| UNIVERSAL HEALTH REALTY INCOME TRUST ITEM 1A Risk Factors We are subject to numerous known and unknown risks, many of which are described below and elsewhere in this Annual Report |
| Any of the events described below could have a material adverse effect on our business, financial condition and results of operations |
| Additional risks and uncertainties that we are not aware of, or that we currently deem to be immaterial, could also impact our business and results of operations |
| A substantial portion of our revenues are dependent upon one operator |
| If UHS experiences financial difficulties, or otherwise fails to make payments to us, our revenues will significantly decline |
| For the year ended December 31, 2005, UHS accounted for 48prca of our revenues |
| In addition, as of December 31, 2005, subsidiaries of UHS leased five of the seven (including Chalmette, which suffered substantial damage from Hurricane Katrina during the third quarter of 2005) hospital facilities owned by us with terms expiring through 2009 |
| We cannot assure you that UHS will continue to satisfy its obligations to us |
| The failure or inability of UHS to satisfy its obligations to us could materially reduce our revenues and net income, which could in turn reduce the amount of dividends we pay and cause our stock price to decline |
| Our relationship with UHS may create conflicts of interest |
| In addition to being dependent upon UHS for a substantial portion of our revenues and leases, since 1986, UHS of Delaware, Inc |
| Pursuant to our Advisory Agreement, the Advisor is obligated to present an investment program to us, to use its best efforts to obtain investments suitable for such program (although it is not obligated to present any particular investment opportunity to us), to provide administrative services to us and to conduct our day-to-day affairs |
| Further, all of our officers are all employees of UHS As of December 31, 2005, we had no employees |
| We believe that the quality and depth of the management and advisory services provided to us by our Advisor and UHS could not be replicated by contracting with unrelated third parties or by being self-advised without considerable cost increases |
| We believe that these relationships have been beneficial to us in the past, but we cannot guarantee that will not become detrimental to us in the future |
| All transactions with UHS must be approved by a majority of our Trustees who are unaffiliated with UHS We believe that our current leases and business dealings with UHS have been entered into on commercially reasonably terms |
| However, because of our historical and continuing relationship with UHS and its subsidiaries, in the future, our business dealings may not be on the same or as favorable terms as we might achieve with a third party with whom we do not have such a relationship |
| Disputes may arise between us and UHS that we are unable to resolve or the resolution of these disputes may not be as favorable to us as a resolution we might achieve with a third party |
| One of our properties suffered substantial damage due to Hurricane Katrina and we cannot guarantee the performance of any substitute property |
| Chalmette Medical Center, our two story, 138-bed acute care hospital located in Chalmette, Louisiana, was severely damaged and closed as a result of Hurricane Katrina during the third quarter of 2005 resulting in a write-down of the carrying-value of the depreciable assets to zero |
| Chalmette is leased by a wholly-owned subsidiary of UHS and pursuant to the terms of the lease in such circumstances, UHS is obligated to: (i) restore the property to substantially the same condition existing before the damage; (ii) offer to acquire the property in accordance with the terms of the lease, or; (iii) offer a substitution property equivalent in value to Chalmette |
| We believe that these expenses will be covered by insurance (UHS is responsible for maintaining replacement cost property insurance), however UHS may be unable to determine the timing and amount of total insurance proceeds collectible by it since the proceeds will be based on factors such as loss causation, ultimate replacement costs of damaged assets and ultimate economic value of business interruption claims |
| The existing lease on Chalmette remains in place and rental income will continue for a period of time while UHS evaluates its options |
| 13 ______________________________________________________________________ [35]Table of Contents We have been discussing with UHS the various alternatives available to UHS and us under the lease with Chalmette, including potentially fulfilling its Chalmette lease obligation by offering us a substitute property or properties equivalent in value |
| Any arrangement will be subject to the approval of our Board of Trustees and the Board of Directors of UHS Although we do not believe that the loss of this facility will have a material adverse effect on us, we cannot guarantee or predict the future performance of the substitute property or properties |
| See Note 2 to the Consolidated Financial Statements for additional disclosure |
| We hold majority, non-controlling equity ownership interests in various LLCs |
| For the year ended December 31, 2005, 59prca of our consolidated and unconsolidated revenues were generated by LLCs in which we hold a majority, non-controlling equity ownership interest |
| Our level of investment and lack of control exposes us to potential losses of our investments and revenues |
| Although our ownership arrangements have been beneficial to us in the past, we cannot guarantee that they will continue to be beneficial in the future |
| We cannot be certain of the availability and terms of external sources of capital to fund the growth of our business when needed |
| To retain our status as a REIT, we are required to distribute 90prca of our taxable income to shareholders and, therefore, we generally cannot use income from operations to fund our growth |
| Accordingly, our growth strategy depends, in part, upon our ability to raise additional capital at reasonable costs to fund new investments |
| We believe we will be able to raise additional debt and equity capital at reasonable costs to refinance our debts at or prior to their maturities and to invest at yields which exceed our cost of capital |
| We cannot predict, however, whether financing will be available to us on satisfactory terms when needed, which could harm our business |
| Our growth strategy is not assured and may fail |
| In addition, the degree to which we are, or in the future may become, leveraged could adversely affect our ability to obtain financing and could make us more vulnerable to competitive pressures |
| Our ability to meet existing and future debt obligations, depends upon our future performance and our ability to secure additional financing on satisfactory terms, each of which is subject to financial, business and other factors that are beyond our control |
| Any failure by us to meet our financial obligations would harm our business |
| The bankruptcy, default, insolvency or financial deterioration of our tenants could significantly delay our ability to collect unpaid rents or require us to find new operators |
| Our financial position and our ability to make distributions to our shareholders may be adversely affected by financial difficulties experienced by any of our major tenants, including bankruptcy, insolvency or a general downturn in the business |
| We are exposed to the risk that our operators may not be able to meet their obligations, which may result in their bankruptcy or insolvency |
| Although our leases and loans provide us the right to terminate an investment, evict an operator, demand immediate repayment and other remedies, the bankruptcy laws afford certain rights to a party that has filed for bankruptcy or reorganization |
| An operator in bankruptcy may be able to restrict our ability to collect unpaid rents or interest during the bankruptcy proceeding |
| Real estate ownership creates risks and liabilities that may result in unanticipated losses or expenses |
| Our business is subject to risks associated with real estate acquisitions and ownership, including: • general liability, property and casualty losses, some of which may be uninsured; • the illiquid nature of real estate and the real estate market that impairs our ability to purchase or sell our assets rapidly to respond to changing economic conditions; • real estate market factors, such as the supply and demand of office space and market rental rates, changes in interest rates as well as an increase in the development of medical office condominiums in certain markets; 14 ______________________________________________________________________ [36]Table of Contents • costs that may be incurred relating to maintenance and repair, and the need to make expenditures due to changes in governmental regulations, including the Americans with Disabilities Act; • environmental hazards at our properties for which we may be liable, including those created by prior owners or occupants, existing tenants, mortgagors or other persons, and; • defaults and bankruptcies by our tenants |
| In addition to the foregoing risks, we cannot predict whether the leases on our properties, including the leases on the properties leased to subsidiaries of UHS, which have options to purchase the respective leased facilities at the end of the lease or renewal terms at the appraised fair market value, will be renewed at their current rates at the end of the lease terms |
| If the leases are not renewed, we may be required to find other operators for these facilities and/or enter into leases with less favorable terms |
| The exercise of purchase options for our facilities may result in a less favorable rate of return for us than the rental revenue currently earned on such facilities |
| Further, the purchase options and rights of first refusal granted to the respective lessees to purchase or lease the respective leased facilities, after the expiration of the lease term, may adversely affect our ability to sell or lease a facility, and may present a potential conflict of interest between us and UHS since the price and terms offered by a third-party are likely to be dependent, in part, upon the financial performance of the facility during the final years of the lease term |
| In connection with our discussions with UHS relating to the damage to Chalmette and its obligations under the Chalmette lease, we have been discussing with UHS the renewal and terms of certain of our leases that are expiring in the near future |
| Any arrangement will be subject to the approval of our Board of Trustees and the Board of Directors of UHS Significant potential liabilities and rising insurance costs and availability may have an adverse effect on the operations of our operators, which may negatively impact their ability to meet their obligations to us |
| As is typical in the healthcare industry, in the ordinary course of business, our operators, including UHS, are subject to medical malpractice lawsuits, product liability lawsuits and other legal actions |
| Some of these actions may involve large claims, as well as significant defense costs |
| If their ultimate liability for professional and general liability claims could change materially from current estimates, if such policy limitations should be partially or fully exhausted in the future, or payments of claims exceed estimates or are not covered by insurance, it could have a material adverse effect on the operations of our operators |
| In addition, the malpractice expenses of our operators, including UHS, have increased in recent years and they continue to experience unfavorable pricing and availability trends in the professional and general liability insurance markets |
| There can be no assurance that insurance will continue to be available at reasonable prices that allow them to maintain adequate coverage |
| If these trends continue, they could have a material adverse effect on their operations |
| Property insurance rates, particularly for earthquake insurance in California, have also continued to increase |
| Our tenants and operators, including UHS, may be unable to fulfill their insurance, indemnification and other obligations to us under their leases and mortgages and thereby potentially expose us to those risks |
| In addition, our tenants and operators may be unable to pay their lease or mortgage payments, which could potentially decrease our revenues and increase our collection and litigation costs |
| Moreover, to the extent we are required to foreclose on the affected facilities, our revenues from those facilities could be reduced or eliminated for an extended period of time |
| In addition, we may in some circumstances be named as a defendant in litigation involving the actions of our operators |
| Although we have no involvement in the activities of our operators and our standard leases generally require our operators to carry insurance to cover us in certain cases, a significant judgment against us in such litigation could exceed our and our operators’ insurance coverage, which would require us to make payments to cover the judgment |
| Increased competition in the health care industry has resulted in lower revenues and higher costs for our operators, including UHS, and may affect our revenues, property values and lease renewal terms |
| The health care industry is highly competitive and competition among hospitals and other health care providers for patients has intensified in recent years |
| In most geographical areas in which our facilities are 15 ______________________________________________________________________ [37]Table of Contents operated, there are other facilities that provide services comparable to those offered by our facilities |
| In addition, some competing facilities are owned by tax-supported governmental agencies or by nonprofit corporations and may be supported by endowments and charitable contributions and exempt from property, sale and income taxes |
| Such exemptions and support are not available to our operators |
| In some markets, certain competing facilities may have greater financial resources, be better equipped and offer a broader range of services than those available at our facilities |
| Certain hospitals that are located in the areas served by our operators’ facilities are specialty or large hospitals that provide medical, surgical and behavioral health services, facilities and equipment that are not available at our operators’ hospitals |
| The increase in outpatient treatment and diagnostic facilities, outpatient surgical centers and freestanding ambulatory surgical also increases competition for our operators |
| In McAllen, Texas, the location of our largest facility, McAllen Medical Center (which is operated by a subsidiary of UHS), intense competition from other healthcare providers, including physician owned facilities, has increased |
| A physician-owned hospital in the market added new in-patient capacity in late 2004 which has eroded a portion of the facility’s higher margin business, including cardiac procedures |
| As a result, the facility continues to experience significant declines in patient volume and profitability |
| Inpatient admissions and patient days at this facility decreased 4prca and 14prca, respectively, during the twelve month periods ended December 31, 2005 as compared to the comparable prior year period |
| During 2004, as compared to 2003, admissions at this facility decreased 7prca, patient days decreased 6prca, net revenues decreased dlra24 million and income before income taxes decreased dlra21 million |
| In response to these competitive pressures, UHS has, among other things, undertaken significant capital investment in the market including a new dedicated 120-bed children’s facility, which is scheduled to be completed and opened in the first quarter of 2006, as well as a 134-bed replacement behavioral health facility, which is scheduled to be completed and opened during the second quarter of 2006 |
| A continuation of the increased provider competition in this market, as well as the additional capacity currently under construction, by UHS and others, could result in additional erosion of the net revenues and financial operating results of McAllen Medical Center which may negatively impact the bonus rentals earned by us on this facility and may potentially have a negative impact on the future lease renewal terms (current lease expires in December, 2006) and the underlying value of the property |
| In addition, the number and quality of the physicians on a hospital’s staff are important factors in determining a hospital’s competitive advantage |
| Typically, physicians are responsible for making hospital admissions decisions and for directing the course of patient treatment |
| The operators of our facilities also compete with other health care providers in recruiting and retaining qualified hospital management, nurses and other medical personnel |
| The operators of our acute care and behavioral health care facilities are experiencing the effects of a shortage of skilled nursing staff nationwide, which has caused and may continue to cause an increase in salaries, wages and benefits expense in excess of the inflation rate |
| In addition, as competition in the health care market has increased, wage rates and physician and other qualified medical support personnel recruiting costs have risen, increasing the continued pressure on a facility’s operating margins and profitability |
| Our operators may experience difficulties attracting and retaining qualified physicians, nurses and medical support personnel |
| We anticipate that our operators, including UHS, will continue to encounter increased competition in the future that could lead to a decline in patient volumes and harm their businesses, which in turn, could harm our business |
| Operators that fail to comply with governmental reimbursement programs such as Medicare or Medicaid, licensing and certification requirements, fraud and abuse regulations or new legislative developments may be unable to meet their obligations to us |
| Our operators, including UHS and its subsidiaries, are subject to numerous federal, state and local laws and regulations that are subject to frequent and substantial changes (sometimes applied retroactively) resulting from legislation, adoption of rules and regulations, and administrative and judicial interpretations of existing law |
| The 16 ______________________________________________________________________ [38]Table of Contents ultimate timing or effect of these changes cannot be predicted |
| Government regulation may have a dramatic effect on our operators’ costs of doing business and the amount of reimbursement received by both government and other third-party payors |
| The failure of any of our operators to comply with these laws, requirements and regulations could adversely affect their ability to meet their obligations to us |
| These regulations include, among other items: • hospital billing practices; • relationships with physicians and other referral sources; • adequacy of medical care; • quality of medical equipment and services; • qualifications of medical and support personnel; • confidentiality, maintenance and security issues associated with health-related information and patient medical records; • the screening, stabilization and transfer of patients who have emergency medical conditions; • licensure and accreditation of our facilities; • hospital rate or budget review; • operating policies and procedures, and; • construction or expansion of facilities and services |
| If our operators fail to comply with applicable laws and regulations, they could be subjected to liabilities, including criminal penalties, civil penalties (including the loss of their licenses to operate one or more facilities), and exclusion of one or more facilities from participation in the Medicare, Medicaid and other federal and state health care programs |
| The imposition of such penalties could jeopardize that operator’s ability to make lease or mortgage payments to us or to continue operating its facility |
| In addition, our bonus rents are based on our operators net revenues, which in turn are affected by the amount of reimbursement that such lessees receive from the government |
| Although UHS and the other operators of our acute care facilities, believe that their policies, procedures and practices comply with governmental regulations, no assurance can be given that they will not be subjected to governmental inquiries or actions, or that they would not be faced with sanctions, fines or penalties if so subjected |
| Because many of these laws and regulations are relatively new, in many cases, our operators don’t have the benefit of regulatory or judicial interpretation |
| In the future, it is possible that different interpretations or enforcement of these laws and regulations could subject their current or past practices to allegations of impropriety or illegality or could require them to make changes in the facilities, equipment, personnel, services, capital expenditure programs and operating expenses |
| Even if they were to ultimately prevail, a significant governmental inquiry or action under one of the above laws, regulations or rules could have a material adverse effect upon them, and in turn, us |
| • Medicare, Medicaid and Private Payor Reimbursement |
| A significant portion of the revenue earned by the operators of our acute care hospitals is derived from federal and state healthcare programs, including Medicare and Medicaid |
| Given increasing budget deficits, the federal government and many states are currently considering additional ways to limit increases in levels of Medicare and Medicaid funding, which could also adversely affect future payments received by operators of our facilities |
| In addition to statutory and regulatory changes to the Medicare and each of the state Medicaid programs, our operators’ operations and reimbursement may be affected by administrative rulings, new or novel interpretations and determinations of existing laws and regulations, post-payment audits, requirements for utilization review and new governmental funding restrictions, all of which may materially increase or decrease program payments as well as affect the cost of providing services and the timing of payments to our facilities |
| 17 ______________________________________________________________________ [39]Table of Contents In addition to changes in government reimbursement programs, our operators’ ability to negotiate favorable service contracts with purchasers of group health services, including managed care providers, significantly affects the revenues and operating results of our facilities |
| Further, a primary collection risk for our operators relates to uninsured patients and the portion of the bill that is the patient’s responsibility, which primarily includes co-payments and deductibles |
| • Health Care Reform |
| An increasing number of legislative initiatives have been introduced or proposed in recent years that would result in major changes in the health care delivery system on a national or a state level |
| Among the proposals that have been introduced are price controls on hospitals, insurance market reforms to increase the availability of group health insurance to small businesses, requirements that all businesses offer health insurance coverage to their employees and the creation of government health insurance plans that would cover all citizens and increase payments by beneficiaries |
| We cannot predict whether any proposals will be adopted or, if adopted, what effect, if any, these proposals would have on operators and, thus, our business |
| If we fail to maintain our REIT status, we will become subject to federal income tax on our taxable income at regular corporate rates |
| In order to qualify as a REIT, we must comply with certain highly technical and complex Internal Revenue Code provisions |
| Although we believe we have been qualified as a REIT since our inception, there can be no assurance that we have been so qualified or will remain qualified in the future |
| Failure to qualify as a REIT may subject us to income tax liabilities, including federal income tax at regular corporate rates |
| The additional income tax incurred may significantly reduce the cash flow available for distribution to shareholders and for debt service |
| In addition, if disqualified, we might be barred from qualification as a REIT for four years following disqualification |
| The market value of our common stock could be substantially affected by various factors |
| Many factors, certain of which are outside of our control, could have an adverse effect on the share price of our common stock |
| These factors include certain of the risks discussed herein, our financial condition, performance and prospects, the market for similar securities issued by REITs, demographic changes, operating results of our operators and other hospital companies, changes in our financial estimates or recommendations of securities analysts, speculation in the press or investment community, the possible effects of war, terrorist and other hostilities, adverse weather conditions, the level of seasonal illnesses, changes in general conditions in the economy or the financial markets, or other developments affecting the health care industry |
| Ownership limitations and anti-takeover provisions in our declaration of trust and bylaws and under Maryland law may delay, defer or prevent a change in control or other transactions that could provide shareholders with a take-over premium |
| We are subject to significant anti-takeover provisions |
| In order to protect us against the risk of losing our REIT status for federal income tax purposes, our declaration of trust permits our Trustees to redeem shares acquired or held in excess of 9dtta8prca of the issued and outstanding shares of our voting stock and, which in the opinion of the Trustees would jeopardize our REIT status |
| In addition, any acquisition of our common or preferred shares that would result in our disqualification as a REIT is null and void |
| The right of redemption may have the effect of delaying, deferring or preventing a change in control of our company and could adversely affect our shareholders’ ability to realize a premium over the market price for the shares of our common stock |
| Our declaration of trust authorizes our Board of Trustees to issue additional shares of common and preferred stock and to establish the preferences, rights and other terms of any series of preferred stock that we issue |
| Although our Board of Trustees has no intention to do so at the present time, it could establish a series of preferred stock that could delay, defer or prevent a transaction or a change in control that might involve the payment of a premium over the market price for our common stock or otherwise be in the best interests of our shareholders |
| 18 ______________________________________________________________________ [40]Table of Contents These provisions could discourage unsolicited acquisition proposals or make it more difficult for a third-party to gain control of us, which could adversely affect the market price of our securities and prevent shareholders from receiving a take-over premium |
| We depend heavily on key management personnel and the departure of one or more of our key executives or a significant portion of our operators’ local hospital management personnel could harm our business |
| The expertise and efforts of our senior executives and key members of our operators’ local hospital management personnel are critical to the success of our business |
| The loss of the services of one or more of our senior executives or of a significant portion of our operators’ local hospital management personnel could significantly undermine our management expertise and our operators’ ability to provide efficient, quality health care services at our facilities, which could harm their business, and in turn, harm our business |
| Increasing investor interest in our sector and consolidation at the operator or REIT level could increase competition and reduce our profitability |
| Our business is highly competitive and we expect that it may become more competitive in the future |
| We compete for the acquisition, leasing and financing of health care related facilities |
| Our competitors include, but are not limited to, other REITs, banks and other companies, including UHS, some of which are larger and have a lower cost of capital than we do |
| Additionally, the potential for consolidation at the REIT or operator level appears to have increased |
| These developments could result in fewer investment opportunities for us and lower spreads over our cost of our capital, which would hurt our growth |