Edgar Filing: Physicians Realty Trust

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 001-36007 (Physicians Realty Trust)

Commission file number: 333-205034-01 (Physicians Realty L.P.)

PHYSICIANS REALTY TRUST

PHYSICIANS REALTY L.P.

(Exact Name of Registrant as Specified in its Charter)



Maryland (Physicians Realty Trust) Delaware (Physicians Realty L.P.) (State of Organization)		46-2519850 80-0941870 (IRS Employer Identification No.)

309 N. Water Street, Suite 500 Milwaukee, Wisconsin (Address of Principal Executive Offices)		53202 (Zip Code)

(414) 367-5600

(Registrant’s Telephone Number, Including Area Code)

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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Physicians Realty Trust Yes ý No o Physicians Realty L.P. Yes ý No o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Physicians Realty Trust Yes ý No o Physicians Realty L.P. Yes ý No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):


Physicians Realty Trust	Large accelerated filer ý Accelerated filer o Non-accelerated filer o Smaller reporting company o Emerging growth company o


Physicians Realty L.P.	Large accelerated filer o Accelerated filer o Non-accelerated filer ý Smaller reporting company o Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Physicians Realty Trust o Physicians Realty L.P. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Physicians Realty Trust Yes o No ý Physicians Realty L.P. Yes o No ý

The number of Physicians Realty Trust’s common shares outstanding as of October 26, 2018 was 182,321,984.

EXPLANATORY NOTE

This Quarterly Report on Form 10-Q combines the Quarterly Reports on Form 10-Q for the quarter ended September 30, 2018 of Physicians Realty Trust (the “Trust”), a Maryland real estate investment trust, and Physicians Realty L.P. (the “Operating Partnership”), a Delaware limited partnership. Unless otherwise indicated or unless the context requires otherwise, all references in this report to “we,” “us,” “our,” and the “Company,” refer to the Trust, together with its consolidated subsidiaries, including the Operating Partnership. References to the “Operating Partnership” mean collectively the Operating Partnership, together with its consolidated subsidiaries. In this report, all references to “common shares” refer to the common shares of the Trust and references to “our shareholders” refer to shareholders of the common shares of the Trust, the term “OP Units” refers to partnership interests of the Operating Partnership and the term “Series A Preferred Units” refers to Series A Participating Redeemable Preferred Units of the Operating Partnership.

The Trust is a self-managed real estate investment trust (“REIT”) formed primarily to acquire, selectively develop, own, and manage healthcare properties that are leased to physicians, hospitals, and healthcare delivery systems. The Trust operates in an umbrella partnership REIT structure (“UPREIT”) in which the Operating Partnership and its subsidiaries hold substantially all of the assets. The Trust’s operations are conducted through the Operating Partnership and wholly-owned and majority-owned subsidiaries of the Operating Partnership. The Trust, as the general partner of the Operating Partnership, controls the Operating Partnership and consolidates the assets, liabilities, and results of operations of the Operating Partnership.

The Trust conducts substantially all of its operations through the Operating Partnership. As of September 30, 2018, the Trust held a 97.2% interest in the Operating Partnership and owns no Series A Preferred Units. Apart from this ownership interest, the Trust has no independent operations.

Noncontrolling interests in the Operating Partnership, shareholders’ equity of the Trust, and partners’ capital of the Operating Partnership are the primary areas of difference between the consolidated financial statements of the Trust and those of the Operating Partnership. OP Units not owned by the Trust are accounted for as limited partners’ capital in the Operating Partnership’s consolidated financial statements and as noncontrolling interests in the Trust’s consolidated financial statements. The differences between the Trust’s shareholders’ equity and the Operating Partnership’s partners’ capital are due to the differences in the equity issued by the Trust and the Operating Partnership, respectively.

The Company believes combining the Quarterly Reports of the Trust and the Operating Partnership, including the notes to the consolidated financial statements, into this single report results in the following benefits:


•	a combined report enhances investors’ understanding of the Trust and the Operating Partnership by enabling investors to view the business as a whole in the same manner as management views and operates the business;


•	a combined report eliminates duplicative disclosure and provides a more streamlined and readable presentation, as a substantial portion of the Company’s disclosure applies to both the Trust and the Operating Partnership; and


•	a combined report creates time and cost efficiencies through the preparation of one combined report instead of two separate reports.

To help investors understand the significant differences between the Trust and the Operating Partnership, this report presents the following separate sections for each of the Trust and the Operating Partnership:


•	the consolidated financial statements in Part I, Item 1 of this report;


•	certain accompanying notes to the consolidated financial statements, including Note 14 (Earnings Per Share and Earnings Per Unit);


•	controls and procedures in Part I, Item 4 of this report; and


•	the certifications of the Chief Executive Officer and the Chief Financial Officer included as Exhibits 31 and 32 to this report.

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PHYSICIANS REALTY TRUST AND PHYSICIANS REALTY L.P.

Quarterly Report on Form 10-Q

for the Quarter Ended September 30, 2018

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		Page Number
Part I	Financial Information

Item 1	Financial Statements (Unaudited)

Financial Statements of Physicians Realty Trust
	Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017	3
	Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2018 and 2017	4
	Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2018 and 2017	5
	Consolidated Statement of Equity for the Nine Months Ended September 30, 2018	6
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2018 and 2017	7

Financial Statements of Physicians Realty L.P.
	Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017	8
	Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2018 and 2017	9
	Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2018 and 2017	10
	Consolidated Statement of Changes in Capital for the Nine Months Ended September 30, 2018	11
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2018 and 2017	12

Notes for Physicians Realty Trust and Physicians Realty L.P.
	Notes to Consolidated Financial Statements	13

Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	34
Item 3	Quantitative and Qualitative Disclosures About Market Risk	52
Item 4	Controls and Procedures	53

Part II	Other Information

Item 1	Legal Proceedings	54
Item 1A	Risk Factors	54
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	54
Item 6	Exhibits	55

SIGNATURES		56

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements made pursuant to safe harbor provisions of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical facts may be forward-looking statements within the meaning of the federal securities laws. In particular, statements pertaining to our capital resources, property performance and results of operations contain forward-looking statements. Likewise, all of our statements regarding anticipated growth in our funds from operations and anticipated market conditions, demographics and results of operations are forward-looking statements. You can identify forward-looking statements by the use of forward-looking terminology such as “believe,” “expect,” “outlook,” “continue,” “project,” “may,” “will,” “should,” “seek,” “approximately,” “intend,” “plan,” “pro forma,” “estimate” or “anticipate” or the negative of these words and phrases or similar words or phrases which are predictions of or indicate future events or trends and which do not relate solely to historical matters. You can also identify forward-looking statements by discussions of strategy, plans, expectations, or intentions.

These forward-looking statements reflect the views of our management regarding current expectations and projections about future events and are based on currently available information. These forward-looking statements are not guarantees of future performance and involve numerous risks and uncertainties and you should not rely on them as predictions of future events. Forward-looking statements depend on assumptions, data, or methods which may be incorrect or imprecise and we may not be able to realize them. We do not guarantee that the transactions and events described will happen as described (or that they will happen at all). The following factors, among others, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements:


•	general economic conditions;


•	adverse economic or real estate developments, either nationally or in the markets where our properties are located;


•	our failure to generate sufficient cash flows to service our outstanding indebtedness, or our ability to pay down or refinance our indebtedness;


•	fluctuations in interest rates and increased operating costs;


•	the availability, terms and deployment of debt and equity capital, including our unsecured revolving credit facility;


•	our ability to make distributions on our common shares;


•	general volatility of the market price of our common shares;


•	our increased vulnerability economically due to the concentration of our investments in healthcare properties;


•	our geographic concentration in Texas causes us to be particularly exposed to downturns in the Texas economy or other changes in Texas market conditions;


•	changes in our business or strategy;


•	our dependence upon key personnel whose continued service is not guaranteed;


•	our ability to identify, hire and retain highly qualified personnel in the future;


•	the degree and nature of our competition;


•	changes in governmental regulations or interpretations thereof, such as real estate and zoning laws and increases in real property tax rates, taxation of REITs, and similar matters;


•	defaults on or non-renewal of leases by tenants;


•	decreased rental rates or increased vacancy rates;


•	difficulties in identifying healthcare properties to acquire and completing acquisitions;


•	competition for investment opportunities;

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•	any adverse effects to the business, financial position or results of Catholic Health Initiatives’ (“CHI”), or one or more of the CHI-affiliated tenants, that impact the ability of CHI-affiliated tenants to pay us rent;


•	the impact of our investments in joint ventures we may make in the future and;


•	the financial condition and liquidity of, or disputes with, any joint venture and development partners with whom we may make co-investments in the future;


•	cybersecurity incidents could disrupt our business and result in the compromise of confidential information;


•	our ability to operate as a public company;


•	changes in accounting principles generally accepted in the United States “GAAP”;


•	lack of or insufficient amounts of insurance;


•	other factors affecting the real estate industry generally;


•	our failure to maintain our qualification as a REIT for U.S. federal income tax purposes;


•	limitations imposed on our business and our ability to satisfy complex rules in order for us to qualify as a REIT for U.S. federal income tax purposes; and


•	Other factors that may materially adversely affect us, or the per share trading price of our common shares, including:


•	the number of our common shares available for future issuance or sale;


•	our issuance of equity securities or the perception that such issuance might occur;


•	future debt;


•	failure of securities analysts to publish research or reports about us or our industry; and


•	securities analysts’ downgrade of our common shares or the healthcare-related real estate sector.

While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. We disclaim any obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions or factors, new information, data or methods, future events, or other changes after the date of this report, except as required by applicable law. You should not place undue reliance on any forward-looking statements that are based on information currently available to us or the third parties making the forward-looking statements. For a further discussion of these and other factors that could impact our future results, performance or transactions, see Part I, Item 1A (Risk Factors) of our Annual Report on Form 10-K for the fiscal year ended December 31, 2017 (the “2017 Annual Report”), and Part II, Item 1A (Risk Factors) of our Quarterly Report on Form 10-Q for the quarterly periods ended March 31, 2018 (the “First Quarterly Report”), and June 30, 2018 (the “Second Quarterly Report,” and together with the First Quarterly Report, the “2018 Quarterly Reports”).

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PART I. Financial Information

Item 1. Financial Statements

Physicians Realty Trust

Consolidated Balance Sheets

(In thousands, except share and per share data)



	September 30, 2018			December 31, 2017
	(unaudited)
ASSETS
Investment properties:
Land and improvements	$	207,473		$	217,695
Building and improvements	3,588,302			3,568,858
Tenant improvements	32,852			23,056
Acquired lease intangibles	449,656			458,713
	4,278,283			4,268,322
Accumulated depreciation	(369,103		)	(300,458		)
Net real estate property	3,909,180			3,967,864
Real estate held for sale	35,426			—
Real estate loans receivable	47,911			76,195
Investments in unconsolidated entities	1,328			1,329
Net real estate investments	3,993,845			4,045,388
Cash and cash equivalents	4,463			2,727
Tenant receivables, net	5,686			9,966
Other assets	148,567			106,302
Total assets	$	4,152,561		$	4,164,383
LIABILITIES AND EQUITY
Liabilities:
Credit facility	$	420,900		$	324,394
Notes payable	966,788			966,603
Mortgage debt	134,724			186,471
Accounts payable	3,824			11,023
Dividends and distributions payable	43,599			43,804
Accrued expenses and other liabilities	61,346			56,405
Acquired lease intangibles, net	14,229			15,702
Total liabilities	1,645,410			1,604,402

Redeemable noncontrolling interest - Series A Preferred Units (2018) and partially owned properties	24,520			12,347

Equity:
Common shares, $0.01 par value, 500,000,000 common shares authorized, 182,173,601 and 181,440,051 common shares issued and outstanding as of September 30, 2018 and December 31, 2017, respectively	1,822			1,814
Additional paid-in capital	2,785,797			2,772,823
Accumulated deficit	(396,127		)	(315,417		)
Accumulated other comprehensive income	20,485			13,952
Total shareholders’ equity	2,411,977			2,473,172
Noncontrolling interests:
Operating Partnership	69,993			73,844
Partially owned properties	661			618
Total noncontrolling interests	70,654			74,462
Total equity	2,482,631			2,547,634
Total liabilities and equity	$	4,152,561		$	4,164,383

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

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Physicians Realty Trust

Consolidated Statements of Income

(In thousands, except share and per share data) (Unaudited)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Revenues:
Rental revenues	$	76,461		$	69,408		$	235,740		$	186,515
Expense recoveries	23,629			21,102			72,225			53,564
Interest income on real estate loans and other	4,938			2,489			9,275			6,185
Total revenues	105,028			92,999			317,240			246,264
Expenses:
Interest expense	16,326			11,998			49,974			33,285
General and administrative	6,593			5,860			22,156			16,845
Operating expenses	29,870			27,471			90,670			70,079
Depreciation and amortization	42,723			32,975			119,024			89,031
Acquisition expenses	—			2,184			—			12,831
Total expenses	95,512			80,488			281,824			222,071
Income before equity in income of unconsolidated entities and gain on sale of investment properties, net:	9,516			12,511			35,416			24,193
Equity in income of unconsolidated entities	28			28			85			85
Gain on sale of investment properties, net	14,227			—			11,664			5,308
Net income	23,771			12,539			47,165			29,586
Net income attributable to noncontrolling interests:
Operating Partnership	(656		)	(362		)	(1,300		)	(823		)
Partially owned properties (1)	(119		)	(53		)	(374		)	(379		)
Net income attributable to controlling interests	22,996			12,124			45,491			28,384
Preferred distributions	(284		)	(106		)	(1,055		)	(505		)
Net income attributable to common shareholders	$	22,712		$	12,018		$	44,436		$	27,879
Net income per share:
Basic	$	0.12		$	0.07		$	0.24		$	0.18
Diluted	$	0.12		$	0.07		$	0.24		$	0.18
Weighted average common shares:
Basic	182,076,513			177,847,424			181,963,693			157,542,167
Diluted	187,473,230			183,298,145			187,622,109			162,480,918

Dividends and distributions declared per common share and OP Unit	$	0.230		$	0.230		$	0.690		$	0.685


(1)	Includes amounts attributable to redeemable noncontrolling interests.

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

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Physicians Realty Trust

Consolidated Statements of Comprehensive Income

(In thousands) (Unaudited)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Net income	$	23,771		$	12,539		$	47,165		$	29,586
Other comprehensive income:
Change in fair value of interest rate swap agreements	914			(916		)	6,533			(1,696		)
Total other comprehensive income	914			(916		)	6,533			(1,696		)
Comprehensive income	24,685			11,623			53,698			27,890
Comprehensive income attributable to noncontrolling interests - Operating Partnership	(679		)	(339		)	(1,484		)	(774		)
Comprehensive income attributable to noncontrolling interests - partially owned properties	(119		)	(53		)	(374		)	(379		)
Comprehensive income attributable to common shareholders	$	23,887		$	11,231		$	51,840		$	26,737

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

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Physicians Realty Trust

Consolidated Statement of Equity

(In thousands) (Unaudited)



	Par Value		Additional Paid in Capital			Accumulated Deficit			Accumulated Other Comprehensive Income		Total Shareholders’ Equity			Operating Partnership Noncontrolling Interest			Partially Owned Properties Noncontrolling Interest			Total Noncontrolling Interests			Total Equity
Balance at January 1, 2018	$	1,814	$	2,772,823		$	(315,417	)	$	13,952	$	2,473,172		$	73,844		$	618		$	74,462		$	2,547,634
Net proceeds from sale of common shares	5		8,049			—			—		8,054			—			—			—			8,054
Restricted share award grants, net	2		4,847			(138		)	—		4,711			—			—			—			4,711
Purchase of OP Units	—		—			—			—		—			(1,555		)	—			(1,555		)	(1,555		)
Conversion of OP Units	1		1,326			—			—		1,327			(1,327		)	—			(1,327		)	—
Dividends/distributions declared	—		—			(125,810		)	—		(125,810		)	(3,576		)	—			(3,576		)	(129,386		)
Preferred distributions	—		—			(1,055		)	—		(1,055		)	—			—			—			(1,055		)
Distributions	—		—			—			—		—			—			(122		)	(122		)	(122		)
Change in market value of Redeemable Noncontrolling Interest in Operating Partnership	—		59			802			—		861			—			—			—			861
Change in fair value of interest rate cap agreements	—		—			—			6,533		6,533			—			—			—			6,533
Net income	—		—			45,491			—		45,491			1,300			165			1,465			46,956
Adjustment for Noncontrolling Interests ownership in Operating Partnership	—		(1,307		)	—			—		(1,307		)	1,307			—			1,307			—
Balance at September 30, 2018	$	1,822	$	2,785,797		$	(396,127	)	$	20,485	$	2,411,977		$	69,993		$	661		$	70,654		$	2,482,631

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

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Physicians Realty Trust

Consolidated Statements of Cash Flows

(In thousands) (Unaudited)



	Nine Months Ended September 30,
	2018			2017
Cash Flows from Operating Activities:
Net income	$	47,165		$	29,586
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization	119,024			89,031
Amortization of deferred financing costs	1,808			1,731
Amortization of lease inducements and above/below-market lease intangibles	3,518			3,780
Straight-line rental revenue/expense	(17,270		)	(11,168		)
Amortization of discount on unsecured senior notes	430			177
Amortization of above market assumed debt	(47		)	(163		)
Gain on sale of investment properties, net	(11,664		)	(5,308		)
Equity in income of unconsolidated entities	(85		)	(85		)
Distributions from unconsolidated entities	86			112
Change in fair value of derivative	(17		)	160
Provision for bad debts	82			(297		)
Non-cash share compensation	6,675			4,976
Net change in fair value of contingent consideration	(50		)	4
Change in operating assets and liabilities:
Tenant receivables	3,891			(754		)
Other assets	(2,799		)	(541		)
Accounts payable	(7,199		)	2,167
Accrued expenses and other liabilities	1,916			14,834
Net cash provided by operating activities	145,464			128,242
Cash Flows from Investing Activities:
Proceeds on sales of investment properties	217,222			18,150
Acquisition of investment properties, net	(242,827		)	(916,270		)
Escrowed cash - acquisition deposits/earnest deposits	2,780			(25,271		)
Capital expenditures on investment properties	(26,358		)	(14,819		)
Issuance of real estate loans receivable	(2,000		)	(38,844		)
Repayment of real estate loans receivable	13,582			1,507
Issuance of note receivable	(20,385		)	—
Repayment of note receivable	—			16,423
Leasing commissions	(2,561		)	(1,184		)
Lease inducements	(73		)	(2,508		)
Net cash used in investing activities	(60,620		)	(962,816		)
Cash Flows from Financing Activities:
Net proceeds from sale of common shares	8,054			804,453
Proceeds from credit facility borrowings	345,000			627,000
Repayment of credit facility borrowings	(246,000		)	(889,000		)
Proceeds from issuance of mortgage debt	—			61,000
Proceeds from issuance of senior unsecured notes	—			396,108
Principal payments on mortgage debt	(51,840		)	(40,999		)
Debt issuance costs	(4,267		)	(1,129		)
Dividends paid - shareholders	(126,088		)	(101,846		)
Distributions to noncontrolling interests - Operating Partnership	(3,640		)	(3,154		)
Preferred distributions paid - OP Unit holder	(627		)	(519		)
Contributions from noncontrolling interest	—			47
Distributions to noncontrolling interests - partially owned properties	(396		)	(1,653		)
Payments of employee taxes for withheld stock-based compensation shares	(1,749		)	(2,583		)
Purchase of Series A Preferred Units	—			(19,961		)
Purchase of OP Units	(1,555		)	(3,757		)
Net cash (used in) provided by financing activities	(83,108		)	824,007
Net increase (decrease) in cash and cash equivalents	1,736			(10,567		)
Cash and cash equivalents, beginning of period	2,727			15,491
Cash and cash equivalents, end of period	$	4,463		$	4,924
Supplemental disclosure of cash flow information - interest paid during the period	$	53,370		$	33,307
Supplemental disclosure of noncash activity - change in fair value of interest rate swap agreements	$	6,533		$	(1,696	)
Supplemental disclosure of noncash activity - assumed debt	$	—		$	26,379
Supplemental disclosure of noncash activity - issuance of OP Units and Series A Preferred Units in connection with acquisitions	$	22,651		$	44,978

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

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Physicians Realty L.P.

Consolidated Balance Sheets

(In thousands, except unit and per unit data)



	September 30, 2018			December 31, 2017
	(unaudited)
ASSETS
Investment properties:
Land and improvements	$	207,473		$	217,695
Building and improvements	3,588,302			3,568,858
Tenant improvements	32,852			23,056
Acquired lease intangibles	449,656			458,713
	4,278,283			4,268,322
Accumulated depreciation	(369,103		)	(300,458		)
Net real estate property	3,909,180			3,967,864
Real estate held for sale	35,426			—
Real estate loans receivable	47,911			76,195
Investments in unconsolidated entities	1,328			1,329
Net real estate investments	3,993,845			4,045,388
Cash and cash equivalents	4,463			2,727
Tenant receivables, net	5,686			9,966
Other assets	148,567			106,302
Total assets	$	4,152,561		$	4,164,383
LIABILITIES AND CAPITAL
Liabilities:
Credit facility	$	420,900		$	324,394
Notes payable	966,788			966,603
Mortgage debt	134,724			186,471
Accounts payable	3,824			11,023
Distributions payable	43,599			43,804
Accrued expenses and other liabilities	61,346			56,405
Acquired lease intangibles, net	14,229			15,702
Total liabilities	1,645,410			1,604,402

Redeemable noncontrolling interest - Series A Preferred Units (2018) and partially owned properties	24,520			12,347

Capital:
Partners’ capital:
General partners’ capital, 182,173,601 and 181,440,051 units issued and outstanding as of September 30, 2018 and December 31, 2017, respectively	2,391,492			2,459,220
Limited partners’ capital, 5,291,504 and 5,364,632 units issued and outstanding as of September 30, 2018 and December 31, 2017, respectively	69,993			73,844
Accumulated other comprehensive income	20,485			13,952
Total partners’ capital	2,481,970			2,547,016
Noncontrolling interest - partially owned properties	661			618
Total capital	2,482,631			2,547,634
Total liabilities and capital	$	4,152,561		$	4,164,383

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

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Physicians Realty L.P.

Consolidated Statements of Income

(In thousands, except unit and per unit data) (Unaudited)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Revenues:
Rental revenues	$	76,461		$	69,408		$	235,740		$	186,515
Expense recoveries	23,629			21,102			72,225			53,564
Interest income on real estate loans and other	4,938			2,489			9,275			6,185
Total revenues	105,028			92,999			317,240			246,264
Expenses:
Interest expense	16,326			11,998			49,974			33,285
General and administrative	6,593			5,860			22,156			16,845
Operating expenses	29,870			27,471			90,670			70,079
Depreciation and amortization	42,723			32,975			119,024			89,031
Acquisition expenses	—			2,184			—			12,831
Total expenses	95,512			80,488			281,824			222,071
Income before equity in income of unconsolidated entities and gain on sale of investment properties, net:	9,516			12,511			35,416			24,193
Equity in income of unconsolidated entities	28			28			85			85
Gain on sale of investment properties, net	14,227			—			11,664			5,308
Net income	23,771			12,539			47,165			29,586
Net income attributable to noncontrolling interests - partially owned properties (1)	(119		)	(53		)	(374		)	(379		)
Net income attributable to controlling interests	23,652			12,486			46,791			29,207
Preferred distributions	(284		)	(106		)	(1,055		)	(505		)
Net income attributable to common unitholders	$	23,368		$	12,380		$	45,736		$	28,702
Net income per common unit:
Basic	$	0.12		$	0.07		$	0.24		$	0.18
Diluted	$	0.12		$	0.07		$	0.24		$	0.18
Weighted average common units:
Basic	187,367,538			183,227,405			187,342,453			162,205,324
Diluted	187,473,230			183,298,145			187,622,109			162,480,918

Distributions declared per common unit	$	0.230		$	0.230		$	0.690		$	0.685


(1)	Includes amounts attributable to redeemable noncontrolling interests.

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

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Physicians Realty L.P.

Consolidated Statements of Comprehensive Income

(In thousands) (Unaudited)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Net income	$	23,771		$	12,539		$	47,165		$	29,586
Other comprehensive income:
Change in fair value of interest rate swap agreements	914			(916		)	6,533			(1,696		)
Total other comprehensive income	914			(916		)	6,533			(1,696		)
Comprehensive income	24,685			11,623			53,698			27,890
Comprehensive income attributable to noncontrolling interests - partially owned properties	(119		)	(53		)	(374		)	(379		)
Comprehensive income attributable to common unitholders	$	24,566		$	11,570		$	53,324		$	27,511

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

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Physicians Realty L.P.

Consolidated Statement of Changes in Capital

(In thousands) (Unaudited)



	General Partner			Limited Partner			Accumulated Other Comprehensive Income		Total Partners’ Capital			Partially Owned Properties Noncontrolling Interest			Total Capital
Balance at January 1, 2018	$	2,459,220		$	73,844		$	13,952	$	2,547,016		$	618		$	2,547,634
Net Proceeds from sale of Trust common shares and issuance of common units	8,054			—			—		8,054			—			8,054
Trust restricted share award grants, net	4,711			—			—		4,711			—			4,711
Purchase of OP Units	—			(1,555		)	—		(1,555		)	—			(1,555		)
Conversion of OP Units	1,327			(1,327		)	—		—			—			—
OP Units - distributions	(125,810		)	(3,576		)	—		(129,386		)	—			(129,386		)
Preferred distributions	(1,055		)	—			—		(1,055		)	—			(1,055		)
Distributions	—			—			—		—			(122		)	(122		)
Change in market value of Redeemable Limited Partners	59			—			—		59			—			59
Buyout of Noncontrolling Interest - partially owned properties	802			—			—		802			—			802
Change in fair value of interest rate swap agreements	—			—			6,533		6,533			—			6,533
Net income	45,491			1,300			—		46,791			165			46,956
Adjustments for Limited Partners ownership in Operating Partnership	(1,307		)	1,307			—		—			—			—
Balance at September 30, 2018	$	2,391,492		$	69,993		$	20,485	$	2,481,970		$	661		$	2,482,631

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

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Physicians Realty L.P.

Consolidated Statements of Cash Flows

(In thousands) (Unaudited)



	Nine Months Ended September 30,
	2018			2017
Cash Flows from Operating Activities:
Net income	$	47,165		$	29,586
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization	119,024			89,031
Amortization of deferred financing costs	1,808			1,731
Amortization of lease inducements and above/below-market lease intangibles	3,518			3,780
Straight-line rental revenue/expense	(17,270		)	(11,168		)
Amortization of discount on unsecured senior notes	430			177
Amortization of above market assumed debt	(47		)	(163		)
Gain on sale of investment properties, net	(11,664		)	(5,308		)
Equity in income of unconsolidated entities	(85		)	(85		)
Distributions from unconsolidated entities	86			112
Change in fair value of derivative	(17		)	160
Provision for bad debts	82			(297		)
Non-cash share compensation	6,675			4,976
Net change in fair value of contingent consideration	(50		)	4
Change in operating assets and liabilities:
Tenant receivables	3,891			(754		)
Other assets	(2,799		)	(541		)
Accounts payable	(7,199		)	2,167
Accrued expenses and other liabilities	1,916			14,834
Net cash provided by operating activities	145,464			128,242
Cash Flows from Investing Activities:
Proceeds on sales of investment properties	217,222			18,150
Acquisition of investment properties, net	(242,827		)	(916,270		)
Escrowed cash - acquisition deposits/earnest deposits	2,780			(25,271		)
Capital expenditures on investment properties	(26,358		)	(14,819		)
Issuance of real estate loans receivable	(2,000		)	(38,844		)
Repayment of real estate loans receivable	13,582			1,507
Issuance of note receivable	(20,385		)	—
Repayment of note receivable	—			16,423
Leasing commissions	(2,561		)	(1,184		)
Lease inducements	(73		)	(2,508		)
Net cash used in investing activities	(60,620		)	(962,816		)
Cash Flows from Financing Activities:
Net proceeds from sale of Trust common shares and issuance of common units	8,054			804,453
Proceeds from credit facility borrowings	345,000			627,000
Repayment of credit facility borrowings	(246,000		)	(889,000		)
Proceeds from issuance of mortgage debt	—			61,000
Proceeds from issuance of senior unsecured notes	—			396,108
Principal payments on mortgage debt	(51,840		)	(40,999		)
Debt issuance costs	(4,267		)	(1,129		)
OP Unit distributions - General Partner	(126,088		)	(101,846		)
OP Unit distributions - Limited Partner	(3,640		)	(3,154		)
Preferred OP Units distributions - Limited Partner	(627		)	(519		)
Contributions from noncontrolling interest	—			47
Distributions to noncontrolling interests - partially owned properties	(396		)	(1,653		)
Payments of employee taxes for withheld stock-based compensation shares	(1,749		)	(2,583		)
Purchase of Series A Preferred Units	—			(19,961		)
Purchase of Limited Partner Units	(1,555		)	(3,757		)
Net cash (used in) provided by financing activities	(83,108		)	824,007
Net increase (decrease) in cash and cash equivalents	1,736			(10,567		)
Cash and cash equivalents, beginning of period	2,727			15,491
Cash and cash equivalents, end of period	$	4,463		$	4,924
Supplemental disclosure of cash flow information - interest paid during the period	$	53,370		$	33,307
Supplemental disclosure of noncash activity - change in fair value of interest rate swap agreements	$	6,533		$	(1,696	)
Supplemental disclosure of noncash activity - assumed debt	$	—		$	26,379
Supplemental disclosure of noncash activity - issuance of OP Units and Series A Preferred Units in connection with acquisitions	$	22,651		$	44,978

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

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Physicians Realty Trust and Physicians Realty L.P.

Notes to Consolidated Financial Statements

Unless otherwise indicated or unless the context requires otherwise, the use of the words “we,” “us,” “our,” and the “Company,” refer to Physicians Realty Trust, together with its consolidated subsidiaries, including Physicians Realty L.P.

Note 1. Organization and Business

Physicians Realty Trust (the “Trust”) was organized in the state of Maryland on April 9, 2013. As of September 30, 2018, the Trust was authorized to issue up to 500,000,000 common shares of beneficial interest, par value $0.01 per share (“common shares”). The Trust filed a Registration Statement on Form S-11 with the Securities and Exchange Commission (the “Commission”) with respect to a proposed underwritten initial public offering (the “IPO”) and completed the IPO of its common shares and commenced operations on July 24, 2013.

The Trust contributed the net proceeds from the IPO to Physicians Realty L.P., a Delaware limited partnership, (the “Operating Partnership”), and is the sole general partner of the Operating Partnership. The Trust and the Operating Partnership are managed and operated as one entity. The Trust has no significant assets other than its investment in the Operating Partnership. The Trust’s operations are conducted through the Operating Partnership and wholly-owned and majority-owned subsidiaries of the Operating Partnership. The Trust, as the general partner of the Operating Partnership, controls the Operating Partnership and consolidates the assets, liabilities, and results of operations of the Operating Partnership. Therefore, the assets and liabilities of the Trust and the Operating Partnership are the same.

ATM Program

On August 5, 2016, the Trust and the Operating Partnership entered into separate At Market Issuance Sales Agreements (the “Sales Agreements”) with each of KeyBanc Capital Markets Inc., Credit Agricole Securities (USA) Inc., JMP Securities LLC, Raymond James & Associates, Inc., and Stifel Nicolaus & Company, Incorporated (the “Agents”), pursuant to which the Trust may issue and sell, from time to time, its common shares having an aggregate offering price of up to $300.0 million, through the Agents (the “ATM Program”). In accordance with the Sales Agreements, the Trust may offer and sell its common shares through any of the Agents, from time to time, by any method deemed to be an “at the market offering” as defined in Rule 415 under the Securities Act of 1933, as amended, which includes sales made directly on the New York Stock Exchange or other existing trading market, or sales made to or through a market maker. With the Trust’s express written consent, sales may also be made in negotiated transactions or any other method permitted by law.

During the quarterly periods ended March 31, 2018, June 30, 2018, and September 30, 2018, the Trust’s issuance and sale of common shares pursuant to the ATM Program are as follows (in thousands, except common shares and price):



	Common shares sold	Weighted average price		Net proceeds
Quarterly period ended March 31, 2018	311,786	$	17.85	$	5,509
Quarterly period ended June 30, 2018	—	—		—
Quarterly period ended September 30, 2018	114,203	17.15		1,947
Year to date	425,989	$	17.66	$	7,456

As of October 26, 2018, the Trust has $164.9 million remaining available under the ATM Program.

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Note 2. Summary of Significant Accounting Policies

The accompanying unaudited consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the periods ended September 30, 2018 and 2017 pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X. All such adjustments are of a normal recurring nature. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. These financial statements should be read in conjunction with the audited financial statements included in the Trust’s and the Operating Partnership’s combined Annual Report on Form 10-K for the year ended December 31, 2017, filed with the Commission on March 1, 2018.

Principles of Consolidation

GAAP requires us to identify entities for which control is achieved through means other than voting rights and to determine which business enterprise is the primary beneficiary of variable interest entities (“VIEs”). ASC 810 broadly defines a VIE as an entity in which either (i) the equity investors as a group, if any, lack the power through voting or similar rights to direct the activities of such entity that most significantly impact such entity’s economic performance or (ii) the equity investment at risk is insufficient to finance that entity’s activities without additional subordinated financial support. We identify the primary beneficiary of a VIE as the enterprise that has both of the following characteristics: (i) the power to direct the activities of the VIE that most significantly impact the entity’s economic performance, and (ii) the obligation to absorb losses or receive benefits of the VIE that could potentially be significant to the entity. We consolidate our investment in a VIE when we determine that we are the VIE’s primary beneficiary. We may change our original assessment of a VIE upon subsequent events, such as the modification of contractual arrangements that affect the characteristics or adequacy of the entity’s equity investments at risk and the disposition of all, or a portion, of an interest held by the primary beneficiary. We perform this analysis on an ongoing basis.

For property holding entities not determined to be VIEs, we consolidate such entities in which the Operating Partnership owns 100% of the equity or has a controlling financial interest evidenced by ownership of a majority voting interest. All intercompany balances and transactions are eliminated in consolidation. For entities in which the Operating Partnership owns less than 100% of the equity interest, the Operating Partnership consolidates the property if it has the direct or indirect ability to control the entities’ activities based upon the terms of the respective entities’ ownership agreements. For these entities, the Operating Partnership records a noncontrolling interest representing equity held by noncontrolling interests.

Noncontrolling Interests

The Company presents the portion of an equity interest it does not own, but controls (and thus consolidates) as noncontrolling interests and classifies such interests as a component of consolidated equity, separate from the Company’s total shareholders’ equity, on the consolidated balance sheets.

Operating Partnership: Net income or loss is allocated to noncontrolling interests (limited partners) based on their respective ownership percentage of the Operating Partnership. The ownership percentage is calculated by dividing the number of OP Units held by the noncontrolling interests by the total OP Units held by the noncontrolling interests and the Trust. Issuance of additional common shares and OP Units changes the ownership interests of both the noncontrolling interests and the Trust. Such transactions and the related proceeds are treated as capital transactions.

Noncontrolling interests in the Company include OP Units held by other investors. As of September 30, 2018, the Trust held a 97.2% interest in the Operating Partnership. As the sole general partner and the majority interest holder, the Trust consolidates the financial position and results of operations of the Operating Partnership.

Holders of OP Units may not transfer their OP Units without the Trust’s prior written consent, as general partner of the Operating Partnership. Beginning on the first anniversary of the issuance of OP Units, OP Unit holders may tender their units for redemption by the Operating Partnership in exchange for cash equal to the market price of the Trust’s common shares at the time of redemption or for unregistered common shares on a one-for-one basis. Such selection to pay cash or issue common shares to satisfy an OP Unit holder’s redemption request is solely within the control of the Trust. Accordingly, the Trust presents the OP Units of the Operating Partnership held by investors other than the Trust as noncontrolling interests within equity in the consolidated balance sheets.

Partially Owned Properties: The Trust and Operating Partnership reflect noncontrolling interests in partially owned properties on the balance sheet for the portion of consolidated properties that are not wholly owned by the Company. The

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earnings or losses from those properties attributable to the noncontrolling interests are reflected as noncontrolling interests in partially owned properties in the consolidated statements of income.

Redeemable Noncontrolling Interests - Series A Preferred Units and Partially Owned Properties

On February 5, 2015, the Company entered into a Second Amended and Restated Agreement of Limited Partnership (the “Partnership Agreement”) which provides for the designation and issuance of the Series A Participating Redeemable Preferred Units of the Operating Partnership (“Series A Preferred Units”). Series A Preferred Units have priority over all other partnership interests of the Operating Partnership with respect to distributions and liquidation. Holders of Series A Preferred Units are entitled to a 5% cumulative return and upon redemption, the receipt of one common share and $200. The holders of the Series A Preferred Units have agreed not to cause the Operating Partnership to redeem their Series A Preferred Units prior to one year from the issuance date. In addition, Series A Preferred Units are redeemable at the option of the holders which redemption obligation may be satisfied, at the Trust’s option, in cash or registered common shares. Instruments that require settlement in registered common shares may not be classified in permanent equity as it is not always completely within an issuer’s control to deliver registered common shares. Due to the redemption rights associated with the Series A Preferred Units, the Company classifies the Series A Preferred Units in the mezzanine section of its consolidated balance sheets.

The Series A Preferred Units were evaluated for embedded features that should be bifurcated and separately accounted for as a freestanding derivative. The Company determined that the Series A Preferred Units contained features that require bifurcation. The Company records the carrying amount of the redeemable noncontrolling interests, less the value of the embedded derivative, at the greater of the carrying value or redemption value in the consolidated balance sheets.

On January 9, 2018, the acquisition of the HealthEast Clinic & Specialty Center (“Hazelwood Medical Commons”) was partially funded with the issuance of 104,172 Series A Preferred Units, with a value of $22.7 million. Due to the redemption rights associated with the Series A Preferred Units, the Trust classifies the Series A Preferred Units in the mezzanine section of its consolidated balance sheets. As of September 30, 2018, the value of the embedded derivative is $3.6 million and is classified in accrued expenses and other liabilities on the consolidated balance sheets.

As of September 30, 2018, there were 104,172 Series A Preferred Units outstanding.

In connection with the acquisition of a medical office portfolio in Minnesota (the “Minnesota portfolio”), the Trust received a $5 million equity investment from a third party, effective March 1, 2015. On March 1, 2018, the equity investment was redeemed for $6.4 million. At any point subsequent to the third anniversary of the investment, the holder could require the Trust to redeem the instrument. Due to the redemption provision, which is outside of the control of the Trust, the Trust classified the investment in the mezzanine section of its consolidated balance sheets. The Trust recorded the carrying amount of the redeemable noncontrolling interests at the greater of the carrying value or redemption value.

In connection with the acquisition on December 29, 2015 of a medical office building located on the campus of the Great Falls Clinic and Hospital in Great Falls, Montana, physicians affiliated with the seller retained a noncontrolling interest which may, at the holders’ option, be redeemed at any time. Due to the redemption provision, which is outside of the control of the Trust, the Trust classifies the investment in the mezzanine section of its consolidated balance sheets. The Trust records the carrying amount of the redeemable noncontrolling interests at the greater of the carrying value or redemption value.

Dividends and Distributions

On September 19, 2018, the Trust announced that its Board of Trustees authorized and the Trust declared a cash dividend of $0.23 per common share for the quarterly period ended September 30, 2018. The distribution was paid on October 18, 2018 to common shareholders and OP Unit holders of record as of the close of business on October 3, 2018.

All distributions paid by the Operating Partnership are declared and paid at the same time as dividends are distributed by the Trust to common shareholders. It has been the Operating Partnership’s policy to declare quarterly distributions so as to allow the Trust to comply with applicable provisions of the Internal Revenue Code of 1986, as amended (the “Code”), governing REITs. The declaration and payment of quarterly distributions remains subject to the review and approval of the Trust’s Board of Trustees.

Our shareholders are entitled to reinvest all or a portion of any cash distribution on their common shares by participating in our Dividend Reinvestment and Share Purchase Plan (“DRIP”), subject to the terms of the plan.

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Tax Status of Dividends and Distributions

Our distributions of current and accumulated earnings and profits for U.S. federal income tax purposes generally are taxable to shareholders as ordinary income. Distributions in excess of these earnings and profits generally are treated as a non-taxable reduction of the shareholders’ basis in the shares to the extent thereof (non-dividend distributions) and thereafter as taxable gain.

Any cash distributions received by an OP Unit holder in respect of its OP Units generally will not be taxable to such OP Unit holder for U.S. federal income tax purposes, to the extent that such distribution does not exceed the OP Unit holder’s basis in its OP Units. Any such distribution will instead reduce the OP Unit holder’s basis in its OP Units (and OP Unit holders will be subject to tax on the taxable income allocated to them by the Operating Partnership with respect to their OP Units when such income is earned by the Operating Partnership, with such income allocation increasing the OP Unit holders’ basis in their OP Units).

Purchases of Investment Properties

With the adoption of ASU 2017-01 in January 2018, the majority of our future acquisitions will be accounted for as asset acquisitions, recording the purchase price for tangible and intangible assets and liabilities based on their relative fair values. Tangible assets primarily consist of land and buildings and improvements. Additionally, the purchase price includes acquisition related expenses, above- or below-market leases, in place leases, and above- or below-market debt assumed. Any future contingent consideration will be recorded when the contingency is resolved. The determination of the fair value requires us to make certain estimates and assumptions.

The determination of fair value involves the use of significant judgment and estimation. The Company makes estimates of the fair value of the tangible and intangible acquired assets and assumed liabilities using information obtained from multiple sources as a result of pre-acquisition due diligence and generally includes the assistance of a third party appraiser. The Company estimates the fair value of an acquired asset on an “as-if-vacant” basis and its value is depreciated in equal amounts over the course of its estimated remaining useful life. The Company determines the allocated value of other fixed assets, such as site improvements, based upon the replacement cost and depreciates such value over the assets’ estimated remaining useful lives as determined at the applicable acquisition date. The fair value of land is determined either by considering the sales prices of similar properties in recent transactions or based on an internal analysis of recently acquired and existing comparable properties within the Company’s portfolio.

The value of above- or below-market leases is estimated based on the present value (using a discount rate which reflected the risks associated with the leases acquired) of the difference between contractual amounts to be received pursuant to the leases and management’s estimate of market lease rates measured over a period equal to the estimated remaining term of the lease. The capitalized above-market or below-market lease intangibles are amortized as a reduction or addition to rental income over the estimated remaining term of the respective leases plus the term of any renewal options that the lessee would be economically compelled to exercise.

In determining the value of in-place leases, management considers current market conditions and costs to execute similar leases in arriving at an estimate of the carrying costs during the expected lease-up period from vacant to existing occupancy. In estimating carrying costs, management includes real estate taxes, insurance, other operating expenses, estimates of lost rental revenue during the expected lease-up periods, and costs to execute similar leases, including leasing commissions, tenant improvements, legal, and other related costs based on current market demand. The values assigned to in-place leases are amortized to amortization expense over the estimated remaining term of the lease. If a lease terminates prior to its scheduled expiration, all unamortized costs related to that lease are written off, net of any required lease termination payments.

The Company calculates the fair value of any long-term debt assumed by discounting the remaining contractual cash flows on each instrument at the current market rate for those borrowings, which the Company approximates based on the rate it would expect to incur on a replacement instrument on the date of acquisition, and recognizes any fair value adjustments related to long-term debt as effective yield adjustments over the remaining term of the instrument.

Based on these estimates, the Company recognizes the acquired assets and assumed liabilities at their estimated relative fair values, which are generally determined using Level 3 inputs, such as market rental rates, capitalization rates, discount rates, or other available market data.

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Impairment of Intangible and Long-Lived Assets

The Company periodically evaluates its long-lived assets, primarily consisting of investments in real estate, for impairment indicators or whenever events or changes in circumstances indicate that the recorded amount of an asset may not be fully recoverable. If indicators of impairment are present, the Company evaluates the carrying value of the related real estate properties in relation to the undiscounted expected future cash flows of the underlying operations. In performing this evaluation, management considers market conditions and current intentions with respect to holding or disposing of the real estate property. The Company adjusts the net book value of real estate properties to fair value if the sum of the expected future undiscounted cash flows, including sales proceeds, is less than book value. The Company recognizes an impairment loss at the time it makes any such determination. If the Company determines that an asset is impaired, the impairment to be recognized is measured as the amount by which the recorded amount of the asset exceeds its fair value. Fair value is typically determined using a discounted future cash flow analysis or other acceptable valuation techniques, which are based, in turn, upon Level 3 inputs, such as revenue and expense growth rates, capitalization rates, discount rates, or other available market data.

The Company did not record any impairment charges in the three and nine month periods ended September 30, 2018 and 2017.

Assets Held for Sale

The Company may sell properties from time to time for various reasons, including favorable market conditions. The Company classifies certain long-lived assets as held for sale once the criteria, as defined by GAAP, has been met. The Company classifies a real estate property, or portfolio, as held for sale when: (i) management has approved the disposal, (ii) the property is available for sale in its present condition, (iii) an active program to locate a buyer has been initiated, (iv) it is probable that the property will be disposed of within one year, (v) the property is being marketed at a reasonable price relative to its fair value, and (vi) it is unlikely that the disposal plan will significantly change or be withdrawn. Following the classification of a property as “held for sale,” no further depreciation or amortization is recorded on the assets and the assets are written down to the lower of carrying value or fair market value, less cost to sell. As of September 30, 2018, the Company classified two properties as held for sale.

Investments in Unconsolidated Entities

The Company reports investments in unconsolidated entities over whose operating and financial policies it has the ability to exercise significant influence under the equity method of accounting. Under this method of accounting, the Company’s share of the investee’s earnings or losses is included in its consolidated statements of income. The initial carrying value of investments in unconsolidated entities is based on the amount paid to purchase the equity interest.

Real Estate Loans Receivable

Real estate loans receivable consists of seven mezzanine loans and one term loan as of September 30, 2018. Generally, each mezzanine loan is collateralized by an ownership interest in the respective borrower, while the term loan is secured by a mortgage of a related medical office building. Interest income on the loans is recognized as earned based on the terms of the loans, subject to evaluation of collectability risks, and is included in the Company’s consolidated statements of income. On a quarterly basis, the Company evaluates the collectability of its loan portfolio, including related interest income receivable, and establishes a reserve for loan losses, if necessary. No such losses have been recognized to date.

Rental Revenue

Rental revenue is recognized on a straight-line basis over the terms of the related leases when collectability is reasonably assured. Recognizing rental revenue on a straight-line basis for leases may result in recognizing revenue for amounts more or less than amounts currently due from tenants. Amounts recognized in excess of amounts currently due from tenants, excluding assets classified as held for sale, net of related allowances, are included in other assets and were approximately $56.7 million and $47.6 million as of September 30, 2018 and December 31, 2017, respectively. If the Company determines that collectability of straight-line rents is not reasonably assured, the Company limits future recognition to amounts contractually owed and, where appropriate, establishes an allowance for estimated losses. Allowance for doubtful accounts, excluding assets classified as held for sale, was approximately $0.2 million and $4.9 million as of September 30, 2018 and December 31, 2017, respectively. Rental revenue is adjusted by amortization of lease inducements and above or below market rents on certain leases. Lease inducements and above or below market rents are amortized over the remaining life of the lease.

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Expense Recoveries

Expense recoveries relate to tenant reimbursement of real estate taxes, insurance, and other operating expenses that are recognized as expense recovery revenue in the period the applicable expenses are incurred. The reimbursements are recorded gross, as the Company is generally the primary obligor with respect to real estate taxes and purchasing goods and services from third-party suppliers, has discretion in selecting the supplier, and bears the credit risk of tenant reimbursement.

The Company has certain tenants with absolute net leases. Under these lease agreements, the tenant is responsible for operating and building expenses.

Derivative Instruments

When the Company has derivative instruments embedded in other contracts, it records them either as an asset or a liability measured at their fair value unless they qualify for a normal purchase or normal sale exception. When specific hedge accounting criteria are not met, changes in the Company’s derivative instruments’ fair value are recognized currently in earnings. Changes in the fair market values of the Company’s derivative instruments are recorded in the consolidated statements of income if the derivative instruments do not qualify for, or the Company does not elect to apply for, hedge accounting. If hedge accounting is applied to a derivative instrument, such changes are reported in accumulated other comprehensive income within the consolidated statement of equity or capital, exclusive of ineffectiveness amounts, which are recognized as adjustments to net income.

To manage interest rate risk for certain of its variable-rate debt, the Company uses interest rate swaps as part of its risk management strategy. These derivatives are designed to mitigate the risk of future interest rate increases by providing a fixed interest rate for a limited, pre-determined period of time. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. As of September 30, 2018, the Company had five outstanding interest rate swap contracts that are designated as cash flow hedges of interest rate risk. For presentational purposes, they are shown as one derivative due to the identical nature of their economic terms. Further detail is provided in Note 7 (Derivatives).

The effective portion of the change in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income (“AOCI”) on the consolidated balance sheets and is subsequently reclassified into earnings as interest expense for the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. For the three and nine months ended September 30, 2018 and the three months ended September 30, 2017 hedge ineffectiveness was insignificant. For the nine months ended September 30, 2017, the Company recorded a $0.2 million loss as a result of hedge ineffectiveness. The Company expects hedge ineffectiveness to be insignificant in the next 12 months.

Income Taxes

The Trust elected to be taxed as a REIT for federal tax purposes commencing with the filing of its tax return for the short taxable year ending December 31, 2013. The Trust had no taxable income prior to electing REIT status. To qualify as a REIT, the Trust must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of its annual REIT taxable income to its shareholders (which is computed without regard to the dividends paid deduction or net capital gain and which does not necessarily equal net income as calculated in accordance with GAAP). As a REIT, the Trust generally will not be subject to federal income tax to the extent it distributes qualifying dividends to its shareholders. If the Trust fails to qualify as a REIT in any taxable year, it will be subject to federal income tax (including any applicable alternative minimum tax) on its taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost, unless the Internal Revenue Service grants the Trust relief under certain statutory provisions. Such an event could materially adversely affect the Trust’s net income and net cash available for distribution to shareholders. However, the Trust intends to continue to operate in such a manner as to continue qualifying for treatment as a REIT. Although the Trust continues to qualify for taxation as a REIT, in various instances, the Trust is subject to state and local taxes on its income and property, and federal income and excise taxes on its undistributed income.

As discussed in Note 1 (Organization and Business), the Trust conducts substantially all of its operations through the Operating Partnership. As a partnership, the Operating Partnership generally is not liable for federal income taxes. The income and loss from the operations of the Operating Partnership is included in the tax returns of its partners, including the Trust, who are responsible for reporting their allocable share of the partnership income and loss. Accordingly, no provision for income taxes has been made on the accompanying consolidated financial statements.

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Tenant Receivables, Net

Tenant accounts receivable are stated net of the applicable allowance. Rental payments under these contracts are primarily due monthly. The Company assesses the collectability of tenant receivables, including straight-line rent receivables, and defers recognition of revenue if collectability is not reasonably assured. The Company bases its assessment of the collectability of rent receivables on several factors, including, among other things, payment history, the financial strength of the tenant, and current economic conditions. If management’s evaluation of these factors indicates it is probable that the Company will be unable to recover the full value of the receivable, the Company provides a reserve against the portion of the receivable that it estimates may not be recovered. At September 30, 2018 and December 31, 2017, the allowance for doubtful accounts was $0.5 million and $1.6 million, respectively.

Management Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the amounts of revenue and expenses reported in the period. Significant estimates are made for the fair value assessments with respect to purchase price allocations, impairment assessments, and the valuation of financial instruments. Actual results could differ from these estimates.

Contingent Liabilities

Certain of our acquisitions provide for additional consideration to the seller in the form of an earn-out associated with lease-up contingencies. The Company recognizes the contingent liabilities only if certain parameters or other substantive contingencies are met, at which time the consideration becomes payable. Resolved contingent liabilities increase our acquired assets and reduce our liabilities.

In January 2017, the FASB issued ASU No. 2017-01, Clarifying the Definition of a Business, which changes the definition of a business to assist entities with evaluating when a set of transferred assets and activities is a business. The Company adopted ASU 2017-01 on January 1, 2018. As such, the Company will record the majority of future real estate investments as asset acquisitions and any future contingent consideration will be recorded when the contingency is resolved. Prior to January 1, 2018, the Company recorded certain contingent liabilities which are included in accrued expenses and other liabilities on its consolidated balance sheets. These were recorded at fair value as of the acquisition date and until they expire, the Company reassesses the fair value at the end of each reporting period, with any changes being recognized in earnings.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current financial statement presentation, with no effect on the previously reported consolidated balance sheets or consolidated statements of income.

Segment Reporting

Under the provision of Codification Topic 280, Segment Reporting, the Company has determined that it has one reportable segment with activities related to leasing and managing healthcare properties.

New Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which creates a new Topic, Accounting Standards Codification Topic 606. The standard is principle-based and provides a five-step model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. We adopted ASU 2014-09 as of January 1, 2018 under the modified retrospective approach. Based on our assessment, we have identified all of our revenue streams and concluded rental income from leasing arrangements represents a substantial portion of our revenue. Income from leasing arrangements is specifically excluded from Topic 606 and will be evaluated with the anticipated adoption of ASU 2016-02, Leases. Therefore, the impact of adopting ASU 2014-09 was minimal on our current recognition and presentation of non-lease revenue. Upon adoption of ASU 2016-02, Topic 606 may apply to executory costs and other components of revenue due under leases that are deemed to be non-lease components (such as common area maintenance and other reimbursement revenue), even when the revenue for such activities is not separately stipulated in the lease. In that case, the revenue from these items previously recognized on a straight-

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line basis under the current lease guidance would be recognized under the new revenue guidance as the related services are delivered.

In February 2016, the FASB issued ASU 2016-02, Leases. The update amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets and making targeted changes to lessor accounting. The standard provides the option of a modified retrospective transition approach or a cumulative effect for all leases existing at, or entered into after, the date of initial application, with an option to use certain transition relief. In July 2018, the FASB issued ASU 2018-11, Leases, Targeted Improvements ("ASU 2018-11"). ASU 2018-11 provides entities with a transition method option to not restate comparative periods presented, but to recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. In addition, ASU 2018-11 provides entities with a practical expedient allowing lessors to not separate non-lease components from the associated lease components when certain criteria are met. ASU 2016-02 and ASU 2018-11 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, and early adoption is permitted. We expect to elect these practical expedients and adopt ASC 842 on January 1, 2019. As a result of adopting ASU 2016-02, the Company will recognize all of its operating leases for which it is the lessee, including ground leases, on its consolidated balance sheets as a lease liability and corresponding right-of-use asset. We have detailed our future minimum lease obligations under non-cancelable leases in Note 12 (Rent Expense). The Company is currently assessing the material impact of the adoption of ASU 2016-02 as well as the adoption of the practical expedients and transition methods to its consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses, which changes the impairment model for most financial instruments by requiring companies to recognize an allowance for expected losses, rather than incur losses as required currently by the other-than-temporary impairment model. ASU 2016-13 will apply to most financial assets measured at amortized cost and certain other instruments, including trade and other receivables, loans, held-to-maturity debt securities, net investments in leases, and off-balance-sheet credit exposures (e.g., loan commitments). ASU 2016-13 is effective for reporting periods beginning after December 15, 2019, with early adoption permitted, and will be applied as a cumulative adjustment to retained earnings as of the effective date. We are currently assessing the potential effect the adoption of ASU 2016-13 will have on our consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payment. ASU 2016-15 clarifies the guidance on the classification of certain cash receipts and payments in the statement of cash flows to reduce diversity in practice with respect to: (i) debt prepayment or debt extinguishment costs; (ii) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; (iii) contingent consideration payments made after a business combination; (iv) proceeds from the settlement of insurance claims; (v) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; (vi) distributions received from equity method investees; (vii) beneficial interests in securitization transactions; and (viii) separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017 with early adoption permitted. The Company adopted ASU 2016-15 on January 1, 2018, with no material effect on its consolidated financial statements and no adjustments made to prior periods.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows: Restricted Cash, which will require companies to include restricted cash with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown in the statement of cash flows. ASU 2016-18 will require disclosure of a reconciliation between the balance sheet and the statement of cash flows when the balance sheet includes more than one line item for cash, cash equivalents, restricted cash, and restricted cash equivalents. An entity with material restricted cash and restricted cash equivalents balances will be required to disclose the nature of the restrictions. ASU 2016-18 is effective for reporting periods beginning after December 15, 2017 and is required to be applied retrospectively to all periods presented. The Company adopted ASU 2016-18 on January 1, 2018, with no material effect on its consolidated financial statements and no adjustments made to prior periods.

In January 2017, the FASB issued ASU No. 2017-01, Clarifying the Definition of a Business, which changes the definition of a business to assist entities with evaluating when a set of transferred assets and activities is a business. ASU 2017-01 states that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not a business. If this initial test is not met, a set cannot be considered a business unless it includes an acquired input and a substantive process that together significantly contribute to the ability to create outputs. In addition, ASU 2017-01 clarifies the requirements for a set of activities to be considered a business and narrows the definition of an output. This ASU is to be applied prospectively and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. The Company adopted ASU 2017-01 on January 1, 2018 and as a result, have classified our real estate acquisitions completed during the nine months ended September 30, 2018 as

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asset acquisitions rather than business combinations due to the fact that substantially all of the fair value of the gross assets acquired were concentrated in a single asset or group of similar identifiable assets. The Company has recorded identifiable assets acquired, liabilities assumed, and any noncontrolling interests associated with any asset acquisitions at cost on a relative fair value basis and has capitalized transaction costs incurred.

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities, which expands and refines hedge accounting for both nonfinancial and financial risk components and aligns the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. It also includes certain targeted improvements to simplify the application of current guidance related to hedge accounting. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted. The Company is currently in the process of evaluating the effects this standard will have on its consolidated financial statements.

Note 3. Acquisitions and Dispositions

Effective January 1, 2018, with our adoption of ASU 2017-01, transaction costs incurred for asset acquisitions are capitalized as a component of purchase price and all other non-capitalizable costs are reflected in “General and Administrative Expenses” on our consolidated statements of income. Certain acquisitions that occurred prior to January 1, 2018 were accounted for as business combinations.

During the nine months ended September 30, 2018, the Company completed acquisitions of 4 operating healthcare properties and 1 land parcel located in 5 states for an aggregate purchase price of approximately $252.8 million. The Company completed a noncontrolling interest buyout for $6.4 million, and a $2.0 million loan transaction, resulting in total investment activity of approximately $261.3 million. The Company also acquired 2 properties and an adjacent land parcel through the conversion and satisfaction of a previously outstanding construction loan. Additionally, the Company acquired 2 parcels of land, which it had previously leased, as the result of a lease restructuring arrangement and equity recapitalization.

During the three months ended September 30, 2018, the Company completed the acquisition of the Northside Medical Midtown MOB located in Atlanta, GA for approximately $82.1 million. The Company also acquired 2 properties and an adjacent land parcel through the conversion and satisfaction of a previously outstanding construction loan, valued at an aggregate $18.8 million. Additionally, the Company acquired 2 parcels of land, which it had previously leased, as the result of a lease restructuring arrangement and equity recapitalization.

For the three months ended September 30, 2018, the Company recorded revenues and net income from its 2018 acquisitions of $3.9 million and $1.4 million, respectively. For the nine months ended September 30, 2018, the Company recorded revenues and net income from its 2018 acquisitions of $9.3 million and $3.4 million, respectively.

The following table summarizes the acquisition date fair values of the assets acquired and the liabilities assumed, which the Company determined using Level 2 and Level 3 inputs (in thousands):



	1st Quarter			2nd Quarter		3rd Quarter		Total
Land	$	7,684		$	—	$	9,632	$	17,316
Building and improvements	82,180			64,197		67,772		214,149
In-place lease intangibles	13,202			8,923		11,777		33,902
Above market in-place lease intangibles	969			—		98		1,067
Below market in-place lease intangibles	(959		)	—		—		(959		)
Below market in-place ground lease	—			—		5,329		5,329
Mortgage escrow	—			—		7,862		7,862
Prepaid expenses	(2,628		)	—		—		(2,628		)
Issuance of Series A Preferred Units	(22,651		)	—		—		(22,651		)
Net assets acquired	$	77,797		$	73,120	$	102,470	$	253,387

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Dispositions

During the three months ended March 31, 2018, the Company sold 2 medical office buildings located in Michigan and Florida for approximately $2.5 million and recognized a net gain on the sale of approximately $0.1 million. During the three months ended June 30, 2018, the Company sold 15 medical office buildings located in 3 states for approximately $90.7 million and recognized a net loss on the sale of approximately $2.6 million. During the three months ended September 30, 2018, the Company sold 17 medical office buildings located in 7 states for approximately $127.2 million and recognized a net gain on the sale of approximately $14.2 million.

The following table summarizes revenues and net income related to the disposed properties for the periods presented (in thousands):



	Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017
Revenues	$	947	$	5,770	$	12,295	$	17,906

Income before net gain on sale of investment properties:	$	1,827	$	1,411	$	5,030	$	4,956
Gain on sale of investment properties, net	14,227		—		11,664		—
Net income	$	16,054	$	1,411	$	16,694	$	4,956

Assets Held for Sale

As of September 30, 2018, the Company classified one portfolio comprised of two properties as held for sale. In accordance with this classification, the following assets are classified as held for sale in the accompanying consolidated balance sheets at September 30, 2018.



Land and improvements	$	3,780
Building and improvements	28,127
Acquired lease intangibles	6,077
Other assets	3,491
Real estate held for sale before accumulated deprecation	41,475
Accumulated depreciation	(6,049		)
Real estate held for sale	$	35,426

Note 4. Intangibles

The following is a summary of the carrying amount of intangible assets and liabilities, excluding assets classified as held for sale if applicable, as of September 30, 2018 and December 31, 2017 (in thousands):



	September 30, 2018							December 31, 2017
	Cost		Accumulated Amortization			Net		Cost		Accumulated Amortization			Net
Assets
In-place leases	$	339,795	$	(102,068	)	$	237,727	$	343,429	$	(85,424	)	$	258,005
Above-market leases	43,472		(11,787		)	31,685		54,148		(11,968		)	42,180
Leasehold interest	712		(226		)	486		712		(183		)	529
Below-market ground leases	65,677		(1,925		)	63,752		60,424		(1,344		)	59,080
Total	$	449,656	$	(116,006	)	$	333,650	$	458,713	$	(98,919	)	$	359,794
Liabilities
Below-market leases	$	14,870	$	(6,374	)	$	8,496	$	14,344	$	(4,479	)	$	9,865
Above-market ground leases	5,965		(232		)	5,733		5,965		(128		)	5,837
Total	$	20,835	$	(6,606	)	$	14,229	$	20,309	$	(4,607	)	$	15,702

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The following is a summary of acquired lease intangible amortization for the three and nine month periods ended September 30, 2018 and 2017, respectively (in thousands):



	Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017
Amortization expense related to in-place leases	$	16,274	$	9,453	$	38,251	$	26,520
Decrease of rental income related to above-market leases	1,075		1,335		3,992		3,987
Decrease of rental income related to leasehold interest	15		15		44		44
Increase of rental income related to below-market leases	615		623		2,109		1,704
Decrease of operating expense related to above-market ground leases	33		34		104		49
Increase in operating expense related to below-market ground leases	255		208		745		581

In the three months ended September 30, 2018, the Company amortized the remaining $6.6 million in-place lease intangibles on a lease which was terminated.

In the nine months ended September 30, 2018, the Company amortized in-place lease intangibles of $6.8 million from new properties purchased since September 30, 2017, $6.6 million from a lease termination, offset by a $1.8 million decrease in amortization from our sold properties during the last twelve months.

Future aggregate net amortization of the acquired lease intangibles, excluding two assets classified as held for sale, as of September 30, 2018, is as follows (in thousands):



	Net Decrease in Revenue			Net Increase in Expenses
2018	$	(573	)	$	9,712
2019	(2,417		)	35,517
2020	(2,554		)	32,791
2021	(2,517		)	30,513
2022	(2,055		)	26,677
Thereafter	(13,559		)	160,536
Total	$	(23,675	)	$	295,746

As of September 30, 2018, the weighted average amortization period for asset lease intangibles and liability lease intangibles is 20 and 21 years, respectively.

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Note 5. Other Assets

Other assets consisted of the following, excluding assets classified as held for sale if applicable, as of September 30, 2018 and December 31, 2017 (in thousands):



	September 30, 2018		December 31, 2017
Straight line rent receivable, net	$	56,702	$	47,599
Interest rate swap	21,200		14,693
Note receivable	20,628		—
Prepaid expenses	17,060		18,103
Lease inducements, net	12,774		14,232
Escrows	9,552		1,996
Leasing commissions, net	5,826		4,128
Earnest deposits	—		2,780
Other	4,825		2,771
Total	$	148,567	$	106,302

Note 6. Debt

The following is a summary of debt as of September 30, 2018 and December 31, 2017 (in thousands):



	September 30, 2018			December 31, 2017
Fixed interest mortgage notes	$	120,931	(1)	$	158,171	(2)
Variable interest mortgage notes	13,908		(3)	28,509		(4)
Total mortgage debt	134,839			186,680
$850 million unsecured revolving credit facility bearing variable interest of LIBOR plus 1.10% at September 30, 2018 and LIBOR plus 1.20% at December 30, 2017, due September 2022	179,000			80,000
$400 million senior unsecured notes bearing fixed interest of 4.30%, due March 2027	400,000			400,000
$350 million senior unsecured notes bearing fixed interest of 3.95%, due January 2028	350,000			350,000
$250 million unsecured term borrowing bearing fixed interest of 2.32% at September 30, 2018 and 2.87% at December 31, 2017, due June 2023	250,000		(5)	250,000		(6)
$150 million senior unsecured notes bearing fixed interest of 4.03% to 4.74%, due January 2023 to 2031	150,000			150,000
$75 million senior unsecured notes bearing fixed interest of 4.09% to 4.24%, due August 2025 to 2027	75,000