Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Executive Overview
Business and Investment Strategy
We are a real estate investment trust (“REIT”) that invests in seniors housing and health care properties through sale-leasebacks, financing leases, mortgage financing, joint ventures and structured finance solutions including preferred equity and mezzanine lending. We seek to create, sustain and enhance stockholder equity value and provide current income for distribution to stockholders through real estate investments in seniors housing and health care properties managed by experienced operators. Our primary seniors housing and health care property classifications include skilled nursing facilities (“SNF”), assisted living facilities (“ALF”), independent living facilities (“ILF”), memory care communities (“MC”) and combinations thereof. We also invest in other (“OTH”) types of properties, such as land parcels, projects under development (“UDP”) and behavioral health care hospitals. To meet these objectives, we attempt to invest in properties that provide opportunity for additional value and current returns to our stockholders and diversify our investment portfolio by geographic location, operator, property classification and form of investment.
We conduct and manage our business as one operating segment for internal reporting and internal decision-making purposes. For purposes of this Annual Report on Form 10-K and other presentations, we generally include ALF, ILF, and MC in the ALF property classification. We have been operating since August 1992.
The following graph summarizes our gross investments as of December 31, 2022:
Substantially all of our revenues and sources of cash flows from operations are derived from operating lease rentals, interest earned on outstanding loans receivable and income from investments in unconsolidated joint ventures. Our investments in owned properties, financing leases, mortgage loans, mezzanine loans and preferred equity investments represent our primary source of liquidity to fund distributions and are dependent upon the performance of the operators on their lease and loan obligations and the rates earned thereon. To the extent that the operators experience operating difficulties and are unable to generate sufficient cash to make payments to us, there could be a material adverse impact on our consolidated results of operations, liquidity and/or financial condition. To mitigate this risk, we monitor our investments through a variety of methods determined by property type and operator. Our monitoring process
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includes periodic review of financial statements for each facility, periodic review of operator credit, scheduled property inspections and review of covenant compliance.
In addition to our monitoring and research efforts, we also structure our investments to help mitigate payment risk. Some operating leases, financing leases and loans are credit enhanced by guaranties and/or letters of credit. In addition, operating leases are typically structured as master leases and loans are generally cross-defaulted and cross-collateralized with other loans, operating leases or agreements between us and the operator and its affiliates.
Depending upon the availability and cost of external capital, we anticipate making additional investments in health care related properties. New investments are generally funded from cash on hand, temporary borrowings under our unsecured revolving line of credit and internally generated cash flows. Our investments generate internal cash from rent and interest receipts and principal payments on mortgage loans receivable. Permanent financing for future investments, which replaces funds drawn under our unsecured revolving line of credit, is expected to be provided through a combination of public and private offerings of debt and equity securities and secured and unsecured debt financing. The timing, source and amount of cash flows provided by financing activities and used in investing activities are sensitive to the capital markets’ environment, especially to changes in interest rates. Changes in the capital markets’ environment may impact the availability of cost-effective capital.
We believe our business model has enabled and will continue to enable us to maintain the integrity of our property investments, including in response to financial difficulties that may be experienced by operators. Traditionally, we have taken a conservative approach to managing our business, choosing to maintain liquidity and exercise patience until favorable investment opportunities arise.
COVID-19
On March 11, 2020, the World Health Organization declared the outbreak of coronavirus (“COVID-19”) as a pandemic, and on March 13, 2020, the United States declared a national emergency with regard to COVID-19. The COVID-19 pandemic has had repercussions across regional and global economies and financial markets. The outbreak of COVID-19 in many countries, including the United States, has significantly and adversely impacted public health and economic activity, and has contributed to significant volatility, dislocations and liquidity disruptions in financial markets.
The operations and occupancy levels at our properties have been adversely affected by COVID-19 and could be further adversely affected by COVID-19 or another pandemic especially if there are infections on a large scale at our properties. The impact of COVID-19 has included, and another pandemic could include, early resident move-outs, our operators delaying accepting new residents due to quarantines or admission suspensions, potential occupants postponing moves to our operators’ facilities, and/or hospitals cancelling or significantly reducing elective surgeries thereby there were fewer people in need of skilled nursing care. Additionally, as our operators have responded to the pandemic, operating costs have begun to rise. A decrease in occupancy, ability to collect rents from residents and/or increase in operating costs could have a material adverse effect on the ability of our operators to meet their financial and other contractual obligations to us, including the payment of rent or interest. In recognition of the pandemic impact affecting our operators, we provided assistance in form of rent abatements and rent deferrals and may continue to provide assistance as needed.
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Portfolio Overview
The following tables summarize our real estate investment portfolio as of December 31, 2022 (dollar amounts in thousands):
Twelve Months Ended
December 31, 2022
Number of Percentage Percentage
Number of SNF ALF Gross of Rental of Total
Number of Percentage Interest Income Percentage
Number of SNF ALF Gross of from Financing of Total
Number of Percentage Interest Income Percentage
Number of SNF ALF Gross of from Mortgage of Total
Number of Percentage Interest Percentage
Number of SNF ALF Gross of and other of Total
Skilled Nursing — — — 15,311 0.8 % 720 0.4 %
Number of Percentage Income from Percentage
Number of SNF ALF Gross of Unconsolidated of Total
Under Development — — — 13,000 0.7 % 1,054 0.7 %
Number Number of Percentage
of SNF ALF Gross of
Under Development — — — 13,000 0.7 %
(2) See Item 2. Properties for discussion of bed/unit count.
As of December 31, 2022, we had $1.6 billion in carrying value of net investments, consisting of $1.0 billion or 65.2% invested in owned and leased properties, $76.0 million or 4.9% invested in financing receivable, $0.4 billion or
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24.9% invested in mortgage loans secured by first mortgages, $58.4 million or 3.7% in notes receivable and $19.3 million or 1.3% in unconsolidated joint ventures.
Rental income, income from financing receivable and interest income from mortgage loans represented 73.2%, 1% and 23.2%, respectively, of Total revenues on the Consolidated Statements of Income for the year ended December 31, 2022. In most instances, our lease structure contains annual rental escalations. Our leases that contain fixed annual rental escalations and/or have annual rental escalations that are contingent upon changes in the Consumer Price Index or the Medicare Market Basket Rate, are generally recognized on a straight-line basis over the minimum lease period. Certain leases have annual rental escalations that are contingent upon changes in the gross operating revenues of the property. This revenue is not recognized until the appropriate contingencies have been resolved. For the year ended December 31, 2022, we recognized a $1.4 million straight-line rental adjustment reflecting higher cash rent received than recorded as rental income and $1.1 million in amortization and write-off of lease incentives. For the remaining leases in place at December 31, 2022, assuming no modification or replacement of existing leases and no new leased investments are added to our portfolio, except for the potential subsequent lease extensions and the leases reported below under Update on Certain Operators, we currently expect that the non-cash straight-line rent portion of rental income will decrease from negative $1.4 million in 2022 to negative $1.9 million for projected annual 2023 which represents higher cash rent received than recorded as rental income. Our cash rental income is projected to increase from $130.7 million in 2022 to $120.8 million for projected annual 2023. At December 31, 2022, the straight-line rent receivable balance on the consolidated balance sheet was $21.8 million.
Many of our existing leases contain renewal options that, if exercised, could result in the amount of rent payable upon renewal being greater or less than that currently being paid. During the year ended December 31, 2022, we renewed one lease covering a 99-bed skilled nursing center in Oregon and a master lease covering 11 skilled nursing centers in Texas with a total of 1,444 beds. See Update on Certain Operators and Former Operators below for discussion regarding renewal of a master lease subsequent to December 31, 2022.
Some of our lease agreements provide purchase options allowing the lessees to purchase the properties they currently lease from us. See Item 8. FINANCIAL STATEMENTS— Note 5. Real Estate Investments. Owned Properties for a table that includes information about purchase options included in our lease agreements.
Update on Certain Operators and Former Operators
Anthem Memory Care
Anthem Memory Care (“Anthem”) operates 11 memory care communities under a master lease and was placed in default in 2017 resulting from Anthem’s partial payment of its minimum rent. However, we did not enforce our rights and remedies pertaining to the event of default, under the stipulation that Anthem achieves sufficient performance and pays agreed upon rent. Anthem increased their rent payment every year between 2017 and 2021. During the second and third quarter of 2022, we agreed to a certain temporary rent reduction totaling $1.5 million. During the fourth quarter of 2022, we received payment of Anthem’s $1.5 million temporary rent reduction and a return to Anthem’s previously agreed upon rent of $0.9 million per month. Accordingly, Anthem paid us the agreed upon annual cash rent of $10.8 million in 2022. Anthem is current on agreed upon rent payments through January and February 2023. We receive regular financial performance updates from Anthem and continue to monitor their performance obligations under the master lease agreement.
Brookdale Senior Living Communities, Inc
The Brookdale master lease matures on December 31, 2023 and provides three renewal options consisting of a two-year renewal option, a five-year renewal option and a 10-year renewal option. The first renewal option expires on February 28, 2023. The master lease provides Brookdale a $4.0 million capital commitment, which matures on February 28, 2023, at a yield of 7% with a reduced rate for qualified ESG projects. During the fourth quarter of 2022, we funded $1.5 million under Brookdale’s capital commitment. Accordingly, we have a remaining commitment of $0.9 million. Brookdale is current on rent payments through January and February 2023.
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Other Operators
During the third quarter of 2022, we terminated a master lease with an operator and transitioned the communities to an existing LTC operator. In connection with the lease termination, we abated rent for June 2022 and have forgiven the former operator’s outstanding deferred rent balance of $7.1 million. Also, we paid the former operator a $0.5 million lease termination fee in exchange for cooperation and assistance in facilitating an orderly transition. The transitioned communities are operated pursuant to a new master lease with a two-year term, with zero rent for each of July, August, September, and October of 2022. Thereafter, cash rent is based on mutually agreed upon fair market rent. In conjunction with the new master lease, we paid the new operator a $0.4 million lease incentive payment which will be amortized as a yield adjustment to rental income over the two-year lease term. LTC is evaluating options for this portfolio.
A master lease covering two assisted living communities is scheduled to mature during 2023. One of the two communities is located in Kentucky. During the third quarter of 2022, we classified this community as held-for-sale and recorded an impairment loss of $1.3 million as a result of our decision to sell the community below our carrying value. We are negotiating a new lease for the other community which is located in Ohio.
Subsequent to December 31, 2022, a master lease covering two skilled nursing centers that was scheduled to mature in 2023 was renewed at the contractual rate for another five years extending the maturity to November 2028. The centers have a total 216 beds and are located in Florida.
Senior Care Centers, LLC – Former Operator
Senior Care Centers, LLC and affiliates and subsidiaries (“Senior Care”) filed for Chapter 11 bankruptcy in December 2018. During 2019, while in bankruptcy, Senior Care assumed LTC’s master lease and, in March 2020, Senior Care emerged from bankruptcy. Concurrent with their emergence from bankruptcy, in accordance with the order confirming Senior Care’s plan of reorganization, Abri Health Services, LLC (“Abri Health”) was formed as the parent company of reorganized Senior Care and became co-tenant and co-obligor with reorganized Senior Care under our master lease. In March 2021, Senior Care and Abri Health (collectively, “Lessee”) failed to pay rent and additional obligations owed under the master lease. Accordingly, we sent the lessee a notice of default and applied proceeds from letters of credit to certain obligations owed under the master lease. Furthermore, we sent the Lessee a notice of termination of the master lease to be effective April 17, 2021. On April 16, 2021, the Lessee filed for Chapter 11 bankruptcy. In August 2021, the United States Bankruptcy Court approved a settlement agreement between Lessee and LTC. The settlement provided for, among other things, a one-time payment of $3.3 million from LTC to the affiliates of Lessee in exchange for cooperation and assistance in facilitating an orderly transition of the 11 skilled nursing centers from the Lessee and its affiliates to affiliates of HMG Healthcare, LLC (“HMG”) which occurred on October 1, 2021. As of October 1, 2021, Senior Care and Abri Health no longer operate any properties in our portfolio.
Senior Lifestyle Corporation
During 2020, an affiliate of Senior Lifestyle (“Senior Lifestyle”) failed to pay its contractual obligations under its master lease. As a result, we applied their letter of credit and deposits to past due rent and to their outstanding notes receivable. Senior Lifestyle did not pay rent or its other obligations under the master lease since 2021. During 2021, we transitioned 18 assisted living communities previously leased to Senior Lifestyle to six operators. These communities are located in Illinois, Ohio, Wisconsin, Colorado, Pennsylvania and Nebraska. Also, during 2021, we sold three Wisconsin communities and a closed community in Nebraska previously leased to Senior Lifestyle for a combined total of $35.9 million. We received total proceeds of $34.8 million and recorded a net gain on sale of $5.4 million. During 2022, an assisted living community located in Colorado, which transitioned from Senior Lifestyle to a new operator during the first quarter of 2021, was closed and the lease was terminated. Additionally, during 2022, we transitioned the remaining community located in New Jersey under the Senior Lifestyle master lease to an existing operator. Accordingly, as of December 31, 2022, Senior Lifestyle does not operate any properties in our portfolio.
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2022 Transactions Overview
The following tables summarizes our transactions in 2022 (dollar amounts in thousand):
Investment in Owned Properties
Number Type Number Initial Total Total
of of of Cash Purchase Transaction Acquisition
Investment in Development and Improvement Projects
Developments Improvements
Assisted Living Communities $ 105 $ 5,538
Skilled Nursing Centers — 2,897
Other — 559
Sold Properties
Type Number Number
of of of Sales Carrying Net
n/a n/a — — — — 214 (3)
Financing Receivable
Financing Receivable. During 2022, we entered into a joint venture and contributed $61.7 million into the JV that purchased three skilled nursing centers located in Florida for $75.8 million. Our JV partner contributed the remaining $14.3 million of equity. The JV leased the centers back to an affiliate of the seller under a 10-year master lease, with two five-year renewal options and provided the seller-lessee with a purchase option, exercisable at the beginning of the fourth year through the end of the fifth year. Accordingly, the transaction has been accounted for as a Financing receivable on our Consolidated Balance Sheets. During 2022, we recognized $1.8 million of Interest income from financing receivable on our Consolidated Statements of Income. Additionally, we recorded $0.8 million provision for expected loan losses during 2022.
Subsequent to December 31, 2022, we entered into a $121.3 million JV with an affiliate of an existing operator
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and contributed $117.9 million into the JV that purchased 11 assisted living and memory care communities from an affiliate of our JV partner. The JV leased the communities back to an affiliate of the seller under a 10-year master lease, with two five-year renewal options. The contractual initial cash yield of 7.25% increases to 7.5% in year three then escalates thereafter based on CPI subject to a floor of 2.0% and a ceiling of 4.0%. Additionally, the JV provided the seller-lessee with a purchase option to buy up to 50% of the properties at the beginning of the third lease year and the remaining properties at the beginning of the fourth lease year through the end of the sixth lease year, with an exit Internal Rate of Return (“IRR”) of 9.0%. In accordance with GAAP, the communities acquired by the JV are required to be presented as a Financing receivable on our Consolidated Balance Sheets.
Investment in Mortgage Loans
Originations and funding under mortgage loans receivable $ 40,732 (1) (2)
Application of interest reserve 6,192
Scheduled principal payments received (1,175)
Mortgage loan premium amortization (6)
Provision for loan loss reserve (457)
Net increase in mortgage loans receivable $ 45,286
Investment in Notes Receivable
Advances under notes receivable $ 37,192 (1)
Principal payments received under notes receivable (2) (6,843)
Provision for credit losses (303)
Net increase in notes receivable $ 30,046
Key Performance Indicators, Trends and Uncertainties
We utilize several key performance indicators to evaluate the various aspects of our business. These indicators are discussed below and relate to concentration risk and credit strength. Management uses these key performance indicators to facilitate internal and external comparisons to our historical operating results in making operating decisions and for budget planning purposes.
Concentration Risk. We evaluate by gross real estate investment our concentration risk in terms of asset mix, real estate investment mix, operator mix and geographic mix. Concentration risk is valuable to understand what portion of our real estate investments could be at risk if certain sectors were to experience downturns. Asset mix measures the portion of our real estate investments that are real property or mortgage loans. Investment mix measures the portion of our investments that relate to our various property types. Operator mix measures the portion of our real estate investments that relate to our top five operators. Geographic mix measures the portion of our real estate investment that relate to our top five states.
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The following table reflects our recent historical trends of concentration risk (gross investment, in thousands):
Asset mix:
Financing receivable 76,767 76,267 — — —
Real estate investment mix:
Operator mix:
Geographic mix:
Credit Strength. We measure our credit strength both in terms of leverage ratios and coverage ratios. Our leverage ratios include debt to gross asset value and debt to market capitalization. The leverage ratios indicate how much of our Consolidated Balance Sheet capitalization is related to long-term obligations. Our coverage ratios include interest coverage ratio and fixed charge coverage ratio. The coverage ratios indicate our ability to service interest and fixed charges (interest). The coverage ratios are based on earnings before interest, taxes, depreciation and amortization for real estate (“EBITDAre”) as defined by National Association of Real Estate Investment Trusts (“NAREIT”). EBITDAre is calculated as net income available to common stockholders (computed in accordance with GAAP) excluding (i) interest expense, (ii) income tax expense, (iii) real estate depreciation and amortization, (iv) impairment write-downs of depreciable real estate, (v) gains or losses on the sale of depreciable real estate, and (vi) adjustments for unconsolidated partnerships and joint ventures. Adjusted EBITDAre is calculated as EBITDAre adjusted for non-recurring items. Leverage ratios and coverage ratios are widely used by investors, analysts and rating agencies in the valuation, comparison, rating and investment recommendations of companies. The following table reflects the recent historical trends for our credit strength measures:
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Balance Sheet Metrics
Year Ended Quarter Ended
Interest coverage ratio (7) 4.3 x 4.4 x (2) 4.2 x 4.3 x 4.4 x 4.3 x
Fixed charge coverage ratio (7) 4.3 x 4.4 x (2) 4.2 x 4.3 x 4.4 x 4.3 x
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Year to Date Quarter Ended
Add: Impairment loss 3,422 2,136 1,286 — — —
Interest coverage ratio 4.3 x 4.4 x 4.2 x 4.3 x 4.4 x 4.3 x
Fixed charge coverage ratio 4.3 x 4.4 x 4.2 x 4.3 x 4.4 x 4.3 x
We evaluate our key performance indicators in conjunction with current expectations to determine if historical trends are indicative of future results. Our expected results may not be achieved and actual results may differ materially from our expectations. This may be a result of various factors, including, but not limited to:
● The status of the economy;
● The status of capital markets, including prevailing interest rates;
● Changes in financing terms;
● Competition within the health care and seniors housing industries;
● Changes in federal, state and local legislation;
● The duration, spread and severity of the COVID-19 outbreak.
Management regularly monitors the economic and other factors listed above. We develop strategic and tactical plans designed to improve performance and maximize our competitive position. Our ability to achieve our financial objectives is dependent upon our ability to effectively execute these plans and to appropriately respond to emerging economic and company-specific trends.
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Operating Results
Year ended December 31, 2022 compared to year ended December 31, 2021 (in thousands):
Years ended December 31,
Revenues:
Interest income from financing receivable 1,762 — 1,762 (2)
Expenses:
Impairment loss 3,422 — (3,422) (7)
Provision for credit losses 1,528 1,021 (507) (8)
Other operating income:
Income from unconsolidated joint ventures 1,504 1,417 87
Income allocated to non-controlling interests (560) (363) (197)
Income allocated to participating securities (580) (458) (122)
Net income available to common stockholders $ 99,444 $ 55,403 $ 44,041
(6) Decreased due to property sales.
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Year ended December 31, 2021 compared to year ended December 31, 2020 (in thousands):
Years ended December 31,
Revenues:
Expenses:
Provision (recovery) for credit losses 1,021 (3) (1,024) (6)
Other operating income:
Gain from property insurance proceeds — 373 (11) (373)
Loss on unconsolidated joint ventures — (11) (758) (12) 758
Income from unconsolidated joint ventures 1,417 432 985 (13)
Income allocated to non-controlling interests (363) (384) 21
Net income attributable to LTC Properties, Inc. 55,861 95,293 (39,432)
Income allocated to participating securities (458) (422) (36)
Net income available to common stockholders $ 55,403 $ 94,871 $ (39,468)
(7) Increased due to Senior Care and Abri Health settlement and related fees.
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Funds From Operations
Funds from Operations (“FFO”) attributable to common stockholders, basic FFO attributable to common stockholders per share and diluted FFO attributable to common stockholders per share are supplemental measures of a REIT’s financial performance that are not defined by GAAP. Real estate values historically rise and fall with market conditions, but cost accounting for real estate assets in accordance with GAAP assumes that the value of real estate assets diminishes predictably over time. We believe that by excluding the effect of historical cost depreciation, which may be of limited relevance in evaluating current performance, FFO facilitates comparisons of operating performance between periods.
We use FFO as a supplemental performance measurement of our cash flow generated by operations. FFO does not represent cash generated from operating activities in accordance with GAAP, and is not necessarily indicative of cash available to fund cash needs and should not be considered an alternative to net income available to common stockholders.
We calculate and report FFO in accordance with the definition and interpretive guidelines issued by NAREIT. FFO, as defined by NAREIT, means net income available to common stockholders (computed in accordance with GAAP) excluding gains or losses on the sale of real estate and impairment write-downs of depreciable real estate plus real estate depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Our calculation of FFO may not be comparable to FFO reported by other REITs that do not define the term in accordance with the current NAREIT definition or that have a different interpretation of the current NAREIT definition from us; therefore, caution should be exercised when comparing our FFO to that of other REITs.
The following table reconciles net income available to common stockholders to FFO attributable to common stockholders (unaudited, amounts in thousands, except per share amounts):
For the Year Ended December 31,
GAAP net income available to common stockholders $ 99,444 $ 55,403 $ 94,871
Add: Impairment loss 3,422 — 3,977
Add: Loss on unconsolidated joint ventures — — 758
Less: Gain on sale of real estate, net (37,830) (7,462) (44,117)
NAREIT FFO attributable to common stockholders per share:
(1) Includes the effect of participating securities.
Critical Accounting Policies and Estimates
Our accounting policies are more fully described under Item 8. FINANCIAL STATEMENTS—Footnote 2. Summary of Significant Accounting Policies. As discussed in Footnote 2, the preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions about future events that affect the amounts reported in our consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Listed below are those policies and estimates that we believe are critical and require the use of significant judgement in their application.
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Impairment of Long-Lived Assets
Assets that are classified as held-for-use are periodically evaluated for impairment when events or changes in circumstances indicate that the asset may be impaired or the carrying amount of the asset may not be recoverable through future undiscounted cash flows. Where indicators of impairment exist, the estimation required in the undiscounted future cash flow assumption includes management’s probability-weighting of various scenarios such as modifying the lease with the existing operator, identifying a replacement operator or sale of the real property investment. In addition, the undiscounted future cashflows include management’s assumptions of rental revenues, net operating income, capitalization rates and expected hold periods. In determining fair value, we use current appraisals or other third-party opinions of value and other estimates of fair value such as estimated discounted future cash flows.
Collectability of operator obligations
We assess the collectability of substantially all our lease payments through maturity. If collectability is not probable, all or a portion of our straight-line rent receivables and other lease receivables may be written-off. In order to assess our lease payments for collectability, we make assumptions that include evaluating lessee’s payment history, the financial strength of the lessee, future market conditions and contractual rents, and timing of expected payments. Our ability to accurately predict collectability of substantially all of our lease payments impacts the timing of straight-line rent and other lease receivable write-offs, if any. While we believe our assumptions are reasonable, changes in these assumptions may have a material impact on our consolidated financial statements.
Liquidity and Capital Resources
Sources and Uses of Cash
As of December 31, 2022, we had a total of$10.4 million of cash and cash equivalents, $270.0 million available under our unsecured revolving line of credit and the potential ability to access the capital markets through the issuance of $130.6 million of common stock under our Equity Distribution Agreements. Furthermore, we have the ability to access the capital markets through the issuance of debt and/or equity securities under an automatic shelf registration statement.
We believe that our current cash balance, cash flow from operations available for distribution or reinvestment, our borrowing capacity and our potential ability to access the capital markets are sufficient to provide for payment of our current operating costs, meet debt obligations and pay common dividends at least sufficient to maintain our REIT status and repay borrowings at, or prior to, their maturity. The timing, source and amount of cash flows used by financing and investing activities are sensitive to the capital markets’ environment, especially to changes in interest rates. In addition, COVID-19 has adversely affected and is expected to continue to adversely affect our operators’ business, results of operations, cash flows and financial condition which could, in turn, adversely affect our financial position.
The operating results of the properties will be impacted by various factors over which the operators/owners may have no control. Those factors include, without limitation, the health of the economy, inflation pressures, employee availability and cost, changes in supply of or demand for competing seniors housing and health care facilities, ability to hire and maintain qualified staff, ability to control rising operating costs, the potential for significant reforms in the health care industry, and the ongoing impact of COVID-19. In addition, our future growth in net income and cash flow may be adversely impacted by various proposals for changes in the governmental regulations and financing of the health care industry, and the continuing impact of COVID-19 or the impact of any other infectious disease outbreaks. We cannot presently predict what impact these potential events may have, if any. We believe that adequate provision has been made for the possibility of loans proving uncollectable but we will continually evaluate the financial status of the operations of the seniors housing and health care properties. In addition, we will monitor our borrowers and the underlying collateral for mortgage loans and will make future revisions to the provision, if considered necessary.
Depending on our borrowing capacity, compliance with financial covenants, ability to access the capital markets, and the payment of dividends may be negatively impacted. We continuously evaluate the availability of cost-effective capital and believe we have sufficient liquidity for our current dividend, corporate expenses and additional capital investments in 2023.
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Our investments, principally our investments in owned properties, financing leases and mortgage loans, are subject to the possibility of loss of their carrying values as a result of changes in market prices, interest rates and inflationary expectations. The effects on interest rates may affect our costs of financing our operations and the fair market value of our financial assets. Generally, our leases have agreed upon annual increases and our loans have predetermined increases in interest rates. Inasmuch as we may initially fund some of our investments with variable interest rate debt, we would be at risk of net interest margin deterioration if medium and long-term rates were to increase.
Our primary sources of cash include rent and interest receipts, borrowings under our unsecured credit facility, public and private issuance of debt and equity securities, proceeds from investment dispositions and principal payments on loans receivable. Our primary uses of cash include dividend distributions, debt service payments (including principal and interest), real property investments (including acquisitions, capital expenditures and construction advances), loan advances and general and administrative expenses. These sources and uses of cash are reflected in our Consolidated Statements of Cash Flows as summarized below (in thousands):
Year Ended December 31, Change
Cash provided by (used in): 2022 2021 $
Cash and cash equivalents, beginning of period 5,161 7,772 (2,611)
Cash and cash equivalents, end of period $ 10,379 $ 5,161 $ 5,218
Debt Obligations
Unsecured Credit Facility. We had an unsecured credit agreement (the “Original Credit Agreement”) that provided for a revolving aggregate commitment of the lenders of up to $600.0 million with the opportunity to increase the commitment size of the credit agreement up to a total of $1.0 billion. The Original Credit Agreement’s maturity was on June 27, 2022 and provided for a one-year extension option at our discretion, subject to customary conditions.
In advance of expiration of the Original Credit Agreement, during the fourth quarter of 2021, we entered into the Third Amended and Restated Credit Agreement (the “Credit Agreement”) to replace the Original Credit Agreement. The Credit Agreement decreased the aggregate commitment of the lenders under the Original Credit Agreement to $500.0 million comprised of a $400.0 million revolving credit facility (the “Revolving Line of Credit”) and two $50.0 million term loans (the “Term Loans”). The Credit Agreement permits us to request increases to the Revolving Line of Credit and Term Loans commitments up to a total of $1.0 billion, extends the maturity of the Revolving Line of Credit to November 19, 2025 and provides for a one-year extension option at our discretion, subject to customary conditions. The Term Loans mature on November 19, 2025 and November 19, 2026. During the fourth quarter of 2022, we entered into the First Amendment to the Third Amended and Restated Credit Agreement (the “Amended Credit Agreement”) to replace London Interbank Offered Rate (“LIBOR”) with the Secured Overnight Financing Rate (“SOFR”), plus a credit spread adjustment of 10 basis points, (“Adjusted SOFR”) as the reference rate for purpose of calculating interest under the Amended Credit Agreement. Other material terms of the Credit Agreement remain unchanged. Based on our leverage at December 31, 2022, the Revolving Line of Credit provides for interest annually at Adjusted SOFR plus 115 points and a facility fee of 20 basis point and the Term Loans provide for interest annually at Adjusted SOFR plus 135 points.
Interest Rate Swap Agreement. In connection with entering into the Term Loans as discussed above, we entered into two receive variable/pay fixed interest rate swap agreements (“Interest Rate Swaps”) with maturities of November 19, 2025 and November 19, 2026, respectively, that will effectively lock-in the forecasted interest payments on the Term Loan borrowings over the four and five year terms of the loans. The Interest Rate Swaps are considered cash flow hedges and are recorded on our Consolidated Balance Sheets at fair value, with changes in the fair value of these instruments recognized in Accumulated other comprehensive income (loss) on our Consolidated Balance Sheets. In connection with entering into the Amended Credit Agreement discussed above, we entered into amendments to our Interest Rate Swaps to account for SOFR as the updated reference rate in the Amended Credit Agreement. During 2022 and 2021, we recorded a $8.9 million increase and $0.2 million decrease, respectively, in fair value of Interest Rate Swaps.
Senior Unsecured Notes. We have senior unsecured notes held by institutional investors with interest rates
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ranging from 3.66% to 5.03%. The senior unsecured notes mature between 2024 and 2033. During 2022, we sold $75.0 million aggregate principal amount of 3.66% senior unsecured notes. The notes have an average 10-year life, scheduled principal payments and mature in May 2033.
The debt obligations by component as of December 31, 2022 are as follows (dollar amounts in thousands):
Applicable Available
Interest Outstanding for
Debt Obligations Rate (1) Balance Borrowing
Term loans, net of debt issue costs 2.69% 99,511 —
Senior unsecured notes, net of debt issue costs (3) 4.25% 538,343 —
(1) Represents weighted average of interest rate as of December 31, 2022.
Our debt borrowings and repayments during the year ended December 31, 2022, are as follows (in thousands):
Debt Obligations Borrowings Repayments
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Equity
Non-controlling Interests. We have entered into partnerships to develop and/or own real estate. Given that our limited members do not have substantive kick-out rights, liquidation rights, or participation rights, we have concluded that the partnerships are VIEs. Since we exercise power over and receive benefits from the VIEs, we are considered the primary beneficiary. Accordingly, we consolidate the VIEs and record the non-controlling interests at cost. As of December 31, 2022, we have the following consolidated VIEs (in thousands):
Gross
Investment Property Consolidated Non-Controlling
Year (1) Purpose Type State Assets Interests
2018 Owned real estate and development ALF/MC OR 18,452 1,164
At December 31, 2022, we had 41,262,191 shares of common stock outstanding, equity on our balance sheet totaled $850.3 million and our equity securities had a market value of $1.5 billion. During the year ended December 31, 2022, we declared and paid $91.5 million of cash dividends.
Common Stock. We have separate equity distribution agreements (collectively, “Equity Distribution Agreements”) to offer and sell, from time to time, up to $200.0 million in aggregate offering price of our common shares. The Equity Distribution Agreements provide for sales of common shares to be made by means of ordinary brokers’ transactions, which may include block trades, or transactions that are deemed to be “at the market” offerings. During the year ended December 31, 2022, we sold 1,792,400 shares of common stock for $68.2 million in net proceeds under our Equity Distribution Agreements. In conjunction with the sale of common stock, we incurred $0.5 million costs associated with this agreement which have been recorded in additional paid in capital as a reduction of proceeds received. At December 31, 2022, we had $130.6 million available under our equity distribution agreement.
During 2022, we acquired 39,463 shares of common stock held by employees who tendered owned shares to satisfy tax withholding obligations. Subsequent to December 31, 2022, we declared a monthly cash dividend of $0.19 per share on our common stock for the months of January, February and March 2023, payable on January 31, February 28 and March 31, 2023, respectively, to stockholders of record on January 23, February 17, and March 23, 2023, respectively.
Stock Based Compensation Plans. During 2021, we adopted, and our shareholders approved the 2021 Equity Participation Plan (the “2021 Plan”) which replaces the 2015 Equity Participation Plan (the “2015 Plan”). Under the 2021 Plan, 1,900,000 shares of common stock have been authorized and reserved for awards, less one share for every one share that was subject to an award granted under the 2015 Plan after December 31, 2020 and prior to adoption. In addition, any shares that are not issued under outstanding awards under the 2015 Plan because the shares were forfeited
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or cancelled after December 31, 2020 will be added to and again be available for awards under the 2021 Plan. Under the 2021 Plan, the shares were authorized and reserved for awards to officers, employees, non-employee directors and consultants. The terms of the awards granted under the 2021 Plan and the 2015 Plan are set by our compensation committee at its discretion.
Restricted Stock and Performance-based Stock Units. During 2022, we granted 221,542 shares of restricted common stock and performance-based stock units under the 2021 Plan as follows:
No. of Price per
Shares Share Award Type Vesting Period
122,865 $ 33.94 Restricted stock ratably over 3 years
86,332 $ 33.94 Performance-based stock units TSR targets (1)
At December 31, 2022, the remaining compensation expense to be recognized related to the future service period of unvested outstanding restricted common stock and performance-based stock units are as follows (dollar amounts in thousands):
Remaining
Compensation
Vesting Date Expense
Stock Options. We did not issue any stock options during the year ended December 31, 2022. At December 31, 2022, we have 10,000 stock options outstanding and exercisable.
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Material Cash Requirements
We monitor our contractual obligations and commitments detailed above to ensure funds are available to meet obligations when due. The following table represents our long-term contractual obligations (scheduled principal payments and amounts due at maturity) as of December 31, 2022, excluding the effects of interest and debt issue costs (in thousands):
The following table represents our projected interest expense, excluding capitalized interest, amortization of debt issue costs and bank fees, as of December 31, 2022 (in thousands):
Also, see Item 8. FINANCIAL STATEMENTS— Note 11. Commitments and Contingencies for additional information regarding our contractual commitments.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks associated with changes in interest rates as they relate to our mortgage loans receivable and debt. Interest rate risk is sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors that are beyond our control.
We do not utilize forward or option contracts, or foreign currencies or commodities, or other types of derivative financial instruments, with exception of interest rate swaps, nor do we engage in “off-balance sheet” transactions. The purpose of the following disclosure is to provide a framework to understand our sensitivity to hypothetical changes in interest rates as of December 31, 2022.
Our future earnings, cash flows and estimated fair values relating to financial instruments are dependent upon prevalent market rates of interest, such as SOFR or term rates of U.S. Treasury Notes. Changes in interest rates generally impact the fair value, but not future earnings or cash flows, of mortgage loans receivable and fixed rate debt. Our mortgage loans receivable and debt, such as our senior unsecured notes, are primarily fixed-rate instruments. Also, we have two interest rate swap agreements to effectively lock-in the forecasted interest payments on our term loans which are based on SOFR. For variable rate debt, such as our revolving line of credit, changes in interest rates generally do not impact the fair value, but do affect future earnings and cash flows.
At December 31, 2022, the fair value of our financing receivable using a 7.6% discount rate was approximately $76.0 million. A 1% increase in such rate would decrease their estimated fair value by $1.9 million while a 1% decrease in such rate would increase their value by $2.0 million. At December 31, 2022, the fair value of our mortgage loans receivable using a 9.3% discount rate was approximately $461.3 million. A 1% increase in such rate would decrease the estimated fair value of our mortgage loans by approximately $30.8 million while a 1% decrease in such rate would
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increase their estimated fair value by approximately $35.1 million. At December 31, 2022, the fair value of our notes receivable using a 7.1% discount rate approximately $61.9 million. A 1% increase in such rate would decrease the estimated fair value of our notes receivable by approximately $1.7 million. while a 1% decrease in such rate would increase their estimated fair value by approximately $1.8 million. At December 31, 2022, the fair value of our senior unsecured notes using a 6.5% discount rate for those maturing before year 2030 and 7.0% discount rate for those maturing at or beyond year 2030 was approximately $477.7 million. A 1% increase in such rate would decrease the estimated fair value of our senior unsecured notes by approximately $19.7 million while a 1% decrease in such rate would increase their estimated fair value by approximately $21.0 million. These discount rates were measured based upon management’s estimates of rates currently prevailing for comparable loans available to us and instruments of comparable maturities.
The estimated impact of changes in interest rates discussed above are determined by considering the impact of the hypothetical interest rates on our borrowing costs, lending rates and current U.S. Treasury rates from which our financial instruments may be priced. We do not believe that future market rate risks related to our financial instruments will be material to our financial position or results of operations. These analyses do not consider the effects of industry specific events, changes in the real estate markets, or other overall economic activities that could increase or decrease the fair value of our financial instruments. If such events or changes were to occur, we would consider taking actions to mitigate and/or reduce any negative exposure to such changes. However, due to the uncertainty of the specific actions that would be taken and their possible effects, the sensitivity analysis assumes no changes in our capital structure.
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ITEM 8. FINANCIAL STATEMENTS
LTC Properties, Inc.
Index to Consolidated Financial Statements
and Financial Statements Schedules
Page
Report of Independent Registered Public Accounting Firm (PCAOB ID: 42) 54
Consolidated Balance Sheets as of December 31, 2022 and 2021 56
Notes to Consolidated Financial Statements 61
Consolidated Financial Statement Schedules
Schedule II—Valuation and Qualifying Accounts 89
Schedule III—Real Estate and Accumulated Depreciation 90
Schedule IV—Mortgage Loans on Real Estate 95
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and the Board of Directors of LTC Properties, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of LTC Properties, Inc. (the Company) as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2022, and the related notes and the financial statement schedules listed in the Index at Item 15(a) (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 16, 2023 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Impairment of Real Property Investments
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/s/ Ernst & Young LLP
We have served as the Company’s auditor since 1992.
Los Angeles, California
February 16, 2023
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LTC PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
December 31,
ASSETS
Investments:
Accumulated depreciation and amortization (389,182) (374,606)
Investments in unconsolidated joint ventures 19,340 19,340
Other assets:
Debt issue costs related to revolving line of credit 2,321 3,057
Prepaid expenses and other assets 11,099 4,191
LIABILITIES
Accrued expenses and other liabilities 32,708 33,234
EQUITY
Stockholders’ equity:
Accumulated other comprehensive income (loss) 8,719 (172)
Total LTC Properties, Inc. stockholders’ equity 828,367 736,714
See accompanying notes.
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LTC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
Year Ended December 31,
Revenues:
Interest income from financing receivable 1,762 — —
Expenses:
Impairment loss 3,422 — 3,977
Provision (recovery) for credit losses 1,528 1,021 (3)
Other operating income:
Gain from property insurance proceeds — — 373
Loss on unconsolidated joint ventures — — (758)
Income from unconsolidated joint ventures 1,504 1,417 432
Income allocated to non-controlling interests (560) (363) (384)
Income allocated to participating securities (580) (458) (422)
Net income available to common stockholders $ 99,444 $ 55,403 $ 94,871
Earnings per common share:
See accompanying notes.
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LTC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
Year Ended December 31,
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LTC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF EQUITY
(In thousands, except per share amounts)
Capital in Cumulative Total Non-
shares Amount Par Value Income OCI Distributions Equity Interests Equity
Issuance of restricted stock 101 1 (1) — — — — — —
Other — — (6) — — — (6) — (6)
Issuance of restricted stock 110 1 (1) — — — — — —
Other — — (70) — — — (70) — (70)
Issuance of restricted stock 135 1 (1) — — — — — —
Other — — (5) — — — (5) (2) (7)
See accompanying notes.
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LTC PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended December 31,
OPERATING ACTIVITIES:
Impairment loss 3,422 — 3,977
Loss on unconsolidated joint ventures — — 758
Income from unconsolidated joint ventures (1,504) (1,417) (432)
Income distributions from unconsolidated joint ventures 351 — 432
Straight-line rental adjustment (income) 1,369 (467) (1,778)
Amortization of lease incentives 877 608 426
Provision (recovery) for credit losses 1,528 1,021 (3)
Application of interest reserve (6,192) (150) —
Amortization of debt issue costs 1,139 1,122 1,029
Other non-cash items, net 113 — 4
Change in operating assets and liabilities
Lease incentives funded (418) (824) (220)
Increase in interest receivable (7,173) (6,776) (6,161)
Increase (decrease) in accrued interest payable 1,489 (471) (767)
Net change in other assets and liabilities 2,115 2,962 (2,021)
INVESTING ACTIVITIES:
Investment in real estate properties (51,817) — (13,581)
Investment in real estate developments (105) — (16,699)
Investment in real estate capital improvements (8,994) (6,298) (6,913)
Capitalized interest — — (354)
Investment in financing receivable (61,747) — —
Investments in unconsolidated joint ventures — (5,676) (8,520)
Principal payments received on notes receivable 6,843 2,694 5,275
FINANCING ACTIVITIES:
Borrowings from term loans — 100,000 —
Proceeds from issuance of senior unsecured notes 75,000 — —
Stock repurchase plan — — (18,012)
Proceeds from common stock issued 68,156 — —
Contribution from non-controlling interests 50 9 —
Distributions paid to non-controlling interests (487) (363) (463)
Other (6) (70) (6)
Increase (decrease) in cash and cash equivalents 5,218 (2,611) 3,528
Cash and cash equivalents, beginning of period 5,161 7,772 4,244
Cash and cash equivalents, end of period $ 10,379 $ 5,161 $ 7,772
Supplemental disclosure of cash flow information:
See accompanying notes.
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1. The Company
LTC Properties, Inc. (“LTC”), a Maryland corporation, commenced operations on August 25, 1992. LTC is a real estate investment trust (“REIT”) that invests primarily in seniors housing and health care properties primarily through sale-leasebacks, mortgage financing, joint ventures and structured finance solutions including preferred equity and mezzanine lending. We conduct and manage our business as one operating segment, rather than multiple operating segments, for internal reporting and internal decision-making purposes. Our primary objectives are to create, sustain and enhance stockholder equity value and provide current income for distribution to stockholders through real estate investments in seniors housing and health care properties managed by experienced operators. Our primary seniors housing and health care property classifications include skilled nursing centers (“SNF”), assisted living communities (“ALF”), independent living communities (“ILF”), memory care communities (“MC”) and combinations thereof. We also invest in other (“OTH”) types of properties, such as land parcels, projects under development (“UDP”) and behavioral health care hospitals. ILF, ALF, MC and combinations thereof are included in the ALF classification.
2. Summary of Significant Accounting Policies
Basis of Presentation. The accompanying consolidated financial statements include the accounts of LTC, our wholly-owned subsidiaries, and our consolidated companies. All intercompany investments, accounts and transactions have been eliminated.
Any reference to the number of properties or facilities, number of units, number of beds, number of operators, and yield on investments in real estate are unaudited and outside the scope of our independent registered public accounting firm’s audit of our consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board.
Consolidation. At inception, and on an ongoing basis, as circumstances indicate the need for reconsideration, we evaluate each legal entity that is not wholly-owned by us for consolidation, first under the variable interest entity (“VIE”), then under the voting model. Our evaluation considers all of our variable interests, including common or preferred equity ownership, loans, and other participating instruments. The variable interest model applies to entities that meet both of the following criteria:
If an entity does meet the above criteria and does not qualify for a scope exception from the VIE model, we will determine whether the entity is a VIE.
A legal entity is determined to be a VIE if it has any of the following three characteristics:
● The obligation to absorb the entity's expected losses;
● The right to receive the entity's expected residual returns; or
If any of the three characteristics of a VIE are met, we conclude that the entity is a VIE and evaluate it for consolidation under the variable interest model.
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If an entity is determined to be a VIE, we evaluate whether we are the primary beneficiary. The primary beneficiary analysis is a qualitative analysis based on power and benefits. We consolidate a VIE if we have both power and benefits - that is (i) we have the power to direct the activities of a VIE that most significantly impact the VIE's economic performance (power), and (ii) we have the obligation to absorb losses of the VIE that could potentially be significant to the VIE, or the right to receive benefits from the VIE that potentially could be significant to the VIE (benefits). If we have a variable interest in a VIE but we are not the primary beneficiary, we account for our investment using the equity method of accounting.
If a legal entity fails to meet any of the three of the characteristics of a VIE, we evaluate such entity under the voting interest model. Under the voting interest model, we consolidate the entity if we determine that we, directly or indirectly, have greater than 50% of the voting shares or if we are the general partner or managing member of the entity and the limited partners or non-managing members do not have substantive participating, liquidation, or kick-out rights.
The FASB requires the classification of non-controlling interests as a component of consolidated equity in the consolidated balance sheet subject to the provisions of the rules governing classification and measurement of redeemable securities. The guidance requires consolidated net income to be reported at the amounts attributable to both the controlling and non-controlling interests. The calculation of earnings per share will be based on income amounts attributable to the controlling interest.
Use of Estimates. Preparation of the consolidated financial statements in conformity with Generally Accepted Accounting Principles (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Our most significant assumptions and estimates are related to the valuation of real estate, purchase price allocation of acquired assets, revenue recognition including the collectability of tenant receivables and asset impairment.
Cash Equivalents. Cash equivalents consist of highly liquid investments with a maturity of three months or less when purchased and are stated at cost which approximates market.
Owned Properties. We make estimates as part of our allocation of the purchase price of acquisitions to the various components of the acquisition based upon the fair value of each component. In determining fair value, we use current appraisals or other third-party opinions of value. The most significant components of our allocations are typically the allocation of fair value to land and buildings and, for certain of our acquisitions, in-place leases and other intangible assets. In the case of the fair value of buildings and the allocation of value to land and other intangibles, the estimates of the values of these components will affect the amount of depreciation and amortization we record over the estimated useful life of the property acquired or the remaining lease term. In the case of the value of in-place leases, we make best estimates based on the 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. These assumptions affect the amount of future revenue that we will recognize over the remaining lease term for the acquired in-place leases. We evaluate each purchase transaction to determine whether the acquired assets meet the definition of an asset acquisition or a business combination. Transaction costs related to acquisitions that are not deemed to be business combinations are included in the cost basis of the acquired assets, while transaction costs related to acquisitions that are deemed to be business combinations are expensed as incurred.
We capitalize direct construction and development costs, including predevelopment costs, interest, property taxes, insurance and other costs directly related and essential to the acquisition, development or construction of a real estate asset. We capitalize construction and development costs while substantive activities are ongoing to prepare an asset for its intended use. We consider a construction project as substantially complete and held available for occupancy upon the issuance of the certificate of occupancy. Costs incurred after a project is substantially complete and ready for its intended use, or after development activities have ceased, are expensed as incurred. For redevelopment, renovation and expansion of existing operating properties, we capitalize the cost for the construction and improvement incurred in connection with the redevelopment, renovation and expansion. Costs previously capitalized related to abandoned acquisitions or developments are charged to earnings. Expenditures for repairs and maintenance are expensed as incurred.
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Depreciation is computed principally by the straight-line method for financial reporting purposes over the estimated useful lives of the assets, which range from 3 to 5 years for computers, 5 to 15 years for furniture and equipment, 35 to 50 years for buildings, 10 to 20 years for site improvements, 10 to 50 years for building improvements and the respective lease term for acquired lease intangibles.
Financing Receivable. As part of our acquisitions, we may from time to time, invest in sale and leaseback transactions. In accordance with ASC Topic 842, Leases (“ACS 842”), we are required to determine whether the sale and leaseback transaction qualifies as a sale. ASC 842 clarifies that an option for the seller-lessee to repurchase a real estate asset would generally preclude accounting for the transfer of the asset as a sale. Therefore, a sale and leaseback transaction of real estate that includes a seller-lessee repurchase option is accounted for as a failed sale and leaseback transaction. As a result, the purchased assets of a failed sale and leaseback transaction would be presented as a Financing receivable on our Consolidated Balance Sheets and the rental revenue from these properties is recorded as Interest income from financing receivable on our Consolidated Statements of Income. Furthermore, upon expiration of the purchase option if the purchase option remains unexercised by the seller-lessee, the purchased assets will be reclassified from Financing receivable to Real property investments on our Consolidated Balance Sheets.
Mortgage Loans Receivable, Net of Loan Loss Reserve. Mortgage loans receivable we originate are recorded on an amortized cost basis.
Working Capital Loans. Our investment in working capital loans consists of loan arrangements with interest ranging between 4% and 8% and maturities between 2023 and 2032.
Mezzanine Loans. Mezzanine financing sits between senior debt and common equity in the capital structure, and typically is used to finance development projects or value-add opportunities on existing operational properties. We seek market-based, risk-adjusted rates of return typically between 7-12% with the loan term typically four to five years. Security for mezzanine loans can include all or a portion of the following credit enhancements; secured second mortgage, pledge of equity interests and personal/corporate guarantees. Mezzanine loans are recorded for GAAP purposes as either a loan, under notes receivable, or joint venture (“JV”), under investment in unconsolidated JVs, depending upon specifics of the loan terms and related credit enhancements.
Investments in unconsolidated joint ventures. From time to time, we provide funding to third-party operators for the acquisition, development and construction (“ADC”) of a property. Under an ADC arrangement, we may participate in the residual profits of the project through the sale or refinancing of the property. These ADC arrangements can have characteristics similar to a loan or similar to a JV or partnership such as participating in the risks and rewards of the project as an owner or an investment partner. If the ADC arrangement characteristics are more similar to a jointly-owned investment or partnership, we account for the ADC arrangement as an investment in an unconsolidated JV under the equity method of accounting or a direct investment (consolidated basis of accounting) instead of applying loan accounting.
We evaluate our ADC arrangements first pursuant to Accounting Standard Codification (“ASC”) 810, Consolidation, to determine whether the ADC arrangement meets the definition of a VIE, as explained above, and whether we are the primary beneficiary. If the ADC arrangement is deemed to be a VIE but we are not the primary beneficiary, or if it is deemed to be a voting interest entity but we do not have a controlling financial interest, we account for our investment in the ADC arrangement using the equity method. Under the equity method, we initially record our investment at cost and subsequently recognize our share of net earnings or losses and other comprehensive income or loss, cash contributions made and distributions received, and other adjustments, as appropriate. Allocations of net income or loss may be subject to preferred returns or allocation formulas defined in operating agreements and may not be according to percentage ownership interests. In certain circumstances where we have a substantive profit-sharing arrangement which provides a priority return on our investment, a portion of our equity in earnings may consist of a change in our claim on the net assets of the underlying JV. Distributions of operating profit from the JVs are reported as part of operating cash flows, while distributions related to a capital transaction, such as a refinancing transaction or sale, are reported as investing activities. Currently we do not have any ADC arrangements.
We periodically perform evaluation of our investment in unconsolidated JVs to determine whether the fair
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value of each investment is less than the carrying value, and, if such decrease in value is deemed to be other-than-temporary, we write the investment down to its estimated fair value as of the measurement date.
Loan Loss Reserve. ASC 326, Financial Instruments- Credit Losses requires a forward looking “expected loss” model to be used for receivables, held-to-maturity debt, loans, and other instruments. When shared risk characteristics exist, ASC 326 requires a collective basis measurement of expected credit losses of the financial assets.
We adopted ASC 326 on January 1, 2020 and determined our Mortgage loans receivable and Notes receivable are within the scope of this ASU. We utilize the probability of default and discounted cash flow methods to estimate expected credit losses. Additionally, we stress-test the results to reflect the impact of unknown adverse future events including recessions. Upon adoption, we concluded that the adoption of ASC 326 did not have a material impact on our financial statements.
We elected not to measure an allowance for expected credit losses on accrued interest receivable under the expected credit loss standard as we have a policy in place to reserve or write off accrued interest receivable in a timely manner through our quarterly review of the loan and property performance. Therefore, we elected the policy to write off accrued interest receivable by reversing interest income and/or recognizing credit loss expense. As of December 31, 2022, the total balance of accrued interest receivable of $46,000,000 was not included in the measurement of expected credit loss. For the years ended December 31, 2022, 2021 and 2020, Company did not recognize any write-off related to accrued interest receivable.
Accrued incentives. As part of our acquisitions and/or amendments, we may commit to provide contingent payments to our sellers or lessees, upon the properties achieving certain rent coverage ratios. Typically, when the contingent incentive payments are funded, cash rent will increase by the amount funded multiplied by a rate stipulated in the agreement. If it is deemed probable, the contingent payment is recorded as a liability at the estimate fair value calculated using a discounted cash flow analysis and accreted to the settlement amount of the estimated payment date. If the contingent payment is provided to the lessee, the payment is recorded as a lease incentive included in the Prepaid expenses and otherassets line item in our Consolidated Balance Sheets and is amortized as a yield adjustment over the life of the lease. The fair value of these contingent liabilities is evaluated on a quarterly basis based on changes in estimates of future operating results and changes in market discount rates. This fair value measurement is based on significant inputs not observable in the market and thus represents a Level 3 measurement.
Impairments. Assets that are classified as held-for-use are periodically evaluated for impairment when events or changes in circumstances indicate that the asset may be impaired or the carrying amount of the asset may not be recoverable through future undiscounted cash flows. Where indicators of impairment exist, the estimation required in the undiscounted future cash flow assumption includes management’s probability-weighting of various scenarios
including whether the management modifies the lease with the existing operator versus identifying a replacement operator and the assumed market lease rate underlying projected future rental cash flows. In determining fair value, we use current appraisals or other third-party opinions of value and other estimates of fair value such as estimated discounted future cash flows. Based on our assessment, during the years ended December 31, 2022, 2021 and 2020, we recognized impairment losses of $3,422,000, $0 and $3,977,000, respectively, related to our real property investments.