HCPI FORM 10-K

10-K 1 d10k.htm HCPI FORM 10-K HCPI FORM 10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2002

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

For the transition period from to

Commission file number 1-8895

HEALTH CARE PROPERTY INVESTORS, INC.

(Exact name of registrant as specified in its charter)

Maryland

33-0091377

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

4675 MacArthur Court; Suite 900

Newport Beach, California

92660

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code (949) 221-0600

Securities registered pursuant to Section 12(b) of the Act:

Title of each class		Name of each exchange on which registered
Common Stock* 7⁷/8% Series A Cumulative		New York Stock Exchange
Redeemable Preferred Stock		New York Stock Exchange
8.70% Series B Cumulative
Redeemable Preferred Stock 8.60% Series C Cumulative		New York Stock Exchange
Redeemable Preferred Stock		New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes ¨ No x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No ¨

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. $2,454,696,000

As of February 14, 2003, there were 59,672,500 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement for the registrant’s 2003 Annual Meeting of Stockholders have been incorporated into Part III of this Report.

PART I

Item 1. BUSINESS

Health Care Property Investors, Inc. (HCPI), a Maryland corporation, was organized in March 1985 to qualify as a real estate investment trust (REIT). We invest in health care related real estate located throughout the United States, including long-term care facilities, acute care and rehabilitation hospitals, medical office buildings, assisted living facilities, retirement living communities, health care laboratory and biotech research facilities, physician group practice clinics and health and wellness centers. We commenced business nearly 18 years ago, making us the second oldest REIT specializing in health care real estate.

As of December 31, 2002, our gross investment in our properties, including partnership interests and mortgage loans, was approximately $3.1 billion. Our portfolio of 463 owned properties in 43 states consisted of:

•

184 long-term care facilities

•

101 assisted living facilities

•

85 medical office buildings

•

35 physician group practice clinics

•

22 acute care hospitals

•

14 retirement living communities

•

Nine rehabilitation hospitals

•

Eight health care laboratory and biotech research facilities

•

Five health and wellness centers

The average age of our properties is 17 years. As of December 31, 2002, approximately 58% of our annualized revenue was derived from properties operated by publicly traded health care providers.

Our senior debt is rated BBB+ by both Standard & Poor’s and Fitch and Baa2 by Moody’s and has been rated medium investment grade continuously since 1986, when we first received a bond rating. Our average annual return to stockholders, assuming reinvestment of dividends and before stockholders’ income taxes, was approximately 17.2% over the period from our initial public offering in May 1985 through December 31, 2002.

References herein to “HCPI”, “the Company”, “we”, “us” and “our” include Health Care Property Investors, Inc. and our wholly-owned subsidiaries and consolidated joint ventures and partnerships, unless the context otherwise requires.

For purposes of this report, “annualized revenue” is intended to be an estimate of our revenue for the 12 months ending December 31, 2003 for assets owned on December 31, 2002 and is calculated as follows:

(a)

base rents, interest or, in the case of our managed properties, net operating income, to be accrued by us during 2003 under existing contracts; plus

(b)

additional rents accrued by us during the 12 months ended December 31, 2002, which were approximately $25 million in the aggregate; plus or minus

(c)

adjustments for: completed asset dispositions; known or expected changes in rent due to contract expirations or rent resets during 2003; and known or expected rent reductions.

We calculate the net operating income of our managed properties by subtracting from contractual rent the anticipated expenses not covered by the tenant under the gross leases underlying such properties. See “Leases and Loans” below.

You can access free of charge a copy of the periodic and current reports we file with the SEC on our website at www.hcpi.com. Our periodic and current reports are made available on our website as soon as reasonably practicable after these reports are filed with the SEC.

Our Properties

Portfolio

As of December 31, 2002, of the 463 properties in our portfolio, we had an ownership interest in 419 properties located in 41 states. We leased 317 of these properties pursuant to long-term triple net leases to 89 health care providers. Under a triple net lease, in addition to the rent obligation, the lessee is responsible for all operating expenses of the property such as utilities, property taxes, insurance and repairs and maintenance. The most significant lessees under triple net leases include the following companies or their affiliates:

•

Tenet Healthcare Corporation (Tenet)

•

American Retirement Corporation (ARC)

•

Emeritus Corporation (Emeritus)

•

HealthSouth Corporation (HealthSouth)

•

Kindred Healthcare, Inc. (Kindred)

•

HCA Inc. (HCA)

•

Beverly Enterprises, Inc. (Beverly)

The remaining 102 owned properties are medical office buildings, physician clinics, health care laboratory and biotech research facilities and surgery centers with triple net, gross or modified gross leases with multiple tenants which are managed by independent property management companies on our behalf. Under gross or modified gross leases, we may be responsible for property taxes, repairs and maintenance and/or insurance on those properties.

We also hold loans on 44 properties that are owned and operated by 14 health care providers including ARC, Beverly and Emeritus. We have provided secured loans in the amount of $276,648,000 on these properties, including 16 long-term care facilities, 16 assisted living facilities, three acute care hospitals and nine retirement living communities. At December 31, 2002, the remaining balance on these secured loans totaled $275,905,000.

Tenet, ARC and Emeritus account for 16.3%, 7.1% and 5.4% of our annualized revenue, respectively. No other single lessee or operator accounts for more than 5.0% of our annualized revenue as of the year ended December 31, 2002.

Equity Investments

Of the 419 health care facilities in which we had an ownership interest as of December 31, 2002, we own 100% of 344 facilities, including:

•

144 long-term care facilities

•

81 assisted living facilities

•

59 medical office buildings

•

35 physician group practice clinics

•

17 acute care hospitals

•

five retirement living communities

•

three rehabilitation hospitals

At December 31, 2002, we also had interests in several limited liability companies and partnerships that together own 84 facilities and one mortgage as further discussed below under “Investments in Consolidated and Non-Consolidated Joint Ventures.”

The following is a summary of our properties grouped by type of facility and equity interest as of December 31, 2002:

Facility Type	Equity Interest Percentage		Number of Facilities	Number of Beds/ Units (3)	Total Investments (4)		Annualized Revenue (1)
				(Dollar amounts in thousands)
Long-Term Care Facilities (2)	100	%	159	19,743	$	633,282	$	76,166
Long-Term Care Facilities	77-80	%	25	2,778		72,624		9,670

			184	22,521		705,906		85,836

Acute Care Hospitals	100	%	20	2,453		640,252		74,772
Acute Care Hospitals	77	%	2	356		42,807		8,254

			22	2,809		683,059		83,026

Medical Office Buildings	100	%	59	—		543,487		52,699
Medical Office Buildings	54-90	%	31	—		178,489		17,704

			90	—		721,976		70,403

Assisted Living Facilities	100	%	97	8,002		469,065		48,643
Assisted Living Facilities	45-50	%	4	412		1,081		—

			101	8,414		470,146		48,643

Retirement Living Communities	100	%	5	1,086		91,416		9,678
Retirement Living Communities (5)	9.8	%	9	3,151		128,735		16,140

			14	4,237		220,151		25,818

Rehabilitation Hospitals	100	%	3	248		41,805		6,108
Rehabilitation Hospitals	90-97	%	6	437		72,174		9,932

			9	685		113,979		16,040

Physician Group Practice Clinics	100	%	35	—		138,228		11,483


Health Care Laboratory and Biotech Research Facilities	54	%	8	—		66,685		6,587

Totals			463	38,666	$	3,120,130	$	347,836

(1)

“Annualized revenue” is calculated as follows:

(a)

base rents, interest or, in the case of our managed properties, net operating income, to be accrued by us during 2003 under existing contracts; plus

(b)

additional rents accrued by us during the 12 months ended December 31, 2002, which were approximately $25 million in the aggregate; plus or minus

(c)

adjustments for: completed asset dispositions; known or expected changes in rent due to contract expirations or rent resets during 2003; and known or expected rent reductions.

(2)

Includes $8,540 of anticipated annualized revenue on leases of the Centennial and Sun properties discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations.

(3)

Assisted living facilities are apartment-like facilities and are therefore stated in units (studio, one or two bedroom apartments) in order to indicate facility size. Medical office buildings (including health and wellness centers), physician group practice clinics and health care laboratory and biotech research facilities are measured in square feet and encompass approximately 5,081,000 square feet, 986,000 square feet and 510,000 square feet, respectively. Long-term care facilities, acute care hospitals and rehabilitation hospitals are measured by licensed bed count.

(4)

Includes partnership and limited liability company investments, and incorporates all partners’ and members’ assets and construction funded as well as our investment in unconsolidated joint ventures.

(5)

Includes a $125 million investment in nine facilities owned by ARC comprised of a $113 million loan and a 9.8% ownership interest in seven limited liability companies, which own a total of nine retirement living communities. See Note 6 to the Consolidated Financial Statements for discussion of our investment with ARC.

Property Types

The following paragraphs describe each type of property.

Long-Term Care Facilities. We have invested in 184 long-term care facilities. Various health care providers operate these facilities. Long-term care facilities offer restorative, rehabilitative and custodial nursing care for people not requiring the more extensive and sophisticated treatment available at acute care hospitals. Ancillary revenues and revenue from subacute care services are derived from providing services to residents beyond room and board and include occupational, physical, speech, respiratory and IV therapy, wound care, oncology treatment, brain injury care and orthopedic therapy as well as sales of pharmaceutical products and other services. Certain long-term care facilities provide some of the foregoing services on an out-patient basis. Long-term care facilities are designed to supplement hospital care and many have transfer agreements with one or more acute care hospitals. These facilities depend to some degree upon referrals from practicing physicians and hospitals. Long-term care services are paid for either by private sources, or through the federal Medicare and state Medicaid programs.

Long-term care facilities generally provide patients with accommodation, complete medical and nursing care, and rehabilitation services including speech, physical and occupational therapy. As a part of the Omnibus Budget Reconciliation Act (OBRA) of 1981, Congress established a waiver program under Medicaid to offer an alternative to institutional long-term care services. The provisions of OBRA and the subsequent OBRA Acts of 1987 and 1990 allow states, with federal approval, greater flexibility in program design as a means of developing cost-effective alternatives to delivering services traditionally provided in the long-term care setting. This was a contributing factor to the past increase in the number of assisted living facilities, which adversely affected some long-term care

facilities as some individuals chose the residential environment and lower cost delivery system provided in the assisted living setting.

Acute Care Hospitals. We have an interest in 19 general acute care hospitals and three long-term acute care hospitals. Acute care hospitals offer a wide range of services such as fully-equipped operating and recovery rooms, obstetrics, radiology, intensive care, open heart surgery and coronary care, neurosurgery, neonatal intensive care, magnetic resonance imaging, nursing units, oncology, clinical laboratories, respiratory therapy, physical therapy, nuclear medicine, rehabilitation services and outpatient services.

Long-term acute care hospitals provide care for patients with complex medical conditions that require more intensive care, monitoring, or emergency back-up than that available in most skilled nursing-based subacute programs. Most long-term acute care hospital patients have severe chronic health problems and are medically unstable or at risk of medical instability. The most common cases treated in this setting include high acuity ventilator-dependent patients and patients with multiple system failures relating to cancer, spinal cord injuries or head injuries.

Services are paid for by private sources, third party payors (e.g., insurance and HMOs), or through the federal Medicare and state Medicaid programs. Medicare provides reimbursement incentives to traditional general acute care hospitals to minimize inpatient length of stay.

Medical Office Buildings. We have investments in 90 medical office buildings, including five health and wellness centers. Many of these buildings are located adjacent to, or on the campus of, acute care hospitals. Medical office buildings contain physicians’ offices and examination rooms, and may also include pharmacies, hospital ancillary service space and day-surgery operating rooms. Health and wellness centers provide testing and preventative health maintenance services. Medical office buildings require more extensive plumbing, electrical, heating and cooling capabilities than commercial office buildings for sinks, brighter lights, special equipment and biological waste mechanisms required for the proper operation of a medical office. Of our owned medical office buildings and health and wellness centers, 23 are master leased on a triple net basis while 67 are managed by third party property management companies and are leased under triple net, gross or modified gross leases under which we are responsible for certain operating expenses.

Assisted Living Facilities. We have investments in 101 assisted living facilities offering studio, one bedroom and two bedroom apartments on a month-to-month basis primarily to individuals who are over 75 years of age with various levels of assistance requirements. More ambulatory residents are provided meals and eat in a central dining area; they may also be assisted with some daily living activities with programs and services that allow residents certain conveniences and make it possible for them to live independently; staff is also available when residents need assistance and for group activities. Services provided to residents who require more assistance with daily living activities, but who do not require the constant supervision other long-term care facilities provide include personal supervision and assistance with eating, bathing, grooming and administering medication. Charges for room and board are generally paid from private sources.

Retirement Living Communities. We have investments in 14 retirement living communities. These communities are large, upscale residential communities in a congregate care and continuing care living setting combined with onsite amenities and services. Residents are provided the comfort, security and convenience of residing within an aging in place environment, eliminating the need to seek

further resident appropriate levels of care. Ancillary and health care services are available at those properties that provide nursing and assisted living care. The full continuum of senior living environment includes independent living apartments and cottages, assisted living and, in some communities, skilled nursing and Alzheimer’s care. Various accommodation terms are available to residents, including monthly rentals, rental life care, fully refundable entrance fees, non-refundable endowments, cooperatives, and condominiums.

Rehabilitation Hospitals. We have investments in nine rehabilitation hospitals. These hospitals provide inpatient and outpatient care for patients who have sustained traumatic injuries or illnesses, such as spinal cord injuries, strokes, head injuries, orthopedic problems, work related disabilities and neurological diseases, as well as treatment for amputees and patients with severe arthritis. Rehabilitation programs encompass physical, occupational, speech and inhalation therapies, rehabilitative nursing and other specialties. Services are paid for by the patient or the patient’s family, third party payors (e.g., insurance and HMOs), or through the federal Medicare program.

Physician Group Practice Clinics. We have investments in 35 physician group practice clinic facilities that are leased to 13 different tenants. These clinics generally provide a broad range of medical services through organized physician groups representing various medical specialties. Each clinic facility is generally leased to a single lessee under a triple net or modified gross lease.

Health Care Laboratory and Biotech Research Facilities. We have investments in eight health care laboratory and biotech research facilities. These facilities are located on a research campus of a major university. The facilities are designed for and accommodate research and development in the biopharmaceutical industry, drug discovery and development, and predictive and personalized medicine. The facilities are leased to two tenants on a long-term basis.

The following table shows, with respect to each property type, the location by state, the number of beds/units, recent occupancy levels, patient revenue mix, Annualized Revenue and information regarding remaining lease terms.

Facility Location	Number of Facilities	Number of Beds/ Units (3)	Average Occupancy (4)		High Quality Revenue Mix (5)		Annualized Revenue (1)		Average Remaining Term (6)
							(Thousands)		(Years)
Long-Term Care Facilities (8)
Alabama	2	306	92	%	32	%	$	1,411	7
Arizona	3	428	62		33			1,325	6
Arkansas (2)	8	765	53		31			1,332	4
California (2)	16	1,599	84		51			5,306	11
Colorado (2)	7	1,055	86		41			5,218	8
Florida (2)	9	931	92		40			5,470	3
Indiana (2)	34	4,243	80		55			17,917	9
Kansas (2)	3	299	97		48			951	5
Kentucky	6	455	95		44			2,481	10
Louisiana	2	235	88		19			655	16
Maryland	3	438	77		33			1,963	15
Massachusetts	5	615	83		41			2,220	10
Michigan (2)	5	574	90		46			2,067	6
Nevada	2	266	94		63			1,751	7
North Carolina (2)	10	1,166	90		44			3,833	4
Ohio	12	1,543	84		49			8,184	9
Oklahoma	12	1,395	89		77			493	6
Tennessee	13	2,192	81		41			11,054	8
Texas	10	1,259	66		45			4,296	8
Washington	2	252	74		85			458	9
Wisconsin (2)	7	1,009	78		45			3,120	4
Other (13 States)	13	1,496	84		45			4,331	9

Sub-Total	184	22,521	81		47			85,836	8

Acute Care Hospitals
Arizona	2	45	94		100			495	10
California	4	828	58		100			28,922	2
Louisiana	2	325	41		100			5,585	3
South Carolina	2	174	22		100			2,755	3
Texas	5	293	54		100			6,893	4
Other (7 States)	7	1,144	61		100			38,376	4

Sub-Total	22	2,809	55	%	100		$	83,026	3

Medical Office Buildings (7)
Arizona	9	—	—		—		$	3,383	6
California	9	—	—		—			10,824	5
Connecticut	2	—	—		—			704	16
Florida	5	—	—		—			1,537	4
Indiana	13	—	—		—			6,723	5
Massachusetts	2	—	—		—			2,279	8
Minnesota	2	—	—		—			2,456	5
Nevada	2	—	—		—			4,889	14
New Jersey	2	—	—		—			2,711	3
Rhode Island	2	—	—		—			526	16
Texas	11	—	—		—			10,983	4
Utah	20	—	—		—			11,824	7
Other (11 States)	11	—	—		—			11,564	7

Sub-Total	90	—	—		—			70,403	6

Facility Location	Number of Facilities	Number of Beds/ Units (3)	Average Occupancy (4)		High Quality Revenue Mix (5)		Annualized Revenue (1)		Average Remaining Term (6)
							(Thousands)		(Years)
Assisted Living Facilities (5)
California	9	700	92		100			5,927	12
Florida	15	1,568	80		99			4,769	12
Idaho	2	124	92		95			532	11
Indiana	4	378	—		—			1,513	10
Kansas	3	286	76		88			1,446	15
Louisiana	3	240	84		100			1,720	11
Michigan	3	320	98		100			1,046	10
New Jersey	4	352	74		84			2,625	9
New Mexico	2	285	77		100			2,221	9
North Carolina	3	230	86		98			1,443	8
Ohio	3	375	71		100			2,455	11
Pennsylvania	3	232	84		100			2,083	6
South Carolina	4	196	78		100			1,269	12
Texas	22	1,660	77		93			11,630	10
Washington	4	320	92		70			1,899	9
Other (17 States)	17	1,148	79		88			6,065	9

Sub-Total	101	8,414	81	%	95		$	48,643	10

Retirement Living Communities (8)
Florida	3	1,199	91	%	98	%	$	7,276	9
South Carolina	2	454	65		90			3,129	9
Texas	4	979	91		100			6,155	10
Other (5 States)	5	1,605	93		97			9,258	5

Sub-Total	14	4,237	89		98			25,818	8

Rehabilitation Facilities
Arkansas	2	120	78		100			3,182	6
Kansas	2	145	63		100			3,735	3
Other (5 States)	5	420	79		100			9,123	6

Sub-Total	9	685	75		100			16,040	5

Physician Group Practice Clinics
California	2	—	—		—			4,789	7
Florida	9	—	—		—			2,500	6
Georgia	2	—	—		—			—	5
North Carolina	2	—	—		—			191	2
Oklahoma	4	—	—		—			202	6
Tennessee	4	—	—		—			1,428	9
Texas	4	—	—		—			—	—
Wisconsin	6	—	—		—			1,717	12
Other (2 States)	2	—	—		—			656	3

Sub-Total	35	—	—		—			11,483	8

Health Care Laboratory and Biotech Research
Utah	8	—	—		—			6,587	11

Sub-Total	8	—	—		—			6,587	11

TOTAL FACILITIES	463	38,666	—		—		$	347,836	7

(1)

“Annualized revenue” is calculated as follows:

(a)

base rents, interest or, in the case of our managed properties, net operating income, to be accrued by us during 2003 under existing contracts; plus

(b)

additional rents accrued by us during the 12 months ended December 31, 2002, which were approximately $25 million in the aggregate; plus or minus

(c)

adjustments for: completed asset dispositions; known or expected changes in rent due to contract expirations or rent resets during 2003; and known or expected rent reductions.

(2)

Includes $8,540 of anticipated annualized revenue in Arkansas, California, Colorado, Florida, Indiana, Kansas, Michigan, North Carolina and Wisconsin on leases with the Centennial and Sun properties discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations.

(3)

Assisted living facilities are apartment-like facilities and are therefore stated in units (studio, one or two bedroom apartments) in order to indicate facility size. Medical office buildings (including wellness centers), physician group practice clinics and health care laboratory and biotech research facilities are measured in square feet and encompass approximately 5,081,000 square feet, 986,000 square feet and 510,000 square feet, respectively. Long-term care facilities, acute care hospitals and rehabilitation hospitals are measured by licensed bed count.

(4)

This information is derived from information provided by our lessees for the most recently provided quarter through September 30, 2002. Excluded are facilities under construction, newly completed facilities under start-up, vacant facilities, and facilities where the data is not available or not meaningful. Occupancy computations are weighted by number of beds/units. Long-Term Care Facilities are computed using available beds which can sometimes be less than the number of licensed beds a facility may have. All occupancy percentages represent performance by our lessees’ health care operations and occupancy for medical office buildings, physician group practice clinics and health care laboratory and biotech research facilities do not apply as many of these facilities are master-leased.

(5)

(6)

Average Remaining Lease Term calculations are weighted by annualized revenue.

(7)

Includes five health and wellness centers.

(8)

Since December 31, 2001, four properties were recharacterized. Two campuses in South Carolina, previously classified as five assisted living facilities and two long-term care facilities, have been combined into two retirement living communities. In addition, one assisted living facility was reclassified and combined with an already existing long-term care facility.

Competition

We compete for real estate acquisitions and financings with health care providers, other health care related real estate investment trusts, real estate partnerships, real estate lenders, and other investors.

Our properties are subject to competition from the properties of other health care providers. Certain of these other operators have capital resources substantially in excess of some of the operators of our facilities. In addition, the extent to which the properties are utilized depends upon several factors, including the number of physicians using the health care facilities or referring patients there, competitive systems of health care delivery and the size and composition of the population in the surrounding area. Private, federal and state payment programs and the effect of other laws and regulations may also have a significant influence on the utilization of the properties. Virtually all of the properties operate in a competitive environment and patients and referral sources, including physicians, may change their preferences for a health care facility from time to time.

Facility Operators

At December 31, 2002, we had investments in 463 properties located in 43 states and operated by 96 health care operators. In addition, approximately 650 leases are in force in the multi-tenant buildings. Listed below are our major operators, the number of facilities operated by those operators, and the annualized revenue and the approximate percentage of annualized revenue derived from those operators.

Operators	Facilities	Annualized Revenue (1)		Percentage of Total Annualized Revenue
	(Dollar amounts in thousands)

Tenet	9	$	56,739	16	%
ARC	15		24,780	7
Emeritus	34		18,738	5
HealthSouth	9		17,074	5
Kindred	22		16,487	5
HCA	9		14,724	4
Beverly	23		9,853	3

(1)

“Annualized revenue” is calculated as follows:

(a)

base rents, interest or, in the case of our managed properties, net operating income, to be accrued by the Company during 2003 under existing contracts; plus

(b)

additional rents accrued by the Company during the 12 months ended December 31, 2002, which were approximately $25 million in the aggregate; plus or minus

(c)

adjustments for: completed or planned asset dispositions; known or expected changes in rent due to contract expirations or rent resets during 2003; and known or expected rent reductions by tenants.

Tenet, ARC, Emeritus, HealthSouth, Kindred, HCA and Beverly are subject to the informational filing requirements of the Securities Exchange Act of 1934, as amended, and accordingly file periodic financial statements on Form 10-K and Form 10-Q with the Securities and Exchange Commission. We obtained all of the financial and other information relating to these operators listed below from their public reports.

The following table summarizes our major public operators’ assets, stockholders’ equity, interim revenue and net income (or net loss) from continuing operations as of or for the nine months ended September 30, 2002.

Operators	Assets		Stockholders’ Equity (Deficit)			Revenue		Net Income/ (Loss) from Operations
	(Dollar amounts in thousands)
Tenet (1)	$	13,923	$	5,893		$	7,481	$	1,269
ARC		860		28			245		(73	)
Emeritus		157		(86	)		106		1
HealthSouth		7,930		3,964			3,387		455
Kindred		1,598		627			2,510		51
HCA		18,527		5,737			14,705		1,653
Beverly		1,533		321			1,888		25

(1)

The information described above for Tenet is for the six months ended November 30, 2002 or as of

November 30, 2002, as applicable.

The following table summarizes our major public operators’ assets, stockholders’ equity, revenue and net income (or net loss) from continuing operations as of or for the year ended December 31, 2001.

Operators	Assets		Stockholders’ Equity (Deficit)			Revenue		Net Income/ (Loss) from Operations
	(Dollar amounts in millions)
Tenet (1)	$	13,814	$	5,619		$	13,913	$	2,094
ARC		850		108			256		(46	)
Emeritus		168		(74	)		141		7
HealthSouth		7,579		3,797			4,380		434
Kindred (2)		1,509		590			2,329		84
HCA		17,730		4,762			17,953		1,624
Beverly		1,681		296			2,713		(240	)

(1)

The information described above for Tenet is for the fiscal year ended May 31, 2002 or as of May 31, 2002, as applicable.

(2)

The information described above for Kindred is for the nine months ended December 31, 2001 or as of December 31, 2001, as applicable. Kindred, formerly Vencor, Inc., was formed in April 2001 upon emerging from bankruptcy.

The current equity market capitalization for each of the operators listed above, based on the closing price of their common stock on February 7, 2003 as reported in the Wall Street Journal, and based on the number of outstanding shares of their common stock as reported in their most recent public filing available is as follows: Tenet, $8.5 billion; HealthSouth, $1.4 billion; Kindred, $280 million; HCA, $20.7 billion; Emeritus, $42.4 million; ARC, $37.4 million; and Beverly, $176.2 million.

Long-Term Care and Assisted Living Operators

Long-Term Care

Approximately 25% of our annualized revenue is currently derived from the long-term care sector. Reduced reimbursements, a nursing shortage and increased liability insurance costs continue to plague the industry. Certain temporary Medicare add-on payments enacted in The Balanced Budget Refinement Act of 1999 and the Medicare, Medicaid and SCHIP Benefit and Protection Act of 2000 expired in October 2002. As a result, Medicare reimbursement to nursing homes declined about 9%, as of October 1, 2002. Other add on payments associated with certain classifications are scheduled to expire October 1, 2003, but there is currently a proposal to defer these cuts until 2005. A planned limitation on patient Medicare rehabilitation therapy procedures scheduled for January 1, 2003 has been delayed until July 2003. It is anticipated that Medicare reimbursement will be further reduced by the therapy cap. The Medicare reimbursement decrease effective October 1, 2002, (but not including future possible reductions) is expected to cause the cash flow coverage of rents (after management fees) of our long-term care facilities on a pro forma basis in the aggregate to decline from 1.4 to 1.2.

Due to economic challenges facing many states, nursing homes will likely continue to be under funded. Some states, such as California, have proposed to reduce Medicaid reimbursement to nursing home providers. Management believes that inadequate Medicare and Medicaid reimbursements and other issues discussed above will cause losses and reduced financial performance for many long-term care facilities and operators.

We cannot assure you that the troubled operations and bankruptcies of certain long-term care operators will not have a material adverse effect on our net income, Funds From Operations (FFO) or the market value of our common stock.

Assisted Living Operators

We currently derive approximately 14% of our annualized revenue from the assisted living industry. This sector has been challenged by overbuilding, slow fill-up, rising insurance costs and higher operating costs associated with increased acuity of residents. Occupancy rates and bottom line performance, including cash flow coverage on rents, are improving. Various operators have continued to expand their portfolios through acquisitions of existing assisted living facilities during this past year and facility new construction continues to remain relatively low, indicating a positive signal for the industry. More operators are reporting positive operating cash flows for their portfolios while others are approaching this milestone.

While improvements are noted for the industry and specific operators, we cannot assure you that the trouble experienced by assisted living operators will not have a material adverse effect on our net income, Funds From Operations (FFO) or the market value of our common stock.

Leases and Loans

The initial base rental rates of the triple net leases of properties we acquired during the three years ended December 31, 2002 have generally ranged from 10% to 13% per annum of the acquisition price of the related property. Initial interest rates on the loans we entered into during the three years ended December 31, 2002 have generally ranged from 8% to 14% per annum. Rental rates vary by lease, taking into consideration many factors, such as:

•

Creditworthiness of the lessee

•

Operating performance of the facility

•

Interest rates at the beginning of the lease

•

Location, type and physical condition of the facility

Certain leases provide for additional rents that are based upon a percentage of increased revenue over specific base period revenue of the leased properties. Others have rent increases based on inflation indices or other factors and some leases and loans have annual fixed rent or interest rate increases (see Note 2 to the Consolidated Financial Statements).

In addition to the minimum and additional rents, each lessee under a triple net lease is responsible for all additional charges, including charges related to non-payment or late payment of rent, taxes and assessments, governmental charges, and utility and other charges. Each triple net lessee is required, at its expense, to maintain its leased property in good order and repair. We are not required to repair, rebuild or maintain the properties leased under triple net leases.

Each lessee with a gross or modified gross lease is also responsible for minimum and additional rents, but may not be responsible for all operating expenses. Under gross or modified gross leases, we may be responsible for property taxes, repairs and maintenance and/or insurance on those properties.

The primary or fixed terms of the triple net and modified gross leases generally range from ten to 15 years, and generally have one or more five-year (or longer) renewal options. The weighted average remaining base lease-term on the triple net and modified gross leases is approximately seven years. The primary term of the gross leases to multiple tenants in the medical office buildings range from one to 20 years, with a weighted average of six years remaining on those leases. Obligations under the triple-net leases, in most cases, have corporate parent or shareholder guarantees. Irrevocable letters of credit from various financial institutions and lease deposits back 141 leases and mortgage loans on 15 facilities which generally cover from one to 12 months of lease or loan payments. We require the lessees and mortgagors to renew such letters of credit during the lease or loan term in amounts that may change based upon the passage of time, improved operating cash flows or improved credit ratings.

Based upon information provided to us by lessees or mortgagors, certain facilities are presently underperforming financially. Individual facilities may underperform as a result of inadequate Medicaid reimbursement, low occupancy, less than optimal patient mix, excessive operating costs, other operational issues or capital needs.

Each lessee, at its expense, may make non-capital additions, modifications or improvements to its leased property. All such alterations, replacements and improvements must comply with the terms and provisions of the lease, and become our property upon termination of the lease. Leases generally require the lessee to maintain adequate insurance on the leased property, naming us and any

mortgagees as additional insureds. In certain circumstances, the lessee may self-insure pursuant to a prudent program of self-insurance if the lessee or the guarantor of its lease obligations has substantial net worth. In addition, each lease requires the lessee to indemnify us or our affiliates against certain liabilities in connection with the leased property.

Development of Facilities

Since 1987, we have committed to the development of 64 facilities. As of December 31, 2002, we have funded costs of approximately $447 million and have completed 61 facilities of our total development commitment. The completed facilities comprise:

•

35 Assisted living facilities

•

Seven long-term care facilities

•

Eight medical office buildings

•

Five rehabilitation hospitals

•

Five acute care hospitals

•

One health care laboratory and biotech research facility

Simultaneously with the commencement of each of these development programs and prior to funding, we enter into a lease agreement with the developer/operator. The base rent under the lease is generally established at a rate equivalent to a specified margin over our cost of money at the commencement of the lease.

Our build to suit development program generally includes a variety of additional forms of credit enhancement and collateral beyond those provided by the leases. During the development period, we generally require additional security and collateral in the form of more than one of the following:

•

Irrevocable letters of credit from financial institutions;

•

Payment and performance bonds; and

•

Completion guarantees by either one or a combination of the developer/operator’s parent entity, other affiliates or one or more of the individual principals who control the developer/operator.

In addition, before we advance any funds under the development agreement, the developer/operator must provide:

•

Satisfactory evidence in the form of an endorsement to our title insurance policy that no intervening liens have been placed on the property since the date of our previous advance;

•

A certificate executed by the project architect that indicates that all construction work completed on the project conforms with the requirements of the applicable plans and specifications;

•

A certificate executed by the general contractor that all work requested for reimbursement has been completed; and

•

Satisfactory evidence that the funds remaining unadvanced are sufficient for the payment of all costs necessary for the completion of the project in accordance with the terms and provisions of the agreement.

As a further safeguard during the development period, we generally will retain 10% of construction funds incurred until we have received satisfactory evidence that the project will be fully completed in accordance with the applicable plans and specifications. We also monitor the progress of the development of each project and the accuracy of the developer/operator’s draw requests by having our own in-house inspector perform regular on-site inspections of the project prior to the release of any requested funds.

Investments in Consolidated and Non-Consolidated Joint Ventures

Consolidated Joint Ventures

At December 31, 2002, we also had varying percentage interests in several limited liability companies and partnerships that together own 84 facilities and one mortgage, as further discussed below:

(1)

A 77% interest in a partnership (Health Care Property Partners) which owns two acute care hospitals and 18 long-term care facilities and has one mortgage on a long-term care facility.

(2)

Interests of between 90% and 97% in six partnerships (HCPI/San Antonio Ltd. Partnership, HCPI/Colorado Springs Ltd. Partnership, HCPI/Little Rock Ltd. Partnership, HCPI/Kansas Ltd. Partnership, Fayetteville Health Associates Ltd. Partnership and Wichita Health Associates Ltd. Partnership), each of which was formed to own a comprehensive rehabilitation hospital.

(3)

A 90% interest in a limited liability company (HCPI Indiana, LLC) which owns six medical office buildings.

(4)

A 59% interest in a limited liability company (HCPI Utah, LLC) which owns 18 medical office buildings.

(5)

A 54% interest in a limited liability company (HCPI Utah II, LLC) which owns seven medical office buildings, seven health care laboratory and biotech research facilities and is constructing one health care laboratory and biotech research facility.

Non-Consolidated Joint Ventures

(6)

An 80% interest in five limited liability companies (Vista-Cal Associates, LLC; Statesboro Associates, LLC; Ft. Worth-Cal Associates, LLC; Perris-Cal Associates, LLC; and Louisiana-Two Associates, LLC) which own an aggregate of six long-term care facilities.

(7)

A 45% – 50% interest in each of four limited liability companies (Seminole Shores Living Center, LLC – 50%; Edgewood Assisted Living Center, LLC – 45%; Arborwood Living Center, LLC – 45%; and Greenleaf Living Center, LLC – 45%) each owning an assisted living facility.

(8)

A 9.8% interest in seven limited liability companies (Fort Austin Real Estate Holdings, LLC; ARC Santa Catalina Real Estate Holdings, LLC; ARC Richmond Place Real Estate Holdings, LLC; ARC Holland Real Estate Holdings, LLC; ARC Sun City Real Estate Holdings, LLC; ARC Lake Seminole Square Real Estate Holdings, LLC; and ARC Brandywine Real Estate Holdings, LLC) which own an aggregate of nine retirement living communities.

Future Acquisitions

We anticipate acquiring additional health care related facilities and leasing them to health care operators or investing in mortgages secured by health care facilities.

Taxation of HCPI

We believe that we have operated in such a manner as to qualify for taxation as a REIT under Sections 856 to 860 of the Internal Revenue Code of 1986, as amended (the “Code”), commencing

with our taxable year ended December 31, 1985, and we intend to continue to operate in such a manner. No assurance can be given that we have operated or will be able to continue to operate in a manner so as to qualify or to remain so qualified. This summary is qualified in its entirety by the applicable Code provisions, rules and regulations promulgated thereunder, and administrative and judicial interpretations thereof.

If we qualify for taxation as a REIT, we will generally not be required to pay federal corporate income taxes on the portion of our net income that is currently distributed to stockholders. This treatment substantially eliminates the “double taxation” (i.e., at the corporate and stockholder levels) that generally results from investment in a corporation. However, we will be required to pay federal income tax under certain circumstances.

The Code defines a REIT as a corporation, trust or association (i) which is managed by one or more trustees or directors; (ii) the beneficial ownership of which is evidenced by transferable shares, or by transferable certificates of beneficial interest; (iii) which would be taxable, but for Sections 856 through 860 of the Code, as a domestic corporation; (iv) which is neither a financial institution nor an insurance company subject to certain provisions of the Code; (v) the beneficial ownership of which is held by 100 or more persons; (vi) during the last half of each taxable year not more than 50% in value of the outstanding stock of which is owned, actually or constructively, by five or fewer individuals; and (vii) which meets certain other tests, described below, regarding the amount of its distributions and the nature of its income and assets. The Code provides that conditions (i) to (iv), inclusive, must be met during the entire taxable year and that condition (v) must be met during at least 335 days of a taxable year of 12 months, or during a proportionate part of a taxable year of less than 12 months.

There presently are two gross income requirements. First, at least 75% of our gross income (excluding gross income from “prohibited transactions” as defined below) for each taxable year must be derived directly or indirectly from investments relating to real property or mortgages on real property or from certain types of temporary investment income. Second, at least 95% of our gross income (excluding gross income from prohibited transactions) for each taxable year must be derived from income that qualifies under the 75% test and all other dividends, interest and gain from the sale or other disposition of stock or securities. A “prohibited transaction” is a sale or other disposition of property (other than foreclosure property) held for sale to customers in the ordinary course of business.

At the close of each quarter of our taxable year, we must also satisfy four tests relating to the nature of our assets. First, at least 75% of the value of our total assets must be represented by real estate assets, certain stock or debt instruments purchased with the proceeds of a stock offering or long term public debt offering by us (but only for the one year period after such offering), cash, cash items and government securities. Second, not more than 25% of our total assets may be represented by securities other than those in the 75% asset class. Third, of the investments included in the 25% asset class, the value of any one issuer’s securities owned by us may not exceed 5% of the value of our total assets and we may not own more than 10% of the vote or value of the securities of a non-REIT corporation, other than certain debt securities and interests in taxable REIT subsidiaries, as defined below. Fourth, not more than 20% of the value of our total assets may be represented by securities of one or more taxable REIT subsidiaries.

We own interests in various partnerships and limited liability companies. In the case of a REIT that is a partner in a partnership or a member of a limited liability company that is treated as a partnership under the Code, Treasury Regulations provide that for purposes of the REIT income and asset tests, the REIT will be deemed to own its proportionate share of the assets of the partnership or

limited liability company and will be deemed to be entitled to the income of the partnership or limited liability company attributable to such share. The ownership of an interest in a partnership or limited liability company by a REIT may involve special tax risks, including the challenge by the Internal Revenue Service (the “Service”) of the allocations of income and expense items of the partnership or limited liability company, which would affect the computation of taxable income of the REIT, and the status of the partnership or limited liability company as a partnership (as opposed to an association taxable as a corporation) for federal income tax purposes. We also own interests in a number of subsidiaries which are intended to be treated as qualified REIT subsidiaries (each a “QRS”). The Code provides that such subsidiaries will be ignored for federal income tax purposes and all assets, liabilities and items of income, deduction and credit of such subsidiaries will be treated as assets, liabilities and such items of ours. If any partnership, limited liability company, or subsidiary in which we own an interest were treated as a regular corporation (and not as a partnership, QRS or taxable REIT subsidiary) for federal income tax purposes, we would likely fail to satisfy the REIT asset tests described above and would therefore fail to qualify as a REIT. We believe that each of the partnerships, limited liability companies, and subsidiaries (other than taxable REIT subsidiaries) in which we own an interest will be treated for tax purposes as a partnership or disregarded entity (in the case of a 100% owned partnership or limited liability company), or QRS, respectively, although no assurance can be given that the Service will not successfully challenge the status of any such organization.

We also own interests in two subsidiaries which are intended to be treated as taxable REIT subsidiaries (each a “TRS”). A REIT may own any percentage of the voting stock and value of the securities of a corporation which jointly elects with the REIT to be a TRS, provided certain requirements are met. A TRS generally may engage in any business, including the provision of customary or noncustomary services to tenants of its parent REIT and of others, except a TRS may not manage or operate a hotel or health care facility. A TRS is treated as a regular corporation and is subject to federal income tax and applicable state income and franchise taxes at regular corporate rates. In addition, a 100% tax may be imposed on a REIT if its rental, service or other agreements with its TRS, or the TRS’s agreements with the REITs tenants, are not on arms’ length terms.

In order to qualify as a REIT, we are required to distribute dividends (other than capital gain dividends) to our stockholders in an amount at least equal to (A) the sum of (i) 90% of our “real estate investment trust taxable income” (computed without regard to the dividends paid deduction and our net capital gain) and (ii) 90% of the net income, if any (after tax), from foreclosure property, minus (B) the sum of certain items of non-cash income. Such distributions must be paid in the taxable year to which they relate, or in the following taxable year if declared before we timely file our tax return for such year, if paid on or before the first regular dividend payment date after such declaration and if we so elect and specify the dollar amount in our tax return. To the extent that we do not distribute all of our net long-term capital gain or distribute at least 90%, but less than 100%, of our “real estate investment trust taxable income”, as adjusted, we will be required to pay tax thereon at regular corporate tax rates. Furthermore, if we should fail to distribute during each calendar year at least the sum of (i) 85% of our ordinary income for such year, (ii) 95% of our capital gain income for such year, and (iii) any undistributed taxable income from prior periods, we would be required to pay a 4% excise tax on the excess of such required distributions over the amounts actually distributed.

If we fail to qualify for taxation as a REIT in any taxable year, and certain relief provisions do not apply, we will be required to pay tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates. Distributions to stockholders in any year in which we fail to

qualify will not be deductible by us nor will they be required to be made. Unless entitled to relief under specific statutory provisions, we will also be disqualified from taxation as a REIT for the four taxable years following the year during which qualification was lost. It is not possible to state whether in all circumstances we would be entitled to the statutory relief. Failure to qualify for even one year could substantially reduce distributions to stockholders and could result in our incurring substantial indebtedness (to the extent borrowings are feasible) or liquidating substantial investments in order to pay the resulting taxes.

We and our stockholders may be required to pay state or local tax in various state or local jurisdictions, including those in which we or they transact business or reside. The state and local tax treatment of us and our stockholders may not conform to the federal income tax consequences discussed above.

Government Regulation

The health care industry is heavily regulated by federal, state and local laws. This government regulation of the health care industry affects us because:

(1)

The financial ability of lessees to make rent and debt payments to us may be affected by governmental regulations such as licensure, certification for participation in government programs, and government reimbursement, and

(2)

Our additional rents are often based on our lessees’ gross revenue from operations, which in turn are affected by the amount of reimbursement such lessees receive from the government.

These laws and regulations are subject to frequent and substantial changes resulting from legislation, adoption of rules and regulations, and administrative and judicial interpretations of existing law. These changes may have a dramatic effect on the definition of permissible or impermissible activities, the relative costs associated with doing business and the amount of reimbursement by both government and other third-party payors. These changes may be applied retroactively. The ultimate timing or effect of these changes cannot be predicted. The failure of any borrower of funds from us or lessee of any of our properties to comply with such laws, regulations and requirements could affect its ability to operate its facility or facilities and could adversely affect such borrower’s or lessee’s ability to make debt or lease payments to us.

Fraud and Abuse Laws. There are various federal and state laws prohibiting fraud by health care providers who participate in, receive payments from or are in a position to make referrals in connection with a government-sponsored health care program, including, but not limited to the Medicare and Medicaid programs. Specifically, Section 1128B(b) of the Social Security Act (the “Anti-Kickback Statute”), the federal self-referral law (Stark), the False Claims Act, and state laws analogous to these federal laws place restrictions on our leasees and other contractors that may affect their core health care operations.

Federal Anti-kickback Statute. The Anti-Kickback Statute prohibits, among other things, the offer, payment, solicitation or receipt of any form of remuneration in return for, or to induce, the referrals of Medicare and Medicaid patients. Limited “safe harbor” regulations define a narrow scope of practices that will be exempted from federal prosecution or other enforcement action under the Anti-Kickback Statute and fail to exempt a wide range of activities frequently engaged in by health care providers and other third parties. Activities that fall outside the safe harbor rules are not

necessarily illegal, although they may be subject to the increased likelihood of scrutiny, investigation or prosecution. In each case, the government must prove that, in soliciting, offering, paying or accepting remuneration, the parties to such activities intended to induce referrals. A significant body of case law has developed in this area, providing additional guidance as to the scope of the Anti-Kickback Statute. Furthermore, health care providers may seek advisory opinions from the Centers for Medicare & Medicaid Services (CMS) concerning the legality of particular relationships subject to the Anti-Kickback Statute’s prohibitions. Although advisory opinions are binding only on the parties to the opinion, these opinions are often used as guidance in determining the legality of future arrangements.

Violations of the Anti-Kickback Statute may result in civil and criminal sanctions and penalties. Civil penalties include temporary or permanent exclusion from government health programs. Criminal sanctions include imprisonment for up to five years, fines of up to $25,000, or both, for each violation. The Balanced Budget Act, signed into law on August 5, 1997 (the “BBA”), expanded the sanctions under the Anti-Kickback Statute to include civil monetary penalties up to $50,000 for each prohibited act and up to three times the total amount of remuneration offered, paid, solicited, or received, without regard to whether a portion of such remuneration was offered, paid, solicited, or received for a lawful purpose. These penalties and sanctions could be applied with respect to many of our lessee and our other contractors, including, but not limited to, professional services arrangements and/or space or equipment leases or subleases. Many states have adopted or are considering legislative proposals similar to the federal Anti-Kickback Statute, some of which apply to the referral of patients for health care services reimbursed by any source, not only the Medicare and other federal government programs. Government sanctions imposed on our lessees and other contractors in violation of these laws could result in a material adverse effect on their operations which could, in turn, adversely affect our business.

Federal Physician Self-Referral Prohibition (Stark). Absent qualifying for one of the Stark limited exceptions, Stark restricts physicians who have financial relationships with health care providers from making referrals for certain designated health services for which payment may be made under Medicare or Medicaid programs to an entity with which the physician (or an immediate family member) has a “financial relationship”. The Stark provisions became effective January 1, 1992 for clinical laboratory services (Stark I) and January 1, 1995 for ten other designated health services (Stark II). The final Stark I regulations became effective on August 14, 1995 and on January 4, 2001, CMS issued Phase I of the final Stark II regulations. Phase I of the final Stark II regulations focuses on the Stark provisions related to prohibited referrals, the general exception to ownership and compensation financial arrangement prohibitions and the related definitions. Phase I of the final Stark II regulations clarifies the definition of designated health services and indirect financial relationships and creates new exceptions for indirect compensation arrangements and fair market value transactions. Most of Phase I of the final Stark II regulations became effective on January 4, 2002. Phase II of the final Stark II regulations was scheduled to be released in 2002, but has been delayed until sometime in 2003. Phase II of the final Stark II regulations is expected to cover the remaining portions of the Stark statute, including those sections relating to Medicaid.

A “financial relationship” under the Stark provisions includes any direct or indirect compensation arrangement with an entity for payment of any remuneration, and any direct or indirect ownership or investment interest in the entity. “Designated health services” include inpatient and outpatient hospital services and do not include skilled nursing services, but do include services which skilled nursing facilities provide to their patients including therapy, durable medical equipment and enteral and parenteral nutrition. Penalties for violating the Stark provisions include denial of payment

from Medicare and Medicaid programs for any services rendered by an entity in violation of the prohibition, civil monetary penalties of up to $15,000 for each offense, additional monetary penalties up to $100,000 for circumvention schemes, and exclusion from the Medicare and Medicaid programs.

Several states have enacted and/or are considering legislation that prohibits physician referral arrangements or requires physicians to disclose any financial interest they may have with a health care provider to their patients when referring patients to that provider. The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) and the BBA expand the penalties for health care fraud, including broader provisions for the exclusion of providers from the Medicare and Medicaid programs. Further, under Operation Restore Trust, a major anti-fraud demonstration project, the Office of Inspector General of the U.S. Department of Health and Human Services, in cooperation with other federal and state agencies, has focused on the activities of skilled nursing facilities, home health agencies, hospices and durable medical equipment suppliers in certain states, including California, in which we have properties. Due to the success of Operation Restore Trust, the project has been expanded to numerous other states and to additional providers, including providers of ancillary nursing home services.

False Claims Act. Another trend affecting the health care industry is the increased use of the federal False Claims Act as a means to combat fraud and abuse among health care providers. The False Claims Act prohibits any person from knowingly presenting false or fraudulent claims for payment to the federal government (including the Medicare and Medicaid programs). The False Claims Act provides for liability of up to three times the amount of damages which the government sustained due to the false claim as well as penalties of $5,500 to $11,000 per false claim. Therefore, repeated submissions of a large number of claims based on small billing errors may be treated as multiple violations of the False Claims Act and can thus result in significant civil monetary penalties. Health care false claims may also subject providers to criminal and civil sanction under state false claims statutes, as well as under common law fraud statutes.

Although violations of the False Claims Act are ordinarily initiated by the relevant government agency, such violations can also be initiated by individuals under the Qui Tam, or whistleblower, provisions of the False Claim Act. The Qui Tam provisions allow individuals with knowledge of False Claims Act violations to bring suit under the False Claims Act on behalf of the federal government. Qui Tam plaintiffs may be awarded a significant percentage of the ultimate amount recovered by the government.

Recently, several False Claims Act cases have been filed based at least in part on alleged violations of federal health care statutes such as the Anti-Kickback Statute and Stark. In addition, various states are considering or have enacted laws modeled after the federal False Claims Act. Even in instances when a whistleblower action is dismissed with no judgment or settlement, the lessee may incur substantial legal fees and other costs relating to an investigation. Certain lessees have been faced with whistleblower suits by former employees, alleging non-compliance with Medicare rules and regulations. For instance, the U.S. Department of Justice recently joined a whistleblower suit filed against Integrated Health Services, Inc., which alleges that the company admitted and retained patients in its long-term care hospitals who did not require acute care and billed Medicare for these allegedly unnecessary services. Some Medicare fiscal intermediaries (private companies that contract with CMS to administer the Medicare program) have also increased scrutiny of cost reports filed by long-term care providers. Findings of violations of the fraud and abuse laws and regulations may jeopardize a

borrower’s or lessee’s ability to operate a facility or to make rent and debt payments, thereby potentially adversely affecting us.

Civil Monetary Penalties Law. In lieu of, or in addition to, criminal proceedings against a person or entity that has committed a fraudulent act, the Secretary of the Department of Health and Human Services is authorized to impose an administrative civil monetary payment under the Civil Monetary Penalties Law (“CMP Law”). The penalty provisions include all federal health care programs. The amount of the fine is up to $10,000 for each item or service fraudulently claimed for reimbursement. In addition, under the CMP Law, a damage assessment of up to three times the amount claimed for each claim for services may be assessed. Our lease arrangements with lessees may also be subject to these fraud and abuse laws. Federal and state laws governing illegal rebates and kickbacks regulate contingent or percentage rent arrangements where our co-investors are physicians or others in a position to refer patients to the facilities. Although only limited interpretive or enforcement guidance is available, we have structured our rent arrangements in a manner that we believe complies with such laws and regulations.

We have no knowledge that would lead us to believe that the facilities in which we have investments are not in substantial compliance with the various regulatory requirements applicable to them, although there can be no assurance that the operators are in compliance or will remain in compliance in the future.

Licensure Risks. Most health care facilities must obtain a license from the state in which they operate. Failure to obtain licensure or loss of licensure would prevent a facility from its ability to provide health care services on the premises. These events could adversely affect the facility operator’s ability to make rent and debt payments. State and local laws also may regulate expansion, including the addition of new beds or services or acquisition of medical equipment, and occasionally the contraction of health care facilities by requiring certificate of need or other similar approval programs. In addition, health care facilities are obligated to comply with the Americans with Disabilities Act and building and safety codes which govern access to and physical design requirements and building standards for facilities.

Environmental Matters. A wide variety of federal, state and local environmental and occupational health and safety laws and regulations affect health care facility operations. Under various federal, state and local environmental laws, ordinances and regulations, an owner of real property or a secured lender (such as us) may be liable for the costs of removal or remediation of hazardous or toxic substances at, under or disposed of in connection with such property, as well as other potential costs relating to hazardous or toxic substances (including government fines and damages for injuries to persons and adjacent property). Such laws often impose such liability without regard to whether the owner or secured lender knew of, or was responsible for, the presence or disposal of such substances and may be imposed on the owner or secured lender in connection with the activities of an operator of the property. The cost of any required remediation, removal, fines or personal or property damages and the owner’s or secured lender’s liability therefore could exceed the value of the property, and/or the assets of the owner or secured lender. In addition, the presence of such substances, or the failure to properly dispose of or remediate such substances, may adversely affect the owner’s ability to sell or rent such property or to borrow using such property as collateral which, in turn, would reduce our revenue.

Although the mortgage loans that we provide and leases covering our properties require the borrower and the lessee to indemnify us for certain environmental liabilities, the scope of such obligations may be limited and we cannot assure that any such borrower or lessee would be able to fulfill its indemnification obligations.

The Federal Medicare and Medicaid Programs. Sources of revenue for lessees and mortgagors may include the federal Medicare program, state Medicaid programs, private insurance carriers, health care service plans and health maintenance organizations, among others. Efforts to reduce costs by these payors will likely continue, which may result in reduced or slower growth in reimbursement for certain services provided by some of our operators. In addition, the failure of any of our operators to comply with various laws and regulations could jeopardize their certification and their ability to continue to participate in the Medicare and Medicaid programs.

Prospective Payment for Hospital Inpatient Services. Medicare payments to acute care hospitals for inpatient services are based on a prospective payment system (“PPS”). Under PPS, a hospital is paid a prospectively established rate based on the category (“Diagnostic Related Group” or “DRG”) in which a patient’s diagnosis is classified. Beginning in 1991, Medicare payments began to phase-in PPS for capital-related inpatient costs over a ten year period. Thus, current Medicare reimbursement to hospitals for capital-related inpatient costs is based on prospective rates rather than the cost-based reimbursement system previously used. DRG rates are subject to adjustment on an annual basis as part of the federal budget reconciliation process. In addition, the BBA mandated the establishment of prospective payment systems for skilled nursing facilities, home health agencies, hospital outpatient departments, and rehabilitation hospitals. See “Health Care Reform” section and further discussion following.

Prospective Payment for Hospital Outpatient Services. Beginning in August 2000, CMS began to reimburse items and services furnished in hospital outpatient departments under a prospective payment system (“Outpatient PPS”) under which all services are categorized into groups called Ambulatory Payment Classifications (“APCs”). Each APC is comprised of a bundle of like outpatient services that are reimbursed at a prospectively established payment rate. Hospitals are reimbursed additional amounts for certain drugs, biologies, and technologies. APC rates are subject to adjustment on an annual basis.

Prospective Payment for Skilled Nursing Facilities. Prior to July 1, 1998, Medicare programs utilized a cost-based reimbursement system for skilled nursing facilities, which reimbursed these facilities for the reasonable direct and indirect allowable costs incurred in providing routine services plus in certain states, a return on equity, subject to certain cost ceilings. These costs normally included allowances for administrative and general costs as well as the costs of property and equipment (depreciation and interest, fair rental allowance or rental expense). Cost-based reimbursement was typically subject to retrospective adjustment through cost report settlement, and for certain states, payments made to a facility on an interim basis that were subsequently determined to be less than or in excess of allowable costs could be adjusted through future payments to the affected facility. State Medicaid reimbursement programs varied as to the methodology used to determine the level of allowable costs which were reimbursed to operators.

The BBA mandated implementation of a per diem prospective payment system to be implemented for skilled nursing facilities (“SNF PPS”) under which skilled nursing facilities are paid a case-mix adjusted federal per diem rate for Medicare-covered services provided by the skilled nursing

facilities. The per diem rate is calculated to cover routine service costs, ancillary costs and most capital-related costs (see further discussion under Health Care Reform). The SNF PPS federal rates are adjusted based upon case-mix and geography and are subject to annual updates. The phased-in implementation of the SNF PPS began with the first cost reporting period beginning on or after July 1, 1998.

Prospective Payment for Long-Term Acute Care Hospitals. Although most hospitals were transferred to the PPS reimbursement methodology in 1983, certain specialty hospitals were excluded from that system. LTACs were one of the exempted types of specialty hospitals. Faced with escalating health care costs, however, congress mandated that by October 1, 2002, LTACs be transitioned from a reasonable cost-based reimbursement system to a congressionally mandated prospective payment system (“LTAC PPS”). CMS has met the statutory implementation date mandate by establishing October 2, 2002 as the effective date of the LTAC PPS, with system changes to follow. The full impact of the new reimbursement methodology is still to be seen.

State Medicaid Programs. Medicaid programs differ in respect from state to state but they are all subject to federally-imposed requirements. At least 50% of the funds available under these programs is provided by the federal government under a matching program. Medicaid programs generally pay for acute and rehabilitative care based on reasonable costs at fixed rates; long-term care facilities are generally reimbursed using fixed daily rates. Medicaid payments are generally below retail rates for lessee-operated facilities. Increasingly, states have introduced managed care contracting techniques in the administration of Medicaid programs. Such mechanisms could have the impact of reducing utilization of and reimbursement to lessee-operated facilities.

Other third party payors in various states and areas base payments on costs, retail rates or, increasingly, negotiated rates. Negotiated rates can include discounts from normal charges, fixed daily rates and prepaid capitated rates.

Regulations Affecting Long-Term Care Facilities. Long-term care facilities are regulated primarily through the licensing of such facilities against a common background established by federal law enacted as part of the Omnibus Budget Reconciliation Act of 1987. Regulatory authorities and licensing standards vary from state to state, and in some instances from locality to locality. These standards are constantly reviewed and revised. State agencies periodically inspect facilities to determine whether they comply with state and/or federal regulations, at which time deficiencies may be identified. The facilities must correct these deficiencies as a condition to continued licensing or certification and participation in government reimbursement programs. Depending on the nature of such deficiencies, remedies can be routine or costly. Similarly, compliance with regulations which cover a broad range of areas such as patients’ rights, staff training, quality of life and quality of resident care may increase facility start-up and operating costs.

In 1999 and 2000, Congress increased funding for state health agencies in order to allow state agencies that conduct skilled nursing facility inspections to intensify Medicare and Medicaid regulatory enforcement efforts. CMS has instructed these state agencies to increase the number of unannounced facility inspections and to investigate consumer complaints about skilled nursing facilities promptly. As a result of these increased enforcement efforts, some of our lessees may be subject to fines and other penalties that could increase their operating costs.

Acute Care Hospitals. Acute care hospitals are also subject to extensive federal, state and local regulation. Acute care hospitals undergo periodic inspections regarding standards of medical care, equipment and hygiene as a condition of state licensure. Various licenses and permits also are required for purchasing and administering narcotics, operating laboratories and pharmacies and the use of radioactive materials and certain equipment. Each of our facilities, the operation of which requires accreditation, is accredited by the Joint Commission on Accreditation of Healthcare Organizations. Such accreditation may be a more cost-effective and time-efficient method of meeting requirements for continued licensing and for participation in government sponsored provider programs.

Acute care hospitals must comply with requirements for various forms of utilization review. In addition, under PPS, each state must have a Peer Review Organization (also known as a Quality Improvement Organization) to carry out federally funded mandated reviews of Medicare patient admissions, treatment and discharges in acute care hospitals.

Assisted Living Facilities. Certain assisted living facilities are subject to federal, state and local licensure, certification and inspection laws. These laws regulate, among other matters, the number of licensed beds, the provision of services, equipment, staffing and operating policies and procedures. Failure to comply with these laws and regulations could result in the denial of reimbursement, the imposition of fines, suspension from federal and state health care programs and, in extreme cases, decertification from federal and state health care programs, revocation of a facility’s operating license or closure of a facility. Such actions may have an effect on the revenue of the operators of properties owned by or mortgaged to us and therefore adversely impact us.

Entrance Fee Communities. Certain of the facilities mortgaged to or owned by us are operated as entrance fee communities. Generally, an entrance fee is an upfront fee or consideration paid by a resident in exchange for some form of long-term benefit. Typically, entrance fees are broken into two components, a refundable component and a non-refundable component. The percentage of each component varies based upon the different contract alternatives at each entrance fee community. Some of the entrance fee communities are subject to significant state regulatory oversight, including, for example, oversight of each facility’s financial condition, establishment and monitoring of reserve requirements and other financial restrictions, the right of residents to cancel their contracts within a specified period of time, lien rights in favor of the residents, restrictions on change of ownership and similar matters. Such oversight and the rights of residents within these entrance fee communities may have an effect on the revenue or operations of the operators of such facilities and therefore adversely impact us.

Physician Group Practice Clinics. Physician group practice clinics are subject to extensive federal, state and local legislation and regulation. Every state imposes licensing requirements on individual physicians and on facilities and services operated by physicians. In addition, federal and state laws regulate health maintenance organizations and other managed care organizations with which physician groups may have contracts. Many states require regulatory approval, including certificates of need, before establishing certain types of physician-directed clinics, offering certain services or making expenditures in excess of statutory thresholds for health care equipment, facilities or programs. In connection with the expansion of existing operations and the entry into new markets, physician clinics and affiliated practice groups may become subject to compliance with additional regulation.

Rehabilitation Hospitals. Rehabilitation hospitals are subject to extensive federal, state and local legislation, regulation, inspection and licensure requirements similar to those of acute care

hospitals. Many states have adopted a “patient’s bill of rights” which provides for certain higher standards for patient care that are designed to decrease restrictions and enhance dignity in treatment.

Health Care Reform

The health care industry continues to face various challenges, including increased government and private payor pressure on health care providers to control costs, the migration of patients from acute care facilities into extended care and home care settings, and the vertical and horizontal consolidation of health care providers. The pressure to control health care costs intensified during 1994 and 1995 as a result of the national health care reform debate and continued as Congress attempted to slow the rate of growth of federal health care expenditures as part of its effort to balance the federal budget.

Changes in the law, new interpretations of existing laws, and changes in payment methodologies may have a dramatic effect on the definition of permissible or impermissible activities, the relative costs associated with doing business and the amount of reimbursement furnished by both government and other third-party payors. These changes may be applied retroactively under certain circumstances. The ultimate timing or effect of legislative efforts cannot be predicted and may impact us in different ways.

The Balanced Budget Act of 1997. The BBA was designed to produce several billion dollars in net savings for the Medicare and Medicaid programs over the five years following enactment.

The BBA repealed the Boren Amendment under which states were required to pay long-term care providers, including skilled nursing facilities, rates that were “reasonable and adequate to meet the cost which must be incurred by efficiently and economically operated facilities.” As a result, states are now required by the BBA to do the following with respect to skilled nursing facility rates:

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Use a public process for determining rates;

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Publish proposed and final rates, the methodologies underlying the rates, and justifications for the rates and

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Give interested parties a reasonable opportunity for review and comment on the proposed rates, methodologies and justifications.

In determining reimbursement rates, consideration is given to health care providers that serve a disproportionate number of low-income patients with special needs. The Secretary of the Department of Health and Human Services is required to conduct a study concerning the effect of rate-setting methodologies on the access to and the quality of services provided to Medicare and Medicaid beneficiaries and report the study results to Congress.

The BBA also provides the federal government with expanded enforcement powers to combat waste, fraud and abuse in delivery of health care services and promulgated larger penalties for fraud and abuse violations. Though applicable to payments for services furnished on or after October 1, 1997, the new requirements are not retroactive. The BBA also strengthened the anti-fraud and abuse laws to provide for stiffer penalties for fraud and abuse violations as discussed previously.

The BBA also reduced the payments made to long-term acute care hospitals (“LTACs”). Regarding LTACs, the BBA reduced the amount of reimbursement for incentive payments established pursuant to the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”) for capital expenditures and bad debts, and for services to certain patients transferred from an acute care hospital. In addition, the BBA for the first time imposed a national ceiling limitation or “national cap” on payments that may be made in each category of hospitals exempt from a prospective payment system. LTACs constitute one such category. The reduction in payments to LTACs mandated by the BBA may adversely effect an LTAC operator’s ability to develop or acquire LTACs in the future.

The Balanced Budget Refinement Act of 1999. In November 1999, President Clinton signed into law the Medicare, Medicaid and State Children’s Health Insurance Policy (SCHIP) Balanced Budget Refinement Act of 1999 (“BBRA”) which reduces some of the reimbursement cutbacks enacted under the BBA. The BBRA delayed implementation of cost-cutting measures and increased payments to some sectors of the health care industry. The BBRA increased payments to long-term care facilities and lessened cutbacks made to disproportionate share hospital payments. The BBRA also provided that changes to the Outpatient PPS must be budget neutral and not result in reduced reimbursement. The extent of the financial relief to be provided by the BBRA is estimated to be $16 billion over five years.

The Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of 2000. In December 2000, President Clinton signed the Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of 2000 (“BIPA”), which provides for across-the-board Medicare and Medicaid payment increases for most health care providers. Overall, passage of BIPA is expected to result in approximately $35 billion in additional reimbursement for providers over the next five years. Additionally, the BIPA extends the moratorium on implementation of a cap for outpatient therapy services throughout 2002. Payments for home health services, hospice services, and LTAC services will also increase under the provisions of the BIPA.

With respect to skilled nursing facilities, to supplement the transition from cost-based reimbursement to SNF PPS, the BBRA and BIPA mandated that skilled nursing facilities temporarily receive certain payments in addition to straight SNF PPS reimbursement. For two of the temporary add-on payments that were set to expire on September 30, 2002, CMS extended the expiration date to at least fiscal year 2004. The remaining two add-on payments, however, did expire as of September 30, 2002. Industry advocates predict that the expiration of the latter two add-on payments will cost skilled nursing facilities approximately $1.4 billion in fiscal year 2003, which could represent a loss of as much as $30 per resident per day.

Other federal initiatives will result in greater operational expenditures for health care providers. For instance, HIPAA requires a significant overhaul of health care information systems to protect individually identifiable medical information and to standardize formatting of health care claims via electronic data codes. In November 1999, the Department of Health and Human Services released proposed privacy regulations to protect the confidentiality of individual health information. Final privacy regulations were released in December 2000. Generally, health care providers must comply with the HIPAA privacy regulations by April 14, 2003. The federal government has estimated that the United States health care industry will spend approximately $18 billion over a ten-year period in order to achieve compliance with these new privacy requirements.

In August 2000, the U.S. Department of Health and Human Services also released final regulations that delineated uniform, national standards for the electronic exchange of medical information and filing of claims under HIPAA. Health care providers must have complied with these regulations relating to electronic data by October 16, 2002, or have received a waiver from the Department to extend the deadline for compliance to October 16, 2003. The federal government estimates that HIPAA compliance will cost health care providers approximately $3.5 billion. However, the federal government has predicted that implementation of these uniform data standards will help to speed conversion from manual to electronic billing systems, resulting in cost savings to health care providers of approximately $30 billion over the next decade.

In addition to the reforms enacted and considered by Congress from time to time, state legislatures periodically consider various health care reform proposals. Congress and state legislatures can be expected to continue to review and assess alternative health care delivery systems, new regulatory enforcement initiatives, and new payment methodologies. Public debate of these issues can be expected to continue in the future. There are numerous initiatives at the federal and state levels for comprehensive reforms affecting the payment for and delivery of health care services. Changes in the law, new interpretations of existing laws, and changes in payment methodology and enforcement priorities may have a dramatic effect on the definition of permissible or impermissible activities, the relative costs associated with doing business and the amount of reimbursement by both government and other third-party payors. These changes may be applied retroactively. The ultimate timing or effect of legislative efforts cannot be predicted and may impact us in different ways.

National health care spending accelerated 8.7 percent in 2001, reaching $1.4 trillion in total, or $5,035 per capita. Prompted mostly by sluggish economic growth and to some extent by faster-paced health spending, the share of Gross Domestic Product for health care spiked 0.8 percentage points in 2001 to 14.1 percent. Total public funding continued to accelerate, increasing 9.4 percent in 2001 and exceeding private funding growth for the second consecutive year. Public payments rose to $647 billion and paid for 45 percent of the nation’s health. Important sources of growth were payment increases to Medicare providers by the BBRA and BIPA as well as increased Medicaid spending. Medicare expenditures increased 7.8 percent to $242 billion is 2001, and financed one-sixth of overall health care costs. With expenditures only slightly less than Medicare’s, Federal and State Medicaid funded $224 billion in 2001. The weak economy and rising unemployment contributed to increased Medicaid enrollment (up 8.5 percent) and to a faster pace of spending growth in 2001 (up 10.8 percent) than in 2000 (up 8.8 percent). We believe that government and private efforts to contain or reduce health care costs will continue. These trends are likely to lead to reduced or slower growth in reimbursement for certain services provided by some of our lessees and mortgagors. We believe that the vast nature of the health care industry, the financial strength and operating flexibility of our operators and the diversity of our portfolio will mitigate the impact of any such diminution in reimbursements. However, we cannot predict whether any of the above proposals or any other proposals will be adopted and, if adopted, no assurance can be given that the implementation of such reforms will not have a material adverse effect on our financial condition or results of operations.

Objectives and Policies

We are organized to invest in income-producing health care related facilities. In evaluating potential investments, we consider such factors as:

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The geographic area, type of property and demographic profile;

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The location, construction quality, condition and design of the property;

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The expertise and reputation of the operator;

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The current and anticipated cash flow and its adequacy to meet operational needs and lease obligations;

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Whether the rent provides a competitive market return to our investors;

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The potential for capital appreciation;

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The tax laws related to real estate investment trusts;

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The regulatory and reimbursement environment in which the properties operate;

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Occupancy and demand for similar health facilities in the same or nearby communities;

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An adequate mix between private and government sponsored patients at health facilities;

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Potential alternative uses of the facilities; and

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Prospects for liquidity through financing or refinancing.

There are no limitations on the percentage of our total assets that may be invested in any one property or partnership. The Investment Committee of the Board of Directors may establish limitations as it deems appropriate from time to time. No limits have been set on the number of properties in which we will seek to invest, or on the concentration of investments in any one facility or any one city or state. We acquire our investments primarily for income.

At December 31, 2002, we had three series of preferred stock, $177.9 million in mortgage notes payable and $888.1 million in aggregate principal amount of debt securities which are senior to the common stock. We may, in the future, issue additional debt or equity securities which will be senior to the common stock. We have authority to offer shares of our capital stock in exchange for investments which conform to our standards and to repurchase or otherwise acquire our shares or other securities.

We may incur additional indebtedness when, in the opinion of our management and directors, it is advisable. For short-term purposes we from time to time negotiate lines of credit, or arrange for other short-term borrowings from banks or otherwise. We arrange for long-term borrowings through public offerings or from institutional investors.

In addition, we may incur additional mortgage indebtedness on real estate which we have acquired through purchase, foreclosure or otherwise. Where leverage is present on terms deemed favorable, we invest in properties subject to existing loans, or secured by mortgages, deeds of trust or similar liens on the properties. We also may obtain non-recourse or other mortgage financing on unleveraged properties in which we have invested or may refinance properties acquired on a leveraged basis.

In March 2001, we introduced a new Dividend Reinvestment and Stock Purchase Plan (the “Plan”). Under the terms of the Plan, existing stockholders may purchase shares of common stock by reinvesting all or a portion of the cash dividends from their shares of common stock, or by making optional cash payments to purchase additional shares of common stock.

On June 20, 2000 we adopted a Stockholder Rights Plan and declared a dividend of one preferred share purchase right for each outstanding share of our common stock. The rights will become exercisable if a person or group of affiliated or associated persons has acquired, or obtained the right to acquire, beneficial ownership of 15% or more of our common stock or following the commencement or announcement of an intention to make a tender offer or exchange offer the

consummation of which would result in the beneficial ownership by a person or group of 15% or more of our common stock. After the rights become exercisable, each right will entitle the holder to purchase from us one one-hundredth (1/100^th) of a share of Series D Junior Participating Preferred Stock at a price of $95 per one one-hundredth (1/100^th) of a Preferred Share, subject to certain anti-dilution adjustments. The rights will at no time have any voting rights.

Each Series D Preferred Share purchasable upon exercise of the rights will be entitled, when, as and if declared, to a minimum preferential quarterly dividend payment of $1.00 per share but will be entitled to an aggregate dividend of 100 times the dividend, if any, declare per common share. In the event our liquidation, dissolution or winding up, the holders of the Series D Preferred Shares will be entitled to a preferential liquidation payment of $100 per share plus any accrued but unpaid dividends but will be entitled to an aggregate payment of 100 times the payment made per common share. Each Series D Preferred Share will have 100 votes and will vote together with our common stock. Finally, in the event of any merger, consolidation or other transaction in which shares of our common stock are exchanged, each Series D Preferred Share will be entitled to receive 100 times the amount received per share of common stock. Series D Preferred Shares will not be redeemable. The rights are protected by customary anti-dilution provisions. Because of the nature of the Preferred Share’s dividend, liquidation and voting rights, the value of one one-hundredth of a Preferred Share purchasable upon exercise of each Right should approximate the value of one common share.

Under certain circumstances, each holder of a right, other than rights that are or were acquired or beneficially owned by a person or group acquiring 15% or more (which rights will thereafter be void), will have the right to receive upon exercise that number of common shares having a market value of two times the then current purchase price of one right. In the event that, after a person acquired 15% or more of our common stock, we were acquired in a merger or other business combination transaction or more than 50% of our assets or earning power were sold, each holder of a right shall have the right to receive, upon the exercise thereof at the then current purchase price of the right, that number of shares of common stock of the acquiring company which at the time of such transaction would have a market value of two times the then current purchase price of one right.

The rights may be redeemed by the Board of Directors at any time prior to the time a person or group acquires 15% or more of our common stock.

The rights will expire on July 27, 2010 (unless earlier redeemed, exchanged or terminated). The Bank of New York is the Rights Agent.

The rights are designed to assure that all of our stockholders receive fair and equal treatment in the event of any proposed takeover of us and to guard against partial tender offers, open market accumulations and other abusive tactics to gain control of us without paying all stockholders a control premium. The rights will cause substantial dilution to a person or group that acquires 15% or more of our stock on terms not approved by our Board of Directors. The rights should not interfere with any merger or other business combination approved by the Board of Directors at any time prior to the first date that a person or group acquires 15% or more of our common stock.

We will not, without the prior approval of a majority of directors, acquire from or sell to any director, officer or employee of HCPI, or any affiliate thereof, as the case may be, any of our assets or other property.

We provide to our stockholders annual reports containing audited financial statements and quarterly reports containing unaudited information.

The policies set forth herein have been established by our Board of Directors and may be changed without stockholder approval.

Health Care Property Investors

		50%
		Health Care Investors, III
HCPI Mortgage Corp.		50%
100%

Texas HCP, Inc.		99%
100%