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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________________________________
FORM 10-Q
____________________________________________________________
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2017
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                     to                     
Commission File Number: 001-11852
____________________________________________________________
HEALTHCARE REALTY TRUST INCORPORATED
(Exact name of Registrant as specified in its charter) 
____________________________________________________________
Maryland
 
62 – 1507028
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
3310 West End Avenue
 
 
Suite 700
 
 
Nashville, Tennessee 37203
 
 
(Address of principal executive offices)
 
 
 
 
 
(615) 269-8175
 
 
(Registrant’s telephone number, including area code)
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
(Do not check if a smaller reporting company)
Smaller reporting company o
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
 
As of October 27, 2017, the Registrant had 124,890,077 shares of Common Stock outstanding.
 


Table of Contents

HEALTHCARE REALTY TRUST INCORPORATED
FORM 10-Q
September 30, 2017

TABLE OF CONTENTS
 
 
Page
 
Item 1.   
 
 
 
 
 
 
Item 2.   
Item 3.   
Item 4.   
 
 
 
Item 1.   
 
 
 
 


Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements
Healthcare Realty Trust Incorporated
Condensed Consolidated Balance Sheets
(Amounts in thousands, except per share data)
 
(Unaudited)
 
 
 
September 30,
2017
 
December 31,
2016
ASSETS
 
 
 
Real estate properties:
 
 
 
Land
$
196,217

 
$
199,672

Buildings, improvements and lease intangibles
3,400,224

 
3,386,480

Personal property
10,300

 
10,291

Construction in progress
1,138

 
11,655

Land held for development
20,123

 
20,123

 
3,628,002

 
3,628,221

Less accumulated depreciation and amortization
(888,875
)
 
(840,839
)
Total real estate properties, net
2,739,127

 
2,787,382

Cash and cash equivalents
196,981

 
5,409

Restricted cash

 
49,098

Assets held for sale and discontinued operations, net
8,772

 
3,092

Other assets, net
200,824

 
195,666

Total assets
$
3,145,704

 
$
3,040,647

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
Liabilities:
 
 
 
Notes and bonds payable
$
1,166,060

 
$
1,264,370

Accounts payable and accrued liabilities
69,918

 
78,266

Liabilities of properties held for sale and discontinued operations
59

 
614

Other liabilities
45,405

 
43,983

Total liabilities
1,281,442

 
1,387,233

Commitments and contingencies


 


Stockholders' equity:
 
 
 
Preferred stock, $.01 par value per share; 50,000 shares authorized; none issued and outstanding

 

Common stock, $.01 par value per share; 300,000 and 150,000 shares authorized; 124,890 and 116,417 shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively
1,249

 
1,164

Additional paid-in capital
3,173,167

 
2,917,914

Accumulated other comprehensive loss
(1,274
)
 
(1,401
)
Cumulative net income attributable to common stockholders
1,055,499

 
995,256

Cumulative dividends
(2,364,379
)
 
(2,259,519
)
Total stockholders' equity
1,864,262

 
1,653,414

Total liabilities and stockholders' equity
$
3,145,704

 
$
3,040,647


The accompanying notes, together with the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, are an integral part of these financial statements.

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Healthcare Realty Trust Incorporated
Condensed Consolidated Statements of Income
For the Three and Nine Months Ended September 30, 2017 and 2016
(Amounts in thousands, except per share data)
(Unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
REVENUES
 
 
 
 
 
 
 
Rental income
$
106,561

 
$
102,534

 
$
315,519

 
$
302,746

Other operating
392

 
1,125

 
1,249

 
3,576

 
106,953

 
103,659

 
316,768

 
306,322

EXPENSES
 
 
 
 
 
 
 
Property operating
40,626

 
37,504

 
116,644

 
109,173

General and administrative
8,021

 
7,859

 
24,720

 
23,687

Acquisition and pursuit costs
507

 
865

 
1,878

 
3,411

Depreciation and amortization
35,873

 
31,985

 
105,148

 
93,668

Bad debts, net of recoveries
14

 
(47
)
 
185

 
(8
)
 
85,041

 
78,166

 
248,575

 
229,931

OTHER INCOME (EXPENSE)
 
 
 
 
 
 
 
Gain on sales of real estate assets
(7
)
 

 
39,519

 
1

Interest expense
(14,107
)
 
(13,759
)
 
(42,694
)
 
(43,512
)
Pension termination

 

 

 
(4
)
Impairment of real estate assets
(5,059
)
 

 
(5,387
)
 

Interest and other income, net
426

 
123

 
616

 
301

 
(18,747
)
 
(13,636
)
 
(7,946
)
 
(43,214
)
INCOME FROM CONTINUING OPERATIONS
3,165

 
11,857

 
60,247

 
33,177

DISCONTINUED OPERATIONS
 
 
 
 
 
 
 
Income (loss) from discontinued operations
8

 
(23
)
 
(9
)
 
(50
)
Gain on sales of real estate properties

 

 
5

 
7

INCOME (LOSS) FROM DISCONTINUED OPERATIONS
8

 
(23
)
 
(4
)
 
(43
)
NET INCOME
$
3,173

 
$
11,834

 
$
60,243

 
$
33,134

BASIC EARNINGS PER COMMON SHARE:
 
 
 
 
 
 
 
Income from continuing operations
$
0.02

 
$
0.10

 
$
0.50

 
$
0.31

Discontinued operations
0.00

 
0.00

 
0.00

 
0.00

Net income
$
0.02

 
$
0.10

 
$
0.50

 
$
0.31

DILUTED EARNINGS PER COMMON SHARE:
 
 
 
 
 
 
 
Income from continuing operations
$
0.02

 
$
0.10

 
$
0.50

 
$
0.31

Discontinued operations
0.00

 
0.00

 
0.00

 
0.00

Net income
$
0.02

 
$
0.10

 
$
0.50

 
$
0.31

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING—BASIC
119,098

 
114,152

 
116,181

 
106,552

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING—DILUTED
119,181

 
115,052

 
116,277

 
107,366

DIVIDENDS DECLARED, PER COMMON SHARE, DURING THE PERIOD
$
0.30

 
$
0.30

 
$
0.90

 
$
0.90

The accompanying notes, together with the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, are an integral part of these financial statements.

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Healthcare Realty Trust Incorporated
Condensed Consolidated Statements of Comprehensive Income
For the Three and Nine Months Ended September 30, 2017 and 2016
(Dollars in thousands)
(Unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
NET INCOME
$
3,173

 
$
11,834

 
$
60,243

 
$
33,134

Other comprehensive income:
 
 
 
 
 
 
 
Forward starting interest rate swaps:
 
 
 
 
 
 
 
Reclassification adjustment for losses included in net income (Interest expense)
43

 
42

 
127

 
126

Total other comprehensive income
43

 
42

 
127

 
126

COMPREHENSIVE INCOME
$
3,216

 
$
11,876

 
$
60,370

 
$
33,260


The accompanying notes, together with the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, are an integral part of these financial statements.

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Healthcare Realty Trust Incorporated
Condensed Consolidated Statement of Equity
(Dollars in thousands, except per share data)
(Unaudited)

 
Common
Stock
 
Additional
Paid-In
Capital
 
Accumulated
Other
Comprehensive
Loss
 
Cumulative
Net
Income Attributable to Common Stockholders
 
Cumulative
Dividends
 
Total
Stockholders’
Equity
Balance at December 31, 2016
$
1,164

 
$
2,917,914

 
$
(1,401
)
 
$
995,256

 
$
(2,259,519
)
 
$
1,653,414

Issuance of common stock
84

 
248,261

 

 

 

 
248,345

Common stock redemptions

 
(503
)
 

 

 

 
(503
)
Stock-based compensation
1

 
7,495

 

 

 

 
7,496

Net income

 

 

 
60,243

 

 
60,243

Reclassification of loss on forward starting interest rate swaps

 

 
127

 

 

 
127

Dividends to common stockholders ($0.90 per share)

 

 

 

 
(104,860
)
 
(104,860
)
Balance at September 30, 2017
$
1,249

 
$
3,173,167

 
$
(1,274
)
 
$
1,055,499

 
$
(2,364,379
)
 
$
1,864,262

The accompanying notes, together with the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, are an integral part of these financial statements.


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Table of Contents

Healthcare Realty Trust Incorporated
Condensed Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2017 and 2016
(Dollars in thousands)
(Unaudited)
 
Nine Months Ended September 30,
 
2017
 
2016
OPERATING ACTIVITIES
 
 
 
Net income
$
60,243

 
$
33,134

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
105,148

 
93,668

Other amortization
3,056

 
2,477

Stock-based compensation
7,496

 
5,649

Amortization of straight-line rent receivable
(4,867
)
 
(5,446
)
Amortization of straight-line rent liability
492

 
(93
)
Gain on sales of real estate assets
(39,525
)
 
(8
)
Impairment of real estate assets
5,387

 

Provision for bad debts, net
175

 
(8
)
Changes in operating assets and liabilities:
 
 
 
Other assets
(6,037
)
 
(1,436
)
Accounts payable and accrued liabilities
(3,301
)
 
(3,889
)
Other liabilities
1,098

 
(21,628
)
Net cash provided by operating activities
129,365

 
102,420

INVESTING ACTIVITIES
 
 
 
Acquisitions of real estate
(72,934
)
 
(162,702
)
Development of real estate
(11,753
)
 
(28,508
)
Additional long-lived assets
(52,305
)
 
(49,794
)
Proceeds from sales of real estate
119,425

 

Proceeds from mortgages and notes receivable repayments
15

 
14

Net cash used in investing activities
(17,552
)
 
(240,990
)
FINANCING ACTIVITIES
 
 
 
Net repayments on unsecured credit facility
(107,000
)
 
(125,000
)
Repayment on term loan

 
(50,000
)
Borrowings of notes and bonds payable

 
11,500

Repayments on notes and bonds payable
(4,654
)
 
(36,786
)
Dividends paid
(104,860
)
 
(96,998
)
Net proceeds from issuance of common stock
248,384

 
450,304

Common stock redemptions
(1,125
)
 
(1,282
)
Debt issuance and assumption costs
(84
)
 
(4,621
)
Net cash provided by financing activities
30,661

 
147,117

Increase in cash, cash equivalents and restricted cash
142,474

 
8,547

Cash, cash equivalents and restricted cash at beginning of period
54,507

 
4,102

Cash, cash equivalents and restricted cash at end of period
$
196,981

 
$
12,649

 
 
 
 
Supplemental Cash Flow Information:
 
 
 
Interest paid
$
42,136

 
$
43,879

Invoices accrued for construction, tenant improvements and other capitalized costs
$
6,842

 
$
10,014

Mortgage notes payable assumed upon acquisition (adjusted to fair value)
$
12,460

 
$
13,951

Capitalized interest
$
681

 
$
828

The accompanying notes, together with the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, are an integral part of these financial statements.

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Table of Contents
Healthcare Realty Trust Incorporated

Notes to the Condensed Consolidated Financial Statements
September 30, 2017
(Unaudited)

Note 1. Summary of Significant Accounting Policies
Business Overview
Healthcare Realty Trust Incorporated (the "Company") is a self-managed, self-administered real estate investment trust ("REIT") that integrates owning, leasing, managing, financing, developing and redeveloping income-producing real estate properties associated primarily with the delivery of outpatient healthcare services throughout the United States. As of September 30, 2017, the Company had gross investments of approximately $3.6 billion in 197 real estate properties located in 26 states totaling approximately 14.4 million square feet. The Company provided leasing and property management services to approximately 11.2 million square feet nationwide.

Basis of Presentation
The Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. They do not include all of the information and footnotes required by GAAP for complete financial statements. However, except as disclosed herein, management believes there has been no material change in the information disclosed in the Notes to the Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2016. All material intercompany transactions and balances have been eliminated in consolidation.

This interim financial information should be read in conjunction with the financial statements included in this report and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. Management believes that all adjustments of a normal, recurring nature considered necessary for a fair presentation have been included. In addition, the interim financial information does not necessarily represent or indicate what the operating results will be for the year ending December 31, 2017 for many reasons including, but not limited to, acquisitions, dispositions, capital financing transactions, changes in interest rates and the effects of other trends, risks and uncertainties.

Use of Estimates in the Condensed Consolidated Financial Statements
Preparation of the Condensed Consolidated Financial Statements in accordance with GAAP requires management to make estimates and assumptions that affect amounts reported in the Condensed Consolidated Financial Statements and accompanying notes. Actual results may differ from those estimates.
Cash, Cash Equivalents and Restricted Cash
Cash and cash equivalents includes short-term investments with original maturities of three months or less when purchased. Restricted cash includes cash held in escrow in connection with proceeds from the sales of certain real estate properties. These sales proceeds were disbursed as the Company acquired real estate investments in like-kind exchanges under Section 1031 of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”). The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the Company's Consolidated Balance Sheets to the combined amounts shown on the Company's Consolidated Statements of Cash Flows:
(Dollars in thousands)
 
9/30/2017
 
12/31/2016
Cash and cash equivalents
 
$
196,981

 
$
5,409

Restricted cash
 

 
49,098

Total cash, cash equivalents and restricted cash
 
$
196,981

 
$
54,507




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Table of Contents


Reclassifications
Condensed Consolidated Statements of Income
Certain reclassifications have been made on the Company's Condensed Consolidated Statements of Income. The Company reclassified acquisition and pursuit costs from the general and administrative line item to a separate line item. The acquisition and pursuit costs line item includes direct third party and travel costs related to the Company's pursuit of acquisitions and developments. In addition, the Company combined the line items labeled depreciation and amortization into one line item. These reclassifications are as follows:
 
 
September 30, 2016
 
 
Three Months Ended
 
Nine Months Ended
(in thousands)
 
As Previously Reported
 
As Reclassified
 
As Previously Reported
 
As Reclassified
General and administrative
 
$
8,724

 
$
7,859

 
$
27,098

 
$
23,687

Acquisition and pursuit costs
 

 
865

 

 
3,411

  Total
 
$
8,724

 
$
8,724

 
$
27,098

 
$
27,098

 
 
 
 
 
 
 
 
 
Depreciation
 
$
29,273

 
$

 
$
85,494

 
$

Amortization
 
2,712

 

 
8,174

 

Depreciation and amortization
 

 
31,985

 

 
93,668

  Total
 
$
31,985

 
$
31,985

 
$
93,668

 
$
93,668


New Accounting Pronouncements
Accounting Standards Update No. 2014-09 and No. 2015-14
In May 2014, the Financial Accounting Standards Board ("FASB") issued ASU No. 2014-09, "Revenue from Contracts with Customers," a comprehensive new revenue recognition standard that supersedes most existing revenue recognition guidance, including sales of real estate. This standard's core principle is that a company will recognize revenue when it transfers goods or services to customers in amounts that reflect the consideration to which the company expects to be entitled in exchange for those goods and services. However, leasing contracts, representing the major source of the Company's revenues, are not within the scope of the new standard and will continue to be accounted for under other standards.

In August 2015, the FASB issued ASU No. 2015-14, "Revenue from Contracts with Customers (Topic 606); Deferral of the Effective Date." This standard is effective for the Company for annual and interim periods beginning after December 15, 2017 with early adoption permitted only as of annual reporting periods beginning after December 15, 2016, including interim periods within that year.

The Company plans to adopt this standard by using the full retrospective adoption method beginning on January 1, 2018. The Company's revenue-producing contracts are primarily leases that are not within the scope of this standard. As a result, the Company does not expect the adoption of this standard to have a material impact on the timing and measurement of the Company's leasing revenues. The Company has identified that parking income, rental lease guaranty income and management fee income will be within the scope of Topic 606. The Company is continuing to assess the impact of this standard and does expect additional disclosures that are required from the adoption of this standard.

Accounting Standards Update No. 2016-02
In February 2016, the FASB issued ASU No. 2016-02, "Leases." For lessees, the new standard establishes a right-of-use ("ROU") model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The Company expects that all of the leases where the Company is the lessee will be recorded on the Company's balance sheet. For lessors, the new standard requires a lessor to classify leases as either sales-type, finance or operating. A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as financing. If the lessor doesn't convey risks and rewards or control, then the lease would be classified as an operating lease.

The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years with early adoption permitted. A modified retrospective transition approach is required for lessors for sales-type, direct financing, and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is in the initial stages of evaluating the impact from the adoption of this new standard on the Consolidated Financial Statements and related notes.

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Accounting Standards Update No. 2016-13
In June 2016, the FASB issued ASU 2016-13, "Measurement of Credit Losses on Financial Instruments." This update is intended to improve financial reporting by requiring timelier recognition of credit losses on loans and other financial instruments that are not accounted for at fair value through net income, including loans held for investment, held-to-maturity debt securities, trade and other receivables, net investment in leases and other such commitments. This update requires that financial statement assets measured at an amortized cost and certain other financial instruments be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. This standard is effective for annual and interim periods beginning after December 15, 2019 with early adoption permitted. The Company is in the initial stages of evaluating the impact from the adoption of this new standard on the Consolidated Financial Statements and related notes.

Accounting Standards Update No. 2016-15
In August 2016, the FASB issued ASU No. 2016-15, "Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments." This update clarifies whether the following items should be classified as operating, investing or financing in the statement of cash flows: (i) debt prepayments and extinguishment costs, (ii) settlement of zero-coupon debt, (iii) settlement of contingent consideration, (iv) insurance proceeds, (v) settlement of corporate-owned life insurance and bank-owned life insurance policies, (vi) distributions from equity method investees, (vii) beneficial interest in securitization transactions and (viii) receipts and payments with aspects of more than one class of cash flows.

This standard is effective for the Company for annual and interim periods beginning on January 1, 2018 with early adoption permitted on a retrospective transition method to each period presented. The Company adopted this standard effective January 1, 2017. There was not a material impact on the Company's Consolidated Financial Statements and related notes resulting from the adoption of this standard.

Accounting Standards Update No. 2017-01
In January 2017, the FASB issued ASU No. 2017-01, "Business Combinations: Clarifying the Definition of a Business." This update modifies the requirements to meet the definition of a business under Topic 805, "Business Combinations." The amendments provide a screen to determine when an integrated set of assets and activities is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not a business. The Company believes that this amendment will result in most of its real estate acquisitions being accounted for as asset acquisitions rather than business combinations. This standard is effective for the Company for annual and interim periods beginning after December 15, 2017 with early adoption permitted. The Company adopted this standard effective January 1, 2017 and has accounted for acquisitions that occurred during the nine months ended September 30, 2017 as asset acquisitions. The impact to the Consolidated Financial Statements and related notes as a result of the adoption of this standard is primarily related to the difference in the accounting of acquisition costs. When accounting for these costs as a part of an asset acquisition, the Company will be permitted to capitalize the costs. The adoption of this standard did not have a material impact on the Consolidated Financial Statements and related notes.

Accounting Standards Update No. 2017-04
In January 2017, the FASB issued ASU 2017-04, "Simplifying the Test for Goodwill Impairment." This update eliminates Step 2 of the goodwill impairment test. As such, an entity will perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize a goodwill impairment charge for the amount by which the reporting unit's carrying amount exceeds its fair value. This standard is effective for the Company for annual and interim periods beginning after December 15, 2019. The Company does not expect a material impact on the Consolidated Financial Statements and related notes from the adoption of this standard.

Accounting Standards Update No. 2017-05
In February 2017, the FASB issued ASU 2017-05, "Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets." This update defines an in-substance nonfinancial asset, unifies guidance related to partial sales of nonfinancial assets, eliminates rules specifically addressing the sales of real estate, removes exception to the financial asset derecognition model and clarifies the accounting for contributions of nonfinancial assets to joint ventures. This standard is effective for the Company for annual and interim periods beginning after December 15, 2017 with early adoption permitted. The Company does not expect a material impact on the Consolidated Financial Statements and related notes from the adoption of this standard.


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Accounting Standards Update No. 2017-09
In May 2017, the FASB issued ASU 2017-09, "Compensation - Stock Compensation - Scope of Modification Accounting." This update provides guidance about which changes to the terms and conditions of share-based awards require an entity to apply modification accounting in Topic 718. This standard is effective for the Company for the annual and interim periods beginning after December 15, 2017 with early adoption permitted. The Company does not expect a material impact on the Consolidated Financial Statements and related notes from the adoption of this standard.

Accounting Standards Update No. 2017-12
In August 2017, the FASB issued ASU 2017-12, "Derivatives and Hedging - Targeted Improvements to Accounting for Hedging Activities." The purpose of this updated guidance is to better align a company’s financial reporting for hedging activities with the economic objectives of those activities. The transition guidance allows for early adoption of the new standard using a modified retrospective transition method in any interim period after issuance of the update, or alternatively requires adoption for fiscal years beginning after December 15, 2018. The modified retrospective transition method will require the Company to recognize the cumulative effect of initially applying this standard as an adjustment to accumulated other comprehensive income with a corresponding adjustment to the opening balance of retained earnings as of the beginning of the fiscal year that an entity adopts the update. While the Company continues to assess all potential impacts of the standard, the Company currently does not expect adoption to have a material impact on the Company's Consolidated Financial Statements.

Note 2. Real Estate Investments
2017 Acquisitions
The following table details the Company's acquisitions for the nine months ended September 30, 2017 (dollars in millions):
Location
Type (1)
 
Date Acquired
 
Purchase Price
 
Mortgage
Note Payable Assumed
(2)
 
Cash
Consideration
(3)
 
Real
Estate
 
Other (4)
 
Square
Footage
St. Paul, Minnesota
MOB
 
3/6/17
 
$
13.5

 
$

 
$
13.5

 
$
13.3

 
$
0.2

 
34,608

San Francisco, California
MOB
 
6/12/17
 
26.8

 

 
26.8

 
26.8

 

 
75,649

Washington, D.C.
MOB
 
6/13/17
 
24.0

 
(12.1
)
 
12.5

 
24.8

 
(0.2
)
 
62,379

Los Angeles, California
MOB
 
7/31/17
 
16.3

 

 
16.7

 
16.9

 
(0.2
)
 
42,780

Total acquisitions
 
 
 
 
$
80.6

 
$
(12.1
)
 
$
69.5

 
$
81.8

 
$
(0.2
)
 
215,416

______
(1)
MOB = medical office building
(2)
The mortgage note payable assumed in the acquisition does not reflect the fair value adjustments totaling $0.4 million recorded by the Company upon acquisition (included in Other).
(3)
Cash consideration excludes prorations of revenue and expense due to/from seller at the time of the acquisition.
(4)
Includes assets acquired, liabilities assumed, and intangibles recognized at acquisition.

Subsequent Acquisitions
The Company is under contract to purchase eight medical office buildings in the Atlanta, Georgia market from Meadows & Ohly, LLC and its affiliates for a total purchase price of $193.8 million. On November 1, 2017, the Company acquired four of these properties totaling 288,880 square feet for a total purchase price of $112.1 million. The Company expects to close on the remaining four properties in December 2017.

On November 1, 2017, the Company acquired a 26,345 square foot medical office building in Seattle, Washington for a purchase price of $12.7 million.


9

Table of Contents


2017 Dispositions
The following table details the Company's dispositions for the nine months ended September 30, 2017 (dollars in millions):
Location
Type (1)
 
Date
Disposed
 
Sales Price
 
Closing Adjustments
 
Net
Proceeds
 
Net Real
Estate
Investment
 
Other
(including
receivables)
(3)
 
Gain/(Impairment)
 
Square
Footage
Evansville, Indiana
OTH
 
3/6/17
 
$
6.4

 
$

 
$
6.4

 
$
1.1

 
$

 
$
5.3

 
29,500

Columbus, Georgia (2)
MOB
 
3/7/17
 
0.6

 

 
0.6

 
0.6

 

 

 
12,000

Las Vegas, Nevada (2)
MOB
 
3/30/17
 
5.5

 
(0.7
)
 
4.8

 
2.2

 
0.3

 
2.3

 
18,147

Texas (3 properties)
IRF
 
3/31/17
 
69.5

 
(1.6
)
 
67.9

 
46.9

 
5.2

 
15.8

 
169,722

Chicago, Illinois (2) (4)
MOB
 
6/16/17
 
0.5

 
(0.1
)
 
0.4

 
0.4

 

 

 
5,100

San Antonio, Texas (2)
IRF
 
6/29/17
 
14.5

 
(0.2
)
 
14.3

 
5.1

 
0.9

 
8.3

 
39,786

Roseburg, Oregon
MOB
 
6/29/17
 
23.2

 
(0.6
)
 
22.6

 
14.5

 
0.3

 
7.8

 
62,246

St. Louis, Missouri
MOB
 
9/7/17
 
2.5

 
(0.1
)
 
2.4

 
7.4

 
0.1

 
(5.1
)
 
79,980

Total dispositions
 
 
 
 
$
122.7

 
$
(3.3
)
 
$
119.4

 
$
78.2

 
$
6.8

 
$
34.4

 
416,481

______
(1)
OTH = other; MOB = medical office building; IRF = inpatient rehabilitation facility
(2)
Previously classified as held for sale.
(3)
Includes straight-line rent receivables, leasing commissions and lease inducements.
(4)
The Company recorded an impairment of approximately $0.3 million in the first quarter of 2017 upon management’s decision to sell. 

Potential Disposition
In October 2017, the Company received notice that a tenant is exercising a purchase option on seven buildings, including five medical office buildings. The seven properties are covered by one purchase option with a stated purchase price of approximately $45.2 million, subject to certain contractual adjustments. The buildings are located in Roanoke, Virginia, and the Company's aggregate net investment was approximately $24.0 million as of September 30, 2017. The closing is expected to occur in April 2018.


10

Table of Contents


Assets Held for Sale
At September 30, 2017 and December 31, 2016, the Company had one and two properties, respectively, classified as held for sale. During the nine months ended September 30, 2017, the Company reclassified four properties to held for sale and five properties were sold. A summary of each of the properties reclassified as held for sale is below:

a 78,731 square foot inpatient rehabilitation facility located in Pittsburgh, Pennsylvania reclassified to held for sale in connection with management's decision to sell the property;

a 39,786 square foot inpatient rehabilitation facility located in San Antonio, Texas reclassified to held for sale in connection with management's decision to sell the property. The Company sold this property in the second quarter of 2017 and recognized an $8.3 million gain on the disposition;

a 5,100 square foot medical office building located in Chicago, Illinois reclassified to held for sale in connection with management's decision to sell the property. In the first quarter of 2017, the Company recorded an impairment charge of $0.3 million. The Company sold this property in the second quarter of 2017 and recognized an immaterial impairment loss on the disposition; and

a 79,980 square foot medical office building located in St. Louis, Missouri reclassified to held for sale when the sale became probable based on the expiration of the due diligence period. The Company sold this property in the third quarter of 2017 and recognized a $5.1 million impairment on the disposition.

The table below reflects the assets and liabilities of the properties classified as held for sale and discontinued operations as of September 30, 2017 and December 31, 2016:
(Dollars in thousands)
September 30,
2017
 
December 31,
2016
Balance Sheet data:
 
 
 
Land
$
1,125

 
$
1,362

Buildings, improvements and lease intangibles
18,231

 
4,410

 
19,356

 
5,772

Accumulated depreciation
(10,657
)
 
(2,977
)
Real estate assets held for sale, net
8,699

 
2,795

Other assets, net (including receivables)
73

 
297

Assets held for sale and discontinued operations, net
$
8,772

 
$
3,092

 
 
 
 
Accounts payable and accrued liabilities
$
49

 
$
22

Other liabilities
10

 
592

Liabilities of properties held for sale and discontinued operations
$
59

 
$
614




11

Table of Contents



Discontinued Operations
The following table represents the results of operations of the properties included in discontinued operations on the Company's Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2017 and 2016.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Dollars in thousands)
2017
 
2016
 
2017
 
2016
Statements of Income data:
 
 
 
 
 
 
 
Revenues
 
 
 
 
 
 
 
Rental income
$

 
$

 
$

 
$

 

 

 

 

Expenses
 
 
 
 
 
 
 
Property operating
2

 
23

 
19

 
50

Bad debts, net of recoveries
(10
)
 

 
(10
)
 

 
(8
)
 
23

 
9

 
50

Other Income (Expense)
 
 
 
 
 
 
 
Interest and other income, net

 

 

 

 

 

 

 

Discontinued Operations
 
 
 
 
 
 
 
Income (Loss) from discontinued operations
8

 
(23
)
 
(9
)
 
(50
)
Gain on sales of real estate assets

 

 
5

 
7

Income (Loss) from Discontinued Operations
$
8

 
$
(23
)
 
$
(4
)
 
$
(43
)

Note 3. Notes and Bonds Payable
The table below details the Company’s notes and bonds payable. 
 
Maturity
Dates
 
Balance as of
 
Effective Interest Rate as of

(Dollars in thousands)
September 30, 2017

 
December 31, 2016

September 30, 2017

Unsecured Credit Facility
7/20
 
$

 
$
107,000

 
2.23
%
Unsecured Term Loan Facility, net of issuance costs
2/19
 
149,667

 
149,491

 
2.43
%
Senior Notes due 2021, net of discount and issuance costs
1/21
 
397,653

 
397,147

 
5.97
%
Senior Notes due 2023, net of discount and issuance costs
4/23
 
247,601

 
247,296

 
3.95
%
Senior Notes due 2025, net of discount and issuance costs
5/25
 
247,987

 
247,819

 
4.08
%
Mortgage notes payable, net of discounts and issuance costs and including premiums
1/18-5/40
 
123,152

 
115,617

 
5.06
%
 
 
 
$
1,166,060

 
$
1,264,370

 
 

Changes in Debt Structure
On May 1, 2017, the Company repaid in full a mortgage note payable bearing interest at a rate of 6.50% per annum with outstanding principal of $0.2 million. The mortgage note encumbered a 60,476 square foot medical office building located in Minnesota.
On June 13, 2017, in connection with the acquisition of a 62,379 square foot medical office property in Washington D.C., the Company assumed a $12.1 million mortgage note payable (excluding a fair value premium adjustment of $0.4 million). The mortgage note payable has a contractual interest rate of 4.69% per annum (effective rate of 4.27% per annum).

On September 28, 2017, the Company repaid in full a mortgage note payable bearing interest at a rate of 5.55% per annum with an outstanding principal of $1.3 million. The mortgage note encumbered a 75,000 square foot property in Tennessee.




12

Table of Contents


Subsequent Activity
On October 2, 2017, the Company repaid in full a mortgage note payable bearing interest at a rate of 5.53% per annum with an outstanding principal of $0.2 million. The mortgage note encumbered a 73,331 square foot property in Ohio.

On November 1, 2017, the Company redeemed $100.0 million of its unsecured senior notes due 2021 at a redemption price equal to an aggregate of $113.4 million, consisting of outstanding principal of $100.0 million, accrued interest of $1.7 million, and a "make-whole" amount of approximately $11.7 million for the early extinguishment of debt. The unaccreted discount and unamortized costs on these notes of $0.5 million was written off upon redemption. The Company will recognize a loss on early extinguishment of debt of approximately $12.2 million related to this redemption in the fourth quarter of 2017.


Note 4. Derivative Financial Instruments
Risk Management Objective of Using Derivatives
In addition to operational risks which arise in the normal course of business, the Company is exposed to economic risks such as interest rate, liquidity and credit risk. In certain situations, the Company may enter into derivative financial instruments such as interest rate swap and interest rate cap agreements to manage interest rate risk exposure arising from variable rate debt transactions that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company's objective in using interest rate derivatives is to manage its exposure to interest rate movements on its variable rate debt.

Cash Flow Hedges of Interest Rate Risk
Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without changing the underlying notional amount.

As of September 30, 2017, the Company did not have any outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk.
The effective portion of changes in the fair value of derivatives designated as, and that qualify as, cash flow hedges is recorded in accumulated other comprehensive income or loss (“OCI”) and is reclassified into earnings as interest expense in the period that the hedged forecasted transaction affects earnings. The effective portion of the Company’s prior interest rate swaps that was recorded in the accompanying Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2017 and 2016 respectively, was as follows:
(Dollars in thousands)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Amount of loss reclassified from accumulated OCI into Interest Expense (effective portion)
 
$
(43
)
 
$
(42
)
 
$
(127
)
 
$
(126
)

The Company estimates that an additional $0.2 million will be reclassified from accumulated other comprehensive loss as an increase to interest expense over the next 12 months.

Note 5. Commitments and Contingencies
Legal Proceedings
The Company is, from time to time, involved in litigation arising in the ordinary course of business. The Company is not aware of any pending or threatened litigation that, if resolved against the Company, would have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.


13

Table of Contents

Redevelopment Activity
The Company redeveloped a medical office building in Nashville, Tennessee, which included a 70,000 square foot expansion. During the nine months ended September 30, 2017, the Company funded approximately $12.2 million on the redevelopment of this property, including approximately $3.2 million related to overages on tenant improvement projects that have been or will be reimbursed by the tenant. The Company expects to spend an additional $0.4 million throughout the remainder of 2017.

In the third quarter of 2017, the Company began the redevelopment of a medical office building in Charlotte, North Carolina, which includes a 38,000 square foot vertical expansion. The total development budget is $12.0 million. During the three months ended September 30, 2017, the Company funded approximately $0.8 million on the redevelopment of this property. The project is expected to be completed in the first quarter of 2019.

Development Activity
The Company developed a 99,957 square foot medical office building in Denver, Colorado. The total development budget is $28.2 million, of which $25.2 million has been spent as of September 30, 2017, including approximately $2.6 million related to overages on tenant improvement projects that have been or will be reimbursed by the tenant. The Company received the certificate of substantial completion on the core and shell in the second quarter of 2017. Tenants began taking occupancy in the third quarter of 2017.
Note 6. Stockholders' Equity

Common Stock    
The following table provides a reconciliation of the beginning and ending shares of common stock outstanding for the nine months ended September 30, 2017 and the year ended December 31, 2016:
 
September 30, 2017
 
December 31, 2016
Balance, beginning of period
116,416,900

 
101,517,009

Issuance of common stock
8,386,035

 
14,063,100

Nonvested share-based awards, net of withheld shares
87,034

 
836,791

Balance, end of period
124,889,969

 
116,416,900


Common Stock Authorization
On May 2, 2017, the Company's shareholders approved an amendment to the Company's Articles of Incorporation to increase the number of authorized shares of common stock from 150,000,000 to 300,000,000.

Equity Offering
On August 14, 2017, the Company issued 8,337,500 shares of common stock, par value $0.01 per share, at $30.90 per share in an underwritten public offering pursuant to the Company's existing effective registration statement. The net proceeds of the offering, after underwriting discount and offering expenses, were approximately $247.1 million.

At-The-Market Equity Offering Program
No shares were sold under this program during the nine months ended September 30, 2017. The Company had 5,868,697 authorized shares remaining available to be sold under the current sales agreements as of October 27, 2017.

Common Stock Dividends
During the nine months ended September 30, 2017, the Company declared and paid common stock dividends totaling $0.90 per share. On October 31, 2017, the Company declared a quarterly common stock dividend in the amount of $0.30 per share payable on November 30, 2017 to stockholders of record on November 16, 2017.


14

Table of Contents


Accumulated Other Comprehensive Loss
The following table represents the changes in balances of each component and the amounts reclassified out of accumulated other comprehensive loss related to the Company during the nine months ended September 30, 2017 and 2016:
 
Forward-starting Interest Rate Swaps
 
(Dollars in thousands)
2017
 
2016
 
Beginning balance
$
(1,401
)
 
$
(1,569
)
 
Amounts reclassified from accumulated other comprehensive loss
127

 
126

 
Ending balance
$
(1,274
)
 
$
(1,443
)
 

Earnings Per Common Share
The Company uses the two-class method of computing net earnings per common shares. Nonvested share-based awards containing non-forfeitable rights to dividends are considered participating securities pursuant to the two-class method. The following table sets forth the computation of basic and diluted earnings per common share for the three and nine months ended September 30, 2017 and 2016.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Dollars in thousands, except per share data)
2017
 
2016
 
2017
 
2016
Weighted average Common Shares outstanding
 
 
 
 
 
 
 
Weighted average Common Shares outstanding
120,895,835

 
115,463,220

 
117,981,159

 
107,829,287

Nonvested shares
(1,797,686
)
 
(1,311,074
)
 
(1,800,180
)
 
(1,277,453
)
Weighted average Common Shares outstanding—Basic
119,098,149

 
114,152,146

 
116,180,979

 
106,551,834

Weighted average Common Shares outstanding—Basic
119,098,149

 
114,152,146

 
116,180,979

 
106,551,834

Dilutive effect of nonvested share-based awards

 
788,265

 

 
697,219

Dilutive effect of employee stock purchase plan
83,242

 
111,625

 
96,260

 
116,794

Weighted average Common Shares outstanding—Diluted
119,181,391

 
115,052,036

 
116,277,239

 
107,365,847

Net Income
 
 
 
 
 
 
 
Income from continuing operations
$
3,165

 
$
11,857

 
$
60,247

 
$
33,177

Dividends paid on nonvested share-based awards
(538
)
 

 
(1,609
)
 

Income from continuing operations applicable to common stockholders
2,627

 
11,857

 
58,638

 
33,177

Discontinued operations
8

 
(23
)
 
(4
)
 
(43
)
Net income applicable to common stockholders
$
2,635

 
$
11,834

 
$
58,634

 
$
33,134

Basic Earnings Per Common Share

 

 
 
 
 
Income from continuing operations
$
0.02

 
$
0.10

 
$
0.50

 
$
0.31

Discontinued operations
0.00

 
0.00

 
0.00

 
0.00

Net income
$
0.02

 
$
0.10

 
$
0.50

 
$
0.31

Diluted Earnings Per Common Share

 

 
 
 
 
Income from continuing operations
$
0.02

 
$
0.10

 
$
0.50

 
$
0.31

Discontinued operations
0.00

 
0.00

 
0.00

 
0.00

Net income
$
0.02

 
$
0.10

 
$
0.50

 
$
0.31



15

Table of Contents


Incentive Plans
A summary of the activity under the Company's stock-based incentive plans for the three and nine months ended September 30, 2017 and 2016 is included in the table below.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Stock-based awards, beginning of period
1,797,686

 
1,311,169

 
1,786,497

 
1,092,262

Granted

 

 
103,615

 
321,580

Vested

 
(96
)
 
(92,426
)
 
(102,769
)
Stock-based awards, end of period
1,797,686

 
1,311,073

 
1,797,686

 
1,311,073


During the nine months ended September 30, 2017 and 2016, the Company withheld 16,581 and 14,442 shares of common stock, respectively, from participants to pay estimated withholding taxes related to shares that vested. No such shares were withheld during the three months ended September 30, 2017 and 2016.

In addition to the stock-based incentive plans, the Company maintains the 2000 Employee Stock Purchase Plan (the "Purchase Plan"). A summary of the activity under the Purchase Plan for the three and nine months ended September 30, 2017 and 2016 is included in the table below.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Outstanding and exercisable, beginning of period
344,572

 
344,908

 
316,321

 
340,958

Granted

 

 
206,824

 
198,450

Exercised
(5,452
)
 
(13,947
)
 
(24,482
)
 
(51,475
)
Forfeited
(9,291
)
 
(3,561
)
 
(36,524
)
 
(17,451
)
Expired

 

 
(132,310
)
 
(143,082
)
Outstanding and exercisable, end of period
329,829

 
327,400

 
329,829

 
327,400


Note 7. Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practical to estimate that value.

Cash, cash equivalents and restricted cash - The carrying amount approximates fair value due to the short term maturity of these investments.

Borrowings under the unsecured credit facility due 2020 and unsecured term loan facility due 2019 - The carrying amount approximates fair value because the borrowings are based on variable market interest rates.

Senior Notes and Mortgage Notes payable - The fair value of notes and bonds payable is estimated using cash flow analyses, based on the Company’s current interest rates for similar types of borrowing arrangements.

The table below details the fair values and carrying values for notes and bonds payable at September 30, 2017 and December 31, 2016.
 
September 30, 2017
 
December 31, 2016
(Dollars in millions)
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
Notes and bonds payable (1)
$
1,166.1

 
$
1,169.4

 
$
1,264.4

 
$
1,265.1

______
(1)
Level 3 - Fair value derived from valuation techniques in which one or more significant inputs or significant value drivers is unobservable.




16

Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Disclosure Regarding Forward-Looking Statements
This report and other materials the Company has filed or may file with the Securities and Exchange Commission, as well as information included in oral statements or other written statements made, or to be made, by management of the Company, contain, or will contain, disclosures that are “forward-looking statements.” Forward-looking statements include all statements that do not relate solely to historical or current facts and can be identified by the use of words such as “may,” “will,” “expect,” “believe,” “anticipate,” “target,” “intend,” “plan,” “estimate,” “project,” “continue,” “should,” “could," "budget" and other comparable terms. These forward-looking statements are based on the current plans and expectations of management and are subject to a number of risks and uncertainties, including the risks described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, that could significantly affect the Company’s current plans and expectations and future financial condition and results.

The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Stockholders and investors are cautioned not to unduly rely on such forward-looking statements when evaluating the information presented in the Company’s filings and reports, including, without limitation, estimates and projections regarding the performance of development projects the Company is pursuing.

For a detailed discussion of the Company’s risk factors, please refer to the Company’s filings with the Securities and Exchange Commission, including its Annual Report on Form 10-K for the year ended December 31, 2016.

Liquidity and Capital Resources
Sources and Uses of Cash
The Company’s primary sources of cash include rent receipts from its real estate portfolio based on contractual arrangements with its tenants and sponsors, borrowings under the Company's unsecured credit facility due 2020, proceeds from the sales of real estate properties and proceeds from public or private debt or equity offerings.

The Company expects to continue to meet its liquidity needs, including funding additional investments, paying dividends, and funding debt service through cash on hand and restricted cash, cash flows from operations, and the cash flow sources described above. The Company had unencumbered real estate assets with a gross book value of approximately $3.3 billion at September 30, 2017, of which a portion could serve as collateral for secured mortgage financing. The Company believes that its liquidity and sources of capital are adequate to satisfy its cash requirements. The Company cannot, however, be certain that these sources of funds will be available at a time and upon terms acceptable to the Company in sufficient amounts to meet its liquidity needs.

Investing Activities
Cash flows provided by investing activities for the nine months ended September 30, 2017 were approximately $17.6 million. Below is a summary of the significant investing activities.
2017 Acquisitions
(Dollars in millions)
 
Health System Affiliation
 
Date
Acquired
 
Purchase Price

 
Mortgage
Notes Payable Assumed

 
Square
Footage

 
Hospital Campus Location
St. Paul, Minnesota
 
Fairview Health
 
3/6/17
 
$
13.5

 
$

 
34,608

 
On
San Francisco, California
 
Sutter Health
 
6/12/17
 
26.8

 

 
75,649

 
On
Washington, D.C.
 
Trinity Health
 
6/13/17
 
24.0

 
(12.1
)
 
62,379

 
On
Los Angeles, California
 
HCA
 
7/31/17
 
16.3

 

 
42,780

 
On
Total acquisitions
 
 
 
 
 
$
80.6

 
$
(12.1
)
 
215,416

 
 


17

Table of Contents


2017 Dispositions
(Dollars in millions)
 
Date Disposed
 
Sales Price
 
Square Footage
 
Property Type (1)
Evansville, Indiana
 
3/6/17
 
$
6.4

 
29,500

 
OTH
Columbus, Georgia (2)
 
3/7/17
 
0.6

 
12,000

 
MOB
Las Vegas, Nevada (2)
 
3/30/17
 
5.5

 
18,147

 
MOB
Texas (3 properties)
 
3/31/17
 
69.5

 
169,722

 
IRF
Chicago, Illinois (2)
 
6/16/17
 
0.5

 
5,100

 
MOB
San Antonio, Texas (2)
 
6/29/17
 
14.5

 
39,786

 
IRF
Roseburg, Oregon
 
6/29/17
 
23.2

 
62,246

 
MOB
St. Louis, Missouri
 
9/7/17
 
2.5

 
79,980

 
MOB
Total dispositions
 
$
122.7

 
416,481

 
 
______
(1)
MOB = medical office building, IRF = inpatient rehabilitation hospital, OTH = other
(2)
Previously classified as held for sale.

Other items funded during the nine months ended September 30, 2017 include the following:
(Dollars in millions)
 
Nine Months Ended September 30, 2017

Re/development
 
$
28.3

1st generation tenant improvements & planned capital expenditures for acquisitions
 
4.2

2nd generation tenant improvements
 
13.4

Capital expenditures
 
12.4

Total capital funding
 
$
58.3


Subsequent Acquisitions
The Company is under contract to purchase eight medical office buildings in the Atlanta, Georgia market from Meadows & Ohly, LLC and its affiliates for a total purchase price of $193.8 million. On November 1, 2017, the Company acquired four of these properties totaling 288,880 square feet for a total purchase price of $112.1 million. The Company expects to close on the remaining four properties in December 2017.

On November 1, 2017, the Company acquired a 26,345 square foot medical office building in Seattle, Washington for a purchase price of $12.7 million.

Financing Activities
Cash flows provided by financing activities for the nine months ended September 30, 2017 were approximately $30.7 million. Inflows from equity related to the Company's common stock issuances, dividend reinvestment program and employee stock purchase plan totaled $248.4 million, net of issuance costs incurred. Aggregate cash outflows totaled approximately $217.7 million primarily associated with dividends paid to common stockholders and debt repayments. See Notes 3 and 6 to the Condensed Consolidated Financial Statements for more information about capital markets and financing activities.

Equity Offering
On August 14, 2017, the Company issued 8,337,500 shares of common stock, par value $0.01 per share, at $30.90 per share in an underwritten public offering pursuant to the Company's existing effective registration statement. The net proceeds of the offering, after underwriting and offering expenses, were approximately $247.1 million. The proceeds will be invested into acquisitions and the repayment of indebtedness.
 
Changes in Debt Structure
On May 1, 2017, the Company repaid in full a mortgage note payable bearing interest at a rate of 6.50% per annum with outstanding principal of $0.2 million. The mortgage note encumbered a 60,476 square foot medical office building located in Minnesota.

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On June 13, 2017, in connection with the acquisition of a 62,379 square foot medical office property in Washington, D.C., the Company assumed a $12.1 million mortgage note payable (excluding a fair value premium adjustment of $0.4 million). The mortgage note payable has a contractual interest rate of 4.69% per annum (effective rate of 4.27% per annum).

On September 28, 2017, the Company repaid in full a mortgage note payable bearing interest at a rate of 5.55% per annum with an outstanding principal of $1.3 million. The mortgage note encumbered a 75,000 square foot property in Tennessee.

Subsequent Activity
On October 2, 2017, the Company repaid in full a mortgage note payable bearing interest at a rate of 5.53% per annum with an outstanding principal of $0.2 million. The mortgage note encumbered a 73,331 square foot property in Ohio.

On November 1, 2017, the Company redeemed $100.0 million of its unsecured senior notes due 2021 at a redemption price equal to an aggregate of $113.4 million, consisting of outstanding principal of $100.0 million, accrued interest of $1.7 million, and a "make-whole" amount of approximately $11.7 million for the early extinguishment of debt. The unaccreted discount and unamortized costs on these notes of $0.5 million was written off upon redemption. The Company will recognize a loss on early extinguishment of debt of approximately $12.2 million related to this redemption in the fourth quarter of 2017.

Operating Activities
Cash flows provided by operating activities increased from $102.4 million for the nine months ended September 30, 2016 to $129.4 million for the nine months ended September 30, 2017. Items impacting cash flows from operations include, but are not limited to, cash generated from property operations, interest payments and the timing related to the payment of invoices and other expenses and receipts of tenant rent.
The Company may, from time to time, sell additional properties and redeploy cash from property sales and mortgage repayments into new investments. To the extent revenues related to the properties being sold and the mortgages being repaid exceed income from these new investments, the Company's results of operations and cash flows could be adversely affected.

Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements that are reasonably likely to have a current or future material effect on the Company’s financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

New Accounting Pronouncements
See Note 1 to the Company's Condensed Consolidated Financial Statements accompanying this report for information on new accounting standards.

Trends and Matters Impacting Operating Results
Management monitors factors and trends important to the Company and the REIT industry to gauge the potential impact on the operations of the Company. In addition to the matters discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, below are some of the factors and trends that management believes may impact future operations of the Company.

Expiring Leases
The Company expects that approximately 15% to 20% of the leases in its multi-tenanted portfolio will expire each year in the ordinary course of business. There are 200 leases totaling 0.6 million square feet in the Company's multi-tenant portfolio that will expire during the remainder of 2017. Approximately 94% of the leases expiring in 2017 are located in buildings on or adjacent to hospital campuses, are distributed throughout the portfolio, and are not concentrated with any one tenant, health system or market area. The Company typically expects to retain 75% to 90% of multi-tenant property tenants upon expiration, and the retention ratio for the first nine months of the year has been within this range.

Five single-tenant net leases were to expire on December 31, 2017. The Company received notice that the tenant is exercising its option to purchase the buildings. The expected closing date is April 2018. The purchase option price is greater than the Company's net investment in the properties. See "Purchase Options" below.
Property Operating Agreement Expirations
Two of the Company’s owned real estate properties as of December 31, 2016 were subject to property operating agreements between the Company and a sponsoring health system. These agreements contractually obligate the sponsoring health system to provide to the Company a minimum return on the Company’s investment in the property in exchange for the right to be involved in the operating decisions of the property, including tenancy. If the minimum return is not achieved through normal

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operations of the property, the Company calculates and accrues to property lease guaranty revenue any shortfalls due from the sponsoring health systems under the terms of the property operating agreement. One agreement expired in January 2017, resulting in a decrease of $0.2 million per quarter in property lease guaranty revenue. The remaining agreement will expire in February 2019. The Company recognized $0.2 million of property lease guaranty revenue in the third quarter of 2017.

Operating Expenses
The Company has historically experienced increases in property taxes throughout its portfolio as a result of increasing assessments and tax rates levied across the country. The Company continues its efforts to appeal property tax increases and manage the impact of the increases. In addition, the Company has historically incurred variability in portfolio utilities expense based on seasonality, with the first and third quarters usually reflecting greater amounts. The effects of these operating expense increases are mitigated in leases that have provisions for operating expense reimbursement. As of September 30, 2017, leases for 85% of the Company's multi-tenant leased square footage allow for some recovery of operating expenses, with 54% allowing recovery of all expenses.
Purchase Options
Additional information about the Company's unexercised purchase options (except as otherwise noted) and the amount and basis for determination of the purchase price is detailed in the table below (dollars in thousands):
 
 
 
 
Gross Real Estate Investment as of September 30, 2017
Year Exercisable
 
Number of Properties
 
Fair Market Value Method (1)

 
Non Fair Market Value Method (2)

 
Total

Current
 
4

 
$
94,973

 
$

 
$
94,973

Exercised option(3)
 
7

 

 
49,010

 
49,010

2018
 

 

 

 

2019
 
2

 
41,521

 

 
41,521

2020
 

 

 

 

2021
 
1

 

 
14,984

 
14,984

2022
 

 

 

 

2023
 

 

 

 

2024
 

 

 

 

2025
 
5

 
18,883

 
221,929

 
240,812

2026
 

 

 

 

2027 and thereafter
 
4

 
118,148

 

 
118,148

Total
 
23

 
$
273,525

 
$
285,923

 
$
559,448

_____
(1)
The purchase option price includes a fair market value component that is determined by an appraisal process.
(2)
Includes properties with stated purchase prices or prices based on fixed capitalization rates. These properties have purchase prices that are on average 13% greater than the Company's current gross investment.
(3)
In October 2017, the Company received notice that a tenant is exercising a purchase option on these seven properties, comprised of five single-tenant net leased buildings and two multi-tenant buildings, are covered by one purchase option with a stated purchase price of approximately $45.2 million, subject to certain contractual adjustments. The Company's aggregate net book value for these properties was $24.0 million at September 30, 2017. The Company recognized net operating income of approximately $4.7 million for the nine months ended September 30, 2017 from these properties. The closing is expected to occur in April 2018.

Non-GAAP Financial Measures and Key Performance Indicators
Management believes that net income, as defined by GAAP, is the most appropriate earnings measurement. However, management considers certain non-GAAP financial measures and key performance indicators to be useful supplemental measures of the Company's operating performance. A non-GAAP financial measure is generally defined as one that purports to measure historical or future financial performance, financial position or cash flows, but excludes or includes amounts that would not be so adjusted in the most comparable GAAP measure. Set forth below are descriptions of the non-GAAP financial measures and key performance indicators management considers relevant to the Company's business and useful to investors, as well as reconciliations of these measures to the most directly comparable GAAP financial measures.

The non-GAAP financial measures and key performance indicators presented herein are not necessarily identical to those presented by other real estate companies due to the fact that not all real estate companies use the same definitions. These measures should not be considered as alternatives to net income (determined in accordance with GAAP), as indicators of the Company's financial performance, or as alternatives to cash flow from operating activities (determined in accordance with GAAP) as measures of the Company's liquidity, nor are these measures necessarily indicative of sufficient cash flow to fund all of the Company's needs. Management believes that in order to facilitate a clear understanding of the Company's consolidated

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historical operating results, these measures should be examined in conjunction with net income as presented in the Condensed Consolidated Financial Statements and other financial data included elsewhere in this report.

Funds from Operations ("FFO"), Normalized FFO and Funds Available for Distribution ("FAD")
FFO and FFO per share are operating performance measures adopted by the National Association of Real Estate Investment Trusts (“NAREIT”). NAREIT defines FFO as the most commonly accepted and reported measure of a REIT’s operating performance equal to “net income (computed in accordance with GAAP), excluding gains (or losses) from sales of property, plus depreciation and amortization related to real estate properties, leasing commission amortization and after adjustments for unconsolidated partnerships and joint ventures.” The Company follows the NAREIT definition in calculating and presenting FFO and FFO per share.

Management believes FFO and FFO per share to be supplemental measures of a REIT’s performance because they provide an understanding of the operating performance of the Company’s properties without giving effect to certain significant non-cash items, primarily depreciation and amortization expense. Historical cost accounting for real estate assets in accordance with GAAP assumes that the value of real estate assets diminishes predictably over time. However, real estate values instead have historically risen or fallen with market conditions. The Company believes that by excluding the effect of depreciation, amortization and gains or losses from sales of real estate, all of which are based on historical costs and which may be of limited relevance in evaluating current performance, FFO and FFO per share can facilitate comparisons of operating performance between periods. The Company reports FFO and FFO per share because these measures are observed by management to also be the predominant measures used by the REIT industry and by industry analysts to evaluate REITs and because FFO per share is consistently reported, discussed, and compared by research analysts in their notes and publications about REITs. For these reasons, management has deemed it appropriate to disclose and discuss FFO and FFO per share. However, FFO 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. FFO should not be considered as an alternative to net income attributable to common stockholders as an indicator of the Company’s operating performance or as an alternative to cash flow from operating activities as a measure of liquidity.
In addition to FFO and FFO per share, the Company presents Normalized FFO, Normalized FFO per share, and funds available for distribution ("FAD"). Normalized FFO is presented by adding to FFO acquisition-related costs, acceleration of deferred financing costs, debt extinguishment costs and other Company-defined normalizing items to evaluate operating performance. FAD is presented by adding to Normalized FFO non-real estate depreciation and amortization, deferred financing fees amortization, share-based compensation expense and provision for bad debts, net; and subtracting maintenance capital expenditures, including second generation tenant improvements and leasing commissions paid and straight-line rent income, net of expense. The Company's definition of these terms may not be comparable to that of other real estate companies as they may have different methodologies for computing these amounts. Normalized FFO and FAD should not be considered as an alternative to net income as an indicator of the Company's financial performance or to cash flow from operating activities as an indicator of the Company's liquidity. Normalized FFO and FAD should be reviewed in connection with GAAP financial measures.


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The table below reconciles net income attributable to common stockholders to FFO, Normalized FFO and FAD for the three and nine months ended September 30, 2017 and 2016:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Amounts in thousands, except per share data)
2017
 
2016
 
2017
 
2016
Net Income
$
3,173

 
$
11,834

 
$
60,243

 
$
33,134

Gain on sales of properties
7

 

 
(39,525
)
 
(8
)
Impairments of real estate assets
5,059

 

 
5,387

 

Real estate depreciation and amortization
36,478

 
32,557

 
107,453

 
95,074

Total adjustments
41,544

 
32,557

 
73,315

 
95,066

Funds from Operations Attributable to Common Stockholders
$
44,717

 
$
44,391

 
$
133,558

 
$
128,200

Acquisition and pursuit costs (1)
507

 
649

 
1,878

 
2,499

Pension termination

 

 

 
4

Revaluation of awards upon retirement

 

 

 
89

Write-off of deferred financing costs upon amendment of line of credit facility

 
81

 

 
81

Normalized Funds from Operations Attributable to Common Stockholders
$
45,224

 
$
45,121

 
$
135,436

 
$
130,873

Non-real estate depreciation and amortization
1,388

 
1,386

 
4,112

 
4,136

Provision for bad debt, net
4

 
(47
)
 
175

 
(8
)
Straight-line rent, net
(1,156
)
 
(1,684
)
 
(4,374
)
 
(5,539
)
Stock-based compensation
2,429

 
1,851

 
7,496

 
5,560

Total non-cash items
2,665

 
1,506

 
7,409

 
4,149

2nd generation TI
(4,481
)
 
(6,013
)
 
(13,438
)
 
(15,774
)
Leasing commissions paid
(1,826
)
 
(1,514
)
 
(4,394
)
 
(4,179
)
Capital additions
(4,203
)
 
(5,088
)
 
(12,390
)
 
(12,839
)
Funds Available for Distribution
$
37,379

 
$
34,012

 
$
112,623

 
$
102,230

Funds from Operations per Common Share—Diluted
$
0.37

 
$
0.39

 
$
1.14

 
$
1.19

Normalized Funds from Operations per Common Share—Diluted
$
0.38

 
$
0.39

 
$
1.16

 
$
1.22

FFO weighted average common shares outstanding - diluted (2)
120,081

 
115,052

 
117,109

 
107,366

_____
(1)
Acquisition and pursuit costs include third party and travel costs related to the pursuit of acquisitions and developments. Beginning in 2017, FFO and FAD are normalized for all acquisition and pursuit costs. Prior to 2017, FFO and FAD were normalized for acquisition and pursuit costs associated with only those acquisitions that closed in the period. These changes were prompted by the Company's adoption of ASU 2017-01 which was effective January 1, 2017.
(2)
Diluted weighted average common shares outstanding for the three and nine months ended September 30, 2017 includes the dilutive effect of nonvested share-based awards outstanding of 899,733 and 831,647, respectively.


Net Operating Income
Net operating income ("NOI") and same store NOI are non-GAAP historical financial measures of performance. Management considers same store NOI a supplemental performance measure because it allows investors, analysts and Company management to measure unlevered property-level operating results. The Company defines NOI as operating revenues (property operating revenue, single-tenant net lease revenue, and property lease guaranty revenue) less property operating expenses related specifically to the property portfolio. NOI excludes straight-line rent, general and administrative expenses, interest expense, depreciation and amortization, gains and losses from property sales, property management fees, amortization of non-cash items, lease termination fees and other revenues and expenses not specifically related to the property portfolio. Same store NOI is historical and not necessarily indicative of future results.


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The following table reflects the Company's same store NOI for the three months ended September 30, 2017 and 2016.
 
 
 
 
 
Same Store NOI for the
 
 
 
 
 
Three Months Ended September 30,
(Dollars in thousands)
Number of Properties 
 
Gross Investment at September 30, 2017
 
2017
 
2016
Multi-tenant Properties
138

 
$
2,547,282

 
$
46,266

 
$
44,143

Single-tenant Net Lease Properties
24

 
524,444

 
12,548

 
12,551

Total
162

 
$
3,071,726

 
$
58,814

 
$
56,694


Properties included in the same store analysis are stabilized properties that have been included in operations and were consistently reported as leased and stabilized properties for the duration of the year-over-year comparison period presented. Accordingly, properties that were recently acquired or disposed of, properties classified as held for sale, and properties in stabilization or conversion from stabilization are excluded from the same store analysis. In addition, the Company excludes properties that meet any of the following Company-defined criteria to be included in the reposition property group:

Properties having less than 60% occupancy that is expected to last at least two quarters;
Properties that experience a loss of occupancy over 30% in a single quarter;
Properties with negative net operating income that is expected to last at least two quarters; or
Condemnation.

Any recently acquired property will be included in the same store pool once the Company has owned the property for eight full quarters. Development properties will be included in the same store pool eight full quarters after substantial completion. Any property included in the reposition property group will be included in the same store analysis once occupancy has increased to 60% or greater with positive net operating income and has remained at that level for eight full quarters.

The following tables reconcile net income to same store NOI and the same store property count to the total owned real estate portfolio:
Reconciliation of Same Store NOI:
 
Three Months Ended September 30,
(Dollars in thousands)
2017
 
2016
Net income
$
3,173

 
$
11,834

(Income) loss from discontinued operations
(8
)
 
23

Income from continuing operations
3,165

 
11,857

Other income (expense)
18,747

 
13,636

General and administrative expense
8,021

 
7,859

Depreciation and amortization expense
35,873

 
31,985

Other expenses (1)
1,932

 
1,488

Straight-line rent revenue
(1,332
)
 
(1,223
)
Other revenue (2)
(1,353
)
 
(1,422
)
NOI
65,053

 
64,180

NOI not included in same store
(6,239
)
 
(7,486
)
Same store NOI
$
58,814

 
$
56,694

 
 
 
 
_____
(1)
Includes acquisition and pursuit costs, bad debt, above and below market ground lease intangible amortization, leasing commission amortization and ground lease straight-line rent.
(2)
Includes management fee income, storage income, interest, mortgage interest income, above and below market lease intangible amortization, lease inducement amortization, lease terminations and tenant improvement overage amortization.



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Reconciliation of Same Store Property Count:
 
Property Count as of September 30, 2017
Same Store Properties
162

Acquisitions
18

Development Conversion
2

Reposition
15

Total Owned Real Estate Properties
197


Results of Operations
Three Months Ended September 30, 2017 Compared to Three Months Ended September 30, 2016
The Company’s results of operations for the three months ended September 30, 2017 compared to the same period in 2016 were significantly impacted by acquisitions, developments, dispositions, gains, impairments recorded and capital markets transactions.

Revenues
Total revenues increased $3.3 million, or 3.2%, to approximately $107.0 million for the three months ended September 30, 2017 compared to $103.7 million in the prior year period and is comprised of the following:
 
Three Months Ended September 30,
 
Change
(Dollars in thousands)
2017
 
2016
 
$
 
%
Property operating
$
92,424

 
$
85,264

 
$
7,160

 
8.4
 %
Single-tenant net lease
12,805

 
16,047

 
(3,242
)
 
(20.2
)%
Straight-line rent
1,332

 
1,223

 
109

 
8.9
 %
Rental income
106,561

 
102,534

 
4,027

 
3.9
 %
Other operating
392

 
1,125

 
(733
)
 
(65.2
)%
Total Revenues
$
106,953

 
$
103,659

 
$
3,294

 
3.2
 %

Property operating revenue increased $7.2 million, or 8.4%, from the prior year period primarily as a result of the following activity:

Acquisitions and developments in 2016 and 2017 contributed $4.9 million.
Leasing activity including contractual rent increases contributed $3.8 million.
Dispositions in 2016 and 2017 resulted in a decrease of $1.5 million.

Single-tenant net lease revenue decreased $3.2 million, or 20.2%, from the prior year period primarily as a result of the following activity:

Dispositions in 2016 and 2017 resulted in a decrease of $2.9 million.
Reduction in lease revenue of $0.5 million upon tenant vacate and classification to held for sale.
An acquisition in 2017 resulted in an increase of $0.2 million.

Straight-line rent increased $0.1 million, or 8.9%, from the prior year period primarily as a result of the following activity:

Net leasing activity including contractual rent increases and the effects of rent abatements resulted in an increase of $0.1 million.
Dispositions in 2016 and 2017 resulted in a decrease of $0.2 million.
Acquisitions and developments in 2016 and 2017 resulted in an increase of $0.2 million.

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Other operating revenue decreased $0.7 million, or 65.2%, from the prior year period primarily as a result of the expiration of four property operating agreements in 2016 and 2017.

Expenses
Property operating expenses increased $3.1 million, or 8.3%, for the three months ended September 30, 2017 compared to the prior year period primarily as a result of the following activity:

Acquisitions and developments in 2016 and 2017 resulted in an increase of $2.1 million.
Increases in portfolio operating expenses as follows:
property tax of approximately $0.8 million;
maintenance and repair expense of approximately $0.8 million;
janitorial expense of approximately $0.2 million;
compensation-related expenses of approximately $0.1 million; and
other expense increases of $0.1 million.
Decrease in utilities expense of approximately $0.4 million.
Dispositions in 2016 and 2017 resulted in a decrease of $0.6 million.

General and administrative expenses increased approximately $0.2 million, or 2.1%, for the three months ended September 30, 2017 compared to the prior year period primarily as a result of the following activity:
Increase in performance-based compensation expense of $0.2 million.
Increase in payroll compensation of $0.1 million.
Decrease in professional fees and other administrative costs of $0.1 million.

Depreciation and amortization expense increased $3.9 million, or 12.2%, for the three months ended September 30, 2017 compared to the prior year period primarily as a result of the following activity:
Acquisitions and developments in 2016 and 2017 resulted in an increase of $3.0 million.
Various building and tenant improvement expenditures resulted in an increase of $3.3 million.
Dispositions in 2016 and 2017 resulted in a decrease of $1.6 million.
Assets that became fully depreciated resulted in a decrease of $0.8 million.

Other income (expense)
In the third quarter of 2017, the Company recorded an impairment of approximately $5.1 million on the sale of one property. There were no such transactions in the third quarter of 2016.
Interest expense increased $0.3 million for the three months ended September 30, 2017 compared to the prior year period. The components of interest expense are as follows:
 
Three Months Ended September 30,
 
Change
(Dollars in thousands)
2017
 
2016
 
$
 
%
Contractual interest
$
13,603

 
$
13,379

 
$
224

 
1.7
 %
Net discount/premium accretion
44

 
(33
)
 
77

 
(233.3
)%
Deferred financing costs amortization
615

 
748

 
(133
)
 
(17.8
)%
Interest rate swap amortization
42

 
42

 

 
 %
Interest cost capitalization
(197
)
 
(377
)
 
180

 
(47.7
)%
Total interest expense
$
14,107

 
$
13,759

 
$
348

 
2.5
 %

Contractual interest expense increased $0.2 million primarily due to an increase in the Unsecured Term Loan interest rate resulting in an increase of approximately $0.3 million and mortgage notes payable repayments resulting in a decrease of approximately $0.1 million.

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Results of Operations
Nine Months Ended September 30, 2017 Compared to Nine Months Ended September 30, 2016
The Company’s results of operations for the nine months ended September 30, 2017 compared to the same period in 2016 were significantly impacted by acquisitions, developments, dispositions, gains, impairments