants to make timely payment of their rent to us at current levels or to seek to amend or terminate their leases which, in turn, would have an adverse effect on our occupancy levels and

our revenue and cash flow and the value of our properties, and potentially, our ability to maintain our dividend at current levels.

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Due to COVID-19 restrictions and its impact on the economy, we may experience a decrease in prospective tenants which could unfavorably impact the volume of new leases, as well as the renewal rate of existing leases. The COVID-19 pandemic may delay our construction projects which could result in increased costs and delay the timing of opening and rental payments from those projects, although no such delays have yet occurred. The COVID-19 pandemic could also impact our indebtedness and the ability to refinance such indebtedness on acceptable terms, as well as risks associated with disruptions in the financial markets and the business of financial institutions as the result of the COVID-19 pandemic which could impact us from a financing perspective; and changes in general economic conditions nationally and regionally in the markets our properties are located resulting from the COVID-19 pandemic. We are not able to fully quantify the impact that these factors will have on our financial results during 2020, but developments related to the COVID-19 pandemic are likely to have a material adverse impact on our future financial results.

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Recent legislation, including the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) and the Paycheck Protection Program and Health Care Enhancement Act (“PPPHCE Act”), has provided grant funding to hospitals and other healthcare providers to assist them during the COVID-19 pandemic. There is a high degree of uncertainty surrounding the implementation of the CARES Act and the PPPHCE Act, and the federal government may consider additional stimulus and relief efforts, but we are unable to predict whether additional stimulus measures will be enacted or their impact. There can be no assurance as to the total amount of financial and other types of assistance our tenants will receive under the CARES Act and the PPPHCE Act, and it is difficult to predict the impact of such legislation on our tenants’ operations or how they will affect operations of our tenants’ competitors. Moreover, we are unable to assess the extent to which anticipated negative impacts on our tenants (and, in turn, us) arising from the COVID-19 pandemic will be offset by amounts or benefits received or to be received under the CARES Act and the PPPHCE Act.

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A substantial portion of our revenues are dependent upon one operator, UHS, which comprised approximately 34% and 30% of our consolidated revenues for the three-month periods ended September 30, 2020 and 2019, respectively, and approximately 33% and 31% of our consolidated revenues for the nine-month periods ended September 30, 2020 and 2019, respectively. We cannot assure you that subsidiaries of UHS will renew the leases on our three acute care hospitals (two of which are scheduled to expire in December, 2021 and one of which is scheduled to expire in December, 2026) and two FEDs at existing lease rates or fair market value lease rates. In addition, if subsidiaries of UHS exercise their options to purchase the respective leased hospital facilities and FEDs upon expiration of the lease terms or otherwise, our future revenues and results of operations could decrease if we were unable to earn a favorable rate of return on the sale proceeds received, as compared to the rental revenue currently earned pursuant to these leases. Please see Note 7 to the condensed consolidated financial statements - Lease Accounting, for additional information related to a potential transaction with a wholly-owned subsidiary of UHS in connection with Southwest Healthcare System, Inland Valley Campus.

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In certain of our markets, the general real estate market has been unfavorably impacted by increased competition/capacity and decreases in occupancy and rental rates which may adversely impact our operating results and the underlying value of our properties.

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A number of legislative initiatives have recently been passed into law that may result in major changes in the health care delivery system on a national or state level to the operators of our facilities, including UHS. No assurances can be given that the implementation of these new laws will not have a material adverse effect on the business, financial condition or results of operations of our operators.

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The potential indirect impact of the Tax Cuts and Jobs Act of 2017, signed into law on December 22, 2017, which makes significant changes to corporate and individual tax rates and calculation of taxes, which could potentially impact our tenants and jurisdictions, both positively and negatively, in which we do business, as well as the overall investment thesis for REITs.

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A subsidiary of UHS is our Advisor and our officers are all employees of a wholly-owned subsidiary of UHS, which may create the potential for conflicts of interest.

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Lost revenues resulting from the exercise of purchase options, lease expirations and renewals and other transactions (see Note 7 to the condensed consolidated financial statements – Lease Accounting for additional disclosure related to lease expirations and subsequent vacancies that occurred during the second and third quarters of 2019 on two hospital facilities.

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Our ability to continue to obtain capital on acceptable terms, including borrowed funds, to fund future growth of our business.

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The outcome and effects of known and unknown litigation, government investigations, and liabilities and other claims asserted against us, UHS or the other operators of our facilities. UHS and its subsidiaries are subject to legal actions, purported shareholder class actions and shareholder derivative cases, governmental investigations and regulatory actions and the effects of adverse publicity relating to such matters. Since UHS comprised approximately 34% and 30% of our consolidated revenues during the three-month periods ended September 30, 2020 and 2019, respectively, and 33% and 31% of our consolidated revenues during the nine-month periods ended September 30, 2020 and 2019, respectively, and since a subsidiary of UHS is our Advisor, you are encouraged to obtain and review the disclosures contained in the Legal Proceedings section of Universal Health Services, Inc.’s Forms 10-Q and 10-K, as publicly filed with the Securities and Exchange Commission. Those filings are the sole responsibility of UHS and are not incorporated by reference herein.

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Failure of UHS or the other operators of our hospital facilities to comply with governmental regulations related to the Medicare and Medicaid licensing and certification requirements could have a material adverse impact on our future revenues and the underlying value of the property.

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The potential unfavorable impact on our business of the deterioration in national, regional and local economic and business conditions, including a further worsening of credit and/or capital market conditions, which may adversely affect our ability to obtain capital which may be required to fund the future growth of our business and refinance existing debt with near term maturities.

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A continuation in the deterioration in general economic conditions which has resulted in increases in the number of people unemployed and/or insured and likely increase the number of individuals without health insurance; as a result, the operators of our facilities may experience declines in patient volumes which could result in decreased occupancy rates at our medical office buildings.

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A continuation of the worsening of the economic and employment conditions in the United States will likely materially affect the business of our operators, including UHS, which will likely unfavorably impact our future bonus rentals (on the UHS hospital facilities) and may potentially have a negative impact on the future lease renewal terms and the underlying value of the hospital properties.

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Real estate market factors, including without limitation, the supply and demand of office space and market rental rates, changes in interest rates as well as an increase in the development of medical office condominiums in certain markets.

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The impact of property values and results of operations of severe weather conditions, including the effects of hurricanes.

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Government regulations, including changes in the reimbursement levels under the Medicare and Medicaid programs.

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The issues facing the health care industry that affect the operators of our facilities, including UHS, such as: changes in, or the ability to comply with, existing laws and government regulations; unfavorable changes in the levels and terms of reimbursement by third party payors or government programs, including Medicare (including, but not limited to, the potential unfavorable impact of future reductions to Medicare reimbursements resulting from the Budget Control Act of 2011, as discussed in the next bullet point below) and Medicaid (most states have reported significant budget deficits that have, in the past, resulted in the reduction of Medicaid funding to the operators of our facilities, including UHS); demographic changes; the ability to enter into managed care provider agreements on acceptable terms; an increase in uninsured and self-pay patients which unfavorably impacts the collectability of patient accounts; decreasing in-patient admission trends; technological and pharmaceutical improvements that may increase the cost of providing, or reduce the demand for, health care, and; the ability to attract and retain qualified medical personnel, including physicians.

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Pending limits for most federal agencies and programs aimed at reducing budget deficits by $917 billion between 2012 and 2021, according to a report released by the Congressional Budget Office. Among its other provisions, the law established a bipartisan Congressional committee, known as the Joint Select Committee on Deficit Reduction (the “Joint Committee”), which was tasked with making recommendations aimed at reducing future federal budget deficits by an additional $1.5 trillion over 10 years. The Joint Committee was unable to reach an agreement by the November 23, 2011 deadline and, as a result, across-the-board cuts to discretionary, national defense and Medicare spending were implemented on March 1, 2013 resulting in Medicare payment reductions of up to 2% per fiscal year with a uniform percentage reduction across all Medicare programs. The Bipartisan Budget Act of 2015, enacted on November 2, 2015, continued the 2% reductions to Medicare reimbursement imposed under the Budget Control Act of 2011. The CARES Act suspended payment reductions between May 1 and December 31, 2020, in exchange for extended cuts through 2030. We cannot predict whether Congress will restructure the implemented Medicare payment reductions or what other federal budget deficit reduction initiatives may be proposed by Congress going forward. We also cannot predict the effect these enactments will have on the operators of our properties (including UHS), and thus, our business.

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An increasing number of legislative initiatives have been passed into law that may result in major changes in the health care delivery system on a national or state level. Legislation has already been enacted that has eliminated the penalty for

failing to maintain health coverage that was part of the original Patient Protection and Affordable Care Act (the “ACA”) and Healthcare and Education Reconciliation Act of 2010 (collectively referred to as the “Legislation”). President Trump has taken executive actions: (i) requiring all federal agencies with authorities and responsibilities under the Legislation to “exercise all authority and discretion available to them to waiver, defer, grant exemptions from, or delay” parts of the Legislation that place “unwarranted economic and regulatory burdens” on states, individuals or health care providers; (ii) the issuance of a final rule in June, 2018 by the Department of Labor to enable the formation of association health plans that would be exempt from certain Legislation requirements such as the provision of essential health benefits; (iii) the issuance of a final rule in August, 2018 by the Department of Labor, Treasury, and Health and Human Services to expand the availability of short-term, limited duration health insurance, (iv) eliminating cost-sharing reduction payments to insurers that would otherwise offset deductibles and other out-of-pocket expenses for health plan enrollees at or below 250 percent of the federal poverty level; (v) relaxing requirements for state innovation waivers that could reduce enrollment in the individual and small group markets and lead to additional enrollment in short-term, limited duration insurance and association health plans; (vi) the issuance of a final rule in June, 2019 by the Departments of Labor, Treasury, and Health and Human Services that would incentivize the use of health reimbursement arrangements by employers to permit employees to purchase health insurance in the individual market, and; (vii) directing the issuance of federal rulemaking by executive agencies to increase transparency of healthcare price and quality information. The uncertainty resulting from these Executive Branch policies has led to reduced Exchange enrollment in 2018 and 2019 and is expected to further worsen the individual and small group market risk pools in future years. It is also anticipated that these and future policies may create additional cost and reimbursement pressures on hospitals, including ours. In addition, while attempts to repeal the entirety of the ACA have not been successful to date, a key provision of the ACA was repealed as part of the Tax Cuts and Jobs Act and on December 14, 2018, a federal U.S. District Court Judge in Texas ruled the entire ACA is unconstitutional. That ruling was stayed and has been appealed. On December 18, 2019, the 5^th Circuit Court of Appeals voted 2-1 to strike down the ACA individual mandate as unconstitutional and sent the case back to the U.S. District Court in Texas to determine which ACA provisions should be stricken with the mandate. On March 2, 2020, the U.S. Supreme Court agreed to hear, during the 2020-2021 term, two consolidated cases, filed by the State of California and the United States House of Representatives, asking the Supreme Court to review the ruling by the Fifth Circuit Court of Appeals. Oral argument is scheduled to be heard on November 10, 2020, and a ruling is not expected until 2021. We are unable to predict the final outcome of this matter which has caused greater uncertainty regarding the future status of the ACA. If all or any parts of the ACA are ultimately found to be unconstitutional, it could have a material adverse effect on the business, financial condition and results of operations of the operators of our properties, and, thus, our business.

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There can be no assurance that if any of the announced or proposed changes described above are implemented there will not be negative financial impact on the operators of our hospitals, which material effects may include a potential decrease in the market for health care services or a decrease in the ability of the operators of our hospitals to receive reimbursement for health care services provided which could result in a material adverse effect on the financial condition or results of operations of the operators of our properties, and, thus, our business.

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Competition for properties include, but are not limited to, other REITs, private investors and firms, banks and other companies, including UHS. In addition, we may face competition from other REITs for our tenants.

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The operators of our facilities face competition from other health care providers, including physician owned facilities and other competing facilities, including certain facilities operated by UHS but the real property of which is not owned by us. Such competition is experienced in markets including, but not limited to, McAllen, Texas, the site of our McAllen Medical Center, a 370-bed acute care hospital, and Riverside County, California, the site of our Southwest Healthcare System-Inland Valley Campus, a 130-bed acute care hospital.

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Changes in, or inadvertent violations of, tax laws and regulations and other factors than can affect REITs and our status as a REIT.

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The individual and collective impact of the changes made by the CARES Act on REITs and their security holders are uncertain and may not become evident for some period of time; it is also possible additional legislation could be enacted in the future as a result of the COVID-19 pandemic which may affect the holders of our securities.

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Should we be unable to comply with the strict income distribution requirements applicable to REITs, utilizing only cash generated by operating activities, we would be required to generate cash from other sources which could adversely affect our financial condition.

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Our ownership interest in five LLCs/LPs in which we hold non-controlling equity interests. In addition, pursuant to the operating and/or partnership agreements of the four LLCs/LPs in which we continue to hold non-controlling ownership interests, the third-party member and the Trust, at any time, potentially subject to certain conditions, have the right to make an offer (“Offering Member”) to the other member(s) (“Non-Offering Member”) in which it either agrees to: (i) sell

the entire ownership interest of the Offering Member to the Non-Offering Member (“Offer to Sell”) at a price as determined by the Offering Member (“Transfer Price”), or; (ii) purchase the entire ownership interest of the Non-Offering Member (“Offer to Purchase”) at the equivalent proportionate Transfer Price. The Non-Offering Member has 60 to 90 days to either: (i) purchase the entire ownership interest of the Offering Member at the Transfer Price, or; (ii) sell its entire ownership interest to the Offering Member at the equivalent proportionate Transfer Price. The closing of the transfer must occur within 60 to 90 days of the acceptance by the Non-Offering Member.

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Fluctuations in the value of our common stock.

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Other factors referenced herein or in our other filings with the Securities and Exchange Commission.

Given these uncertainties, risks and assumptions, you are cautioned not to place undue reliance on such forward-looking statements. Our actual results and financial condition, including the operating results of our lessees and the facilities leased to subsidiaries of UHS, could differ materially from those expressed in, or implied by, the forward-looking statements.

Forward-looking statements speak only as of the date the statements are made. We assume no obligation to publicly update any forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking information, except as may be required by law. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this cautionary statement.

Critical Accounting Policies and Estimates

We consider our critical accounting policies to be those that require us to make significant judgments and estimates when we prepare our financial statements, including the following:

Purchase Accounting for Acquisition of Investments in Real Estate: Purchase accounting is applied to the assets and liabilities related to all real estate investments acquired from third parties. In accordance with current accounting guidance, we account for our property acquisitions as acquisitions of assets, which requires the capitalization of acquisition costs to the underlying assets and prohibits the recognition of goodwill or bargain purchase gains. The fair value of the real estate acquired is allocated to the acquired tangible assets, consisting primarily of land, building and tenant improvements, and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, and acquired ground leases, based in each case on their fair values. Loan premiums, in the case of above market rate assumed loans, or loan discounts, in the case of below market assumed loans, are recorded based on the fair value of any loans assumed in connection with acquiring the real estate.

The fair values of the tangible assets of an acquired property are determined based on comparable land sales for land and replacement costs adjusted for physical and market obsolescence for the improvements. The fair values of the tangible assets of an acquired property are also determined by valuing the property as if it were vacant, and the “as-if-vacant” value is then allocated to land, building and tenant improvements based on management’s determination of the relative fair values of these assets. Management determines the as-if-vacant fair value of a property based on assumptions that a market participant would use, which is similar to methods used by independent appraisers. In addition, there is intangible value related to having tenants leasing space in the purchased property, which is referred to as in-place lease value. Such value results primarily from the buyer of a leased property avoiding the costs associated with leasing the property and also avoiding rent losses and unreimbursed operating expenses during the hypothetical lease-up period. Factors considered by management in performing these analyses include an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar leases. In estimating carrying costs, management includes real estate taxes, insurance and other operating expenses and estimates of lost rental revenue during the expected lease-up periods based on current market demand. Management also estimates costs to execute similar leases including leasing commissions, tenant improvements, legal and other related costs. The value of in-place leases are amortized to expense over the remaining initial terms of the respective leases.

In allocating the fair value of the identified intangible assets and liabilities of an acquired property, above-market and below-market in-place lease values are recorded based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) estimated fair market lease rates from the perspective of a market participant for the corresponding in-place leases, measured, for above-market leases, over a period equal to the remaining non-cancelable term of the lease and, for below-market leases, over a period equal to the initial term plus any below market fixed rate renewal periods. The capitalized above-market lease values are amortized as a reduction of rental

income over the remaining non-cancelable terms of the respective leases. The capitalized below-market lease values, also referred to as acquired lease obligations, are amortized as an increase to rental income over the initial terms of the respective leases.

Asset Impairment: We review each of our properties for indicators that its carrying amount may not be recoverable. Examples of such indicators may include a significant decrease in the market price of the property, a change in the expected holding period for the property, a significant adverse change in how the property is being used or expected to be used based on the underwriting at the time of acquisition, an accumulation of costs significantly in excess of the amount originally expected for the acquisition or development of the property, or a history of operating or cash flow losses of the property. When such impairment indicators exist, we review an estimate of the future undiscounted net cash flows (excluding interest charges) expected to result from the real estate investment’s use and eventual disposition and compare that estimate to the carrying value of the property. We consider factors such as future operating income, trends and prospects, as well as the effects of leasing demand, competition and other factors. If our future undiscounted net cash flow evaluation indicates that we are unable to recover the carrying value of a real estate investment, an impairment loss is recorded to the extent that the carrying value exceeds the estimated fair value of the property. The evaluation of anticipated cash flows is highly subjective and is based in part on assumptions regarding future occupancy, rental rates and capital requirements that could differ materially from actual results in future periods. Since cash flows on properties considered to be long-lived assets to be held and used are considered on an undiscounted basis to determine whether the carrying value of a property is recoverable, our strategy of holding properties over the long-term directly decreases the likelihood of their carrying values not being recoverable and therefore requiring the recording of an impairment loss. If our strategy changes or market conditions otherwise dictate an earlier sale date, an impairment loss may be recognized and such loss could be material. If we determine that the asset fails the recoverability test, the affected assets must be reduced to their fair value.

We generally estimate the fair value of rental properties utilizing a discounted cash flow analysis that includes projections of future revenues, expenses and capital improvement costs that a market participant would use based on the highest and best use of the asset, which is similar to the income approach that is commonly utilized by appraisers. In certain cases, we may supplement this analysis by obtaining outside broker opinions of value or third party appraisals.

In considering whether to classify a property as held for sale, we consider factors such as whether management has committed to a plan to sell the property, the property is available for immediate sale in its present condition for a price that is reasonable in relation to its current value, the sale of the property is probable, and actions required for management to complete the plan indicate that it is unlikely that any significant changes will made to the plan. If all the criteria are met, we classify the property as held for sale. Upon being classified as held for sale, depreciation and amortization related to the property ceases and it is recorded at the lower of its carrying amount or fair value less cost to sell. The assets and related liabilities of the property are classified separately on the consolidated balance sheets for the most recent reporting period. Only those assets held for sale that constitute a strategic shift or that will have a major effect on our operations are classified as discontinued operations.

An other than temporary impairment of an investment in an unconsolidated LLC is recognized when the carrying value of the investment is not considered recoverable based on evaluation of the severity and duration of the decline in value, including projected declines in cash flow. To the extent impairment has occurred, the excess carrying value of the asset over its estimated fair value is charged to income.

Federal Income Taxes: No provision has been made for federal income tax purposes since we qualify as a REIT under Sections 856 to 860 of the Internal Revenue Code of 1986, and intend to continue to remain so qualified. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of our annual REIT taxable income to shareholders. As a REIT, we generally will not be subject to federal, state or local income tax on income that we distribute as dividends to our shareholders.

We are subject to a federal excise tax computed on a calendar year basis. The excise tax equals 4% of the amount by which 85% of our ordinary income plus 95% of any capital gain income for the calendar year exceeds cash distributions during the calendar year, as defined. No provision for excise tax has been reflected in the financial statements as no tax was due.

Earnings and profits, which determine the taxability of dividends to shareholders, will differ from net income reported for financial reporting purposes due to the differences for federal tax purposes in the cost basis of assets and in the estimated useful lives used to compute depreciation and the recording of provision for investment losses.

Results of Operations

During the three-month period ended September 30, 2020, net income was $5.2 million, as compared to $4.7 million during the third quarter of 2019. The $540,000 increase was attributable to:

•

$891,000 decrease resulting from lease expirations on two hospital facilities located in Corpus Christi, Texas, and Evansville, Indiana, that occurred on June 1, 2019 and September 30, 2019, respectively (each facility has remained vacant since the respective date of lease expiration);

•

$695,000 increase resulting from a decrease in interest expense, primarily due to a decrease in our average cost of borrowings under our revolving credit agreement, partially offset by an increase in our average outstanding borrowings;

•

$252,000 increase in bonus rentals earned on the three hospital facilities leased to subsidiaries of UHS, and;

•

$484,000 of other combined net increases.

During the nine-month period ended September 30, 2020, net income was $14.4 million, as compared to $13.1 million during the nine-month period of 2019. The $1.3 million increase was attributable to:

•

$2.14 million decrease resulting from lease expirations on two hospital facilities located in Corpus Christi, Texas, and Evansville, Indiana, as mentioned above;

•

$250,000 decrease resulting from a gain on the sale of land recorded during the first nine months of 2019;

•

$404,000 increase resulting from a decrease in depreciation and amortization expense;

•

$1.84 million increase resulting from a decrease in interest expense, primarily due to a decrease in our average cost of borrowings under our revolving credit agreement, partially offset by an increase in our average outstanding borrowings;

•

$303,000 increase in bonus rentals earned on the three hospital facilities leased to subsidiaries of UHS, and;

•

$1.16 million of other combined net increases.

Total revenues decreased $174,000, or 0.9% during the three-month period ended September 30, 2020, as compared to the comparable quarter of 2019, and decreased $124,000, or 0.2% during the nine-month period ended September 30, 2020, as compared to the comparable period of 2019. The net decrease was due primarily to the $842,000 and $1.74 million of revenues recorded during the three and nine-month periods ended September 30, 2019, respectively, in connection with the two hospital facilities that had lease expirations and vacancies in June and September of 2019, as mentioned above.

Included in our other operating expenses are expenses related to the consolidated medical office buildings and two vacant hospital facilities (as discussed herein), which totaled $4.8 million and $4.9 million for the three-month periods ended September 30, 2020 and 2019, respectively, and $14.2 million and $13.8 million for the nine-month periods ended September 30, 2020 and 2019, respectively. A large portion of the expenses associated with our consolidated medical office buildings is passed on directly to the tenants either directly as tenant reimbursements of common area maintenance expenses or included in base rental amounts. Tenant reimbursements for operating expenses are accrued as revenue in the same period the related expenses are incurred and are included as lease revenue in our condensed consolidated statements of income. Included in our operating expenses for the three and nine months ended September 30, 2020, is $153,000 and $533,000, respectively, of aggregate operating expenses related to the two above-mentioned vacant hospital facilities located in Corpus Christi, Texas, and Evansville, Indiana.

Funds from operations (“FFO”) is a widely recognized measure of performance for Real Estate Investment Trusts (“REITs”). We believe that FFO and FFO per diluted share, which are non-GAAP financial measures, are helpful to our investors as measures of our operating performance. We compute FFO, as reflected on the attached Supplemental Schedules, in accordance with standards established by the National Association of Real Estate Investment Trusts (“NAREIT”), which may not be comparable to FFO reported by other REITs that do not compute FFO in accordance with the NAREIT definition, or that interpret the NAREIT definition differently than we interpret the definition. FFO adjusts for the effects of gains, such as gains on transactions during the periods presented. To the extent a REIT recognizes a gain or loss with respect to the sale of incidental assets, such as the sale of land peripheral to operating properties, the REIT has the option to exclude or include such gains and losses in the calculation of FFO. We have opted to exclude gains and losses from sales of incidental assets in our calculation of FFO. FFO does not represent cash generated from operating activities in accordance with GAAP and should not be considered to be an alternative to net income determined in accordance with GAAP. In addition, FFO should not be used as: (i) an indication of our financial performance determined in accordance with GAAP; (ii) an alternative to cash flow from operating activities determined in accordance with GAAP; (iii) a measure of our liquidity, or; (iv) an indicator of funds available for our cash needs, including our ability to make cash distributions to shareholders.

Below is a reconciliation of our reported net income to FFO for the three and nine-month periods ended September 30, 2020 and 2019 (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
Net income	$	5,193	$	4,653	$	14,447	$	13,126
Depreciation and amortization expense on consolidated investments		6,399		6,430		19,160		19,564
Depreciation and amortization expense on unconsolidated affiliates		290		280		869		854
Gain on sale of land		-		-		-		(250	)
Funds From Operations	$	11,882	$	11,363	$	34,476	$	33,294
Weighted average number of shares outstanding - Basic		13,748		13,735		13,741		13,731
Weighted average number of shares outstanding - Diluted		13,770		13,757		13,763		13,751
Funds From Operations per diluted share	$	0.86	$	0.83	$	2.50	$	2.42

Our FFO increased $519,000, or $.03 per diluted share, during the third quarter of 2020, as compared to the third quarter of 2019. The net increase was primarily due to: (i) an unfavorable impact of $891,000, or $.06 per diluted share, related to the above-mentioned vacancies at two of our hospitals as a result of lease expirations on June 1, 2019 and September 30, 2019 (excluding the related interest expense impact); (ii) a favorable impact of $695,000, or $.05 per diluted share, resulting from a decrease in interest expense, resulting primarily from a decrease in our average cost of borrowings pursuant to our revolving credit agreement, partially offset by an increase in our average outstanding borrowings; (iii) a favorable impact of $252,000, or $.02 per diluted share, resulting from an increase in bonus rental earned on the three hospital facilities leased to subsidiaries of UHS, and; (iv) other combined net increases of $463,000, or $.02 per diluted share.

Our FFO increased $1.2 million, or $.08 per diluted share, during the first nine months of 2020, as compared to the first nine months of 2019, primarily due to: (i) an unfavorable impact of $2.1 million, or $.16 per diluted share, related to the above-mentioned vacancies at two of our hospitals as a result of lease expirations on June 1, 2019 and September 30, 2019 (excluding the related interest expense impact); (ii) a favorable impact of $1.8 million, or $.13 per diluted share, resulting from a decrease in interest expense, resulting primarily from a decrease in our averagpe cost of borrowings pursuant to our revolving credit agreement, partially offset by an increase in our average outstanding borrowings; (iii) a favorable impact of $303,000, or $.02 per diluted share, resulting from an increase in bonus rental earned on the three hospital facilities leased to subsidiaries of UHS, and; (iv) other combined net increases of $1.2 million, or $.09 per diluted share.

Other Operating Results

Interest Expense:

As reflected in the schedule below, interest expense was $2.0 million and $2.7 million during the three-month periods ended September 30, 2020 and 2019, respectively and $6.3 million and $8.1 million during the nine-month periods ended September 30, 2020 and 2019, respectively (amounts in thousands):


	Three Months Ended September 30, 2020				Three Months Ended September 30, 2019				Nine Months Ended September 30, 2020				Nine Months Ended September 30, 2019
Revolving credit agreement	$	948			$	1,900			$	3,646			$	5,805
Mortgage interest		645				645				1,957				2,037
Interest rate caps income, net		-				-				-				(122	)	(a.)
Interest rate swaps expense/(income), net		299		(b.)		(17	)	(b.)		430		(b.)		(17	)	(b.)
Amortization of financing fees		220				157				549				480
Amortization of fair value of debt		(13	)			(13	)			(39	)			(39	)
Capitalized interest on major projects		(128	)			(13	)			(254	)			(13	)
Other interest		(7	)			-				-				1
Interest expense, net	$	1,964			$	2,659			$	6,289			$	8,132

(a.)

Represents interest paid to us by the counterparties pursuant to two interest rate caps with a combined notional amount of $60 million, which expired in March, 2019.

(b.)

Represents net interest paid by us to/(paid to us by) the counterparties pursuant to three interest rate SWAPs with a combined notional amount of $140 million.

Interest expense decreased by approximately $695,000 during the three-month period ended September 30, 2020, as compared to the comparable period of 2019, due primarily to: (i) a $952,000 decrease in the interest expense on our revolving credit agreement resulting from a decrease in our average cost of borrowings pursuant to our revolving credit agreement (1.4% during the three months ended September 30, 2020 as compared to 3.5% in the comparable quarter of 2019), partially offset by an increase in our average outstanding borrowings ($220.1 million during the three months ended September 30, 2020 as compared to $198.6 million in the comparable 2019 quarter); (ii) a $316,000 net increase in interest rate swap expense during the third quarter of 2020 as compared to the third quarter of 2019; (iii) a $115,000 decrease in interest expense related to capitalized interest on major projects, and; (iv) $56,000 of other combined net increases in interest expense.

Interest expense decreased by approximately $1.8 million during the nine-month period ended September 30, 2020, as compared to the comparable period of 2019, due primarily to: (i) a $2.2 million decrease in the interest expense on our revolving credit agreement resulting from a decrease in our average cost of borrowings pursuant to our revolving credit agreement (1.9% during the nine months ended September 30, 2020 as compared to 3.6% in the comparable nine-month period of 2019), partially offset by an increase in our average outstanding borrowings ($216.3 million during the nine months ended September 30, 2020 as compared to $196.2 million in the comparable 2019 nine month-period); (ii) a $569,000 net increase in interest rate swap/caps expense during the nine-months ended September 30, 2020 as compared to the comparable period in 2019; (iii) a $80,000 decrease in mortgage interest expense, resulting primarily from the repayment of a mortgage loan during the second quarter of 2019; (iv) a $241,000 decrease in interest expense related to capitalized interest on major projects, and; (v) $68,000 of other combined net increases in interest expense.

COVID-19 Impact

The COVID-19 pandemic began to significantly impact the United States in mid-March, 2020. As a result of various policies implemented by the federal and state governments, and varying by individual state, many non-essential businesses in the nation were closed for varying time periods. We believe that by June 30, 2020, substantially all of our tenants had resumed operations of their businesses.

Tenants representing approximately 99% of our occupied square footage have paid their rent through September 30, 2020. Although COVID-19 has not had a material adverse impact on our results of operations through September 30, 2020, we believe that the potentially adverse impact that the pandemic may have on our future operations and financial results of our tenants, and in turn ours, will depend upon many factors, most of which are beyond our, or our tenants’, ability to control or predict. Since the underlying businesses in each of our properties are operated by the tenants, we can provide no assurance that the businesses will continue to operate in the future, or stay current with their lease obligations.

Since the bonus rents earned by us on the three acute care hospitals leased to wholly-owned subsidiaries of Universal Health Services, Inc., are computed based upon a computation that compares each hospital’s current quarter revenue to the corresponding quarter in the base year, we could experience significant declines in future bonus rental revenue earned on these properties should those hospitals

continue to experience significant declines in patient volumes and revenues. These hospitals believe that, to the extent that they experience revenue declines and increased expenses resulting from the COVID-19 pandemic, as ultimately measured over the life of the pandemic, they are eligible for emergency fund grants as provided for by the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”). Our financial statements for the three and nine-month periods ended September 30, 2020 include bonus rental attributable to revenues recorded by these three hospitals in connection with CARES Act grants.

Throughout the common areas of many properties in our portfolio, we have implemented COVID-19 risk mitigating actions such as, enhanced cleaning protocols including supplemental cleaning and sanitizing of high-touch points, limiting points of entry at certain facilities, and coordinating with health care providers to assess or screen patients prior to entering certain of our MOBs.

Disclosures Related to Certain Hospital Facilities

Please refer to Note 7 to the condensed consolidated financial statements - Lease Accounting, for additional information regarding certain of our hospital facilities including Southwest Healthcare System, Inland Valley Campus; Evansville, Indiana; Corpus Christi, Texas, and; Kindred Hospital Chicago Central.

Liquidity and Capital Resources

Net cash provided by operating activities

Net cash provided by operating activities was $32.8 million during the nine-month period ended September 30, 2020 as compared to $31.7 million during the comparable period of 2019. The $1.0 million net increase was attributable to:

•

A favorable change of $1.4 million due to an increase in net income plus/minus the adjustments to reconcile net income to net cash provided by operating activities (depreciation and amortization, amortization related to above/below market leases, amortization of debt premium, amortization of deferred financing costs, stock-based compensation and gain on sale of land), as discussed above;

•

an unfavorable change of $90,000 in lease receivable;

•

a favorable change of $239,000 in accrued interest;

•

a favorable change of $490,000 in tenant reserves, deposits and deferred and prepaid rents, and;

•

other combined net unfavorable changes of $1.0 million, resulting primarily from the timing of prepaid expense payments.

Net cash used in investing activities

Net cash used in investing activities was $16.8 million during the first nine months of 2020 as compared to $7.9 million during the first nine months of 2019.

During the nine-month period ended September 30, 2020 we funded: (i) $18.8 million in additions to real estate investments including $14.4 million of construction costs related to a newly constructed, 108-bed behavioral health care hospital located in Clive, Iowa, that is scheduled to be completed in late 2020 or early 2021, and tenant improvements at various MOBs, and; (ii) $3.2 million in equity investments in unconsolidated LLCs. In addition, during the nine-months ended September 30, 2020, we received $5.2 million of cash distributions from our unconsolidated LLCs, consisting of proceeds generated from a construction loan obtained by Grayson Properties II during the second quarter of 2020.

During the nine-month period ended September 30, 2019 we funded: (i) $798,000 in equity investments in unconsolidated LLCs; (ii) $7.5 million in capital additions to real estate investments including tenant improvements at various MOBs and $1.3 million for the purchase of land related to the newly constructed behavioral health care hospital located in Clive, Iowa, and; (iii) $200,000 as a deposit on real estate assets. In addition, during the nine-month period ended September 30, 2019 we received: (i) $245,000 of cash proceeds from the divestiture of land, and; (ii) $343,000 of cash distributions in excess of income received from our unconsolidated LLCs.

Net cash used in financing activities

Net cash used in financing activities was $15.8 million during the nine months ended September 30, 2020, as compared to $22.4 million during the nine months ended September 30, 2019.

During the nine-month period ended September 30, 2020, we paid: (i) $1.4 million on mortgage notes payable that are non-recourse to us; (ii) $372,000 of financing costs related to the revolving credit agreement, including amendment fees, and; (iii) $28.4 million of

dividends. Additionally, during the nine months ended September 30, 2020, we received: (i) $14.2 million of net borrowings on our revolving credit agreement, and; (ii) $266,000 of net cash from the issuance of shares of beneficial interest, as discussed below.

During the nine-month period ended September 30, 2019, we paid: (i) $3.8 million on mortgage notes payable that are non-recourse to us, including the repayment of $2.5 million related to a previously outstanding mortgage note payable on one property that was funded utilizing borrowings under our revolving credit agreement; (ii) $35,000 of financing costs related to the revolving credit agreement, and; (iii) $28.0 million of dividends. Additionally, during the nine months ended September 30, 2019, we received (i) $9.3 million of net borrowings on our revolving credit agreement, and; (ii) $165,000 of net cash from the issuance of shares of beneficial interest.

During the second quarter of 2020, we commenced an at-the-market (“ATM”) equity issuance program, pursuant to the terms of which we may sell, from time-to-time, common shares of our beneficial interest up to an aggregate sales price of $100 million to or through our agent banks. No shares were issued pursuant to this ATM equity program during the third quarter of 2020. During the second quarter of 2020, pursuant to this ATM equity program, we issued 2,704 shares at an average price of $101.30 per share which generated approximately $270,000 of net cash proceeds (net of compensation to BofA Securities, Inc. of approximately $4,000). Additionally, we paid or incurred approximately $507,000 in various fees and expenses related to the commencement of our ATM program.

Additional cash flow and dividends paid information for the nine-month periods ended September 30, 2020 and 2019:

As indicated on our condensed consolidated statement of cash flows, we generated net cash provided by operating activities of $32.8 million and $31.7 million during the nine-month periods ended September 30, 2020 and 2019, respectively. As also indicated on our statement of cash flows, non-cash expenses including depreciation and amortization expense, amortization related to above/below market leases, amortization of debt premium, amortization of deferred financing costs, stock-based compensation expense and gain on transaction (as applicable) are the primary differences between our net income and net cash provided by operating activities during each period.

We declared and paid dividends of $28.4 million during the nine months ended September 30, 2020 and declared and paid dividends of $28.0 million during the nine months ended September 30, 2019. During the first nine months of 2020, the $32.8 million of net cash provided by operating activities was approximately $4.4 million greater than the $28.4 million of dividends paid during the first nine months of 2020. During the first nine months of 2019, the $31.7 million of net cash provided by operating activities was approximately $3.7 million greater than the $28.0 million of dividends paid during the first nine months of 2019.

As indicated in the cash flows from investing activities and cash flows from financing activities sections of the statements of cash flows, there were various other sources and uses of cash during the nine months ended September 30, 2020 and 2019. From time to time, various other sources and uses of cash may include items such as investments and advances made to/from LLCs, additions to real estate investments, acquisitions/divestiture of properties, net borrowings/repayments of debt, and proceeds generated from the issuance of equity. Therefore, in any given period, the funding source for our dividend payments is not wholly dependent on the operating cash flow generated by our properties. Rather, our dividends as well as our capital reinvestments into our existing properties, acquisitions of real property and other investments are funded based upon the aggregate net cash inflows or outflows from all sources and uses of cash from the properties we own either in whole or through LLCs, as outlined above.

In determining and monitoring our dividend level on a quarterly basis, our management and Board of Trustees consider many factors in determining the amount of dividends to be paid each period. These considerations primarily include: (i) the minimum required amount of dividends to be paid in order to maintain our REIT status; (ii) the current and projected operating results of our properties, including those owned in LLCs, and; (iii) our future capital commitments and debt repayments, including those of our LLCs. Based upon the information discussed above, as well as consideration of projections and forecasts of our future operating cash flows, management and the Board of Trustees have determined that our operating cash flows have been sufficient to fund our dividend payments. Future dividend levels will be determined based upon the factors outlined above with consideration given to our projected future results of operations.

We expect to finance all capital expenditures and acquisitions and pay dividends utilizing internally generated and additional funds. Additional funds may be obtained through: (i) borrowings under our existing $350 million revolving credit agreement (which had $117.3 million of available borrowing capacity, net of outstanding borrowings and letters of credit as of September 30, 2020); (ii) borrowings under or refinancing of existing third-party debt pursuant to mortgage loan agreements entered into by our consolidated and unconsolidated LLCs/LPs; (iii) the issuance of equity pursuant to our ATM program, and/or; (iv) the issuance of other long-term debt.

We believe that our operating cash flows, cash and cash equivalents, available borrowing capacity under our revolving credit agreement and access to the capital markets provide us with sufficient capital resources to fund our operating, investing and financing requirements for the next twelve months, including providing sufficient capital to allow us to make distributions necessary to enable us to continue to qualify as a REIT under Sections 856 to 860 of the Internal Revenue Code of 1986. In the event we need to access

the capital markets or other sources of financing, there can be no assurance that we will be able to obtain financing on acceptable terms or within an acceptable time. Our inability to obtain financing on terms acceptable to us could have a material unfavorable impact on our results of operations, financial condition and liquidity.

Credit facilities and mortgage debt

In June 2020, we entered into the first amendment (the “First Amendment”) to the revolving credit agreement (“Credit Agreement”), pursuant to which, among other things, an additional tranche of revolving credit commitments in the amount of $50 million, designated as the “Revolving B Facility”, was established thereby increasing the aggregate revolving credit commitment to $350 million from $300 million. The Credit Agreement, as amended, which is scheduled to mature in March 2022, provides for a revolving credit facility in an aggregate principal amount of $350 million, including a $40 million sublimit for letters of credit and a $30 million sublimit for swingline/short-term loans. Borrowings under the Credit Agreement are guaranteed by certain subsidiaries of the Trust. In addition, borrowings under the Credit Agreement are secured by first priority security interests in and liens on all equity interests in certain of the Trust’s wholly-owned subsidiaries. The remainder of the revolving credit commitments provided under the Credit Agreement that were in effect prior to giving effect to the First Amendment, has been designated as the “Revolving A Facility”.

The following table includes a summary of the required compliance ratios, giving effect to the covenants contained in the Credit Agreement (dollar amounts in thousands):

	Covenant	September 30, 2020			December 31, 2019
Tangible net worth	> =$125,000	$	150,247		$	167,181
Total leverage	< 60%		44.0	%		42.3	%
Secured leverage	< 30%		8.8	%		9.1	%
Unencumbered leverage	< 60%		40.6	%		38.5	%
Fixed charge coverage	> 1.50x	4.5x			4.0x

Facility Name	Outstanding Balance (in thousands) (a.)			Interest Rate			Maturity Date
700 Shadow Lane and Goldring MOBs fixed rate mortgage loan	$	5,492			4.54	%	June, 2022
BRB Medical Office Building fixed rate mortgage loan		5,560			4.27	%	December, 2022
Desert Valley Medical Center fixed rate mortgage loan		4,549			3.62	%	January, 2023
2704 North Tenaya Way fixed rate mortgage loan		6,615			4.95	%	November, 2023
Summerlin Hospital Medical Office Building III fixed rate mortgage loan		13,101			4.03	%	April, 2024
Tuscan Professional Building fixed rate mortgage loan		3,076			5.56	%	June, 2025
Phoenix Children’s East Valley Care Center fixed rate mortgage loan		8,780			3.95	%	January, 2030
Rosenberg Children's Medical Plaza fixed rate mortgage loan		12,565			4.42	%	September, 2033
Total, excluding net debt premium and net financing fees		59,738
Less net financing fees		(505	)
Plus net debt premium		154
Total mortgages notes payable, non-recourse to us, net	$	59,387

(a.)

All mortgage loans require monthly principal payments through maturity and either fully amortize or include a balloon principal payment upon maturity.

Changes in market rates on our fixed rate debt impacts the fair value of debt, but it has no impact on interest incurred or cash flow.

Off Balance Sheet Arrangements

As of September 30, 2020, we are party to certain off balance sheet arrangements consisting of standby letters of credit and equity and debt financing commitments. Our outstanding letters of credit at September 30, 2020 totaled $5.6 million related to Grayson Properties II. As of December 31, 2019, we did not have any off balance sheet arrangements other than equity and debt financing commitments.

Acquisition and Divestiture Activity

Please see Note 4 to the condensed consolidated financial statements for completed transactions.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Reference is made to Item 7A in our Annual Report on Form 10-K for the year ended December 31, 2019. There have been no material changes in the quantitative and qualitative disclosures during the first nine months of 2020, except for the additional disclosure below.

Financial Instruments

We measure our interest rate swaps at fair value on a recurring basis. The fair value of our interest rate swaps is based on quotes from third parties. We consider those inputs to be “level 2” in the fair value hierarchy as outlined in the authoritative guidance for disclosures in connection with derivative instruments and hedging activities. At September 30, 2020, the fair value of our interest rate swaps was a net liability of $4.7 million which is included in accrued expenses and other liabilities on the accompanying condensed consolidated balance sheet. During the third quarter of 2020, we paid or accrued approximately $299,000 to the counterparty by us, adjusted for the previous quarter accrual, pursuant to the terms of the swaps. During the first nine months of 2020, we paid or accrued approximately $430,000 in net payments made to the counterparty by us, adjusted for the previous quarter accrual, pursuant to the terms of the swaps (consisting of approximately $521,000 in payments, adjusted for the previous quarter accrual, or accruals made to the counterparty by us, offset by approximately $91,000 of payments paid to us by the counterparty). From inception of the swap agreements through September 30, 2020 we paid or accrued approximately $322,000 in net payments made to the counterparty by us pursuant to the terms of the swap (consisting of approximately $199,000 in payments or accruals made to us by the counterparty, offset by approximately $521,000 of payments due to the counterparty from us). Cash flow hedges are accounted for by recording the fair value of the derivative instrument on the balance sheet as either an asset or a liability, with a corresponding amount recorded in accumulated other comprehensive income (“AOCI”) within shareholders’ equity. Amounts are classified from AOCI to the income statement in the period or periods the hedged transaction affects earnings.

The sensitivity analysis related to our fixed and variable rate debt assumes current market rates with all other variables held constant. As of September 30, 2020, the fair value and carrying-value of our debt is approximately $290.2 million and $286.8 million, respectively. As of that date, the fair value exceeds the carrying-value by approximately $3.4 million.

The table below presents information about our financial instruments that are sensitive to changes in interest rates. The interest rate swaps include the $50 million swap agreement entered into during the third quarter of 2019, the $35 million swap agreement entered into in January, 2020 and the $55 million swap agreement entered into in March, 2020. For debt obligations, the amounts of which are as of September 30, 2020, the table presents principal cash flows and related weighted average interest rates by contractual maturity dates.

	Maturity Date, Year Ending December 31
(Dollars in thousands)	2020			2021			2022			2023			2024			Thereafter			Total
Long-term debt:
Fixed rate:
Debt(a)	$	505		$	2,081		$	12,197		$	11,892		$	13,550		$	19,513		$	59,738
Average interest rates		4.3	%		4.3	%		4.4	%		4.4	%		4.4	%		4.3	%		4.3	%
Variable rate:
Debt(b)	$	—		$	—		$	227,100		$	—		$	—		$	—		$	227,100
Average interest rates		1.4	%		1.4	%		1.4	%	—			—			—				1.4	%
Interest rate swaps:
Notional amount(c)	$	—		$	—		$	—		$	—		$	85,000		$	55,000		$	140,000
Interest rates	—			—			—			—				1.3	%		0.57	%		1.0	%

(a)

Consists of non-recourse mortgage notes payable.

(b)

Includes $227.1 million of outstanding borrowings under the terms of our $350 million revolving credit agreement.

(c)

Includes a $50 million interest rate swap that became effective on September 16, 2019, and a $35 million interest rate swap that became effective on January 15, 2020, both of which are scheduled to mature during 2024. Additionally included is a $55 million interest rate swap that became effective on March 25, 2020, which is scheduled to mature in 2027.

As calculated based upon our variable rate debt outstanding as of September 30, 2020 that is subject to interest rate fluctuations, and giving effect to the above-mentioned interest rate swap, each 1% change in interest rates would impact our net income by approximately $871,000.

Item 4. Controls and Procedures

As of September 30, 2020, under the supervision and with the participation of our management, including the Trust’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we performed an evaluation of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “1934 Act”).

Based on this evaluation, the CEO and CFO have concluded that our disclosure controls and procedures are effective to ensure that material information is recorded, processed, summarized and reported by management on a timely basis in order to comply with our disclosure obligations under the 1934 Act and the SEC rules thereunder.

There have been no changes in our internal control over financial reporting or in other factors during the first nine months of 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

UNIVERSAL HEALTH REALTY INCOME TRUST

Item 1A. Risk Factors

Our Annual Report on Form 10-K for the year ended December 31, 2019 and our Form 10-Q for the quarterly period ended March 31, 2020 (the “first quarter 2020 Form 10-Q”) include listings of risk factors to be considered by investors in our securities. Except for the risk factors disclosed in Part II, Item 1A of the first quarter 2020 Form 10-Q, which is hereby incorporated by reference into this Part II, Item 1A of this Form 10-Q, there have been no material changes in our risk factors from those set forth in our Annual Report on Form 10-K for the year ended December 31, 2019.

Item 6. Exhibits

(a.)

Exhibits:



31.1		Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15(d)-14(a) under the Securities Exchange Act of 1934, as amended.

31.2		Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15(d)-14(a) under the Securities Exchange Act of 1934, as amended.

32.1		Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS		Inline XBRL Instance Document – the instance document does not appear in the Interactive Data file because iXBRL tags are embedded within the Inline XBRL document

101.SCH		Inline XBRL Taxonomy Extension Schema Document

101.CAL		Inline XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF		Inline XBRL Taxonomy Extension Definition Linkbase Document

101.LAB		Inline XBRL Taxonomy Extension Label Linkbase Document

101.PRE		Inline XBRL Taxonomy Extension Presentation Linkbase Document

104		The cover page from the Trust’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2020 has been formatted in Inline XBRL

Signatures

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

Date: November 6, 2020		UNIVERSAL HEALTH REALTY INCOME TRUST (Registrant)

		/s/ Alan B. Miller
		Alan B. Miller,
		Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer)

		/s/ Charles F. Boyle
		Charles F. Boyle, Vice President and Chief Financial Officer (Principal Financial Officer)