Leases and Management Agreements With Five Star

Our Senior Living Communities Leased by Five Star. We are Five Star’s largest landlord and Five Star is our largest tenant. We leased 185, 177 and 181 senior living communities to Five Star as of December 31, 2016, 2015 and 2014, respectively. We lease senior living communities to Five Star pursuant to the following five leases with Five Star:


•	Lease No. 1, which expires in 2024 and includes 83 independent living communities, assisted living communities and SNFs.


•	Lease No. 2, which expires in 2026 and includes 47 independent living communities, assisted living communities and SNFs.


•	Lease No. 3, which expires in 2028 and includes 17 independent living communities and assisted living communities, all of which secure our mortgage debts payable to the Federal National Mortgage Association.


•	Lease No. 4, which expires in 2032 and includes 29 independent living communities, assisted living communities and SNFs.


•	Lease No. 5, which expires in 2028 and includes nine assisted living communities.

Under our leases with Five Star, Five Star pays us annual rent plus percentage rent equal to 4% of the increase in gross revenues at certain of our senior living communities over base year gross revenues as specified in the applicable lease. Five Star’s obligation to pay percentage rent under Lease No. 5 commences in 2018. We determine percentage rent due under these leases annually and recognize it at year end when all contingencies are met. We recognized total rental income from Five Star of $203,581, $196,919 and $196,269 (including percentage rent of $5,686, $5,666 and $5,752, for the years ended December 31, 2016, 2015 and 2014, respectively. As of December 31, 2016, Five Star’s total annual rent payable to us was $203,356, excluding percentage rent. As of December 31, 2016 and 2015, our rents receivable from Five Star were $18,320 and $17,466, respectively, and those amounts are included in due from affiliate in our consolidated balance sheets. Under our leases with Five Star, Five Star has the option to extend the lease term for two consecutive 10 or 15 year terms. We have the right, in connection with a financing or other capital raising transaction, to reassign one or more of the communities covered by Lease No. 5, and, after repayment of certain mortgage debt financing of ours, to reassign one or more of the communities covered by Lease No. 3, to another of our long term lease agreements with Five Star.

Our leases with Five Star are so called “triple net” leases which generally require Five Star to pay rent and all property operating expenses, to indemnify us from liability which may arise by reason of our ownership of the properties, to maintain the properties at Five Star’s expense, to remove and dispose of hazardous substances on the properties in compliance with applicable law and to maintain insurance on the properties for Five Star’s and our benefit. In the event of any damage, or immaterial condemnation, of a leased property, Five Star is generally required to rebuild with insurance or condemnation proceeds or, if such proceeds are insufficient, other amounts made available by us, if any, but if other amounts are made available by us, the rent will be increased accordingly. In the event of any material or total condemnation of a leased property, the lease will terminate with respect to that leased property, in which event we will be entitled to the condemnation proceeds and the rent will be reduced accordingly. In the event of any material or total destruction of a leased property, Five Star may terminate the lease with respect to that leased property, in which event Five Star will be required to pay us any shortfall in the amount of proceeds we receive from insurance compared to the replacement cost of that leased property and the rent will be reduced accordingly.

Under our leases with Five Star, Five Star may request that we purchase certain improvements to the leased communities in return for rent increases in accordance with a formula specified in the applicable lease; however, we are not obligated to purchase such improvements and Five Star is not obligated to sell them to us. During the years ended December 31, 2016, 2015 and 2014, we purchased $21,438, $21,444 and $25,804, respectively, of such improvements and Five Star’s annual rent payable to us increased by $1,719, $1,734 and $2,066, respectively, in accordance with the terms of the applicable leases.

Five Star is our most significant tenant. The following is a summary of the assets leased and revenues earned from Five Star as a tenant as of and for the years ended December 31, 2016 and 2015 compared to all our other assets and revenues from all sources:



	At				At
	December 31, 2016				December 31, 2015
	Real Estate Properties, at Cost		% of Total		Real Estate Properties, at Cost		% of Total
Five Star	$	2,293,257	30	%	$	2,147,388	29	%
All others	5,437,266		70	%	5,309,552		71	%
	$	7,730,523	100	%	$	7,456,940	100	%



	Year Ended				Year Ended
	December 31, 2016				December 31, 2015
	Total revenues		% of Total		Total revenues		% of Total
Five Star	$	203,581	19	%	$	196,919	20	%
All others	854,441		81	%	801,854		80	%
	$	1,058,022	100	%	$	998,773	100	%

See Note 3 for further information on the effects of certain of our property acquisitions and dispositions on our leases with Five Star.

Our Senior Living Communities Managed by Five Star. Five Star managed 68, 60 and 46 senior living communities for our account as of December 31, 2016, 2015 and 2014, respectively. We lease our senior living communities that are managed by Five Star and include assisted living units or SNFs to our TRSs, and Five Star manages these communities pursuant to long term management agreements.

As of December 31, 2016, we owned 68 senior living communities that are managed by Five Star. During the year ended December 31, 2016, Five Star began managing for our account eight senior living communities we own with an aggregate 696 living units. Two of these communities, located in North Carolina and Alabama with a combined 263 living units, had previously been leased to unrelated third parties that defaulted on such leases. We acquired one of these communities, located in Georgia with 38 living units, in May 2016. Five of these communities, located in Georgia with a combined 395 living units, had previously been managed by affiliates of one of the unrelated third parties that defaulted on its lease referred to above. In December 2016, we terminated the in place management agreements for these communities and entered into new management agreements with Five Star to manage these five communities for our account. One of these new management agreements was added to one of our existing pooling agreements with Five Star and the remaining four new management agreements were added to a new pooling agreement with Five Star. During the year ended December 31, 2016, we also sold a formerly managed memory care building located in Florida. See Note 3 to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K for further information regarding our acquisitions and dispositions.

On June 29, 2016, we and Five Star terminated three of our four then existing pooling agreements and entered into the 10 new pooling agreements that combine our AL Management Agreements for senior living communities. Our management agreement with Five Star for the part of our senior living community located in New York that is not subject to the requirements of New York healthcare licensing laws, as described elsewhere herein, and the management agreement for one of our assisted living communities located in California, are not currently included in any of our pooling agreements with Five Star. Pursuant to our AL Management Agreements and the new pooling agreements, Five Star receives:


•	a management fee equal to either 3% or 5% of the gross revenues realized at the applicable communities,


•	reimbursement for its direct costs and expenses related to such communities,


•	an annual incentive fee equal to either 35% or 20% of the annual net operating income of such communities remaining after we realize an annual minimum return equal to either 8% or 7% of our invested capital, or, in the case of 10 communities, a specified amount plus 7% of our invested capital since December 31, 2015, and


•	a fee for its management of capital expenditure projects equal to 3% of amounts funded by us.

Each of the new pooling agreements combines various calculations of revenues and expenses from the operations of the applicable communities covered by such agreement.

Under the new pooling agreements, the calculations of Five Star’s fees and of our annual minimum return related to our AL Management Agreement that became effective before May 2015 and had been pooled under one of the previously existing pooling agreements are generally the same as they were under the previously existing pooling agreements. However, for certain communities, the new pooling agreements reduced our annual minimum return to 7%, and also, with respect to 10 communities, reset our annual minimum return as of January 1, 2016 to specified amounts. For our AL Management Agreements that became effective from and after May 2015, the new pooling agreements increased the management fee we pay Five Star from 3% to 5% of the gross revenues realized at the applicable community, and changed the annual incentive fee we pay Five Star from 35% to 20% of the annual net operating income of the applicable community remaining after we realize our requisite annual minimum return.

We also have a pooling agreement with Five Star that combines our management agreements with Five Star for senior living communities consisting only of independent living units, or the IL Pooling Agreement.

Our management agreements with Five Star generally expire between 2030 and 2040, and are subject to automatic renewal for two consecutive 15 year terms, unless earlier terminated or timely notice of nonrenewal is delivered. These management agreements also generally provide that we and Five Star each have the option to terminate the agreements upon the acquisition by a person or group of more than 9.8% of the other’s voting stock and upon certain change in control events affecting the other party, as defined in the applicable agreements, including the adoption of any shareholder proposal (other than a precatory proposal) with respect to the other party, or the election to the board of directors or trustees, as applicable, of the other party of any individual, if such proposal or individual was not approved, nominated or appointed, as the case may be, by a majority of the other party’s board of directors or board of trustees, as applicable, in office immediately prior to the making of such proposal or the nomination or appointment of such individual.

We own a senior living community in New York with 310 living units, a part of which is managed by Five Star pursuant to a long term management agreement with us with respect to the senior living units at this community that are not subject to the requirements of New York healthcare licensing laws. The terms of this management agreement are substantially consistent with the terms of our other management agreements with Five Star for communities that include assisted living units, except that the management fee payable to Five Star is equal to 5% of the gross revenues realized at that part of the community and there is no incentive fee payable by us to Five Star. This management agreement expires on December 31, 2031.

In order to accommodate certain requirements of New York healthcare licensing laws, one of our TRSs subleases the part of this community that is subject to the requirements of those laws, to D&R Yonkers LLC, an entity which is owned by our President and Chief Operating Officer and Five Star’s chief financial officer and treasurer. Five Star manages this part of the community pursuant to a long term management agreement with D&R Yonkers LLC under which Five Star earns a management fee equal to 3% of the gross revenues realized at that part of the community and no incentive fee is payable to Five Star. D&R Yonkers LLC’s management agreement with Five Star expires on August 31, 2017, and is subject to renewal for nine consecutive five year terms, unless earlier terminated or timely notice of nonrenewal is delivered. We have entered into an indemnification agreement with the owners of D&R Yonkers LLC pursuant to which we have agreed to indemnify them for costs, losses and expenses they may sustain by reason of being a member, director or officer of D&R Yonkers LLC or in connection with any costs, losses or expenses under our TRS’s sublease with D&R Yonkers LLC or the management agreement between D&R Yonkers LLC and Five Star. Our transactions and balances with D&R Yonkers LLC are eliminated upon consolidation for accounting purposes and are not separately stated and do not appear in our consolidated financial statements.

We incurred management fees of $11,918, $10,728 and $9,765 for the years ended December 31, 2016, 2015 and 2014, respectively, with respect to the communities Five Star manages for us. These amounts are included in property operating expenses in our consolidated statements of comprehensive income.

See Note 3 for further information on the effects of certain of our property acquisitions and dispositions on our management agreements with Five Star.