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:

·2016 Transaction Overview
·Dividends
·Results of Operations
·Liquidity and Capital Resources
·Contractual Obligations
·Off-Balance Sheet Arrangements
·Inflation
·Non-GAAP Financial Measure Reconciliations
·Critical Accounting Policies
·Recent Accounting Pronouncements

2016 Transaction Overview

Spin-Off of Real Estate Portfolio

On October 31, 2016, we completed our previously announced Spin-Off of QCP. QCP’s assets include 338 properties, primarily comprised of the HCRMC DFL investments and an equity investment in HCRMC. Following the completion of the Spin-Off on October 31, 2016, QCP is an independent, publicly-traded, self-managed and self-administrated REIT. As a result of the Spin-Off, the operations of QCP are now classified as discontinued operations in all periods presented herein. We entered into a Separation and Distribution Agreement (the “Separation and Distribution Agreement”) with QCP in connection with the Spin-Off. The Separation and Distribution Agreement divides and allocates the assets and liabilities of HCP prior to the Spin-Off between QCP and HCP, governs the rights and obligations of the parties regarding the Spin-Off, and contains other key provisions relating to the separation of QCP’s business from HCP.

In connection with the Spin-Off, we entered into a Transition Services Agreement ("TSA") with QCP. Per the terms of the TSA, we agreed to provide certain administrative and support services to QCP on a transitional basis for established fees, which are expected to approximate the actual cost incurred by us in providing the transition services to QCP for the relevant period. The TSA will terminate on the expiration of the term of the last service provided under the agreement, which will be on or prior to October 30, 2017. The TSA provides that QCP generally has the right to terminate a transition service upon thirty days' notice to us. The TSA contains provisions under which we will, subject to certain limitations, be obligated to indemnify QCP for losses incurred by QCP resulting from our breach of the TSA.

See Notes 1 and 5 to the Consolidated Financial Statements for further information on the Spin-Off.

Investment Transactions

In January 2016, we acquired a portfolio of five private pay senior housing communities with 364 units and a skilled nursing facility with 120 beds for $95 million. All of the communities were developed within the past two years and are triple-net leased to four regional operators.

In July 2016, we acquired two Class A life science buildings totaling 136,000 square feet and a four-acre parcel of land in San Diego, California for $49 million.

In September 2016, we acquired a portfolio of seven private pay senior housing communities for $186 million, including the assumption of $74 million of debt, at a 4.0% interest rate, maturing in 2044. Consisting of 526 assisted living and memory care units, the portfolio is managed by Senior Lifestyle Corporation in a 100% owned RIDEA structure.

In November 2016, we entered into agreements with Maria Mallaband Care Group (“Maria Mallaband”) to acquire a portfolio of predominantly private pay prime care homes located in London/South-East England for $131 million (£105 million). In mid-2017, through the exercise of a call option, subject to certain contingencies, we intend to convert our bridge loan provided to Maria Mallaband in November into fee ownership and enter into a Master Lease with Maria Mallaband.

In December 2016, we acquired a portfolio of 10 MOBs, including nine on-campus MOBs, located throughout the U.S. in a sale-leaseback transaction with Community Health Systems for $163 million. The MOBs have an initial lease term of 15 years.

Developments

Through February 13, 2017, we have leased 73% of The Cove Phase I, which consists of two Class A buildings totaling 247,000 square feet and was delivered in the third quarter of 2016. In response to Phase I leasing success and continued strong demand from life science users in South San Francisco, in February 2016, we commenced a $220 million development, The Cove Phase II, which adds two Class A buildings totaling 230,000 square feet and is expected to be delivered by the third quarter of 2017. Through February 13, 2017, we have leased 100% of The Cove Phase II. In response to The Cove Phase I and Phase II leasing success, in October 2016, we commenced the $211 million development of The Cove Phase III, which adds two Class A buildings representing up to 336,000 square feet.

In June 2016, we commenced a $62 million multi-building development project encompassing 301,000 square feet at our Ridgeview Business Park in Poway, California, which is 50% leased. The project includes a $32 million build-to-suit project with an existing tenant for 152,000 square feet and is expected to be completed in 2018 as part of a larger leasing transaction.

Disposition Transactions

In January 2017, we sold four life science facilities in Salt Lake City, Utah for $76 million.

In May 2016, we entered into a master contribution agreement with Brookdale to contribute our ownership interest in RIDEA II to an unconsolidated JV owned by HCP and an investor group led by Columbia Pacific Advisors, LLC (“CPA”) (the “HCP/CPA JV”). The members agreed to recapitalize RIDEA II with $602 million of debt, of which $360 million was provided by a third-party and $242 million was provided by HCP. In return, we received $480 million in cash proceeds from the HCP/CPA JV and $242 million in note receivables and retained an approximate 40% beneficial interest in RIDEA II (the note receivable and 40% beneficial interest are herein referred to as the “RIDEA II Investments”). This transaction resulted in HCP deconsolidating the net assets of RIDEA II because it will no longer direct the activities that most significantly impact the venture. The closing of these transactions occurred in January 2017.

In October 2016, we entered into definitive agreements to sell 64 SH NNN assets, currently under triple-net leases with Brookdale, for $1.125 billion to affiliates of Blackstone Real Estate Partners VIII, L.P. The closing of this transaction is expected to occur during 2017 and remains subject to regulatory and third party approvals and other customary closing conditions. Additionally, in October 2016, we entered into definitive agreements for a multi-element transaction with

Brookdale to: (i) sell or transition 25 assets currently triple-net leased to Brookdale, for which Brookdale will receive a $10.5 million annual rent reduction upon lease termination, (ii) re-allocate annual rent of $9.6 million from those 25 assets to the remaining Brookdale triple-net lease portfolio (occurred on November 1, 2016) and (iii) transition eight triple-net leased assets into RIDEA structures (seven of which closed in December 2016 and one of which closed in January 2017). The closing of the sale or transition of the 25 assets and corresponding rent reduction is expected to occur throughout 2017 and remain subject to regulatory and third party approvals and other customary closing conditions.

During the year ended December 31, 2016, we sold: (i) a portfolio of five post-acute/skilled nursing and two SH NNN facilities for $130 million, (ii) five life science facilities for $386 million, (iii) seven SH NNN facilities for $88 million, (iv) three MOBs for $20 million and (v) three SHOP facilities for $41 million and recognized total gain on sales of $165 million.

In January 2016, we entered into a definitive agreement for purchase options that were exercised on eight life science facilities in South San Francisco, California, to be sold in two tranches for $311 million (sold in November 2016 and discussed above) and $269 million, respectively. The second tranche is expected to close in the third quarter of 2018.

In June 2016 and September 2016, we received $51 million and $19 million, respectively, from the monetization of three senior housing development loans, recognizing $15 million and $4 million of incremental interest income, respectively, which represents our participation in the appreciation of the underlying real estate assets.

Financing Activities

In January 2017, we paid down $440 million on our revolving line of credit facility, primarily using proceeds from our RIDEA II joint venture disposition.

During 2016, we repaid $2.0 billion of senior unsecured notes, $1.1 billion of which was prepaid using proceeds from the Spin-Off. In addition, we settled $388 million of mortgage debt, $108 million of which was prepaid using proceeds from the Spin-Off. As a result of the prepayment of debt using proceeds from the Spin-Off, we incurred aggregate loss on debt extinguishments of $46 million, primarily related to prepayment penalties.

In July 2016, we exercised a one-year extension option on our £137 million ($169 million at December 31, 2016), four-year unsecured term loan that was entered into on July 30, 2012 (the “2012 Term Loan”). Based on our credit ratings at December 31, 2016, the 2012 Term Loan accrues interest at a rate of GBP LIBOR plus 1.40%.

Dividends

Quarterly cash dividends paid during 2016 aggregated to $2.095 per share. On February 2, 2017, our Board of Directors declared a quarterly cash dividend of $0.37 per common share. The dividend will be paid on March 2, 2017 to stockholders of record as of the close of business on February 15, 2017.

Results of Operations

We evaluate our business and allocate resources among our reportable business segments: (i) senior housing triple-net (SH NNN), (ii) senior housing operating portfolio (SHOP), (iii) life science and (iv) medical office. 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 tenant and operator properties. We have other non-reportable segments that are comprised primarily of our U.K. care homes, debt investments and hospitals. We evaluate performance based upon: (i) property net operating income from continuing operations (“NOI”) and (ii) adjusted NOI (cash NOI) of the combined consolidated and unconsolidated investments in each segment. 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

Net Operating Income

NOI and adjusted NOI are non-U.S. generally accepted accounting principles (“GAAP”) supplemental financial measures used to evaluate the operating performance of real estate. We include properties from our consolidated portfolio, as well as our pro-rata share of properties owned by our unconsolidated joint ventures in our NOI and adjusted NOI. We believe providing this information assists investors and analysts in estimating the economic interest in our total portfolio of real estate. Our pro-rata share information is prepared on a basis consistent with the comparable consolidated amounts, is intended to reflect our proportionate economic interest in the operating results of properties in our portfolio and is calculated by applying our actual ownership percentage for the period. We do not control the unconsolidated joint ventures, and the pro-rata presentations of revenues and expenses included in NOI (see below) do not represent our legal claim to such items. The joint venture members or partners are entitled to profit or loss allocations and distributions of cash flows according to the joint venture agreements, which provide for such allocations generally according to their invested capital.

The presentation of pro-rata information has limitations, which include, but are not limited to, the following (i) the amounts shown on the individual line items were derived by applying our overall economic ownership interest percentage determined when applying the equity method of accounting and do not necessarily represent our legal claim to the assets and liabilities, or the revenues and expenses and (ii) other companies in our industry may calculate their pro-rata interest differently, limiting the usefulness as a comparative measure. Because of these limitations, the pro-rata financial information should not be considered independently or as a substitute for our financial statements as reported under GAAP. We compensate for these limitations by relying primarily on our GAAP financial statements, using the pro-rata financial information as a supplement.

NOI is defined as rental and related revenues, including tenant recoveries, resident fees and services, and income from DFLs, less property level operating expenses; NOI excludes all other financial statement amounts included in net income (loss) as presented in Note 14 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 non-cash interest, amortization of market lease intangibles, non-refundable entrance fees and lease termination fees (“non-cash adjustments”). Adjusted NOI is oftentimes referred to as “cash NOI.” We use NOI and adjusted NOI to make decisions about resource allocations, to assess and compare property level performance, and to evaluate our same property portfolio (“SPP”), as described below. We believe that net income (loss) is the most directly comparable GAAP measure to NOI. NOI should not be viewed as an alternative measure of operating performance to net income (loss) as defined by GAAP since 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 they may use different methodologies for calculating NOI. For a reconciliation of NOI and Adjusted NOI to net income (loss) by segment, 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.

Same Property Portfolio

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 include properties from our consolidated portfolio, as well as properties owned by our unconsolidated joint ventures in our SPP NOI and adjusted NOI (see NOI above for further discussion regarding our use of pro-rata share information and its limitations). 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, excluding assets held for sale. 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) control(s) 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 (i) certain non-property specific operating expenses that are allocated to each operating segment on a consolidated basis and (ii) entrance fees and related activity such as deferred expenses, reserves and management fees related to entrance fees. A property is removed from our SPP when it is sold, placed into redevelopment or changes its reporting structure. For a reconciliation of SPP to total portfolio adjusted NOI and other relevant disclosures by segment, refer to our Segment Analysis below.

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 (loss) applicable to common shares (computed in accordance with GAAP), excluding gains or losses from sales of depreciable property, including any current and deferred taxes directly associated with sales of depreciable property, impairments of, or related to, depreciable real estate, plus real estate and other depreciation and amortization, and adjustments to compute our share of FFO and FFO as adjusted (see below) from joint ventures. Adjustments for joint ventures are calculated to reflect our pro-rata share of both our consolidated and unconsolidated joint ventures. We reflect our share of FFO for unconsolidated joint ventures by applying our actual ownership percentage for the period to the applicable reconciling items on an entity by entity basis. We reflect our share for consolidated joint ventures in which we do not own 100% of the equity by adjusting our FFO to remove the third party ownership share of the applicable reconciling items based on actual ownership percentage for the applicable periods. Our pro-rata share information is prepared on a basis consistent with the comparable consolidated amounts, is intended to reflect our proportionate economic interest in the operating results of properties in our portfolio and is calculated by applying our actual ownership percentage for the period. We do not control the unconsolidated joint ventures, and the pro-rata presentations of reconciling items included in FFO (see above) do not represent our legal claim to such items. The joint venture members or partners are entitled to profit or loss allocations and distributions of cash flows according to the joint venture agreements, which provide for such allocations generally according to their invested capital.

The presentation of pro-rata information has limitations which include, but are not limited to, the following: (i) the amounts shown on the individual line items were derived by applying our overall economic ownership interest percentage determined when applying the equity method of accounting or allocating noncontrolling interests, and do not necessarily represent our legal claim to the assets and liabilities, or the revenues and expenses; and (ii) other companies in our industry may calculate their pro-rata interest differently, limiting the usefulness as a comparative measure. Because of these limitations, the pro-rata financial information should not be considered independently or as a substitute for our financial statements as reported under GAAP. We compensate for these limitations by relying primarily on our GAAP financial statements, using the pro-rata financial information as a supplement. 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 (loss). 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 non-comparable items including, but not limited to, severance-related charges, litigation provisions, preferred stock redemption charges, impairments (recoveries) of non-depreciable assets, prepayment costs (benefits) associated with early retirement or payment of debt, foreign currency remeasurement losses (gains) and transaction-related items (“FFO as adjusted”). Prepayment costs (benefits) associated with early retirement of debt include the write-off of unamortized deferred financing fees, or additional costs, expenses, discounts, make-whole payments, penalties or premiums incurred as a result of early retirement or payment of debt. 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 and is frequently used by analysts, investors and other

interested parties in the evaluation of our performance as a REIT. At the same time that NAREIT created and defined its FFO measure for the REIT industry, it also recognized that “management of each of its member companies has the responsibility and authority to publish financial information that it regards as useful to the financial community.” We believe stockholders, potential investors and financial analysts who review our operating performance are best served by an FFO run-rate earnings measure that includes, in addition to adjustments made to arrive at the NAREIT defined measure of FFO, other adjustments to net income (loss). FFO as adjusted is used by management in analyzing our business and the performance of our properties, and we believe it is important that stockholders, potential investors and financial analysts understand this measure used by management. We use FFO as adjusted to: (i) evaluate our performance in comparison with expected results and results of previous periods, relative to resource allocation decisions, (ii) evaluate the performance of our management, (iii) budget and forecast future results to assist in the allocation of resources, (iv) assess our performance as compared with similar real estate companies and the industry in general and (v) evaluate how a specific potential investment will impact our future results. Other REITs or real estate companies may use different methodologies for calculating an adjusted FFO measure, and accordingly, our FFO as adjusted may not be comparable to those reported by other REITs. For a reconciliation of net income (loss) to FFO and FFO as adjusted and other relevant disclosure, refer to “Non-GAAP Financial Measure Reconciliations” below.

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) non-cash interest and depreciation related to DFLs and lease incentive amortization (reduction of straight-line rents) and (vi) deferred revenues, 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: (i) is 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. Adjustments for joint ventures are calculated to reflect our pro-rata share of both our consolidated and unconsolidated joint ventures. We reflect our share of FAD for unconsolidated joint ventures by applying our actual ownership percentage for the period to the applicable reconciling items on an entity by entity basis. We reflect our share for consolidated joint ventures in which we do not own 100% of the equity by adjusting our FAD to remove the third party ownership share of the applicable reconciling items based on actual ownership percentage for the applicable periods (see FFO above for further disclosure regarding our use of pro-rata share information and its limitations). 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 performance and is frequently used by analysts, investors, and other interested parties in the evaluation of our performance as a REIT. We believe FAD is an alternative run-rate earnings measure that improves the understanding of our operating results among investors and makes comparisons with: (i) expected results, (ii) results of previous periods and (iii) results among REITs, more meaningful. FAD does not represent cash generated from operating activities determined in accordance with GAAP and is not necessarily indicative of cash available to fund cash needs as it excludes the following items which generally flow through our cash flows from operating activities: (i) adjustments for changes in working capital or the actual timing of the payment of income or expense items that are accrued in the period, (ii) transaction-related costs, (iii) litigation provision, (iv) severance-related expenses and (v) actual cash receipts from interest income recognized on loans receivable (in contrast to our FAD adjustment to exclude non-cash interest and depreciation related to our investments in direct financing leases). Furthermore, FAD is adjusted for recurring capital expenditures, which are generally not considered when determining cash flows from operations or liquidity. FAD is a non-GAAP supplemental financial measure and should not be considered as an alternative to net income (loss) determined in accordance with GAAP. For a reconciliation of net income (loss) to FAD and other relevant disclosure, refer to “Non-GAAP Financial Measure Reconciliations” below.

Comparison of the Year Ended December 31, 2016 to the Year Ended December 31, 2015 and the Year Ended December 31, 2015 to the Year Ended December 31, 2014

Overview(1)

2016 and 2015

Results for the years ended December 31, 2016 and 2015 (dollars in thousands except per share data):

Year EndedYear EndedPer
December 31, 2016December 31, 2015Share
AmountPer Diluted ShareAmountPer Diluted ShareChange
Net income (loss) applicable to common shares$626,549$1.34$(560,552)$(1.21)$2.55
FFO applicable to common shares1,119,1532.39(10,841)(0.02)2.41
FFO as adjusted applicable to common shares1,282,3902.741,470,1673.16(0.42)
FAD applicable to common shares1,215,6961,261,849
(1)For the reconciliation of non-GAAP financial measures, see “Non-GAAP Financial Measure Reconciliations” section below.

Earnings per share (“EPS”) increased primarily as a result of the following:

·impairment charges during 2015 not repeated in 2016;
·increased NOI from: (i) our 2015 and 2016 acquisitions, (ii) annual rent escalations and (iii) developments placed in service;
·increased gains on sales of real estate due to a higher volume of disposition activity during 2016;
·a reduction in interest expense as a result of debt repayments during 2015 and 2016; and
·a net termination fee expense recognized in 2015 not repeated in 2016.

The increase in EPS was partially offset by the following:

·a reduction in income from our HCRMC investments as a result of: (i) the HCRMC lease amendment effective April 1, 2015, (ii) the sale of non-strategic assets during the second half of 2015 and 2016, and (iii) a change in income recognition to a cash basis method beginning in January 2016;
·the impact from the Spin-Off of QCP resulting in: (i) increased transaction costs and (ii) loss on debt extinguishment, representing penalties on the prepayment of debt using proceeds from the Spin-Off;
·increased income tax expense related to our estimated exposure to state built-in gain tax;
·a reduction in interest income from placing our Four Seasons senior notes (“Four Seasons Notes”) on cost recovery status in the third quarter of 2015 and loan repayments during 2015 and 2016;
·increased severance-related charges during 2016 primarily related to the departure of our former President and Chief Executive Officer (“CEO”) in July 2016;
·increased depreciation and amortization from our 2015 and 2016 acquisitions; and
·a reduction of foreign currency remeasurement gains recognized as a result of effective hedges designated in September 2015.

FFO increased primarily as a result of the aforementioned events impacting EPS, excluding depreciation and amortization and gains on sales of real estate, both of which are adjustments to our calculation of FFO.

FFO as adjusted decreased primarily as a result of the following:

·a reduction in income from our HCRMC investments as a result of: (i) the HCRMC lease amendment effective April 1, 2015, (ii) the sale of non-strategic assets during the second half of 2015 and 2016 and (iii) a change in income recognition to a cash basis method beginning in January 2016;
·decreased income from the QCP assets included in the Spin-Off; and
·a reduction in interest income from placing our Four Seasons Notes on cost recovery status in the third quarter of 2015 and loan repayments during 2015 and 2016.

The decrease in FFO as adjusted was partially offset by the following:

·increased NOI from: (i) our 2015 and 2016 consolidated acquisitions, (ii) annual rent escalations and (iii) developments placed in service; and
·a reduction in interest expense as a result of debt repayments during 2015 and 2016.

FAD increased primarily as a result of the following:

·increased NOI from: (i) our 2015 and 2016 consolidated acquisitions, (ii) annual rent escalations and (iii) developments placed in service; and
·increased incremental interest income from the payoff of participating development loans.

The increase in FAD was partially offset by the following:

·decreased income from our HCRMC investments as a result of the HCRMC lease amendment effective April 1, 2015 and the sale of non-strategic assets during the second half of 2015 and the first half of 2016;
·decreased income from the QCP assets included in the Spin-Off;
·decreased interest income from placing our Four Seasons Notes on cost recovery status in the third quarter of 2015 and loan repayments during 2015 and 2016; and
·increased leasing costs and second generation capital expenditures.

2015 and 2014

Results for the years ended December 31, 2015 and 2014 (dollars in thousands except per share data):

Year EndedYear EndedPer
December 31, 2015December 31, 2014Share
AmountPer Diluted ShareAmountPer Diluted ShareChange
Net (loss) income applicable to common shares$(560,552)$(1.21)$919,796$2.00$(3.21)
FFO applicable to common shares(10,841)(0.02)1,381,6343.00(3.02)
FFO as adjusted applicable to common shares1,470,1673.161,398,6913.040.12
FAD applicable to common shares1,261,8491,178,822

EPS and FFO decreased primarily as a result of the following:

·impairments related to our: (i) HCRMC DFL investments, (ii) investment in Four Seasons Notes and (iii) equity investment in HCRMC;
·net fees recognized in 2014 for terminating the leases on 49 senior housing properties in a transaction with Brookdale not repeated in 2015;
·increased transaction-related items as a result of higher levels of transactional activity in 2015; and
·a severance-related charge related to the departure of our former Executive Vice President and Chief Investment Officer in June 2015.

The decreases were partially offset by following:

·increased NOI from our 2014 and 2015 acquisitions;
·incremental interest income from the repayments of three development loans resulting from our share in the appreciation of the underlying real estate assets;
·impairment recovery from a repayment of a loan receivable; and
·increased foreign currency remeasurement gains.

Additionally, EPS decreased as a result of: (i) decreased gain on sales of real estate and (ii) increased depreciation expense, partially offset by increased equity income from unconsolidated joint venture as a result of gain on sales of real estate from HCP Ventures III, LLC and HCP Ventures IV, LLC.

FFO as adjusted and FAD increased primarily as a result of increased NOI from: (i) our 2014 and 2015 acquisitions and (ii) incremental interest income from the repayments of three development loans resulting from our share in the appreciation of the underlying real estate assets. The increases were partially offset by: (i) the decrease in income from DFLs as a result of the HCRMC Lease Amendment and (ii) placing our Four Seasons Notes on cost recovery status in the third quarter of 2015.

Segment Analysis

The tables below provide selected operating information for our SPP and total property portfolio for each of our business segments. For the year ended December 31, 2016, our consolidated SPP consists of 644 properties representing properties acquired or placed in service and stabilized on or prior to January 1, 2015 and that remained in operations under a consistent reporting structure. For the year ended December 31, 2015, our consolidated SPP consisted of 653 properties acquired or placed in service and stabilized on or prior to January 1, 2014 and that remained in operations under a consistent reporting structure. Our total property portfolio consists of 802, 1,205 and 1,196 properties at December 31, 2016, 2015 and 2014, respectively, and excludes properties classified as held for sale and discontinued operations.

Senior Housing Triple-Net

2016 and 2015

Results as of and for the years ended December 31, 2016 and 2015 (dollars in thousands except per unit data):

SPPTotal Portfolio
20162015Change20162015Change
Rental revenues(1)$302,976$304,442$(1,466)$423,118$428,269$(5,151)
Operating expenses(237)(637)400(6,710)(3,427)(3,283)
NOI302,739303,805(1,066)416,408424,842(8,434)
Non-cash adjustments to NOI(5,282)(7,550)2,268(7,566)(9,716)2,150
Adjusted NOI$297,457$296,255$1,202408,842415,126(6,284)
Non-SPP adjusted NOI(111,385)(118,871)7,486
SPP adjusted NOI$297,457$296,255$1,202
Adjusted NOI % change0.4%
Property count(2)205205210295
Average capacity (units)(3)20,26920,26828,45528,777
Average annual rent per unit$14,684$14,645$14,604$14,544
(1)Represents rental and related revenues and income from DFLs.
(2)From our 2015 presentation of SPP, we removed nine SH NNN properties from SPP that were sold, 17 SH NNN properties that were transitioned
to a RIDEA structure in our SHOP segment and 64 SH NNN properties that were classified as held for sale.
(3)Represents average capacity as reported by the respective tenants or operators for the 12-month period and a quarter in arrears from the periods presented.

SPP. SPP NOI decreased primarily as a result of lower rents in our portfolio of assets leased to Sunrise Senior Living (the “Sunrise Portfolio”). SPP adjusted NOI increased primarily as a result of annual rent escalations, partially offset by lower cash rent received from our Sunrise portfolio.

Non-SPP. Non-SPP NOI and adjusted NOI decreased primarily as a result of: (i) nine SH NNN facilities sold in 2016 and (ii) the transition of 17 SH NNN facilities to a RIDEA structure (reported in our SHOP segment), partially offset by five SH NNN facilities acquired in the first quarter of 2016.

Total Portfolio. NOI and adjusted NOI decreased based on the combined decrease to non-SPP, partially offset by the increase to SPP adjusted NOI discussed above.

2015 and 2014

Results as of and for the years ended December 31, 2015 and 2014 (dollars in thousands except per unit data):

SPPTotal Portfolio
20152014Change20152014Change
Rental revenues(1)$423,719$426,045$(2,326)$428,269$538,113$(109,844)
Operating expenses(1,500)(1,586)86(3,427)(3,629)202
NOI422,219424,459(2,240)424,842534,484(109,642)
Non-cash adjustments to NOI(10,773)(24,169)13,396(9,716)(66,474)56,758
Adjusted NOI$411,446$400,290$11,156415,126468,010(52,884)
Non-SPP adjusted NOI(3,680)(67,720)64,040
SPP adjusted NOI$411,446$400,290$11,156
Adjusted NOI % change2.8%
Property count(2)293293295296
Average capacity (units)(3)28,55628,62628,77733,917
Average annual rent per unit$10,207$9,955$14,544$13,907
(1)Represents rental and related revenues and income from DFLs.
(2)From our 2014 presentation of SPP, we removed 12 senior housing properties that were sold.
(3)Represents average capacity as reported by the respective tenants or operators for the 12-month period and a quarter in arrears from the periods presented.

SPP. SPP NOI decreased primarily as a result of lower rents in our Sunrise Portfolio. SPP adjusted NOI increased primarily as a result of annual rent escalations.

Non-SPP. Non-SPP NOI and adjusted NOI decreased primarily as a result of $38 million of net revenues recognized from a 2014 transaction with Brookdale and the transition of RIDEA II properties from SH NNN to SHOP.

Total Portfolio. NOI and adjusted NOI decreased based on the combined decrease to non-SPP, partially offset by the increase to SPP adjusted NOI discussed above.

Senior Housing Operating Portfolio

2016 and 2015

Results as of and for the years ended December 31, 2016 and 2015 (dollars in thousands, except per unit data):

SPPTotal Portfolio
20162015Change20162015Change
Resident fees and services$439,607$419,217$20,390$686,822$518,264$168,558
HCP share of unconsolidated JV revenues174,366167,5936,773204,591181,41023,181
Operating expenses(311,278)(298,648)(12,630)(480,870)(371,016)(109,854)
HCP share of unconsolidated JV share of operating expenses(150,544)(145,448)(5,096)(166,791)(151,962)(14,829)
NOI152,151142,7149,437243,752176,69667,056
Non-cash adjustments to NOI———20,07634,045(13,969)
Adjusted NOI$152,151$142,714$9,437263,828210,74153,087
Non-SPP adjusted NOI(111,677)(68,027)(43,650)
SPP adjusted NOI$152,151$142,714$9,437
Adjusted NOI % change6.6%
Property count(1)8383152130
Average capacity (units)16,91516,82424,72820,354
Average annual rent per unit$11,489$11,010$11,111$10,558
(1)From our 2015 presentation of SPP, we removed two SHOP properties from SPP that were sold and a SHOP property that was classified as held for sale.

SPP. SPP NOI and adjusted NOI increased primarily as a result of increased occupancy and rates for resident fees and services.

Non-SPP. Non-SPP NOI and adjusted NOI increased as a result of 2015 acquisitions, primarily our RIDEA III acquisition. The increase to non-SPP NOI was partially offset by an $8 million net termination fee related to our RIDEA III acquisition, which was not repeated in 2016.

Total Portfolio. NOI and adjusted NOI increased based on the combined increases to SPP and non-SPP discussed above.

2015 and 2014

Results as of and for the years ended December 31, 2015 and 2014 (dollars in thousands, except per unit data):

SPPTotal Portfolio
20152014Change20152014Change
Rental revenues$160,053$152,841$7,212$518,264$243,612$274,652
HCP share of unconsolidated JV revenues———181,41057,740123,670
Operating expenses(99,815)(96,450)(3,365)(371,016)(163,650)(207,366)
HCP share of unconsolidated JV share of operating expenses———(151,962)(49,571)(102,391)
NOI60,23856,3913,847176,69688,13188,565
Non-cash adjustments to NOI———34,04510,16023,885
Adjusted NOI$60,238$56,391$3,847210,74198,291112,450
Non-SPP adjusted NOI(150,503)(41,900)(108,603)
SPP adjusted NOI$60,238$56,391$3,847
Adjusted NOI % change6.8%
Property count(1)202013085
Average capacity (units)4,6124,61316,72412,177
Average annual rent per unit$8,676$8,283$13,227$6,848

SPP. SPP NOI and adjusted NOI increased primarily as a result of increased occupancy and rates for resident fees and services.

Non-SPP. Non-SPP NOI and adjusted NOI increased as a result of: (i) acquisitions, primarily the CCRC JV in 2014 and RIDEA III in 2015, (ii) the transition of RIDEA II properties from SH NNN to SHOP and (iii) an $8 million net termination fee related to our RIDEA III acquisition in 2015.

Total Portfolio. NOI and adjusted NOI increased based on the combined increases to SPP and non-SPP discussed above.

Life Science

2016 and 2015

Results as of and for the years ended December 31, 2016 and 2015 (dollars and sq. ft. in thousands, except per sq. ft. data):

SPPTotal Portfolio
20162015Change20162015Change
Rental revenues(1)$306,317$295,515$10,802$358,537$342,984$15,553
HCP share of unconsolidated JV revenues7,4857,0304557,5997,106493
Operating expenses(58,812)(58,779)(33)(72,478)(70,217)(2,261)
HCP share of unconsolidated JV share of operating expenses(1,601)(1,612)11(1,601)(1,612)11
NOI253,389242,15411,235292,057278,26113,796
Non-cash adjustments to NOI505(6,630)7,135(3,003)(10,392)7,389
Adjusted NOI$253,894$235,524$18,370289,054267,86921,185
Non-SPP adjusted NOI(35,160)(32,345)(2,815)
SPP adjusted NOI$253,894$235,524$18,370
Adjusted NOI % change7.8%
Property count(2)111111120122
Average occupancy97.6%96.5%97.4%96.8%
Average occupied sq. ft.6,6396,5597,5947,423
Average annual total revenues per occupied sq. ft.$47$45$48$46
Average annual rental revenues per occupied sq. ft.$39$38$40$38
(1)Represents rental and related revenues and tenant recoveries.
(2)From our 2015 presentation of SPP, we removed five life science facilities that were sold and four life science facilities that were classified as held for sale.

SPP. SPP NOI and adjusted NOI increased primarily as a result of mark-to-market lease renewals, new leasing activity and increased occupancy. Additionally, SPP adjusted NOI increased as a result of annual rent escalations and a decline in rent abatements.

Non-SPP. Non-SPP NOI and adjusted NOI increased primarily as a result of life science acquisitions in 2015 and 2016 and increased occupancy in a development placed in operation in 2016, partially offset by five life science facilities sold in 2016.

Total Portfolio. NOI and adjusted NOI increased based on the combined increases to SPP and non-SPP discussed above.

During the year ended December 31, 2016, 1.4 million square feet of new and renewal leases commenced at an average annual base rent of $32.70 per square foot, including 114,000 square feet related to a development placed in service at an average annual base rent of $55.80 per square foot, compared to 1.3 million square feet of expired and terminated leases with an average annual base rent of $26.25 per square foot. During the year ended December 31, 2016, we classified 324,000 square feet as real estate and related assets held for sale, net with an average annual base rent of $18.81 per square foot, acquired properties with 61,000 occupied square feet with an average annual base rent of $47.79 per square foot and disposed of 535,000 square feet with an average annual base rent of $53.46 per square foot.

2015 and 2014

Results as of and for the years ended December 31, 2015 and 2014 (dollars and sq. ft. in thousands, except per sq. ft. data):

SPPTotal Portfolio
20152014Change20152014Change
Rental revenues(1)$317,937$298,720$19,217$342,984$314,114$28,870
HCP share of unconsolidated JV revenues7,0306,8881427,1066,888218
Operating expenses(59,053)(54,554)(4,499)(70,217)(63,080)(7,137)
HCP share of unconsolidated JV share of operating expenses(1,612)(1,749)137(1,612)(1,749)137
NOI264,302249,30514,997278,261256,17322,088
Non-cash adjustments to NOI(8,892)(9,423)531(10,392)(10,375)(17)
Adjusted NOI$255,410$239,882$15,528267,869245,79822,071
Non-SPP adjusted NOI(12,459)(5,916)(6,543)
SPP adjusted NOI$255,410$239,882$15,528
Adjusted NOI % change6.5%
Property count(2)111111122115
Average occupancy96.9%92.3%96.8%92.5%
Average occupied sq. ft.6,9806,6467,4236,888
Average annual total revenues per occupied sq. ft.$45$45$46$45
Average annual rental revenues per occupied sq. ft.$37$37$38$38
(1)Represents rental and related revenues and tenant recoveries.
(2)From our 2014 presentation of SPP, we removed a life science facility that was placed into land held for development, which no longer meets our criteria for SPP as of the date placed into development.

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

Non-SPP. Non-SPP NOI and adjusted NOI increased primarily as a result of our life science development projects placed into service during 2014 and life science acquisitions in 2014 and 2015.

Total Portfolio. NOI and adjusted NOI increased based on the combined increases to SPP and non-SPP discussed above.

During the year ended December 31, 2015, 694,000 square feet of new and renewal leases commenced at an average annual base rent of $33.52 per square foot compared to 412,000 square feet of expired and terminated leases with an average annual base rent of $33.47 per square foot. During the year ended December 31, 2015, we acquired properties with 158,000 occupied square feet with an average annual base rent of $38.80 per square foot.

Medical Office

2016 and 2015

Results as of and for the years ended December 31, 2016 and 2015 (dollars and sq. ft. in thousands, except per sq. ft. data):

SPPTotal Portfolio
20162015Change20162015Change
Rental revenues(1)$376,346$367,804$8,542$446,280$415,351$30,929
HCP share of unconsolidated JV revenues1,8761,834421,9961,870126
Operating expenses(141,897)(138,130)(3,767)(173,687)(162,054)(11,633)
HCP share of unconsolidated JV share of operating expenses(595)(612)17(595)(612)17
NOI235,730230,8964,834273,994254,55519,439
Non-cash adjustments to NOI(463)(2,381)1,918(3,557)(4,933)1,376
Adjusted NOI$235,267$228,515$6,752270,437249,62220,815
Non-SPP adjusted NOI(35,170)(21,107)(14,063)
SPP adjusted NOI$235,267$228,515$6,752
Adjusted NOI % change3.0%
Property count(2)203203239227
Average occupancy91.9%91.6%91.5%90.7%
Average occupied sq. ft.13,07913,00815,80014,778
Average annual total revenues per occupied sq. ft.$29$28$28$28
Average annual rental revenues per occupied sq. ft.$24$23$24$23
(1)Represents rental and related revenues and tenant recoveries.
(2)From our 2015 presentation of SPP, we removed three MOBs that were sold and six MOBs that were placed into redevelopment.

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

Non-SPP. Non-SPP NOI and adjusted NOI increased primarily as a result of increased occupancy in former redevelopment and development properties that have been placed into operations and additional NOI from our MOB acquisitions in 2015 and 2016, partially offset by the sale of three MOBs.

Total Portfolio. NOI and adjusted NOI increased based on the combined increases to SPP and non-SPP discussed above.

During the year ended December 31, 2016, 2.4 million square feet of new and renewal leases commenced at an average annual base rent of $22.96 per square foot, including 211,000 square feet related to developments and redevelopments placed into service at an average annual base rent of $24.62, compared to 2.1 million square feet of expiring and terminated leases with an average annual base rent of $23.19 per square foot. During the year ended December 31, 2016, we acquired properties with 897,000 square feet with an average annual base rent of $14.70 per square foot, including 756,000 square feet with a triple-net annual base rent of $13.00 per square foot, and disposed of 82,000 square feet with an average annual base rent of $23.94 per square foot.

2015 and 2014

Results as of and for the years ended December 31, 2015 and 2014 (dollars and sq. ft. in thousands, except per sq. ft. data):

SPPTotal Portfolio
20152014Change20152014Change
Rental revenues(1)$358,769$352,442$6,327$415,351$368,055$47,296
HCP share of unconsolidated JV revenues1,8341,789451,8701,82545
Operating expenses(137,411)(135,375)(2,036)(162,054)(147,144)(14,910)
HCP share of unconsolidated JV share of operating expenses(612)(571)(41)(612)(571)(41)
NOI222,580218,2854,295254,555222,16532,390
Non-cash adjustments to NOI(663)(846)183(4,933)(1,291)(3,642)
Adjusted NOI$221,917$217,439$4,478249,622220,87428,748
Non-SPP adjusted NOI(27,705)(3,435)(24,270)
SPP adjusted NOI$221,917$217,439$4,478
Adjusted NOI % change2.1%
Property count(2)205205227215
Average occupancy90.5%91.2%90.7%90.8%
Average occupied sq. ft.12,66712,75014,77813,237
Average annual total revenues per occupied sq. ft.$28$28$28$28
Average annual rental revenues per occupied sq. ft.$24$23$23$23
(1)Represents rental and related revenues and tenant recoveries.
(2)From our 2014 presentation of SPP, we removed a MOB that was sold.

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

Non-SPP. Non-SPP NOI and adjusted NOI increased primarily as a result of our MOB acquisitions in 2014 and 2015.

Total Portfolio. NOI and adjusted NOI increased based on the combined increases to SPP and non-SPP discussed above.

During the year ended December 31, 2015, 2.4 million square feet of new and renewal leases commenced at an average annual base rent of $23.82 per square foot compared to 2.4 million square feet of expiring and terminated leases with an average annual base rent of $24.15 per square foot. During the year ended December 31, 2015, we acquired properties with 1.9 million occupied square feet with an average annual base rent of $16.19 per square foot, including 1.2 million square feet with a triple-net annual base rent of $10.74 per square foot, and disposed of 17,000 square feet with an average annual base rent of $17.50 per square foot.

Other Income and Expense Items

Results for the years ended December 31, 2016, 2015 and 2014 (in thousands):

Year Ended December 31,2016 vs.2015 vs.
20162015201420152014
Interest income$88,808$112,184$73,623$(23,376)$38,561
Interest expense464,403479,596439,742(15,193)39,854
Depreciation and amortization568,108504,905455,01663,20349,889
General and administrative103,61195,96581,7657,64614,200
Acquisition and pursuit costs9,82127,30917,142(17,488)10,167
Impairments, net—108,349—(108,349)108,349
Gain on sales of real estate, net164,6986,3773,288158,3213,089
Loss on debt extinguishments(46,020)——(46,020)—
Other income, net3,65416,2089,252(12,554)6,956
Income tax (expense) benefit(4,473)9,807506(14,280)9,301
Equity income (loss) from unconsolidated joint ventures11,3606,590(3,605)4,77010,195
Total discontinued operations265,755(699,086)665,276964,841(1,364,362)
Noncontrolling interests’ share in earnings(12,179)(12,817)(14,358)6381,541

Interest income. The decrease in interest income for the year ended December 31, 2016 was primarily the result of: (i) placing our Four Seasons Notes on cost recovery status in the third quarter of 2015 and (ii) paydowns in our loan portfolio. The decrease in interest income was partially offset by additional interest income from: (i) the Four Seasons senior secured term loan purchased in the fourth quarter of 2015 and (ii) additional fundings in our loan portfolio, including our £105 million ($131 million) loan to Maria Mallaband in November 2016.

The increase in interest income for the year ended December 31, 2015 was primarily the result of: (i) fundings through our U.K. loan facility to HC-One in November 2014 and February 2015, (ii) incremental interest income from the repayments of three development loans resulting from the appreciation of the underlying real estate assets and (iii) additional fundings under our mezzanine loan facility with Tandem in May 2015. The increase in interest income was partially offset by the impact of placing our Four Seasons Notes on cost recovery status in the third quarter of 2015.

Interest expense. The decrease in interest expense for the year ended December 31, 2016 was primarily the result of: (i) mortgage debt repayments during 2015 and 2016, primarily from mortgage debt secured by properties in our SH NNN, life science and medical office segments, (ii) senior unsecured notes payoffs during 2015 and 2016 and higher capitalized interest. The decrease in interest expense was partially offset by: (i) senior unsecured notes issued during 2015 and (ii) increased borrowings under our line of credit facility.

The increase in interest expense for the year ended December 31, 2015 was primarily the result of: (i) senior unsecured notes issued during 2014 and 2015, (ii) increased borrowings from our term loan originated in 2015, (iii) increased borrowings under our line of credit facility and (iv) lower capitalized interest. The increase in interest expense was partially offset by: (i) repayments of senior unsecured notes and (ii) mortgage debt that matured during 2014 and 2015. The increased borrowings were used to fund our investment activities and to refinance our debt maturities.

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

As of December 31,(1)
201620152014
Balance:
Fixed rate$7,614,473$10,659,378$8,841,676
Variable rate1,545,366397,432847,016
Total$9,159,839$11,056,810$9,688,692
Percentage of total debt:
Fixed rate83.1%96.4%91.3%
Variable rate16.93.68.7
Total100%100%100%
Weighted average interest rate at end of period:
Fixed rate4.26%4.68%5.01%
Variable rate2.23%1.72%1.59%
Total weighted average rate3.91%4.57%4.71%
(1)At December 31, 2016, 2015 and 2014, excludes $92 million, $94 million and $97 million of other debt, respectively, 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, 2016, 2015 and 2014, principal balances of $46 million, $71 million and $71 million of variable-rate mortgages, respectively, are presented as fixed-rate debt as the interest payments were swapped from variable to fixed. At December 31, 2016, 2015 and 2014, principal balances of £220 million ($272 million), £357 million ($526 million) and £137 million ($214 million) term loans, respectively, are presented as fixed-rate debt as the interest payments were swapped from variable to fixed.

Depreciation and amortization. The increase in depreciation and amortization expense for the year ended December 31, 2016 was primarily the result of the impact of acquisitions primarily in our SHOP and medical office segments.

The increase in depreciation and amortization expense for the year ended December 31, 2015 was primarily the result of the impact of our acquisitions primarily in our SHOP, life science and medical office segments and redevelopment projects placed in service during 2014 and 2015 primarily in our life science and medical office segments. The increase in depreciation and amortization expense was partially offset by additional depreciation expense recognized in 2014 as a result of a change in estimate of the depreciable life and residual value of certain properties in our SN NNN and medical office segments.

General and administrative expenses. The increase in general and administrative expenses for the year ended December 31, 2016 was primarily the result of: (i) higher severance-related charges primarily resulting from the departure of our former President and CEO in July 2016 and (ii) higher professional fees in 2016, partially offset by lower compensation related expenses.

The increase in general and administrative expenses for the year ended December 31, 2015 was primarily the result of: (i) a severance-related charge resulting from the resignation of our former Executive Vice President and Chief Investment Officer in June 2015 and (ii) higher compensation related expenses.

Acquisition and pursuit costs. The decrease in acquisition and pursuit costs for the year ended December 31, 2016 was primarily a result of lower levels of transactional activity in 2016 compared to the same period in 2015.

The increase in acquisition and pursuit costs for the year ended December 31, 2015 was primarily due to higher levels of transactional activity in 2015, including transactional costs related to the U.K. and RIDEA III investments.

Beginning in the first quarter of 2017, upon the Company’s planned adoption of the Financial Accounting Standards Board’s Accounting Standards Update No. 2017-01, Clarifying the Definition of a Business, the Company expects a decrease in acquisition and pursuit costs recognized within its consolidated statements of operations. See Note 2 to the Consolidated Financial Statements for further information.

Impairments, net. During the year ended December 31, 2015, we recognized the following impairment charges: (i) $112 million related to our investment in Four Seasons Notes and (ii) $3 million related to a MOB. The impairment charges were partially offset by a $6 million impairment recovery related to the repayment of a loan.

Gain on sales of real estate, net. During the year ended December 31, 2016, we sold a portfolio of five facilities in one of our non-reportable segments and two SH NNN facilities for $130 million, five life science facilities for $386 million, seven SH NNN facilities for $88 million, three MOBs for $20 million and three SHOP facilities for $41 million, recognizing total gain on sales of $165 million.

During the year ended December 31, 2015, we sold the following assets: (i) nine SH NNN facilities for $60 million, resulting from Brookdale’s exercise of its purchase option, (ii) two parcels of land in our life science segment for $51 million and (iii) a MOB for $0.4 million, recognizing total gain on sales of $6 million.

Loss on debt extinguishments. During the fourth quarter of 2016, using proceeds from the Spin-Off, we repaid $1.1 billion of senior unsecured notes that were due to mature in January 2017 and January 2018 and repaid $108 million of mortgage debt; incurring aggregate loss on debt extinguishments of $46 million, primarily related to prepayment penalties.

Other income, net. The decrease in other income, net for the year ended December 31, 2016 was primarily the result of a reduction of foreign currency remeasurement gains from remeasuring assets and liabilities denominated in GBP to U.S. dollars (“USD”) as a result of effective hedges designated in September 2015.

The increase in other income, net for the year ended December 31, 2015 was primarily the result of the impact from remeasuring assets and liabilities denominated in GBP to USD.

Income tax (expense) benefit. The increase in income taxes for the year ended December 31, 2016 was primarily the result of recognizing tax liabilities representing our estimated exposure to state built-in gain tax.

The decrease in income taxes for the year ended December 31, 2015 was primarily the result of the tax benefit related to our share of operating losses from our RIDEA joint ventures formed as part of the 2014 Brookdale transaction and related to our U.K. real estate investments in 2015.

Equity income (loss) from unconsolidated joint ventures. The increase in equity income from unconsolidated joint ventures for the year ended December 31, 2016 was primarily the result of increased income from our share of gains on sales of real estate.

The increase in equity income from unconsolidated joint ventures for the year ended December 31, 2015 was primarily the result of our share of gains on sales of real estate from HCP Ventures III, LLC and HCP Ventures IV, LLC, partially offset by our share of operating losses recognized from the CCRC JV.

Total discontinued operations. Discontinued operations for the years ended December 31, 2016, 2015 and 2014 resulted in income of $266 million, loss of $699 million and income of $665 million, respectively. Income and loss from discontinued operations primarily relates to the operations of QCP. Income from discontinued operations increased during the year ended December 31, 2016 as a result of impairment charges during 2015 not repeated in 2016. The increase in discontinued operations was partially offset by the following: (i) a reduction in income from our HCRMC investments as a result of the HCRMC lease amendment effective April 1, 2015, the sale of non-strategic assets during the second half of 2015 and the first half of 2016, and a change in income recognition to a cash basis method beginning in January 2016, (ii) transaction costs of $87 million related to the Spin-Off and (iii) increased income tax expense related to our estimated exposure to state built-in gain tax. During the years ended December 31, 2015 and 2014, we recognized impairments of $1.3 billion and $36 million, respectively, related to our HCRMC portfolio.

Liquidity and Capital Resources

We anticipate: (i) funding recurring operating expenses, (ii) meeting debt service requirements including principal payments and maturities, and (iii) satisfying our distributions to our stockholders and non-controlling interest members, for the next 12 months primarily by using cash flow from operations, available cash balances and cash from our various sources of financing.

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 31, 2017, we had a credit rating of BBB from Fitch, Baa2 from Moody’s and BBB from S&P Global 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 $95 million and $340 million at December 31, 2016 and 2015, respectively, reflecting a decrease of $245 million. The following table sets forth changes in cash flows (dollars in thousands):

Year Ended December 31,
20162015Change
Net cash provided by operating activities$1,214,131$1,222,145$(8,014)
Net cash used in investing activities(410,617)(1,672,005)1,261,388
Net cash (used in) provided by financing activities(1,054,265)614,087(1,668,352)

The decrease in operating cash flow is primarily the result of increased transaction costs and decreased income related to the Spin-Off, partially offset by our 2015 and 2016 acquisitions, annual rent increases and increased working capital. Our cash flow from operations is 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, 2016:

·made investments of $1.3 billion (development, leasing and acquisition of real estate, investments in unconsolidated joint ventures and loans, and purchases of securities) and received proceeds of $908 million primarily from real estate and DFL sales;
·paid cash dividends on common stock of $980 million, which were generally funded by cash provided by our operating activities and cash on hand; and
·received net proceeds of $1.7 billion from the Spin-Off of QCP, raised proceeds of $1.2 billion primarily from our net
borrowings under our bank line of credit, and repaid $2.9 billion under our bank line of credit, senior unsecured notes and mortgage debt.

Debt

Bank line of credit and Term Loans. Our $2.0 billion unsecured revolving line of credit facility (the “Facility”) matures on March 31, 2018 and contains a one-year extension option. Borrowings under the Facility accrue interest at LIBOR plus a margin that depends on 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 31, 2017, the margin on the Facility was 1.05%, and the facility fee was 0.20%. The Facility also includes a feature that allows 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, 2016, we had $900 million, including £372 million ($460 million), outstanding under the Facility with a weighted average effective interest rate of 1.821%. In January 2017, we paid down $440 million on the Facility primarily using proceeds from our RIDEA II transaction.

On July 30, 2012, we entered into a credit agreement with a syndicate of banks for a £137 million ($169 million at December 31, 2016) unsecured term loan, which matures in 2017. Based on our credit ratings at January 31, 2017, the 2012 Term Loan accrues interest at a rate of GBP LIBOR plus 1.40%.

On January 12, 2015, we entered into a credit agreement with a syndicate of banks for a £220 million ($272 million at December 31, 2016) four-year unsecured term loan (the “2015 Term Loan”) that accrues interest at a rate of GBP LIBOR plus 1.15%, subject to adjustments based on our credit ratings (the 2012 and 2015 Term Loans are collectively, the “Term Loans”). Proceeds from the 2015 Term Loan were used to repay a £220 million draw on the Facility that partially funded the November 2014 HC-One Facility (see Note 7 to the Consolidated Financial Statements). Concurrently, we entered into a three-year interest rate swap agreement that effectively fixes the interest rate of the 2015 Term Loan (1.97% at December 31, 2016). The 2015 Term Loan contains a one-year committed extension option.

The Facility and Term Loans contain certain financial restrictions and other customary requirements, including cross-default provisions to other indebtedness. 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 $6.5 billion at December 31, 2016, which requirement was reduced, via an amendment to the Facility, effective upon the completion of the Spin-Off of QCP on October 31, 2016. At December 31, 2016, we were in compliance with each of these restrictions and requirements of the Facility and Term Loans.

Senior unsecured notes. At December 31, 2016, we had senior unsecured notes outstanding with an aggregate principal balance of $7.2 billion. Interest rates on the notes ranged from 2.79% to 6.88%, with a weighted average effective interest rate of 4.34% and a weighted average maturity of six years at December 31, 2016. 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, 2016, we believe we were in compliance with these covenants.

Mortgage debt. At December 31, 2016, we had $619 million in aggregate principal amount of mortgage debt outstanding that is secured by 36 healthcare facilities (including redevelopment properties) with a carrying value of $899 million. Interest rates on the mortgage debt ranged from 3.02% to 7.50%, with a weighted average effective interest rate of 3.40% and a weighted average maturity of six years at December 31, 2016.

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 or 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.

Equity

At December 31, 2016, we had 468 million shares of common stock outstanding, equity totaled $5.9 billion, and our equity securities had a market value of $14.1 billion.

At December 31, 2016, non-managing members held an aggregate of 4 million units in five limited liability companies (“DownREITs”) for 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).

At-The-Market Program. In June 2015, we established an at-the-market program, in connection with the renewal of our Shelf Registration Statement. Under this program, we may sell shares of our common stock from time to time having an aggregate gross sales price of up to $750 million through a consortium of banks acting as sales agents or directly to the banks acting as principals. There was no activity during the year ended December 31, 2016 and, as of December 31, 2016, shares of our common stock having an aggregate gross sales price of $676 million were available for sale under the at-the-market program. Actual future sales will depend upon a variety of factors, including but not limited to market conditions, the trading price of our common stock and our capital needs. We have no obligation to sell the remaining shares available for sale under our program.

Shelf Registration

We filed a prospectus with the SEC as part of a registration statement on Form S-3ASR, using a shelf registration process, which expires in June 2018. Under the “shelf” process, we may sell any combination of the securities described in the prospectus through one or more offerings. The securities described in the prospectus include common stock, preferred stock, depositary shares, debt securities and warrants.

Contractual Obligations

The following table summarizes our material contractual payment obligations and commitments at December 31, 2016 (in thousands):

More than
Total(1)20172018-20192020-2021Five Years
Bank line of credit(2)$899,718$—$899,718$—$—
Term loans(3)441,181169,305271,876——
Senior unsecured notes7,200,000250,000450,0002,000,0004,500,000
Mortgage debt618,940479,7957,48015,184116,481
U.K. loan commitments(4)43,10739,9463,161——
Construction loan commitments(5)124124———
Development commitments(6)117,019114,2292,790——
Ground and other operating leases412,0557,29414,75113,706376,304
Interest(7)2,265,501337,433584,054485,911858,103
Total$11,997,645$1,398,126$2,233,830$2,514,801$5,850,888
(1)Excludes $92 million of other debt that represents life care bonds and demand notes that have no scheduled maturities. Additionally, excludes a $100 million unsecured revolving credit facility commitment to QCP, which is available to be drawn upon by QCP through the fourth quarter of 2017 and matures in the fourth quarter of 2018. The unsecured revolving credit facility will automatically and permanently decrease each calendar month by an amount equal to 50% of QCP's and its restricted subsidiaries’ retained cash flow for the prior calendar month. All borrowings under the unsecured revolving credit facility will be subject to the satisfaction of certain conditions (see Note 1 to the Consolidated Financial Statements).
(2)Includes £372 million ($460 million) translated into USD.
(3)Represents £357 million translated into USD.
(4)Represents £35 million translated into USD for commitments to fund our U.K. loan facilities.
(5)Represents commitments to finance development projects and related working capital financings.
(6)Represents construction and other commitments for developments in progress.
(7)Interest on variable-rate debt is calculated using rates in effect at December 31, 2016.

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 above under “Contractual Obligations”.

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, and remaining other 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.

Non-GAAP Financial Measure Reconciliations

Funds From Operations and Funds Available for Distribution

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

Year Ended December 31,
20162015201420132012
Net income (loss) applicable to common shares$626,549$(560,552)$919,796$969,103$812,289
Depreciation and amortization of real estate, in-place lease and other intangibles572,998510,785459,995429,174366,512
Other depreciation and amortization11,91922,22318,86414,32612,756
Gain on sales of real estate, net(164,698)(6,377)(31,298)(69,866)(31,454)
Taxes associated with real estate dispositions60,451————
Impairments of real estate—2,948—1,372—
Equity income from unconsolidated joint ventures(11,360)(57,313)(49,570)(64,433)(54,455)
FFO from unconsolidated joint ventures44,07190,49870,87374,32464,933
Noncontrolling interests’ and participating securities’ share in earnings13,37714,13416,79515,90317,547
Noncontrolling interests’ and participating securities’ share in FFO(34,154)(27,187)(23,821)(20,639)(21,620)
FFO applicable to common shares$1,119,153$(10,841)$1,381,634$1,349,264$1,166,508
Distributions on dilutive convertible units8,732—13,79913,27613,028
Diluted FFO applicable to common shares$1,127,885$(10,841)$1,395,433$1,362,540$1,179,536
Weighted average shares used to calculate diluted FFO per common share471,566462,795464,845461,710434,328
Impact of adjustments to FFO:
Transaction-related items(1)$96,586$32,932$(18,856)$6,191$5,339
Other impairments, net(2)—1,446,80035,913—7,878
Loss on debt extinguishment(3)46,020————
Severance-related charges(4)16,9656,713—27,2445,642
Foreign currency remeasurement losses (gains)585(5,437)———
Litigation provision3,081————
Preferred stock redemption charge————10,432
$163,237$1,481,008$17,057$33,435$29,291
FFO as adjusted applicable to common shares$1,282,390$1,470,167$1,398,691$1,382,699$1,195,799
Distributions on dilutive convertible units and other12,84913,59713,76613,22012,957
Diluted FFO as adjusted applicable to common shares$1,295,239$1,483,764$1,412,457$1,395,919$1,208,756
Weighted average shares used to calculate diluted FFO as adjusted per common share(5)473,340469,064464,845461,710433,607
Diluted earnings per common share$1.34$(1.21)$2.00$2.13$1.90
Depreciation and amortization1.211.101.000.930.85
Impairments on real estate and DFL depreciation0.030.060.040.030.03
Taxes related to real estate dispositions and gain on sales of real estate, net(0.22)(0.01)(0.07)(0.15)(0.07)
Joint venture and participating securities FFO adjustments0.030.040.030.010.01
Diluted FFO per common share$2.39$(0.02)$3.00$2.95$2.72
Transaction-related items(1)0.200.07(0.04)0.010.01
Other impairments, net(2)—3.110.08—0.02
Loss on debt extinguishment(3)0.10————
Severance-related charges(4)0.040.01—0.060.01
Foreign currency remeasurement losses (gains)—(0.01)———
Litigation provision0.01————
Preferred stock redemption charge————0.03
FFO as adjusted applicable to common shares$2.74$3.16$3.04$3.02$2.79
Year Ended December 31,
20162015201420132012
FFO as adjusted applicable to common shares$1,282,390$1,470,167$1,398,691$1,382,699$1,195,799
Amortization of market lease intangibles, net(1,197)(1,295)(949)(6,646)(2,232)
Amortization of deferred compensation(6)15,58123,23321,88523,32723,277
Amortization of deferred financing costs20,01420,22219,26018,54116,501
Straight-line rents(18,003)(28,859)(41,032)(39,587)(47,311)
DFL non-cash interest(7)2,600(87,861)(77,568)(86,055)(94,240)
Other depreciation and amortization(11,919)(22,223)(18,864)(14,326)(12,756)
Deferred revenues – tenant improvement related(1,883)(2,594)(2,306)(2,906)(1,570)
Deferred revenues – additional rents(76)(219)42263(85)
Leasing costs and tenant and capital improvements(88,953)(82,072)(74,464)(64,557)(61,440)
Lease restructure payments16,60422,6579,425——
Joint venture adjustments – CCRC entrance fees29,99830,91811,443——
Joint venture and other FAD adjustments(7)(29,460)(80,225)(67,121)(52,471)(61,298)
FAD applicable to common shares$1,215,696$1,261,849$1,178,822$1,158,082$954,645
Distributions on dilutive convertible units13,08814,23013,79913,2767,714
Diluted FAD applicable to common shares$1,228,784$1,276,079$1,192,621$1,171,358$962,359
(1)For the year ended December 31, 2016, transaction-related items primarily relate to the Spin-Off. For the year ended December 31, 2015, transaction-related items primarily relate to acquisition and pursuit costs. For the year ended December 31, 2014, transaction-related items include a net benefit from the 2014 Brookdale transaction, partially offset by acquisition and pursuit costs. For the years ended December 31, 2013 and 2012, transaction-related items primarily relate to acquisition and pursuit costs.
(2)For the year ended December 31, 2015, other impairments, net include impairment charges of: (i) $1.3 billion related to our HCRMC DFL investments, (ii) $112 million related to our Four Seasons Notes and (iii) $46 million related to our equity investment in HCRMC, partially offset by an impairment recovery of $6 million related to a loan payoff. For the year ended December 31, 2014, the other impairment relates to our equity investment in HCRMC.
(3)Represents penalties of $46 million from the prepayment of $1.1 billion of senior unsecured notes and $108 million of mortgage debt using proceeds from the Spin-Off.
(4)For the year ended December 31, 2016, severance-related charges primarily relate to the departure of our former President and CEO. For the year ended December 31, 2015, the severance-related charge relates to the departure of our former Executive Vice President and Chief Investment Officer. For the year ended December 31, 2013, the severance-related charge relates to the departure of our former Chairman, CEO and President.
(5)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.
(6)Excludes $7 million primarily related to the acceleration of deferred compensation for restricted stock units that vested upon the departure of our former President and CEO, which is included in the severance-related charges for the year ended December 31, 2016. Excludes $3 million related to the acceleration of deferred compensation for restricted stock units and stock options that vested upon the departure of our former Executive Vice President and Chief Investment Officer, which is included in the severance-related charge for year ended December 31, 2015. Excludes $17 million related to the acceleration of deferred compensation for restricted stock units and options that vested upon the departure of our former CEO, which is included in severance-related charges for the year ended December 31, 2013.
(7)Our equity investment in HCRMC was accounted for using the equity method, which required an elimination of DFL income that is proportional to our ownership in HCRMC. Further, our share of earnings from HCRMC (equity income) increased for the corresponding elimination of related lease expense recognized at the HCRMC entity level, which we presented as a non-cash joint venture FAD adjustment. Beginning in January 2016, as a result of placing our equity investment in HCRMC on a cash basis method of accounting, we no longer eliminated our proportional ownership share of income from DFLs to equity income (loss) from unconsolidated joint ventures. See Note 5 to the Consolidated Financial Statements for additional discussion.

Critical Accounting Policies

The preparation of financial statements in conformity with U.S. 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 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, do not have a controlling financial interest, (ii) the equity investment at risk is insufficient to finance that entity’s activities without additional subordinated financial support, or (iii) substantially all of the entity’s activities involve or are performed on behalf of an equity investor that holds disproportionately few voting rights. We make judgments with respect to our level of influence or control over 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, and 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 VIE, 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 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 controls of the VIE to determine if we could rely on the financial information it provides. 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 controls 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 prior to or shortly after the end of the lease term, (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) is equal to 90% or more of the excess estimated fair value (over retained tax credits) of the leased asset. If one of the four criteria is met and the minimum lease payments are determined to be reasonably predictable and collectible, the lease arrangement is generally accounted for as a direct financing lease. If the assumptions utilized in the above classifications 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 leased asset until the tenant improvements are substantially complete. 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 a tenant improvement 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, is 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 receivable 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, the net investment in the DFL represents receivables for the sum of future minimum lease payments receivable and the estimated residual values of the leased properties, less the unamortized 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. 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-investment, the timing and amount of our interest income recognized would be impacted.

Loans receivable and DFLs (collectively, “Finance Receivables”), are reviewed and assigned an internal rating of Performing, Watch List or Workout. Finance Receivables that are deemed Performing meet all present contractual obligations, and collection and timing, of all amounts owed is reasonably assured. Watch List Finance Receivables are defined as Finance Receivables that do not meet the definition of Performing or Workout. Workout Finance Receivables are defined as Finance Receivables in which we have determined, based on current information and events, that: (i) it is probable we will be unable to collect all amounts due according to the contractual terms of the agreement, (ii) the tenant, operator, or borrower is delinquent on making payments under the contractual terms of the agreement (iii) and we have commenced action or anticipate pursuing action in the near term to seek recovery of our investment.

Finance Receivables are placed on nonaccrual status when management determines that the collectibility of contractual amounts is not reasonably assured (the asset will have an internal rating of either Watch List or Workout). Further, we perform a credit analysis to support the tenant’s, operator’s, borrower’s and/or guarantor’s repayment capacity and the underlying collateral values. We use the cash basis method of accounting for Finance Receivables placed on nonaccrual status unless one of the following conditions exist whereby we utilize the cost recovery method of accounting: (i) if we determine that it is probable that we will only recover the recorded investment in the Finance Receivable, net of associated allowances or charge-offs (if any), or (ii) we cannot reasonably estimate the amount of an impaired Finance Receivable. For cash basis method of accounting we apply payments received, excluding principal paydowns, to interest income so long as that amount does not exceed the amount that would have been earned under the original contractual terms. For cost recovery method of accounting any payment received is applied to reduce the recorded investment. Generally, we return a Finance Receivable to accrual status when all delinquent payments become current under the terms of the loan or lease agreements and collectibility of the remaining contractual loan or lease payments is reasonably assured.

Allowances are established for Finance Receivables on an individual basis utilizing an estimate of probable losses, if they are determined to be impaired. Finance Receivables are impaired when it is deemed probable that we will be unable to collect all amounts due in accordance with the contractual terms of the loan or lease. An allowance is based upon our assessment of the lessee’s or borrower’s overall financial condition, economic resources, 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 the expected future cash flows discounted at the Finance Receivable’s effective interest rate, fair value of collateral, general economic conditions and trends, historical and industry loss experience, and other relevant factors, as appropriate. Should a Finance Receivable be deemed partially or wholly uncollectible, the uncollectible balance is charged off against the allowance in the period in which the uncollectible determination has been made.

Real Estate

We make estimates as part of our process for allocating a purchase price to the various identifiable assets of an acquisition based upon the relative fair value of each asset. The most significant components of our allocations are typically buildings as-if-vacant, land and in-place leases. In the case of allocating fair value to buildings and intangibles, our fair value estimates will affect the amount of depreciation and amortization we record over the estimated useful life of each asset acquired or the remaining lease term. In the case of allocating fair value to 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 to be considered substantially complete and available for occupancy and cease capitalization of costs upon the completion of the related tenant improvements.

Impairment of Long-Lived Assets

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, but at least annually. 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.

The determination of the fair value of real estate assets involves significant judgment. This judgment is based on our analysis and estimates of fair value of real estate assets, 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 of investments in unconsolidated joint ventures and as to whether a deficiency in fair value is “other-than-temporary” 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 a 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.

Previous: Item 6. Selected Financial Data · Next: Item 7A. Quantitative and Qualitative Disclosures About Market Risk