Universal Health Realty Income Trust: Form 10-Q for the period ended Sep 30, 2024

Overview

We are a real estate investment trust (“REIT”) that commenced operations in 1986. We invest in healthcare and human-service related facilities currently including acute care hospitals, behavioral health care hospitals, specialty facilities, free-standing emergency departments, childcare centers and medical/office buildings. As of November 1, 2024, we have seventy-six real estate investments or commitments located in twenty-one states consisting of:

• six hospital facilities consisting of three acute care hospitals and three behavioral health care hospitals;
• four free-standing emergency departments (“FEDs”);
• sixty medical/office buildings, including four owned by unconsolidated limited liability companies (“LLCs”)/limited liability partnerships (“LPs”);
• four preschool and childcare centers;
• one specialty facility that is currently vacant, and;
• one vacant parcel of land located in Chicago, Illinois.

Forward Looking Statements and Certain Risk Factors

You should carefully review all of the information contained in this Quarterly Report, and should particularly consider any risk factors that we set forth in our Annual Report on Form 10-K for the year ended December 31, 2023, this Quarterly Report and in other reports or documents that we file from time to time with the Securities and Exchange Commission (the “SEC”). In this Quarterly Report, we state our beliefs of future events and of our future financial performance. This Quarterly Report contains “forward-looking statements” that reflect our current estimates, expectations and projections about our future results, performance, prospects and opportunities. Words such as “may,” “will,” “should,” “could,” “would,” “predicts,” “potential,” “continue,” “expects,” “anticipates,” “future,” “intends,” “plans,” “believes,” “estimates,” “appears,” “projects” and similar expressions, or the negative of those words and expressions, as well as statements in future tense, identify forward-looking statements. You should be aware that those statements are only our predictions. Actual events or results may differ materially. In evaluating those statements, you should specifically consider various factors, including the risks described elsewhere herein and in our Annual Report on Form 10-K for the year ended December 31, 2023 in Item 1A Risk Factors and in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Forward Looking Statements and Risk Factors and in Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Forward Looking Statements and Certain Risk Factors, as included herein. Those factors may cause our actual results to differ materially from any of our forward-looking statements.

Forward-looking statements should not be read as a guarantee of future performance or results and will not necessarily be accurate indications of the times at, or by which, such performance or results will be achieved. Forward-looking information is based on information available at the time and/or our good faith belief with respect to future events and is subject to risks and uncertainties that are difficult to predict and many of which are outside of our control. Many factors could cause actual performance or results to differ materially from those expressed in the statements. Such factors include, among other things, the following:

• The increase in interest rates has significantly increased our interest expense thereby reducing our net income, cash provided by operating activities and funds from operations, as well as unfavorably impacting our ability to access the capital markets on favorable terms. The increased interest rates on our borrowings and/or the increased costs related to new construction could also affect our ability to make additional attractive investments. The effects of increased interest rates on our borrowings, including the unfavorable impact on the terms of recent and future interest rate swap and/or cap agreements, could unfavorably impact our future rental revenue and expenses, including interest expense, and may potentially have a material unfavorable impact on our future net income, cash provided by operating activities, funds from operations, lease renewal terms, the underlying value of our properties, our ability to grow our portfolio, and the value of our common shares.
• Our tenants have experienced inflationary pressures, primarily in personnel and certain other costs. The extent of any future impacts from inflation on our tenants’ businesses and results of operations will be dependent upon how long the elevated inflation levels persist and the extent to which the rate of inflation further increases, if at all, neither of which we are able to predict. If elevated levels of inflation were to persist or if the rate of inflation were to accelerate, expenses of our tenants, and our direct operating expenses that are not passed on to our tenants, could increase faster than anticipated and may require utilization of our and our tenants’ capital resources sooner than expected. Further, given the complexities of the reimbursement landscape in which our tenants operate, their payers may be unwilling or unable to increase reimbursement rates to compensate for inflationary impacts. This may impact their ability and willingness to make rental payments.
• A substantial portion of our revenues are dependent upon one operator, UHS, which comprised approximately 40% and 41% of our consolidated revenues for the three-month periods ended September 30, 2024 and 2023, respectively, and approximately 41% for each of the nine-month periods ended September 30, 2024 and 2023. We cannot assure you that subsidiaries of UHS will renew the leases on the hospital facilities and free-standing emergency departments, upon the scheduled expirations of the existing lease terms. In addition, if subsidiaries of UHS exercise their options to purchase the respective leased hospital facilities and FEDs, and do not enter into a substitution arrangement upon expiration of the lease terms or otherwise, our future revenues and results of operations could decrease if we were unable to earn a favorable rate of return on the sale proceeds received, as compared to the rental revenue currently earned pursuant to these leases. Please see Note 2 to the condensed consolidated financial statements - Relationship with Universal Health Services, Inc. (“UHS”) and Related Party Transactions, for additional information related to a lease renewal between us and Wellington Regional Medical Center, a wholly-owned subsidiary of UHS.
• In the past, staffing shortages have, at times, required our tenants to hire expensive temporary personnel and/or enhance wages and benefits to recruit and retain nurses and other clinical staff and support personnel. Our tenants have also experienced general inflationary cost increases related to certain other operating expenses. Many of these factors, which had a material unfavorable impact on the operating results of certain of our tenants during 2022, moderated to a certain degree during 2023 and 2024.
• President Biden signed into law fiscal year 2025 appropriations to federal agencies for continuing projects and activities through December 20, 2024. We cannot predict whether or not there will be future legislation averting a federal government shutdown, however, the operating results and results of operations of certain of our tenants, and therefore potentially ours, could be materially unfavorably impacted by a federal government shutdown.
• In certain of our markets, the general real estate market has been unfavorably impacted by increased competition/capacity and decreases in occupancy and rental rates which may adversely impact our operating results and the underlying value of our properties.
• A number of legislative initiatives have recently been passed into law that may result in major changes in the health care delivery system on a national or state level to the operators of our facilities, including UHS. No assurances can be given that the implementation of these new laws will not have a material adverse effect on the business, financial condition or results of operations of our operators.
• A subsidiary of UHS is our Advisor and our officers are all employees of a wholly-owned subsidiary of UHS, which may create the potential for conflicts of interest.
• Potential unfavorable tax consequences and reduced income resulting from an inability to complete, within the statutory timeframes, anticipated tax deferred like-kind exchange transactions pursuant to Section 1031 of the Internal Revenue Code, if, and as, applicable from time-to-time.
• The potential unfavorable impact on our business of the deterioration in national, regional and local economic and business conditions, including a worsening of credit and/or capital market conditions, which may adversely affect our ability to obtain capital which may be required to fund the future growth of our business and refinance existing debt with near term maturities.
• A deterioration in general economic conditions which may result in increases in the number of people unemployed and/or insured and likely increase the number of individuals without health insurance. Under these circumstances, the operators of our facilities may experience declines in patient volumes which could result in decreased occupancy rates at our medical office buildings.
• A worsening of the economic and employment conditions in the United States would likely materially affect the business of our operators, including UHS, which would likely unfavorably impact our future bonus rental revenue (on one UHS hospital facility) and may potentially have a negative impact on the future lease renewal terms and the underlying value of the hospital properties.
• There is a heightened risk of future cybersecurity threats, including ransomware attacks targeting healthcare providers. If successful, future cyberattacks could have a material adverse effect on our business. Any costs that we, or our third-party property managers, incur as a result of a data security incident or breach, including costs to update security protocols to mitigate such an incident or breach could be significant. Any breach or failure in our, our third-party property managers', our tenants’, or our or their respective third-party service providers’ operational security systems, can result in loss of data or an unauthorized disclosure of or access to sensitive or confidential member or protected personal or health information and could result in violations of applicable privacy and other laws, significant penalties or fines, litigation, loss of customers, significant damage to our or their reputation and business, and other liability or losses. We may also incur additional costs related to cybersecurity risk management and remediation. There can be no assurance that we, our third-party property managers, our tenants or our or their service providers, if applicable, will not suffer losses relating to cyber-attacks or other

information security breaches in the future or that insurance coverage (if applicable) will be adequate to cover all the costs resulting from such events.

• The outcome and effects of known and unknown litigation, government investigations, and liabilities and other claims asserted against us, UHS or the other operators of our facilities. UHS and its subsidiaries are subject to legal actions, purported shareholder class actions and shareholder derivative cases, governmental investigations and regulatory actions and the effects of adverse publicity relating to such matters. Since UHS comprised approximately 40% and 41% of our consolidated revenues during the three and nine-months ended September 30, 2024, respectively, and since a subsidiary of UHS is our Advisor, you are encouraged to obtain and review the disclosures contained in the Legal Proceedings section of Universal Health Services, Inc.’s Forms 10-Q and 10-K, as publicly filed with the Securities and Exchange Commission. Those filings are the sole responsibility of UHS and are not incorporated by reference herein.
• Failure of UHS or the other operators of our hospital facilities to comply with governmental regulations related to the Medicare and Medicaid licensing and certification requirements could have a material adverse impact on our future revenues and the underlying value of the property.
• Real estate market factors, including without limitation, the supply and demand of office space and market rental rates, changes in interest rates as well as an increase in the development of medical office condominiums in certain markets.
• The impact of property values and results of operations of severe weather conditions, including the effects of hurricanes.
• Government regulations, including changes in the reimbursement levels under the Medicare and Medicaid programs.
• The issues facing the health care industry that affect the operators of our facilities, including UHS, such as: changes in, or the ability to comply with, existing laws and government regulations; unfavorable changes in the levels and terms of reimbursement by third party payers or government programs, including Medicare (including, but not limited to, the potential unfavorable impact of future reductions to Medicare reimbursements resulting from the Budget Control Act of 2011, as discussed in the next bullet point below) and Medicaid (most states have reported significant budget deficits that have, in the past, resulted in the reduction of Medicaid funding to the operators of our facilities, including UHS); demographic changes; the ability to enter into managed care provider agreements on acceptable terms; an increase in uninsured and self-pay patients which unfavorably impacts the collectability of patient accounts; decreasing in-patient admission trends; technological and pharmaceutical improvements that may increase the cost of providing, or reduce the demand for, health care, and; the ability to attract and retain qualified medical personnel, including physicians.
• The Budget Control Act of 2011 imposed annual spending limits for most federal agencies and programs aimed at reducing budget deficits including Medicare payment reductions of up to 2% per fiscal year. Current legislation extended those cuts through 2032. We cannot predict whether Congress will restructure the implemented Medicare payment reductions or what other federal budget deficit reduction initiatives may be proposed by Congress going forward. We also cannot predict the effect these enactments will have on the operators of our properties (including UHS), and thus, our business.
• An increasing number of legislative initiatives have been passed into law that may result in major changes in the health care delivery system on a national or state level. Legislation has already been enacted that has eliminated the penalty for failing to maintain health coverage that was part of the original Patient Protection and Affordable Care Act (the “ACA”). President Biden has undertaken executive actions that will strengthen the ACA. To date, the Biden administration has issued executive orders implementing a special enrollment period permitting individuals to enroll in health plans outside of the annual open enrollment period and reexamining policies that may undermine the ACA or the Medicaid program. The American Rescue Plan Act of 2021's expansion of subsidies to purchase coverage through an exchange, which the Inflation Reduction Act of 2022, passed on August 16, 2022, continues through 2025, is anticipated to increase exchange enrollment. It is also anticipated that these policies, to the extent that they remain as implemented, may create additional cost and reimbursement pressures on hospitals, including ours. In addition, while attempts to repeal the entirety of the ACA have not been successful to date, a key provision of the ACA was eliminated as part of the Tax Cuts and Jobs Act and on December 14, 2018, a federal U.S. District Court Judge in Texas ruled the entire ACA is unconstitutional. That ruling was ultimately appealed to the United States Supreme Court, which decided in California v. Texas that the plaintiffs in the matter lacked standing to bring their constitutionality claims. On September 7, 2022, the ACA faced its most recent challenge when a Texas Federal District Court judge, in the case of Braidwood Management v. Becerra, ruled that certain provisions violate the Appointments Clause of the U.S. Constitution and the Religious Freedom Restoration Act. The decision was appealed to the U.S. Court of Appeals for the Fifth Circuit, which on June 21, 2024 affirmed the District Court’s ruling regarding preventive services recommended by United States Preventive Services Task Force being unconstitutional. However, the Fifth Circuit overturned the nationwide injunction imposed by the District Court, preserving access to the majority of preventive services in dispute for now. The matter is expected to be the subject of additional litigation, having been remanded in part to the District Court. Any future efforts to challenge, replace or replace the ACA or expand or substantially amend its provision is unknown.
• There can be no assurance that if any of the announced or proposed changes described above are implemented there will not be negative financial impact on the operators of our hospitals, which material effects may include a potential decrease in the market for health care services or a decrease in the ability of the operators of our hospitals to receive reimbursement for health care services provided which could result in a material adverse effect on the financial condition or results of operations of the operators of our properties, and, thus, our business.
• Competition for properties include, but are not limited to, other REITs, private investors and firms, banks and other companies, including UHS. In addition, we may face competition from other REITs for our tenants.
• The operators of our facilities face competition from other health care providers, including physician owned facilities and other competing facilities, including certain facilities operated by UHS but the real property of which is not owned by us. Such competition is experienced in markets including, but not limited to, McAllen, Texas, the site of our McAllen Medical Center, a 370-bed acute care hospital.
• Changes in, or inadvertent violations of, tax laws and regulations and other factors that can affect REITs and our status as a REIT, including possible future changes to federal tax laws that could materially impact our ability to defer gains on divestitures through like-kind property exchanges.
• Should we be unable to comply with the strict income distribution requirements applicable to REITs, utilizing only cash generated by operating activities, we would be required to generate cash from other sources which could adversely affect our financial condition.
• We hold non-controlling equity interests in four LLCs/LPs, pursuant to the operating and/or partnership agreements of which, the third-party member and the Trust, at any time, potentially subject to certain conditions, have the right to make an offer (“Offering Member”) to the other member(s) (“Non-Offering Member”) in which it either agrees to: (i) sell the entire ownership interest of the Offering Member to the Non-Offering Member at a price as determined by the Offering Member (“Transfer Price”), or; (ii) purchase the entire ownership interest of the Non-Offering Member at the equivalent proportionate Transfer Price. The Non-Offering Member has 60 to 90 days to either: (i) purchase the entire ownership interest of the Offering Member at the Transfer Price, or; (ii) sell its entire ownership interest to the Offering Member at the equivalent proportionate Transfer Price. The closing of the transfer must occur within 60 to 90 days of the acceptance by the Non-Offering Member.
• Fluctuations in the value of our common stock, which, among other things could be affected by the current increasing interest rate environment.
• Our business, results of operations, financial condition, or stock price may be adversely affected if we are not able to achieve our environmental, social and governance (“ESG”) goals or comply with emerging ESG regulations, or otherwise meet the expectations of our stakeholders with respect to ESG matters.
• Other factors referenced herein or in our other filings with the Securities and Exchange Commission.

Given these uncertainties, risks and assumptions, you are cautioned not to place undue reliance on such forward-looking statements. Our actual results and financial condition, including the operating results of our lessees and the facilities leased to subsidiaries of UHS, could differ materially from those expressed in, or implied by, the forward-looking statements.

Forward-looking statements speak only as of the date the statements are made. We assume no obligation to publicly update any forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking information, except as may be required by law. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this cautionary statement.

Critical Accounting Policies and Estimates

There have been no significant changes to our critical accounting policies or estimates from those disclosed in our 2023 Annual Report on Form 10-K.

Results of Operations

During the three-month period ended September 30, 2024, net income was $4.0 million, as compared to $3.9 million during the third quarter of 2023. The $125,000 increase was attributable to:

• an increase of $451,000 resulting from an aggregate net increase in the income generated at various properties, and;
• a decrease of $326,000 resulting from an increase in interest expense due primarily to an increase in our average outstanding borrowings as well as a slight increase in our average borrowing rate.

During the nine-month period ended September 30, 2024, net income was $14.6 million, as compared to $11.8 million during the corresponding nine-month period of 2023. The $2.8 million increase was attributable to:

• an increase of $2.5 million resulting from an aggregate net increase in the income generated at various properties;
• an increase of $1.9 million resulting from a reduction in the expenses related to our property located in Chicago, Illinois, including $1.1 million from demolition expenses incurred during the first nine months of 2023, and $563,000 related to a property tax reduction recorded during the first nine months of 2024 which related primarily to prior periods, and;
• a decrease of $1.6 million resulting from an increase in interest expense due primarily to increases in our average borrowing rate as well as our average outstanding borrowings.

Revenues increased $271,000, or 1.1%, to $24.5 million during the three-month period ended September 30, 2024, as compared to $24.2 million during the three-month period ended September 30, 2023. The increase during the third quarter of 2024, as compared to the third quarter of 2023, was primarily due to an aggregate net increase generated at various properties, including the revenues generated at an MOB located in McAllen, Texas, that was acquired during the third quarter of 2023.

Revenues increased $3.1 million, or 4.4%, to $74.4 million during the nine-month period ended September 30, 2024, as compared to $71.3 million during the nine-month period ended September 30, 2023. The increase during the first nine months of 2024, as compared to the first nine months of 2023, was primarily due to an aggregate net increase generated at various properties, including the increased revenues generated at a newly constructed MOB located in Reno, Nevada, that opened during the first quarter of 2023, and the revenues generated at an MOB located in McAllen, Texas, that was acquired during the third quarter of 2023.

A large portion of the expenses associated with our consolidated medical office buildings is passed on directly to the tenants either directly as tenant reimbursements of common area maintenance expenses or included in base rental amounts. Tenant reimbursements for operating expenses are accrued as revenue in the same period the related expenses are incurred and are included as lease revenue in our condensed consolidated statements of income.

Other operating expenses amounted to $6.8 million during the third quarter of 2024 and $7.1 million during the third quarter of 2023. Included in our other operating expenses (excluding ground lease expenses) are expenses related to the consolidated medical office buildings which included two vacant properties during the third quarter of 2024 and three vacant properties during the third quarter of 2023 (the divestiture of one of these vacant properties was completed during the fourth quarter of 2023 and the demolition of one of these vacant properties was substantially completed during the second quarter of 2023). Other operating expenses amounted to $19.5 million and $20.0 million during the nine-month periods ended September 30, 2024 and 2023, respectively, (excluding $1.1 million of demolition expenses incurred during the first nine month of 2023). Our operating expenses during the nine-month period ended September 30, 2024 include a property tax reduction of approximately $563,000, which related primarily to prior periods, recorded in connection with our property located in Chicago, Illinois.

Funds from operations (“FFO”) is a widely recognized measure of performance for Real Estate Investment Trusts (“REITs”). We believe that FFO and FFO per diluted share, which are non-GAAP financial measures, are helpful to our investors as measures of our operating performance. We compute FFO in accordance with standards established by the National Association of Real Estate Investment Trusts (“NAREIT”), which may not be comparable to FFO reported by other REITs that do not compute FFO in accordance with the NAREIT definition, or that interpret the NAREIT definition differently than we interpret the definition. FFO adjusts for the effects of certain items, such as gains on transactions that occurred during the periods presented. To the extent a REIT recognizes a gain or loss with respect to the sale of incidental assets, the REIT has the option to exclude or include such gains and losses in the calculation of FFO. We have opted to exclude gains and losses from sales of incidental assets in our calculation of FFO, if and when applicable. FFO does not represent cash generated from operating activities in accordance with GAAP and should not be considered to be an alternative to net income determined in accordance with GAAP. In addition, FFO should not be used as: (i) an indication of our financial performance determined in accordance with GAAP; (ii) an alternative to cash flow from operating activities determined in accordance with GAAP; (iii) a measure of our liquidity, or; (iv) an indicator of funds available for our cash needs, including our ability to make cash distributions to shareholders.

Below is a reconciliation of our reported net income to FFO for the three and nine-month periods ended September 30, 2024 and 2023 (in thousands):

Our FFO increased $124,000 to $11.3 million during the third quarter of 2024, as compared to $11.2 million during the third quarter of 2023. The net increase was primarily due to the $125,000 increase in net income, as discussed above.

Our FFO increased $2.9 million to $36.1 million during the first nine months of 2024, as compared to $33.2 million during the first nine months of 2023. The net increase was primarily due to: (i) an increase in net income of $2.8 million, as discussed above, and; (ii) an increase in depreciation and amortization expense incurred by our consolidated and unconsolidated affiliates.

Other Operating Results

Interest Expense:

As reflected in the schedule below, interest expense was $4.8 million and $4.5 million during the three-month periods ended September 30, 2024 and 2023, respectively, and $13.9 million and $12.3 million during the nine-month periods ended September 30, 2024 and 2023, respectively (amounts in thousands):

(a.)Please see below in Quantitative and Qualitative Disclosures About Market Risk-Financial Instruments for disclosure regarding our various interest rate swap agreements. During the three and nine-month periods ended September 30, 2024 and 2023, net interest was paid to us from the counterparties pursuant to the interest rate swaps that were active during each period.

Interest expense increased by $326,000 during the three-month period ended September 30, 2024, as compared to the comparable period of 2023, due primarily to: (i) a $510,000 increase in the interest expense on our Credit Agreement primarily resulting from slight increases in our average cost of borrowings (6.93% average effective rate during the third quarter of 2024, as compared to 6.89% average effective rate during the comparable quarter of 2023) as well as increases in our average outstanding borrowings ($339.6 million during the three months ended September 30, 2024 as compared to $311.4 million in the comparable quarter of 2023); (ii) a $5,000 net increase in other combined interest expenses; (iii) a $27,000 increase due to a net decrease in interest rate swap income, partially offset by; (iv) a $216,000 decrease in mortgage interest expense (due primarily to repayment, utilizing borrowings under our Credit Agreement, of a $12.2 million fixed rate mortgage loan that matured during the second quarter of 2024).

Interest expense increased by $1.6 million during the nine-month period ended September 30, 2024, as compared to the comparable period of 2023, due primarily to: (i) a $2.5 million increase in the interest expense on our Credit Agreement primarily resulting from increases in our average cost of borrowings (6.94% average effective rate during the first nine months of 2024, as compared to 6.52% average effective rate during the comparable nine months of 2023) and in our average outstanding borrowings ($334.9 million during the nine months ended September 30, 2024 as compared to $305.4 million in the comparable nine-month period of 2023); (ii) a $149,000 increase due to a decrease in capitalized interest on a major project that was substantially completed during the first quarter of 2023; (iii) a $74,000 net increase in other combined interest expenses, partially offset by; (iv) a $615,000 favorable change in interest rate swap income, and; (v) a $527,000 decrease in mortgage interest expense (due primarily to repayment, utilizing borrowings under our Credit Agreement, of a $12.2 million fixed rate mortgage loan that matured during the second quarter of 2024).

Liquidity and Capital Resources

Net cash provided by operating activities

Net cash provided by operating activities was $33.8 million during the nine-month period ended September 30, 2024 as compared to $32.5 million during the comparable period of 2023. The $1.3 million net increase was attributable to:

• a favorable change of $3.0 million due to an increase in net income plus/minus the adjustments to reconcile net income to net cash provided by operating activities (depreciation and amortization, amortization related to above/below market leases, amortization of debt premium, amortization of deferred financing costs and stock-based compensation expense), as discussed above;
• an unfavorable change of $618,000 in accrued expenses and other liabilities;
• an unfavorable change of $488,000 in lease receivable;
• a favorable change of $289,000 in accrued interest;
• a favorable change of $270,000 in leasing costs paid;
• an unfavorable change of $222,000 in tenant reserves, deposits and deferred and prepaid rents, and;
• other combined net unfavorable changes of $1.0 million.

Net cash used in investing activities

Net cash used in investing activities was $11.2 million during the first nine months of 2024 as compared to $19.8 million during the first nine months of 2023.

During the nine-month period ended September 30, 2024 we funded: (i) $5.9 million in equity investments in unconsolidated LLCs, and; (ii) $6.0 million in additions to real estate investments, including tenant improvements at various MOBs. In addition, during the nine months ended September 30, 2024, we received $765,000 of cash in excess of income from LLCs.

During the nine-month period ended September 30, 2023 we funded: (i) $12.2 million in additions to real estate investments including construction costs related to the Sierra Medical Plaza I medical office building located in Reno, Nevada, that was substantially completed during the first quarter of 2023, as well as tenant improvements at various MOBs; (ii) $7.6 million, including transaction costs, on the August, 2023 acquisition of the McAllen Doctor's Center medical office building, as discussed in Note 4 to the consolidated financial statements–Acquisitions and Divestitures, and; (iii) $4.1 million in equity investments in unconsolidated LLCs. In addition, during the nine months ended September 30, 2023, we received: (i) $531,000 of cash in excess of income from LLCs, and; (ii) $3.5 million of repayments of an advance we had provided to an unconsolidated LLC during 2021.

Net cash used in financing activities

Net cash used in financing activities was $24.4 million during the nine months ended September 30, 2024, as compared to $11.9 million during the nine months ended September 30, 2023.

During the nine-month period ended September 30, 2024, we paid: (i) $13.2 million on mortgage notes payable that are non-recourse to us, including a $12.2 million repayment of a fixed rate mortgage loan that matured during the second quarter of 2024; (ii) $2.1 million of financing costs, primarily related to the second amendment to the Credit Agreement, as discussed herein, and; (iii) $30.2 million of dividends, including $85,000 of previously accrued dividends. Additionally, during the nine months ended September 30, 2024, we received: (i) $21.2 million of net borrowings pursuant to our Credit Agreement, and; (ii) $17,000 of net cash from the issuance of shares of beneficial interest.

During the nine-month period ended September 30, 2023, we paid: (i) $5.4 million on mortgage notes payable that are non-recourse to us, including a $4.2 million repayment of a fixed rate mortgage loan that matured during the first quarter of 2023; (ii) $222,000 of financing costs related to the first amendment to our Credit Agreement, and; (iii) $29.8 million of dividends, including $58,000 of previously accrued dividends. Additionally, during the nine months ended September 30, 2023, we received: (i) $23.4 million of net borrowings pursuant to our Credit Agreement, and; (ii) $118,000 of net cash from the issuance of shares of beneficial interest.

During the second quarter of 2024, we filed a shelf registration statement on Form S-3 (File No. 333-278730) (the “Form S-3”), registering the offer and sale, from time-to-time, of an indeterminate amount of the common shares of our beneficial interest, preferred shares and debt securities up to an aggregate initial offering price of $100 million to or through one or more underwriters, dealers or agents, or directly to purchasers. The Form S-3 became effective on April 30, 2024.

No shares were issued under the Form S-3 since the effective date of April 30, 2024 through September 30, 2024. As of September 30, 2024, we have paid or incurred approximately $297,000 in various fees and expenses related to the Form S-3. The availability of the potential liquidity under this shelf registration statement depends on investor demand, market conditions and other factors. We make no assurance regarding when, or if, we will issue any securities under this registration statement.

Additional cash flow and dividends paid information for the nine-month periods ended September 30, 2024 and 2023:

As indicated on our condensed consolidated statement of cash flows, we generated net cash provided by operating activities of $33.8 million and $32.5 million during the nine-month periods ended September 30, 2024 and 2023, respectively. As also indicated on our statement of cash flows, non-cash expenses including depreciation and amortization expense, amortization related to above/below market leases, amortization of debt premium, as applicable, amortization of deferred financing costs and stock-based compensation expense, as well as changes in certain assets and liabilities, are the primary differences between our net income and net cash provided by operating activities during each period.

We declared and paid dividends of $30.2 million and $29.8 million during the nine-month periods ended September 30, 2024 and 2023, respectively. During the first nine months of 2024, the $33.8 million of net cash provided by operating activities was approximately $3.5 million greater than the $30.2 million of dividends paid during the first nine months of 2024. During the first nine months of 2023, the $32.5 million of net cash provided by operating activities was approximately $2.7 million greater than the $29.8 million of dividends paid during the first nine months of 2023.

As indicated in the cash flows from investing activities and cash flows from financing activities sections of the statements of cash flows, there were various other sources and uses of cash during the nine months ended September 30, 2024 and 2023. From time to time, various other sources and uses of cash may include items such as investments and advances made to/from LLCs, additions to real estate investments, acquisitions/divestiture of properties, net borrowings/repayments of debt, and proceeds generated from the issuance of equity. Therefore, in any given period, the funding source for our dividend payments is not wholly dependent on the operating cash flow generated by our properties. Rather, our dividends as well as our capital reinvestments into our existing properties, acquisitions of real property and other investments are funded based upon the aggregate net cash inflows or outflows from all sources and uses of cash from the properties we own either in whole or through LLCs, as outlined above.

In determining and monitoring our dividend level on a quarterly basis, our management and Board of Trustees consider many factors in determining the amount of dividends to be paid each period. These considerations primarily include: (i) the minimum required amount of dividends to be paid in order to maintain our REIT status; (ii) the current and projected operating results of our properties, including those owned in LLCs, and; (iii) our future capital commitments and debt repayments, including those of our LLCs. Based upon the information discussed above, as well as consideration of projections and forecasts of our future operating cash flows, management and the Board of Trustees have determined that our operating cash flows have been sufficient to fund our dividend payments. Future dividend levels will be determined based upon the factors outlined above with consideration given to our projected future results of operations.

We expect to finance all capital expenditures and acquisitions and pay dividends utilizing internally generated and additional funds. Additional funds may be obtained through: (i) borrowings under our $425 million Credit Agreement (which had $77.2 million of available borrowing capacity, net of outstanding borrowings as of September 30, 2024); (ii) borrowings under or refinancing of existing third-party debt pursuant to mortgage loan agreements entered into by our consolidated and unconsolidated LLCs/LPs; (iii) the issuance of other long-term debt, and/or; (iv) the issuance of equity. In April, 2024 we filed a shelf registration statement on Form S-3 with the Securities and Exchange Commission pursuant to which we many offer up to $100 million of securities pursuant to supplemental prospectuses which we may file from time to time.

We believe that our operating cash flows, cash and cash equivalents, available borrowing capacity under our Credit Agreement and access to the capital markets provide us with sufficient capital resources to fund our operating, investing and financing requirements for the next twelve months, including providing sufficient capital to allow us to make distributions necessary to enable us to continue to qualify as a REIT under Sections 856 to 860 of the Internal Revenue Code of 1986. In the event we need to access the capital markets or other sources of financing, there can be no assurance that we will be able to obtain financing on acceptable terms or within an acceptable time. Our inability to obtain financing on terms acceptable to us could have a material unfavorable impact on our results of operations, financial condition and liquidity.

Credit facilities and mortgage debt

Management routinely monitors and analyzes the Trust’s capital structure in an effort to maintain the targeted balance among capital resources including the level of borrowings pursuant to our revolving credit facility, the level of borrowings pursuant to non-recourse mortgage debt secured by the real property of our properties and our level of equity including consideration of equity issuances. This ongoing analysis considers factors such as the current debt market and interest rate environment, the current/projected occupancy and financial performance of our properties, the current loan-to-value ratio of our properties, the Trust’s current stock price, the capital resources required for anticipated acquisitions and the expected capital to be generated by anticipated divestitures. This analysis, together with consideration of the Trust’s current borrowings outstanding under the credit agreement, non-recourse mortgage borrowings and equity, assists management in deciding which capital resource to utilize when events such as refinancing of specific debt components occur or additional funds are required to finance the Trust’s growth.

On September 30, 2024, we entered into a second amendment to our credit agreement, dated as of July, 2021, and amended in May, 2023, among the Trust as borrower, the lenders party thereto and Wells Fargo Bank, N.A., as administrative agent ("Credit Agreement"). Among other things, the second amendment provided for the following: (i) extended the maturity date to September 30, 2028 (from July, 2025 previously), and; (ii) increased the aggregate borrowing capacity under the credit facility to $425 million (from $375 million previously) comprised of a $125 million non-amortizing term loan ("Term Loan"), and a $300 million revolving loan commitment which includes a $40 million sublimit for letters of credit, and a $30 million sublimit for swingline/short-term loans. Under the terms of the Credit Agreement, we may request that the revolving line of credit and/or the Term Loan be increased by up to an additional aggregate amount of $50 million, and we have the option to extend the maturity date for up to two additional six-month periods. Borrowings under the new facility are guaranteed by certain subsidiaries of the Trust. In addition, borrowings under the new facility are secured by first priority security interests in and liens on all equity interests in most of the Trust’s wholly-owned subsidiaries.

On May 15, 2023, we entered into the first amendment to our Credit Agreement dated as of July 2, 2021. The amendment replaced LIBOR with term SOFR plus .10% (“Adjusted Term SOFR”) as an alternative benchmark rate under the Credit Agreement.

Borrowings under the Credit Agreement will bear interest at a rate equal to, at our option, the Adjusted Term SOFR for either one, three, or six months or the Base Rate, plus in either case, a specified margin depending on our total leverage ratio, as determined by the formula set forth in the Credit Agreement. The applicable margin after the second amendment ranges from 1.10% to 1.35% for SOFR revolving loans and 0.10% to 0.35% for Base Rate revolving loans. The applicable margin ranges from 1.20% to 1.65% for Adjusted Term SOFR loans and 0.20% to 0.65% for Base Rate term loans. The Credit Agreement, as amended by the second amendment, defines “Base Rate” as the greatest of (a) the Administrative Agent’s prime rate, (b) the federal funds effective rate plus 1/2 of 1%, and (c) one month Adjusted Term SOFR plus 1%. The Trust will also pay a quarterly facility fee on the $300 million revolving loan commitment ranging from 0.15% to 0.35% (depending on the Trust’s total leverage ratio).

The margins over Adjusted Term SOFR, Base Rate and the facility fee are based upon our total leverage ratio. At September 30, 2024, the applicable margin over the Adjusted Term SOFR rate for revolving loans was 1.20%, the margin over the Base Rate was 0.20% and the facility fee was 0.20%. At September 30, 2024, the applicable margin over the Adjusted Term SOFR rate for term loans was 1.35% and the margin over the Base Rate was .35%.

At September 30, 2024, we had $347.7 million of outstanding borrowings pursuant to the terms of our $425 million Credit Agreement and $77.2 million of available borrowing capacity. There are no compensating balance requirements. At December 31, 2023, we had $326.6 million of outstanding borrowings pursuant to the terms of our Credit Agreement in effect at that time, $3.1 million of outstanding letters of credit and $45.3 million of available borrowing capacity.

In our consolidated statements of cash flows, we report cash flows pursuant to our Credit Agreement on a net basis. Aggregate borrowings under our Credit Agreement were $17.2 million and $23.2 million during the quarters ended September 30, 2024 and 2023, respectively, and aggregate repayments were $12.4 million and $13.1 million during the quarters ended September 30, 2024 and 2023, respectively. Aggregate borrowings under our Credit Agreement were $64.2 million and $57.7 million during the nine-months ended September 30, 2024 and 2023, respectively, and aggregate repayments were $43.0 million and $34.3 million during the nine-months ended September 30, 2024 and 2023, respectively.

The Credit Agreement contains customary affirmative and negative covenants, including limitations on certain indebtedness, liens, acquisitions and other investments, fundamental changes, asset dispositions and dividends and other distributions. The Credit Agreement also contains restrictive covenants regarding the Trust’s ratio of total debt to total assets, the fixed charge coverage ratio, the ratio of total secured debt to total asset value, the ratio of total unsecured debt to total unencumbered asset value, and minimum tangible net worth, as well as customary events of default, the occurrence of which may trigger an acceleration of amounts then outstanding under the Credit Agreement. We are in compliance with all of the covenants in the Credit Agreement at September 30, 2024, and were in compliance with all of the covenants of the Credit Agreement at December 31, 2023. We also believe that we would remain in compliance if, based on the assumption that the majority of the potential new borrowings will be used to fund investments, the full amount of our commitment was borrowed.

The following table includes a summary of the required compliance ratios, giving effect to the covenants contained in the Credit Agreement (dollar amounts in thousands):

28

As indicated on the following table, we have various mortgages, all of which are non-recourse to us, included on our condensed consolidated balance sheet as of September 30, 2024 (amounts in thousands):

(a.)All mortgage loans require monthly principal payments through maturity and either fully amortize or include a balloon principal payment upon maturity.

(b.)This loan is scheduled to mature within the next twelve months, at which time we will either refinance pursuant to a new mortgage loan or repay the mortgage balance in full utilizing borrowings under our Credit Agreement.

On April 10, 2024, the $12.2 million fixed rate mortgage loan on Summerlin Hospital Medical Office Building III was fully repaid utilizing borrowings under our Credit Agreement.

At September 30, 2024 and December 31, 2023, we had various mortgages, all of which were non-recourse to us, included in our condensed consolidated balance sheet. The mortgages are secured by the real property of the buildings as well as property leases and rents. The mortgages outstanding as of September 30, 2024, had a combined carrying value of approximately $19.8 million and a combined fair value of approximately $18.4 million. The mortgages outstanding as of December 31, 2023, had a combined carrying value of approximately $33.1 million and a combined fair value of approximately $31.2 million. The fair value of our debt was computed based upon quotes received from financial institutions. We consider these to be “level 2” in the fair value hierarchy as outlined in the authoritative guidance for disclosure in connection with debt instruments. Changes in market rates on our fixed rate debt impacts the fair value of debt, but it has no impact on interest incurred or cash flow.

Off Balance Sheet Arrangements

As of September 30, 2024, we had off balance sheet arrangements consisting of certain equity and debt financing commitments. As a result of the first quarter, 2024 partial repayment of the Grayson Properties II construction loan, the associated $3.1 million letter of credit was cancelled. (See Note 5 to the condensed consolidated financial statements-Summarized Financial Information of Equity Affiliates). As of December 31, 2023, we had off balance sheet arrangements consisting of standby letters of credit and equity and debt financing commitments. Our outstanding letters of credit at December 31, 2023 totaled $3.1 million related to Grayson Properties II.

Acquisition and Divestiture Activity

Please see Note 4 to the condensed consolidated financial statements-Acquisitions and Divestitures.

Financial Instruments

Active Interest Rate Swap Agreements:

In October, 2024, we entered into an interest rate swap agreement on a total notional amount of $85 million with a fixed interest rate of 3.2725% that we designated as a cash flow hedge. The interest rate swap became effective on October 2, 2024 and is scheduled to mature on September 30, 2028. If one-month term SOFR is above 3.2725%, the counterparty pays us, and if one-month term SOFR is less than 3.2725%, we pay the counterparty, the difference between the fixed rate of 3.2725% and one-month term SOFR. This interest rate swap was entered into in replacement of two interest rate swap agreements, on an aggregate total notional amount of $85 million, that expired on September 16, 2024, as discussed below.

In December, 2023, we entered into an interest rate swap agreement on a total notional amount of $25 million with a fixed interest rate of 3.9495% that we designated as a cash flow hedge. The interest rate swap became effective on December 1, 2023 and is scheduled to mature on December 1, 2027. If one-month term SOFR is above 3.9495%, the counterparty pays us, and if one-month term SOFR is less than 3.9495%, we pay the counterparty, the difference between the fixed rate of 3.9495% and one-month term SOFR.

In March, 2020, we entered into an interest rate swap agreement on a total notional amount of $55 million with a fixed interest rate of 0.565% that we designated as a cash flow hedge. The interest rate swap became effective on March 25, 2020 and is scheduled to mature on March 25, 2027. On May 15, 2023, this interest rate swap agreement was modified to replace the benchmark rate from LIBOR to term SOFR. If one-month term SOFR is above 0.505%, the counterparty pays us, and if one-month term SOFR is less than 0.505%, we pay the counterparty, the difference between the fixed rate of 0.505% and one-month term SOFR.

Expired Interest Rate Swap Agreements in 2024:

On September 16, 2024, the following interest rate swap agreements, on an aggregate total notional amount of $85 million, expired on their maturity dates: (i) an interest rate swap on a total notional amount of $35 million, with a fixed interest rate of 1.4975%, that was effective since January, 2020, and; (ii) an interest rate swap on a total notional amount of $50 million, with a fixed interest rate of 1.144%, that was effective since September, 2019.

We measure our interest rate swaps at fair value on a recurring basis. The fair value of our interest rate swaps is based on quotes from third parties. We consider those inputs to be “level 2” in the fair value hierarchy as outlined in the authoritative guidance for disclosures in connection with derivative instruments and hedging activities. At September 30, 2024, the fair value of our interest rate swaps was a net asset of $3.3 million which is included in deferred charges and other assets on the accompanying condensed consolidated balance sheet. During the third quarter of 2024, we received approximately $1.5 million from the counterparty, adjusted for the previous quarter accrual, pursuant to the terms of the swaps. During the first nine months of 2024, we received approximately $4.8 million from the counterparty, adjusted for the previous quarter accrual, pursuant to the terms of the swaps. During the third quarter of 2023, we received approximately $1.6 million from the counterparty, adjusted for the previous quarter accrual, pursuant to the terms of the swaps. During the first nine months of 2023, we received approximately $4.3 million from the counterparty, adjusted for the previous quarter accrual, pursuant to the terms of the swaps. Cash flow hedges are accounted for by recording the fair value of the derivative instrument on the balance sheet as either an asset or a liability, with a corresponding amount recorded in accumulated other comprehensive income (“AOCI”) within shareholders’ equity. Amounts are reclassified from AOCI to the income statement in the period or periods the hedged transaction affects earnings. We do not expect any gains or losses on our interest rate swaps to be reclassified to earnings in the next twelve months.

The sensitivity analysis related to our fixed and variable rate debt assumes current market rates with all other variables held constant. As of September 30, 2024, the fair value and carrying value of our debt is approximately $366.0 million and $367.0 million, respectively. As of that date, the carrying value exceeds the fair value by approximately $1.0 million.

The table below presents information regarding our financial instruments that are sensitive to changes in interest rates. For debt obligations, the amounts of which are as of September 30, 2024, the table presents principal cash flows and related weighted average interest rates by contractual maturity dates.

(Dollars in thousands)

(a) Consists of non-recourse mortgage notes payable.

(b) Consists of $347.8 million of outstanding borrowings under the terms of our $425 million Credit Agreement which has a scheduled maturity date of September 30, 2028.

(c) Consists of: (i) an interest rate swap on a total notional amount of $55 million with a fixed interest rate of 0.565% that became effective on March 25, 2020 and is scheduled to mature on March 25, 2027, and; (ii) an interest rate swap on a total notional amount of $25 with a fixed interest rate of 3.9495% that became effective on December 1, 2023 and is scheduled to mature on December 1, 2027. On October 2, 2024, we entered into a new interest rate swap agreement (which is not reflected on the table above) on a total notional amount of $85 million with a fixed interest rate of 3.2725% that is scheduled to mature on September 30, 2028. This new interest rate swap agreement was entered into in replacement of two interest rate swap agreements, on an aggregate total notional amount of $85 million which expired on September 16, 2024, consisting of a $35 million notional amount with a fixed interest rate of 1.41%, and a $50 million notional amount with a fixed interest rate of 1.065%.

As calculated based upon our variable rate debt outstanding as of September 30, 2024 that is subject to interest rate fluctuations, and giving effect to the two interest rate swaps as reflected on the table above, each 1% change in interest rates would impact our net income by approximately $2.7 million. This impact does not give effect to the above-mentioned interest rate swap agreement entered into on October 2, 2024, on a total notional amount of $85 million with a fixed interest rate of 3.2725%.

As of September 30, 2024, under the supervision and with the participation of our management, including the Trust’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we performed an evaluation of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “1934 Act”).

Based on this evaluation, the CEO and CFO have concluded that our disclosure controls and procedures are effective to ensure that material information is recorded, processed, summarized and reported by management on a timely basis in order to comply with our disclosure obligations under the 1934 Act and the SEC rules thereunder.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting or in other factors during the third quarter of 2024 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Our Annual Report on Form 10-K for the year ended December 31, 2023 includes a listing of risk factors to be considered by investors in our securities. There have been no material changes in our risk factors from those set forth in our Annual Report on Form 10-K for the year ended December 31, 2023.