Diversified Healthcare Trust
Q3 2017 Earnings Call Transcript

Published: 9 Nov 2017

[Operator:]

Good day, and welcome to the Senior Housing Properties Trust Third Quarter 2017 Financial Results Conference Call. [Operator Instructions] Please also note that today’s event is being recorded. I would now like to turn the conference over to Mr. Brad Shepherd, Director of Investor Relations. Sir you may begin.

[Brad Shepherd:]

Thank you. Welcome to Senior Housing Properties Trust call covering the third quarter 2017 results. Joining me on today's call are David Hegarty, 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 Senior Housing. Today's conference call contains forward-looking statements within the meaning of the Private Securities and Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based upon Senior Housing's present beliefs and expectations as of today, Thursday, November 9, 2017. The company undertakes no do obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission or SEC. In addition, this call may contain non-GAAP numbers, including normalized funds from operations or normalized FFO and cash-based net operating income or cash NOI. Reconciliations of net income attributable to common shareholders to these non-GAAP figures and the components to calculate AFFO, CAD or FAD are available on our supplemental operating and financial data package found on our website at www.snhreit.com. Actual results may differ materially from those projected in any forward-looking statements. Additional information concerning factors that could cause those differences is contained in our filings with the SEC. Investors are cautioned not to place undue reliance upon any forward-looking statements. I'd now like to turn the call over to Dave.

[David Hegarty:]

Thank you, Brad. And good afternoon to our shareholders, analysts and other interested parties joining this call. We’re pleased to report and discuss our third quarter 2017 results, today we reported normalized funds from operations or normalized FFO per share of $0.44 per share which was $0.01 shy of the third quarter 2016 normalized FFO. We’ve noted previously that on a temporary basis the joint venture we completed in the first quarter of 2017 would reduce our quarterly FFO by up to $0.03 per share per quarter until we can accretively reinvest the proceeds. We were able to partially mitigate some of this dilution by refinancing a large amount of expensive mortgage debt prior to the third quarter. Additionally, our cash same store operations stabilized sequentially and produced year-over-year growth despite the challenges presented by hurricanes Harvey and Irma. In regards to the hurricanes, we were fortunate that we experience very minimal damage to our properties. In fact, we incurred less than a $1 million of hurricane related cost at our managed senior living communities and medical office buildings. Now specific highlights for the third quarter, where we grew consolidated cash NOI by 1.2%, a consolidated same store cash NOI by 50 basis points, achieved MOB occupancy greater than 95% for the 40th consecutive quarter, continued to generate over 97% of our revenues by private pay properties, amended our $1 billion revolving credit facility extending its maturity to 2022, and lowering the interest rate, amended our $200 million unsecured term loan due 2022 lowering the interest rate, invested $40.7 million of CapEx in our Triple Net senior living portfolio that will generate of $1.2 million of additional rent under the terms of our lease agreements, acquired one life science MOB located in Maryland to $16.2 million, received BOMA 360 Award for operational best practices at two of our medical office buildings in addition to the ones we received earlier this year. Subsequent to the quarter and we acquired two MOBs for approximately $39 million, entered into an agreement to acquired two life science MOB for approximately $71 million and finally today, we announced that we’ve entered an agreement to acquire six senior living communities from Five Star Senior Living for approximately $104 million and plan to add them to our managed senior living portfolio when acquired. Approximately 42% of our NOI in the third quarter was attributable triple net lease senior living communities, 14% to managed senior living communities, 41% to medical office buildings and the remaining 3% triple net lease to wellness center operators. In the third quarter, our total portfolio cash NOI increased $1.9 million or 1.2% compared to the third quarter last year. This increase will equal the result of the NOI growth from our triple net lease senior living portfolio as well as acquisitions made in our medical office building portfolio. Our triple net lease senior living portfolio continues to produce consistent growth with same store cash NOI increasing 1.5% in the quarter compared to third quarter last year. This increase is a result of $43.4 million we funded to three different tenants, capital improvements at our [community] since the beginning of third quarter of last year. The triple net leasing living portfolio at occupancy of 84.3% for the 12 months ended June 30th 2017 which was 30 basis points from the 12 months ended March 30th 2017. Rent coverage was 1.26 times the 12 months ended June 30th 2017. There was a slight decrease from 1.27 times coverage we reported last quarter and while our overall coverage declined slightly this quarter, the coverage of our five-star leases remains flat. We are pleased that the coverage helped steady this growth particularly while a significant capital in projects were underway at many of our leased communities. Our managed senior living portfolio same store cash NOI decreased 3.8 % or approximately $870,000 year-over-year. in the quarter, we saw an increase in average costly rates of 80 basis points offset by a decrease of 90 basis points in occupancy compared to the prior year. We saw an encouraging trend of increasing monthly occupancy throughout the quarter. This trend continued into our – with average daily sense was up about 70 basis points over our third quarter average. A modest increase in revenue we saw was offset by a 1.3% increase in total same store senior living operating expenses. Half of this expense increased year-over-year with the result of $500,000 real estate tax abatement we received at a senior living community in Dallas in the third quarter of 2016. We continually appeal real estate taxes and to the extent we’re successful it will impact our same store results. The remainder of the increase in operating expenses can be attributed to costs associated with hurricanes Harvey and Irma with the majority coming from labor related overtime. We have one community in Houston, 11 communities in Florida, 11 communities in Georgia and five communities in South Carolina that were impacted by the hurricanes one way or another. Between the two hurricanes, we created about $0.5 million in overtime and we labor related cost and another $150,000 in clean up related costs. We expect to have an additional $150,000 of cleanup and damage related costs in the fourth quarter. While our exposures to two hurricanes was limited, we feel very fortunate that our communities fared so well through these disasters. We attribute this good fortune to our operators being well prepared in much of the new capital investments in the communities being compliant with the best practices in hurricane prone areas. Operationally the three properties with the largest decrease in NOI year-over-year at two of our rental CCRCs located in Fort Myers, Florida and the Laguna Hills, California and one independent living facility located in Dallas, Texas. As Rick will explain later when he discusses our capital expenditures in more detail, these three properties are currently undergoing major renovations intended to better position themselves in their respective markets but in the near-term these renovations are a disruption to operations especially when marketing to new residents. As a reminder, we do not remove properties and maybe considered unstabalized, undergoing renovations or repositioning from our same store performance which may make our results not comparable to many of our peers. Have we adjusted for the prior year tax abatement, and the hurricane cost, our same store results this quarter for our managed portfolio would have reported an increase in same store cash NOI $280,000 or 1.2%. With regard to investment activity in our managed senior learning portfolio today we announced that we entered into an agreement to acquire six senior learning communities with approximately 600 units from Five Star Senior Living for a $104 million and we will add them to our managed senior living portfolio. The six properties are looking at Alabama, Arizona, Indiana and Tennessee, they are currently 91% occupied and have potential for future development included one significant shuffle ready independent living expansion at a great community that already offers assisted living home care. This is located within a large age restricted 55 and over plan retirement community. Turning to our medical office building portfolio. Our medical office building portfolio same store cash NOI increased 90 basis points year-over-year and overall occupancy at the end of the quarter was 95.8%. This was the 14th consecutive quarter that our medical office portfolio has reported occupancy north of 95% which is indicative of quality and stability of this portfolio. Tenant retention for the third quarter was 73%, bringing our year to date retention to just over 80%. Retention for the quarter was affected by the vacancy of 80,000 square feet of space previously occupied by life science tenant in the Southwest suburb of Boston. This tenant had occupied a total of 315,000 square feet in three separate buildings. They were acquired in 2015 by another life science company and the leases on this space expired in July in 2017. Our team was able to renew this tenant in two of the three buildings, the tenant vacated the third building. This vacancy had a quarterly impact of approximately $200,000 year-over-year. We have had a very strong interest in the vacated space from several potential tenants however, we will likely see this as a variance in our life science portfolio for a quarter to going forward until it’s relent. We had one other decrease worth noting on a comparable cash NOI basis in our life science portfolio this quarter. We were successful in renewing a 200,000-square foot tenant, but we agreed to two months of free ramp, while these two situations accounted for approximately $570,000 reduced cash NOI year-over-year we should be able to recover this in future quarters and are extremely pleased with the fact that these tenants renewed an approximately 430,000 square feet of space with no down time associated with the leases and far less tenant improvement dollars than there would have been for new leases. As I talk about the leasing details of our life science portfolio, I’d like to point out that in our supplemental this quarter for the first time, we separate performance of our life science buildings from our traditional medical office buildings. Our invest in life science buildings now accounts for approximately half of our total $3.6 billion that we invested in medical office buildings. So, while we manage our MOBs and life science buildings as one segment we have provided additional disclosure related to the performance of the two product types to increase transparency and create a better understanding of our portfolio. We also have three traditional medical office buildings that brought the MOB portfolio cash NOI down by approximately $1.1 million year-over-year. However, we expect all three of these properties negative performance will reverse in the fourth quarter as a result of new leasing and timing. As I mentioned earlier, our investment activity in our MOB segment has increased slightly. In the quarter, we acquired one MOB located just outside of Washington D.C to $16.2 million. And subsequent to quarter end, we acquired two Class A MOBs for a total $38.7 million and entered into agreements to acquire two Class A life science MOBs for $71.1 million. I’d like to now turn it over to Rick to provide a more detailed discussion on our financial results for the quarter.

[Rick Siedel:]

Thank you, Dave and good afternoon, everyone. Our normalized FFO was $104 million for the third quarter, $0.44 per share and we declared a $0.39 per share dividend subsequent to quarter end. Rental income for the quarter increased $2.8 million or 1.7% from the third quarter of last year to $168.3 million. This increase is primarily due to rents from the two-triple net lease senior living communities and three medical office buildings we acquired since the end of the second quarter 2016. Resident fees and services revenues from our managed senior living communities totaled $98.3 million for the quarter which was a modest decline compared to the same quarter last year as increases in average monthly rates were offset by decreases in occupancy and changes in acquity mix. Property operating expenses from our MOBs and managed senior living communities increased 1.3% in the third quarter to $104.7 million compared to the same period last year. Within our managed senior living portfolio, the $650,000 of hurricane related cost and $500,000 of real estate tax increase at one property as Dave mentioned earlier explains the majority of the consolidated year-over-year property operating expense increase. Our MOB portfolio’s property operating expense remained well controlled with the year-over-year increase primarily attributable to the acquisition of the three properties since last year. Our MOB portfolio faired very well through the hurricanes this quarter with less than $100,000 of repairs and cleanup expenses. General and administrative expenses decreased $245,000 or 2% this quarter compared with the third quarter of last year excluding the $8 million accrual this quarter for the estimated business management incentive fee. The incentive fee accrued this quarter is based on SNH’s total return in comparison to the SNL US REIT healthcare index through the beginning of 2015 through the end of the third quarter of 2017. SNH outperformed the index by 4.7% over that period. SNH’S total return was 10% compared to the 5.3% total return for the index. The annualized estimated incentive fee for 2017 as calculated at the end of the third quarter was $29.4 million up $1.3 million from the prior quarters estimate due to our relative performance this quarter against the index. We have accrued $22 million year-to-date. This incentive fee accrual may increase or decrease over the remainder of the year depending on how SNH performed relative to the index. Interest expense decreased $3.3 million or 7.7% this quarter compared to the third quarter of 2016. We had a $5.5 million decrease in interest expense this quarter relative to 2016 as a result of the prepayments of mortgage debts prior to this quarter totaling $437 million with a weighted average interest rate of 6.5%. This is offset by an increase of $1.5 million of interest expense from our revolver which had weighted borrowings of 452 million at 2.5% this quarter compared to weighted borrowing of 280 million and at 1.8% in the same quarter last year. As we announced on our last earnings call, in the third quarter we amended our $1 billion unsecured revolving credit facility reducing the interest rate by 10 basis points and extending the maturity to January of 2022 as our existing facility has been scheduled to maturity in January of 2018. At the same time, we also amended our $200 million unsecured term loan that matures in 2022 to reduce the interest rate payable by 45 basis points. The annual savings from these amendments based on our loan balances at the end of the quarter would be approximately $1.9 million. At September 30, we have $28.9 million cash on hand and $471 million outstanding on the revolver. Our total debt to assets at the end of the third quarter was 41.1% down through 42.9% one year ago and debt to adjusted EBITDA was 5.9 times down from 6.1 times a year ago. In connection with the acquisition of the six Five Star Senior Living communities, we expect to assume approximately $33.7 million of mortgage debt and the remainder of the purchase with cash on hand takes from the revolver. In the third quarter, we spend $31.3 million on capital expenditures of which $12 million or approximately 38% is considered recurring and includes building improvements, leasing costs and tenant improvements at our MOBs and managed senior living communities. The most significant of these recurring items included replacement of a number of roof top units and significant HVAC upgrades at a number of our MOBs that we expect to serve our tenants for years to come. In our managed senior living portfolio, the recurring CapEx was related to unit upgrade and elevate our modernization as well as upgrading life safety and IT systems. The remaining portion of our capital expenditures, $19.3 million was spent on development and redevelopment capital projects. The majority of this $14.7 million was funding of projects within our larger triple net lease senior living portfolio which will increase the annual due from our tenants. Some of these projects will be a temporary drag on our rent coverage metrics as the expanded communities need to re-stabilized, but in the medium and longer-term add value for our tenants and for SNH. The remaining $4.6 million was primarily spent on our managed senior living portfolio. In our managed senior portfolio, we recently finished four major capital projects and currently have an additional four ongoing major renovations intended to improve our communities and give them a competitive advantage in their respective markets. We mentioned on our last earnings call that our senior living community outside of Chicago had a grand reopening in July and we’ve seen a noticeable increase in occupancy there. Two other projects, our rehab the home unit in Scottsdale and a multimillion dollar renovation at one of our premier independent living facilities in Dallas have been concluded and hosted grand reopenings in October. We have been anticipating the completion of these projects and are enthusiastic about the future performance of their communities. The four major ongoing renovations in our managed portfolio are located in New York, Laguna Hills, California, Deerfield Beach and Fort Myers, Florida. These four properties were responsible for the substantial majority of the managed redevelopment CapEx spend during the third quarter. Our performance in the third quarter of 2017 was very stable despite the challenges that the senior living industry faced. Our management team continues to focus on investing our properties, compete with new competition and changing demand in our market without the need for us to make significant portfolio transformations or changes to our strategy. For the first three quarters of this year, SNH produced total shareholder returns of 9.5% compared to 6% at the SNL, US REIT Healthcare Index and 3.6% for the R&D. The dividend yields above 8% we still believe we traded a multiple that did not reflect the relative value or the conservative risk profile of our high-quality portfolio. With that, I will now turn the call over to the operator for questions.

[Operator:]

Ladies and gentlemen, at this time we will start the question-and-answer session [Operator Instructions]. And our first question today comes from Tayo Okusanya from Jefferies. Please go ahead with your question.

[Tayo Okusanya:]

Could you talk a little bit about the cap rates on the recent acquisitions?

[David Hegarty:]

Sure. Look with regards to the recent announced transaction with Five Star. Each of those properties was independently valued and the cap rate ranges between 7 and 7.5 for those assets. And with regards to the Medical Office Buildings and Life Science properties, the cap rates are in the mid-8 to 1 as highest, about 13%. But generally, the average is close to about 9.

[Tayo Okusanya:]

Are those cap rates are meaningfully higher versus what you’re kind of seeing some of your peers buying assets at? Could you kind of talk a little bit about what's causing that difference, is it just because they were kind of not heavily marketed transactions, the quality of the portfolio?

[David Hegarty:]

Sure. For one thing they are one-off individual properties and through our acquisitions groups, we see about 99% of the properties available for sale across the country in this area. And these particular ones they might have been something with the lease term being a bit shorter than somebody could get financing for or couple of our relationships. They for instance one of the properties in Overland Park, Kansas is a clinical research lab with a company called Quintiles, and they are a publicly traded, A rated company and for long-term lease for about 9 years. So, kind of unique situation and I have found that we have been successful in many more offers that we’ve made lately. So, I envision the acquisition pipeline to pick-up.

[Tayo Okusanya:]

Then just one more for me if you don’t mind. Now the Five Start transaction given you guys are doing it as a RIDEA transaction. Could you talk about what the potential upside is you are expecting from the portfolio I noticed it’s already 91% occupied? So, what do you kind of think about the stabilized same-store NOI growth out of that portfolio. What are you kind of expecting from it?

[David Hegarty:]

Well, for one thing these properties we believe that we can put some additional capital into the properties and achieve better rates and to some degree occupancy. In addition, we believe that there is one significant community in Tennessee that they would, well, we with them to build a 91-unit independent living community on the premises. And that is significant capital investment and so we believe that, we would get the benefit of the upside with that. And so, we would hope to, we could achieve another 50 to 100 basis points increase in return over the next couple of years from our investments in these assets.

[Operator:]

Our next question comes from [indiscernible] from Bank of America Merrill Lynch. Please go ahead with your question.

[Unidentified Analyst:]

Hi, it’s Kevin up for Juan. I just had a question relating to the first question, basically since you guys have been acquiring MOB is kind of shorter lease terms. What is your I guess your confidence in the current, I guess MOB releasing market as far as like rent per square foot goes moving forward?

[David Hegarty:]

We are very confident in releasing our renewal of existing space within the medical office building area. It seems like on a national basis, I’d say the average is around $24, $28 a foot, but since these particular investments we’re looking at, we evaluate the market that we’re acquiring it within and the downside risk or opportunity risk of releasing it should the tenant not renew there. So, we’re trying to pick our Class A assets, I want to just mention in Overland Park is silver lead rated building. So, I guess I would expect the releasing to be very positive, very likely and we believe that the rents in place the below market in our situation.

[Operator:]

Our next question comes from Michael Carroll from RBC Capital Markets. Please go ahead with your question.

[Michael Carroll:]

Yeah. Thanks, David can you talk a little bit about the agreement by the six Five Star communities. Do you know what Five Star's plan with that cash is?

[David Hegarty:]

Sure. For one thing in Five Star's case, from their perspective is a positive that they can reach some value out of these assets from cash, because they are certainly not getting the valuation in their stock price. And then what they’re going to -- they virtually have no debt to prepay down, we’re going assume some debt as part of the transaction. But the cash is going to be reinvested into the existing portfolio that they have. As you know they come to us typically for a lot of the capital and the rent goes up by normally about 8% on the amount funded. This would allow them to invest some of their own cash without seeking capital from us and some of it. And then just they’ve done a lot of extensive investing in electronic medical records in other IT systems and this allows them to continue to rollup up those programs. Rick, I don’t know if you have anything you want to add to that.

[Rick Siedel:]

Yeah, no I think that’s right that Five Star's going to continue to invest in their profitability initiatives and make sure that they’re well positioned, they still own 20 communities after this along with all properties that they lease from us and other landlords. From our perspective, it was a good deal, very stable assets 91% occupied. And because Five Star's managed them before there is virtually zero transition risk here. So, we’re excited about some of the expansion opportunities within this portfolio and looking forward to getting out of the underway.

[Michael Carroll:]

Okay. Then how much does it cost for their electronic medical records program. It seems like they’ve been or did you sell your last round of assets to fund that within -- or is this more going into your property levels.

[David Hegarty:]

This is continuing to rollout that program. I believe they are spending several millions of dollars per year in all of the skilled nursing facilities as well as the skilled nursing units within the CCRC and again some of the more traditional IT software, so it's an ongoing project and I believe they rolled that out in about more than half of the facilities at this point.

[Unidentified Analyst:]

Okay and then just last question, how much capacity do you see you have out there to go out there and acquire most assets, I mean are you done after the senior housing deal and the MOB deals, are you going to go out there and be more aggressive?

[Rick Siedel:]

I mean based on the cap rates, I wouldn’t say we been particularly aggressive I mean I think a lot of success has to do with the patient continuing to evaluate every deal without there and our underwriting team certainly stays busy. I think we still have plenty of capacity based on what we see in the pipeline right now, there were a lot of balances, possibly a little higher than it has been in the past but with our equity price trading where it is there is not of appetite for that. We do have some other options we could look to refinancing the long-term debt, we can look to sell assets, either into the JV or outright. So I think we got a number of options but we also have some time, taking a good hard look at the pipeline, we're not particularly concerned about where we're from a liquidity perspective.

[David Hegarty:]

Several trade actions not likely to close still just about yearend '17 or throughout the first quarter of '18.

[Operator:]

[Operator Instructions] Our next question comes from Bryan Maher from FBR. Please go ahead.

[Bryan Maher:]

You touched a little bit upon one of my questions, which is your appetite for doing more of the vertex type deals, how many assets in the portfolio are big enough for you to contemplate doing a JV and not too similar to what [Gov] is doing with kind of upgrading their portfolio, selling of some of the lower end stuff, would you consider doing that as well.

[David Hegarty:]

I think that’s on the table for us to consider. Vertex was an unusual transaction actually $1 billion transaction. So I don’t -- doing any acquisition of that size or nature for the foreseeable future, but I do see that, we have both the living side of business as well as the medical office life science side, so I could envision taking some of the housing assets and potentially putting them into a JV as opposed to life science and medical office. But I think I do have assets, [indiscernible] in LA would be another example of an asset that would yield of several hundred of millions of dollars of new fresh capital. But I would say right now those are options that we have available to us, I think we try to keep our structure as stable and simply as possible and we do have some flexibility in our balance sheet to debt issuances or even a follow on from secured that if we chose to. And with regards to assets sales, I think we do look at selling assets, I think historically it’s been smaller amounts I could see envision maybe $50 million or something like that, but that’s another option for us to consider. It’s not out of the question.

[Bryan Maher:]

And then just as a kind of a follow up. What are you seeing in the way of seller motivation? Is it picking up with where we saw cap rates decline 2% of the bigger portfolio earlier this year. Or is it been stable. What are you seeing from the seller community?

[David Hegarty:]

I think a couple of things, one is that a number of investors made investments in properties and added value several years ago and took advantage of the weaker economy. And now that the properties are leased up, I think they just want to capitalized on selling it. Some transactions want to close by year-end because of concerns about potential tax changes like maybe 10-31 rules maybe revised in the certain circumstances. Although at the moment, we seem to be pretty safe, but there are all kinds of tax rules are influx at the moment. And we’re finding a few motivated sellers who really want to push the year-end closings. I mean the main thing capital, certainly in senior living business and I think right now people are concerned about lending sources and re-financing risk and things like that. So, that’s causing some people to sell sooner than they would have preferred to.

[Operator:]

[Operator Instructions] And at this time it showing no additional questions. We like to turn the conference call back over to management for any closing remarks.

[David Hegarty:]

I like to thank you all for joining us on today’s call. And I look forward to meeting up with several of you at NAREIT Conference down in Dallas next week. Have a good day. Good bye.

[Operator:]

Ladies and gentlemen, that does conclude today’s conference call. We thank you for attending. You may now disconnect your lines.