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Discontinued Operations and Dispositions of Real Estate | 12 Months Ended
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Dec. 31, 2016
Discontinued Operations and Dispositions of Real Estate |
Discontinued Operations and Dispositions of Real Estate | NOTE 5. Discontinued Operations and Dispositions of Real Estate Discontinued Operations - Quality Care Properties, Inc. On October 31, 2016, the Company completed the Spin-Off of its subsidiary, QCP. The following is a summary of the assets and liabilities transferred to QCP at the Spin-Off date (in thousands):
|  | October 31, |  | December 31,
|  | 2016 |  | 2015
ASSETS |  |  |  |  |  |
Real estate: |  |  |  |  |  |
Buildings and improvements |  | $ | 191,633 |  | $ | 191,633
Land |  |  | 14,147 |  |  | 14,147
Accumulated depreciation and amortization |  |  | (71,845) |  |  | (65,319)
Net real estate |  |  | 133,935 |  |  | 140,461
Net investment in direct financing leases |  |  | 5,107,180 |  |  | 5,154,316
Cash and cash equivalents |  |  | 6,096 |  |  | 6,058
Restricted cash |  |  | — |  |  | 14,526
Intangible assets, net |  |  | 18,517 |  |  | 17,049
Other assets, net |  |  | 6,620 |  |  | 7,790
Total assets |  | $ | 5,272,348 |  | $ | 5,340,200
LIABILITIES |  |  |  |  |  |
Accounts payable and accrued liabilities |  | $ | 46,925 |  | $ | 5,453
Deferred revenue |  |  | 667 |  |  | 687
Total liabilities |  |  | 47,592 |  |  | 6,140
Net assets |  | $ | 5,224,756 |  | $ | 5,334,060
The results of discontinued operations through October 31, 2016, the Spin-Off date, are included in the consolidated results for the years ended December 31, 2016, 2015 and 2014. Summarized financial information for discontinued operations for the years ended December 31, 2016, 2015, and 2014 is as follows (in thousands):
|  | Year Ended December 31, |
|  | 2016 |  | 2015 |  | 2014 |
Revenues: |  |  |  |  |  |  |  |  |  |
Rental and related revenues |  | $ | 22,971 |  | $ | 27,651 |  | $ | 27,111 |
Tenant recoveries |  |  | 1,233 |  |  | 1,464 |  |  | 1,029 |
Income from direct financing leases |  |  | 384,752 |  |  | 572,835 |  |  | 598,629 |
Interest income |  |  | — |  |  | — |  |  | 868 |
Total revenues |  |  | 408,956 |  |  | 601,950 |  |  | 627,637 |
Costs and expenses: |  |  |  |  |  |  |  |  |  |
Depreciation and amortization |  |  | (4,892) |  |  | (5,880) |  |  | (4,979) |
Operating |  |  | (3,367) |  |  | (3,697) |  |  | (3,309) |
General and administrative |  |  | (67) |  |  | (57) |  |  | (410) |
Transaction costs |  |  | (86,765) |  |  | — |  |  | — |
Impairments |  |  | — |  |  | (1,295,504) |  |  | — |
Other income, net |  |  | 71 |  |  | 70 |  |  | 85 |
Income (loss) before income taxes and income from and impairments of equity method investment |  |  | 313,936 |  |  | (703,118) |  |  | 619,024 |
Income tax expense |  |  | (48,181) |  |  | (796) |  |  | (756) |
Income from equity method investment |  |  | — |  |  | 50,723 |  |  | 53,175 |
Impairments of equity method investment |  |  | — |  |  | (45,895) |  |  | (35,913) |
Net income (loss) from discontinued operations |  | $ | 265,755 |  | $ | (699,086) |  | $ | 635,530 |
During the fourth quarter of 2016, using proceeds from the Spin-Off, the Company repaid $500 million of 6.0% senior unsecured notes that were due to mature in January 2017, $600 million of 6.7% senior unsecured notes that were due to mature in January 2018 and $108 million of mortgage debt; incurring aggregate loss on debt extinguishments of $46 million. HCR ManorCare, Inc. Discontinued operations is primarily comprised of QCP’s HCRMC DFL investments and equity investment in HCRMC. During the years ended December 31, 2016, 2015 and 2014, the Company recognized DFL income of $385 million, $573 million and $599 million, respectively, and received cash payments of $385 million, $483 million and $519 million, respectively, from the HCRMC DFL investments. The carrying value of the HCRMC DFL investments was $5.2 billion at December 31, 2015. The following summarizes the significant transactions and impairments related to HCRMC: 2014 During the year ended December 31, 2014, the Company concluded that its equity investment in HCRMC was other-than-temporarily impaired and recorded an impairment charge of $36 million. The impairment charge reduced the carrying amount of the Company’s equity investment in HCRMC from $75 million to its fair value of $39 million. The fair value of the Company’s equity investment was based on an income approach utilizing a discounted cash flow valuation model and inputs were considered to be Level 3 measurements within the fair value hierarchy. The following is a summary of the quantitative information about fair value measurements for the impairment related to the Company’s equity ownership interest in HCRMC using a discounted cash flow valuation model:
Description of Input(s) to the Valuation |  | Valuation Inputs |
Range of revenue growth rates(1) |  | (0.2%)-3.5% |
Range of occupancy growth rates(1) |  | (0.3%)-0.2% |
Range of operating expense growth rates(1) |  | 0.6%-2.8% |
Discount rate |  | 13.7% |
Range of earnings multiples |  | 6.0x-7.0x |
| (1) |  | For growth rates, the value ranges provided represent the highest and lowest input utilized in the valuation model for any forecasted period.
2015 During the three months ended March 31, 2015, the Company and HCRMC agreed to market for sale the real estate and operations associated with 50 non-strategic facilities that were under the Master Lease. During the year ended December 31, 2015, the Company completed sales of 22 non-strategic HCRMC facilities for $219 million. During the year ended December 31, 2016, the Company sold an additional 11 facilities for $62 million, bringing the total facilities sold to 33 at the time of the Spin-Off. On March 29, 2015, certain subsidiaries of the Company entered into an amendment to the Master Lease (the “HCRMC Lease Amendment”) effective April 1, 2015. The HCRMC Lease Amendment reduced initial annual rent by a net $68 million and reset the minimum rent escalation to 3.0% for each lease year through the expiration of the initial term. The initial term was extended five years to an average of 16 years. As consideration for the rent reduction, the Company received a Deferred Rent Obligation (“DRO”) from the Lessee equal to an aggregate amount of $525 million. As a result of the HCRMC Lease Amendment, the Company recorded an impairment charge of $478 million related to its HCRMC DFL investments. The impairment charge reduced the carrying value of the HCRMC DFL investments from $6.6 billion to $6.1 billion, based on the present value of the future lease payments effective April 1, 2015 under the Amended Master Lease discounted at the original DFL investments’ effective lease rate. Additionally, HCRMC agreed to sell, and HCP agreed to purchase, nine post-acute facilities for an aggregate purchase price of $275 million. Through December 31, 2015, HCRMC and HCP completed seven of the nine facility purchases for $184 million. Through Spin-Off, HCRMC and HCP completed the remaining two facility purchases for $91 million, bringing the nine facility purchases to an aggregate $275 million, the proceeds of which were used to settle a portion of the DRO discussed above. As of September 30, 2015, the Company concluded that its equity investment in HCRMC was other-than-temporarily impaired and recorded an impairment charge of $27 million. The impairment charge reduced the carrying amount of the Company’s equity investment in HCRMC from $48 million to its fair value of $21 million. The fair value of the Company’s equity investment in HCRMC was based on a discounted cash flow valuation model and inputs were considered to be Level 3 measurements within the fair value hierarchy. The following is a summary of the quantitative information about fair value measurements for the impairment related to the Company’s equity ownership interest in HCRMC using a discounted cash flow valuation model:
Description of Input(s) to the Valuation |  | Valuation Inputs |
Range of revenue growth rates(1) |  | (1.8%)-3.0% |
Range of occupancy growth rates(1) |  | (0.8%)-0.2% |
Range of operating expense growth rates(1) |  | (1.1%)-3.1% |
Discount rate |  | 15.20% |
Range of earnings multiples |  | 6.0x-7.0x |
| (1) |  | For growth rates, the value ranges provided represent the highest and lowest input utilized in the valuation model for any forecasted period.
As part of the Company’s fourth quarter 2015 review process, including its internal rating evaluation, it assessed the collectibility of all contractual rent payments under the Amended Master Lease, as discussed below and assigned an internal rating of “Watch List” as of December 31, 2015. Further, the Company placed the HCRMC DFL investments on nonaccrual status and began utilizing a cash basis method of accounting in accordance with its policies (see Note 2). As a result of assigning an internal rating of “Watch List” to its HCRMC DFL investments during the quarterly review process, the Company further evaluated the carrying amount of its HCRMC DFL investments and determined that it was probable that its HCRMC DFL investments were impaired. As a result of the significant decline in HCRMC’s fixed charge coverage ratio in the fourth quarter of 2015, combined with a lower growth outlook for the post-acute/skilled nursing business, the Company determined that it was probable that its HCRMC DFL investments were impaired. In the fourth quarter of 2015, the Company recorded an allowance for DFL losses (impairment charge) of $817 million, reducing the carrying amount of its HCRMC DFL investments from $6.0 billion to $5.2 billion. The allowance for credit losses was determined as the present value of expected future (i) in-place lease payments under the HCRMC Amended Master Lease and (ii) estimated market rate lease payments, each discounted at the original HCRMC DFL investments’ effective lease rate. Impairments related to an allowance for credit losses are included in impairments, net. The market rate lease payments were based on an income approach utilizing a discounted cash flow valuation model. The significant inputs to this valuation model included forecasted EBITDAR (defined as earnings before interest, taxes, depreciation and amortization, and rent), rent coverage ratios and real estate capitalization rates and are summarized as follows (dollars in thousands):
|  |  |  |  | Post-acute/ |
|  | Senior Housing |  |  | Skilled nursing |
Description of Input(s) to the Valuation |  | DFL Valuation Inputs |  |  | DFL Valuation Inputs |
Range of EBITDAR |  | $75,000-$85,000 |  |  | $385,000-$435,000 |
Range of rent coverage ratio |  | 1.05x-1.15x |  |  | 1.25x-1.35x |
Range of real estate capitalization rate |  | 6.25%-7.25% |  |  | 7.50%-8.50% |
In December 2015, the Company concluded that its equity investment in HCRMC was other-than-temporarily impaired and recorded an impairment charge of $19 million, reducing its carrying value to zero. Beginning in January 2016, income was recognized only if cash distributions were received from HCRMC. 2016 The Company’s acquisition of the HCRMC DFL investments in 2011 was subject to federal and state built-in gain tax of up to $2 billion if all the assets were sold within 10 years. At the time of acquisition, the Company intended to hold the assets for at least 10 years, at which time the assets would no longer be subject to the built-in gain tax. In December 2015, the U.S. Federal Government passed legislation which permanently reduced the holding period, for federal tax purposes, to five years. The Company satisfied the five year holding period requirement in April 2016. This legislation was not extended to certain states, which maintain a 10 year requirement. During the year ended December 31, 2016, the Company determined that it may sell assets during the next five years and, therefore, recorded a deferred tax liability of $47 million, representing its estimated exposure to state built-in gain tax. Dispositions of Real Estate Held for Sale At December 31, 2016, 64 SH NNN facilities, four life science facilities and a SHOP facility were classified as held for sale, with an aggregate carrying value of $928 million, primarily comprised of real estate assets of $809 million. At December 31, 2015, four life science facilities were classified as held for sale, with an aggregate carrying value of $314 million, primarily comprised of real estate assets of $288 million. Liabilities of assets held for sale is primarily comprised of intangible liabilities at both December 31, 2016 and 2015. 2016 Dispositions During the year ended December 31, 2016, the Company sold the following: (i) a portfolio of five post-acute/skilled nursing facilities and two SH NNN facilities for $130 million, (ii) five life science facilities for $386 million, (iii) seven SH NNN facilities for $88 million, (iv) three MOBs for $20 million and (v) three SHOP facilities for $41 million. 2015 Dispositions During the year ended December 31, 2015, the Company sold the following: (i) nine SH NNN facilities for $60 million resulting from Brookdale’s exercise of its purchase option received as part of the Brookdale Transaction, (ii) two parcels of land in its life science segment for $51 million and (iii) a MOB for $400,000. 2014 Dispositions During the year ended December 31, 2014, the Company sold the following: (i) two post-acute/skilled nursing facilities for $22 million, (ii) a hospital for $17 million, (iii) a senior housing facility for $16 million and (iv) a MOB for $145,000. On August 29, 2014, in conjunction with the Brookdale Transaction, the Company contributed three senior housing facilities with a carrying value of $92 million into the CCRC JV (an unconsolidated joint venture with Brookdale discussed in Note 3). The Company recorded its investment in the CCRC JV for the contribution of these properties at their carrying value (carryover basis) and therefore did not recognize either a gain or loss upon the contribution. Pending Dispositions In October 2016, the Company entered into definitive agreements to sell 64 SH NNN assets (classified as held for sale as of December 31, 2016), currently under triple-net leases with Brookdale, for $1.125 billion to affiliates of Blackstone Real Estate Partners VIII L.P. The closing of this transaction is expected to occur in the first quarter of 2017 and remains subject to regulatory and third party approvals and other customary closing conditions. Additionally, in October 2016, the Company entered into definitive agreements for a multi-element transaction with Brookdale to: (i) sell or transition 25 assets currently triple-net leased to Brookdale, for which Brookdale will receive a $10.5 million annual rent reduction upon lease termination, (ii) re-allocate annual rent of $9.6 million from those 25 assets to the remaining Brookdale triple-net lease portfolio (occurred on November 1, 2016) and (iii) transition eight triple-net leased assets into RIDEA structures (seven of which closed in December 2016 and one of which closed in January 2017). The closing of the sale or transition of the 25 assets and corresponding rent reduction is expected to occur throughout 2017 and remains subject to regulatory and third party approvals and other customary closing conditions. In January 2016, the Company entered into a definitive agreement for purchase options that were exercised on eight life science facilities in South San Francisco, California, to be sold in two tranches for $311 million (sold in November 2016 and discussed above) and $269 million, respectively. The second tranche is expected to close in the third quarter of 2018. Subsequent Events In January 2017, the Company sold four life science facilities in Salt Lake City, Utah for $76 million. In May 2016, the Company entered into a master contribution agreement with Brookdale to contribute its ownership interest in RIDEA II to an unconsolidated JV owned by HCP and an investor group led by Columbia Pacific Advisors, LLC (“CPA”) (the “HCP/CPA JV”). The members agreed to recapitalize RIDEA II with $602 million of debt, of which $360 million was provided by a third-party and $242 million was provided by HCP. In return, the Company received $480 million in cash proceeds from the HCP/CPA JV and $242 million in note receivables and retained an approximately 40% beneficial interest in RIDEA II (the note receivable and 40% beneficial interest are herein referred to as the “RIDEA II Investments”). The Company’s RIDEA II Investments are recognized and accounted for as equity method investments. This transaction resulted in the Company deconsolidating the net assets of RIDEA II because it will not direct the activities that most significantly impact the venture. These transactions closed in January 2017.

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