(2) Relationship with Universal Health Realty Income Trust and Related Party Transactions

Relationship with Universal Health Realty Income Trust:

At September 30, 2014, we held approximately 6.1% of the outstanding shares of Universal Health Realty Income Trust (the “Trust”). We serve as Advisor to the Trust under an annually renewable advisory agreement pursuant to the terms of which we conduct the Trust’s day-to-day affairs, provide administrative services and present investment opportunities. In addition, certain of our officers and directors are also officers and/or directors of the Trust. Management believes that it has the ability to exercise significant influence over the Trust, therefore we account for our investment in the Trust using the equity method of accounting. We earned an advisory fee from the Trust, which is included in net revenues in the accompanying condensed consolidated statements of income, of approximately $700,000 and $600,000 during the three-month periods ended September 30, 2014 and 2013, respectively, and approximately $1.9 million and $1.8 million during the nine-month periods ended September 30, 2014 and 2013, respectively.

Our pre-tax share of income from the Trust was $1.7 million and $86,000 during the three-month periods ended September 30, 2014 and 2013, respectively, and $2.1 million and $599,000 for the nine-month periods ended September 30, 2014 and 2013, respectively. Included in our share of the Trust’s income for the three and nine-month periods ended September 30, 2014, was approximately $1.6 million related to our share of an aggregate gain on fair value recognition recorded by the Trust during the third quarter of 2014 in connection with its purchases of third-party minority ownership interests in various limited liability companies in which the Trust formerly held noncontrolling majority ownership interests (the Trust now owns 100% of each of these entities).

The carrying value of our investment in the Trust was approximately $9 million and $8 million at September 30, 2014 and December 31, 2013, respectively, and is included in other assets in the accompanying condensed consolidated balance sheets. The market value of this investment, based on the closing price of the Trust’s stock on the respective dates, was approximately $33 million at September 30, 2014 and $32 million at December 31, 2013.

Total rent expense under the operating leases on the hospital facilities with the Trust was approximately $4.0 million during each of the three-month periods ended September 30, 2014 and 2013, and approximately $12.0 million for each of the nine-month periods ended September 30, 2014 and 2013. In addition, certain of our subsidiaries are tenants in several medical office buildings owned by limited liability companies in which the Trust holds either 100% ownership interests or non-controlling majority ownership interests.

During the third quarter of 2014, we provided notification to the Trust that, upon the December, 2014 expiration of the current lease term on The Bridgeway, we intend to exercise our option to purchase the real property of the facility. We anticipate that the purchase of The Bridgeway’s real property (a 103-bed behavioral health facility located in North Little Rock, Arkansas) will occur on December 31, 2014. Pursuant to the terms of the lease, we and the Trust are both required to obtain appraisals of the property to determine its fair market value. Based upon the preliminary property appraisals obtained by each party, we estimate that the purchase price of The Bridgeway’s real property will approximate $17.0 million to $17.5 million.

In addition, we are currently negotiating with the Trust regarding the Trust’s potential ownership of the real property of two free-standing emergency departments located in Texas which are currently under construction by us and scheduled to be completed during the first quarter of 2015. Since these potential transactions are contingent upon the completion and execution of acquisition and lease agreements (subsidiaries of ours are expected to operate the facilities), we can provide no assurance that these transactions will ultimately occur. Should they occur, pursuant to the terms of the acquisition and lease agreements as currently contemplated, we estimate that the aggregate construction cost/sales proceeds of these facilities will approximate $12.5 million to $13.0 million, and the aggregate rent expense paid to the Trust at the commencement of the leases will approximate $850,000 to $900,000 annually.

The table below details the renewal options and terms for each of our four hospital facilities leased from the Trust:

Hospital Name

Type of Facility

Annual
Minimum
Rent

End of Lease Term

Renewal
Term
(years)

McAllen Medical Center

Acute Care

5,485,000

December, 2016

(a)

Wellington Regional Medical Center

Acute Care

3,030,000

December, 2016

(b)

Southwest Healthcare System, Inland Valley Campus

Acute Care

2,648,000

December, 2016

(b)

The Bridgeway

Behavioral Health

930,000

December, 2014

(c)

(a)	We have three 5-year renewal options at existing lease rates (through 2031).

(b)	We have one 5-year renewal option at existing lease rates (through 2021) and two 5-year renewal options at fair market value lease rates (2022 through 2031).

(c)

As discussed above, we have provided notification to the Trust that we intend to purchase the real property of The Bridgeway upon expiration of the current lease term in December, 2014. We had two 5-year renewal options at fair market value lease rates (2015 through 2024) remaining on this property.

Other Related Party Transactions:

In December, 2010, our Board of Directors approved the Company’s entering into supplemental life insurance plans and agreements on the lives of our chief executive officer and his wife. As a result of these agreements, based on actuarial tables and other assumptions, during the life expectancies of the insureds, we would pay approximately $25 million in premiums and certain trusts, owned by our chief executive officer, would pay approximately $8 million in premiums. Based on the projected premiums mentioned above, and assuming the policies remain in effect until the death of the insureds, we will be entitled to receive death benefit proceeds of no less than $33 million representing the $25 million of aggregate premiums paid by us as well as the $8 million of aggregate premiums paid by the trusts. These agreements did not have a material effect on our consolidated financial statements or results of operations during 2013 or the first nine months of 2014.

A member of our Board of Directors and member of the Executive Committee is Of Counsel to Norton Rose Fulbright, one of the law firms used by us as outside counsel. This Board member is also the trustee of certain trusts for the benefit of our Chief Executive Officer (“CEO”) and his family. This law firm also provides personal legal services to our CEO.