Leases and Management Agreements With Five Star

Our Senior Living Communities Leased by Five Star. We are Five Star’s largest landlord and Five Star is our largest tenant. We leased 185, 185 and 177 senior living communities to Five Star as of December 31, 2017, 2016 and 2015, respectively. We lease senior living communities to Five Star pursuant to the following five leases with Five Star:


•	Lease No. 1, which expires in 2024 and includes 83 independent living communities, assisted living communities and SNFs.


•	Lease No. 2, which expires in 2026 and includes 47 independent living communities, assisted living communities and SNFs.


•	Lease No. 3, which expires in 2028 and includes 17 independent living communities and assisted living communities.


•	Lease No. 4, which expires in 2032 and includes 29 independent living communities, assisted living communities and SNFs.


•	Lease No. 5, which expires in 2028 and includes nine assisted living communities.

Under our leases with Five Star, Five Star pays us annual rent plus percentage rent equal to 4% of the increase in gross revenues at certain of our senior living communities over base year gross revenues as specified in the applicable lease. Five Star’s obligation to pay percentage rent under Lease No. 5 commences in 2018. We determine percentage rent due under these leases annually and recognize it at year end when all contingencies are met. We recognized total rental income from Five Star of $210,539, $203,581 and $196,919 (including percentage rent of $5,533, $5,686 and $5,666) for the years ended December 31, 2017, 2016 and 2015, respectively. As of December 31, 2017, Five Star’s total annual rent payable to us was $206,329, excluding percentage rent. As of December 31, 2017 and 2016, our rents receivable from Five Star were $18,539 and $18,320, respectively, and those amounts are included in due from affiliate in our consolidated balance sheets. Under our leases with Five Star, Five Star has the option to extend the lease term for two consecutive 10 or 15 year terms. We have the right, in connection with a financing or other capital raising transaction, to reassign one or more of the communities covered by Lease No. 3 or Lease No. 5 to another of our long term lease agreements with Five Star.

Our leases with Five Star are “triple net” leases, which generally require Five Star to pay rent and all property operating expenses, to indemnify us from liability which may arise by reason of our ownership of the properties, to maintain the properties at Five Star’s expense, to remove and dispose of hazardous substances on the properties in compliance with applicable law and to maintain insurance on the properties for Five Star’s and our benefit. In the event of any damage, or immaterial condemnation, of a leased property, Five Star is generally required to rebuild with insurance or condemnation proceeds or, if such proceeds are insufficient, other amounts made available by us, if any, but if other amounts are made available by us, the rent will be increased accordingly. In the event of any material or total condemnation of a leased property, the lease will terminate with respect to that leased property, in which event we will be entitled to the condemnation proceeds and the rent will be reduced accordingly. In the event of any material or total destruction of a leased property, Five Star may terminate the lease with respect to that leased property, in which event Five Star will be required to pay us any shortfall in the amount of proceeds we receive from insurance compared to the replacement cost of that leased property and the rent will be reduced accordingly.

Under our leases with Five Star, Five Star may request that we purchase certain improvements to the leased communities in return for rent increases in accordance with a formula specified in the applicable lease; however, we are not obligated to purchase such improvements and Five Star is not obligated to sell them to us. During the years ended December 31, 2017, 2016 and 2015, we purchased $39,800, $21,438 and $21,444, respectively, of such improvements and Five Star’s annual rent payable to us increased by $3,193, $1,719 and $1,734, respectively, in accordance with the terms of the applicable leases.

Five Star is our most significant tenant. The following is a summary of the assets leased and revenues earned from Five Star as a tenant as of and for the years ended December 31, 2017 and 2016 compared to all our other assets and revenues from all sources:



	As of December 31, 2017				As of December 31, 2016
	Carrying Value of Investment⁽¹⁾		% of Total		Carrying Value of Investment⁽¹⁾		% of Total
Five Star	$	2,330,630	27.5	%	$	2,290,029	27.8	%
All others	6,144,320		72.5	%	5,961,935		72.2	%
	$	8,474,950	100.0	%	$	8,251,964	100.0	%


(1)	Represents the gross book value of real estate assets before depreciation and purchase price allocations, less impairment write downs, if any. Five Star also manages our managed senior living communities. The carrying value of investment for those communities is included in the "All others" category.



	Year Ended				Year Ended
	December 31, 2017				December 31, 2016
	Total Revenues⁽¹⁾		% of Total		Total Revenues ⁽¹⁾		% of Total
Five Star	$	210,539	19.6	%	$	203,581	19.2	%
All others	864,280		80.4	%	854,441		80.8	%
	$	1,074,819	100.0	%	$	1,058,022	100.0	%


(1)	Five Star also manages our managed senior living communities. Our revenues from those communities are included in the “All others” category.

During the quarter ended June 30, 2017, we and Five Star agreed to amend the applicable lease for certain construction, expansion and development projects at two senior living communities we own and lease to Five Star. If and when Five Star requests that we purchase improvements related to these specific projects from them, Five Star’s annual rent payable to us will increase by an amount equal to the interest rate then applicable to our borrowings under our revolving credit facility plus 2% per annum of the amount we purchased. This amount of increased rent will apply until 12 months after a certificate of occupancy is issued with respect to the project; thereafter, Five Star’s annual rent payable to us will be revised to equal the amount otherwise determined pursuant to the capital improvement formula specified in the applicable lease.

See Note 3 for further information on the effects of certain of our property acquisitions and dispositions on our leases with Five Star.

Our Senior Living Communities Managed by Five Star. Five Star managed 70, 68 and 60 senior living communities for our account as of December 31, 2017, 2016 and 2015, respectively. We lease our senior living communities that are managed by Five Star and include assisted living units or SNFs to our TRSs, and Five Star manages these communities pursuant to long term management agreements.

We have pooling agreements with Five Star that combine most of our AL Management Agreements. The pooling agreements combine various calculations of revenues and expenses from the operations of the applicable communities covered by such agreements. Our AL Management Agreements and pooling agreements generally provide that Five Star receives:


•	a management fee equal to either 3% or 5% of the gross revenues realized at the applicable communities,


•	reimbursement for its direct costs and expenses related to such communities,


•	an annual incentive fee equal to either 35% or 20% of the annual net operating income of such communities remaining after we realize an annual minimum return equal to either 8% or 7% of our invested capital, or, in the case of certain of the communities, a specified amount plus 7% of our invested capital since December 31, 2015, and


•	a fee for its management of capital expenditure projects equal to 3% of amounts funded by us

On June 29, 2016, we and Five Star terminated three of our four then existing pooling agreements and entered 10 new pooling agreements that combine various of our AL Management Agreements with Five Star. Under the current pooling agreements for our AL Management Agreements, the calculations of Five Star’s fees and of our annual minimum return related to our AL Management Agreement that became effective before May 2015 and had been pooled under one of the previously existing pooling agreements are generally the same as they were under the previously existing pooling agreements. However, for certain communities, the current pooling agreements reduced our annual minimum return to 7%, and also, with respect to 10 communities, reset our annual minimum return as of January 1, 2016 to specified amounts. For our AL Management Agreements that became effective from and after May 2015, the current pooling agreements increased the management fee we pay Five Star from 3% to 5% of the gross revenues realized at the applicable community, and changed the annual incentive fee we pay Five Star from 35% to 20% of the annual net operating income of the applicable community remaining after we realize our requisite annual minimum return.

Our management agreement with Five Star for the part of our senior living community located in New York that is not subject to the requirements of New York healthcare licensing laws, as described elsewhere herein, and the management agreement for one of our assisted living communities located in California, are not currently included in any of our pooling agreements with Five Star.

We also have a pooling agreement with Five Star that combines our management agreements with Five Star for senior living communities consisting only of independent living units.

Our management agreements with Five Star generally expire between 2030 and 2041, and are subject to automatic renewal for two consecutive 15 year terms, unless earlier terminated or timely notice of nonrenewal is delivered. These management agreements also generally provide that we, and in some cases Five Star, each have the option to terminate the agreements upon the acquisition by a person or group of more than 9.8% of the other’s voting stock and upon certain change in control events affecting the other party, as defined in the applicable agreements, including the adoption of any shareholder proposal (other than a precatory proposal) with respect to the other party, or the election to the board of directors or trustees, as applicable, of the other party of any individual, if such proposal or individual was not approved, nominated or appointed, as the case may be, by a majority of the other party’s board of directors or board of trustees, as applicable, in office immediately prior to the making of such proposal or the nomination or appointment of such individual.

In December 2016, in connection with our entering into management agreements with Five Star for the five senior living communities located in Georgia with a combined 395 living units, we entered an additional pooling agreement with Five Star on terms substantially consistent with those of the pooling agreements described above.

During the quarter ended June 30, 2017, we and Five Star agreed to amend the applicable management and pooling agreements for a construction, expansion and development project at a senior living community that we own and that is managed by Five Star. Our minimum return on invested capital for this specific project will increase by an amount equal to the interest rate then applicable to our borrowings under our revolving credit facility plus 2% per annum. This amount of increased minimum return will apply until 12 months after a certificate of occupancy is issued with respect to the project; thereafter, the amount of annual minimum return on invested capital will be revised to equal the amount otherwise determined pursuant to the applicable management and pooling agreements. We and Five Star also agreed that the commencement of the measurement period for determining whether the specified annual minimum return under the applicable management and pooling agreements has been achieved will be deferred until 12 months after a certificate of occupancy is issued with respect to the project.

In November 2017, we entered a transaction agreement with Five Star pursuant to which we agreed to acquire six senior living communities from Five Star. Pursuant to this transaction agreement, we also agreed that, as we acquire these communities, (i) we and Five Star would enter into new management agreements for Five Star to manage these senior living communities for us and (ii) the new management agreements would be combined pursuant to two new pooling agreements to be entered between us and Five Star. In December 2017, January 2018 and February 2018, we acquired, and Five Star began managing for our account, two of these senior living communities located in Alabama and Indiana, one of these senior living communities located in Tennessee, and one of these senior living communities located in Arizona, respectively, and in connection with those acquisitions, we entered management agreements with Five Star for each of these senior living communities and two new pooling agreements with Five Star. Pursuant to the terms of the management and pooling agreements for five of these senior living communities, we will pay Five Star a management fee equal to 5% of the gross revenues realized at these communities plus reimbursement for Five Star’s direct costs and expenses related to its operation of these communities, as well as an annual incentive fee equal to 20% of the annual net operating income of such communities remaining after we realize an annual minimum return equal to 7% of our invested capital for these senior living communities. The terms of the management and pooling agreement for one of these senior living communities that is subject to an ongoing construction, expansion and development project are substantially the same as the terms of the management and pooling agreements for the other five senior living communities, except that our annual minimum return on invested capital related to the ongoing construction and development project at this community will be an amount equal to the interest rate then applicable to borrowings under our revolving credit facility plus 2% per annum. This amount of minimum return will apply until the earlier of 12 months after a certificate of occupancy is issued with respect to the project and the third anniversary of our acquisition of this community; thereafter, the amount of annual minimum return on invested capital related to this project will be 7% of our invested capital. Also pursuant to the terms of the management and pooling agreements for these senior living communities, we will pay Five Star a fee for its management of capital expenditure projects at these senior living communities equal to 3% of amounts funded by us. The terms of these management and pooling agreements will expire in 2041 and will be subject to automatic renewals for two 15 year periods thereafter, unless earlier terminated or timely notices of nonrenewal are delivered. The remaining acquisitions under the transaction agreement are subject to conditions, including our assumption of certain applicable mortgage debt and receipt of any applicable regulatory approvals. The conditions to these acquisitions may not be met and some or all of these acquisitions may not be completed, may be delayed or the terms of these acquisitions or the management and pooling agreements for these communities may change.

Also in November 2017, we amended our preexisting pooling agreements with Five Star, among other things, to provide that, with respect to our right to terminate all of the management agreements covered by a preexisting pooling agreement if we do not receive our annual minimum return under such agreement in each of three consecutive years, the commencement year for the measurement period for determining whether the specified annual minimum return under the applicable pooling agreement has been achieved will be 2017.

We own a senior living community in New York with 310 living units, a part of which is managed by Five Star pursuant to a long term management agreement with us with respect to the senior living units at this community that are not subject to the requirements of New York healthcare licensing laws. The terms of this management agreement are substantially consistent with the terms of our other management agreements with Five Star for communities that include assisted living units, and that provide for a management fee payable to Five Star equal to 5% of the gross revenues realized, except there is no incentive fee payable by us to Five Star. This management agreement expires on December 31, 2031.

In order to accommodate certain requirements of New York healthcare licensing laws, one of our TRSs subleases the part of this community that is subject to the requirements of those laws to D&R Yonkers LLC, an entity which is owned by our President and Chief Operating Officer and Five Star’s chief financial officer and treasurer. Five Star manages this part of the community pursuant to a long term management agreement with D&R Yonkers LLC under which Five Star earns a management fee equal to 3% of the gross revenues realized at that part of the community and no incentive fee is payable to Five Star. D&R Yonkers LLC’s management agreement with Five Star expires on August 31, 2022, and is subject to renewal for eight consecutive five year terms, unless earlier terminated or timely notice of nonrenewal is delivered. We have entered an indemnification agreement with the owners of D&R Yonkers LLC, pursuant to which we have agreed to indemnify them for costs, losses and expenses they may sustain by reason of being a member, director or officer of D&R Yonkers LLC or in connection with any costs, losses or expenses under our TRS’s sublease with D&R Yonkers LLC or the management agreement between D&R Yonkers LLC and Five Star. Our transactions and balances with D&R Yonkers LLC are eliminated upon consolidation for accounting purposes and are not separately stated and do not appear in our consolidated financial statements.

We incurred management fees of $14,080, $11,918 and $10,728 for the years ended December 31, 2017, 2016 and 2015, respectively, with respect to the communities Five Star manages for us. These amounts are included in property operating expenses or have been capitalized, as appropriate, in our consolidated financial statements.

In addition to management services to us, Five Star also provides certain other services to residents at some of the senior living communities it manages for us, such as rehabilitation services. At senior living communities Five Star manages for us where Five Star provides rehabilitation services on an outpatient basis, the residents, third party payers or government programs pay Five Star for those rehabilitation services. At senior living communities Five Star manages for us where Five Star provides both inpatient and outpatient rehabilitation services, we generally pay Five Star for these services and charges for these services are included in amounts charged to residents, third party payers or government programs. We incurred fees of $7,525, $7,707 and $7,737 for the years ended December 31, 2017, 2016 and 2015, respectively, with respect to rehabilitation services Five Star provided at senior living communities it manages for us that are payable by us. These amounts are included in property operating expenses in our consolidated statements of comprehensive income.

See Note 3 for further information on the effects of certain of our property acquisitions and dispositions on our management agreements with Five Star.