** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, DC 20549**

 

**FORM 10-Q**

 

**ý****    QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d)**

**OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended September 30,2005**

 

**OR**

 

**o****    TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**Commission File Number 1-15319**

 

**SENIORHOUSING PROPERTIES TRUST**

 
| **Maryland**            | ** ** | **04-3445278**                     |
|-------------------------|------------|------------------------------------|
| (State of Organization) |       | (IRS Employer  Identification No.) |

 

**400 Centre Street, Newton,Massachusetts 02458**

 

**617-796-8350**

 

Indicate by check markwhether the registrant:  (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months, and (2) hasbeen subject to such filing requirements for the past 90 days. Yes ý  No o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).    Yes ý  No o

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).    Yes o  No ý

 

Number of registrant’scommon shares outstanding as of November 1, 2005:  68,562,227

 

 

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SENIOR HOUSING PROPERTIES TRUST

 

FORM 10-Q

 

September 30, 2005

 

INDEX

 
| PART I         | Financial Information                                                                                 |   |
|---------------------|-------------------------------------------------------------------------------------------------------|--------|
|                |                                                                                                  |   |
|   Item 1. | Financial Statements (unaudited)                                                                      |   |
|                |                                                                                                  |   |
|                | Consolidated  Balance Sheet – September 30,  2005 and December 31, 2004                |   |
|                |                                                                                                  |   |
|                | Consolidated  Statement of Income – Three and Nine Months Ended September 30, 2005 and 2004 |   |
|                |                                                                                                  |   |
|                | Consolidated  Statement of Cash Flows – Nine Months  Ended September 30, 2005 and 2004 |   |
|                |                                                                                                  |   |
|                | Notes  to Consolidated Financial Statements                                                           |   |
|                |                                                                                                  |   |
|   Item 2. | Management’s Discussion and  Analysis of Financial Condition and Results of Operations           |   |
|                |                                                                                                  |   |
|   Item 3. | Quantitative and Qualitative  Disclosures about Market Risk                                           |   |
|                |                                                                                                  |   |
|   Item 4. | Controls and Procedures                                                                               |   |
|                |                                                                                                  |   |
|                | Warning  Concerning Forward Looking Statements                                                        |   |
|                |                                                                                                  |   |
|                | Statement  Concerning Limited Liability                                                               |   |
|                |                                                                                                  |   |
| PART II        | Other Information                                                                                     |   |
|                |                                                                                                  |   |
|   Item 1. | Legal Proceedings                                                                                     |   |
|                |                                                                                                  |   |
|   Item 2. | Unregistered Sales of Equity  Securities and Use of Proceeds                                          |   |
|                |                                                                                                  |   |
|   Item 5. | Other Information                                                                                     |   |
|                |                                                                                                  |   |
|   Item 6. | Exhibits                                                                                              |   |
|                |                                                                                                  |   |
|                | Signatures                                                                                            |   |

 

*In thisQuarterly Report on Form 10-Q, the terms “SNH”, “Senior Housing”, “theCompany”, “we”, “us” and “our” refer to Senior Housing Properties Trust and itsconsolidated subsidiaries, unless otherwise noted.*

 

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SENIOR HOUSING PROPERTIES TRUST

 

**PART I.****     ****Financial Information**

 

**Item1.**        Financial Statements

** **

CONSOLIDATED BALANCE SHEET

(in thousands, except share amounts)

 
| ** **                                                                                                                                                   | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                   | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| ** **                                                                                                                                                   | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| ASSETS                                                                                                                                                       |       |                   |       |                  |       |
| Real estate properties, at cost:                                                                                                                             |       |                   |       |                  |       |
| Land                                                                                                                                                         |       | $                      | 180,285    |                  | $          | 178,353 |   |
| Buildings and improvements                                                                                                                                   |       | 1,451,728              |       | 1,422,599             |       |
|                                                                                                                                                         |       | 1,632,013              |       | 1,600,952             |       |
| Less accumulated depreciation                                                                                                                                |       | 231,118                |       | 199,232               |       |
|                                                                                                                                                         |       | 1,400,895              |       | 1,401,720             |       |
|                                                                                                                                                         |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                                    |       | 1,856                  |       | 3,409                 |       |
| Restricted cash                                                                                                                                              |       | 2,501                  |       | 6,176                 |       |
| Deferred financing fees, net                                                                                                                                 |       | 11,312                 |       | 9,367                 |       |
| Other assets                                                                                                                                                 |       | 23,839                 |       | 27,058                |       |
| Total assets                                                                                                                                                 |       | $                      | 1,440,403  |                  | $          | 1,447,730 |   |
|                                                                                                                                                         |       |                   |       |                  |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                                    |       |                   |       |                  |       |
| Unsecured revolving bank credit facility                                                                                                                     |       | $                      | 59,000     |                  | $          | 37,000 |   |
| Senior unsecured notes due 2012 and 2015, net of  discount                                                                                                   |       | 393,898                |       | 393,775               |       |
| Junior subordinated debentures due 2041                                                                                                                      |       | 28,241                 |       | 28,241                |       |
| Secured debt and capital leases                                                                                                                              |       | 70,618                 |       | 76,162                |       |
| Accrued interest                                                                                                                                             |       | 10,361                 |       | 12,519                |       |
| Other liabilities                                                                                                                                            |       | 10,199                 |       | 9,366                 |       |
| Total liabilities                                                                                                                                            |       | 572,317                |       | 557,063               |       |
|                                                                                                                                                         |       |                   |       |                  |       |
| Commitments and contingencies                                                                                                                                |       |                   |       |                  |       |
|                                                                                                                                                         |       |                   |       |                  |       |
| Shareholders’ equity:                                                                                                                                   |       |                   |       |                  |       |
| Common shares of beneficial interest, $0.01 par  value: 80,000,000 shares authorized, 68,562,227 and 68,495,908 shares issued  and outstanding, respectively |       | 685                    |       | 685                   |       |
| Additional paid-in capital                                                                                                                                   |       | 1,035,343              |       | 1,034,686             |       |
| Cumulative net income                                                                                                                                        |       | 251,510                |       | 208,491               |       |
| Cumulative distributions                                                                                                                                     |       | (425,349               | )          | (359,567              | )          |
| Unrealized gain on investments                                                                                                                               |       | 5,897                  |       | 6,372                 |       |
| Total shareholders’ equity                                                                                                                              |       | 868,086                |       | 890,667               |       |
| Total liabilities and shareholders’ equity                                                                                                              |       | $                      | 1,440,403  |                  | $          | 1,447,730 |   |

 

*See accompanying notes.*

 

1

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SENIOR HOUSING PROPERTIES TRUST

 

CONSOLIDATED STATEMENT OFINCOME

(in thousands, except per share amounts)

(unaudited)

 
| ** **                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                   |       |                                       |       |                                      |       |   |   |   |   |
| Revenues:                              |       |                                       |       |                                      |       |   |   |   |   |
| Rental income                          |       | $                                          | 39,506     |                                      | $          | 35,426 |   | $ | 117,489 |   | $ | 105,444 |   |
| Interest and other income              |       | 738                                        |       | 318                                       |       | 1,588 |   | 2,349 |   |
| Total revenues                         |       | 40,244                                     |       | 35,744                                    |       | 119,077 |   | 107,793 |   |
|                                   |       |                                       |       |                                      |       |   |   |   |   |
| Expenses:                              |       |                                       |       |                                      |       |   |   |   |   |
| Interest                               |       | 11,911                                     |       | 10,285                                    |       | 34,585 |   | 30,910 |   |
| Depreciation                           |       | 10,923                                     |       | 9,743                                     |       | 32,428 |   | 29,015 |   |
| General and administrative             |       | 3,281                                      |       | 2,797                                     |       | 9,762 |   | 8,858 |   |
| Total expenses                         |       | 26,115                                     |       | 22,825                                    |       | 76,775 |   | 68,783 |   |
|                                   |       |                                       |       |                                      |       |   |   |   |   |
| Income from  continuing operations     |       | 14,129                                     |       | 12,919                                    |       | 42,302 |   | 39,010 |   |
| Gain on sale of  property              |       | —                                     |       | —                                    |       | 717 |   | 1,219 |   |
| Net income                             |       | $                                          | 14,129     |                                      | $          | 12,919 |   | $ | 43,019 |   | $ | 40,229 |   |
|                                   |       |                                       |       |                                      |       |   |   |   |   |
| Weighted average  shares outstanding   |       | 68,543                                     |       | 63,477                                    |       | 68,525 |   | 63,102 |   |
|                                   |       |                                       |       |                                      |       |   |   |   |   |
| Basic and  diluted earnings per share: |       |                                       |       |                                      |       |   |   |   |   |
| Income from continuing operations      |       | $                                          | 0.21       |                                      | $          | 0.20 |   | $ | 0.62 |   | $ | 0.62 |   |
| Gain on sale of property               |       | —                                     |       | —                                    |       | 0.01 |   | 0.02 |   |
| Net income                             |       | $                                          | 0.21       |                                      | $          | 0.20 |   | $ | 0.63 |   | $ | 0.64 |   |

 

*Seeaccompanying notes*.

 

2

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SENIOR HOUSING PROPERTIES TRUST

 

CONSOLIDATEDSTATEMENT OF CASH FLOWS

(in thousands)

(unaudited)

 
| ** **                                                                     | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                     | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| Cash flows from operating activities:                                          |       |                                     |       |   |   |
| Net income                                                                     |       | $                                        | 43,019     |   | $ | 40,229 |   |
| Adjustments to reconcile net income to cash provided  by operating activities: |       |                                     |       |   |   |
| Depreciation                                                                   |       | 32,428                                   |       | 29,015 |   |
| Gain on sale of property                                                       |       | (717                                     | )          | (1,219 | ) |
| Amortization of deferred finance fees and debt  discounts                      |       | 1,728                                    |       | 1,579 |   |
| Changes in assets and liabilities:                                             |       |                                     |       |   |   |
| Restricted cash                                                                |       | 3,675                                    |       | (5 | ) |
| Other assets                                                                   |       | 2,975                                    |       | 335 |   |
| Accrued interest                                                               |       | (2,158                                   | )          | (1,886 | ) |
| Other liabilities                                                              |       | 1,259                                    |       | 4,141 |   |
| Cash provided by operating activities                                          |       | 82,209                                   |       | 72,189 |   |
|                                                                           |       |                                     |       |   |   |
| Cash flows from investing activities:                                          |       |                                     |       |   |   |
| Acquisitions                                                                   |       | (35,486                                  | )          | (34,809 | ) |
| Proceeds from sale of real estate                                              |       | 4,600                                    |       | 5,900 |   |
| Mortgage financing provided                                                    |       | (24,000                                  | )          | — |   |
| Mortgage financing repaid                                                      |       | 24,000                                   |       | — |   |
| Cash used for investing activities                                             |       | (30,886                                  | )          | (28,909 | ) |
|                                                                           |       |                                     |       |   |   |
| Cash flows from financing activities:                                          |       |                                     |       |   |   |
| Proceeds from issuance of common shares, net                                   |       | —                                   |       | 86,144 |   |
| Proceeds from borrowings on revolving bank credit  facility                    |       | 79,000                                   |       | 53,000 |   |
| Repayments of borrowings on revolving bank credit  facility                    |       | (57,000                                  | )          | (125,000 | ) |
| Repayment of debt                                                              |       | (5,544                                   | )          | (588 | ) |
| Deferred financing fees                                                        |       | (3,550                                   | )          | — |   |
| Distributions to shareholders                                                  |       | (65,782                                  | )          | (57,472 | ) |
| Cash used for financing activities                                             |       | (52,876                                  | )          | (43,916 | ) |
|                                                                           |       |                                     |       |   |   |
| Decrease in cash and cash equivalents                                          |       | (1,553                                   | )          | (636 | ) |
| Cash and cash equivalents at beginning of period                               |       | 3,409                                    |       | 3,530 |   |
| Cash and cash equivalents at end of period                                     |       | $                                        | 1,856      |   | $ | 2,894 |   |
|                                                                           |       |                                     |       |   |   |
| Supplemental cash flow information:                                            |       |                                     |       |   |   |
| Interest paid                                                                  |       | $                                        | 35,015     |   | $ | 31,217 |   |
|                                                                           |       |                                     |       |   |   |
| Non-cash investing and financing activities:                                   |       |                                     |       |   |   |
| Issuance of common shares                                                      |       | 657                                      |       | 733 |   |

 

*See accompanying notes.*

 

3

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SENIOR HOUSING PROPERTIES TRUST

 

NOTESTO CONSOLIDATED FINANCIAL STATEMENTS

 

**Note1.  Basis of Presentation**

 

The accompanying consolidated financial statements ofSenior Housing Properties Trust and our consolidated subsidiaries have beenprepared without audit.  Certaininformation and footnote disclosures required by accounting principlesgenerally accepted in the United States for complete financial statements havebeen condensed or omitted.  We believethe disclosures made are adequate to make the information presented notmisleading.  However, the accompanyingconsolidated financial statements should be read in conjunction with theconsolidated financial statements and notes contained in our Annual Report on Form 10-Kfor the year ended December 31, 2004. In the opinion of our management, all adjustments, which include onlynormal recurring adjustments considered necessary for a fair presentation, havebeen included.  All intercompanytransactions and balances between us and our consolidated subsidiaries havebeen eliminated.  Operating results forinterim periods are not necessarily indicative of the results that may beexpected for the full year.

 

DEFERRED PERCENTAGE RENTS.  We recognize percentage rental incomereceived for the first, second and third quarters in the fourth quarter.Percentage rent deferred was $812,000 and $2.4 million for the three and ninemonths ended September 30, 2005, respectively, and $775,000 and $2.4million for the three and nine months ended September 30, 2004,respectively.

 

**Note2.  Real Estate Properties**

 

At September 30,2005, we owned 184 properties located in 32 states.

 

On June 3, 2005, we purchased from Five StarQuality Care, Inc., or Five Star, four assisted living communities for$24.0 million, which we leased back to Five Star.  These properties contain 299 living units and100% of the revenues at these facilities are paid by residents from theirprivate resources.  These communitieswere added to a master lease for 97 communities from us to Five Star which hasa current term ending in 2020, plus tenant renewal options thereafter.  The annual rent under the master leaseincreased by $2.2 million and percentage rent, based on increases in grossrevenues at the four properties added, will commence in 2007.

 

In addition to this sale leaseback, we provided a$43.5 million first mortgage line of credit to assist Five Star with financingup to 75% of the purchase price of six assisted living communities located insuburban Pittsburgh, Pennsylvania. Five Star borrowed $24.0 million on thisline of credit for the June 2005 closing of its acquisition andsubsequently repaid the borrowing in August 2005. On October 31, 2005, wepurchased the six properties that secured this line of credit from Five Starfor $58.0 million, Five Star’s purchase price for the properties, and we leasedthem back to Five Star. Simultaneous with our purchase, we cancelled the lineof credit.  These properties were addedto the existing master lease described above. The annual rent under the master lease increased by $5.2 million andpercentage rent, based on increases in gross revenues at the six propertiesadded, will commence in 2007.

 

OnMay 18, 2005, we sold a nursing home to Five Star for $4.6 million andrecognized a gain of $717,000.  Thisproperty was part of a master lease for properties we lease to Five Star.  Under the terms of our lease with Five Star,upon the sale of the property the annual rent payable to us was reduced by 10%of the net proceeds that we received from the sale, or $460,000.

 

During the nine monthsended September 30, 2005, pursuant to the terms of our leases with FiveStar, we purchased $11.5 million of improvements made to our properties leasedby Five Star, and, as a result, the annual rent payable to us by Five Star increasedby 10% of the amounts invested, or $1.1 million.

 

4

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**Note3.  Unrealized Gain on Investments**

 

On September 30,2005, we owned one million common shares of HRPT Properties Trust, or HRPT, and35,000 common shares of Five Star, which are carried at fair market value inOther Assets on our Consolidated Balance Sheet. The Unrealized Gain on Investments shown on our Consolidated BalanceSheet represents the difference between the market value of these shares ofHRPT and Five Star calculated by using quoted market prices on September 30,2005 ($12.41 and $6.90 per share, respectively) and on the dates they wereacquired ($6.50 and $7.26 per share, respectively).

 

**Note4.  Comprehensive Income**

 

The following is areconciliation of net income to comprehensive income for the three and ninemonths ended September 30, 2005 and 2004 (dollars in thousands):

 
| ** **                               | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                               | ** ** | **2005**                                  | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income                               |       | $                                         | 14,129     |                                     | $          | 12,919 |   | $ | 43,019 |   | $ | 40,229 |   |
| Other  comprehensive income:             |       |                                      |       |                                     |       |   |   |   |   |
| Change in unrealized gain on investments |       | (34                                       | )          | 1,076                                    |       | (475 | ) | 996 |   |
| Comprehensive  income                    |       | $                                         | 14,095     |                                     | $          | 13,995 |   | $ | 42,544 |   | $ | 41,225 |   |

 

**Note5.  Indebtedness**

 

On July 29, 2005, weamended our unsecured revolving bank credit facility to increase the availableborrowing amount from $250.0 million to $550.0 million and extend the maturitydate from November 2005 to November 2009, with an option to extendthe maturity by one additional year upon payment of a fee. The annual interestpayable for amounts drawn under the facility was reduced from LIBOR plus 1.45%to LIBOR plus 1.00%.  In certaincircumstances, the amount of unsecured borrowings available under this facilitymay be increased to $1.1 billion. Certain financial and other covenants in the facility were also amendedto reflect current market conditions. The interest rate on this facility averaged 4.7% and 4.5% for the threeand nine months ended September 30, 2005, respectively, and 2.9% and 2.6%for the three and nine months ended September 30, 2004.

 

As discussed in Note 2, we sold a property to FiveStar on May 18, 2005. Simultaneous with this sale, we repaid the $4.2million mortgage note that was secured by this property.  This mortgage note was also secured by $4.3million of restricted cash, which became unrestricted when the mortgage notewas prepaid.

 

#### **Note 6. Shareholders’ Equity**

 

## **On August 19,2005, we paid a $0.32 per share, or $21.9 million, distribution to our commonshareholders for the quarter ended June 30, 2005.  On October 6, 2005, we declared adistribution of $0.32 per share, or $21.9 million, to be paid to commonshareholders of record on October 20, 2005 with respect to our results forthe quarter ended September 30, 2005. We expect to pay this distributionon or about November 18, 2005.**

## ** **

Underthe terms of our advisory agreement with Reit Management and Research, LLC, orRMR, on April 4, 2005, we issued 39,019 common shares in payment of anincentive fee for services rendered by RMR during 2004.  These restricted securities were issuedpursuant to an exemption from registration provided under Section 4(2) ofthe Securities Act of 1933, as amended.

 

5

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#### **Note 7.  Commitments and Contingencies**

 

Asdescribed in our 2004 Annual Report on Form 10-K, we are in litigationwith HealthSouth Corporation, or HealthSouth. In January 2002, HealthSouth settled adefault under its lease with us by exchanging properties. We delivered toHealthSouth title to five nursing homes which HealthSouth leased from us. Inexchange, HealthSouth delivered to us title to two rehabilitation hospitals andwe entered an amended lease, reducing the annual rent from $10.3 million to $8.7million, extending the lease term and changing other lease terms betweenHealthSouth and us.  A primary factorwhich caused us to lower the rent for an extended lease term was the purportedcredit strength of HealthSouth. In agreeing to lower the rent and extend thelease term, we relied upon statements made by certain officers of HealthSouth,upon financial statements and other documents provided by HealthSouth, uponpublic statements made by HealthSouth and its representatives concerningHealthSouth’s financial condition and upon publicly available documents filedby HealthSouth.

 

InMarch 2003, the SEC accused HealthSouth and some of its executives ofpublishing false financial information; since then, according to publishedreports, at least 15 former HealthSouth executives, including all five of itsformer chief financial officers, have pled guilty to various crimes. In April 2003,we commenced a lawsuit against HealthSouth in the Massachusetts Land Courtseeking, among other matters, to reform the amended lease, based uponHealthSouth’s fraud, by increasing the rent payable to us back to $10.3 millionfrom January 2, 2002 until the termination or expiration of the amendedlease and to change the lease term to its historical expiration on January 1,2006, among other matters. HealthSouth has defended this lawsuit and assertedcounterclaims against us arising from this and unrelated matters. Thislitigation is pending at this time. In June 2004, we declared an event ofdefault under the amended lease because HealthSouth failed to deliver to usaccurate and timely financial information as required by the amended lease. On October 26,2004, we terminated the amended lease because of this event of default bysending a notice of lease termination to HealthSouth. On November 2, 2004,HealthSouth brought a second lawsuit against us in the Massachusetts SuperiorCourt seeking to prevent our termination of the amended lease. On September 25,2005, the court ruled that our termination was proper and we have begun work toidentify and qualify a new tenant operator for the hospitals. HealthSouth willlikely appeal the court’s decision that our lease termination was proper. Webelieve our lease with HealthSouth requires that, after termination,HealthSouth manage the hospitals for our account for a management fee duringthe period of the transition to a new tenant and remit the net cash flow to us.During the pendency of these disputes, HealthSouth has continued to pay us atthe disputed rent amount and we have applied the payments received against thenet cash flow due, but we do not know how long HealthSouth may continue to makepayments. According to affidavits submitted during this litigation byHealthSouth, the leased hospitals produced cash flow in prior periods ofapproximately $14 million per year in excess of amounts paid by HealthSouth tous. We do not know the cash flow currently being produced by these hospitals.The court has also granted our request to sequester the net cash proceeds ofthe hospitals and appointed a receiver to calculate and hold these amountsuntil the litigation is concluded. HealthSouth disputes that the court orderrequires the sequestration of cash flow from the date of the lease terminationto the present.  On June 27, 2005,HealthSouth filed with the SEC a restated Annual Report on Form 10-K forperiods ending December 31, 2003. HealthSouth’s restated Form 10-Kincludes financial data which shows HealthSouth to have a substantial negativenet worth and a history of substantial operating losses. To date we have beenunable to obtain reliable current financial information about the operations ofHealthSouth or our hospitals. Accordingly, we do not know if we will be able tocollect any amounts which the courts may determine to be owed to us byHealthSouth. If we ultimately prevail in our litigation and are entitled toreceive the cash flows, net of a management fee, from the hospitals’operations, and if, as a result, under Internal Revenue Code laws andregulations applicable to REITs these properties are foreclosure properties,the cash flows received would be subject to income tax at corporate rates.Based on the 2004 cash flow amount disclosed by HealthSouth, we estimate thatthe potential tax due for the period from the date of the lease terminationthrough September 30, 2005, could range between $3.0 million and $6.0million, and is largely dependent upon the actual cash flow that we receive. Legal expenses incurred related to this matterwere approximately $350,000 and $1,240,000, respectively, for the quarter andnine months ended September 30, 2005 and $75,000 and $125,000,respectively, for the quarter and nine months ended September 30, 2004,and are included in general and administrative expenses. We expect these legal expenses to continue solong as our litigations with HealthSouth continue, but we cannot predict the amount of these futureexpenses at this time.

 

6

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**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

The following discussionshould be read in conjunction with our consolidated financial statements andnotes thereto included in this quarterly report and our Annual Report on Form 10-Kfor the year ended December 31, 2004.

 

**PORTFOLIO OVERVIEW**

** **

**The following tables present an overview of our portfolio:**

 
| **As of September 30, 2005  (dollars in thousands)** | ** ** | **# of  Properties** | ** ** | **# of Units/Beds** | ** ** | **Carrying Value  of Investment (1)** | ** ** | **% of  Investment** | ** ** | **Annualized  Current Rent** | ** ** | **% of  Annualized  Current Rent** | ** ** |
|-----------------------------------------------------------|------------|----------------------|------------|---------------------|------------|---------------------------------------|------------|----------------------|------------|------------------------------|------------|------------------------------------|------------|
| Facility Type                                             |       |                 |       |                |       |                                  |       |                 |       |                         |       |                               |       |
| Independent living communities (2)                        |       | 36                   |       | 10,412              |       | $                                     | 905,693    |                 | 55.5       | %                            | $          | 90,824                             |       | 56.3 | % |
| Assisted living facilities                                |       | 85                   |       | 5,636               |       | 463,717                               |       | 28.4                 | %          | 44,718                       |       | 27.7                               | %          |
| Skilled nursing facilities                                |       | 61                   |       | 6,309               |       | 219,050                               |       | 13.4                 | %          | 17,128                       |       | 10.6                               | %          |
| Hospitals                                                 |       | 2                    |       | 364                 |       | 43,553                                |       | 2.7                  | %          | 8,700                        |       | 5.4                                | %          |
| Total                                                     |       | 184                  |       | 22,721              |       | $                                     | 1,632,013  |                 | 100.0      | %                            | $          | 161,370                            |       | 100.0 | % |
|                                                      |       |                 |       |                |       |                                  |       |                 |       |                         |       |                               |       |
| Tenant/Operator                                           |       |                 |       |                |       |                                  |       |                 |       |                         |       |                               |       |
| Five Star/Sunrise (3)                                     |       | 31                   |       | 7,307               |       | $                                     | 631,605    |                 | 38.7       | %                            | $          | 64,478                             |       | 40.0 | % |
| Five Star                                                 |       | 101                  |       | 7,906               |       | 433,521                               |       | 26.6                 | %          | 34,207                       |       | 21.2                               | %          |
| Sunrise/Marriott (4)                                      |       | 14                   |       | 4,091               |       | 325,473                               |       | 19.9                 | %          | 31,197                       |       | 19.3                               | %          |
| NewSeasons/IBC (5)                                        |       | 10                   |       | 1,019               |       | 87,641                                |       | 5.4                  | %          | 9,287                        |       | 5.7                                | %          |
| HealthSouth (6)                                           |       | 2                    |       | 364                 |       | 43,553                                |       | 2.7                  | %          | 8,700                        |       | 5.4                                | %          |
| Alterra Healthcare Corporation                            |       | 18                   |       | 894                 |       | 61,126                                |       | 3.7                  | %          | 7,136                        |       | 4.4                                | %          |
| Genesis HealthCare Corporation                            |       | 1                    |       | 156                 |       | 13,007                                |       | 0.8                  | %          | 1,535                        |       | 1.0                                | %          |
| 5 private companies (combined)                            |       | 7                    |       | 984                 |       | 36,087                                |       | 2.2                  | %          | 4,830                        |       | 3.0                                | %          |
| Total                                                     |       | 184                  |       | 22,721              |       | $                                     | 1,632,013  |                 | 100.0      | %                            | $          | 161,370                            |       | 100.0 | % |

 

Tenant OperatingStatistics (Quarter Ended September 30) (7)

 
| ** **                     | ** ** | ** **        | ** ** | ** **    | ** ** | ** **      | ** ** | ** **   | ** ** | **Percentage of Operating Revenue  Sources** | ** ** |
|--------------------------------|------------|-------------------|------------|---------------|------------|-----------------|------------|--------------|------------|----------------------------------------------|------------|
| ** **                     | ** ** | **Rent Coverage** | ** ** | **Occupancy** | ** ** | **Private Pay** | ** ** | **Medicare** | ** ** | **Medicaid**                                 | ** ** |
| ** **                     | ** ** | **2005**          | ** ** | **2004**      | ** ** | **2005**        | ** ** | **2004**     | ** ** | **2005**                                     | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Five Star/Sunrise (3)          |       | 1.11              | x          | 1.06          | x          | 92              | %          | 90           | %          | 84                                           | %          | 85 | % | 12 | % | 11 | % | 4 | % | 4 | % |
| Five Star (8)                  |       | 1.77              | x          | 1.78          | x          | 90              | %          | 89           | %          | 44                                           | %          | 35 | % | 18 | % | 21 | % | 38 | % | 44 | % |
| Sunrise/Marriott (4)           |       | 1.27              | x          | 1.26          | x          | 90              | %          | 91           | %          | 79                                           | %          | 82 | % | 16 | % | 14 | % | 5 | % | 4 | % |
| NewSeasons/IBC (5)             |       | 1.17              | x          | 1.19          | x          | 80              | %          | 80           | %          | 100                                          | %          | 100 | % | — |   | — |   | — |   | — |   |
| HealthSouth (6)                |       | NA                |       | NA            |       | NA              |       | NA           |       | NA                                           |       | NA |   | NA |   | NA |   | NA |   | NA |   |
| Alterra Healthcare             |       | 1.87              | x          | 1.58          | x          | 88              | %          | 82           | %          | 98                                           | %          | 98 | % | — |   | — |   | 2 | % | 2 | % |
| Genesis HealthCare             |       | 1.82              | x          | 1.92          | x          | 94              | %          | 97           | %          | 24                                           | %          | 22 | % | 29 | % | 33 | % | 47 | % | 45 | % |
| 5 private companies (combined) |       | 1.86              | x          | 1.87          | x          | 84              | %          | 85           | %          | 24                                           | %          | 25 | % | 26 | % | 19 | % | 50 | % | 56 | % |

 

Tenant OperatingStatistics (Nine Months Ended September 30) (7)

 
| ** **                     | ** ** | ** **        | ** ** | ** **    | ** ** | ** **      | ** ** | ** **   | ** ** | **Percentage of Operating Revenue  Sources** | ** ** |
|--------------------------------|------------|-------------------|------------|---------------|------------|-----------------|------------|--------------|------------|----------------------------------------------|------------|
| ** **                     | ** ** | **Rent Coverage** | ** ** | **Occupancy** | ** ** | **Private Pay** | ** ** | **Medicare** | ** ** | **Medicaid**                                 | ** ** |
| ** **                     | ** ** | **2005**          | ** ** | **2004**      | ** ** | **2005**        | ** ** | **2004**     | ** ** | **2005**                                     | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Five Star/Sunrise (3)          |       | 1.15              | x          | 1.08          | x          | 92              | %          | 90           | %          | 84                                           | %          | 85 | % | 12 | % | 11 | % | 4 | % | 4 | % |
| Five Star (8)                  |       | 1.68              | x          | 1.68          | x          | 88              | %          | 88           | %          | 44                                           | %          | 35 | % | 19 | % | 20 | % | 37 | % | 45 | % |
| Sunrise/Marriott (4)           |       | 1.25              | x          | 1.30          | x          | 90              | %          | 89           | %          | 80                                           | %          | 82 | % | 15 | % | 13 | % | 5 | % | 5 | % |
| NewSeasons/IBC (5)             |       | 1.13              | x          | 1.07          | x          | 81              | %          | 79           | %          | 100                                          | %          | 100 | % | — |   | — |   | — |   | — |   |
| HealthSouth (6)                |       | NA                |       | NA            |       | NA              |       | NA           |       | NA                                           |       | NA |   | NA |   | NA |   | NA |   | NA |   |
| Alterra Healthcare             |       | 1.79              | x          | 1.62          | x          | 86              | %          | 82           | %          | 98                                           | %          | 98 | % | — |   | — |   | 2 | % | 2 | % |
| Genesis HealthCare             |       | 1.85              | x          | 1.87          | x          | 95              | %          | 96           | %          | 20                                           | %          | 21 | % | 30 | % | 33 | % | 50 | % | 46 | % |
| 5 private companies (combined) |       | 1.77              | x          | 1.92          | x          | 85              | %          | 86           | %          | 25                                           | %          | 25 | % | 25 | % | 21 | % | 50 | % | 54 | % |

 

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**(1)**   Amountsare before depreciation, but after impairment write downs.

** **

**(2)**   Propertieswhere the majority of units are independent living apartments are classified asindependent living communities.

** **

**(3)**   These31 properties are leased to Five Star and 30 are managed by Sunrise SeniorLiving, Inc., or Sunrise. Sunrise does not guaranty Five Star’s leaseobligations. Rent coverage is after non-subordinated management fees of $5.7million and $16.8 million, and $5.5 million and $14.6 million in the quarterand nine months ended September 30, 2005 and 2004, respectively. On November 1,2005, Five Star began to directly operate 12 of these 31 properties.

** **

**(4)**   MarriottInternational, Inc., or Marriott, guarantees the lease for the 14properties leased to Sunrise.

** **

**(5)**   IndependenceBlue Cross, or IBC, a Pennsylvania health insurer, guarantees the lease for the10 properties leased to NewSeasons Assisted Living Communities, Inc., orNewSeasons.

 

7

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(6)   Because we do not have reliable information about HealthSouth’soperations, we do not disclose any operating or financial data for thesehospitals or this operator.  See Note 7to the Consolidated Financial Statements above.

 

(7)   All tenant operating data presented are based upon the operating resultsprovided by our tenants for the indicated quarterly periods, or the most recentprior period for which tenant operating results are available to us from ourtenants. Rent coverage is calculated as operating cash flow from our tenants’facility operations, before subordinated charges and capital expenditure reserves,divided by rent payable to us. We have not independently verified our tenants’operating data.

 

**(8)**   Includesdata for periods prior to our ownership of certain properties included in thislease.

 

8

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**RESULTS OF OPERATIONS**

 

**Three Months Ended September 30, 2005,Compared to Three Months Ended September 30, 2004:**

 
| ** **                           | ** ** | **2005**                                      | ** ** | **2004**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|--------------------------------------|------------|-----------------------------------------------|------------|------------|------------|-------------------|------------|--------------|------------|
| ** **                           | ** ** | **(in thousands, except per share  amounts)** | ** ** | ** ** | ** ** |
| Rental income                        |       | $                                             | 39,506     |       | $          | 35,426            |       | $            | 4,080      |   | 11.5 | % |
| Interest and  other income           |       | 738                                           |       | 318        |       | 420               |       | 132.1        | %          |
|                                 |       |                                          |       |       |       |              |       |         |       |
| Interest expense                     |       | 11,911                                        |       | 10,285     |       | 1,626             |       | 15.8         | %          |
| Depreciation  expense                |       | 10,923                                        |       | 9,743      |       | 1,180             |       | 12.1         | %          |
| General and  administrative expense  |       | 3,281                                         |       | 2,797      |       | 484               |       | 17.3         | %          |
|                                 |       |                                          |       |       |       |              |       |         |       |
| Net income                           |       | $                                             | 14,129     |       | $          | 12,919            |       | $            | 1,210      |   | 9.4 | % |
| Weighted average  shares outstanding |       | 68,543                                        |       | 63,477     |       | 5,066             |       | 8.0          | %          |
| Net income per  share                |       | $                                             | 0.21       |       | $          | 0.20              |       | $            | 0.01       |   | 5.0 | % |

 

Rentalincome increased because of the full impact of rents from our real estate acquisitionstotaling $184.3 million made since July 1, 2004. Interest and other incomefor the three months ended September 30, 2005 includes $352,000 ofmortgage interest income related to the $24.0 million mortgage financingprovided to Five Star in June 2005 and repaid in August 2005.

 

Interestexpense increased due to our assumption of $48.8 million of debt in connectionwith an acquisition during the fourth quarter of 2004 and higher interest costsassociated with our revolving bank credit facility. Our weighted averagebalance outstanding and interest rate under our revolving bank credit facilitywas $74.6 million and 4.7% and $32.7 million and 3.0% for the three monthsended September 30, 2005 and 2004, respectively.

 

Depreciation expense forthe third quarter of 2005 increased as a result of depreciation on our realestate acquisitions totaling $184.3 million made since July 1, 2004. General and administrative expenses include $350,000 and $75,000 of HealthSouthlitigation costs in the third quarters of 2005 and 2004, respectively. General and administrative expenses, exclusive of litigation costs, increasedin 2005 by $209,000, or 7.7%, due to acquisitions since July 1, 2004.

 

Netincome and net income per share increased because of the changes in revenuesand expenses described above.  Theweighted average number of shares outstanding increased as a result of ourissuance of common shares in December 2004.

 

9

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**Nine Months Ended September 30, 2005, Comparedto Nine Months Ended September 30, 2004:**

 
| ** **                           | ** ** | **2005**                                      | ** ** | **2004**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|--------------------------------------|------------|-----------------------------------------------|------------|------------|------------|-------------------|------------|--------------|------------|
| ** **                           | ** ** | **(in thousands, except per share  amounts)** | ** ** | ** ** | ** ** |
| Rental income                        |       | $                                             | 117,489    |       | $          | 105,444           |       | $            | 12,045     |   | 11.4 | % |
| Interest and  other income           |       | 1,588                                         |       | 2,349      |       | (761              | )          | (32.4        | )%         |
|                                 |       |                                          |       |       |       |              |       |         |       |
| Interest expense                     |       | 34,585                                        |       | 30,910     |       | 3,675             |       | 11.9         | %          |
| Depreciation  expense                |       | 32,428                                        |       | 29,015     |       | 3,413             |       | 11.8         | %          |
| General and  administrative expense  |       | 9,762                                         |       | 8,858      |       | 904               |       | 10.2         | %          |
| Gain on sale of  properties          |       | 717                                           |       | 1,219      |       | (502              | )          | (41.2        | )%         |
|                                 |       |                                          |       |       |       |              |       |         |       |
| Net income                           |       | $                                             | 43,019     |       | $          | 40,229            |       | $            | 2,790      |   | 6.9 | % |
| Weighted average  shares outstanding |       | 68,525                                        |       | 63,102     |       | 5,423             |       | 8.6          | %          |
| Net income per  share                |       | $                                             | 0.63       |       | $          | 0.64              |       | $            | (0.01      | ) | (1.6 | )% |

 

Rentalincome increased because of the full impact of rents from our real estateacquisitions totaling $211.2 million made since January 1, 2004.  Interest and other income for the nine monthsended September 30, 2005 includes $517,000 of mortgage interest incomerelated to the $24.0 million financing provided to Five Star in June 2005and repaid in August 2005. For the nine months ended September 30,2004, it includes a $1.25 million settlement payment we received from Marriottin January 2004.

 

Interestexpense increased due to our assumption of $48.8 million of debt in connectionwith an acquisition during the fourth quarter of 2004 and higher interest costsassociated with our revolving bank credit facility.  Our weighted average balance outstanding andinterest rate under our revolving bank credit facility was $55.3 million and 3.4%and $36.4 million and 2.6% for the nine months ended September 30, 2005and 2004, respectively.

 

Depreciation expense forthe nine months ended September 30, 2005 increased as a result ofdepreciation on our real estate acquisitions totaling $211.2 million made sinceJanuary 1, 2004. General and administrative expenses include$1,250,000 and $125,000 of HealthSouth litigation costs for the nine monthsended September 30, 2005 and 2004, respectively, and in 2004, $775,000 ofdue diligence costs incurred in connection with a failed potentialacquisition. General and administrative expenses, exclusive of litigationand due diligence costs, increased in 2005 by $554,000, or 7.0%, due toacquisitions made since January 1, 2004.

 

Netincome increased because of the changes in revenues and expenses describedabove. Net income per share decreased because of the increase in the weightedaverage number of shares outstanding that resulted from our issuance of commonshares during 2004 and the larger gain on sale of properties in the 2004 periodthan in the 2005 period.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Our Operating Liquidity and Resources

 

Rents from our propertiesare our principal sources of funds for current expenses and distributions toshareholders.  We generally receiveminimum rents monthly or quarterly from our tenants and we receive percentagerents monthly, quarterly or annually. This flow of funds has historically been sufficient for us to pay ouroperating expenses, debt service and distributions to shareholders.  We believe that our operating cash flow willbe sufficient to meet our operating expenses, debt service and distributionpayments for the foreseeable future.

 

10

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Our Investment and Financing Liquidity and Resources

 

## **In order to fund acquisitions and to accommodate cash needsthat may result from timing differences between our receipt of rents and ourneed to pay operating expenses and our desire to make distributions to ourshareholders, we maintain a revolving bank credit facility with a group ofcommercial banks and other lenders. In July 2005, we amended our existingrevolving bank credit facility to extend its maturity from November 2005to November 2009, with an extension option to November 2010 uponpayment of an extension fee. Availability under the revolving bank credit facility increased from$250.0 million to $550.0 million, and the amended facility includes a featureunder which we may expand the maximum borrowing to $1.1 billion, in certaincircumstances.  Borrowings under ourrevolving bank credit facility are unsecured. We may borrow, repay and reborrow funds until maturity. No principalrepayment is due until maturity.  We payinterest on borrowings under the revolving bank credit facility at LIBOR plus amargin.**

## ** **

In June 2005,we purchased four assisted living communities for $24.0 million and loaned$24.0 million under a mortgage line of credit for up to $43.5 million securedby six assisted living facilities.  Wefunded these amounts, totaling $48.0 million, with borrowings under ourrevolving bank credit facility and cash on hand.  The borrower repaid the $24.0 millionmortgage in August 2005 and we used the proceeds to repay amountsoutstanding under our revolving bank credit facility. On October 31, 2005,we purchased the six properties securing the mortgage line of credit for $58.0million with borrowings under our revolving bank credit facility and cash onhand.  Simultaneous with our purchase, weterminated the line of credit.

 

In May 2005,we sold one nursing home for $4.6 million. We used the proceeds to repay borrowings and for general businesspurposes.  We prepaid one of our mortgageobligations for $4.2 million in connection with the sale of this property.

 

During 2005, we purchased$11.5 million of improvements made to some of our properties. We borrowed onour revolving bank credit facility and used cash on hand to fund thesepurchases.

 

At September 30,2005, we had $1.9 million of cash and cash equivalents and $491.0 millionavailable for borrowing under our revolving bank credit facility.  We expect to use cash balances, borrowingsunder our revolving bank credit facility and net proceeds of offerings ofequity or debt securities to fund future property acquisitions and expendituresrelated to the repair, maintenance or renovation of our properties.

 

Whensignificant amounts are outstanding under our revolving bank credit facility oras the maturity dates of our revolving bank credit facility and term debtsapproach, we will explore alternatives for the repayment of amounts due.  Such alternatives may include incurringadditional debt and issuing new equity securities.  As of September 30, 2005, we had $1.5billion available on an effective shelf registration statement. An effectiveshelf registration statement allows us to issue public securities on anexpedited basis, but it does not assure that there will be buyers for suchsecurities.  Although there can be noassurance that we will complete any debt or equity offerings or otherfinancings, we believe we will have access to various types of financing,including debt or equity offerings, with which to finance future acquisitionsand to pay our debts and other obligations.

 

On August 19,2005, we paid a $0.32 per common share, or $21.9 million, distribution to ourcommon shareholders for the quarter ended June 30, 2005.  On October 6, 2005, we declared adistribution of $0.32 per common share, or $21.9 million, to be paid to ourcommon shareholders of record on October 20, 2005 with respect to ourresults for the quarter ended September 30, 2005.  We expect to pay this distribution on orabout November 18, 2005, using cash on hand and borrowings under ourrevolving bank credit facility.

 

11

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**As of September 30, 2005, our contractualobligations were as follows (dollars in thousands):**

 
| ** **                      | ** ** | **Payments due by period** | ** ** |
|---------------------------------|------------|----------------------------|------------|
| **Contractual Obligations**     | ** ** | **Total**                  | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| Long-Term Debt  Obligations(1)  |       | $                          | 487,266    |   | $ | 258 |   | $ | 2,200 |   | $ | 2,491 |   | $ | 482,317 |   |
| Revolving Bank  Credit Facility |       | 59,000                     |       | — |   | — |   | 59,000 |   | — |   |
| Capital Lease  Obligations      |       | 6,593                      |       | 219 |   | 1,905 |   | 2,209 |   | 2,260 |   |
| Ground Lease  Obligations       |       | 3,105                      |       | 142 |   | 284 |   | 284 |   | 2,395 |   |
| Purchase Obligations            |       | 58,000                     |       | 58,000 |   | — |   | — |   | — |   |
| Total                           |       | $                          | 613,964    |   | $ | 58,619 |   | $ | 4,389 |   | $ | 63,984 |   | $ | 486,972 |   |

 

----

(1)   Our term debtmaturities are as follows:  $281.8million in 2012; $12.5 million in 2013; $150.0 million in 2015; $14.7 millionin 2027; and $28.2 million in 2041.

 

On June 3,2005, we agreed to provide Five Star an acquisition line of credit secured byfirst mortgages on six assisted living properties.  On October 31, 2005, we purchased these sixproperties from Five Star for $58.0 million, Five Star’s purchase price for theproperties.  Simultaneous with ourpurchase, we terminated the line of credit.

 

As of November 1, 2005, wehave no commercial paper, derivatives, swaps, hedges, joint ventures orpartnerships. We have no off balance sheet arrangements other than our trustpreferred securities issued by an unconsolidated subsidiary of ours. The juniorsubordinated debentures due in 2041 which fund these trust preferred securitiesare included on our balance sheet.

 

## **Debt Covenants**

## ** **

Our principal debtobligations at September 30, 2005, were our unsecured revolving bankcredit facility, two issues totaling $395.0 million of unsecured senior notesand our $28.2 million of junior subordinated debentures.  Our senior notes are governed by an indenture.  This indenture and related supplements andour revolving bank credit facility contain a number of financial ratiocovenants which generally restrict our ability to incur debts, including debtssecured by mortgages on our properties in excess of calculated amounts, requireus to maintain a minimum net worth, restrict our ability to make distributionsunder certain circumstances and require us to maintain other ratios.  Our junior subordinated debentures aregoverned by an indenture which is generally less restrictive than the indenturegoverning our senior notes and the terms of our revolving bank creditfacility.  As of September 30, 2005,we believe we were in compliance with all of the covenants under our indenturesand related supplements and our revolving bank credit facility.

 

In addition to ourunsecured debt obligations, we had $70.6 million of mortgage debt and securedbonds outstanding at September 30, 2005. Our mortgage debt and secured bonds are secured by 21 of our properties.

 

Noneof our indentures and related supplements, our revolving bank credit facilityor our other debt obligations contains provisions for acceleration which couldbe triggered by our debt ratings. However, in certain circumstances ourrevolving bank credit facility uses our senior debt rating to determine thefees and the interest rate payable.

 

Ourpublic debt indenture and related supplements contain cross default provisionswith any other debts of $10.0 million or more. Similarly, a default on our public debt or junior subordinateddebentures indenture would be a default under our revolving bank creditfacility.

 

12

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## **Related Party Transactions**

## ** **

On June 3, 2005, wepurchased from Five Star four assisted living communities for $24.0 million,which we leased back to Five Star.  Theseproperties contain 299 living units and 100% of the revenues at thesefacilities are paid by residents from their private resources.  These communities were added to a masterlease for 97 communities from us to Five Star which has a current term endingin 2020, plus tenant renewal options thereafter.  The annual rent under the master leaseincreased by $2.2 million and percentage rent, based on increases in grossrevenues at the four properties added, will commence in 2007.

 

In addition to this saleleaseback, we provided a $43.5 million first mortgage line of credit to assistFive Star with financing up to 75% of the purchase price of six assisted livingcommunities located in suburban Pittsburgh, Pennsylvania. Five Star borrowed$24.0 million on this line of credit for the June 2005 closing of itsacquisition and subsequently repaid the borrowing in August 2005. On October31, 2005, wepurchased the six properties that secured this line of credit from Five Starfor $58.0 million, Five Star’s purchase price for the properties, and we leasedthem back to Five Star. Simultaneous with our purchase, we cancelled the lineof credit.  These properties were addedto the existing master lease described above. The annual rent under the master lease increased by $5.2 million andpercentage rent, based on increases in gross revenues at the six propertiesadded, will commence in 2007.

 

On May 18, 2005, we sold a nursing home to FiveStar for $4.6 million and recognized a gain of $717,000.  This property was part of a master lease forproperties we lease to Five Star.  Underthe terms of our lease with Five Star, upon the sale of the property the annualrent payable to us was reduced by 10% of the net proceeds that we received fromthe sale, or $460,000.

 

During the nine months ended September 30, 2005,pursuant to the terms of our leases with Five Star, we purchased $11.5 millionof improvements made to our properties leased by Five Star, and, as a result,the annual rent payable to us by Five Star increased by 10% of the amountsinvested, or $1.1 million.

 

13

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**Item3.  Quantitative and QualitativeDisclosures about Market Risk**

 

We are exposed to risksassociated with market changes in interest rates.  We manage our exposure to this market risk bymonitoring available financing alternatives. Our strategy to manage exposure to changes in interest rates isunchanged since December 31, 2004. Other than as described below, we do not foresee any significant changesin our exposure to fluctuations in interest rates or in how we manage thisexposure in the future.

 

Our unsecured revolvingbank credit facility accrues interest at floating rates.  The facility was amended and the maturitydate was extended from November 2005 to November 2009.  At September 30, 2005, we had $59.0million outstanding under our revolving bank credit facility. We may makerepayments under our revolving bank credit facility at any time without penalty.  We borrow in U.S. dollars and borrowingsunder our revolving bank credit facility accrue interest at LIBOR plus amargin.  Accordingly, we are vulnerableto changes in U.S. dollar based short term interest rates, specificallyLIBOR.  A change in interest rates wouldnot affect the value of this floating rate debt but would affect our operatingresults.  For example, the interest ratepayable on our outstanding revolving indebtedness of $59.0 million at September 30,2005, was 4.84% per annum.  The followingtable presents the impact a 10% change in interest rates would have on ourfloating rate interest expense at September 30, 2005 (dollars inthousands):

 
| ** **                  | ** ** | **Impact of Changes in Interest  Rates** | ** ** |
|-----------------------------|------------|------------------------------------------|------------|
| ** **                  | ** ** | **Interest Rate  Per Year**              | ** ** | **Outstanding  Debt** | ** ** | **Total Interest  Expense Per  Year** | ** ** |
| At September 30,  2005 |       | 4.84                                     | %          | $ | 59,000 |   | $ | 2,856 |   |
| 10% reduction               |       | 4.36                                     | %          | $ | 59,000 |   | $ | 2,572 |   |
| 10% increase                |       | 5.32                                     | %          | $ | 59,000 |   | $ | 3,139 |   |

 

Theforegoing table shows the impact of an immediate change in floating interestrates.  If interest rates were to changegradually over time, the impact would be spread over time.  Our exposure to fluctuations in floatinginterest rates will increase or decrease in the future with increases ordecreases in the outstanding amount under our revolving bank credit facility orother floating rate obligations.

 

**Item4.  Controls and Procedures**

 

As of the end of theperiod covered by this report, our management carried out an evaluation, underthe supervision and with the participation of our managing trustees, Presidentand Chief Operating Officer and Treasurer and Chief Financial Officer, of theeffectiveness of our disclosure controls and procedures pursuant to ExchangeAct Rules 13a-15 and 15d-15.  Basedupon that evaluation, our managing trustees, President and Chief OperatingOfficer and Treasurer and Chief Financial Officer concluded that our disclosurecontrols and procedures are effective.

 

There have been nochanges in our internal control over financial reporting during the quarterended September 30, 2005, that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

 

14

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**WARNING CONCERNING FORWARD LOOKING STATEMENTS**

** **

THISQUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD LOOKING STATEMENTS WITHINTHE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 ANDOTHER FEDERAL SECURITIES LAWS.  THESESTATEMENTS REPRESENT OUR PRESENT BELIEFS AND EXPECTATIONS, BUT THEY MAY NOTOCCUR FOR VARIOUS REASONS.  FOR EXAMPLE:

 

•      A MASSACHUSETTS TRIAL COURT HAS DECIDEDTHAT OUR TERMINATION OF HEALTHSOUTH’S LEASE OF TWO HOSPITALS WAS PROPER.  HEALTHSOUTH MAY APPEAL THIS DECISION ANDHEALTHSOUTH’S APPEAL MAY BE SUCCESSFUL.

 

•      THE LEASE REQUIRES HEALTHSOUTH TOCONTINUE OPERATIONS OF THE HOSPITALS DURING THE PERIOD OF TRANSITION TO A NEWTENANT.  HEALTHSOUTH MAY BEUNWILLING OR UNABLE TO CONTINUE ITS OPERATIONS. IN SUCH CIRCUMSTANCES, WE MAY SEEK DAMAGES FROM HEALTHSOUTH AND TOCONTINUE THE HOSPITALS’ OPERATIONS WITH APPROPRIATE REGULATORY APPROVALS, BUTWE MAY BE UNABLE TO COLLECT SUCH DAMAGES FROM HEALTHSOUTH OR TO CONTINUETHE HOSPITALS’ OPERATIONS.

 

•      THE COURT GRANTED OUR REQUEST TO HAVE THECASH FLOW FROM THE HOSPITALS SEQUESTERED AND APPOINTED A RECEIVER TO CALCULATEAND HOLD THESE AMOUNTS.  ONE IMPLICATIONOF THIS STATEMENT IS THAT SOME OF THIS CASH FLOW MAY BE PAID TO US.  HOWEVER, HEALTHSOUTH’S HISTORICAL STATEMENTSABOUT ITS CASH FLOW HAVE BEEN INACCURATE AND THE EXISTENCE AND AMOUNT OF CASHFLOW FROM THE HOSPITALS WHICH WE OWN AND WHICH HEALTHSOUTH OPERATES MAY NOTBE ACCURATELY STATED.  HEALTHSOUTHDISPUTES THAT THE COURT ORDER REQUIRES THE SEQUESTRATION OF CASH FLOW FROM THEDATE OF THE LEASE TERMINATION TO THE PRESENT; AND WE INTEND TO SEEK CLARIFICATIONFROM THE COURT ON THIS ISSUE.

 

•      IN A SECOND LITIGATION, WE ARE SEEKING TOCOLLECT INCREASED RENT FROM HEALTHSOUTH BETWEEN JANUARY 2002 AND THETERMINATION OF OUR LEASE WITH HEALTHSOUTH. THE FACT THAT WE HAVE RECEIVED A FAVORABLE RULING IN A SEPARATELITIGATION ABOUT THE LEASE TERMINATION MAY IMPLY THAT WE WILL ALSO SUCCEEDIN THIS INCREASED RENT LITIGATION. HOWEVER, THE LEASE DEFAULTS IN THE LEASE TERMINATION LITIGATION ARESOMEWHAT DIFFERENT FROM THE FRAUDULENT INDUCEMENT CLAIMS PENDING IN THE RENTINCREASE LITIGATION. ALSO, THESE CASES ARE PENDING IN DIFFERENT COURTS. WEBELIEVE OUR RENT INCREASE CLAIMS ARE VALID. HOWEVER, THOSE CLAIMS HAVE NOT BEEN DETERMINED AND THE FACT THAT WE HAVERECEIVED A FAVORABLE RULING REGARDING THE LEASE TERMINATION MAY NOT MEANWE WILL SUCCEED IN THIS SECOND CASE.

 

•      THEIMPLICATION OF THESE FORWARD LOOKING STATEMENTS MAY BE THAT WE WILLEVENTUALLY RECEIVE MORE INCOME FROM OUR OWNERSHIP OF THE TWO HOSPITALS THAN THE$8.7 MILLION PER YEAR BEING PAID BY HEALTHSOUTH SINCE JANUARY 2002.  HOWEVER, THIS IMPLICATION MAY NOT BEREALIZED FOR MANY DIFFERENT REASONS:  THECOURTS MAY NEVER ORDER HEALTHSOUTH TO PAY ANY INCREASED AMOUNTS.  EVEN IF THE COURTS ORDER HEALTHSOUTH TO PAYAN INCREASED AMOUNT, HEALTHSOUTH MAY BE UNABLE TO DO SO.  WE MAY BE UNABLE TO IDENTIFY A NEWTENANT FOR THESE HOSPITALS WHO OBTAINS APPROPRIATE LICENSES AND WHO IS WILLINGOR ABLE TO PAY INCREASED RENTS.  THEFINANCIAL RESULTS OF THE HOSPITALS’ OPERATIONS MAY DECLINE AND THISDECLINE MAY BE MATERIAL.  IN FACT,HEALTHSOUTH MAY CEASE PAYING THE $8.7 MILLION PER YEAR WHICH IT HASHISTORICALLY PAID TO US UNTIL A NEW OPERATOR ASSUMES THE OPERATIONS.

 

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•      LITIGATIONIS EXPENSIVE. SINCE THE CURRENT LITIGATIONS BETWEEN US AND HEALTHSOUTH BEGAN INAPRIL 2003, WE HAVE SPENT APPROXIMATELY $1.5 MILLION IN LITIGATIONCOSTS.  THE EXPENSE OF THESE LITIGATIONSHAS BEEN SOMEWHAT CONCENTRATED DURING THE PAST 12 MONTHS.  WE EXPECT THAT THESE EXPENSES WILL CONTINUEAND MAY INCREASE SO LONG AS THE LITIGATIONS CONTINUE.  MOREOVER, WE ARE UNABLE TO PROVIDE ANYPROJECTIONS AS TO WHEN THESE LITIGATIONS MAY END OR THE AMOUNTS OF FUTURELITIGATION COSTS.

 

FORALL OF THE FOREGOING REASONS YOU ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ONFORWARD LOOKING STATEMENTS. EXCEPT AS MAY BE REQUIRED BY APPLICABLE LAW,WE DO NOT INTEND TO IMPLY THAT WE WILL RELEASE PUBLICLY THE RESULT OF ANYREVISION TO THE FORWARD LOOKING STATEMENTS CONTAINED IN THIS QUARTERLY REPORTTO REFLECT THE FUTURE OCCURRENCE OF PRESENTLY UNANTICIPATED EVENTS.

 

**STATEMENT CONCERNING LIMITEDLIABILITY**

 

THE ARTICLES OF AMENDMENTAND RESTATEMENT ESTABLISHING SENIOR HOUSING PROPERTIES TRUST, DATED SEPTEMBER 20,1999, A COPY OF WHICH, TOGETHER WITH ALL AMENDMENTS AND SUPPLEMENTS THERETO, ISDULY FILED IN THE OFFICE OF THE STATE DEPARTMENT OF ASSESSMENTS AND TAXATION OFMARYLAND, PROVIDES THAT THE NAME “SENIOR HOUSING PROPERTIES TRUST” REFERS TOTHE TRUSTEES UNDER THE DECLARATION OF TRUST AS TRUSTEES, BUT NOT INDIVIDUALLYOR PERSONALLY, AND THAT NO TRUSTEE, OFFICER, SHAREHOLDER, EMPLOYEE OR AGENT OFSENIOR HOUSING PROPERTIES TRUST SHALL BE HELD TO ANY PERSONAL LIABILITY,JOINTLY OR SEVERALLY, FOR ANY OBLIGATION OF, OR CLAIM AGAINST, SENIOR HOUSINGPROPERTIES TRUST.  ALL PERSONS DEALINGWITH SENIOR HOUSING PROPERTIES TRUST, IN ANY WAY, SHALL LOOK ONLY TO THE ASSETSOF SENIOR HOUSING PROPERTIES TRUST FOR THE PAYMENT OF ANY SUM OR THEPERFORMANCE OF ANY OBLIGATION.

 

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**PART II.****        OtherInformation**

 

**Item1.**    Legal Proceedings

** **

**In January 2002,HealthSouth settled a default under its lease with us by exchanging properties.We delivered to HealthSouth title to five nursing homes which HealthSouthleased from us.  In exchange, HealthSouthdelivered to us title to two rehabilitation hospitals and we entered an amendedlease, reducing the annual rent from $10.3 million to $8.7 million, extendingthe lease term and changing other lease terms between HealthSouth and us. Aprimary factor which caused us to lower the rent for an extended lease term wasthe purported credit strength of HealthSouth. In agreeing to lower the rent andextend the lease term, we relied upon statements made by certain officers ofHealthSouth, upon financial statements and other documents provided byHealthSouth, upon public statements made by HealthSouth and its representativesconcerning HealthSouth’s financial condition and upon publicly availabledocuments filed by HealthSouth.**

** **

**In March 2003,the SEC accused HealthSouth and some of its executives of publishing falsefinancial information; since then, according to published reports, at least 15former HealthSouth executives, including all five of its former chief financialofficers, have pled guilty to various crimes. In April 2003, we commenceda lawsuit against HealthSouth in the Massachusetts Land Court seeking, amongother matters, to reform the amended lease, based upon HealthSouth’s fraud, byincreasing the rent payable to us back to $10.3 million from January 2, 2002until the termination or expiration of the amended lease and to change thelease term to its historical expiration on January 1, 2006, among othermatters. HealthSouth has defended this lawsuit and asserted counterclaimsagainst us arising from this and unrelated matters. This litigation is pendingat this time.**

** **

**In June 2004,we declared an event of default under the amended lease because HealthSouthfailed to deliver to us accurate and timely financial information as requiredby the amended lease. On October 26, 2004, we terminated the amended leasebecause of this event of default by sending a notice of lease termination toHealthSouth.  On November 2, 2004,HealthSouth brought a second lawsuit against us in the Massachusetts SuperiorCourt seeking to prevent our termination of the amended lease.  On September 25, 2005, the court ruledthat our termination was proper and we have begun work to identify and qualifya new tenant operator for the hospitals. HealthSouth will likely appeal thecourt’s decision that our lease termination was proper.  We believe our lease with HealthSouthrequires that, after termination, HealthSouth manage the hospitals for ouraccount for a management fee during the period of the transition to a newtenant and remit the net cash flow to us. During the pendency of these disputes, HealthSouth has continued to payus at the disputed rent amount and we have applied the payments receivedagainst the net cash flow due, but we do not know how long HealthSouth maycontinue to make payments.  According toaffidavits submitted during this litigation by HealthSouth, the leasedhospitals produced cash flow in prior periods of approximately $14 million peryear in excess of amounts paid by HealthSouth to us. We do not know the cashflow currently being produced by these hospitals.  The court has also granted our request tosequester the net cash proceeds of the hospitals and appointed a receiver tocalculate and hold these amounts until the litigation is concluded.  HealthSouth disputes that the court orderrequires the sequestration of cash flow from the date of the lease terminationto the present.**

** **

**On June 27,2005, HealthSouth filed with the SEC a restated Annual Report on Form 10-Kfor periods ending December 31, 2003. HealthSouth’s restated Form 10-K includes financial data whichshows HealthSouth to have a substantial negative net worth and a history ofsubstantial operating losses.  To date wehave been unable to obtain reliable current financial information about theoperations of HealthSouth or our hospitals. Accordingly, we do not know if we will be able to collect any amountswhich the courts may determine to be owed to us by HealthSouth.  If we ultimately prevail in our litigationand are entitled to receive the cash flows, net of a management fee, from thehospitals’ operations, under Internal Revenue Code laws and regulationsapplicable to real estate investment trusts,**

 

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or REITs, theseproperties may be deemed foreclosure properties and the cash flows receivedmight be subject to income tax at corporate rates.

** **

In the ordinary course ofbusiness we may be involved in other legal proceedings; however, we are notaware of any other material pending or threatened legal proceeding affecting usor any of our properties for which we might become liable or the outcome ofwhich we expect to have a material impact on us.

 

**Item 2.**    Unregistered Sales of Equity Securitiesand Use of Proceeds

** **

**On September 13,2005, pursuant to our incentive share award plan, our officers and certainemployees of our manager, RMR, received grants totaling 24,300 common shares ofbeneficial interest, par value $0.01 per share, valued at $19.40 per share, theclosing price of our common shares on the New York Stock Exchange on thatday.  All of these grants were madepursuant to an exemption from registration contained in Section 4(2) ofthe Securities Act of 1933, as amended.**

** **

**Item5.**    Other Information

** **

**Wehave been informed by RMR, our manager, that the beneficial ownership of RMRhas partially changed.  RMR wasbeneficially owned by Barry M. Portnoy and Gerard M. Martin, our managingtrustees. Mr. Portnoy and his son, Adam D. Portnoy, have acquired Mr. Martin’sbeneficial ownership in RMR.  Mr. Martinremains a director of RMR and, together with Mr. Barry Portnoy, continuesas one of our managing trustees.**

** **

**Item 6.**    Exhibits

 
| 10.1   |   | Amended and  Restated Credit Agreement, dated as of July 29, 2005, by and among the  Company, Wachovia Bank, National Association, as Administrative Agent, the  Sole Arranger, the Sole Book Manager, the Syndication Agents and the  Documentation Agents signatory thereto, and each of the financial  institutions initially a signatory thereto as a Lender. (*Incorporated  by reference to the Company’s Current Report on Form 8-K dated August 1,  2005*) |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.2   |   | Third Amendment  to Second Amended and Restated Master Lease Agreement, dated as of October  31, 2005, by and among certain subsidiaries of the Company, as Landlord, and  Five Star Quality Care Trust, as Tenant. *(filed herewith)*                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 12.1   |   | Computation of  Ratio of Earnings to Fixed Charges.*(filed  herewith)*                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 31.1   |   | Certification  Required by Rule 13a-14(a) / 15d – 14(a) of the Securities  Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.*(filed  herewith)*                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 31.2   |   | Certification  Required by Rule 13a-14(a) / 15d – 14(a) of the Securities  Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.*(filed  herewith)*                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 31.3   |   | Certification  Required by Rule 13a-14(a) / 15d – 14(a) of the Securities  Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.*(filed  herewith)*                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 31.4   |   | Certification  Required by Rule 13a-14(a) / 15d – 14(a) of the Securities  Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.*(filed  herewith)*                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 32     |   | Certification  Pursuant to 18 U.S.C. Sec. 1350, as adopted pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002.*(furnished  herewith)*                                                                                                                                                                                                                                                                                                                                     |

 

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SIGNATURES

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 

 
|   | SENIOR  HOUSING PROPERTIES TRUST |
|--------|----------------------------------|
|   |                             |
|   |                             |
|   | By:                              | /s/ David J.  Hegarty |   |
|   |                             | David J. Hegarty |
|   |                             | President and  Chief Operating Officer |
|   |                             | Dated:  November 2, 2005 |
|   |                             |   |
|   |                             |   |
|   | By:                              | /s/ John R.  Hoadley |   |
|   |                             | John R. Hoadley |
|   |                             | Treasurer and  Chief Financial Officer |
|   |                             | (principal  financial officer) |
|   |                             | Dated:  November 2, 2005 |

 

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