Diversified Healthcare Trust
Q4 2016 Earnings Call Transcript

Published:

  • Operator:
    Good morning. And welcome to the Senior Housing Properties Trust Fourth Quarter Financial Results Conference Call. All participants will be listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Brad Shepherd, Director of Investor Relations. Please go ahead.
  • Brad Shepherd:
    Thank you. Welcome to the Senior Housing Properties Trust call covering the fourth quarter 2016 results. Joining me today 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 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 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, Monday, February 27th, 2017. The Company undertakes no obligation to revise or publicly release the results of any revisions to 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 operation or normalized FFO and cash-based net operating income or cash NOI. A reconciliation of these non-GAAP figures to net income and the components to calculate AFFO, CAD, or FAD are available in our supplemental operating and financial data package found in 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. Now I'd like the turn the call over to Dave.
  • David Hegarty:
    Thank you, Brad, and good morning everyone and thank you for joining us today on our fourth quarter earnings call. Earlier this morning, we reported normalized funds from operations or normalized FFO of $0.50 per share for the fourth quarter compared to $0.51 per share for the same quarter in 2015. For the full year 2016, we reported normalized FFO per share of $1.88, an increase of $0.04 per share or 2.2% over the prior year. We are pleased with the solid operating performance for the fourth quarter as we benefited from excellent operations as well as investments in our existing portfolio. SNH continues to offer investors a safe and secured dividend yield of almost 8% per annum while continuing to invest surplus cash flows and to enhancing our existing portfolio for future growth. Specific highlights for the fourth quarter whether we grew consolidated NOI by 4.2% compared to the fourth quarter of 2015 grew consolidated same property NOI by 1.4% compared to the fourth quarter of 2015. Prepaid $48 million of high cost mortgage notes encumbering nine properties, acquired two senior living communities and one medical office building for $37 million bringing our growth acquisition volume for 2016 to $226 million with an average cap rate of 9.3%. Sold one medical office building and one former memory care building for $5 million and subsequent to quarter end, we acquired one MOB for $15.5 million. And finally increased our MOB occupancy to 96.5%, the highest since 2011. Our portfolio is comprised of well diversified private pay focused, healthcare real estate, which is designed to benefit from the ageing demographic and related healthcare life science trends. For the year, SNHs total return was an impressive 43% and we believe there is more potential for growth. In the fourth quarter, approximately 45% of our NOI was attributable to triple net lease senior living communities, 14% to managed senior living communities, 39% to medical office buildings, and the remaining 2% triple net lease to wellness center operators. In the fourth quarter, we increased our total portfolio net operating income over the fourth year last year by $7 million or 4.2%. This total NOI increase is the result of a positive performance of our same store portfolio, which increased by $2.3 million as well as incremental NOI from our external investments of $4.7 million. The 1.4% increase in same store total portfolio NOI would have been 2.2% this quarter if not the casualty losses in Hurricane evacuation cost of over $1 million. Now focussing on our results within these property type our triple net lease senior living portfolio continues to produce consistent steady growth with same store NOI increasing 1.8% in the quarter compared to the fourth quarter last year. Percentage rent of $10.2 million earned for 2016 represents an increase of 1.1% as compared to 2015. This percentage rent is a result of the structure of our triple net lease portfolio where we share in the underlying revenue growth of the properties but are not burdening our tenants with fixed rent increases in times of challenging operations. The triple net senior living portfolio had occupancy of 85.1% and rent coverage of 1.31 times for the 12 months ended September 30, 2016. This is a slight decrease from 1.33 times coverage we reported last quarter. The slight decline in coverage quarter-over-quarter was mostly attributable to weaker performance in the skilled nursing operations and our leased CCRCs and standalone skilled nursing facilities. We report our rent coverage one quarter in areas [ph] and in the third quarter Five Star reported being down approximately $2 million in skilled nursing revenue. The Five Star management spoke about the challenges they were seeing within that industry including the effort led by accountable care organization to decrease lengths of stay as well as the increasing options for care outside of the traditional nursing home environment. Five Star is addressing this skilled nursing challenges by transforming skilled nursing units at some of our CCRCs and to into higher-margin we have the home units as well as becoming fully electronic with medical records that all the standalone skilled nursing facilities by the end of 2017. These strategies are expected to increase occupancy at the CCRCs and the skilled nursing facilities. The same property occupancy impacted by new competition in certain markets within our lease portfolio, but we are now seeing the new stats beginning to plateau. The third quarter of 2016 saw a historical low in occupancy in our lease portfolio and we feel it’s at or near the bottom heading into 2017. 2017 may still yet prove to be challenging but we remain optimistic that occupancy will hold steady with improving age population demographics on the horizon. Our tenants continue to respond to the supply challenges by controlling cost and increasing rents in markets where they can. We continue to partner with them by providing the necessary capital that the communities remain competitive. We are comfortable with our tenant’s ability to cover the rent due to us going forward. Our managed senior living portfolio same-store cash NOI decreased 3.1% year-over-year. There are two important things to note about this decrease, first by comparing this quarter to an exceptionally strong fourth quarter 2015 where we saw year-over-year same store growth in this portfolio in excess of 11%. Second, as I mentioned earlier, we had some casualty losses and hurricane evacuation cost in the fourth quarter that negatively impacted our managed portfolios NOI by a little over $1 million. Adjusting for these costs our same store NOI for the managed portfolio was a positive 1.5% as compared to the same quarter a year ago, and a positive 2.5% on a full year-over-year basis. In October, Hurricane Matthew impacted 14 of our 68 managed properties across three states, Florida, Georgia and South Carolina. Occupancy decreased 60 basis points in the managed same-store portfolio over the prior year; however we saw a slight increase in total revenues as average monthly rate increased just over 1.6%. As a result, our independent and assisted -- revenues were up over $800,000 or 1.2% compared to the same quarter last year. This game in IL and AL revenues this quarter was once again offset by a decrease in skilled nursing revenue of almost $600,000 compared to the same quarter last year. A third of this decrease is related to one community in Arizona where the skilled nursing win [ph] was closed and is being converted to assisted living and memory care. Our same store numbers include all communities even if a component is being repositioned. This conversion is just one example of the ways we are identifying opportunities to generate growth by investing capital in our managed senior living communities. Over 90% of the $7 million we spent this quarter on redevelopment projects were spent on our managed senior living communities. As a matter of fact, two of our biggest projects in progress, one in New York and one in California where we invested almost $2 million this quarter showed NOI growth of over 33% compared to the same quarter last year. We are still seeing the effects of the supply pressure in areas such as Texas and Arizona, however, I’d like point out that our managed communities are very well diversified geographically to 68 managed communities spread across 18 states. Florida has the highest concentration of managed properties with 11 and it’s also our best performing with the same store NOI increasing 13% as compared to the fourth quarter last year despite supply pressures there as well. On the topic of new supply, I’d like to share with you analysis we did this quarter where we compared the neck [ph] under construction data for the managed communities that we have in the markets that NIC tracks. For starters, NIC data covers just under 80% of the markets that are managed communities are located in. We found that about 11% of our Q4, 2016 managed community NOI is located within five miles of new construction that is projected to open in 2017 or 2018. As we point out every quarter, our operations are committed to increasing profitability during this time of increased competition through revenue generating initiatives, controlling cost, investing in human capital and furthering the programming that makes them the providers of choice in our markets. We will continue to pioneer with our operators to identify growth opportunities within the portfolio and fund the capital necessary to achieve it. The Medical office buildings, our MOB portfolio had another strong stable quarter with the 2.7% increase in same-store NOI as compared to the fourth quarter of 2015 and overall occupancy at the end of the quarter of 96.5% is the highest occupancy we’ve had in five years. Additionally, this is the 11th consecutive quarter that our Medical office portfolio has reported occupancy north of 95% improving the quality and stability of this segment of our real estate portfolio. We have leasing [ph] activity in our MOB portfolio during the fourth quarter, a 75,000 square foot biotech MOB located in San Francisco Bay area became vacant on October 31st and we were able to immediately backfill with a 10-year deal with another biotech tenant for the entire space. With this new deal, we had a total of one month of vacancy and a gap rent roll up of approximately 15%. Also, in the fourth quarter, we backfilled [ph] 25,000 square feet vacated by nano therapeutics. You may recall the sale leaseback transaction we did back in May with this existing lifescience tenant of ours, this tenant vacated 32,000 square feet in our research park in Florida to occupy a new 166,000 square foot [Indiscernible] property that we acquired. We backfilled the vacant space with biopharmaceutical tenant in our leased term of over seven years. The MOB occupancy in these leasing examples demonstrates the strength of RMRs asset management and property management teams. Now turning into our acquisition disposition activities. In the fourth quarter we acquired two assisted living communities and one Medical office building for a combined purchase price of approximately $37 million. The two assist living communities contained a total of 126 units and are located in Southern Illinois. These are a 100% private pay facilities and are leased to Five Star with an initial lease rate of 7.5%. Five Star already had an operational presence in the area so the management team transition team from the existing operator to Five Star were seamless and the communities will be able to take advantage of this supply chain and other operating efficiencies. Also, because of the high occupancy and the need for memory care, there is potential for expansion at both of these facilities. The 96,000 square foot MOB we purchased in Ohio is approximately 20 miles outside of Cincinnati and serves as the headquarters in manufacturing facilities of a publicly traded medical device manufacturer. The lease has approximately 14 years of term left when the building was purchased at an 8.2% cap rate. Subsequent to quarter end, in January we acquired 117,000 square foot MOB in the Kansas City Metro market at a 7.7% cap rate for $15.5 million. This property is fully occupied and 90% of it is leased to the University of Kansas hospital authority, an A rated healthcare system and has a remaining lease term of approximately 11 years. In the fourth quarter, we sold one medical office building located in Pennsylvania and one former memory care building at a senior living community located in Florida for a total of approximately $4.9 million. But these transactions are 2016 dispositions total of approximately $35.1 million. We’ve been and continue to be very disciplined with our acquisition activity mainly due to current asset pricing and our relative cost of capital. We are still seeing a considerable amount of deals and we’ll continue to monitor the investment opportunities in the senior living and medical office markets. However, acquisition activity for the foreseeable future will likely be modest with individual properties in small portfolios and we will continue to identify opportunities to invest in our existing portfolio. Now I would like to turn it over to Rick to provide a more detailed discussion about financial results for the quarter.
  • Rick Siedel:
    Thank you, Dave and good morning everyone. Our normalised FFO was $118.6 million for the fourth quarter or $0.50 per share. We declared a $0.39 per share dividend in the first quarter of 2017 resulting in a full-year normalized FFO payout ratio of 83%, which is down almost 2% from last year. Rental income for the quarter increased $4.6 million or 2.7% from the fourth quarter of last year to $175.3 million. This increase is primarily due to our acquisitions of three medical office buildings and nine triple net leased senior living communities since the beginning of 2016. On a same-store basis, rental income increased $1.8 million or 1.1%. This increase was primarily attributable to rent increases as a result of our funding of capital improvements at certain of our triple net leased senior living communities and leasing activity in our MOB portfolio, partially offset by decreased escalation income largely related to decreased real estate tax. As we remind you every quarter, we recognized all of the percentage rent related to our triple net leased senior living communities in the fourth quarter for both our GAAP and non-GAAP performance measures. Percentage rent recognized for the year totaled $10.2 million or 1.1% increase over last year despite occupancies that were down 50 basis points on average across our triple net leased portfolio. Resident fees and services revenue totaled $99 million for the quarter. This represents an increase of $2.2 million or 2.3% over last year largely attributable to the three communities added to the managed portfolio during 2016. On a same-store basis revenue at our managed senior living communities increased 28 basis points versus last year to $91.8 million for the quarter. Average monthly rates increase 1.6% year-over-year while occupancy for the quarter decreased to 87.1% from 87.7% last year. Property operating expenses from our MOBs and managed senior living communities decreased 24 basis points in the fourth quarter to a $101 million compared to the same period last year on our consolidated basis and 24 basis points on our same-store basis to $94.8 million. These decreases are primarily due to decreased real estate taxes, savings and utilities and other expenses partially offset by casualty losses and hurricane evacuation cost that Dave mentioned earlier. Our consolidated property operating expenses also included costs associated with newly acquired or recently transitioned managed senior living communities and MOBs. We’ve seen improvement in our operating margins in both our MOB and managed senior living segment. Our MOBs had NOI margins of 71.7% for the quarter, an increase 160 basis points over last year. Our managed senior living communities NOI margins improved 115 basis points year-over-year to 24.6% for the quarter. General and administrative expenses increased $1.4 million or 13.2% to $11.6 million this quarter compared with the fourth quarter of last year. This increase is due to higher business management fees directly related to the price appreciation of our shares which were nearly 30% higher on average in the fourth quarter of 2016 than they were in fourth quarter of 2015. We’ve recorded non-cash impairment charges totaling $1.7 million in the fourth quarter primarily related to writing down the value of our investment in Five Star’s common shares for accounting purposes as their shares have traded below our carrying costs long enough for us to treat the depressed share price as other than temporary. Interest expense increased 15% to $43.7 million this quarter compared to the fourth quarter of 2015. This increase was primarily of the result of our utilization of attractively priced 10-year interest-only secured debt of $620 million during the third quarter of 2016 and the issuance of 30-year bonds during the first quarter of 2016 to term out the floating-rate borrowing under our revolving credit facility. During 2016 we paid off $163.9 million of mortgages with the weighted average interest rate of 6% and we’ll continue to look for opportunities to pay off high interest rate secured debt. Our total debt to gross asset at the end of the fourth quarter was 43.4% and debt to adjusted EBITDA with 5.7 times. While we are operating at the upper end of our historical range we have more room to comfortably take leverage up and not risk our investment grade rating. That being said, we are constantly thinking about an evaluating ways to bring leverage down during this period where our acquisition volume is more modest. We recognize $659,000 of dividend income during the quarter from our investment in the RMR Group common stock. We expect dividend income to run at this level per quarter for the foreseeable future. As a reminder, SNH holds approximately 2.6 million shares of RMR evaluated over $130 million. Owning these shares further aligns interests for their external manager and we’ve earned over 105% on our adjusted basis. In the fourth quarter we invested $8.9 million into revenue producing capital improvements at our triple net leased senior living communities, for which we would generally earned an 8% return on the amount funded. The majority of these improvements relates to additions to existing communities that we believe will improve our tenant's rent coverage once construction is complete and the additional units are stabilized. Our recurring capital expenditures for the fourth quarter totaled $17.7 million an included $2.9 million at MOBs for building improvements, which included a number of elevator modernization project throughout the portfolio, $9.3 million of MOB tenant improvement and leasing cost which were expected and help us maintain our MOB activities in the future and $5.5 million at our managed senior living communities where we have intentionally increased our capital expenditures to make sure our properties are well positioned to compete with any new supply coming on line. We also spent $7.2 million on development and redevelopment capital projects with the vast majority of it being spend at our managed senior living communities as Dave mentioned. These projects include major renovation intended to reposition their property in its market or give our community a competitive edge against new supply that we see entering the market. December 31st we had $31.7 million a cash on hand and $673 million available on our $1 billion revolver. I’d now like to turn the call back over to the operator for question. Thank you. We will now begin the question-and-answer session. [Operator Instructions]. And our first question comes from Michael Carroll with RBC Capital Markets. Please go ahead.
  • Michael Carroll:
    Yes, thanks. Can you guys provide some color on the Five Star coverage ratios? Do you think that coverage ratio will stabilize at this current level or do you expect it will drop modestly over the next few quarters?
  • David Hegarty:
    Well, with the Five Star coverage ratios, I think those are the numbers just as they reported, there are a couple instances. I think these two properties alone that would return the numbers back to the same level of last quarter. So, I would expect that that we probably continue at about this level. I don’t expect any noticeable decline at all. And in fact as you saw probably this morning they also announced the new $100 million line – working capital line of credit, so they are in great shape as far as we’re concerned.
  • Michael Carroll:
    And do you what’s their plans are for those challenged assets within that portfolio? Did they plan on starting those anytime soon, or do they think they can turn those around and is that something you guys support?
  • David Hegarty:
    That will be a decision that they have to make. We will work with them if they choose these assets are ones that they do not intend to keep, but at the moment I can't speak to what their intention is.
  • Michael Carroll:
    And then, David, can you talk a little bit about the weakness you highlighted related sniff within that portfolio. Now did that also impact the triple net portfolio or is that only the managed portfolio?
  • David Hegarty:
    It has affected both the managed portfolio as well as the triple net portfolio. Wherever we have a number of CCRCs, that are rental CCRCs that have a name that is particularly is skilled nursing and just the way healthcare is being advanced today, they are really encouraging people to go directly from the hospital to home or to certain network skilled nursing facilities or units that are within the market area of the healthcare system. And what they have found is that converting a number of the units to rehab the home programs and implementing significant electronic medical records systems that become very attractive to the healthcare systems and wherever they’ve implemented a new program like that it has tremendously benefited them. So they are going through a process of converting a number of facilities to rehap the home unit. So I expect that trend to -- in fact, like in our case, we’ve reported third quarter down we were down about a $1 million in skilled nursing revenue and this quarter we’re down about 578,000. So they’ve made a significant dent in that and we expect things to continue to improve actually.
  • Michael Carroll:
    Great. Thank you.
  • David Hegarty:
    You’re welcome.
  • Operator:
    The next question comes from Bryan Maher with FBR & Company. Please go ahead.
  • Bryan Maher:
    Good morning, guys. Couple of quick questions. You talked that you're seeing a lot of deal flow, but can you tell us if that's been increasing let’s say in the fourth quarter and the first quarter, kind of flattish or down?
  • David Hegarty:
    I think it’s been a pretty steady flow more so in the medical office building area. We do see a number of assisted living facilities available in the market, but I would say, we’ll see this somewhat of an uptick in medical office and probably flat on senior living.
  • Bryan Maher:
    And do you think you'll see more deal activity in the medical office building in 2017 over the senior living facilities?
  • David Hegarty:
    More than likely that will be the case. Within the senior living particularly we’re focus on trying to add wings, units and our refurbishments that will significantly allow us to raise rates. So, it will be more of an internal story for the senior living portfolio and for external it will be mostly looking for acquisition opportunities.
  • Bryan Maher:
    Great. And then lastly, the House Republicans had their kind of draft of the Affordable Care Act to repeal and replace for the last couple of days. Did you guys have a chance to look at that? Do you any thoughts on what the initial shot across the bow is and how that might impact you?
  • David Hegarty:
    Well, obviously it’s till too early to tell. I think we’ll probably do fine within our portfolio, and we’re expected to have meaningful impact. Obviously, there’s a lot of debate to go on about how funds are allocated by states and how each state will handle that. But I think that there’s going to be a lot of debate about this before they finally come up with what the final plan is.
  • Bryan Maher:
    Okay, great. Thank you.
  • Operator:
    [Operator Instructions]. The next question comes from Nick Yulico with UBS. Please go ahead.
  • Unidentified Analyst:
    Hi. Good morning everyone. This is [Indiscernible] here for Nick. So looking at the results for senior’s housing, it seems like occupancy has decline, and rents are positive but relatively muted. And since you don't provide explicit guidance can you talk a little bit more about your expectations and how you see these trends playing out in 2017 in particular how you manage the portfolio during a challenging environment?
  • David Hegarty:
    Sure. It’s pretty obviously difficult to predict what’s going to happened for the rest of 2017, you know we are in February. But I think we’re seeing that a lot of different pricing methodology has been put in place to try to maximise what they can in different states, but at different facilities. But I know – and one thing I’d like to comment about the rates is that, with the portfolio of independent living, assisted living and skilled nursing, what we find is that on the independent living the rates are much lower yet it's the most profitable piece of healthcare in our portfolio, while skilled nursing will probably actually generate the highest rate on a monthly basis, but the lowest margin. So I won’t read too much into the rate increases. That’s based upon a calculation of overall revenues for our portfolio and they’re not a published room rates or specific rates that we’re pushing through at each facility. I think we determined that our rates actually have gone up in certain phase like Florida they are typically 3% or so, while we’re not able to raise rates at all in Texas and Arizona very much. So, as far as I can see, I think things seem to be plateauing as far as new construction affecting occupancy at units. And so I think I would expect maybe the same or possibly slightly down a bit, but not a major change.
  • Unidentified Analyst:
    Okay. Thank you very much.
  • David Hegarty:
    You’re welcome.
  • Operator:
    And this conclude our our question-and-answer session. I’d now like to turn the conference back over to Mr. David Hegarty for any closing remarks.
  • David Hegarty:
    I just like to thank you all for joining us this morning. We’re obviously very pleased with this quarter and look forward to moving on for the next. Thank you. Have good day.
  • Operator:
    And this concludes our conference for today. Thank you for attending today's presentation and you may now disconnect.