Diversified Healthcare Trust
Q2 2008 Earnings Call Transcript

Published: 24 Aug 2008

[Operator:]

Good day, everyone, and welcome to the Senior Housing Properties Trust Second Quarter 2008 Financial Results Conference Call. This call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to the Director of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

[Tim Bonang:]

Thank you, Cynthia, and good afternoon, everyone. Joining me on today’s call are Dave Hegarty, President and Chief Operating Officer, and Rick Doyle, Chief Financial Officer. Today’s call includes a presentation by management followed by a question-and-answer session. Before we begin today’s call, I would like to state that today’s conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and the Federal Securities Laws. These forward-looking statements are based on Senior Housing’s present beliefs and expectations as of today, August 7, 2008. The company undertakes no 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 regarding this reporting period. In addition, this call may contain non-GAAP numbers, including funds from operations or FFO. A reconciliation of FFO to net income is available in our supplemental package found in the Investor Relations section of our website. Additional results may differ materially from those projected in forward-looking statements. Additional information concerning factors that could cause those differences is contained in our 2007 Form 10-K and Second Quarter Form 10-Q to be filed with the SEC within the next day, as well as in our Q2 supplemental operating and financial data found on our website at www.snhreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements. And with that, I would like to turn the call over to Dave Hegarty.

[Dave Hegarty:]

Thank you, Tim, and good afternoon, everyone, and thank you for joining us during this very busy reporting season that’s going on. We are pleased with the results for the quarter during what is a transformational period as we take steps to diversify our tenant base and product type. Our previously announced $565 million of acquisitions, a medical office, clinic and biotech laboratory buildings allows us to enter the MOB space in a meaningful way. When these transactions are complete, we will have expanded our tenant base from ten to nearly 400 tenants, and over 20% of our rents will come from medical office clinic and biotech laboratory buildings. We believe these steps will bring more securities where it is already a very secure portfolio. I’d like to point out a couple of events during the quarter that enhanced our financial position for the future. First, in early June, we completed a significant equity offering and raised net proceeds of approximately 394 million, which we used to reduce our outstanding balances on our revolving credit facility to zero, and provided cash for future acquisitions. This was followed by an upgrade of our public debt to investment grade status by Standard & Poor’s. Looking to our second quarter results, I would point out that the timing of our equity offering and the phased closings of our MOB transaction had a transitional influence on our results as we deployed the proceeds of the offering. As such, this morning, we recorded FFO of $0.41 per share for the second quarter and ended the quarter in an excellent position. As the equity proceeds are invested, we expect our FFO to steadily increase, and we believe that we will be able to take advantage of a range of investment opportunities in the near future. For example, as of June 30, our cash balance was 186 million. This amount had not yet been invested into income producing properties. Now, Rick will review our quarterly financial results and properties acquired, and then I will discuss the ministry events, the activities with our tenants, lease performance and acquisitions opportunities before we take any questions. Let me turn it over to Rick now.

[Operator:]

Today’s question and answer session will be conducted electronically. (Operator instructions). We will take our first question from Tayo Okusanya with UBS. Please go ahead.

[Tayo Okusanya:]

Hi, yes. Good afternoon, gentlemen. Congratulations on another good quarter.

[Dave Hegarty:]

Thanks, Tayo.

[Tayo Okusanya:]

The question I have I believe has to do more with the whole relationships with RMR. I think people judge you have a lot of liquidity, people judge you are in a good position to continue to make accretive acquisitions, but the stock has been literally – has under performed its peers ever since you guys did HRT deal. I was just wondering going forward with all the fire power you have, what opportunities do you have to diversify away from doing business with other RMR affiliated companies such that investors feel a little more comfortable in regards to investing in the stock? It really kind of seems like it’s what’s holding thing back at this point.

[Dave Hegarty:]

Sure, thanks. Tayo, I guess first I think that the stock has been on a drag a bit recently because of the fact we did raise the equity proceeds and those funds have not been invested. So, this quarter was a bit down from a expected performance just because we had so much cash on hand. And so hopefully I would get – expect to put that to use in the near term, and that should significantly improve the results for the quarter and that would allow us to raise the dividend and so on. Now I think as far as the opportunities out there, we are seeing a number of opportunities that are away from Five Star. On the HRT front I don’t – we don’t have any current other transactions, or follow-on transactions in mind with them. So, maybe down the road, there could be something, but we are seeing mostly today a number of opportunities in the medical office building area. We are very optimistic that some of those will come to fruition in the near term. So, I don’t want to give you any specifics but we do have several on the line and we expect that we’d be able to finish documenting and closing them in the near term.

[Tayo Okusanya:]

What about in your core assisted living portfolio, any opportunities for you to do something with other assisted living operators out there?

[Dave Hegarty:]

We’re optimistic that there will be. We’ve had a few situations that we’ve bid on and have come close on. We’re to trying to be as aggressive as we can in our bidding. I think there is –

[Tayo Okusanya:]

But even apart from bidding and owning the assets, are there opportunities to lease the assets to other operators apart from Five Star, is that something that will become a reality over the next three to six months?

[Dave Hegarty:]

That’s actually what I was referring to is sale-leaseback type transaction with other operators. The sentiment that we are seeing out there is that the larger players really don’t want to do sale leaseback transactions for the foreseeable future, because you obviously have a Ameritas buying them back, and you have Brookdale would buy back as many as they could today. And so it’s going to be more the mom and pop and regional operators, and we’ve made proposals with the regional operators. But to be honest NHP and Ventas and some of the others have just been more aggressive and willing to live with much smaller secure deposits or much less capitalized companies than we would require. And I guess we are not willing to go so much on the risk curve that we’re just a step away from taking on the operator’s risk of those properties. And so that tends to be why we are not winning a number of transactions with other third parties.

[Tayo Okusanya:]

Okay. Fair enough, thank you.

[Dave Hegarty:]

Welcome.

[Operator:]

We will take our next question form Jerry Doctrow with Stifel Nicolaus. Please go ahead.

[Jerry Doctrow:]

Thanks. Yes, actually a little bit on the same lines. David, I was wondering on the MOBs that you are seeing out there in the environment, is that also been very competitive, you know whether they are sort of general theme of things that sort of work for you, whether you are on campus or off campus, I mean more of your stuff I think you acquired from HRP is kind of off campus stuff. And just if you can give me a little more color there maybe what cap rates might be and that sort of thing, or yields might be?

[Dave Hegarty:]

Sure. Well, there are a few differentiating factors between us and some of our peers in that we are not willing to do any transactions that have say a land lease or a fee restriction to us with a certain hospital system or hospital group. And as a result, a lot of the on campus properties are ones that we are not willing to do or just it’s not the right situation, and besides a lot of on campus is going for the lowest cap rate. So, what we are finding is that the most opportunity for us are near campus but off campus, and in some of the ones we are buying form HRPT and some of the ones that we are seeing out there that are most – that work for us are actually well established standalone medical office buildings and that may be – are affiliated with nearby hospital systems but they are one off large medical office buildings. And so from a cap rate perspective, we are able to see the rates – cap rates in the high sevens, low eight range and actually I expect us to be able to do a number of transactions. What’s also interesting too is that in our existing portfolio, the very first property we did buy from HRPT when we acquired it, it was 89% occupied and it has gone up. We’ve signed up a couple new tenants and currently it is at 97% occupancy. So, I think the standalone medical office buildings are working for us.

[Jerry Doctrow:]

Okay. And then I think kind of following up on the diversification issue, I found it interesting that you would talk about Five Star not being your first choice on NewSeasons and focus on diversifying which I certainly agree would be I think beneficial for the stock. The – I guess my issue is whether there is other things. We cover Five Star as well, and I think Five Star has been encouraging (inaudible) to simplify its business structure so whether you take the existing portfolio and sort of move, whether it’s the skilled nursing assets or the rehab hospitals, whatever, to a new operator, I mean Five Star gives you obviously some – a public company a strong balance sheet, but it does create sort of the concentration risk. So is that sort of a discussion that have had or you think about because I think would benefit both companies?

[Dave Hegarty:]

Right. Well, periodically we do discuss some of those options and a lot of negotiations really can’t come from the SNH side. They really have to be – Five Star has to make some strategic decisions if they want to exit some of those assets, and depending on the situation, they most likely would probably have to be compensated by somebody. In the NewSeasons situation, you probably have the reverse where NewSeasons paid Five Star to take over those leaseholds and Five Star would probably want to be compensated by somebody to take over their leaseholds, and then we would have to approve such a transition. And depending on who it is, we’d probably want to encourage that, but that’s where the decision has to be driven from. We can’t tell them you should – we’d really like you to switch operators for these properties, it’s just not something we can force upon a tenant.

[Jerry Doctrow:]

Right. I mean I think the point which probably is obvious to you guys already is, I think there are some of those transactions even if you were to take a leasehold tenant that was much less well capitalized, I think the diversification and their refocus on their core business would be beneficial for both sides. So, that’s just my editorial comment, I will let somebody ask.

[Dave Hegarty:]

Okay. We do bid on other scenarios like even skilled nursing facilities which is not our preferred investment property type if it was with say seven or ten different operating companies. We would find that attractive because of the diversification and we would be more aggressive chasing the situation like that than doing any transaction with one new tenant.

[Jerry Doctrow:]

Okay. Thanks.

[Dave Hegarty:]

All right.

[Operator:]

We will take our next question from Philip Martin with Cantor Fitzgerald. Please go ahead.

[Philip Martin:]

Good afternoon.

[Dave Hegarty:]

Hi, Phil. Good afternoon.

[Philip Martin:]

Dave, just a question on, as you are out there looking at investment opportunities in the senior living area, private pay senior living, are you finding – are you finding there are properties that you might like to have but are just being – that are under performing because of the operator and does the REIT legislation that was recently signed allow you to maybe think differently now about going after those opportunities to try to affect some change operationally and benefit from any change you might be able to help provide given your experience in the sector?

[Dave Hegarty:]

Yes. There are those situations out there and that would be a good appropriate use for the new legislation. And the REIT – we could hire almost any operator, including Five Star to operate while we take on the risk, Philip, of those properties. We don’t necessarily want to go into the senior living business ourselves and keep the bottom line. Once it’s stabilized, we’d probably look to probably more do a sale leaseback type transaction, but that is the way that we could get some initial improvement in the return on the assets, with us bearing the risk during that fill up stage and stabilization.

[Philip Martin:]

Do you find that there is a higher percentage of under – of what you would consider under – or properties not performing up to their expectations on the senior living side out there – or no?

[Dave Hegarty:]

No. Actually I would say that there are more than I would have expected out there that are under performing today, and I am not sure it’s fully captured in all the statistics like the NIC statistics will have occupancy levels in the high 80s, low 90s, but there are quite a few properties out there that are 60% and 70% occupancy that are pretty decent properties. And so – and I think they are fairly highly levered, so there may be opportunities out there to step in, save somebody from debt, becoming foreclosed on and to improve the performance of those properties.

[Philip Martin:]

Okay, thank you.

[Dave Hegarty:]

You are welcome.

[Operator:]

(Operator instructions) And we will take our next question from Kevin Ellich with RBC Capital Markets. Please go ahead.

[Kevin Ellich:]

Good afternoon, guys. Thanks for taking my questions.

[Dave Hegarty:]

Hi, Kevin.

[Kevin Ellich:]

Last night Five Star mentioned there is about a 100 assisted living units that are being converted to Alzheimer’s units in five communities. Was this something you guys had talked about previously or is this something new? I can’t remember.

[Dave Hegarty:]

Well, this has been ongoing as far as – I don’t know that they’ve raised that before in a prior call and we have not. I don’t believe that it’s because of the foray into buying the Wellstead in Minnesota in the Somerford properties which are – all those are predominantly Alzheimer’s. The demand for Alzheimer’s care continues to significantly increase and what they are finding is that it is very meaningful to be able to provide that service in a decent size assisted living property. So, they have just gone through a property-by-property basis and identified areas where there’s the demand for that service. And that is part of their capital improvement budgeting process they’ve gone through.

[Kevin Ellich:]

Okay. And then if I – if my memory’s correct, I think the Wellstead, on the assisted living side, the census was pretty low. Have you guys been able to – have you been able to increase that at all, do you know?

[Dave Hegarty:]

Not in any meaningful way. It’s still – I believe still is hovering in the mid 60s range for the assisted living component, while the Alzheimer’s still stays in the – above 90% occupancy levels. I know that they have been trying to formulate a good marketing program to encourage people to look at that because that – Wellstead has such as strong reputation as being known for an Alzheimer’s facility that people who are looking for assisted living don’t even really seriously consider it. But I know you have been to the property and several other people have toured it, and the assisted living units are at least the twice the size of a typical assisted living unit, and has a full kitchen, and it’s almost very much like having a fully sledged multi family apartment, one bedroom apartment, and the rates are the same as if it was a the traditional assisted living unit. And I don’t think that’s known out there. I don’t – I think the marketing effort is still being ramped up for that.

[Kevin Ellich:]

Okay. And then on the 20 properties that you are going to close on tomorrow, Rick, maybe, is that all going to be paid for in cash or have you guys planned on any debt for that?

[Rick Doyle:]

No, that will be all in cash.

[Kevin Ellich:]

All in cash, okay. And for the two senior living properties that you acquired, did you say they were in Birmingham?

[Dave Hegarty:]

Yes.

[Kevin Ellich:]

Just wondering if you could give a little more in detail on that, what the sense is, is it all AL or any independent living in that?

[Dave Hegarty:]

It’s all AL with an Alzheimer’s component in one of the building. There are each about 62 units per building, and the occupancy levels are in the mid 90% for each location. And what’s interesting about this is – these two properties have been under agreement for a long time and they required HUD approval and the process was just so painful that ultimately the decision was made to just pay off the HUD loans. And we could have walked at any points along the way if we didn’t like the performance of the property. So for a good two years, these have been running at that that mid to high 90% occupancy levels and maintained and improved the bottom line performance. So – but these are our desirable assets.

[Kevin Ellich:]

Okay. And then lastly, have you seen any economic impact on the wellness facilities that you had acquired a couple of quarters ago?

[Dave Hegarty:]

Not any of consequence. They are still up around the 1.9 times coverage and membership has held pretty steady.

[Kevin Ellich:]

Excellent. Thanks, guys.

[Dave Hegarty:]

You are welcome.

[Operator:]

And gentlemen at this time, there are no further questions. Mr. Hegarty, I will turn the conference back over to you for closing comments.

[Dave Hegarty:]

Thank you very much, everyone. And Rick and I will be at the NIC Conference in Chicago in September as well as UBS is having Healthcare REIT and Operator conference in Chicago on September 9, and we will be attending both and we’ll be available to talk with anybody who would like to be with us. Thank you. Have a good day.

[Operator:]

Ladies and gentlemen, this will conclude the Senior Housing Properties Trust second quarter 2008 financial results conference call. We thank you for your participation.