REAL ESTATE

As of December 31, 2018, we owned 220 health care real estate properties located in 33 states and consisting of 143 senior housing communities, 72 skilled nursing facilities, 3 hospitals and 2 medical office buildings. Our senior housing properties include assisted living facilities, senior living campuses, independent living facilities, and entrance-fee communities. These investments (excluding our corporate office of $2,471,000) consisted of properties with an original cost of approximately $2,815,894,000, rented under triple-net leases to 30 lessees.

Acquisitions and New Leases of Real Estate

During the year ended December 31, 2018, we announced the following real estate investments and commitments as described below (dollars in thousands):



Operator	Date	Properties	Asset Class	Amount
The Ensign Group	January/May 2018	3	SNF	$	43,404
Bickford Senior Living	April 2018	5	SHO	69,750
Comfort Care Senior Living	May 2018	2	SHO	17,140
Ignite Medical Resorts	December 2018	1	SNF	25,350
				$	155,644

Ensign

On January 12, 2018, NHI acquired from a developer a skilled nursing facility in Waxahachie, Texas for a cash investment of $14,404,000, and in May, we acquired from another developer two skilled nursing facilities in Garland and Fort Worth, Texas, for a cash investment totaling $29,000,000. Additional consideration of $1,275,000 for the Waxahachie property and $1,250,000 for each of Garland and Ft. Worth were contributed by the lessee, The Ensign Group (“Ensign”). We have capitalized the tenant contributions as a component of the cost of the facilities and have recorded the contributions as deferred revenue, which we are amortizing to revenue over the term of the master lease to which these properties have now been added. The remaining term of the master lease extends through April 2031, plus renewal options. The blended initial lease rate is set at 8.1%, subject to annual escalators based on prevailing inflation rates. The acquisitions were accounted for as an asset purchase and fulfill our original commitment to acquire and lease to Ensign four skilled nursing facilities in New Braunfels, Waxahachie, Garland and Fort Worth, Texas.

Comfort Care

On May 31, 2018, NHI acquired two assisted living facilities in Bridgeport and Saginaw, Michigan for a cash investment of $17,140,000, inclusive of $100,000 in closing costs. We leased the facilities to affiliates of Comfort Care Senior Living (“Comfort Care”) for a term of fifteen years at an initial lease rate of 7.25% with annual escalators adjusted for prevailing inflation rates, subject to a floor and ceiling of 2% and 3%, respectively. The lease provides for an initial six-month cash escrow. With the acquisition, NHI also obtained fair value-based purchase options for two newly constructed facilities operated by Comfort Care, with the purchase option windows to open upon stabilization. The acquisition was accounted for as an asset purchase.

Ignite

In December 2018, we reached an agreement with Ignite Team Partners, LLC, d/b/a Ignite Medical Resorts, to develop a $25,350,000 skilled nursing facility in suburban Milwaukee. The facility is currently under construction with an expected opening date in the fourth quarter of 2019. The facility will be leased to Ignite Healthcare, Inc. (“Ignite”) for a term of 12 years, with two ten-year renewal options, at an initial lease rate of 9.5% plus annual fixed escalators. Ignite will be eligible for an earn-out of up to $2,000,000, to be funded beginning in 2026 upon the attainment of specified metrics. NHI will have a right of first offer on future Ignite projects. We accounted for the transaction as an asset purchase. At December 31, 2018, we had funded $4,674,000, including $2,000,000 for the purchase of land.

Major Customers

Bickford

As of December 31, 2018, our Bickford Senior Living (“Bickford”) portfolio consists of leases with primary lease expiration dates as follows (in thousands):



	Lease Expiration
	June 2023		September 2024			September 2027		May 2031		April 2033		Total
Number of Properties	13		10			4		20		5		52
2018 Annual Contractual Rent	$	11,133	$	9,264		$	1,515	$	19,988	$	3,165	$	45,065
2018 Straight Line Rent Adjustment	588		(260		)	221		3,865		614		5,028
Total Revenues	$	11,721	$	9,004		$	1,736	$	23,853	$	3,779	$	50,093

On April 30, 2018, we acquired an assisted living/memory-care portfolio in Ohio and Pennsylvania comprising five facilities, one of which is subject to a ground lease with remaining term, including extensions, of 50 years. The purchase price was $69,750,000, including $500,000 in closing costs and $1,750,000 in specified capital improvements, which will be added to the lease base upon funding. In addition to the cash consideration stated above, we recorded an intangible liability of $590,000 to recognize our above-market obligation for the ground lease. We included this portfolio in a separate master lease with Bickford which provides for a lease rate of 6.85%, with annual fixed escalators over a term of 15 years plus renewal options, subject to a fair market value rent reset feature available to NHI between years three and five.

Of our total revenues, $50,093,000 (17%), $41,606,000 (15%) and $30,732,000 (12%) were recognized as rental income from Bickford for the years ended December 31, 2018, 2017 and 2016, including $5,028,000, $5,102,000, and $858,000 in straight-line rent income, respectively.

Senior Living Communities

As of December 31, 2018, we leased nine retirement communities to Senior Living Communities (“Senior Living”) under a 15-year master lease which began in December 2014, contains two 5-year renewal options and provides for an annual escalator of 4% in 2018 and 3% thereafter.

Of our total revenue, $45,868,000 (16%), $45,735,000 (16%) and $40,332,000 (16%) in lease revenues were derived from Senior Living for the years ended December 31, 2018, 2017 and 2016, respectively, including $5,436,000, $6,984,000 and $7,369,000 in straight-line rent.

Holiday

As of December 31, 2018, we leased 25 independent living facilities to an affiliate of Holiday Retirement (“Holiday”) at an original cost of $493,000,000. The 17-year master lease began in December 2013 and provides for a minimum annual escalator of 3.5% after 2017.

Of our total revenues, $43,311,000 (15%), $43,817,000 (16%) and $43,817,000 (18%) were derived from Holiday for the years ended December 31, 2018, 2017 and 2016, respectively, including $5,616,000, $7,397,000 and $8,965,000 in straight-line rent, respectively. Our tenant operates the facilities pursuant to a management agreement with a Holiday-affiliated manager.

In November 2018, we entered into a lease amendment and guaranty release (“the Agreement”) with Holiday. The Agreement extends the term of the lease, increases required minimum capital expenditure per unit and provides NHI with a stronger projected 2019 lease coverage ratio. Below is a summary of the provisions of the new agreement:


•	We are to receive consideration of approximately $65,762,000 consisting of a combination of cash and real estate equaling $55,125,000 and the forfeiture to us of $10,637,000 which is one-half of the original $21,275,000 security deposit.


•	The agreement provided that, in lieu of cash mentioned above, we could have sole discretion to acquire a Holiday property that will be leased back to Holiday at an agreed-upon rent and subject to the same terms and conditions of the amended master lease. On January 31, 2019, we acquired a senior housing facility in Vero Beach, Florida as discussed in Note 15.

•

The lease maturity is extended by five years to December 31, 2035, and will be secured by the remaining half of the NHI-held security deposit. Additionally, NHI is requiring $5,000,000 of equity to be contributed into the Holiday tenant entity (“the Credit Enhancement”). The use of the Credit Enhancement will be limited to payment of NHI rent and NHI-approved capital expenditures. Future return of the Credit Enhancement will further be limited by performance measures, including liquidity and lease service coverage ratio covenants. The Agreement also requires that $6,500,000 of equity be contributed to the Holiday management company.


•	Effective January 1, 2019, Holiday rent was reset to $31,500,000 for the existing 25 properties, as opposed to the $39,000,000 previously obligated, with escalators commencing annually November 1, 2020, equal to the greater of 2.0% or 45% of trailing 12 months year‐over‐year revenue growth of the NHI/Holiday portfolio, not to exceed 3.0%.


•	We have committed to invest up to $5,000,000 in capital expenditures into the communities at a 7.0% lease rate on funds drawn. In addition, Holiday has committed to a minimum of $1,500 per unit in annual capital expenditures.


•	NHI and Holiday are reviewing the portfolio to identify underperforming properties within the existing Holiday lease. A subsequent sale of properties, if any, would reduce the rent owed us by 7.0% of the net proceeds received by NHI. Stated levels of our security deposit and tenant Credit Enhancement will not be adjusted as a result of any future sale.

NHC

As of December 31, 2018, we leased 42 facilities under two master leases to National HealthCare Corporation (“NHC”), a publicly-held company and the lessee of our legacy properties. The facilities leased to NHC consist of 3 independent living facilities and 39 skilled nursing facilities (4 of which are subleased to other parties for whom the lease payments are guaranteed to us by NHC). These facilities are leased to NHC under the terms of an amended master lease agreement originally dated October 17, 1991 (the “1991 lease”) which includes our 35 remaining legacy properties and a master lease agreement dated August 30, 2013 (the “2013 lease”) which includes 7 skilled nursing facilities acquired from a third party.

The 1991 lease has been amended to extend the lease expiration to December 31, 2026. There are two additional 5-year renewal options, each at fair rental value of such leased property as negotiated between the parties and determined without including the value attributable to any improvements to the leased property voluntarily made by NHC at its expense. Under the terms of the lease, the base annual rental is $30,750,000 and rent escalates by 4% of the increase, if any, in each facility’s revenue over a 2007 base year. The 2013 lease provides for a base annual rental of $3,450,000 and has a lease expiration of August 2028. Under the terms of the 2013 lease, rent escalates 4% of the increase, if any, in each facility’s revenue over a 2014 base year. For both the 1991 lease and the 2013 lease, we refer to this additional rent component as “percentage rent.” During the last three years of the 2013 lease, NHC will have the option to purchase the facilities for $49,000,000.

The following table summarizes the percentage rent income from NHC (in thousands):



	Year Ended December 31,
	2018		2017		2016
Current year	$	3,411	$	3,127	$	2,932
Prior year final certification¹	285		194		547
Total percentage rent	$	3,696	$	3,321	$	3,479

¹For purposes of the percentage rent calculation described in the Master Lease Agreement, NHC’s annual revenue by facility for a given year is certified to NHI by March 31st of the following year.

Of our total revenues, $37,843,000 (13%), $37,467,000 (13%) and $37,626,000 (15%) in 2018, 2017 and 2016, respectively, were derived from NHC.

The chairman of our board of directors is also a director on NHC’s board of directors. As of December 31, 2018, NHC owned 1,630,462 shares of our common stock.

Tenant Non-Compliance

Affiliates of East Lake

In documents we have previously filed with and furnished to the SEC, we have used the shorthand “East Lake” to refer to the East Lake Capital Management affiliated entities for whom we have acted or continue to act as landlord. These entities consist of EL FW Intermediary I, LLC (for the Freshwater/Watermark continuing care retirement communities) and SH Regency Leasing, LLC (for the three assisted living facilities in Tennessee, Indiana and North Carolina referred to as “Regency”).

On June 15, 2018, East Lake Capital Management LLC and certain related entities, including Regency, filed suit against NHI and NHI-REIT of Axel, LLC, in the District Court of Dallas County, Texas; 95th Judicial District for injunctive and declaratory relief and unspecified monetary damages, including attorney’s fees. The suit sought, among other things, to enjoin NHI from making certain references to East Lake in NHI’s public filings. In response to this lawsuit, related litigation, and other circumstances, we entered motions calling for the immediate appointment of a receiver and for pre-judgment possession, hearing, and bond.

Resulting from these claims and counterclaims, on December 6, 2018, the plaintiff parties entered into an agreement with NHI under Texas Rule of Civil Procedure 11, which rule ensures the enforceability of an agreement between lawyers in a case when the agreement is in writing and filed in the papers of the court. As a result of the agreement, Regency vacated our facilities in Indiana and North Carolina on December 7, 2018 and in Tennessee on December 14, 2018. Due to a decrease in occupancy and the deferral of needed maintenance and capital expenditures related to their operation, NHI made arrangements with operators to manage the three facilities. NHI will receive 95% of operating cash flow, if any, as generated by the facilities until such time as operations become stabilized or more formal agreements are entered into.

The original libel action of the East Lake affiliated entities survives the Rule 11 agreement and is set to continue in February 2019. NHI is not precluded from further action in damages under terms of the lease.

As of December 31, 2018, based on our assessment of likely undiscounted cash flows we determined no impairment charge was required on the land, building and improvements formerly leased to Regency. We wrote off straight-line receivables from the Regency properties totaling $1,820,000 during the fourth quarter of 2018.

Of our total revenues, $5,103,000 (2%), $5,466,000 (2%), and $5,444,000 (2%) in lease revenues were derived from Regency for the years ended December 31, 2018, 2017 and 2016, respectively.

With Regency’s relinquishment of possession of the three NHI facilities as discussed above, our prospective entry into management agreements with operators willing to venture into speculative operations entails structuring the agreements so that NHI, who stands to gain the most from rehabilitation of the properties, will likely expect to absorb most of the losses, if any, that these operators will encounter during revitalization of operations at the three properties. As a result of finalizing these agreements, entity-level operations at each facility may be considered variable interests, the operators may be considered variable interest entities (“VIEs”), and NHI may potentially be considered the primary beneficiary of those entities. Consequently, NHI may be required to consolidate these operations in 2019. If so, we expect that our statements of income will reflect revenues and expenses from these foreclosed operations. During 2018, activities at these facilities were immaterial to the results of NHI’s operations.

For operations which we place in our TRS, we have NOL carryforwards of $462,000 available to offset taxable income in the TRS. The carry-forwards expire beginning in 2028.

Other

In the second quarter of 2018, we identified a single-property lease with a tenant in Wisconsin as non-performing. Lease revenues from the tenant have comprised less than 1% of our rental income, and the tenant is two months, or $840,000, in arrears on its rent payments to us as of December 31, 2018. In accordance with our revenue recognition policies, we will recognize future rental income from the lease in the period in which cash is received. Additionally, we may transition the lease to a new tenant. As a consequence of this course of action, the related straight-line receivable is considered uncollectible. Accordingly, in June 2018, we wrote off the balance of $1,436,000 pertaining to this tenant and included this amount in loan and realty losses in our consolidated statement of income. Personal guarantees totaling $3,000,000 remain in place.

We have determined that another of our tenants, The LaSalle Group, with five buildings in Illinois and Texas, is in material non-compliance with provisions of our lease regarding mandated coverage ratios, working capital requirements and timeliness of rent payments. Lease revenues from the tenant have comprised less than 2% of our rental income, and the tenant is two months in arrears on its rent payments to us as of December 31, 2018. As of October 31, 2018, we wrote off the accumulated straight-line rent receivable of $1,496,000, we ceased recording straight-line rent income, and we adopted the cash basis for recognition of revenues from this tenant. We have made no rent concessions to the tenant as of December 31, 2018.

Based on our assessment of current operations and the availability of suitable operating partners, we are seeking new tenants or managers for the other properties mentioned above. If we enter into a management agreement rather than a lease as we seek to stabilize the operations of these facilities and if our resulting operating partner does not have adequate liquidity to accept the risks and rewards of ownership, NHI might be deemed the primary beneficiary of the operations and might be required to consolidate those statements of financial position and results of operations of the managers or operating partners into our consolidated financial statements.

Of our total revenue, $5,540,000 (2%), $6,141,000 (2%), and $1,957,000 (1%) in lease revenues were derived from the above other tenants for the years ended December 31, 2018, 2017 and 2016, respectively.

In February 2019 we released a tenant from the provisions of a forbearance letter we originally issued in October 2017.

Utilization of Tenant Escrow Deposits

We have available to us a total of $3,485,000 in escrowed deposits for the above-mentioned non-compliant tenants. Through the end of 2018, we made no draws against these deposits. When tenants have been changed to cash basis and prior to adjudication of any amounts in controversy, we assess the probability of recovery, if any, through legal recourse against amounts on escrow. We consider available escrowed funds to the extent, under governing lease provisions, that specified costs incurred are to be borne by the tenant. Accordingly, we have recognized $2,534,000 as a receivable against these escrowed deposits to satisfy property tax liabilities and as reimbursement for expenses explicitly delineated under the leases.

Other Lease Activity

We have adjusted rental income for the amortization of lease inducement payments resulting from the settlement of contingencies identified in Note 6. Amortization of these payments against revenues was $387,000, $119,000 and $40,000 for the years ended December 31, 2018, 2017 and 2016, respectively.

Future Minimum Lease Payments

At December 31, 2018, the future minimum lease payments (excluding percentage rent) to be received by us under our operating leases with our tenants are as follows (in thousands):



2019	$	304,887
2020	254,321
2021	255,806
2022	258,245
2023	252,602
Thereafter	1,705,141
	$	3,031,002