Diversified Healthcare Trust
Q1 2021 Earnings Call Transcript

Published: 7 May 2021

[Operator:]

Good morning, and welcome to the Diversified Healthcare Trust First Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. Please note, this event is being recorded. I would now like to turn the conference over to Mr. Michael Kodesch, Director of Investor Relations. Please go ahead.

[Michael Kodesch:]

Good morning, and welcome to Diversified Healthcare Trust Call covering the first quarter of 2021 results. Joining me on today's call are Jennifer Francis, President and Chief Operating Officer; and Rick Siedel, Chief Financial Officer and Treasurer. Today's call includes a presentation by management followed by a question-and-answer session. I would like to note that the transcription recording and retransmission of today's conference call are strictly prohibited without the prior written consent of Diversified Healthcare Trust, or DHC.

[Jennifer Francis:]

Thank you, Michael, and good morning. Welcome to our first quarter 2021 earnings call. To begin today's call, I'll provide detailed commentary on the current operating environment and some of the recent actions we've taken to meet our long-term goal of maximizing shareholder returns. We believe the country is beginning to recover from the pandemic as we're seeing a marked decrease in confirmed COVID-19 cases and hospitalizations across the United States, since these metrics surged at the start of '21. We believe these trends have been and will continue to be supported by the vaccine rollout, which is progressing at various time lines across each state. Within our own portfolio, COVID-19 vaccination clinics at our shop communities are complete, which we believe is a critical step toward improving resident competence in senior living and growing the profitability of our shop segment. Upon completion of the vaccination clinics, over 96% of residents and almost half of the employees within our shop segment were vaccinated. Although we expect this number to fluctuate with move-ins and move-outs, Five Star Senior Living continues to work to educate employees about the benefits of being vaccinated. And we hope that will encourage higher acceptance. Vaccinations have also had an impact on the number of active COVID cases in our communities. As of May 1, only 11 residents in our managed communities had active cases of COVID-19. All of these communities in our shop segment are accepting new residents.

[Rick Siedel:]

Thanks, Jennifer and good morning, everyone. As Jennifer said, we believe the country is now beginning to recover from the COVID-19 pandemic, but our first quarter results are reflective of what has been an unprecedented 12 months in the senior living business. This extraordinary time of declining occupancies and expense pressure in our shop segment, along with steps, we took to shore up our balance sheet and think longer term about our liquidity needs have resulted in normalized FFO attributable to common shareholders of $0.02 per share and adjusted EBITDA $73.2 million for the first quarter of 2021. As the shop segment has now experienced several quarters of pandemic impacted results. Much of my commentary will compare the first quarter's results with the fourth quarter of 2020 or sequential quarters to provide more meaningful comparisons than year over year changes. Sequentially same property cash basis NOI in our shop segment was down $8.3 million from the fourth quarter. Same property revenues in our shop segment, we're down 4.5% from the fourth quarter driven by lower occupancy.

[Operator:]

The first question today comes from Bryan Maher with B. Riley Securities. Please go ahead.

[Bryan Maher:]

There are a couple of questions from me. When we think about the transitioning of the 108 senior living facilities, have you identified any in there that you are just planning on selling and not transitioning? Or is the goal to transition all 108, see how they go and then make a sell decision? And if so, how long are you going to give those properties to show some improvement?

[Jennifer Francis:]

So we have not identified any predisposition at this point, Bryan. We feel very positive about the operators that we've met with. We're in varying stages of transition. We've talked to dozens of, of operators and then issued RFPs to probably more than 20 operators. We've interviewed 10, but are expecting to interview another 10 and we've even started touring some of those operators and doing some diligence. So we're pretty far along in the process. And at this point, we're in discussions on all of the communities that we're transitioning and the operators that we've been speaking to are pretty excited about the prospect of managing these communities.

[Bryan Maher:]

Great. And how should we think about the new contracts on those properties? Will they be similar to the Five Star contracts or will they vary in some degree that we should be thinking about?

[Jennifer Francis:]

It's early to tell. I think they'll be pretty similar to Five Stars. At this point where we're just starting to, as I said, we've issued RFPs, we've received proposals. So we're starting the stage of negotiation of those, but they will all be management contracts and five stars contractors at market. So I think they'll be pretty similar.

[Bryan Maher:]

Okay. And then on the property that you bought next to the MOB in Maryland, you've been a little vague on what you might do with that property. Can you give us a little color as to maybe two or three options that you might convert that to?

[Jennifer Francis:]

Sure. So I think it's important to note that the properties that's under agreement and we're currently in diligence is one unit of a two unit condo building. The second unit is the 92,000 square foot MOB that we currently own. And this is a situation where the whole is greater than the sum of the parts. So while the MOB that we own is a good building, it will be better when it's combined and put back together with this hotel. This is a market. Silver Spring is a great market. This building is close to the metro. It has many nearby retail amenities. It's about a 20 minute metro ride to Union Station in DC. So this is a market where there are a few life sciences tenants in the market. And then the existing building is a hotel. So on its own, it's a strong investment, but together -- our redevelopment group is looking at it during this diligence period, and they're looking at it as, should the whole thing be converted to a hotel, should the whole thing be converted to life sciences. And so we have a couple of good, strong options that we'll get further along in our diligence and determine what the best step, the path forward is.

[Bryan Maher:]

Great. That's some good color. First of all, thank you for the shop occupancy per month in your release. That goes through March, where we see the uptick, sequentially. And I think you made some comment in your prepared remarks regarding April, but I didn't catch that. What would that number for occupancy be in April?

[Jennifer Francis:]

Let's see. For April, our spot occupancy at the end of April -- I'm sorry, the occupancy was 71.8%.

[Bryan Maher:]

Does that 71.8% compare to the 69.5% in March? So 130 bp increase month-to-month?

[Michael Kodesch:]

No, Bryan. We have to -- on a go-forward basis, we made the announcement of the restructuring with Five Star on April 9. And as you can imagine, once we announced that they were exiting the skilled nursing space and that we were shutting those units down, we haven't had a lot of sniff move-ins in those units, and we have been placing residents elsewhere. So April forward, and we did look at what March would look like, and February on a comparative basis. But we're generally starting to strip out that 1,500 SNF units out of the Five Star retained portfolio, just to make it more meaningful comparisons. So if we look at the entire portfolio, this is the Five Star retain, excluding the sniff and the transition communities. We did see occupancy increase from February to March 10 basis points on average, and from March to April, another 30 basis points. And then, I don't know if Jennifer said it, but we ended April with spot occupancy at 71.8% in that portfolio. And then just to provide a little bit more color, there is a difference between the properties. Five Star is looking to retain, or is retaining and the transition properties, the ones they're retaining are generally the properties they believe they're better at operating and have more confidence in. Those properties ended with spot occupancy of 73.8% while the transition properties ended at 67.1% at the end of April. So there's still some work to do, but as Jennifer said, the operators we've been talking to are really excited. And frankly, our team's been touring all of these assets and we're excited about the possibilities as well.

[Bryan Maher:]

Right. So there's a lot to unpack in what you just said.but to dumb it down a little bit; would you say that no matter how you sliced it, March to April was positive?

[Jennifer Francis:]

Without a doubt, Bryan. In addition to that, this activity, leads activity, activity, tour activity has been very strong. We had 400 move-ins in our shop portfolio in the week beginning, April 25. And that's the most move-ins that we've had in the portfolio in 14 months. So occupancy is growing, move-ins are growing. The increase in leads has been substantial. As I said, we had close to a 30% increase in leads in the first quarter. Over the fourth quarter of '20 more than 40% increase in web leads. So we're really starting to feel a change. Our increase in tours has been substantial. And then, close to an 80% increase in repeat tours in the shop portfolio. And those are people who are coming back for a second tour. So we're really feeling like things are turning.

[Operator:]

The next question comes from Jason Idoine with RBC. Please go ahead.

[Jason Idoine:]

I just wanted to ask about how you went about selecting the 108 properties that you're going to be transitioning. So based off of your comments to Bryan's questions, sounds like those might have been some of the weaker operating properties. So I guess, what gives you confidence that a new operator will be able to come in and improve results and that those transitions won't ultimately be overly disruptive?

[Jennifer Francis:]

Yes. Thanks for your question, Jason. I would say that they're not weak communities. We've spent a good deal of time with Five Star talking about their strengths. They've obviously spent a long time or a lot of time thinking about where they can excel, and what the determination was is they're better at managing larger communities that have residents who have a lower level of care. And I think that determination plays out when you look at the buildings that we're transitioning. They tend to be smaller. They tend to, and I'm talking generalizations, but they tend to have residents who require a higher level of care. And so it became pretty obvious when we and Five Star and Senior Living Asset Management went through each asset, asset by asset, to determine which Five Star would continue to manage and which we would transition over. Just based on that criteria; larger, independent assisted living, independent and assisted living buildings, Five Star's better at managing those.

[Jason Idoine:]

Got it. Okay. And then, what would slow down those transitions? It seems like, I think previously when you guys were transitioning some assets there was some delays with licensing switches. So just what are your thoughts on any potential administrative delays that could be caused by COVID or anything along those lines that could maybe slow down those transitions?

[Jennifer Francis:]

Yes. We've got a team of folks that have been working on that for some time, and these are managed communities. When we transitioned from a leased to managed relationship with Five Star, when Five Star leased communities from us, they held the license. And when we transitioned, it took that year to transition over, really because of the change in who held the license. And now DHC is licensed in all of these communities because Five Star is our manager. So transitioning managers is much easier than transitioning from leased to managed, because we do not have to transition the licenses. So that should not hold us up at all. Because it's just not a requirement. I don't know that there's -- It's a lot of communities to transition.but we have a team both at Five Star and at Senior Living Asset Management that are going to be focused on that transition. And as part of our interview process with operators, we spend a good deal of time talking about their transition expertise and how they're going to do it. And it's part of what we're looking for in new operators, is operators who have done this and are expert at it.

[Jason Idoine:]

Got it. Okay. And then my last question is, how did you guys think about the new management agreement, obviously when taking the incentive fee cap off and at a point where we're at a trough in the business? And then also not having to pay the termination fee and having a stake in Five Star's business. So I guess, with those puts and takes, how did you guys weigh those?

[Jennifer Francis:]

There were a lot of puts and takes. And so this was -- we spent a good deal of time coming up with the changes to the management agreement. With the negotiation of any agreement there are gives and takes and this is where we settled, and we think that both parties gained and both parties settled at some point, but we're pretty happy. We do strongly believe that an incentive fee is important. We want our manager to be motivated, to continue to grow NOI, to grow EBITDA. And so that's where the incentive fee comes into play, and so we think it's pretty important.

[Jason Idoine:]

Okay. Sorry. And then I do have one other one. So did you mention what the 2020 for the targeted EBITDA level was going to be? I think you did in your prepared remarks. But I would just be curious, I guess, how did you guys come to that number?

[Michael Kodesch:]

Yes, it was based on budget. The budget process works is the senior living asset management and Five Star work closely together on establishing a budget for the coming year. So in the late spring, early summer of last year, they met and talked about every community. And so the target for the 2021 budget, or the target EBITDA, is about a $100 million in the retained communities. Again, we don't think that EBITDA will come close to that number. So I think we will not pay an incentive fee this year.

[Operator:]

Your next question comes from Jonathan Hughes with Raymond James. Please go ahead.

[Jonathan Hughes:]

We've seen some recent public to public M&A activity across the REIT space, and a few of those were scenarios where the target is a company that just hasn't worked or had structural headwinds and a merger was a win-win for both shareholder basis. So as I look at DHC where the 10-year total return CAGR has been negative 10% versus the health care REIT average of positive 7, it seems like things just aren't working here and haven't for a while. So Jennifer, you mentioned a focus on maximizing value in your first report prepared remarks. And I know the last year has been very difficult. But has the Board or RMR explored all ways to maximize value at DHC, including a sale of the Company, or at least announcement of a review of strategic alternatives and not just transitions and more cap ex investment?

[Jennifer Francis:]

I mean, the Board, I think has conversations and ways all options on a regular basis. Our focus is to stabilize our portfolio and we feel -- Obviously our MOB life sciences portfolio is pretty strong. And in some instances we put capital into those buildings to reposition them. We're really focused on stabilizing our senior living portfolio as a way to maximize shareholder value. So that's our strategy.

[Jonathan Hughes:]

I mean, I hear the comment. But I mean the same store NOI in life science and MOBs has been negative for a couple of times now. And we haven't seen that at any of the peers. So maybe this is a question for the Board. Where's the accountability for the performance, and frankly under-performance, of DHC over the past decade? I mean, every Board member, with the exception of one, has served for an average of 11 years and is on another RMR managed REIT Board. Mean do shareholders' voice, this accountability concern to you and the Board? And if so what do you tell them?

[Jennifer Francis:]

Jonathan, I'm struggling a little bit with the 10 year period. I mean if you look back there have been a number of actions taken to try to be more shareholder friendly and to enhance returns for our shareholders. The 10 year number is -- If you look back, it was a very different business 10 years ago. Starting with, in 2015, there was a significant restructuring in order to make RMR the manager that was previously private public and be more transparent. And we actually distributed those shares out to shareholders. And then, obviously, the senior living business has changed since 10 years ago. So there was a significant restructuring from leases to management contracts. And essentially the entire industry did that. Maybe we were a little late, because again, there is a certain amount of related party transaction that we don't want to do something like that unless we absolutely have to, because it could be disruptive to shareholders. COVID was not expected. And we have repositioned the portfolio more towards medical office and life science. If you look at our more recent redevelopment activity, I mean, the team is hitting home runs on that stuff. And again, if we've got some long-term leased assets that are finally rolling after a 15 year term, you're going to have some vacancy and we're going to reposition those portfolios. So if other peers have been out buying brand new buildings with 2% rent steps, if different than what was in our portfolio. But we are doing everything we can to maximize value in our portfolio.

[Jonathan Hughes:]

What is the breakup fee payable to RMR if they were to be terminated as manager of DHC and a change of control transaction?

[Jennifer Francis:]

Again, we are focused on the business and moving it forward. That stuff is disclosed in the SEC filings if you want to dig through it. But that is not what we're focused on.

[Operator:]

As there are no further questions at this time, I would like to turn the conference back over to Ms. Francis for closing remarks.

[Jennifer Francis:]

Thank you. And thank you for joining our call today. We look forward to seeing many of you at the upcoming REIT week, NAREIT 2021 Investor Conference. Operator, that concludes our call.

[Operator:]

That does conclude our conference for today. Thank you all for participating. You may now disconnect your lines.