KND » Topics » Rent Reset Issue with Ventas, Inc.

This excerpt taken from the KND 8-K filed Nov 2, 2005.

Rent Reset Issue with Ventas, Inc.

 

The Company also provided guidance on its current estimate of the potential rent reset under its master lease agreements (the “Master Lease Agreements”) with Ventas, Inc. (NYSE:VTR) (“Ventas”). The Company leases 39 of its 73 hospitals and 186 of its 245 nursing centers from Ventas. The current aggregate annual rent under the Master Lease Agreements approximates $190 million and the annual rent escalator, subject to certain parameters, is 3 1/2%.

 

As previously disclosed in the Company’s filings with the Securities and Exchange Commission (the “SEC”), Ventas has a one-time option to reset the rent and the related rent escalators under each of the original Master Lease Agreements to the “Fair Market Rental” of the leased properties. Fair Market Rental is determined through an appraisal procedure set forth in the Master Lease Agreements. A summary of the appraisal procedure is set forth below.

 

Ventas has indicated that based upon currently available information, reports of experts and current conditions, if Ventas were currently entitled to, and did, exercise the rent reset option, the base rent under the Master Lease Agreements would increase by at least $35 million per year.

 

The Company has performed substantial analysis of the potential rent reset, including internal analysis and the engagement of several independent appraisal firms to estimate the rent reset on many of the leased properties. At this time, the Company has a significant disagreement with Ventas on the potential value of the rent reset option, both with respect to the annual base rent and the level of the annual rent escalator. As a general matter, the Company believes that the aggregate rent on its hospitals may increase while the aggregate rent on its nursing centers would decline. The Company’s analysis is based upon a number of factors, some of which are subject to change, including, without limitation, reimbursement rates and regulatory changes affecting the leased properties, the historical and projected financial results of the individual leased properties, the condition, age and capital requirements of the leased properties, the method of calculating market rents, current market rents and industry market rents for long-term acute care hospitals and nursing centers, the terms of the Master Lease Agreements that limit operational flexibility, the aggregate rental value of the portfolio of skilled nursing facilities and long-term acute care hospitals contained within each Master Lease Agreement, and the inherent risks involved in any third party appraisal process.


Mr. Diaz commented, “While we continue to enhance and expand our analysis of the potential rent reset, we have performed substantial work to support our estimate, including third party appraisals on each of our hospitals and approximately one-fourth of our nursing centers leased from Ventas. We have reviewed our analysis with additional unaffiliated third parties who have supported our conclusions.”

 

Commenting on the issues associated with the potential rent reset, Mr. Diaz noted, “While our analysis has indicated a significant difference of opinion with Ventas regarding the value of the rent reset, we also understand that the determination of fair market rents requires certain levels of subjectivity and judgment related to the many variables that may be considered under the circumstances. As a result, we believe it is important for investors to consider the possibility of a wide range of outcomes with respect to the rent reset issue.”

 

“We clearly have a significant difference of opinion with Ventas regarding the value of the potential rent reset,” Mr. Diaz further commented. “We have developed a good working relationship with Ventas over the last few years and we will continue to engage in a constructive dialogue with Ventas on this issue as well as other issues that may benefit both companies in the future. Nevertheless, if we are unable to resolve our differences, we are comfortable with the appraisal procedure set forth in the Master Lease Agreements and believe we have a compelling case in support of our conclusions.”

 

Generally, the Master Lease Agreements provide that Ventas can initiate the rent reset procedure under each Master Lease Agreement at any time between January 20, 2006 and July 19, 2007 by delivering a notice to the Company proposing the Fair Market Rental (as described below) for the balance of the lease term (the “Reset Proposal Notice”). If the Company and Ventas are unable to reach an agreement on the Fair Market Rental within 30 days following delivery of the Reset Proposal Notice, the Company and Ventas each must select an independent appraiser. These two appraisers then will have ten days to select a third independent appraiser (the “Independent Appraiser”). The Independent Appraiser will have 60 days to complete its determination of Fair Market Rental and the annual rent escalator, which determination will be final and binding on the parties. Within 30 days following the Independent Appraiser’s determination, Ventas may elect to exercise its right to reset Fair Market Rental by sending the Company a final exercise notice (the “Final Exercise Notice”).

 

Alternatively, Ventas may decide not to exercise its rent reset option, in which event the rent and existing 3 1/2% contingent annual escalator would remain at their then current levels under the Master Lease Agreements. Provided that Ventas exercises its rent reset right in accordance with the Master Lease Agreements, the rent reset will become effective on the later of July 19, 2006 or the date of delivery of the Reset Proposal Notice, which can be no later than July 19, 2007.

 

As a condition to exercising its rent reset right, upon delivery of the Final Exercise Notice, Ventas is required to pay the Company a reset fee equal to a prorated portion of $5 million based upon the proportion of base rent payable under the Master Lease Agreement(s) with respect to which rent is reset to the total base rent payable under all of the Master Lease Agreements.

 

“Fair Market Rental” is generally defined under the Master Lease Agreements as the amount (including escalations) that a willing tenant would pay, and a willing landlord would accept, for leasing the leased properties for the term (including renewal terms). Fair Market Rental is to be determined on the basis of certain assumptions, including (1) all leased properties are in good condition and repair (given their respective ages and prevailing healthcare industry standards with respect to what is considered good condition and repair), without any deferred maintenance (but allowing for ordinary wear and tear), (2) all leased properties are in material compliance with applicable laws and have all authorizations necessary for use as a nursing center or hospital, as applicable, and (3) the replacement cost of the leased properties are not determinative of Fair Market Rental. In addition, Fair Market Rental shall take into account market conditions, market levels of earnings before interest,


income taxes, depreciation, amortization, rent and management fees (“EBITDARM”), the ratio of market levels of EBITDARM to market levels of rent and the actual levels of EBITDARM at the applicable leased properties, as well as historical levels of EBITDARM at the applicable leased properties (including the EBITDARM of the leased properties measured as of April 20, 2001).

 

Under the Master Lease Agreements, Ventas has a right to sever properties from the existing leases in order to create additional leases, a device adopted to facilitate its financing flexibility. However, for purposes of the rent reset right, the additional leases are disregarded and the Fair Market Rental is determined for each of the four original Master Lease Agreements.

 

Additional information regarding the Master Lease Agreements is contained in the Company’s Form 10-K for the year ended December 31, 2004 and copies of the Master Lease Agreements filed with the SEC.

 

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