Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The information set forth in this Item 7 is intended to provide readers with an understanding of our financial condition, changes in financial condition and results of operations. We will discuss and provide our analysis in the following order:

·2014 Transaction Overview
·Dividends
·Results of Operations
·Liquidity and Capital Resources
·Non-GAAP Financial Measures—FFO and FAD
·Off-Balance Sheet Arrangements
·Contractual Obligations
·Inflation
·Critical Accounting Policies
·Recent Accounting Pronouncements

2014 Transaction Overview

Investment Transactions

In 2014 we completed $2.1 billion of investment transactions, including $777 million (£483 million) in debt and real estate in the United Kingdom (“U.K.”) and $588 million for our 49% interest in the industry’s largest CCRC joint venture, which transactions are further described below:

Brookdale Lease Amendments and Terminations and the Formation of Two RIDEA Joint Ventures (“Brookdale Transaction”)

On August 29, 2014, HCP and Brookdale, through a Master Contribution and Transactions Agreement, closed a multiple-element transaction that has three major components:

·formed new unconsolidated joint ventures that collectively own 14 campuses of continuing care retirement communities (the “CCRC JV”). At closing, Brookdale contributed eight of its owned campuses; we contributed two campuses previously leased to Brookdale and cash used to acquire four additional campuses from third parties. HCP and Brookdale own 49% and 51%, respectively, of the CCRC JV, and Brookdale manages these communities;
·amended existing lease agreements on 153 HCP-owned senior housing communities, including the termination of embedded tenant purchase options relating to 30 properties and future rent reductions; and
·terminated existing lease agreements on 49 HCP-owned senior housing properties, including the termination of embedded tenant purchase options relating to 19 properties. At closing, we contributed 48 of these properties to a newly formed RIDEA partnerships (the “RIDEA Subsidiaries”); the 49th property was contributed on January 1, 2015. Brookdale owns a 20% noncontrolling equity interest in the RIDEA Subsidiaries and manages the facilities on behalf of the partnership.

£395 Million Debt Investment in U.K. Care Home Portfolio

In November 2014, we were the lead investor in the financing for Formation Capital and Safanad’s acquisition of NHP, a company that, at closing, owned 273 nursing and residential care homes representing over 12,500 beds in the U.K. principally operated by HC-One. We provided a loan facility totaling $630 million (£395 million), secured by substantially all of NHP’s assets, with £363 million drawn at closing.

Other Investment Transactions

During the year ended December 31, 2014, we completed $634 million of additional investments and commitments in 34 properties across our senior housing, life science and medical office segments, including $147 million (£88 million) for 23 care homes in the U.K. Additionally, we funded $287 million for construction and other capital projects, primarily in our life science, medical office and senior housing segments.

Financing Activities

We raised $2.1 billion of debt in 2014 and through January 2015, including the following transactions:

·On January 21, 2015, we issued $600 million of 3.4% senior unsecured notes due 2025. The notes were priced at 99.185% of the principal amount with a yield-to-maturity of 3.497%.
·On January 12, 2015, we completed a $333 million (£220 million) four-year unsecured term loan that accrues interest at a rate of GBP LIBOR plus 0.975%, subject to adjustments based on our credit ratings. Concurrently, we entered into a three-year interest rate swap agreement that effectively fixes the rate of the term loan at 1.79%.
·On August 14, 2014, we issued $800 million of 3.875% senior unsecured notes due 2024. The notes were priced at 99.63% of the principal amount with an effective yield-to-maturity of 3.92%.
·On February 12, 2014, we issued $350 million of 4.2% senior unsecured notes due 2024. The notes were priced at 99.537% of the principal amount with an effective yield-to-maturity of 4.257%.

On March 31, 2014, we amended our unsecured revolving credit facility and increased it by $500 million to $2 billion. The amended facility reduces our funded interest cost by 17.5 basis points and extends the maturity date to March 31, 2018. Based on our current credit ratings, the amended facility bears interest annually at LIBOR plus 92.5 basis points and has a facility fee of 15.0 basis points. Other terms of the amended facility were substantially unchanged, including a one-year extension option at our discretion, and the ability to increase the commitments by an aggregate amount of up to $500 million, subject to customary conditions.

During the year ended December 31, 2014, we repaid $911 million of aggregate senior unsecured notes and mortgage debt with a weighted average interest rate of 4.33%.

Dividends

Quarterly dividends paid during 2014 aggregated $2.18 per share, which represents a 3.8% increase from 2013. On January 29, 2015, our Board of Directors declared a quarterly cash dividend of $0.565 per common share. The annualized distribution rate per share for 2015 increased 3.7% to $2.26, compared to $2.18 for 2014. The dividend will be paid on February 24, 2015 to stockholders of record as of the close of business on February 9, 2015.

Results of Operations

We evaluate our business and allocate resources among our five business segments: (i) senior housing, (ii) post-acute/skilled nursing, (iii) life science, (iv) medical office and (v) hospital. Under the medical office segment, we invest through the acquisition and development of MOBs, which generally require a greater level of property management. Otherwise, we primarily invest, through the acquisition and development of real estate, in single tenants and operators occupied properties and debt issued by tenants and operators in these sectors. The accounting policies of the segments are the same as those described in the summary of significant accounting policies (see Note 2 to the Consolidated Financial Statements).

Non-GAAP Financial Measures

Same Property Portfolio

Our evaluation of results of operations by each business segment includes an analysis of NOI and adjusted NOI of our Same Property Portfolio (“SPP”) and our total property portfolio. We believe NOI provides relevant and useful information because it reflects only income and operating expense items that are incurred at the property level and presents them on an

unleveraged basis. We use NOI and adjusted NOI to make decisions about resource allocations and to assess and compare property level performance. SPP NOI and adjusted NOI information allows us to evaluate the performance of our property portfolio under a consistent population by eliminating changes in the composition of our portfolio of properties. We identify our SPP as stabilized properties that remained in operations and were consistently reported as leased properties or RIDEA properties for the duration of the year‑over‑year comparison periods presented. Accordingly, it takes a stabilized property a minimum of 12 months in operations under a consistent reporting structure to be included in our SPP. Newly acquired operating assets are generally considered stabilized at the earlier of lease‑up (typically when the tenant(s) controls the physical use of at least 80% of the space) or 12 months from the acquisition date. Newly completed developments and redevelopments, are considered stabilized at the earlier of lease‑up or 24 months from the date the property is placed in service. SPP NOI excludes certain non‑property specific operating expenses that are allocated to each operating segment on a consolidated basis. A property is removed from our SPP when it is sold or placed into redevelopment. NOI and adjusted NOI are non-GAAP supplemental financial measures; for a reconciliation of net income to NOI and adjusted NOI and other relevant disclosure, refer to Note 14 to the Consolidated Financial Statements.

Operating expenses generally relate to leased medical office and life science properties and senior housing RIDEA properties. We generally recover all or a portion of our leased medical office and life science property expenses through tenant recoveries. We present expenses as operating or general and administrative based on the underlying nature of the expense. Periodically, we review the classification of expenses between categories and make revisions based on changes in the underlying nature of the expenses.

Funds From Operations

We believe FFO applicable to common shares, diluted FFO applicable to common shares, and diluted FFO per common share are important supplemental non-GAAP measures of operating performance for a REIT. Because the historical cost accounting convention used for real estate assets utilizes straight-line depreciation (except on land), such accounting presentation implies that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen and fallen with market conditions, presentations of operating results for a REIT that use historical cost accounting for depreciation could be less informative. The term FFO was designed by the REIT industry to address this issue.

FFO as defined by the National Association of Real Estate Investment Trusts (“NAREIT”) is net income applicable to common shares (computed in accordance with GAAP), excluding gains or losses from sales of property, impairments of, or related to, depreciable real estate, plus real estate and DFL depreciation and amortization, and after adjustments for joint ventures. Adjustments for joint ventures are calculated to reflect FFO on the same basis. FFO does not represent cash generated from operating activities in accordance with GAAP, is not necessarily indicative of cash available to fund cash needs and should not be considered an alternative to net income. We compute FFO in accordance with the current NAREIT definition; however, other REITs may report FFO differently or have a different interpretation of the current NAREIT definition from ours.

In addition, we present FFO before the impact of severance‑related charges, litigation settlement charges, preferred stock redemption charges, impairments (recoveries) of non‑depreciable assets and transaction‑related items (defined below) (“FFO as adjusted”). Transaction-related items include acquisition and pursuit costs (e.g., due diligence and closing) and gains/charges incurred as a result of mergers and acquisitions and lease amendment or termination activities. Management believes that FFO as adjusted provides a meaningful supplemental measurement of our FFO run-rate. This measure is a modification of the NAREIT definition of FFO and should not be used as an alternative to net income (determined in accordance with GAAP) or NAREIT FFO.

Funds Available for Distribution

FAD is defined as FFO as adjusted after excluding the impact of the following: (i) amortization of acquired market lease intangibles, net; (ii) amortization of deferred compensation expense; (iii) amortization of deferred financing costs, net; (iv) straight-line rents; (v) accretion and depreciation related to DFLs; and (vi) deferred revenues, effective 2014, excluding amounts amortized into rental income that are associated with tenant funded improvements owned/recognized by us and up-front cash payments made by tenants to reduce their contractual rents. Also, FAD is: (i) computed after deducting recurring capital expenditures, including leasing costs and second generation tenant and capital improvements; and (ii) includes lease restructure payments and adjustments to compute our share of FAD from our unconsolidated joint ventures

and those related to CCRC non-refundable entrance fees. Other REITs or real estate companies may use different methodologies for calculating FAD, and accordingly, our FAD may not be comparable to those reported by other REITs. Although our FAD computation may not be comparable to that of other REITs, management believes FAD provides a meaningful supplemental measure of our ability to fund our ongoing dividend payments. In addition, management believes that in order to further understand and analyze our liquidity, FAD should not be compared with net cash flows from operating activities as determined in accordance with GAAP and presented in our consolidated financial statements. FAD does not represent cash generated from operating activities determined in accordance with GAAP, and FAD should not be considered as an alternative to net income (determined in accordance with GAAP) as an indication of our performance, as an alternative to net cash flows from operating activities (determined in accordance with GAAP), or as a measure of our liquidity.

Net Operating Income (“NOI”)

NOI and adjusted NOI are non-GAAP supplemental financial measures used to evaluate the operating performance of real estate. NOI is defined as rental and related revenues, including tenant recoveries, resident fees and services, and income from DFLs, less property level operating expense; NOI excludes all other financial statement amounts included in net income as presented in Note14 to the Consolidated Financial Statements. Management believes NOI provides relevant and useful information because it reflects only income and operating expense items that are incurred at the property level and presents them on an unleveraged basis. Adjusted NOI is calculated as NOI after eliminating the effects of straight-line rents, DFL accretion, amortization of market lease intangibles and lease termination fees. Adjusted NOI is oftentimes referred to as “cash NOI.” We use NOI and adjusted NOI to make decisions about resource allocations and to assess and compare property level performance. We believe that net income is the most directly comparable GAAP measure to NOI. NOI should not be viewed as an alternative measure of operating performance to net income as defined by GAAP because it does not reflect various excluded items. Further, our definition of NOI may not be comparable to the definition used by other REITs or real estate companies, as those companies may use different methodologies for calculating NOI.

Comparison of the Year Ended December 31, 2014 to the Year Ended December 31, 2013

Overview(1)

Results are for the years ended December 31, 2014 and 2013 (dollars in thousands except per share data):

Year EndedYear EndedPer
December 31, 2014December 31, 2013Share
AmountPer ShareAmountPer ShareChange
FFO$1,381,634$3.00$1,349,264$2.95$0.05
FFO as adjusted1,398,6913.041,382,6993.020.02
FAD1,178,8222.571,158,0822.540.03
Net income919,7962.00969,1032.13(0.13)
(1)For the reconciliation, see “Non-GAAP Financial Measures—FFO and FAD” section beginning on page 56.

FFO increased $0.05 per share primarily as a result of: (i) net gains from the Brookdale Transaction, (ii) increased NOI from our SPP and our 2013 and 2014 acquisitions, and (iii) a general and administrative charge in 2013 resulting from the termination of our former chief executive officer. The aforementioned were partially offset by: (i) an impairment charge in 2014 for our equity ownership investment in HCRMC and (ii) favorable one-time items including interest income in 2013 from the par payoff of our Barchester debt investments and sale of marketable equity securities.

FFO as adjusted and FAD increased $0.02 and $0.03 per share, respectively, primarily as a result of increased NOI from our SPP and 2013 and 2014 acquisitions, which were partially offset by favorable one-time items including interest income in 2013 from the par payoff of our Barchester debt investments and sale of marketable equity securities.

Earnings per share ("EPS") decreased $0.13 per share primarily as a result of: (i) decreased gain on sales of real estate and (ii) increased depreciation expense, partially offset by the net result of the aforementioned events impacting FFO.

Segment NOI and Adjusted NOI

The tables below provide selected operating information for our SPP and total property portfolio for each of our five business segments. Our consolidated SPP consists of 1,011 properties representing properties acquired or placed in service and stabilized on or prior to January 1, 2013 and that remained in operations under a consistent reporting structure through December 31, 2014. Our consolidated total property portfolio represents 1,108 and 1,079 properties at December 31, 2014 and 2013, respectively, and excludes properties classified as discontinued operations.

Senior Housing

As part of the previously described Brookdale Transaction, we contributed 49 properties (one property was contributed on January 1, 2015) that were triple-net leased into a RIDEA structure, with Brookdale managing the communities and acquiring a 20% equity interest in the RIDEA partnerships. For the 49 properties in the RIDEA partnerships, we report the resident-level revenues and corresponding operating expenses in our consolidated financial statements rather than the pre-transaction triple-net rents. In future periods, we expect increases in resident fee and service revenue and operating expenses and a decrease in rental and related revenues.

Additionally, we created the CCRC JV, which is managed by Brookdale. In future periods, we expect to record our share of income from unconsolidated joint ventures; also, as a result of deconsolidating three senior housing properties that were contributed to the CCRC JV, we expect a decrease in rental and related revenues and depreciation expense.

See information regarding the Brookdale Transaction in Note 3 to the Consolidated Financial Statements.

Results are as of and for the years ended December 31, 2014 and 2013 (dollars in thousands except per unit data):

SPPTotal Portfolio
20142013(2)Change20142013Change
Rental revenues(2)$506,592$505,629$963$621,114$602,506$18,608
Resident fees and services153,251146,2457,006241,965146,28895,677
Total segment revenues$659,843$651,874$7,969$863,079$748,794$114,285
Operating expenses(98,191)(93,792)(4,399)(167,407)(95,603)(71,804)
NOI$561,652$558,082$3,570$695,672$653,191$42,481
Straight-line rents(25,690)(34,613)8,923(30,392)(43,268)12,876
DFL accretion(9,216)(14,750)5,534(9,216)(14,750)5,534
Amortization of market lease intangibles, net(613)(781)168(588)(681)93
Lease termination fees———(38,001)—(38,001)
Adjusted NOI$526,133$507,938$18,195$617,475$594,492$22,983
Adjusted NOI % change3.6%
Property count387387465444
Average capacity (units)(3)38,54538,54145,68445,400
Average annual rent per unit(4)$13,693$13,285$13,596$13,174
(1)From our 2013 presentation of SPP, we removed one senior housing property that was sold and 51 senior housing properties that were contributed to partnerships under a RIDEA structure as part of the Brookdale Transaction and no longer meet our criteria for SPP upon contribution.
(2)Represents rental and related revenues and income from DFLs.
(3)Represents average capacity as reported by the respective tenants or operators for a twelve-month period that is a quarter in arrears from the periods presented.
(4)Average annual rent per unit for operating properties under a RIDEA structure is based on NOI.

SPP NOI and Adjusted NOI. SPP NOI increased primarily from improved performance from RIDEA properties; SPP adjusted NOI improved as a result of annual rent increases and improved performance from RIDEA properties.

Total Portfolio NOI and Adjusted NOI. In addition to the impact of our SPP, our total portfolio NOI increased as a result of recognizing net fees of $38 million from the Brookdale Transaction (see Note 3 to the Consolidated Financial Statements). Our total portfolio NOI and adjusted NOI also increased as a result of our senior housing acquisitions in 2014 and 2013.

Post-Acute/Skilled Nursing

Results are as of and for the years ended December 31, 2014 and 2013 (dollars in thousands, except per bed data):

SPPTotal Portfolio
20142013(1)Change20142013Change
Rental revenues(2)$553,778$540,403$13,375$555,322$541,805$13,517
Operating expenses(168)(443)275(2,087)(2,485)398
NOI$553,610$539,960$13,650$553,235$539,320$13,915
Straight-line rents(799)(553)(246)(835)(553)(282)
DFL accretion(68,251)(71,125)2,874(68,352)(71,305)2,953
Amortization of market lease intangibles, net4646—4646—
Adjusted NOI$484,606$468,328$16,278$484,094$467,508$16,586
Adjusted NOI % change3.5%
Property count301301301302
Average capacity (beds)(3)38,33338,25338,44138,464
Average annual rent per bed$12,645$12,253$12,646$12,218
(1)From our 2013 presentation of SPP, we removed a post-acute/skilled nursing property that was sold.
(2)Represents rental and related revenues and income from DFLs.
(3)Represents average capacity as reported by the respective tenants or operators for a twelve-month period that is a quarter in arrears from the periods presented.

NOI and Adjusted NOI. SPP and total portfolio NOI and adjusted NOI increased primarily as a result of annual rent escalations from our HCRMC DFL investments.

HCRMC equity method and DFL investments. On December 19, 2014, we concluded that our 9.4% equity ownership interest in HCRMC was other-than-temporarily impaired, and we recorded an impairment charge of $36 million, or $0.08 per diluted share, in the fourth quarter of 2014; the impairment charge reduced the carrying amount of our equity investment in HCRMC to $39 million. We made this conclusion principally based on the receipt and review of HCRMC’s preliminary base financial forecast for 2015, together with HCRMC’s year-to-date operating results through November 2014. HCRMC’s preliminary base financial forecast and operating results primarily reflected a continued shift in patient payor sources from Medicare to Medicare Advantage, which negatively impacts reimbursement rates and length of stay for HCRMC’s skilled nursing segment. HCRMC has indicated that its 2015 preliminary base financial forecast does not include the effect of any dispositions, acquisitions or other initiatives HCRMC may undertake to improve financial performance in 2015.

We believe that HCRMC’s trailing Twelve-month Fixed Charge Coverage (“TFCC”) ratio may continue to deteriorate over the next several quarters. HCRMC’s 2015 preliminary base financial forecast implies that the TFCC ratio is projected to decline to 1.07x at the end of 2015, compared to the TFCC ratio of 1.08x at the end of 2014, before the impact of $24 million of certain general and professional liability charges that HCRMC incurred in the second quarter of 2014. As noted above, the TFCC ratio is calculated using HCRMC’s 2015 preliminary base financial forecast that does not include the effects of any dispositions, acquisitions or other initiatives HCRMC may undertake to improve financial performance in 2015.

Notwithstanding these developments, HCRMC’s 2015 preliminary base financial forecast also indicates that HCRMC will continue to meet its contractual obligations to us under a master lease (the “Master Lease”). Therefore, we continue to believe that the collection and timing of all amounts owed by HCRMC under our Master Lease are reasonably assured. HCRMC believes that it is favorably positioned to grow as part of the ongoing changes in the healthcare environment.

Based on discussions with the management of HCRMC and our evaluation of other industry data, we note the following factors that influenced our evaluation of HCRMC: (i) Medicare rate increases of 1.7% and 1.4% took effect on October 1, 2014 for the skilled nursing and hospice businesses, respectively; (ii) additional cost cutting measures were implemented in the fourth quarter of 2014; (iii) new facility developments and expansions will be operational in 2015; (iv) assisted living and hospice operations demonstrated continued growth; (v) HCP and HCR ManorCare have jointly agreed to market for sale certain non-strategic assets that are under the master lease; the purpose of the dispositions is to increase EBITDAR, reduce rent and improve HCRMC’s TFCC; however, no assurances can be given that the facilities will be sold or as to the timing of the sales; and (vi) hospital admissions are forecasted to improve in 2015.

While we remain confident in HCRMC’s ongoing adjustments to their business model, HCRMC has not been able to reverse the decline in their financial performance. Failure of HCRMC to reverse the decline in its financial performance may lead us to conclude that the collection and timing of contractual obligations, or a portion thereof, under the Master Lease may not be reasonably assured; in which case, we would place the HCRMC DFL, or a portion thereof, on nonaccrual status. If we further determine that it is probable that we will not be able to collect all amounts due under the terms of the Master Lease, we may incur an impairment on our HCRMC DFL, or a portion thereof.

Life Science

Results are as of and for the years ended December 31, 2014 and 2013 (dollars and sq. ft. in thousands, except per sq. ft. data):

SPPTotal Portfolio
20142013(1)Change20142013Change
Rental revenues$247,062$243,558$3,504$264,164$251,919$12,245
Tenant recoveries46,00443,6282,37649,95044,9604,990
Total segment revenues$293,066$287,186$5,880$314,114$296,879$17,235
Operating expenses(53,512)(50,888)(2,624)(63,080)(56,956)(6,124)
NOI$239,554$236,298$3,256$251,034$239,923$11,111
Straight-line rents(8,105)(12,557)4,452(9,608)(11,347)1,739
Amortization of market lease intangibles, net(12)179(191)1039310
Lease termination fees—(194)194(570)(194)(376)
Adjusted NOI$231,437$223,726$7,711$240,959$228,475$12,484
Adjusted NOI % change3.4%
Property count105105111111
Average occupancy93.1%91.5%93.0%91.8%
Average occupied sq. ft.6,3256,2126,6376,480
Average annual total segment revenues per occupied sq. ft.$45$44$46$44
Average annual rental revenues per occupied sq. ft.$38$37$38$37
(1)From our 2013 presentation of SPP, we removed three life science facilities that were placed into land held for development and a life science facility that was placed into redevelopment in 2014, which no longer meet our criteria for SPP as of the date placed into development.

SPP NOI and Adjusted NOI. SPP NOI and adjusted NOI increased as a result of increased average occupancy. Additionally, SPP adjusted NOI increased as a result of annual rent escalations.

Total Portfolio NOI and Adjusted NOI. In addition to the impact of our SPP, our total portfolio NOI and adjusted NOI increased primarily as a result of the impact of our life science development projects placed in service during 2014 and 2013.

During the year ended December 31, 2014, 1.5 million square feet of new and renewal leases commenced at an average annual base rent of $30.40 per square foot compared to 1.1 million square feet of expiring leases with an average annual base rent of $30.83 per square foot. During the year ended December 31, 2014, we acquired a fully-occupied 83,000 square foot building with an average annual base rent of $33.87 per square foot.

Medical Office

Results are as of and for the years ended December 31, 2014 and 2013 (dollars and sq. ft. in thousands, except per sq. ft. data):

SPPTotal Portfolio
20142013(1)Change20142013Change
Rental revenues$296,216$292,680$3,536$312,734$299,102$13,632
Tenant recoveries54,93552,7692,16658,22253,2324,990
Total segment revenues$351,151$345,449$5,702$370,956$352,334$18,622
Operating expenses(134,275)(131,148)(3,127)(148,199)(139,376)(8,823)
NOI$216,876$214,301$2,575$222,757$212,958$9,799
Straight-line rents(1,270)(3,088)1,818(2,022)(3,161)1,139
Amortization of market lease intangibles, net995950458611,037(176)
Lease termination fees(192)(23)(169)(245)(23)(222)
Adjusted NOI$216,409$212,140$4,269$221,351$210,811$10,540
Adjusted NOI % change2.0%
Property count203203215206
Average occupancy91.491.3%90.7%90.7%
Average occupied sq. ft.12,61812,58213,17812,767
Average annual total segment revenues per occupied sq. ft.$28$27$28$27
Average annual rental revenues per occupied sq. ft.$23$23$24$23
(1)From our 2013 presentation of SPP, we removed a MOB that was sold.

SPP NOI and Adjusted NOI. SPP NOI and adjusted NOI increased primarily as a result of annual rent escalations.

Total Portfolio NOI and Adjusted NOI. In addition to the impact of our SPP, our total portfolio NOI and adjusted NOI increased primarily as a result of our medical office acquisitions in 2014.

During the year ended December 31, 2014, 2.6 million square feet of new and renewal leases commenced at an average annual base rent of $23.15 per square foot compared to 2.6 million square feet of expiring and terminated leases with an average annual base rent of $25.06 per square foot. During the year ended December 31, 2014, we acquired six MOBs with 953,000 occupied square feet that have average annual base rent of $25.00 per square foot.

Hospital

Results are as of and for the years ended December 31, 2014 and 2013 (dollars in thousands, except per bed data):

SPPTotal Portfolio
20142013Change20142013Change
Rental revenues(1)$82,667$69,213$13,454$83,992$69,603$14,389
Tenant recoveries2,5152,457582,5162,45759
Total segment revenues$85,182$71,670$13,512$86,508$72,060$14,448
Operating expenses(3,773)(3,813)40(3,830)(3,862)32
NOI$81,409$67,857$13,552$82,678$68,198$14,480
Straight-line rents1,83518,386(16,551)1,81318,378(16,565)
Amortization of market lease intangibles, net(1,369)(6,825)5,456(1,370)(6,824)5,454
Adjusted NOI$81,875$79,418$2,457$83,121$79,752$3,369
Adjusted NOI % change3.1%
Property count15151616
Average capacity (beds)(2)2,1612,1492,2212,175
Average annual rent per bed$39,634$38,730$39,149$38,437
(1)Represents rental and related revenues and income from DFLs.
(2)Represents average capacity as reported by the respective tenants or operators for a twelve-month period that is a quarter in arrears from the periods presented. Certain operators in our hospital portfolio are not required under their respective leases to provide operational data.

NOI and Adjusted NOI. SPP and total portfolio NOI increased primarily due to a net $12 million correction in 2013 that reduced previously recognized non-cash revenues including straight-line rents and accelerated amortization of below market lease intangibles related to our Medical City Dallas hospital. SPP and total portfolio adjusted NOI increased primarily as a result of annual rent escalations.

Other Income and Expense Items

Interest income. Interest income decreased $12 million to $74 million for the year ended December 31, 2014. The decrease was primarily the result of the repayment of our Barchester loan in September 2013, partially offset by interest earned from the June 2013 funding under the Tandem Health Care mezzanine loan facility and the November 2014 U.K. debt investment (see Note 7 to the Consolidated Financial Statements).

Interest expense. For the year ended December 31, 2014, interest expense increased $4 million to $440 million. The increase was primarily the result of net increase in indebtedness as presented below.

The table below sets forth information with respect to our debt, excluding premiums and discounts (dollars in thousands):

As of December 31,(1)
20142013
Balance:
Fixed rate$8,841,676$8,581,889
Variable rate847,01633,955
Total$9,688,692$8,615,844
Percentage of total debt:
Fixed rate91.3%99.6%
Variable rate8.70.4
Total100%100%
Weighted average interest rate at end of period:
Fixed rate5.01%5.10%
Variable rate1.59%1.13%
Total weighted average rate4.71%5.08%
(1)At December 31, 2014, excludes $97 million of other debt that represents non-interest bearing life care bonds and occupancy fee deposits at certain of our senior housing facilities and demand notes that have no scheduled maturities. At December 31, 2013, excludes $75 million of other debt that represents non-interest bearing life care bonds and occupancy fee deposits at certain of our senior housing facilities. At December 31, 2014 and 2013, $71 million and $72 million of variable-rate mortgages, respectively, and a £137 million ($214 million and $227 million, respectively) term loan are presented as fixed-rate debt as the interest payments were swapped from variable to fixed.

Our exposure to expense fluctuations related to our variable rate indebtedness is mitigated by our interest rate swap contracts. For a more detailed discussion of our interest rate risk, see Item 7A.

Depreciation and amortization expense. Depreciation and amortization expenses increased $37 million to $460 million for the year ended December 31, 2014. The increase was primarily the result of acquisitions, redevelopment projects placed in service and changes in estimates of the depreciable lives and residual values of certain properties.

General and administrative expenses. General and administrative expenses decreased $21 million to $82 million for the year ended December 31, 2014. The year ended December 31, 2013 included $27 million of severance-related charges resulting from the termination of our former chief executive officer (see Note 16 to the Consolidated Financial Statements).

Acquisition and pursuit costs. Acquisition and pursuit costs expenses increased $11 million to $17 million for the year ended December 31, 2014. The increase was primarily due to higher levels of transactional activity in 2014, including transactional costs related to the Brookdale Transaction and the U.K. real estate and debt investments. Acquisition and pursuit costs were previously included in general and administrative expenses.

Other income, net. For the year ended December 31, 2014, other income, net decreased $11 million to $8 million. The decrease was primarily the result of gains from the sale of marketable equity securities during 2013; there were no comparable gains from the sale of marketable securities in 2014.

Income taxes. For the year ended December 31, 2014, income taxes decreased by $6 million to $250,000. The decrease in income taxes was primarily due to the losses of our TRS entities during the year ended December 31, 2014.

Equity income from unconsolidated joint ventures. For the year ended December 31, 2014, equity income from unconsolidated joint ventures decreased $15 million to $50 million. The decrease in equity income from unconsolidated joint ventures was primarily the result of: (i) our share of losses from the CCRC JV investment formed in 2014; (ii) the decline in operating performance of our HCRMC equity interest; and (iii) a 2013 one-time distribution received from a senior housing joint venture that exceeded our investment balance.

Impairment of investments in unconsolidated joint ventures. During the year ended December 31, 2014, we recognized an impairment of $36 million related to our 9.4% equity ownership interest in HCRMC (see Notes 8 and 17 to the Consolidated Financial Statements).

Gain on sales of real estate (continued and discontinued). During the year ended December 31, 2014, we sold five properties for total gain on sales of real estate of $31 million. During the year ended December 31, 2013, we sold 13 properties for total gain on sales of real estate of $70 million (see Note 5 to the Consolidated Financial Statements).

Comparison of the Year Ended December 31, 2013 to the Year Ended December 31, 2012

Overview(1)

Results are for the years ended December 31, 2013 and 2012 (dollars in thousands except per share data):

Year EndedYear EndedPer
December 31, 2013December 31, 2012Share
AmountPer ShareAmountPer ShareChange
FFO$1,349,264$2.95$1,166,508$2.72$0.23
FFO as adjusted1,382,6993.021,195,7992.790.23
FAD1,158,0822.54954,6452.230.31
Net income969,1032.13812,2891.900.23
(1)For the reconciliation, see “Non-GAAP Financial Measures—FFO and FAD” section beginning on page 56.

FFO, FFO as adjusted and EPS each increased $0.23 per share primarily resulting from: (i) real estate acquisitions, property developments placed in service and debt investments (e.g., the BlackStone JV acquisition, Tandem Health Care loan facility, and Four Seasons debt investment); (ii) par payoff of our Barchester debt investments; (iii) gain from sales of marketable equity securities and (iv) increased NOI from our SPP.

FAD increased $0.31 per share primarily as a result of the aforementioned benefits impacting FFO, FFO as adjusted and EPS and growth in cash-based rents.

Segment NOI and Adjusted NOI

The tables below provide selected operating information for our SPP and total property portfolio for each of our five business segments. Our consolidated SPP consists of 909 properties representing properties acquired or placed in service and stabilized on or prior to January 1, 2012 and that remained in operations under a consistent reporting structure through December 31, 2013. Our consolidated total property portfolio represents 1,079 and 1,071 properties at December 31, 2013 and 2012, respectively, and excludes properties classified as discontinued operations.

Senior Housing

During the fourth quarter of 2012 and first quarter of 2013, we acquired a portfolio of 133 senior housing communities from the Blackstone JV (see Note 4 to the Consolidated Financial Statements). The transaction closed in two stages: (i) 129 senior housing facilities during the fourth quarter of 2012 for $1.7 billion; and (ii) four senior housing facilities during the first quarter of 2013 for $38 million. The results of operations from the acquisitions are reflected in our consolidated financial statements from those respective dates.

Results are as of and for the years ended December 31, 2013 and 2012 (dollars in thousands except per unit data):

SPPTotal Portfolio
20132012(1)Change20132012Change
Rental revenues(2)$465,254$459,058$6,196$602,506$481,559$120,947
Resident fees and services146,288139,0737,215146,288139,0737,215
Total segment revenues$611,542$598,131$13,411$748,794$620,632$128,162
Operating expenses(92,674)(88,575)(4,099)(95,603)(91,423)(4,180)
NOI$518,868$509,556$9,312$653,191$529,209$123,982
Straight-line rents(15,413)(25,662)10,249(43,268)(30,406)(12,862)
DFL accretion(14,750)(18,812)4,062(14,750)(18,812)4,062
Amortization of market lease intangibles, net(1,196)(1,432)236(681)(1,320)639
Adjusted NOI$487,509$463,650$23,859$594,492$478,671$115,821
Adjusted NOI % change5.1%
Property count310310444439
Average capacity (units)(3)35,03835,03445,40036,694
Average annual rent per unit(4)$13,932$13,252$13,174$13,140
(1)From our 2012 presentation of SPP, we removed two senior housing properties that were sold or classified as held for sale.
(2)Represents rental and related revenues and income from DFLs.
(3)Represents average capacity as reported by the respective tenants or operators for a twelve-month period that is a quarter in arrears from the periods presented.
(4)Average annual rent per unit for operating properties under a RIDEA structure is based on NOI.

SPP NOI and Adjusted NOI. SPP NOI increased primarily as a result of rent increases related to new leases or leases recognized on a cash basis and increased NOI from RIDEA properties. SPP adjusted NOI improved primarily as a result of annual rent increases including increases from properties that were previously transitioned from Sunrise to other operators and increased NOI from RIDEA properties.

Total Portfolio NOI and Adjusted NOI. In addition to the impact of our SPP, our total portfolio NOI and adjusted NOI primarily increased as a result of our Blackstone JV acquisition.

Post-Acute/Skilled Nursing

Results are as of and for the years ended December 31, 2013 and 2012 (dollars in thousands, except per bed data):

SPPTotal Portfolio
20132012(1)Change20132012Change
Rental revenues(2)$541,805$530,037$11,768$541,805$530,037$11,768
Operating expenses(485)(475)(10)(2,485)(475)(2,010)
NOI$541,320$529,562$11,758$539,320$529,562$9,758
Straight-line rents(553)(724)171(553)(724)171
DFL accretion(71,305)(75,428)4,123(71,305)(75,428)4,123
Amortization of market lease intangibles, net4646—4646—
Adjusted NOI$469,508$453,456$16,052$467,508$453,456$14,052
Adjusted NOI % change3.5%
Property count302302302302
Average capacity (beds)(3)38,46438,45938,46438,459
Average annual rent per bed$12,218$11,802$12,218$11,802
(1)From our 2012 presentation of SPP, we removed 10 post-acute/skilled nursing properties that were sold or classified as held for sale.
(2)Represents rental and related revenues and income from DFLs.
(3)Represents average capacity as reported by the respective tenants or operators for a twelve-month period that is a quarter in arrears from the periods presented.

NOI and Adjusted NOI. SPP and total portfolio NOI and adjusted NOI primarily increased as a result of annual rent increases.

Life Science

Results are as of and for the years ended December 31, 2013 and 2012 (dollars and sq. ft. in thousands, except per sq. ft. data):

SPPTotal Portfolio
20132012Change20132012Change
Rental revenues$240,777$240,145$632$251,919$246,811$5,108
Tenant recoveries42,97542,16481144,96042,8532,107
Total segment revenues$283,752$282,309$1,443$296,879$289,664$7,215
Operating expenses(49,636)(47,914)(1,722)(56,956)(53,173)(3,783)
NOI$234,116$234,395$(279)$239,923$236,491$3,432
Straight-line rents(11,604)(8,590)(3,014)(11,347)(9,730)(1,617)
Amortization of market lease intangibles, net112462(350)93411(318)
Lease termination fees(194)(175)(19)(194)(175)(19)
Adjusted NOI$222,430$226,092$(3,662)$228,475$226,997$1,478
Adjusted NOI % change(1.6)%
Property count102102111109
Average occupancy93.0%91.4%91.8%89.6%
Average occupied sq. ft.6,2196,1086,4806,250
Average annual total segment revenues per occupied sq. ft.$44$45$44$45
Average annual rental revenues per occupied sq. ft.$37$38$37$38

SPP NOI and Adjusted NOI. SPP NOI decreased primarily as a result of mark-to-market rent reductions on renewed leases. SPP adjusted NOI decreased primarily as a result of a $4 million rent payment received in February 2012 in connection with a lease amendment and mark-to-market rent reductions, partially offset by annual rent escalations.

Total Portfolio NOI and Adjusted NOI. In addition to the impact of our SPP, our total portfolio NOI increased primarily as a result of rents on recent development projects placed in service during 2013 and 2012.

During the year ended December 31, 2013, 545,000 square feet of new and renewal leases commenced at an average annual base rent of $27.43 per square foot compared to 392,000 square feet of expiring and terminated leases with an average annual base rent of $32.83 per square foot.

Medical Office

Results are as of and for the years ended December 31, 2013 and 2012 (dollars and sq. ft. in thousands, except per sq. ft. data):

SPPTotal Portfolio
20132012(1)Change20132012Change
Rental revenues$265,176$263,726$1,450$299,102$283,561$15,541
Tenant recoveries46,71946,61510453,23249,4473,785
Total segment revenues$311,895$310,341$1,554$352,334$333,008$19,326
Operating expenses(118,643)(117,901)(742)(139,376)(132,132)(7,244)
NOI$193,252$192,440$812$212,958$200,876$12,082
Straight-line rents(1,472)(4,381)2,909(3,161)(5,258)2,097
Amortization of market lease intangibles, net5102902201,037457580
Lease termination fees(23)(314)291(23)(314)291
Adjusted NOI$192,267$188,035$4,232$210,811$195,761$15,050
Adjusted NOI % change2.3%
Property count181181206206
Average occupancy91.6%91.3%90.7%91.2%
Average occupied sq. ft.11,39511,35112,76712,147
Average annual total segment revenues per occupied sq. ft.$27$27$27$27
Average annual rental revenues per occupied sq. ft.$23$23$23$23
(1)From our 2012 presentation of SPP, we removed two MOBs that were placed into redevelopment in 2013, which no longer meet our criteria for SPP as of the date they were placed into redevelopment.

Total Portfolio NOI and Adjusted NOI. Total portfolio NOI and adjusted NOI increased primarily as a result of the impact of our MOB acquisitions during 2012.

During the year ended December 31, 2013, 2.1 million square feet of new and renewal leases commenced at an average annual base rent of $21.54 per square foot compared to 2.2 million square feet of expiring and terminated leases with an average annual base rent of $22.06 per square foot.

Hospital

Results are as of and for the years ended December 31, 2013 and 2012 (dollars in thousands, except per bed data):

SPPTotal Portfolio
20132012(1)Change20132012Change
Rental revenues(2)$64,249$74,815$(10,566)$69,603$77,872$(8,269)
Tenant recoveries2,4572,3261312,4572,326131
Total segment revenues$66,706$77,141$(10,435)$72,060$80,198$(8,138)
Operating expenses(3,812)(3,506)(306)(3,862)(3,513)(349)
NOI$62,894$73,635$(10,741)$68,198$76,685$(8,487)
Straight-line rents19,238(554)19,79218,378(1,134)19,512
Amortization of market lease intangibles, net(6,725)(347)(6,378)(6,824)(447)(6,377)
Adjusted NOI$75,407$72,734$2,673$79,752$75,104$4,648
Adjusted NOI % change3.7%
Property count14141615
Average capacity (beds)(3)2,1322,0562,1752,087
Average annual rent per bed$37,151$37,091$38,437$37,679
(1)From our 2012 presentation of SPP, we removed two hospitals that were sold or classified as held for sale.
(2)Represents rental and related revenues and income from DFLs.
(3)Represents average capacity as reported by the respective tenants or operators for a twelve-month period that is a quarter in arrears from the periods presented. Certain operators in our hospital portfolio are not required under their respective leases to provide operational data.

SPP and Total Portfolio NOI and Adjusted NOI. SPP and total portfolio NOI primarily decreased due to a net $12 million correction in 2013 that reduced previously recognized non-cash revenues including straight-line rents and to increasing amortization of below market lease intangibles related to our Medical City Dallas hospital. SPP and total portfolio adjusted NOI increased due to annual rent increases, a new lease on our Plano hospital and rents on our Fresno hospital that was placed in service in January 2013.

Other Income and Expense Items

Interest income. Interest income increased $62 million to $86 million for the year ended December 31, 2013. The increase was primarily the result of interest income from the repayment of our Barchester loan in September 2013 (acquired earlier in 2013 at a discount), additional interest income earned from the second tranche of our mezzanine loan facility to Tandem Health Care in June 2013 and interest earned from our Four Seasons senior unsecured notes purchased in 2012 (see Notes 7 and 10 to the Consolidated Financial Statements).

Interest expense. For the year ended December 31, 2013, interest expense increased $19 million to $435 million. The increase was primarily the result of increases in the average outstanding indebtedness during 2013 compared to 2012 and a decrease of capitalized interest in 2013 related to assets that were under development in our life science and medical office segments and were placed in service during 2013 and 2012. These increases were partially offset by a decrease in interest rates.

Our exposure to expense fluctuations related to our variable rate indebtedness is mitigated by our interest rate swap contracts. For a more detailed discussion of our interest rate risk, see “Quantitative and Qualitative Disclosures About Market Risk” section in Item 7A.

The table below sets forth information with respect to our debt, excluding premiums and discounts (dollars in thousands):

As of December 31,(1)
20132012
Balance:
Fixed rate$8,581,889$8,606,075
Variable rate33,95540,385
Total$8,615,844$8,646,460
Percentage of total debt:
Fixed rate99.6%99.5%
Variable rate0.40.5
Total100%100%
Weighted average interest rate at end of period:
Fixed rate5.10%5.23%
Variable rate1.13%1.49%
Total weighted average rate5.08%5.22%
(1)Excludes $75 million and $82 million at December 31, 2013 and 2012, respectively, of other debt that represents non‑interest bearing life care bonds and occupancy fee deposits at certain of our senior housing facilities, which have no scheduled maturities. At December 31, 2013 and 2012, $72 million and $86 million of variable‑rate mortgages, respectively, and a £137 million ($227 million and $223 million, respectively) term loan are presented as fixed‑rate debt as the interest payments under such debt have been swapped (pay fixed and receive float).

Depreciation and amortization expense. Depreciation and amortization expenses increased $70 million to $423 million for the year ended December 31, 2013. The increase was primarily the result of the impact of our senior housing facility and MOB acquisitions during 2012.

General and administrative expenses. General and administrative expenses increased $35 million to $103 million for the year ended December 31, 2013. The year ended December 31, 2013 included $27 million of severance-related charges resulting from the termination of our former Chairman, Chief Executive Officer and President (see Note 16 to the Consolidated Financial Statements). The year ended December 31, 2012 included $7 million related to an insurance recovery for previously incurred legal expenses.

Acquisition and pursuit costs. Acquisition and pursuit costs decreased $5 million to $6 million for the year ended December 31, 2013. The decrease was primarily the result of acquiring 133 senior housing communities from the Blackstone JV during the fourth quarter of 2012.

Impairments. During the year ended December 31, 2013, we recognized impairments of $1 million, included in discontinued operations, as a result of the reclassification of two MOBs to held for sale (see Note 17 to the Consolidated Financial Statements). During the year ended December 31, 2012, we recognized an impairment of $8 million as a result of the disposition of a life science land parcel (see Note 17 to the Consolidated Financial Statements).

Other income, net. For the year ended December 31, 2013, other income, net increased $15 million to $18 million. The increase was primarily the result of gains from the sale of marketable equity securities during 2013 of $11 million.

Income taxes. For the year ended December 31, 2013, income taxes increased by $7 million to $6 million. The increase in income taxes was primarily due to the increase in taxable income of our TRS entities during the year ended December 31, 2013.

Equity income from unconsolidated joint ventures. For the year ended December 31, 2013, equity income from unconsolidated joint ventures increased $10 million to $64 million. The increase was primarily the result of: (i) a one-time distribution received from a senior housing development joint venture that exceeded our investment balance and (ii) the improved operating performance from our HCRMC equity investment.

Discontinued operations. Income from discontinued operations for the year ended December 31, 2013 was $74 million, compared to $46 million for the comparable period in 2012. The increase is primarily due to an increase in gains on real estate dispositions of $38 million, partially offset by a decline in operating income from discontinued operations of $8 million and impairment charges in discontinued operations of $1 million.

Preferred stock dividends. On March 22, 2012, we announced the redemption of all outstanding shares of preferred stock. On April 23, 2012, we redeemed all outstanding shares of our preferred stock and paid all accrued and unpaid dividends to the redemption date. During the year ended December 31, 2012, we incurred a redemption charge of $10 million related to the original issuance costs of the preferred stock (this charge is presented as an additional preferred stock dividend in our consolidated income statements).

Liquidity and Capital Resources

We anticipate satisfying our distributions to our shareholders and non-controlling interest members for the next 12 months by primarily using cash flow from operations and available cash balances. Additionally, we expect to meet our scheduled financing maturities for 2015 (excluding future acquisitions) with the proceeds from our January 2015 $600 million senior unsecured note offering.

Our principal investing liquidity needs for the next 12 months are to:

·fund capital expenditures, including tenant improvements and leasing costs; and
·fund future acquisition, transactional and development activities.

We anticipate satisfying these future investing needs using one or more of the following:

·issuance of common or preferred stock;
·issuance of additional debt, including unsecured notes and mortgage debt;
·draws on our credit facilities; and/or
·sale or exchange of ownership interests in properties.

Access to capital markets impacts our cost of capital and ability to refinance maturing indebtedness, as well as our ability to fund future acquisitions and development through the issuance of additional securities or secured debt. Credit ratings impact our ability to access capital and directly impact our cost of capital as well. For example, as noted below, our revolving line of credit facility accrues interest at a rate per annum equal to LIBOR plus a margin that depends upon our credit ratings. We also pay a facility fee on the entire revolving commitment that depends upon our credit ratings. As of January 30, 2015, we had a credit rating of BBB+ from Fitch, Baa1 from Moody’s and BBB+ from S&P on our senior unsecured debt securities.

Cash Flow Summary

The following summary discussion of our cash flows is based on the Consolidated Statements of Cash Flows and is not meant to be an all-inclusive discussion of the changes in our cash flows for the periods presented below.

Cash and cash equivalents were $184 million and $301 million at December 31, 2014 and 2013, respectively, representing a decrease of $117 million. The following table sets forth changes in cash flows (dollars in thousands):

Year Ended December 31,
20142013Change
Net cash provided by operating activities$1,248,621$1,148,987$99,634
Net cash used in investing activities(1,511,879)(196,648)(1,315,231)
Net cash provided by (used in) financing activities144,797(900,416)1,045,213

The increase in operating cash flows is primarily the result of the following: (i) the impact from our investments, (ii) redevelopment assets placed in service and (iii) rent escalations and resets. Our cash flows from operations are dependent upon the occupancy levels of our buildings, rental rates on leases, our tenants’ performance on their lease obligations, the level of operating expenses and other factors.

The following are significant investing and financing activities for the year ended December 31, 2014:

·paid dividends on common stock of $1 billion, which were funded by cash provided by our operating activities;
·made investments and capital expenditures of $1.7 billion (e.g., debt investments, the CCRC JV, acquisition and development of real estate, etc.) and repaid $935 million of mortgages and senior unsecured notes; and
·raised proceeds of $2 billion primarily from issuing senior unsecured notes and revolving line of credit facility borrowings and an additional $224 million from sales of real estate and loan repayments.

Debt

Bank line of credit and Term Loans. On March 31, 2014, we amended our unsecured revolving line of credit facility (the “Facility”) with a syndicate of banks, which was scheduled to mature in March 2016, increasing the borrowing capacity by $500 million to $2 billion. The amended Facility matures on March 31, 2018, with a one-year committed extension option. Borrowings under the Facility accrue interest at LIBOR plus a margin that depends upon our credit ratings. We pay a facility fee on the entire revolving commitment that depends on our credit ratings. Based on our credit ratings at January 30, 2015, the margin on the Facility was 0.925%, and the facility fee was 0.15%. The Facility also includes a feature that will allow us to increase the borrowing capacity by an aggregate amount of up to $500 million, subject to securing additional commitments from existing lenders or new lending institutions. At December 31, 2014, we had $839 million (includes £355 million) outstanding under the Facility with a weighted average effective interest rate of 1.60%.

On July 30, 2012, we entered into a credit agreement with a syndicate of banks for a £137 million ($214 million at December 31, 2014) four-year unsecured term loan (the “2012 Term Loan”). Based on our credit ratings at January 30, 2014, the Term Loan accrues interest at a rate of GBP LIBOR plus 1.20%. Concurrent with the closing of the Term Loan, we entered into a four-year interest rate swap contract that fixes the rate of the Term Loan at 1.81%, subject to adjustments based on our credit ratings. The 2012 Term Loan contains a one-year committed extension option.

On January 12, 2015, we entered into a credit agreement with a syndicate of banks for a £220 million ($333 million) four-year unsecured term loan (the “2015 Term Loan”) that accrues interest at a rate of GBP LIBOR plus 0.975%, subject to adjustments based on our credit ratings. At closing, we entered into a three-year interest rate swap agreement that effectively fixes the rate of the term loan at 1.79% (the 2012 and 2015 Term Loans are collectively the “Term Loans”). Proceeds from the 2015 Term Loan were used to repay £220 million outstanding on the Facility as of the closing date.

The Facility and Term Loans contain certain financial restrictions and other customary requirements. Among other things, these covenants, using terms defined in the agreements, (i) limit the ratio of Consolidated Total Indebtedness to Consolidated Total Asset Value to 60%, (ii) limit the ratio of Secured Debt to Consolidated Total Asset Value to 30%, (iii) limit the ratio of Unsecured Debt to Consolidated Unencumbered Asset Value to 60% and (iv) require a minimum Fixed Charge Coverage ratio of 1.5 times. The Facility and Term Loans also require a Minimum Consolidated Tangible Net Worth of $9.5 billion at December 31, 2014 (applicable to the Facility and 2012 Term Loan). At December 31, 2014, we were in compliance with each of these restrictions and requirements of the Facility and 2012 Term Loan.

Senior unsecured notes. At December 31, 2014, we had senior unsecured notes outstanding with an aggregate principal balance of $7.6 billion. Interest rates on the notes ranged from 2.79% to 6.99% with a weighted average effective interest rate of 4.95% and a weighted average maturity of six years at December 31, 2014. The senior unsecured notes contain certain covenants including limitations on debt, maintenance of unencumbered assets, cross-acceleration provisions and other customary terms. At December 31, 2014, we believe we were in compliance with these covenants.

On January 21, 2015, we issued $600 million of 3.40% senior unsecured notes due 2025. The notes were priced at 99.185% of the principal amount with an effective yield-to-maturity of 3.497%; net proceeds from this offering were $591 million.

A portion of the proceeds from these senior notes was used to repay the entire $105 million U.S. dollar amount outstanding on the Facility as of the closing date.

Mortgage debt. At December 31, 2014, we had $1 billion in aggregate principal amount of mortgage debt outstanding that is secured by 70 healthcare facilities (including redevelopment properties) with a carrying value of $1.3 billion. Interest rates on the mortgage debt ranged from 0.44% to 8.41% with a weighted average effective interest rate of 6.16% and a weighted average maturity of three years at December 31, 2014.

Mortgage debt generally requires monthly principal and interest payments, is collateralized by real estate assets and is generally non-recourse. Mortgage debt typically restricts transfer of the encumbered assets, prohibits additional liens, restricts prepayment, requires payment of real estate taxes, requires maintenance of the assets in good condition, requires maintenance of insurance on the assets, and includes conditions to obtain lender consent to enter into and terminate material leases. Some of the mortgage debt is also cross-collateralized by multiple assets and may require tenants or operators to maintain compliance with the applicable leases or operating agreements of such real estate assets.

Debt Maturities. The following table summarizes our stated debt maturities and scheduled principal repayments at December 31, 2014 (in thousands):

Senior
Bank LineUnsecured
Yearof Credit(1)(2)Term Loan(3)NotesMortgageTotal(4)
2015$—$—$400,000$40,628$440,628
2016—213,610900,000292,2221,405,832
2017——750,000581,8911,331,891
2018838,516—600,0006,5831,445,099
2019——450,0002,072452,072
Thereafter——4,550,00063,1704,613,170
838,516213,6107,650,000986,5669,688,692
Discounts, net——(23,806)(2,135)(25,941)
$838,516$213,610$7,626,194$984,431$9,662,751
(1)Includes £355 million translated into U.S. dollars as of December 31, 2014.
(2)In January 2015, we repaid all but £135 million outstanding under the Facility primarily with proceeds from the January 2015 senior unsecured notes issuance and term loan.
(3)Represents £137 million translated into U.S. dollars.
(4)Excludes $97 million of other debt that represents life care bonds and demand notes that have no scheduled maturities that are discussed in Note 11 to the Consolidated Financial Statements.

Derivative Financial Instruments

We use derivative financial instruments to mitigate the effects of interest rate and foreign exchange fluctuations on specific forecasted transactions as well as recognized financial obligations or assets. We do not use derivative financial instruments for speculative or trading purposes.

The following table summarizes our outstanding interest-rate and foreign currency swap contracts as of December 31, 2014 (dollars and GBP in thousands):

Fixed
HedgeRate/BuyNotional/Sell
Date EnteredMaturity DateDesignationAmountFloating/Exchange Rate IndexAmountFair Value
July 2005(1)July 2020Cash Flow3.82%BMA Swap Index$45,600$(5,939)
November 2008October 2016Cash Flow5.95%1 Month LIBOR+1.50%$26,000(1,724)
July 2012June 2016Cash Flow1.81%1 Month GBP LIBOR+1.20%£137,000178
July 2012June 2016Cash Flow$34,100Buy USD/Sell GBP£21,700276
July 2014December 2015Cash Flow$7,500Buy USD/Sell GBP£4,400653
(1)Represents three interest-rate swap contracts, which hedge fluctuations in interest payments on variable-rate secured debt due to overall changes in hedged cash flows.

For a more detailed description of our derivative financial instruments, see Note 24 to the Consolidated Financial Statements and in Item 7A in this report.

Equity

At December 31, 2014, we had 460 million shares of common stock outstanding. At December 31, 2014, equity totaled $11 billion, and our equity securities had a market value of $21 billion.

As of December 31, 2014, there were a total of 4 million DownREIT units outstanding in five limited liability companies in which we are the managing member. The DownREIT units are exchangeable for an amount of cash approximating the then-current market value of shares of our common stock or, at our option, shares of our common stock (subject to certain adjustments, such as stock splits and reclassifications).

Shelf Registration

We have a prospectus that we filed with the SEC as part of a registration statement on Form S-3ASR, using a shelf registration process which expires in July 2015. Under the “shelf” process, we may sell any combination of the securities described in the prospectus in one or more offerings. The securities described in the prospectus include common stock, preferred stock, depositary shares, debt securities and warrants.

Non-GAAP Financial Measures—FFO and FAD

Funds From Operations

The following is a reconciliation from net income applicable to common shares, the most directly comparable financial measure calculated and presented in accordance with GAAP, to FFO and FFO as adjusted (in thousands, except per share data):

Year Ended December 31,
20142013201220112010
Net income applicable to common shares$919,796$969,103$812,289$515,302$307,498
Depreciation and amortization of real estate, in-place lease and other intangibles:
Continuing operations459,995423,312353,704346,055303,957
Discontinued operations—5,86212,80811,3409,490
Other depreciation and amortization18,86414,32612,7568,840—
Gain on sales of real estate(31,298)(69,866)(31,454)(3,107)(19,925)
Impairments of real estate—1,372———
Gain upon consolidation of joint venture———(7,769)—
Impairments of interests in unconsolidated joint venture————71,693
Equity income from unconsolidated joint ventures(49,570)(64,433)(54,455)(46,750)(4,770)
FFO from unconsolidated joint ventures70,87374,32464,93356,88725,288
Noncontrolling interests’ and participating securities’ share in earnings16,79515,90317,54718,06215,767
Noncontrolling interests’ and participating securities’ share in FFO(23,821)(20,639)(21,620)(20,953)(18,361)
FFO applicable to common shares$1,381,634$1,349,264$1,166,508$877,907$690,637
Distributions on dilutive convertible units13,79913,27613,0286,91611,847
Diluted FFO applicable to common shares$1,395,433$1,362,540$1,179,536$884,823$702,484
Diluted FFO per common share$3.00$2.95$2.72$2.19$2.25
Weighted average shares used to calculate diluted FFO per common share464,845461,710434,328403,864312,797
Diluted earnings per common share$2.00$2.13$1.90$1.29$1.00
Depreciation and amortization of real estate, in-place lease and other intangibles1.000.930.850.891.02
Impairments on real estate and DFL depreciation0.040.030.030.020.23
Gain on sales of real estate and upon consolidation of joint venture(0.07)(0.15)(0.07)(0.03)(0.06)
Joint venture and participating securities FFO adjustments0.030.010.010.020.06
Diluted FFO per common share$3.00$2.95$2.72$2.19$2.25
Impact of adjustments to FFO:
Transaction-related items(1)$(18,856)$6,191$5,339$29,558$11,003
Other impairments (recoveries)(2)35,913—7,87815,400(11,900)
Severance-related charges—27,2445,6424,827—
Preferred stock redemption charge——10,432——
Litigation settlement and provision charges———125,000—
$17,057$33,435$29,291$174,785$(897)
FFO as adjusted applicable to common shares$1,398,691$1,382,699$1,195,799$1,052,692$689,740
Distributions on dilutive convertible units and other13,76613,22012,95711,64612,089
Diluted FFO as adjusted applicable to common shares$1,412,457$1,395,919$1,208,756$1,064,338$701,829
Diluted FFO as adjusted per common share$3.04$3.02$2.79$2.71$2.25
Weighted average shares used to calculate diluted FFO as adjusted per common share(3)464,845461,710433,607393,237311,285
(1)For the year ended December 31, 2014, transaction-related items include a net benefit from the Brookdale Transaction, partially offset by acquisition and pursuit costs. For the years ended December 31, 2013 and 2012, transaction-related items are primarily attributable to acquisition and pursuit costs. For the years ended December 31, 2011 and 2010, transaction-related items are primarily attributable to our HCRMC acquisition.
(2)For the year ended December 31, 2014, other impairments (recoveries) relate to our equity ownership interest in HCRMC.
(3)Our weighted average shares for the year ended December 31, 2012 used to calculate diluted FFO as adjusted eliminate the impact of 22 million shares from our common stock offering completed on October 19, 2012; proceeds from this offering were used to fund the Blackstone JV acquisition. Our weighted average shares used to calculate diluted FFO as adjusted eliminate the impact of 46 million shares of common stock from our December 2010 offering and 30 million shares from our March 2011 common stock offering (excludes 4.5 million shares sold to the underwriters upon exercise of their option to purchase additional shares), which issuances increased our weighted average shares by 12.9 million and 1.5 million for the years ended December 31, 2011 and 2010, respectively. Proceeds from these offerings were used to fund a portion of the cash consideration for the HCRMC acquisition.

Funds Available for Distribution

The following is a reconciliation of FFO as adjusted to FAD (in thousands, except per share data):

Year Ended December 31,
20142013201220112010
FFO as adjusted applicable to common shares$1,398,691$1,382,699$1,195,799$1,052,692$689,740
Amortization of market lease intangibles, net(949)(6,646)(2,232)(4,510)(6,378)
Amortization of deferred compensation(1)21,88523,32723,27720,03414,924
Amortization of deferred financing costs, net(2)19,26018,54116,50113,7169,078
Straight-line rents(41,032)(39,587)(47,311)(59,173)(47,243)
DFL accretion(3)(77,568)(86,055)(94,240)(74,007)(10,641)
Other depreciation and amortization(18,864)(14,326)(12,756)(8,840)—
Deferred revenues – tenant improvement related(2,306)(2,906)(1,570)(2,371)(3,714)
Deferred revenues – additional rents42263(85)52(270)
Leasing costs and tenant and capital improvements(74,464)(64,557)(61,440)(52,903)(54,237)
Lease restructure payments9,425————
Joint venture adjustments – CCRC entrance fees11,443————
Joint venture and other FAD adjustments(3)(67,121)(52,471)(61,298)(46,250)(6,143)
FAD applicable to common shares$1,178,822$1,158,082$954,645$838,440$585,116
Distributions on dilutive convertible units13,79913,2767,7146,9166,676
Diluted FAD applicable to common shares$1,192,621$1,171,358$962,359$845,356$591,792
Diluted FAD per common share$2.57$2.54$2.23$2.16$1.92
Weighted average shares used to calculate diluted FAD per common share464,845461,710431,429390,944308,953
(1)Excludes $16.7 million related to the acceleration of deferred compensation for restricted stock units and options that vested upon termination of the our former chief executive officer, which is included in severance-related charges for the year ended December 31, 2013.
(2)Excludes $11.3 million related to the write-off of unamortized loan fees related to an expired bridge loan commitment and $0.8 million related to the amortization of deferred issuance costs of the senior notes, which costs are included in transaction-related items for the year ended December 31, 2011.
(3)Our ownership interest in HCRMC is accounted for using the equity method, which requires an ongoing elimination of DFL income that is proportional to our ownership in HCRMC. Further, our share of earnings from HCRMC (equity income) increases for the corresponding elimination of related lease expense recognized at the HCRMC entity level, which we present as a non-cash joint venture FAD adjustment.

Off-Balance Sheet Arrangements

We own interests in certain unconsolidated joint ventures as described under Note 8 to the Consolidated Financial Statements. Except in limited circumstances, our risk of loss is limited to our investment in the joint venture and any outstanding loans receivable. In addition, we have certain properties which serve as collateral for debt that is owed by a previous owner of certain of our facilities, as described under Note 12 to the Consolidated Financial Statements. Our risk of loss for these certain properties is limited to the outstanding debt balance plus penalties, if any. We have no other

material off-balance sheet arrangements that we expect would materially affect our liquidity and capital resources except those described below under Contractual Obligations.

Contractual Obligations

The following table summarizes our material contractual payment obligations and commitments at December 31, 2014 (in thousands):

Less thanMore than
Total(1)One Year2016-20172018-2019Five Years
Bank line of credit(2)(3)$838,516$—$—$838,516$—
Term loan(4)213,610—213,610——
Senior unsecured notes7,650,000400,0001,650,0001,050,0004,550,000
Mortgage debt986,56640,628874,1138,65563,170
U.K. loan facility commitment(5)49,89424,94724,947——
Construction loan commitments(6)10,53510,535———
Development commitments(7)66,84066,840———
Ground and other operating leases245,4906,75611,20810,264217,262
Interest(8)2,552,894428,741716,362445,797961,994
Total$12,614,345$978,447$3,490,240$2,353,232$5,792,426
(1)Excludes $97 million of other debt that represents life care bonds and demand notes that have no scheduled maturities.
(2)Includes £355 million translated into U.S. dollars as of December 31, 2014.
(3)In January 2015, we repaid all but £135 million outstanding under the Facility primarily with proceeds from the January 2015 senior unsecured notes issuance and term loan.
(4)Represents £137 million translated into U.S. dollars as of December 31, 2014.
(5)Represents £32 million translated into U.S. dollars as of December 31, 2014 for commitments to fund our U.K. loan facility.
(6)Represents commitments to finance development projects and related working capital financings.
(7)Represents construction and other commitments for developments in progress.
(8)Interest on variable-rate debt is calculated using rates in effect at December 31, 2014.

Inflation

Our leases often provide for either fixed increases in base rents or indexed escalators, based on the Consumer Price Index or other measures, and/or additional rent based on increases in the tenants’ operating revenues. Most of our MOB leases require the tenant to pay a share of property operating costs such as real estate taxes, insurance and utilities. Substantially all of our senior housing, life science, post-acute/skilled nursing and hospital leases require the tenant or operator to pay all of the property operating costs or reimburse us for all such costs. We believe that inflationary increases in expenses will be offset, in part, by the tenant or operator expense reimbursements and contractual rent increases described above.

Critical Accounting Policies

The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires our management to use judgment in the application of accounting policies, including making estimates and assumptions. We base estimates on the best information available to us at the time, our experience and on various other assumptions believed to be reasonable under the circumstances. These estimates affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If our judgment or interpretation of the facts and circumstances relating to various transactions or other matters had been different, it is possible that different accounting would have been applied, resulting in a different presentation of our consolidated financial statements. From time to time, we re-evaluate our estimates and assumptions. In the event estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current estimates and assumptions about matters that are inherently uncertain. For a more detailed discussion of our significant accounting policies, see Note 2 to the Consolidated Financial Statements. Below is a discussion of accounting policies that we consider critical in that they may require complex judgment in their application or require estimates about matters that are inherently uncertain.

Principles of Consolidation

The consolidated financial statements include the accounts of HCP, Inc., our wholly owned subsidiaries and joint ventures that we control, through voting rights or other means. We consolidate investments in variable interest entities (“VIEs”) when we are the primary beneficiary of the VIE. A variable interest holder is considered to be the primary beneficiary of a VIE if it has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and has the obligation to absorb losses of, or the right to receive benefits from, the entity that could potentially be significant to the VIE.

We make judgments about which entities are VIEs based on an assessment of whether (i) the equity investors as a group, if any, do not have a controlling financial interest, or (ii) the equity investment at risk is insufficient to finance that entity’s activities without additional subordinated financial support. We make judgments with respect to our level of influence or control of an entity and whether we are (or are not) the primary beneficiary of a VIE. Consideration of various factors includes, but is not limited to, our ability to direct the activities that most significantly impact the entity’s economic performance, our form of ownership interest, our representation on the entity’s governing body, the size and seniority of our investment, our ability and the rights of other investors to participate in policy making decisions, replace the manager and/or liquidate the entity, if applicable. Our ability to correctly assess our influence or control over an entity when determining the primary beneficiary of a VIE affects the presentation of these entities in our consolidated financial statements. When we perform a re-analysis of the primary beneficiary at a date other than at inception of the variable interest entity, our assumptions may be different and may result in the identification of a different primary beneficiary.

If we determine that we are the primary beneficiary of a VIE, our consolidated financial statements would include the operating results of the VIE (either tenant or borrower) rather than the results of the variable interest in the VIE. We would require the VIE to provide us timely financial information and would review the internal control of the VIE to determine if we could rely on the financial information they provide. If the VIE has deficiencies in its internal controls over financial reporting, or does not provide us with timely financial information, this may adversely impact the quality and/or timing of our financial reporting and our internal control over financial reporting.

Revenue Recognition

At the inception of a new lease arrangement, including new leases that arise from amendments, we assess the terms and conditions to determine the proper lease classification. A lease arrangement is classified as an operating lease if none of the following criteria are met: (i) transfer of ownership to the lessee, (ii) lessee has a bargain purchase option during or at the end of the lease term, (iii) the lease term is equal to 75% or more of the underlying property’s economic life, or (iv) the present value of future minimum lease payments (excluding executory costs) are equal to 90% or more of the excess estimated fair value (over retained tax credits) of the leased building. If one of the four criteria is met and the minimum lease payments are determined to be reasonably predicable and collectible, the lease arrangement is generally accounted for as a direct financing lease. If the assumptions utilized in the above classification assessments were different, our lease classification for accounting purposes may have been different; thus the timing and amount of our revenue recognized would have been impacted, which may be material to our consolidated financial statements.

We recognize rental revenue for operating leases on a straight-line basis over the lease term when collectibility of all minimum lease payments is reasonably assured and the tenant has taken possession or controls the physical use of a leased asset. If the lease provides for tenant improvements, we determine whether the tenant improvements are owned by the tenant or us. When we are the owner of the tenant improvements, the tenant is not considered to have taken physical possession or have control of the physical leased asset until the tenant improvements are substantially completed. When the tenant is the owner of the tenant improvements, any tenant improvement allowance funded is treated as a lease incentive and amortized as a reduction of revenue over the lease term. The determination of ownership of the tenant improvements is subject to significant judgment. If our assessment of the owner of the tenant improvements was different, the timing and amount of our revenue recognized would be impacted.

Certain leases provide for additional rents that are contingent upon a percentage of the facility’s revenue in excess of specified base amounts or other thresholds. Such revenue is recognized when actual results reported by the tenant, or estimates of tenant results, exceed the base amount or other thresholds. The recognition of additional rents requires us to

make estimates of amounts owed and to a certain extent are dependent on the accuracy of the facility results reported to us. Our estimates may differ from actual results, which could be material to our consolidated financial statements.

We maintain an allowance for doubtful accounts, including an allowance for operating lease straight-line rent receivables, for estimated losses resulting from tenant defaults or the inability of tenants to make contractual rent and tenant recovery payments. We monitor the liquidity and creditworthiness of our tenants and operators on a continuous basis. This evaluation considers industry and economic conditions, property performance, credit enhancements and other factors. For straight-line rent amounts, our assessment is based on income recoverable over the term of the lease. We exercise judgment in establishing allowances and consider payment history and current credit status in developing these estimates. These estimates may differ from actual results, which could be material to our consolidated financial statements.

We use the direct finance method of accounting to record income from DFLs. For leases accounted for as DFLs, future minimum lease payments are recorded as a receivable. For leases accounted for as DFLs, the net investment in the DFL represents receivables for the sum of minimum lease payments receivable and the estimated residual values of the leased properties, less the unearned income. Unearned income is deferred and amortized to income over the lease terms to provide a constant yield when collectibility of the lease payments is reasonably assured. Investments in DFLs are presented net of unamortized unearned income. The determination of estimated useful lives and residual values are subject to significant judgment. If these assessments were to change, the timing and amount of our revenue recognized would be impacted.

Loans receivable are classified as held-for-investment based on management’s intent and ability to hold the loans for the foreseeable future or to maturity. We recognize interest income on loans, including the amortization of discounts and premiums, using the interest method applied on a loan-by-loan basis when collectibility of the future payments is reasonably assured. Premiums, discounts and related costs are recognized as yield adjustments over the term of the related loans. If management determined that certain loans should no longer be classified as held for maturity, the timing and amount of our interest income recognized would be impacted.

Loans and DFLs are placed on non-accrual status at such time as management determines that collectibility of contractual amounts is not reasonably assured. While on non-accrual status, loans and DFLs are either accounted for on a cash basis, in which income is recognized only upon receipt of cash, or on a cost-recovery basis, were cash receipts reduce the carrying value of the loan or DFL, based on management’s judgment of collectibility.

Allowances are established for loans and DFLs based upon an estimate of probable losses on an individual basis if they are determined to be impaired. Loans and DFLs are impaired when it is deemed probable that we will be unable to collect all amounts due on a timely basis in accordance with the contractual terms of the loan or lease. Determining the adequacy of the allowance is complex and requires significant judgment by us about the effect of matters that are inherently uncertain. The allowance is based upon our assessment of the borrower’s or lessee’s overall financial condition, resources and payment record; the prospects for support from any financially responsible guarantors; and, if appropriate, the net realizable value of any collateral. These estimates consider all available evidence including, as appropriate, the performance of our tenants, operators or borrowers, the present value of the expected future cash flows discounted at the loan’s or DFL’s effective interest rate, the fair value of collateral, general economic conditions and trends, historical and industry loss experience, and other relevant factors. While our assumptions are based in part upon historical data, our estimates may differ from actual results, which could be material to our consolidated financial statements.

Real Estate

We make estimates as part of our allocation of the purchase price of acquisitions to the various components of the acquisition based upon the relative fair value of each component. The most significant components of our allocations are typically the allocation of fair value to the buildings as-if-vacant, land and in-place leases. In the case of the fair value of buildings and the allocation of value to land and other intangibles, our estimates of the values of these components will affect the amount of depreciation and amortization we record over the estimated useful life of the property acquired or the remaining lease term. In the case of the value of in-place leases, we make our best estimates based on our evaluation of the specific characteristics of each tenant’s lease. Factors considered include estimates of carrying costs during hypothetical expected lease-up periods, market conditions and costs to execute similar leases. Our assumptions affect the amount of future revenue that we will recognize over the remaining lease term for the acquired in-place leases.

A variety of costs are incurred in the development and leasing of properties. After determination is made to capitalize a cost, it is allocated to the specific component of a project that is benefited. Determination of when a development project is substantially complete and capitalization must cease involves a degree of judgment. The costs of land and buildings under development include specifically identifiable costs. The capitalized costs include pre-construction costs essential to the development of the property, development costs, construction costs, interest costs, real estate taxes and other costs incurred during the period of development. We consider a construction project as substantially completed and available for occupancy and cease capitalization of costs upon the completion of the related tenant improvements.

Impairment of Long-Lived Assets and Goodwill

We assess the carrying value of our real estate assets and related intangibles (“real estate assets”) when events or changes in circumstances indicate that the carrying amount of the real estate assets may not be recoverable. Recoverability of real estate assets is measured by comparing the carrying amount of the real estate assets to the respective estimated future undiscounted cash flows. The estimated future undiscounted cash flows are calculated utilizing the lowest level of identifiable cash flows that are largely independent of the cash flows of other assets and liabilities. In order to review our real estate assets for recoverability, we consider market conditions, as well as our intent with respect to holding or disposing of the asset. If our analysis indicates that the carrying value of the real estate assets is not recoverable on an undiscounted cash flow basis, we recognize an impairment charge for the amount by which the carrying value exceeds the fair value of the real estate asset.

Goodwill is tested for impairment at least annually based on certain qualitative factors to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Potential impairment indicators and qualitative factors include a significant decline in real estate valuations, restructuring plans, current macroeconomic conditions, state of the equity and capital markets or a significant decline in the value of our market capitalization. If we determine that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we apply the required two-step quantitative approach. The quantitative procedures of the two-step approach (i) compare the fair value of a reporting unit with its carrying amount, including goodwill and, if necessary, (ii) compare the implied fair value of reporting unit goodwill with the carrying amount of that goodwill as if it had been acquired in a business combination at the date of the impairment test. The excess fair value of the reporting unit over the fair value of assets and liabilities is the implied value of goodwill and is used to determine the amount of impairment, if any. We estimate the fair value of the assets and liabilities in the reporting unit through various valuation techniques, including applying capitalization rates to segment net operating income, quoted market values and third-party appraisals, as necessary. The fair value of the reporting unit may also include an allocation of an enterprise value premium that we estimate a third party would be willing to pay for the company.

The determination of the fair value of real estate assets and goodwill involves significant judgment. This judgment is based on our analysis and estimates of fair value of real estate assets and reporting units, future operating results and resulting cash flows of each real estate asset whose carrying amount may not be recoverable. Our ability to accurately predict future operating results, resulting cash flows and estimate and allocate fair values impacts the timing and recognition of impairments. While we believe our assumptions are reasonable, changes in these assumptions may have a material impact on our financial results.

Investments in Unconsolidated Joint Ventures

The initial carrying value of investments in unconsolidated joint ventures is based on the amount paid to purchase the joint venture interest or the carrying value of the assets prior to the sale or contribution of the interests to the joint venture. We evaluate our equity method investments for impairment indicators based upon a comparison of the fair value of the equity method investment to our carrying value. If we determine there is a decline in the fair value of our investment in an unconsolidated joint venture below its carrying value and it is other-than-temporary, an impairment is recorded. The determination of the fair value and as to whether a deficiency in fair value is “other-than-temporary” of investments in unconsolidated joint ventures involves significant judgment. Our estimates consider all available evidence including, as appropriate, the present value of the expected future cash flows discounted at market rates, general economic conditions and trends, severity and duration of the fair value deficiency, and other relevant factors. Capitalization rates, discount rates and credit spreads utilized in our valuation models are based upon rates that we believe to be within a reasonable range of current market rates for the respective investments. While we believe our assumptions are reasonable, changes in these assumptions may have a material impact on our financial results.

Income Taxes

As part of the process of preparing our consolidated financial statements, significant management judgment is required to evaluate our compliance with REIT requirements. Our determinations are based on interpretation of tax laws, and our conclusions may have an impact on the income tax expense recognized. Adjustments to income tax expense may be required as a result of: (i) audits conducted by federal, state and local tax authorities, (ii) our ability to qualify as a REIT, (iii) the potential for built-in gain recognition, and (iv) changes in tax laws. Adjustments required in any given period are included within the income tax provision.

Recent Accounting Pronouncements

See Note 2 to the Consolidated Financial Statements for the impact of new accounting standards. There were no accounting pronouncements that were issued, but not yet adopted by us, that we believe will materially impact our consolidated financial statements.

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