Leases and Management Agreements With Five Star

Five Star recently announced that, due to current senior living industry conditions and its recurring operating losses, which are expected to continue through at least 2019, and the risk that it may not be able to obtain sufficient funding for its operating requirements, there is substantial doubt about Five Star's ability to continue as a going concern. Our Independent Trustees and Five Star’s independent directors are currently evaluating our lease and management arrangements with Five Star in light of these issues. As a result, there may be agreed changes to our arrangements with Five Star in the future. We cannot be sure that any changes to these arrangements will be agreed to or occur, or whether Five Star will be able to continue as a going concern.

Our Senior Living Communities Leased by Five Star. We are Five Star’s largest landlord and Five Star is our largest tenant. We leased 184, 185 and 185 senior living communities to Five Star as of December 31, 2018, 2017 and 2016, 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 82 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 4.0% 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 commenced in 2018. We determine percentage rent due under these leases annually and recognize it when all contingencies are met, which is typically at year end. We recognized total rental income from Five Star of $212,622, $210,539 and $203,581 (including percentage rent of $5,525, $5,533 and $5,686) for the years ended December 31, 2018, 2017 and 2016, respectively. As of December 31, 2018, Five Star’s total annual rent payable to us was $207,664, excluding percentage rent. As of December 31, 2018, 2017 and 2016, our rents receivable from Five Star were $18,697, $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 increases in annual rent 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, 2018, 2017 and 2016, we purchased $17,956, $39,800 and $21,438, respectively, of such improvements and Five Star’s annual rent payable to us increased by $1,433, $3,193 and $1,719, 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, 2018 and 2017 compared to all our other assets and revenues from all sources:



	As of December 31, 2018				As of December 31, 2017
	Carrying Value of Investment⁽¹⁾		% of Total		Carrying Value of Investment⁽¹⁾		% of Total
Five Star	$	2,253,853	26.7	%	$	2,330,630	27.5	%
All others	6,174,791		73.3	%	6,144,320		72.5	%
	$	8,428,644	100.0	%	$	8,474,950	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, 2018				December 31, 2017
	Total Revenues⁽¹⁾		% of Total		Total Revenues ⁽¹⁾		% of Total
Five Star	$	212,622	19.0	%	$	210,539	19.6	%
All others	904,542		81.0	%	864,280		80.4	%
	$	1,117,164	100.0	%	$	1,074,819	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 2.0% 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 76, 70 and 68 senior living communities for our account as of December 31, 2018, 2017 and 2016, 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 3.0% or 5.0% 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 35.0% or 20.0% of the annual net operating income of such communities remaining after we realize an annual minimum return equal to either 8.0% or 7.0% of our invested capital, or, in the case of certain of the communities, a specified amount plus 7.0% of our invested capital since December 31, 2015, and


•	a fee for its management of capital expenditure projects equal to 3.0% 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 7.0%, 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 3.0% to 5.0% of the gross revenues realized at the applicable community, and changed the annual incentive fee we pay Five Star from 35.0% to 20.0% 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 2042, 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 2.0% 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 acquired 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, February 2018 and June 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, one of these senior living communities located in Arizona, and two of these senior living communities located in Tennessee, 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 these senior living communities, we will pay Five Star a management fee equal to 5.0% 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 20.0% of the annual net operating income of such communities remaining after we realize an annual minimum return equal to 7.0% 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 2.0% 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 7.0% 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 3.0% 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.

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. The commencement year for these purposes for communities that Five Star began managing for our account since November 2017 are generally the year or two following the year the management agreement was entered.

In June 2018, Five Star began managing for our account, pursuant to a management agreement and our existing Pooling Agreement No. 12 with Five Star, as amended and restated, a senior living community we own located in California with 98 living units after the previous tenant defaulted on its lease with us. 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 2.0% 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 7.0% of our invested capital.

In November 2018, Five Star began managing for our account, pursuant to a management agreement with Five Star, a senior living community we own located in Colorado with 238 living units after the previous tenant defaulted on its lease with us. We and Five Star both have the option to terminate the management agreement with respect to this community as of December 31, 2019.

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 5.0% 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.

We incurred management fees of $14,426, $14,080 and $11,918 for the years ended December 31, 2018, 2017 and 2016, 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 $6,442, $7,525 and $7,707 for the years ended December 31, 2018, 2017 and 2016, 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.