| Related Person Transactions | Note 10. Related Person Transactions
We have relationships and historical and continuing transactions with Five Star, RMR LLC and others related to them, including other companies to which RMR LLC provides management services and which have trustees, directors and officers who are also our trustees or officers. For further information about these and other such relationships and certain other related person transactions, please refer to our Annual Report.
Five Star : Five Star was our 100% owned subsidiary until we distributed its common shares to our shareholders in 2001. We are Five Star’s largest stockholder. As of June 30, 2016, we owned 4,235,000 of Five Star’s common shares, representing approximately 8.6% of Five Star’s outstanding common shares. Five Star is our largest tenant and a manager of certain of our senior living communities.
Our investment in Five Star common shares, which is included in other assets in our condensed consolidated balance sheets, is recorded at fair value, with the related unrealized gain (loss) included in cumulative other comprehensive income (loss) in our condensed consolidated balance sheets. We recognize the increase or decrease in the fair value of our Five Star common shares each reporting period as unrealized gain or loss on investment in available for sale securities which is a component of other comprehensive income (loss) in our condensed consolidated statements of comprehensive income. For further information, see Notes 4 and 7.
On June 29, 2016, we entered into a transaction agreement, or the Transaction Agreement, and related agreements, or, collectively, the Transaction Documents, with Five Star. Pursuant to the Transaction Documents, among other things, on June 29, 2016, we and Five Star completed a sale and leaseback transaction with respect to certain senior living communities owned by Five Star and amended the pooling arrangements related to Five Star’s management of certain senior living communities we own. Significant terms of the Transaction Documents are summarized below.
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Pursuant to the Transaction Agreement, we and Five Star entered into a purchase and sale agreement whereby we purchased seven senior living communities from Five Star for an aggregate purchase price of $112,350 , and we and Five Star simultaneously entered into a new long term lease agreement, or the New Lease, whereby we have leased those seven senior living communities to Five Star.
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Pursuant to the New Lease, Five Star is required to pay initial annual rent of $8,426 , plus, beginning in 2018, percentage rent equal to 4% of the amount by which gross revenues, as defined in the New Lease, of each community exceeds gross revenues of such community in 2017. The initial term of the New Lease expires on December 31, 2028 and Five Star has options to extend the term of the New Lease for two consecutive 15 -year terms. Pursuant to the New Lease, Five Star may request that we purchase certain improvements to the communities in return for rent increases in accordance with the formula specified in the New Lease; however, we are not obligated to purchase such improvements and Five Star is not required to sell them to us. Pursuant to the Transaction Agreement, we have the right, in connection with a financing or other capital raising transaction, to reassign one or more of the communities covered by the New Lease to another existing or new long term lease agreement between us and Five Star. Other terms of the New Lease are substantially similar to those of our other four preexisting long term leases with Five Star, such terms being described in our Annual Report, which descriptions are incorporated herein by reference.
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Pursuant to the Transaction Agreement, our three existing pooling agreements with Five Star that combined for certain purposes certain of our management agreements with Five Star for senior living communities that include assisted living units, or AL Management Agreements, were terminated. Also pursuant to the Transaction Agreement, we entered into 10 new pooling agreements with Five Star, or the New Pooling Agreements. Nine of the New Pooling Agreements combine six AL Management Agreements and one of the New Pooling Agreements currently combines five AL Management Agreements. Each New Pooling Agreement combines various calculations of revenues and expenses from the operations of the applicable communities covered by such New Pooling Agreement.
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Pursuant to the New Pooling Agreements, the AL Management Agreements covered by each New Pooling Agreement generally provide Five Star with a management fee equal to either 3% or 5% of the gross revenues realized at such communities plus reimbursement for its direct costs and expenses related to such communities, as well as an annual incentive fee equal to either 35% or 20% of the annual net operating income of such communities remaining after we realize an annual minimum return equal to either 8% or 7% of our invested capital, or, in the case of nine communities, a specified amount plus 7% of our invested capital since December 31, 2015. The calculations of Five Star’s fees and of our annual minimum return related to any AL Management Agreement that became effective before May 2015 and had been pooled under one of the previously existing pooling agreements are generally the same as they were under the previously existing pooling agreements. However, with respect to certain communities, our annual minimum return was reduced to 7% , and also, with respect to the nine communities referenced above, our annual minimum return was reset as of 2016 to the specified amounts. With regard to AL Management Agreements that became effective from and after May 2015, the management fee was changed to 5%, rather than the prior 3%, of the gross revenues realized at the applicable community, and the incentive fee was changed to 20%, rather than the prior 35%, of the annual net operating income of the applicable community remaining, in all cases after we realize our requisite annual minimum return. Pursuant to the New Pooling Agreements, we will pay Five Star a fee for its management of capital expenditure projects equal to 3% of amounts funded by us.
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The terms of the AL Management Agreements covered by the New Pooling Agreements expire between 2030 and 2039 and are subject to automatic renewals, unless earlier terminated or timely notices of nonrenewal are delivered. The right that we and Five Star each had under the AL Management Agreements that became effective from and after May 1, 2015 to terminate each such AL Management Agreement as of December 31, 2016 was eliminated pursuant to the applicable New Pooling Agreement. Five Star has a limited right under the AL Management Agreements to require underperforming communities to be sold, and we have the right to terminate all the AL Management Agreements subject to a New Pooling Agreement if we do not receive our annual minimum return under such New Pooling Agreement in each of three consecutive years, commencing with calendar year 2016, subject to certain Five Star cure rights.
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The New Pooling Agreements collectively combine all AL Management Agreements except for the management agreement related to one assisted living community located in New York and the management agreement related to one assisted living community located in California, and, other than as described below, the terms of those management agreements were not amended as part of the transactions contemplated by the Transaction Documents. The terms of our existing pooling agreement with Five Star that combines our management agreements with Five Star for senior living communities that include only independent living units, and the terms of those management agreements, also were not amended as part of the transactions contemplated by the Transaction Documents.
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Pursuant to the Transaction Agreement, we and Five Star amended the management agreement for one California community so that the calculation of our annual minimum return under that agreement is fixed at $3,610 plus 7% of any amount funded by us for capital expenditures at this community since December 31, 2015.
Because of the continuing relationships between us and Five Star, the terms of the Transaction Documents were negotiated and approved by special committees of our Board of Trustees and Five Star’s board of directors composed of our Independent Trustees and Five Star’s independent directors who are not also Trustees or directors of the other party, which committees were represented by separate counsel.
As of June 30, 2016 and 2015, we leased 184 and 180 senior living communities to Five Star, respectively. We recognized total rental income from Five Star of $48,234 and $47,753 for the three months ended June 30, 2016 and 2015, respectively, and $96,341 and $95,443 for the six months ended June 30, 2016 and 2015, respectively. These amounts exclude estimated percentage rent payments we received from Five Star of $1,388 and $1,393 for the three months ended June 30, 2016 and 2015, respectively, and $2,861 and $2,824 for the six months ended June 30, 2016 and 2015, respectively. We determine actual percentage rent due under our Five Star leases annually and recognize any resulting amount as rental income at year end when all contingencies are met. As of June 30, 2016 and December 31, 2015, we had rents receivable from Five Star of $16,065 and $17,466 , respectively. Those amounts are included in other assets in our condensed consolidated balance sheets.
During the six months ended June 30, 2016 and 2015, pursuant to the terms of our leases with Five Star, we purchased $11,836 and $8,902 , respectively, of improvements to properties leased to Five Star, and, as a result, the annual rent payable to us by Five Star increased by approximately $949 and $717 , respectively.
In April 2016, Five Star began managing a senior living community we own located in North Carolina with 87 living units where the prior tenant had defaulted on its lease. In May 2016, Five Star began managing a senior living community located in Georgia with 38 private pay units that we acquired in May 2016 for a purchase price of approximately $8,400 , excluding closing costs. We acquired this community using a TRS structure. In July 2016, Five Star began managing an additional senior living community we own located in Alabama with 163 living units where the prior tenant had defaulted on its lease. The terms by which Five Star is managing these senior living communities are described above.
As of June 30, 2016 and 2015, Five Star managed 62 and 60 senior living communities for our account, respectively. We incurred management fees payable to Five Star of $ 2,819 and $2,699 for the three months ended June 30, 2016 and 2015, respectively, and $5,623 and $5,222 for the six months ended June 30, 2016 and 2015, respectively. These amounts are included in property operating expenses in our condensed consolidated statements of comprehensive income.
D&R Yonkers LLC: In order to accommodate certain requirements of New York licensing laws, one of our TRSs subleases a part of a senior living community we own that is managed by Five Star to D&R Yonkers LLC. D&R Yonkers LLC is owned by our President and Chief Operating Officer and Five Star’s chief financial officer and treasurer. Our transactions and balances with D&R Yonkers LLC are eliminated upon consolidation for accounting purposes and are not separately stated and do not appear in our condensed consolidated financial statements.
RMR LLC: Pursuant to our business management agreement with RMR LLC, we recognized net business management fees of $9,243 and $9,144 for the three months ended June 30, 2016 and 2015, respectively, and $17,590 and $18,014 for the six months ended June 30, 2016 and 2015, respectively. No incentive fees were estimated to be payable to RMR LLC for the three or six months ended June 30, 2016 and 2015, respectively. The net business management fees we recognized for the 2016 and 2015 periods are included in general and administrative expenses in our condensed consolidated statements of comprehensive income.
In accordance with the terms of our business management agreement, we issued 68,983 of our common shares to RMR LLC for the period from January 1, 2015 through May 31, 2015 as payment for a part of the business management fee we recognized for that period. Beginning June 1, 2015, all management fees under our business management agreement are paid in cash.
Pursuant to our property management agreement with RMR LLC, we recognized aggregate net property management and construction supervision fees of $2,686 and $2,532 for the three months ended June 30, 2016 and 2015, respectively, and $5,232 and $4,969 for the six months ended June 30, 2016 and 2015, respectively. These amounts are included in property operating expenses or have been capitalized, as appropriate, in our condensed consolidated financial statements.
We are generally responsible for all of our operating expenses, including certain expenses incurred by RMR LLC on our behalf. Our property level operating expenses are generally incorporated into rents charged to our tenants, including certain payroll and related costs incurred by RMR LLC. We reimbursed RMR LLC $2,171 and $1,494 for property management related expenses for the three months ended June 30, 2016 and 2015, respectively, and $4,299 and $3,235 for the six months ended June 30, 2016 and 2015, respectively. These amounts are included in property operating expenses in our condensed consolidated statements of comprehensive income.
We have historically awarded share grants to certain RMR LLC employees under our equity compensation plans. In addition, under our business management agreement we reimburse RMR LLC for our allocable costs for internal audit services. The amounts recognized as expense for share grants to RMR LLC employees and internal audit costs were $589 and $316 for the three months ended June 30, 2016 and 2015, respectively, and $1,174 and $777 for the six months ended June 30, 2016 and 2015, respectively. These amounts are included in general and administrative expenses in our condensed consolidated statements of comprehensive income.
We lease office space to RMR LLC in certain of our properties for its property management offices. Pursuant to our lease agreements with RMR LLC, we recognized rental income from RMR LLC for leased office space of $61 and $171 for the three and six months ended June 30, 2016, respectively. We recognized rental income from RMR LLC for leased office space of $102 for the six months ended June 30, 2015, $51 of which related to rental income from the first three months of 2015.
RMR Inc.: In connection with our June 2015 acquisition of shares of class A common stock of RMR Inc., we recorded a liability for the amount by which the estimated fair value of these shares exceeded the price we paid for these shares. This liability is included in accounts payable and other liabilities in our condensed consolidated balance sheets. A part of this liability is being amortized on a straight line basis through December 31, 2035 as an allocated reduction to our business management and property management fee expense. We amortized $943 and $1,886 of this liability, respectively, for the three and six months ended June 30, 2016, and $243 of this liability for both the three and six months ended June 30, 2015. These amounts are included in the net business management and property management fee amounts for such periods. As of June 30, 2016, the remaining unamortized amount of this liability was $73,819 .
As of June 30, 2016, we owned 2,637,408 shares of class A common stock of RMR Inc. We receive dividends on our RMR Inc. class A common shares as declared and paid by RMR Inc. to all holders of its class A common shares. We received a dividend of $789 on our RMR Inc. class A common shares during the three months ended June 30, 2016, which was for the period from December 14, 2015 through March 31, 2016. Since then, we have not yet received any other dividends on our RMR Inc. class A common shares. On July 12, 2016, RMR Inc. declared a regular quarterly dividend of $0.25 per class A common share payable to shareholders of record on July 22, 2016. RMR Inc. has stated that it expects to pay this dividend on or about August 18, 2016.
Our investment in RMR Inc. class A common shares, which is included in other assets in our condensed consolidated balance sheets, is recorded at fair value, with the related unrealized gain (loss) included in cumulative other comprehensive income (loss) in our condensed consolidated balance sheets. We recognize the increase or decrease in the fair value of our RMR Inc. class A common shares each reporting period as unrealized gain or loss on investment in available for sale securities which is a component of other comprehensive income (loss) in our condensed consolidated statements of comprehensive income. For further information, see Notes 4 and 7.
AIC: We and six other companies to which RMR LLC provides management services each own Affiliates Insurance Company, or AIC, in equal amounts. We and the other AIC shareholders participate in a combined property insurance program arranged and reinsured in part by AIC; as part of this program, in June 2016, we renewed our one year standalone insurance policy through June 30, 2017, that provides coverage for one very large property we own. We currently expect to pay aggregate annual premiums, including taxes and fees, of approximately $3,607 in connection with this insurance program for the policy year ending June 30, 2017, which amount may be adjusted from time to time as we acquire and dispose of properties that are included in this insurance program.
As of June 30, 2016 and December 31, 2015, our investment in AIC had a carrying value of $7,016 and $6,827 , respectively . These amounts are included in other assets in our condensed consolidated balance sheets. We recognized income of $17 and $23 related to our investment in AIC for the three months ended June 30, 2016 and 2015, respectively, and $94 and $95 for the six months ended June 30, 2016 and 2015, respectively. Our other comprehensive income includes our proportionate part of unrealized gains (loss) on securities which are owned by AIC of $43 and ($64) for the three months ended June 30, 2016 and 2015, respectively, and $95 and ($19) for the six months ended June 30, 2016 and 2015, respectively. |
