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Brookdale Lease Amendments and Terminations and the Formation of Two RIDEA Joint Ventures (“Brookdale Transaction”) | 12 Months Ended
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Dec. 31, 2015
Brookdale Lease Amendments and Terminations and the Formation of Two RIDEA Joint Ventures ("Brookdale Transaction") |
Brookdale Lease Amendments and Terminations and the Formation of Two RIDEA Joint Ventures ("Brookdale Transaction") | NOTE 3. Brookdale Lease Amendments and Terminations and the Formation of Two RIDEA Joint Ventures (“Brookdale Transaction”) On July 31, 2014, Brookdale Senior Living (“Brookdale”) completed its acquisition of Emeritus Corporation (“Emeritus”). On August 29, 2014, the Company and Brookdale completed a multiple-element transaction with three major components:
| · |  | amended existing lease agreements on 153 HCP-owned senior housing communities previously leased and operated by Emeritus, that included the termination of embedded purchase options in these leases relating to 30 properties and future rent reductions;
| · |  | terminated existing lease agreements on 49 HCP-owned senior housing properties previously leased and operated by Emeritus, that included the termination of embedded purchase options in these leases relating to 19 properties. At closing, the Company contributed 48 of these properties to newly formed consolidated partnership s that are operated under a structure permitted by the Housing and Economic Recovery Act of 2008 (commonly referred to as “RIDEA”) (“RIDEA II”); the 49 th property was contributed on January 1, 2015. Brookdale owns a 20% noncontrolling equity interest in the RIDEA II and manages the facilities on behalf of the partnership; and
| · |  | entered into new unconsolidated joint ventures that own 14 campuses of continuing care retirement communities (“CCRC”) in a RIDEA structure (collectively, the “CCRC JV”) with the Company owning a 49% equity interest and Brookdale owning a 51% equity interest. Brookdale manages these communities on behalf of this partnership.
Leases Amended on 153 Properties (“NNN Lease Restructuring”) The Company and Brookdale entered into amended and restated triple-net master leases for 153 properties formerly leased to Emeritus. As part of the lease amendments, Brookdale forfeited purchase option rights related to 30 of these properties. The master leases have weighted average initial terms of 15 years, with two extension options that average 10 years each. While the total base rent for 2014 remained unchanged, these leases provide for reduced escalators beginning in 2015 compared to those which were in-place; the leases contain reduced rent payments of $6.5 million in 2016 and $7.5 million each subsequent year thereafter. All obligations under the amended and restated leases are guaranteed by Brookdale. In addition, the new leases include a purchase option in favor of Brookdale that was exercised with nine communities sold during 2015 for $60 million in proceeds. Effectively, the Company paid consideration of $129 million to terminate the existing purchase options and received consideration of: (i) $76 million for lower rent payments and escalators discussed above and (ii) $53 million to settle the amount that the Company owed to Brookdale for the RIDEA II transaction discussed below. See the Fair Value Measurement Techniques and Quantitative Information section below for additional information. The Company amortize s the $53 million of net consideration paid to Brookdale for the NNN Lease Restructuring as a reduction in rental income on a straight-line basis over the term of the new leases. Additionally, the lease-related intangibles, initial direct costs and straight-line rent receivables associated with the previous leases will be amortized prospectively over the new (or amended) lease terms. Lease Terminations of 49 Properties that were contributed to a RIDEA Structure (RIDEA II) The Company and Brookdale terminated leases for a 49 property portfolio, which resulted in Brookdale forfeiting its purchase option rights to 19 of these properties; the net value of the terminated leases and forfeited purchase options was $108 million ($131 million for the value of the terminated leases, less $23 million for the value of the forfeited purchase options). At closing, the Company contributed the properties into partnerships, with Brookdale owning a 20% noncontrolling equity interest in each of the RIDEA II (“SH PropCo” and “SH OpCo”). Brookdale’s 20% interest in the RIDEA II was valued at $47 million. Brookdale also manages the properties on behalf of the RIDEA II under long-term management contracts. See the Fair Value Measurement Techniques and Quantitative Information section below for additional information. As consideration for the net value of $108 million for the terminated leases and the $47 million sale to Brookdale of the 20% noncontrolling interest in the RIDEA II, the Company received the following: (i) a $34 million short-term receivable recorded in other assets; (ii) a $68 million note from Brookdale (the “Brookdale Receivable”) recorded in loans receivable (see Note 7) that was repaid in November 2014; and (iii) an effective offset for the $53 million associated with the additional consideration owed by the Company to Brookdale for the NNN Lease Restructuring transaction discussed above. The fair values of the short-term receivable and Brookdale Receivable were estimated based on similar instruments available in the marketplace and are considered to be Level 2 measurements within the fair value hierarchy. As a result of terminating these leases, the Company recognized a net gain of $38 million consisting of: (i) $108 million gain based on the fair value of the net consideration received; less (ii) $70 million to write-off the direct leasing costs and straight-line rent receivables related to the former in-place leases. The Company has identified the SH PropCo and SH OpCo entities as VIEs (see Note 21 for additional information). Continuing Care Retirement Communities Joint Venture HCP and Brookdale formed new unconsolidated joint ventures, that own ed 14 CCRC campuses at formation, in a RIDEA structure (“CCRC PropCo” and “CCRC OpCo”). HCP and Brookdale own 49% and 51%, respectively, of CCRC PropCo and CCRC OpCo, based on each company’s respective contributions. At closing, CCRC PropCo own ed eight campuses that are leased to CCRC OpCo; CCRC OpCo own ed six campuses and the operations of the campuses leased from CCRC PropCo. Brookdale manages the campuses of the CCRC JV under long-term management contracts. At closing, Brookdale contributed eight of its owned campuses; the Company contributed two campuses previously leased to Brookdale valued at $162 million (carrying value of $92 million) and $370 million of cash (includes amounts used to fund the purchase of properties and working capital), which was primarily used to acquire four additional campuses from third parties. At closing, the CCRC JV campuses were encumbered by $569 million of mortgage and entrance fee obligations. The Company has identified the CCRC OpCo entity as a VIE (see Note 21 for additional information). Fair Value Measurement Techniques and Quantitative Information The fair values of the forfeited rental payments and purchase option rights related to the NNN Lease Restructuring and the RIDEA II were based on the income approach and are considered Level 3 measurements within the fair value hierarchy. The Company utilized discounted cash flow models with observable and unobservable valuation inputs. These fair value measurements, or valuation techniques, were based on current market participant expectations and information available as of the close of the transaction on August 29, 2014. A summary of the quantitative information about fair value measurements for the NNN Lease Restructuring and RIDEA II transactions follows (dollars in thousands):
|  | Fair Value |  | Valuation Technique |  | Valuation Inputs |  | Input Average or Range |
NNN Lease Restructuring |  |  |  |  |  |  |  |  |  |
Rental payment concessions by HCP |  | $ | 76,000 |  | Discounted Cash Flow |  | NNN Rent Coverage Ratio |  | 1.20x |
(benefiting Brookdale) |  |  |  |  |  |  | NNN Rent Growth Rate |  | 3.0% |
|  |  |  |  |  |  | Discount Rate |  | 8.00%-8.50% |
Forfeited purchase options by |  | $ | (129,000) |  | Discounted Cash Flow |  | Capitalization Rates |  | 7.50%-9.25% |
Brookdale (benefiting HCP) |  |  |  |  |  |  | Discount Rate |  | 10.50%-11.00% |
|  |  |  |  |  |  | Exercise Probability |  | 100.00% |
RIDEA II |  |  |  |  |  |  |  |  |  |
Forfeited rental payments by HCP |  | $ | 131,000 |  | Discounted Cash Flow |  | NNN Rent Coverage Ratio |  | 1.20x |
(benefiting Brookdale) |  |  |  |  |  |  | NNN Rent Growth Rate |  | 3.0% |
|  |  |  |  |  |  | EBITDAR Growth Rate |  | 5.5% |
|  |  |  |  |  |  | Discount Rate |  | 8.00%-11.00% |
Forfeited purchase options by |  | $ | (23,000) |  | Discounted Cash Flow |  | Capitalization Rates |  | 7.50%-9.25% |
Brookdale (benefiting HCP) |  |  |  |  |  |  | Discount Rate |  | 10.50%-11.00% |
|  |  |  |  |  |  | Exercise Probability |  | 1 00.00% |
In determining which valuation technique would be utilized to calculate fair value for the multiple elements of this transaction, the Company considered the market approach, obtaining published investor survey and sales transaction data, where available. The information obtained was consistent with the valuation inputs and assumptions utilized by the selected income approach that was applied to this transaction. Investor survey and sales transaction data reviewed for similar transactions in similar marketplaces, included, but were not limited to, sales price per unit, rent coverage ratios, rental rate growth as well as capitalization and discount rates. Rental Payment Concessions. The fair value of the rental payment concessions related to the NNN Lease Restructuring Transaction was determined as the present value of the difference between (i) the remaining contractual rental payments of the in-place leases, limited to the first purchase option date (where available) and market rents to complete the initial lease term of the amended Brookdale leases thereafter and (ii) the contractual rental payments under the amended Brookdale leases. Forfeited Rental Payments. The fair value of the forfeited rental payments related to the RIDEA II transaction was calculated as the present value of the difference between (i) the remaining contractual rental payments of the terminated in-place leases, limited to first purchase option date, where available and (ii) the forecasted cash flows of the facility-level operating results of the RIDEA II. Forfeited Purchase Option Rights. The fair value of the forfeited purchase option rights was determined as the present value of the difference between (i) the fair value of the underlying property as of the initial exercise date and (ii) the exercise price for purchase option rights as defined in the lease agreement. To determine the fair value of the underlying property as of the initial exercise date, the Company utilized a cash flow model that incorporated growth rates to forecast the underlying property’s operating results and applied capitalization rates to establish its expected fair value. The Company utilized an appropriate risk-adjusted discount rate to estimate the present value as of the closing date of the transaction.

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