Fair Value Measurements

6 Months Ended

Jun. 30, 2017

8. Fair Value Measurements

The FASB Accounting Standards Codification (“ASC”) 825-10, “Financial Instruments,” requires the disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practical to estimate that value.

Fair value represents the estimate of the proceeds to be received, or paid in the case of a liability, in a current transaction between willing parties. ASC 820, “Fair Value Measurement” establishes a fair value hierarchy to categorize the inputs used in valuation techniques to measure fair value. Inputs are either observable or unobservable in the marketplace. Observable inputs are based on market data from independent sources and unobservable inputs reflect the reporting entity’s assumptions about market participant assumptions used to value an asset or liability.

Our balance sheets include the following financial instruments: cash and cash equivalents, real estate note receivable, tenant and other receivables, net, deferred costs and other assets, restricted cash, notes payable, net, accounts payable and accrued liabilities, prepaid rent and security deposits and distributions payable. With the exception of notes payable and our contingent consideration discussed below, we consider the carrying values of our financial instruments to approximate fair value because they generally expose the Company to limited credit risk and because of the short period of time between origination of the financial assets and liabilities and their expected settlement.

As of June 30, 2017, the estimated fair value of the contingent consideration related to the Armbrook Village and Sumter Grand acquisitions is $1.7 million and $0.0 million, respectively, which represents a total reduction in fair value of contingent consideration in the condensed consolidated statements of operations of $3.7 million for the three and six months ended June 30, 2017. Based on the facts and circumstances that existed as of June 30, 2017, the Company derecognized the liability related to Sumter Grand due to the termination of the management agreement, delivered July 31, 2017, effective August 30, 2017. The termination of the management agreement contractually terminates the earnout agreement. A change in fair value of contingent consideration is recorded when a change in the projected timing to achieve certain specified net operating income thresholds occurs for Armbrook Village. The liability related to Armbrook Village is included in accounts payable and accrued liabilities in our accompanying condensed consolidated balance sheets.

The fair value of the contingent consideration is based on significant inputs which are not observable to the market and as a result are classified in Level 3 of the fair value hierarchy. The fair value is derived by making assumptions on the timing of the lease up process based on actual performance as compared to internal underwriting models and applying a discount rate of 9.0% to the actual Armbrook Village liability to obtain a present value.

The fair value of the Company’s notes payable is estimated by discounting future cash flows of each instrument at rates that reflect the current market rates available to the Company for debt of the same terms and maturities. The fair value of the notes payable was determined using Level 2 inputs of the fair value hierarchy. Based on the estimates used by the Company, the fair value of notes payable was $374.1 million and $369.2 million, compared to the carrying values of $375.7 million ($372.0 million, net of discount and deferred financing costs) and $370.1 million ($366.1 million, net of discount and deferred financing costs) at June 30, 2017 and December 31, 2016, respectively.

There were no transfers between Level 1 or 2 during the three and six months ended June 30, 2017.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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Sentio Healthcare Properties Inc 10-Q