National Health Realty 10-Q 2004 Q2 Quarterly report

FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Quarterly Report Under Section 13 of 15(d)
of the Securities Exchange Act of 1934
For quarter ended June 30, 2004	Commission file number 333-37173
NATIONAL HEALTH REALTY, INC.
(Exact name of registrant as specified in its Charter)
Maryland	52-2059888
(State or other jurisdiction of incorporation or	(I.R.S. Employer Identification No.)
organization
100 Vine Street
Murfreesboro, TN	37130
(Address of principal	(Zip Code)
executive offices)
Registrant's telephone number, including area code (615) 890-2020
Indicate by check mark whether the registrant
(1)     Has filed all reports required to be filed by Section 13 or 15(d), of the Securities Exchange
Act of 1934 during the preceding 12 months.
Yes X	No
(2)     Has been subject to such filing requirements for the past 90 days.
Yes X	No
Indicate by check mark whether the registrant is an accelerated filer. Yes x No
5,595,588 shares of common stock were outstanding as of July 31, 2004.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.
NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
	June 30,	December 31,
	2004	2003
	(unaudited)
ASSETS
Real estate properties:
Land	$ 19,504	$ 19,504
Buildings and improvements	147,767	147,767
	167,271	167,271
Less accumulated depreciation	(43,323)	(40,340)
Real estate properties, net	123,948	126,931
Mortgage and other notes receivable	13,753	44,595
Interest and rent receivable	201	403
Cash and cash equivalents	5,860	4,982
Marketable securities	6,118	5,598
Deferred costs and other assets	253	369
Total Assets	$150,133	$182,878
LIABILITIES
Debt	$ 17,000	$ 47,820
Minority interest in consolidated subsidiaries	14,081	14,174
Accounts payable and other accrued expenses	1,306	1,311
Accrued interest	37	10
Dividends payable	3,191	4,723
Distributions payable to partners	404	598
Total Liabilities	36,019	68,636
Commitments, contingencies and guarantees
STOCKHOLDERS' EQUITY
Cumulative convertible preferred stock,
$.01 par value; 5,000,000 shares
authorized; none issued and outstanding	---	---
Common stock, $.01 par value;
75,000,000 shares authorized;
9,595,588 shares issued and outstanding	96	96
Capital in excess of par value of common stock	135,594	135,536
Cumulative net income	59,880	54,206
Cumulative dividends	(84,091)	(77,711)
Unrealized gains on marketable securities	2,635	2,115
Total Stockholders' Equity	114,114	114,242
Total Liabilities and Stockholders' Equity	$150,133	$182,878

The accompanying notes to interim condensed consolidated financial statements are an integral part of these financial statements.

The interim condensed balance sheet at December 31, 2003 is derived from the audited financial statements at that date.

NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
INTERIM CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
	Three Months Ended		Six Months Ended
	June 30,		June 30,
	2004	2003	2004	2003
	(in thousands,except share amounts)
REVENUES:
Rental income	$ 4,305	$ 4,244	$ 8,645	$ 8,602
Mortgage interest income	581	1,584	1,651	3,168
	4,886	5,828	10,296	11,770
EXPENSES:
Interest	172	1,085	500	2,134
Depreciation of real estate	1,492	1,589	2,983	3,179
Amortization of loan costs	---	119	8	235
General and administrative	430	213	619	416
	2,094	3,006	4,110	5,964
INCOME BEFORE MINORITY INTEREST
IN CONSOLIDATED SUBSIDIARIES
AND NON-OPERATING INCOME	2,792	2,822	6,186	5,806
NON-OPERATING INCOME (investment
and interest income)	103	106	205	210
MINORITY INTEREST IN
CONSOLIDATED SUBSIDIARIES	(325)	(329)	(717)	(676)
NET INCOME	$ 2,570	$ 2,599	$ 5,674	$ 5,340
NET INCOME PER COMMON SHARE:
Basic	$ .27	$ .27	$ .59	$ .56
Diluted	$ .26	$ .27	$ .58	$ .55
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING:
Basic	9,594,214	9,570,323	9,592,401	9,570,323
Diluted	9,793,784	9,744,245	9,803,939	9,738,749
Common dividends per share declared	$ .3325	$ .3325	$ .6650	$ .6650

The accompanying notes to interim condensed consolidated financial statements are an integral part of these financial statements.

NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
	Six Months Ended
	June 30,
	2004	2003
	(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$ 5,674	$ 5,340
Depreciation of real estate	2,983	3,179
Amortization of loan costs	8	235
Minority interest in consolidated subsidiaries	717	676
Decrease in interest and rent receivable	202	173
Increase (decrease) in other assets	39	(151)
Increase in accounts payable and accrued liabilities	22	261
NET CASH PROVIDED BY OPERATING ACTIVITIES	9,645	9,713
CASH FLOWS FROM INVESTING ACTIVITIES:
Disposal of property and equipment, net	---	25
Increase in deposit on real estate properties sold	---	750
Collection of mortgage notes receivable	30,842	1,345
Distribution from unconsolidated investment	67	---
NET CASH PROVIDED BY INVESTING ACTIVITIES	30,909	2,120
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt	17,000	---
Payments on long-term debt	(47,820)	(1,676)
Dividends paid to stockholders	(7,912)	(6,364)
Distributions paid to partners	(1,002)	(808)
Issuance of common shares	58	---
NET CASH USED IN FINANCING ACTIVITIES	(39,676)	(8,848)
INCREASE IN CASH AND CASH EQUIVALENTS	878	2,985
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD	4,982	5,696
CASH AND CASH EQUIVALENTS, END OF PERIOD	$ 5,860	$ 8,681
Supplemental Information:
Cash payments for interest expense	$ 473	$ 895

The accompanying notes to interim condensed consolidated financial statements are an integral part of these financial statements.

NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
INTERIM CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003
(dollars in thousands)
								Unrealized
	Cumulative Convertible				Capital in			Gains	Total
	Preferred Stock		Common Stock		Excess of	Cumulative	Cumulative	on Marketable	Stockholders'
	Shares	Amount	Shares	Amount	Par Value	Net Income	Dividends	Securities	Equity
BALANCE AT 12/31/03	---	$ ---	9,590,588	$ 96	$135,536	$ 54,206	$(77,711)	$ 2,115	$114,242
Net income	---	---	---	---	---	5,674	---	---	5,674
Unrealized gains on market-
able securities	---	---	---	---	---	---	---	520	520
Total comprehensive income									6,194
Shares sold	---	---	5,000	---	58	---	---	---	58
Dividends to common share-
holders ($.6650 per share)	---	---	---	---	---	---	(6,380)	---	(6,380)
BALANCE AT 6/30/04	---	$ ---	9,595,588	$ 96	$135,594	$ 59,880	$(84,091)	$ 2,635	$114,114
BALANCE AT 12/31/02	---	$ ---	9,570,323	$ 96	$135,324	$ 42,361	$(63,440)	$ 135	$114,476
Net income	---	---	---	---	---	5,340	---	---	5,340
Unrealized gains on marketable
securities	---	---	---	---	---	---	---	531	531
Total comprehensive income									5,871
Dividends to common share-
holders ($.6650 per share)	---	---	---	---	---	---	(6,364)	---	(6,364)
BALANCE AT 6/30/03	---	$ ---	9,570,323	$ 96	$135,324	$ 47,701	$(69,804)	$ 666	$113,983

The accompanying notes to interim condensed consolidated financial statements are an integral part of these financial statements.

NOTE 1. SIGNIFICANT ACCOUNTING POLICIES

The unaudited financial statements to which these notes are attached include, in our opinion, all adjustments which are necessary to fairly present the financial position, results of operations and cash flows of National Health Realty, Inc. (NHR or the Company) and its majority owned subsidiaries. We assume that users of these interim financial statements have read or have access to the audited December 31, 2003, financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations and that the adequacy of additional disclosure needed for a fair presentation, except in regard to material contingencies, may be determined in that context. See our web page at www.nationalhealthrealty.com. Accordingly, footnotes and other disclosures which would substantially duplicate the disclosure contained in our most recent annual report to stockholders have been omitted. This quarter's interim financial information is not necessarily indicative of the results that may be expected for a full year for a variety of reasons including changes in interest rates, rents, operations and the timing of debt and equity financings.

NOTE 2. EARNINGS PER SHARE

Basic earnings per share is based on the weighted average number of common shares outstanding during the year.

Diluted earnings per share assumes the exercise of stock options using the treasury stock method.

The following table summarizes the earnings and the average number of common shares and common equivalent shares used in the calculation of basic and diluted earnings per share.

	Three Months Ended		Six Months Ended
	June 30		June 30
	2004	2003	2004	2003
BASIC:
Weighted average common shares	9,594,214	9,570,323	9,592,401	9,570,323
Net income available to common stockholders	$2,570,000	$ 2,599,000	$5,674,000	$ 5,340,000
Net income per common share	$ .27	$ .27	$ .59	$ .56
DILUTED:
Weighted average common shares	9,594,214	9,570,323	9,592,401	9,570,323
Stock options	199,570	173,922	211,538	168,426
Average common shares outstanding	9,793,784	9,744,245	9,803,939	9,738,749
Net income available to common stockholders	$2,570,000	$ 2,599,000	$5,674,000	$ 5,340,000
Net income per common share	$ .26	$ .27	$ .58	$ .55

NOTE 3. COMMITMENTS, CONTINGENCIES AND GUARANTEES

NHR began operating on December 31, 1997 after the exchange of NHR common stock for certain assets of NHC including mortgage notes receivable and real property. In order to protect the REIT status of NHR, certain NHC unitholders received limited partnership units of NHR/OP, L.P. rather than shares of common stock of NHR. As a result of certain unitholders' involuntary acceptance of NHR/OP, L.P. partnership units to benefit all other unitholders, we have indemnified those certain unitholders for any tax consequence resulting from any involuntary conversion of NHR/OP, L.P. partnership units into shares of NHR common stock. The indemnification expires at such time as the NHR/OP, L.P. unitholders are in a position to voluntarily convert their partnership units into NHR common stock on a tax free basis without violating applicable REIT requirements.

We believe that we have operated our business so as to qualify as a REIT under Sections 856 through 860 of the Internal Code of 1986, as amended (the "Code") and we intend to continue to operate in such a manner, but no assurance can be given that we will be able to qualify at all times. If we qualify as a REIT, we will generally not be subject to federal corporate income taxes on our net income that is currently distributed to stockholders. This treatment substantially eliminates the "double taxation" (at the corporate and stockholder levels) that typically applies to corporate dividends. Our failure to continue to qualify under the applicable REIT qualification rules and regulations would cause us to owe state and federal income taxes and would have a material adverse impact on our financial position, results of operations and cash flows.

NHC HealthCare/Nashville, LLC, a wholly owned subsidiary of our investment advisor, National HealthCare Corporation ("NHC"), is the operator of a long-term care facility in Nashville, Tennessee which sustained extensive fire damage on September 25, 2003.There have been an undetermined number of deaths and other personal injuries related to the fire.NHR has no ownership or involvement in the damaged facility.

Although NHR does not own the damaged facility, NHR currently owns or leases 14 facilities to NHC subsidiaries. The leases require the operator to maintain replacement cost property and casualty insurance, including business interruption coverage, with NHR being the loss payee. NHR is also an additional named insured on a professional and general liability policy issued by a subsidiary of NHC. Under the terms of the leases, the operator is required to maintain limits of not less than $1,000,000 per occurrence and $1,000,000 in the aggregate. NHR is advised that the current policy limits exceed these requirements. NHC and its subsidiaries are the largest group of tenants of NHR and their potential liability from this incident and the impact, if any, on NHR cannot be determined at this time.

NOTE 4. MORTGAGE NOTE RECEIVABLE

The following is a summary of the terms and amounts of mortgage and other notes receivable:

Final		Interest Rate	Principal Amount
Payment Date	Payment Terms	at 6/30/04	(In Thousands)
2016	Monthly payments of $43,318, which
	includes interest at the prime rate plus 2%	6.25%	$ 4,789
2014	Monthly payments of $38,250, which
	includes interest at 8.5%	8.50%	4,376
2016	Monthly payments of $7,845, which includes
	interest at the prime rate plus 2%	6.25%	593
2014	Monthly payments of $5,396, which includes
	interest at 9.0%	9.00%	120
2005	Monthly payments of $72,800, which
	includes interest at 10.5%	10.25%	2,088
2005	Monthly payments of $10,400, which
	includes interest at 10.5%	10.25%	434
2005	Monthly payments of $46,800, which
	includes interest at 10.5%	10.25%	1,353
	Weighted Average Interest and Total	8.19%	$13,753

FCC Notes Receivable Prepayments

On February 27, 2004, we received prepayments of the balance (approximately $30,384,000) of our 10.25% notes receivable from Florida Convalescent Centers, Inc. or affiliates (FCC) of Sarasota, Florida. The notes were scheduled to mature on October 31, 2004.

The proceeds of the prepayments plus cash on hand were used to pay 100% (approximately $31,175,000) of the credit facility debt, which had a current interest rate of 3.10%.

NOTE 5. INVESTMENT IN MARKETABLE SECURITIES

On September 17, 2002, we purchased 225,000 shares of National Health Investors, Inc. ("NHI") common stock for approximately $3,483,000. At June 30, 2004, the fair value of the shares is $6,118,000. This investment in marketable securities is classified as an investment in securities available for sale. Unrealized gains and losses on available for sale securities are recorded in stockholders' equity in accordance with SFAS No. 115.

NOTE 6. STOCK OPTION PLAN

Our stockholders have approved the 1997 Stock Option and Appreciation Rights Plan under which options to purchase shares of our common stock are available for grant to our consultants, advisors, directors and employees at a price no less than the market value of the stock on the date the option is granted. The vesting period and term of the options is from five to six years. The following table summarizes option activity:

		Weighted
	Number	Average
	of Shares	Exercise Price
Outstanding December 31, 2000	397,000	$ 8.42
Options granted	15,000	10.74
Outstanding December 31, 2001	412,000	8.51
Options granted	10,000	16.95
Outstanding December 31, 2002	422,000	8.71
Options granted	15,000	14.80
Options exercised	(25,000)	11.67
Outstanding December 31, 2003	412,000	8.75
Options granted	20,000	16.50
Options exercised	(5,000)	11.50
Options forfeited	(20,000)	11.42
Outstanding June 30, 2004	407,000	8.97
Options exercisable	40,000	$14.37

At June 30, 2004, options to purchase 40,000 shares of common stock are outstanding and exercisable. Exercise prices on the options range from $6.50 to $16.95 per share. The weighted average contractual life of options outstanding at June 30, 2004 is 1.5 years. We have reserved 500,000 shares of common stock for issuance under the stock option plan. At June 30, 2004, options to purchase 36,802 additional shares of common stock may be issued under the stock option plan.

Based on the number of options granted and the historical and expected future trends of factors affecting valuation of those options, management believes that the additional compensation cost, as calculated in accordance with SFAS 123, has no effect on our earnings per share.

NOTE 7. TERM NOTE PAYABLE

In May 2004, we negotiated a $17,000,000 bank term loan. The proceeds of the loan were used to repay a note payable to NHC in the approximate amount of $14,922,000 (interest rate of LIBOR +2.25% with a floor of 4%) and a senior secured note payable to NHC in the approximate amount of $1,723,000 (interest rate of 8.4%). The term note payable requires monthly interest payments at the interest rate of 30 day LIBOR plus 1.50%. Quarterly principal payments in the amount of $425,000 are required beginning September 1, 2004 and continuing until maturity (May 14, 2007) at which time the entire outstanding principal balance shall be due.

NOTE 8. NEW ACCOUNTING PRONOUNCEMENTS

In May 2003 the FASB issued Statement of Financial Accounting Standards No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS 150 establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. SFAS 150 was generally effective for NHR July 1, 2003. As originally issued, SFAS 150 would have required NHR to measure the minority interests in NHR/OP, L.P. on the consolidated balance sheet at estimated fair value at the balance sheet date, with a charge or credit to income (specifically, interest expense) for the change in carrying value during the period. In November 2003, the FASB deferred for an indefinite period the application of the classification and measurement guidance in SFAS 150 to non-controlling interests in limited-life subsidiaries (such as NHR/OP, L.P.). Measurement of the minority interests in NHR/OP, L.P. at estimated fair value at each balance sheet date, if and when required, would result in significant volatility in NHR's financial position and results of operations.

In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that the guarantor recognize, at the inception of certain guarantees, a liability for the fair value of the obligation undertaken in issuing such guarantees. FIN 45 also requires additional disclosure requirements about the guarantor's obligations under certain guarantees that it has issued. The initial recognition and measurement provisions of this interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. Through June 30, 2004, adoption of FIN 45 has not had a material effect on NHR's financial statements. The future effect of FIN 45 on NHR's financial statements will depend on whether we enter into new or modify existing guarantees.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46), which requires the consolidation of variable interest entities by the primary beneficiary of such variable interest entity. FIN 46, as revised by the FASB, generally requires that variable interest entities must be consolidated by their primary beneficiary effective March 31, 2004. NHR has adopted all provisions of FIN 46 effective March 31, 2004. The implementation of FIN 46 has not had a material effect on our financial position, results of operations or cash flows.

Item 2.Management's Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

National Health Realty, Inc. (NHR or the Company) is a real estate investment trust (REIT) that began operations on January 1, 1998. Currently our assets, through our subsidiary NHR/OP, L.P. (the Operating Partnership), include the real estate of 26 health care facilities, including 19 licensed skilled nursing facilities, six assisted living facilities and one independent living center (the Health Care Facilities). We also own eight first and second mortgage promissory notes with principal balances totaling $13,753,000 (the Notes) at June 30, 2004 and secured by the real property of health care facilities. Our revenues are derived primarily from rent and interest income from these real estate properties and mortgages receivable. Our primary lessee is National HealthCare Corporation (NHC) which leases 14 of our 23 properties and guarantees the lease payments on the remaining nine properties.

Competitive Restrictions-

We have an Advisory Services Agreement with National HealthCare Corporation (NHC) pursuant to which NHC will provide us with investment advice, office space and personnel. NHC owns or manages 74 long-term care health care facilities with 9,208 beds in 10 states. The advisory services agreement provides that prior to the earlier to occur of (i) the termination of the advisory agreement for any reason or (ii) NHC ceasing to be actively engaged as the investment advisor for National Health Investors, Inc. (NHI), we will not (without the prior approval of NHI) transact business with any party, person, company or firm other than NHC. It is the intent of the foregoing restriction that we will not be actively or passively engaged in the pursuit of additional investment opportunities, but rather will focus upon our capacities as landlord and note holder of those certain assets we currently hold.

Areas of Focus-

On February 27, 2004, we received a prepayment of $30.3 million on our 10.25% notes receivable from Florida Convalescent Centers, Inc. The notes were scheduled to mature on October 31, 2004.

The proceeds of the prepayment plus cash on hand were used to pay 100% of NHR's $31.2 million credit facility debt, which had a current interest rate of 3.10%.

Based on these transactions, NHR's net cash inflows for the period from March 1, 2004 through the scheduled maturity of the FCC notes will be increased by $1.3 million due to the reduction of principal and interest payments required under the credit facility, offset by the reduction of principal and interest that would have been received from the FCC notes. However, due to the prepayment of the FCC notes and the credit facility and the difference between the interest rates of each instrument, NHR's net income will be reduced by $1.5 million for this same period in 2004.

NHR's quarterly common stock dividend of 33.25 cents per share is expected to remain unchanged for the near future.

ACCOUNTING ESTIMATES

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and cause our reported net income to vary significantly from period to period.

Our significant accounting policies and the associated estimates and the issues which impact these estimates are as follows:

Revenue Recognition - Mortgage Interest and Rental Income

We collect interest and rent from our customers. Generally our policy is to recognize revenues on an accrual basis as earned. However, we may in the future determine that, based on insufficient historical collections and the lack of expected future collections, revenue for interest or rent is not realizable. For any such nonperforming investments, our policy is to recognize interest or rental income only in the period when payments are received. If conclusions as to the realizibility of revenue change, our revenues could vary significantly from period to period.

Valuations of and Impairments to Our Investments

Since the passage of the Balanced Budget Act of 1997 affecting SNFs January 1999, the long-term care industry has experienced material reductions in government and private insurance reimbursement. Some legislative relief was granted in 2000 and 2001 as a result of the Balanced Budget Refinement Act of 1999, but some of those add-on provisions expired October 1, 2002 materially reducing reimbursement. Effective October 1, 2003, the Centers for Medicare and Medicaid Services (CMS) increased reimbursement for Medicare Part A by 3.26% in addition to the annual inflationary increase of 3%. No material changes to reimbursement are expected until CMS refines the current RUG III case-mix methodology. The long-term health care industry has also experienced a dramatic increase in professional liability claims and in the cost of insurance to cover such claims. These factors have combined to cause a number of bankruptcy filings, bankruptcy court rulings and court judgments about refinancing which have affected some of our lessees and mortgagees.

Decisions about valuations and impairments of our investments require significant judgements and estimates on the part of management. We monitor the liquidity and credit worthiness of our tenants and borrowers on an on-going basis. For real estate properties, the need to recognize an impairment is evaluated on a property by property basis in accordance with Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS 144). Recognition of an impairment is based upon estimated future cash flows from a property compared to the carrying value of the property. For notes receivable, impairment recognition is based upon an evaluation of the estimated collectibility of loan payments on a specific loan basis in accordance with Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan - An Amendment of FASB Statements No. 5 and 15". While we believe that the carrying amounts of our properties and notes receivable are realizable, it is possible that future events could require us to make significant adjustments or revisions to these estimates.REIT Status and Taxes

We believe that we have operated our business so as to qualify as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code") and we intend to continue to operate in such a manner, but no assurance can be given that we will be able to qualify at all times. If we qualify as a REIT, we will generally not be subject to federal corporate income taxes on our net income that is currently distributed to its stockholders. This treatment substantially eliminates the "double taxation" (at the corporate and stockholder levels) that typically applies to corporate dividends. Our failure to continue to qualify under the applicable REIT qualification rules and regulations would cause us to owe state and federal income taxes and would have a material adverse impact on our financial position, results of operations and cash flows.

CAPITAL RESOURCES AND LIQUIDITY

FCC Notes and Bank Credit Facility Prepayments

On February 27, 2004, we received prepayment of the balance (approximately $30,384,000) of our 10.25% notes receivable from Florida Convalescent Centers, Inc. or affiliates (FCC) of Sarasota, Florida. The notes were scheduled to mature on October 31, 2004.

The proceeds of the prepayments plus cash on hand were used to pay 100% (approximately $31,175,000) of the credit facility debt, which had a current interest rate of 3.10%.

Term Note Payable

In May 2004, we borrowed $17,000,000 under a bank term loan with an interest rate of 30 day LIBOR plus 1.5% and a three year term. The proceeds of the loan were used to repay a note payable to NHC in the approximate amount of $14,922,000 (interest rate of LIBOR + 2.25% with a floor of 4%) and a senior secured note payable to NHC in the approximate amount of $1,723,000 (interest rate of 8.4%). The new term note payable requires monthly interest payments plus quarterly principal payments in the amount of $425,000 until maturity on May 14, 2007 at which time the entire outstanding principal balance is due.

Leases

We lease our 23 health care facilities to various lessees: 14 properties are leased to NHC, and nine properties that were previously leased to NHC are leased to nine separate lessees not related to NHC. With respect to these nine properties, NHC remains obligated under its master lease agreement and continues to remain obligated to make the lease payments to us. Lease payments made to us from the new lessees are credited against NHC's overall rent obligation. At June 30, 2004, all payments are current. Our leases with NHC and the nine separate lessees have initial five or ten year terms with provisions for two five year renewal terms.

Contractual Cash Obligations

Our contractual cash obligations for periods subsequent to June 30, 2004 are as follows:

		Less than
(in thousands)	Total	1 Year	2-3 Years	4-5 Years	After 5 Years
Long-term debt	$17,000	$1,700	$15,300	$ ---	$ ---
Total Contractual Cash Obligations	$17,000	$1,700	$15,300	$ ---	$ ---

Interest expense has not been included in the above table due to the difficulty in projecting variable rate interest. During the period ended June 30, 2004, our cash payments for interest were $473,000.

We expect that current cash on hand, marketable securities, short-term notes receivable, operating cash flows, and as needed, our borrowing capacity will be adequate to finance our operating and financing requirements for 2004 and 2005.

Sources and Uses of Funds

Our leasing and mortgage services generated net cash from operating activities during the six months ended June 30, 2004 in the amount of $9,645,000 compared to $9,713,000 in the prior period. Net cash from operating activities generally includes net income plus non-cash expenses, such as depreciation and amortization and provision for loan losses, if any, and working capital changes. The period to period increase is due primarily to reduced interest expense offset in part by reduced mortgage interest income.

Cash flows provided by investing activities totaled $30,909,000 during the six months ended June 30, 2004 compared to $2,120,000 in the prior period. Collection of mortgage notes receivable provided $30,842,000 of cash flow in the current period compared to $1,345,000 in the same period last year. An increase in distributions from an unconsolidated investment provided $67,000 of cash flow in the current period compared to no cash flow in the prior period. A decrease in the deposit on real estate properties sold provided no cash flow this year compared to $750,000 last year.

Cash flows used in financing activities totaled $39,676,000 ($8,848,000 last year) and included payments on long-term debt of $47,820,000 ($1,676,000 last year), payments for dividends to stockholders of $7,912,000 ($6,364,000 last year), and payments for cash distributions to partners of $1,002,000 ($808,000 last year) offset in part by $17,000,000 in proceeds from long-term debt (- 0 - last year).

Dividends

We intend to pay quarterly distributions to our stockholders in an amount at least sufficient to satisfy the distribution requirements of a real estate investment trust. Such requirements necessitate that at least 90% of our taxable income be distributed annually. The primary source for distributions will be rental and interest income we earn on the real property and mortgage notes receivable.

Debt to Equity Ratio

At June 30, 2004, our debt as a percentage of total liabilities and capital was 13.0%.

Our current cash on hand, marketable securities, collections on leases and notes receivable, operating cash flows and, as needed, our borrowing capacity are expected to be adequate to pay or finance any scheduled debt reduction, plus our operating requirements for 2004 and into 2005.

RESULTS OF OPERATIONS

Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003

Net income for the three months ended June 30, 2004 is $2,570,000 versus $2,599,000 for the same period in 2003, a decrease of 1.1%. Diluted earnings per common share is 26 cents in the 2004 period, compared to 27 cents in the 2003 period.

Total revenues for the three months ended June 30, 2004 decreased $945,000 to $4,989,000 from $5,934,000 for the three months ended June 30, 2003. Revenues from rental income increased $61,000 or 1.4% when compared to the same period in 2003. Revenues from mortgage interest decreased $1,003,000 or 63.3% in 2004 as compared to the same period in 2003.

The increase in rental income is due to increased percentage rent. Percentage rent is calculated at 3% of the amount by which gross revenues of each leased health care center in each quarter of each year after 1999 exceed the gross revenues of such health care facility in the applicable quarter of 1999.

The decrease in mortgage income is the result of lower balances of notes receivable. We received prepayments on mortgages receivable totaling $30,384,000 in February 2004 and totaling $21,982,000 in November 2003. Mortgage interest decreased also because of the reductions in the principal of mortgage notes receivable due to regular monthly amortization.

Total expenses for the 2004 three month period decreased $912,000 or 30.3% to $2,094,000 from $3,006,000 for the 2003 three month period. Interest expense decreased $913,000 or 84.1% in the 2004 three month period as compared to the 2003 period. Depreciation of real estate decreased $97,000 or 6.1%. General and administrative costs increased $217,000 or 1.9%.

Interest expense decreased due primarily to principal paydowns in the fourth quarter of 2003 ($22 million) and the first quarter of 2004 ($31 million) on the credit facility and the senior secured notes payable to NHC ($4 million). There was an additional principal paydown of approximately $1,723,000 on the senior secured notes payable to NHC in the second quarter of 2004. In addition, interest expense decreased due to the decreased rate effective December 31, 2003 and May 14, 2004 on approximately $14,922,000 of debt. General and administrative costs increased due to a writeoff of $252,000 of previously capitalized costs for a transaction that did not materialize.

Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003

Net income for the six months ended June 30, 2004 is $5,674,000 versus $5,340,000 for the same period in 2003, an increase of 6.3%. Diluted earnings per common share is 58 cents in the 2004 period, compared to 55 cents in the 2003 period.

Total revenues for the six months ended June 30, 2004 decreased $1,479,000 to $10,501,000 from $11,980,000 for the six months ended June 30, 2003. Revenues from rental income increased $43,000 or ..5% when compared to the same period in 2003. Revenues from mortgage interest decreased $1,517,000 or 47.9% in 2004 as compared to the same period in 2003.

The increase in rental income is due to increased percentage rent offset in part by adjustments in the first quarter of 2003 which had not been previously determined. Percentage rent is calculated at 3% of the amount by which gross revenues of each leased health care center in each quarter of each year after 1999 exceed the gross revenues of such health care facility in the applicable quarter of 1999.

The decrease in mortgage income is the result of lower balances of notes receivable. We received prepayments on mortgages receivable totaling $30,384,000 in February 2004 and totaling $21,982,000 in November 2003. Mortgage interest decreased also because of the reductions in the principal of mortgage notes receivable due to regular monthly amortization.

Total expenses for the 2004 six month period decreased $1,854,000 or 31.1% to $4,110,000 from $5,964,000 for the 2003 six month period. Interest expense decreased $1,634,000 or 76.6% in the 2004 six month period as compared to the 2003 period. Depreciation of real estate decreased $196,000 or 6.2%. General and administrative costs increased $203,000 or 48.8%.

Interest expense decreased due primarily to principal paydowns in the fourth quarter of 2003 ($22 million) and the first quarter of 2004 ($31 million) on the credit facility and the senior secured notes payable to NHC ($4 million). There was an additional principal paydown of approximately $1,723,000 on the senior secured notes payable to NHC in the second quarter of 2004. In addition, interest expense decreased due to the decreased rates effective December 31, 2003 and May 14, 2004 on approximately $14,922,000 of debt. General and administrative costs increased due to a writeoff of $252,000 of previously capitalized costs for a transaction that did not materialize.

Non-Operating Income

Revenues from investment and interest income for the three months ended June 30, 2004 decreased $3,000 or 2.8% compared to the same period in 2003. Investment and interest income for the three months ended June 30, 2004 includes $95,000 of dividend and $8,000 of bank interest income.

Revenues from investment and interest income for the six months ended June 30, 2004 decrease $5,000 or 2.9% compared to the same period in 2003. Investment and interest income for the six months ended June 30, 2004 includes $191,000 of dividend and $14,000 of bank interest income.

Funds From Operations

Our funds from operations ("FFO") for the six months ended June 30, 2004, on a diluted basis was $8,321,000, an increase of $160,000 as compared to $8,161,000 for the same period in 2003. FFO represents net earnings available to common stockholders, excluding the effects of asset dispositions, plus depreciation associated with real estate investments. Diluted FFO assumes, if dilutive, the conversion of convertible subordinated debentures, the conversion of cumulative convertible preferred stock and the exercise of stock options using the treasury stock method.

We believe that funds from operations is an important supplemental measure of operating performance for a real estate investment trust. Because the historical cost accounting convention used for real estate assets requires straight-line depreciation (except on land), such accounting presentation implies that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen and fallen with market conditions, presentations of operating results for a real estate investment trust that use historical cost accounting for depreciation could be less informative, and should be supplemented with a measure such as FFO. The term FFO was designed by the real estate investment trust industry to address this issue. Our measure may not be comparable to similarly titled measures used by other REITs. Consequently, our funds from operations may not provide a meaningful measure of our performance as compared to that of other REITs. Since other REITs may not use our definition of FFO, caution should be exercised when comparing our Company's FFO to that of other REITs. Funds from operations in and of itself does not represent cash generated from operating activities in accordance with GAAP (funds from operations does not include changes in operating assets and liabilities) and therefore should not be considered an alternative to net earnings as an indication of operating performance, or to net cash flow from operating activities as determined by GAAP in the United States, as a measure of liquidity and is not necessarily indicative of cash available to fund cash needs.

The following table reconciles net income to funds from operations:

	Three Months Ended		Six Months Ended
	June 30		June 30
	2004	2003	2004	2003
Net income applicable to common stockholders	$2,570	$2,599	$5,674	$5,340
Adjustments:
Real estate depreciation	1,492	1,589	2,983	3,179
Minority interest in NHR/OP, L.P. share
of add back for real estate depreciation	(168)	(180)	(336)	(358)
Funds from operations	$3,894	$4,008	$8,321	$8,161
Weighted average shares:
Basic	9,594,214	9,570,323	9,592,401	9,570,323
Diluted	9,793,784	9,744,245	9,803,939	9,738,449

FUTURE RENTAL AND MORTGAGE INTEREST INCOME UNCERTAINTIES

Our rental and mortgage interest income revenues are believed by management to be secure. However, the majority of the income of our lessees and borrowers is derived from the lessees' participation in the Medicare and Medicaid programs. Adverse changes in these programs or the inability of our lessees and borrowers to participate in these programs would have a material adverse impact on the financial position, results of operations and cash flows of our lessees and borrowers and their resultant ability to service their obligations to us. Additionally, prepayment by our borrowers of their mortgage notes to us would reduce our future income.

INCOME TAXES

We intend at all times to qualify as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. Therefore, we will not be subject to federal income tax provided we distribute at least 90% of our annual REIT taxable income to our stockholders and meet other requirements to continue to qualify as a REIT. Accordingly, no provision for federal income taxes has been made in the consolidated financial statements. Our failure to continue to qualify under the applicable REIT qualification rules and regulations would have a material adverse impact on our financial position, results of operations and cash flows.

IMPACT OF INFLATION

Inflation may affect us in the future by changing the underlying value of our real estate or by impacting our cost of financing operations.

Our revenues are primarily from long-term investments. Our leases with NHC require increases in rent income based on increases in the revenues of the leased facilities.

FORWARD-LOOKING STATEMENTS

References throughout this document to the Company, "we" or "us" include National Health Realty, Inc. and its subsidiaries. In accordance with the Securities and Exchange Commission's "Plain English" guidelines, this Quarterly Report on Form 10-Q has been written in the first person. In this document, the words "we", "our", "ours" and "us" refer only to National Health Realty, Inc. and its subsidiaries and not any other person.

This Quarterly Report on Form 10-Q and other information we provide from time to time, contains certain "forward-looking" statements as that term is defined by the Private Securities Litigation Reform Act of 1995. All statements regarding our expected future financial position, results of operations, cash flows, funds from operations, continued performance improvements, ability to service and refinance our debt obligations, ability to finance growth opportunities, and similar statements including, without limitations, those containing words such as "believes", "anticipates", "expects", "intends", "estimates", "plans", and other similar expressions are forward-looking statements.

Forward-looking statements involve known and unknown risks and uncertainties that may cause our actual results in future periods to differ materially from those projected or contemplated in the forward-looking statements as a result of, but not limited to, the following factors:

*     national and local economic conditions, including their effect on the availability and cost of labor, utilities and materials;

*    the effect of government regulations and changes in regulations governing the healthcare industry, including compliance with such regulations by us and our borrowers and/or lessees;

*    changes in Medicare and Medicaid payment levels and methodologies and the application of such methodologies by the government and its fiscal intermediaries;

*     the ability to pay when due or refinance certain debt obligations maturing within the next nine months;

*    the competitive environment in which we operate;

See the notes to the quarterly financial statement, and "Item 1. Business" as is found in our 2003 Annual Report on Form 10-K for a discussion of various governmental regulations and other operating factors relating to the healthcare industry and the risk factors inherent in them. The Annual Report and Form 10-Q's are available on our web site atwww.nationalhealthrealty.com. You should carefully consider those risks before making any investment decisions in the Company. These risks and uncertainties are not the only ones facing the Company. There may be additional risks that we do not presently know of or that we currently deem immaterial. If any of the risks actually occur, our business, financial condition or results of operations could be materially adversely affected. In that case, the trading price of our Common Stock could decline, and you may lose all or part of your investment. Given these risks and uncertainties, we can give no assurances that these forward-looking statements will, in fact, transpire and, therefore, caution investors not to place undue reliance on them.

Item 3.Quantitative and Qualitative Information About Market Risk

INTEREST RATE RISK

Our cash and cash equivalent consist of highly liquid investments with a maturity of less than three months. All of our mortgage and other notes receivable bear interest at fixed interest rates. As a result of the short-term nature of our cash instruments and because the interest rates on our investments in notes receivable are fixed, a hypothetical 10% change in interest rates would have no impact on our future earnings and cash flows related to these instruments.

As of June 30, 2004, all of our long-term debt ($17,000,000) bears interest at floating interest rates. Because the interest rates of these instruments are variable, a hypothetical 10% increase in interest rates would result in additional annual interest expense of $44,000 and a 10% reduction in interest rates would result in annual interest expense declining $44,000.

We currently do not use any derivative instruments to hedge our interest rate expense or for trading purposes. The use of such instruments would be subject to strict approvals by our senior officers. Therefore, our exposure related to such derivative instruments is not material to our financial position, results of operations or cash flows.

Item 4.Controls and Procedures

As of June 30, 2004, an evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer ("CEO") and Principal Accounting Officer ("PAO"), of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the Company's management, including the CEO and PAO, concluded that the Company's disclosure controls and procedures were effective as of June 30, 2004. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls during the quarterly period ended or subsequent to June 30, 2004.

PART II. OTHER INFORMATION

Item 1.Legal Proceedings.  None

Item 2.Changes in Securities.  Not applicable

Item 3.Defaults Upon Senior Securities.  None

Item 4.Submission of Matters to a Vote of Security Holders.

(a) The annual meeting of the shareholders was held on April 20, 2004.

(b) Matters voted upon at the meeting are as follows:

PROPOSAL NO. 1: Re-election of Joseph M. Swanson to serve as director for a term of three years or until his successor has been fully elected and qualified.

		Withholding
Nominee	Voting For	Authority	Percent For
Joseph M. Swanson	8,451,494	135,765	98.4

PROPOSAL NO. 2: To ratify the Audit Committee's selection of Ernst & Young LLP as independent auditors for the year ending December 31, 2004.

Voting For	Voting Against	Abstaining	Percent For
8,561,829	15,624	9,806	99.7

Item 5.Other Information.  None

Item 6.Exhibits and Reports on Form 8-K.

(a) List of exhibits

Exhibit No.	Description
31	Rule 13a-14(a)/15d-14(a) Certifications
	302 Certification of W. Andrew Adams
	302 Certification of Donald K. Daniel
99	Additional Exhibits
	906 Certification of W. Andrew Adams
	906 Certification of Donald K. Daniel

(b) Reports on Form 8-K

Form 8-K filed on June 15, 2004 regarding second quarter dividend to shareholders.

Form 8-K filed on June 16, 2004 regarding resignation of Ernst & Young LLP as the Company's certifying auditors.

Form 8-K filed on August 6, 2004 regarding second quarter earnings announcement.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	NATIONAL HEALTH REALTY, INC.
	(Registrant)
Date August 9, 2004	s/W. Andrew Adams
	W. Andrew Adams
	Chief Executive Officer
Date August 9, 2004	s/Donald K. Daniel
	Donald K. Daniel
	Principal Accounting Officer

Exhibit 31

CERTIFICATION

I, W. Andrew Adams, certify that:

1. I have reviewed this quarterly report on Form 10-Q of National Health Realty, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function);

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date: August 9, 2004
	s/W. Andrew Adams
	W. Andrew Adams
	Chairman and President
	Chief Executive Officer

CERTIFICATION

I, Donald K. Daniel, certify that:

1. I have reviewed this quarterly report on Form 10-Q of National Health Realty, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function);

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date: August 9, 2004
	s/Donald K. Daniel
	Donald K. Daniel
	Vice President and Controller
	Principal Accounting Officer

Exhibit 99

Certification of Quarterly Report on Form 10-Q

of National Health Realty, Inc.

For The Quarter Ended June 30, 2004

The undersigned hereby certify, pursuant to 18 U.S.C. Section 906 of the Sarbanes-Oxley Act of 2002, that, to the undersigned's best knowledge and belief, the Quarterly Report on Form 10-Q for National Health Realty, Inc. ("Issuer") for the period ending June 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"):

(a)	fully complies with the requirements of section 13(a) or 15(d) of the
	Securities Exchange Act of 1934; and
(b)	the information contained in the Report fairly presents, in all material
	respects, the financial condition and results of operations of the Issuer.

This Certification accompanies the Quarterly Report on Form 10-Q of the Issuer for the quarterly period ended June 30, 2004.

This Certification is executed as of August 9, 2004.

s/W.Andrew Adams

W. Andrew Adams

Chief Executive Officer

s/Donald K. Daniel

Donald K. Daniel

Principal Accounting Officer

A signed original of this written statement required by Section 906 has been provided to National Health Realty, Inc. and will be retained by National Health Realty, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.