Diversified Healthcare Trust (DHC) 2005 Q1 法說會逐字稿

Good day, everyone, and welcome to the Senior Housing Properties Trust first quarter earnings financial results conference call. Just as a reminder, this call is being recorded. At this time for opening remarks and introductions I would now like to turn the conference over to the Manager of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Thank you and good afternoon, everyone, and welcome to the Senior Housing Properties Trust first quarter 2005 investor conference call. My name's Tim Bonang and I'm the Manager of Investor Relations for SNH. Joining me on today's call are David Hegarty, President and Chief Operating Officer, and John Hoadley, Chief Financial Officer.

The agenda for 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 call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and federal securities laws. These forward-looking statements are based on SNH's present beliefs and expectations as of today, May 3, 2005.

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. Actual results may differ materially from those projected in these forward-looking statements.

Additional information concerning factors that could cause those differences is contained in our Form 10-K filed with the Securities and Exchange Commission and in our Q1 supplemental operating and financial data found on our Web site at www.snhreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements.

Now I would like to turn the call over to David Hegarty.

Thank you, Tim, and good afternoon, everyone, and welcome to our first quarter 2005 investor conference call. First let me say please pardon my voice today since I was unfortunate to have caught a cold this past weekend so if I lose my voice during the call, you'll know why.

Before I begin, I'd like to point out that Tim's role as Manager of Investor Relations is a new position that we have recently created at the Company in order to enhance our Investor Relations efforts.

In addition to this conference call, we've prepared a comprehensive supplemental operating and financial report for the first quarter. This report was released this morning and is currently available for download at our Web site. We hope that Tim's position, this conference call, and the supplemental reporting package will help investors better understand SNH.

Since this is our first conference call, we thought it might be appropriate to spend some time going through a brief history and overview of SNH before we get into the specifics of the first quarter results.

SNH is a New York Stock Exchange listed real estate investment trust that invests in senior living properties that are triple net leased to senior living and nursing home operators in the United States.

SNH was created in October 1999 as a result of our predecessor, HRPT Properties Trust spinning off its triple net leased Senior Housing Properties to existing HRPT shareholders. Prior to the spinoff of SNH, HRPT had been in the business of owning healthcare properties since 1986.

And HRPT retained a 49% ownership interest in SNH at the time of the spinoff. Today HRPT owns 8.7 million common shares, or 12.6% of SNH.

SNH currently owns 181 senior living properties with the majority of the properties being independent living and assisted living communities. Today, a majority of our current rental stream come from properties where almost all the residents private resources.

We have not always been so fortunate to have this revenue mix and it has taken a concerted effort to reposition the Company to be less reliant on government funded programs such as Medicare and Medicaid.

All of SNH's growth since 1999 has come from acquiring private pay properties. Since the time of our spin off from HRPT to end of first quarter we've grown the percentage of rent coming from private pay properties from 50% to 84% today.

I believe it's important to highlight a few significant events in our history to understand our operations today.

In 2000, approximately 50% of our rent came from properties leased to national long-term care operators that filed bankruptcy, predominantly Integrated Health Services, Mariner Post Acute Network, and Sun Healthcare.

Rather than spend the better part of two years in bankruptcy proceedings letting our assets languish and not knowing the financial condition of our ultimate tenant, we chose to negotiate a settlement with each of these operators that included SNH taking back the operations of the nursing homes in exchange for not filing claims in the bankruptcy proceedings. This way SNH could invest capital in the properties and work to improve the occupancy levels at the properties.

Our goal was to preserve and enhance the value of the properties to lease or sell them at a later date when the markets for skilled nursing facilities improved.

Then in 2001, SNH purchased 31 high-end retirement communities from Crestline Capital Corporation. Crestline was a spinoff from Host Marriott and these properties had long-term management contracts with Marriott Senior Living Services.

These properties were very attractive to us because they were previously built or acquired by the Forum Group, which was a developer known for developing Class-A retirement communities in the late 1980s, early 1990s. And these properties were over 50% independent living apartments and over 80% of the revenues at the properties were from residents' private resources.

SNH acquired these high-end retirement communities and combined them with the 55 nursing homes, taken back in 2000, to form a new publicly traded senior living operator with over $600 million in revenues. This new operator, called Five Star Quality Care, was spun off to existing shareholders of SNH in late 2001, and trades on the American Stock Exchange under the symbol, SVE.

Five Star leased all of these properties back from SNH for approximately $70 million of rent in two separate leases. And the rent for the 31 private pay retirement communities was set at $63 million per year, and the rent for the 55 nursing homes was $7 million per year.

SNH has gone on to finance additional properties that are operated by Five Star and other operators. In February 2003, SNH provided sale/lease-back financing to Alterra Healthcare as part of their bankruptcy reorganization. And in December 2003, SNH provided sale lease-back financing to New Seasons Assisted Living Communities, a subsidiary of Independence Blue Cross in Philadelphia.

In the last few years, Five Star has acquired two regional senior living operations as well as several individual properties which we have financed.

The most recent of these acquisitions was the $148 million purchase of 31 assisted living communities in November 2004. As a result, Five Star is our largest tenant representing 60% of our current rents in these two different leases.

Today SNH has 181 properties in 32 states and the annual rent from all these properties is currently $159 million per year, and they are leased to 11 different operators. The average lease term is 12 years, the largest lease is the master lease to Five Star for the 31 up-scale retirement communities we acquired from Crestline in 2001.

These properties have long-term management contracts with Sunrise Senior Living Services. And the rent today is $64 million, or 40% of our current rent.

This means the profitability of these communities is dependent on the management by Sunrise. Sunrise is a senior living property manager listed on the New York Stock Exchange.

The next largest lease is with Five Star for 51 of the original skilled nursing facilities, plus 47 independent and assisted living communities acquired since the spinoff of Five Star in 2001.

The rent for these total 98 properties is $32 million per year, and the lease is a master lease for all the properties. This lease represents 20% of our annual rent.

The third largest lease is with Sunrise Senior Living Services directly. Sunrise leases 14 retirement communities directly from us for $31.2 million per year which is another 20% of our annual rent.

And this lease is guaranteed by Marriott International for the remaining lease terms. Marriott today has $10 billion in annual revenues and is rated BAA 2 and BBB+ by Moody's and Standard & Poor's.

The next largest lease is with New Seasons Assisted Living Communities for ten assisted living facilities. The annual GAAP rent is $9.3 million, and represents 6% of our rent.

This lease is also guaranteed by New Seasons parent company, Independence Blue Cross in Philadelphia. Independence Blue Cross is a health insurer with over 3.5 million members and has an investment grade claim paying rating.

Another significant tenant of ours is Alterra Healthcare. We own and lease 18 assisted living facilities to Alterra for annual rent of $7.1 million, or 4.5% of our annual rent.

Now before turning my attention to the first quarter results, I'd like to briefly describe SNH's management.

As some of you may already know, SNH has been externally managed by REIT Management Research, or RMR, since its founding in 1999. In addition to managing SNH, RMR is also the external manager of two other REITs, Hospitality Property Trust, and HRPT Properties Trust.

RMR is a nationwide real estate company which was founded in 1986 to manage public investments in real estate. As of March 31,2005, RMR oversaw a combined $11 billion worth of public real estate assets located in 42 states, Washington D.C., Puerto Rico, and Ontario, Canada.

RMR currently has about 400 employees and officers located throughout the United States. RMR handles all the day-to-day operations of SNH including property acquisitions, asset management, financial reporting, corporate finance and Investor Relations, and SNH has no employees although the executive officers, including myself and John Hoadley, devote a majority of our time to SNH and we are employees of RMR.

We believe that SNH benefits from this relationship with RMR because it gets to draw upon the resources of a large real estate focused organization. During the time RMR has managed SNH, shareholders have received average total annual returns of 12.7%.

SNH also benefits because RMR's services are provided to SNH at a competitive price to its peers. RMR's fees for its services results in G&A expenses for SNH which are very competitive to other healthcare REITs measured both as a percentage of assets and as a percentage of revenues.

The RMR compensation formula is a simple 50 basis points on new invested assets plus an incentive fee paid in restricted shares based upon annual growth and FFO per share. There are no capital raising fees, acquisition fees, disposition fees, or any other types of fees paid to RMR.

Now I'd like to focus on some of the specifics regarding the first quarter results.

Funds from operations, or FFO, during the first quarter 2005 were $0.37 per share versus FFO of $0.38 per share last year. And each period had unusual items that affect the comparability of the two periods.

The current quarter had approximately $400,000 of legal costs associated with litigation with HealthSouth concerning two rehabilitation hospitals located in the Boston area. To learn more about this litigation please read our disclosures in our earnings release, the supplemental and 10-K.

Without this expense our FFO for the quarter would have been $0.38 per share. The prior year's results included a $1.25 million settlement with Marriott International on a legal matter, and a $775,000 charge that we took for an abandoned acquisition. Without these items, the 2004 normal FFO per share would have been $0.37 per share.

These 2005 quarterly results reflect a full quarter of rent from the 31 assisted living properties acquired in November 2004, interest expense on $49 million of mortgage debt assumed with this acquisition, and the impact of the 5 million share equity issuance in December 2004.

The equity issuance in December 2004, which completed the financing of our November 2004 acquisition, left SNH well poised for growth without having to access the capital markets. We currently have a very low debt level representing 32% of our total market capitalization and the vast majority of our $250 million revolving credit facility is currently undrawn and available for acquisitions today.

The recently declared dividend of $0.32 per share represents 86% of our reported FFO, but would be 84% of our normal FFO for the quarter. We are very comfortable with this payout ratio for Healthcare REITs at this time and in October 2004 we raised the quarterly dividend by a penny per share per quarter, or a 3.2% raise.

Our board considers the appropriate level of the dividend regularly on a quarterly basis.

In all of our leases a master lease is, except the Sunrise leases, so a tenant cannot pick and choose which facilities they want to renew or reject at the end of the lease term. In underwriting new investments we evaluate the viability of the properties and the credit worthiness of the parent company who will be required to be a guarantor.

And in several cases we also obtain a cash security deposit if warranted.

As you know, the quality of our earnings is only as good as the properties and operators which we invest in, and the largest lease it's leased to the 31 retirement communities to Five Star but those properties are managed by Sunrise. And the operations at these properties cover the rental obligations to us by 1.14 times during the quarter.

The next largest lease is a lease with Five Star for 98 properties which they operate. And as I mentioned earlier, in this lease 51 of the original nursing homes in 47 of the independent and assisted living facilities that they've acquired since inception.

The rent coverage ratio for the 2005 quarter was 1.63 times versus 1.62 times for the comparable period in 2004.

As I mentioned, we look at the properties and the credit of the guarantor. Between these two leases we have a significant credit exposure to Five Star.

Five Star incurred operating losses in 2002 and 2003, but in 2004 it turned the corner and became profitable. Five Star, in fact, Five Star was able to raise $30 million of new equity in December of 2004.

So based on their most recent disclosures we believe that Five Star's credit profile is solid. They have $100 million of book equity, a $12.5 million line of credit, and $40 million of unencumbered private pay assisted living properties.

Our next largest lease is directly with Sunrise Senior Living for 14 retirement communities. The coverage ratio and the occupancy have declined from the first quarter of 2004. Much of this is because of many major renovation projects that are underway in these properties, but the coverage is still a comfortable 1.25 times the rent.

The fourth largest lease is with New Seasons and they had a modest pick up in revenue in the 2005 quarter due to rate increases, plus they also implemented new cost control measures and the result is a 1.1 times coverage ratio compared to .96 coverage ratio last year.

The leases with Alterra, Genesis, and five private regional operators have very good coverage of the rent except for one property which involves $1.2 million of rent. In that case we have five more years of lease term and a six-month cash security deposit, plus multiple guarantors on the lease.

We believe we have an excellent portfolio of private pay senior living properties. Of the 181 properties of which 117 are independent living and assisted living properties that are almost entirely private pay residents. The balance of the portfolio consists of 62 skilled nursing facilities and two rehabilitation hospitals.

The 117 independent living and assisted living properties have almost 16,000 units, which are about 70% of our total units, but they represent 84% of our total rent. So we're very conservative in our underwriting, and if you compare our per unit investment to the current market value of these types of units, I'd say we compare very favorably.

We have about 10,000 independent living units that we purchased for about $87,000 per unit, and have over 5,000 assisted living units that we purchased for approximately $82,000 per unit. Also, our nursing home beds, our investments are an average of about $34,000 per bed, which we believe is a very reasonable investment amount.

Now in the first quarter we did not make any acquisitions. In fiscal 2004 we made $187 million worth of acquisitions and we continue to look at many new opportunities.

The market for acquiring private pay independent living and assisted living is very competitive today. Opportunity funds with access to low-cost debt are bidding up the price for these property types and competition among other healthcare REITs is very intense.

However, we do see many opportunities to invest in and we're constantly reviewing situations to invest in and have made several bids over the course of the time, but many properties today are being sold at very low cap rates. Nevertheless, we continue to pursue a number of transactions both portfolios and individual properties.

Now I'll turn the presentation over to John Hoadley, our Chief Financial Officer, to provide some more details regarding the first quarter results.

Thank you, Dave.

Before getting into the details regarding the quarter, I want to briefly note where we ended 2004 with regard to compliance with new Sarbanes-Oxley rules. We filed 2004 full-year audited financial results with an unqualified opinion from our auditor, Ernst & Young, regarding the effectiveness of our internal controls over financial reporting.

The revenues for the quarter ended March 31, 2005 were $39.2 million, which is a $2.7 million increase over 2004 revenues for the comparable period. Included in 2004 revenues is $1.25 million of other income representing a settlement payment for Marriott International for past litigation.

Excluding this one-time payment in 2004, operating revenues would have increased $3.9 million year-over-year, or an increase of 11%.

Interest expense in 2005 increased over 2004 by $853,000, which is primarily due to the $49 million of new debt assumed in the November 2004 acquisition. This is fixed rate mortgage debt with an average interest rate of 6.75% and matures in 2012, 2013.

Depreciation expense increased by $1.2 million, to $10.7 million in the 2005 quarter. This increase is attributable to the $187 million of new real estate investments during 2004.

General and administrative expenses appear to be relatively flat year-over-year at $3.4 million in 2005 versus $3.3 million in 2004. However, the 2004 G&A includes a $775,000 write-off of costs incurred in pursuing a terminated transaction, and the 2005 G&A had $400,000 of legal fees related to the HealthSouth litigation.

Excluding these two items, G&A increased about $450,000 in 2005 versus 2004, and is comprised of increased costs associated with the 2004 investments and increased accounting costs, New York Stock Exchange fees, and other minor items.

During 2004 SNH issued 10 million new common shares. Five million shares in January and 5 million shares in December. Today SNH has 68.5 million shares outstanding.

SNH has a good matching of assets and liabilities. 100% of our investments are fee interests in senior living properties. The average lease term remaining of the portfolio is 12 years. Only 1% of our revenues come up for renewal in the next five years.

On the liability side, the real estate is primarily funded with long-term, fixed rate, unsecured debt. SNH has $536 million of debt.

Only $42 million of debt matures in the next 12 months and it is principally our revolving credit facility. In fact, our credit facility matures in November 2005 and can be extended for a year with a fee.

The current facility has capacity of $250 million, and we are considering whether to extend or refinance this facility in 2005.

The rest of our debt is comprised of two senior note issuances due in 2012 and 2015 for $395 million, junior subordinated debentures, totaling $28 million due in 2041, and mortgages and capital leases due mostly in 2012 and 2013, for a total of $76 million. The junior subordinated debentures have a coupon of 10 1/8% and can be prepayed at par beginning in June of 2006.

Only 5% of our capital is secured debt. Our capital structure is very straightforward. We have no joint ventures, derivatives or rating triggers in our debt instruments.

Typically we maintain a debt to total book capital ratio of about 35 to 45%. On a book basis today we're at approximately 38% debt to total capital. In the first quarter of 2005 our EBITDA to interest coverage ratio was 3.3 times, which is unchanged versus a year ago.

That concludes our prepared remarks. Operator, we are now ready to take questions.

Thank you. Our question-and-answer session will be conducted electronically. [Operator instructions] We will pause for just a moment to assemble our queue. And our first question will come from Philip Martin with Stifel Nicolaus.

Boy, that's a first for me. Just a couple of quick questions. First of all, the transaction that was passed on in the first quarter, can you go into some detail on that and maybe the size and scope of the transaction and maybe why it was passed on, et cetera?

That transaction was actually the first quarter of 2004.

Okay. I just misheard you then.

Secondly, the acquisition environment, what if anything in the first quarter has changed? I mean, obviously the first quarter was, you know, a volatile quarter in terms of interest rates. I'm wondering what happened from, you know, in terms of negotiations. Are you seeing more deal flow out there? Are sellers getting a little more, I guess, not impatient, but are they looking to put properties up for sale? And what is the quality of the assets that you are seeing out there?

Well, I would not say that the deal flow has really slowed down. I think it's in fact probably picked up. And I think it's because that operated fee that it's a hot market and like other real estate they should be in the market to sell properties.

And many of the properties were properties that were developed several years ago and might have struggled back then but today they've been put in the hands of smaller operators who have spent the time to fill up the units at those facilities and get them to a near stabilized occupancy level and now are trying to capitalize on the hot market. So we are seeing steady flow of deals come through.

I think in this first quarter I would clearly say that we've looked at over $2 billion of situations to consider for investment, and they've ranged from individual facilities up to multifacility portfolios. And what we're seeing is certainly at the real top Class-A product type in the independent living and assisted living is that the institutional investors are just so aggressive and willing to pay up based upon pro forma adjustments and their cost of capital is still very cheap.

I would say the majority of the capital for those types of investors tend to be more floating rate, maybe three-year, five-year-type money, rather than long-term fixed rate financing sources. And so that's been a challenge to get some of the best opportunities out there.

There are also, you know, there's a number of nursing home deals that we've passed on just because we're not looking at nursing homes to invest in. We've, we don't provide mezzanine loans and we don't provide subordinated debt or make equity investment in operators so there are a lot of situations that we just would not be willing to invest in ourselves.

We're trying to keep ourselves very strict to investing in private pay, ILAL, that have current and existing cash flows to support the current rent level and so on. It's very difficult for to us adhere to our criteria and thus we submitted many bids during the period but were unsuccessful. Some bids are starting to come in where people are waiving a good part of the diligence, putting down non-refundable deposits and so on, and so it's definitely a heated environment.

Are you passing on deals because some of the structures are a little bit unwieldy or a little, you know, too many boxes, too many arrows, that sort of thing or is it just really aggressive pricing, you know, the non-refundable deposits, et cetera?

It's mostly aggressive pricing. There are a couple transactions out there that do have exactly the structural impediments that you mentioned where it might be some crazy debt on the property that we would have to assume that we're not willing to do so.

Or many times, too, there are operators out there who would love to, in their ideal world, would love to do a sale management back arrangement and not be on the hook for a lease, and we're not willing to enter into that type of arrangement. So, you know, there are others who are just willing to be more aggressive than we are in some of that stuff.

How about operators? Are they themselves looking to, I'm sure many of them are looking to monetize some of the value in their portfolio and do or consider some sale lease-backs, but are they also looking to monetize these assets to raise money for new development? What are you seeing on the new development front, which has been very quiet the last several years?

On the development front, I still don't see a lot of new development going on. I mean, there's, people are starting to think about it, and I'd still say that probably the majority of the, if you look at total industry, I'd say the largest player in development is still Sunrise. But, you know, most everybody else is looking at onesies and twosies here and there. So I'd say there's not a large scale development pipeline going on.

And last question. In terms of potential investment targets this year, I know in the past you've felt reasonably comfortable doing 100 to 150 million a year, and that's more or less where you've come out at, sometimes a little higher, sometimes a little lower, but what is your feeling at this point, you know, in being able to achieve those targets, or something around those targets?

Sure. Well, Philip, as you know, we don't provide guidance as a matter of policy, so I can't tell you what to expect for this year. All I can do is point at past history and as you mentioned, we have usually done at least 100 million, somewhere between 100 and 200 million.

Sometimes it takes, it's an opportunistic business so you can't exactly predict when it's going to happen. Last year we did 187 million, but approximately 150 million was transaction that closed in November but the seeds of that transaction began in May of last year, so it took quite a while for it to ultimately be consummated. So I can't give you guidance on what to expect for this year, just point to the fact we've done it in the past.

Next we'll hear a question from Jerry Doctrow with Legg Mason.

Good afternoon. First of all, let me compliment you on your first conference call which we're delighted to see. I think you're doing an excellent job with it and, I for one, at least appreciate it a good deal.

Thanks, Jerry.

Just, I had a few different things. I guess, one, I was curious whether you bid on the Provident transaction because it involved some of the Brookdale assets that you guys were in before. I don't know if you can comment on that or not.

We did not bid on the Provident Senior Living transaction. We did obviously evaluate all the filings and run different models and assumptions but we were not willing to clearly pay what others were willing to pay for it.

We do like the assets. They're very nice assets. And as you mentioned, we used to own several of those assets back in the late 1990s, and we turned around and ultimately sold those assets back to Brookdale at a substantial profit back then, back around 2000, I guess it was.

And, David, the biggest issue I get these days from investors that are looking at SNH is just, I think, some nervousness about the HRPT ownership and those shares I think are sort of acting as an overhang. Is there any, I guess, policy out there or how should we be thinking of that, you know, as a risk? Could we wake up one day and see HRPT sort of having sold that block out?

No, I mean, we realize that's out there. I mean, I can tell you that we won't be selling it in an open market, dumping all our shares on the market.

What we've done twice successfully is to tag on to an equity offering being done by SNH, and we've raised the amount of equity that we needed to raise, which was in both cases 5 million shares, and then had them piggyback on to our offering to the extent there was increased demand for our shares they rebought from HRPT's inventory, and then if there's an over allotment option or so on it's exercised those shares come out of HRPT's holdings, and that way that's satisfied.

I would expect we'll look for opportunities eventually down the road of something like that, you know, or if there was another investor who would buy and hold that would be possibly another situation but that's the only two scenarios I can envision.

Okay. And you talked about coverage. I think specifically on a couple of these, a number of them seem like they were just moving down maybe a little bit, certainly if we would go fourth quarter to first quarter. Anything more specifically about any of the particular, just the big portfolios that we should understand in terms of coverages?

No, I mean, I would say that there is a bit of seasonality in the numbers, because I do believe that residents try to hang on, I guess, or I don't know how to properly describe it, but they, you know, want to make it through the holidays in the December time period, November/December, and then the cold winter comes in, and it tends to be more of a [recent] occupancy, either due to deaths or due to people having to go to hospitals or relocating to warmer climates, so there is a bit of a seasonality to the first quarter of 2005 versus year-end.

In particularly the Sunrise/Marriott guaranteed portfolio I know they're well underway with a couple of major renovations that have taken down a number of available units at some large communities while they do those projects. But otherwise, I guess I would not look anything, nothing else that's taken away from the occupancy levels.

And are the renovations so extensive we're still going to see multiquarter impacts or is it going to come back quicker than that?

I'm sorry?

Is the length of the renovation so extensive it will be like a multiquarter impact, or is this something you'll see snap back maybe second quarter?

They would probably take the better part of a year to be completely done with them, so I think it would be more of a gradual come-back.

Okay. And the, any change in just the FF&E reserve? I think that's Five Star Sunrise if I remember correctly. Is that, those properties are still covering a little bit of that but not all of that? Is that sort of the right way to think about it?

They're covering all of the FF&E reserve. This 1.14 times covers 100% of Sunrise's management fee which is about 7% of revenues, which in fact the management fee ratcheted up last July 1 at these properties to 7%.

Okay.

And then they normally have about 7.5, $8 million of FF&E reserve, and that is covered by this amount. And then there's some more, a little bit more left over for --

So those would turn cash flow positive as well?

That's right.

Okay. Let's see. I think that's all that I have. Thanks.

Okay. You're welcome.

We'll now move on to Steve Swett with Wachovia Securities.

Good afternoon, Dave and John. On the legal expenses related to the HealthSouth litigation, is the amount that you guys incurred in Q1, is that a fair run rate?

I guess I really can't comment on that because I can't predict how the legal avenues will go.

All right. Well, if all things sort of stay as they are, is that, I mean, is that a fair number to use?

I really can't give you any guidance on what the course is going to take over the next couple of months.

Okay. On the acquisitions and the environment out there, given the competition for transactions and the fact that you guys have the ability with Five Star maybe to pursue some transactions that are a little bit other than just pure market transactions, how do you feel about your concentration in Five Star? Do you think that's a limitation at this point, or are you still willing to pursue acquisitions and use Five Star as a lessee and increase your exposure to them?

Well, each transaction is a case-by-case basis. If we like the assets, and we have a right of first refusal on their financing, so if we really like the assets, then we would be interested in financing them for them. We would not let the amount of exposure we have to them limit us from making further investments if we think it's a good asset.

Having said that I mean, ideally we are looking for investment opportunities to diversify away from Five Star, and we've made some proposals to do so this first quarter, and, but, you know, we can't predict today if those will come to fruition.

Okay. Thanks.

We will now hear from Brent Johnson with RBC Capital Markets.

Hi. Good morning. Brett Johnson with Jay Leupp. Most of my questions have been answered, just a couple of quick follow-ups and things that you guys have discussed already. It looks like the coverage on your Five Star Sunrise lease has improved the last few quarters just a bit. Wondering if you could talk about what Sunrise has been doing to improve operations there and if you expect this to continue?

Well, I can comment that they have been very good about increasing the occupancy levels at the properties and pushing revenues. There's virtually no discounting going on within the portfolio to raise revenues, but to increase occupancies, and they've been being a lot more focused on the expenses than they historically have been. So they're working to try to keep those in line, too. I think insurance costs are moderating somewhat, and it's more just occupancy increases and focus on the operations.

Great. Then a question also on the new season IBC lease. Looks like the coverage has fallen a bit there. I was wondering if you could just comment on that and are you concerned at all about this lease, or are you comfortable with where the coverage is?

I'm comfortable with this lease because when we made the investment we knew it was approximately 79, 80% occupied, and they've been staying at pretty much about that level throughout the last year or so. But they have been pushing rates a little bit and, but their organizational structure is geared towards being a larger company so they are looking to grow, and so they have not done anything on the cost side to, you know, to try to make these numbers look better at the current time.

We do rely, too, quite a bit, on the guarantee. We get a lot of comfort in the fact that IBC is its parent and guarantees the lease. And IBC doesn't have any debt outstanding, but they have an investment grade claim paying rating, as well as since it's an insurance company it's highly regulated and has a very large cash and investment portfolio.

Great. Okay. And two more quick questions. What is the average annual contractual increase in rent that you guys have in your portfolio? And is that mainly kind of a lease by lease, is it CPI, or is it a fixed increase?

It is lease by lease. The majority, let's say all the Five Star leases, there it's 4% of the growth in revenues over 2005 revenues and that begins in 2006. So, you know, we won't see any increase this year, it should kick in next year.

As far as the other leases, the lease to Sunrise is 4.5% of the growth in revenues, then a year over, let's see, over a base amount, which was back in 1994. And then everybody else has increases that are 3%, or 2.9% of the increases in the seasons lease, and Alterra is --

Yeah, this is John. Alterra kicked in last year, and it's 10% of the growth in revenues over, I think, 2003.

Okay. If you were to go through and kind of take a weighted average of all those together, and I understand that Five Star kicks in in '06, but what would that be for '05 and '06? Is that kind of 1 to 2%?

It depends on the revenues. We're not really sure what the revenues will be at this point.

Okay. And then the last question I had was just a follow-up question on the acquisition environment. What are the, on kind of an absolute basis, what are the cap rates that you guys are seeing with a lot of these portfolios or assets that are being traded? And if you could, I guess, talk about where those are relative to where they were maybe two or three quarters ago?

Well, what's interesting is, I mean, cap rates, it's a little bit difficult to talk about because some of it, one person might be thinking of on historical 12 months results and somebody else is thinking on next year's budget results and so on, but what I've seen is for the truly Class-A property types that are trading hands out there, they're going for about 8% cap rates on 2005 pro forma numbers. That's the type of aggressive bidding that's going on. Or even lower cap rates than that in some cases.

For sale/lease-backs and more bread-and-butter-type facilities I think we're seeing more in the closer to around the nine cap rate for those types of investments. Sometimes, you know, one-off deals might be 100 basis higher or lower.

Great. Thanks very much, guys.

You're welcome.

We'd like to mind our phone audience that if you do have a question for our presenters today please press star one at this time. Next we'll hear a question from Ray Garson with UBS.

Thanks. Just a couple more quick ones. Dave, with respect to, I guess, the old Marriott properties where you talked about some major capital renovation going on there, are you all funding a portion of that, or how is that being paid for, I guess?

Sunrise is funding those assets out of their own credit facilities. So we have not been asked to fund those. And, you know, if that were to continue at the end of lease term, all that reverts to us, we would take ownership to that, if they didn't renew.

Okay. When you look at, what I guess I'll classify as the Crestline assets, are there more significant capital projects that are being evaluated as a way of maybe improving the performance longer term there?

Well, as you can see, the occupancies have moved up at that portfolio and coverage ratio has been coming up better so with those 31 properties, so it's an ongoing FF&E expenditures are going on.

They have some individual projects, you know, but they're not major renovations to the extent that we are seeing in the other portfolio,14 leased properties to Sunrise. They're more, a new roof, or just an enhancement to an existing facility, but they're not adding any significant units or doing any major structural redesigns or anything.

I think they're keeping the properties up nicely through the normal FF&E expenditures. And they've been moving the occupancy up and the rates up and stuff so I think they've been being pretty competitive with the product.

Okay. I mean, you gave us some color kind of around kind of where stuff's trading. Where are you guys bidding? Are you still looking for nine-plus-type yields on your invested capital and that's where your bids are not clearing? How should we think about, assuming that history is right and you're going to put some money to work, what kind of yields should we be thinking about you're targeting for that money as we go forward here?

Sure. Well, when we're looking at investments we're trying to stay around the 9% area for our bids and I think if there's some situations, if we can do something jointly with Five Star, we'd probably stay around that area.

And, you know, as our past history would indicate, once in awhile we come across some particular transactions that we feel very strongly about that we want to be very aggressive for, and we know how to turn it up a little bit and be more aggressive in getting that transaction, or it might be a privately negotiated transaction that we can give them something unique that works for them and it's a structural issue that will allow us to get something close to our 9% return.

So, I mean, I think, 9% is still our targeted return. If we have to be very aggressive on a transaction we really like, we probably would not, we'd go a bit lower, but I don't think we could go to the 8% that some others have been doing.

Sure. Have you thought about selling any assets in this market?

Only a couple here and there, non-performing assets or assets that are hurting, say, the portfolio performance. But the problem is, if we sold some of our top end assets that we have to turn around and find new investments to invest it back into, which is hard enough, so we tend to not touch the things that are performing nicely at the current time.

We'll move on to hear a question from Chris Pike with UBS.

Good afternoon, everybody. David, just wanted to clarify a couple things on the acquisition side. You talk about a 9% cap. When you're bidding for the assets, where does it fall out of bed? In other words, are you in the first round and then everyone comes back, and then maybe you lose out in the second or third round, or is 9% firm and you just don't go any further?

It's probably more of the first scenario where we make our bid and then they come back for a second round and ask us to sweeten it and do something, then it seems people really turn it up a notch, and we may not be as aggressive as others and be willing to do that.

And acquisitions that you passed on in the first quarter did you get any further past that point or that's pretty much where you stopped with the acquisitions in the quarter as well, or potential acquisitions?

Well, I mean, if we get past that --

I mean, did you stop at the first round or did you actually try to push a little bit and then just said, hey, this is too rich, we're folding?

Most of them on the first round, you know, we were limited, we did submit bids on the second round, but, you know, we might have been able to go another 25 basis points lower in the cap rate or something like that to try to get it but some others are still going 50 basis points or 100 basis points lower.

Okay. I think Steve asked about, you know, looking to source Five Star, how about some of your other operators, how aggressively are you looking to perhaps organically source deals with those folks?

And second part of that question is, is that where some of these deals have been coming from, or potential deals been coming from, or have they been totally new operators?

Some have been from existing operators in the portfolio and some other ones have been, a couple new operators out there that we've, with the security deposit and so on, we'd be able to do a transaction with them. But, you know, like I say, there's a couple of our existing operators, too, that we have made proposals with and not been successful.

Then finally, in terms of C&L how aggressively do you see those folks out there being that it's getting close to the time they have to make a decision on what they're doing?

C&L's been pretty aggressive, and they're probably one of the parties that I would say would target an 8% cap rate and also they may, they have said in their public filings that they, particularly with Horizon Bay, they're willing to do a, it's a sale/lease-back, but they essential set up an entity in the middle to be their tenant, and then hire Horizon Bay to be the manager.

So that tenant, from our perspective, we would not be comfortable having a tenant without a lot of substance to it, and so we would not be able to do a transaction like that or be willing to do it, and they are. So they are very aggressive out there.

Okay. Great. Thanks a lot.

We will now hear from Ray Lamanski with BB&T High Yield.

Good afternoon. Question I have has to do with senior notes. I noticed that they currently carry a rating of BB from both agencies with a stable outlook, yet when I look at the credit statistics actually, the statistics are equal if not superior to some of your counterparts who are carrying investment grade ratings. I was wondering if an investment grade rating is a corporate goal at this point, and if so, in what time frame are you looking to try to achieve it and are there trade-offs that you are concerned about between achieving such a rating and your growth plans for the Company?

Sure. Well, as you point out, on paper we look like we certainly would qualify as investment grade status and we compare very favorably against the other larger healthcare REITs in this space. Historically, what has held us back from investment grade status has been our concentration with Five Star and the fact that Five Star reported operating losses in 2002 and 2003.

The rating agencies definitely want to see Five Star improve its results and develop some substance, which in 2004, it turned a profit for the year, a decent profit, and they also raised equity, so they have a decent size equity balance and capital structure. So that should help us.

And looking forward, I think really they have to develop a track record, you know, one year doesn't, you know, change everything. I think they have to develop a little bit longer track record and I would say that for to us achieve investment grade rated status, one of two scenarios would probably have to happen.

One would be that we grow with other operators to make Five Star less of a percentage of our portfolio, or that Five Star grow and develop a track record of profitability and build up its equity base and so on. And our objective, I'm not sure it's all within our control, obviously.

As far as your other question, will we trade off growth, if it's a nice quality portfolio of assets and Five Star is the leading bidder, and we have an opportunity to finance that transaction, I think we would finance that transaction because of the quality of the assets. It may cut against us in working with the rating agencies, but I think that that's what we're in the business of doing, is financing senior living assets.

Sure.

So I can't give you any guidance whether it will be this year or not. We've not approached the rating agencies recently to ask for an increase, but if we're accessing the capital markets next time we most likely will talk to them about it.

It is a goal.

Thank you.

It is a goal.

We will now hear from Ed Turville with Roehms Group.

Good afternoon. My question just relates to asset sales.

Again, in the early part of your commentary, you mentioned that the nursing home properties, when they were acquired and then worked on, would be held and then at an opportune time might be sold and it would seem, given current market conditions, that this would be moving into a very opportune time to change that mix of assets within the Company, and use that capital for either assisted living or, I don't know if you've ever measured the, given valuations, the value of your stock relative to the holdings that would remain and that possibly that capital could be used to repurchase Company shares to the benefit of the existing shareholders.

Sure. Well, with regards to the nursing home properties, you know, it was our goal at the time of taking back these assets that we would try to enhance the value of the assets and sell them or release them at the time that the market came back. Well in the interim we did do the transaction with Five Star and spun off Five Star.

Right now, they are encumbered by leases with Five Star so it's really not SNH's decision anymore as to whether nursing home assets would be sold. It would probably be a joint decision if those assets were burdening Five Star or burdening us.

Right now those properties are performing very well, and at the time of the spinoff the rent was set at a pretty low level of $7 million, and so, you know, individually the coverage ratio on those properties has grown significantly, so I think they're actually a positive for Five Star at this time. So I don't imagine we'd be selling nursing home assets in bulk.

And as far as selling assets, all of our assets are encumbered by leases at the present time, so we would have to sell them with leases in place. And so the only other buyers might be some other REITs. I don't think we'd realize the, you know, much of potential differential there unless the leases can be modified in some way.

And philosophically, as far as selling assets to buy back stock, you know, we actually don't believe in the long-term that that would necessarily be to the benefit of the Company. Might get a short-term boost but historically we've looked at track records over the course of time and eventually it recedes back to more or less the level it was prior to that. It's not in the current plans.

What is the prospect for the $7 million lease payments to be increased to reflect the higher value and higher earning prospects of those assets from when they originally?

There's a long lease term period on those leases, so I guess we only get that percentage of growth in revenues at the properties, and that really kicks in in 2006. And it's done on a property by, let's see, I think it's property by property basis. And so just gradually those revenues, particularly skilled nursing facilities, have high revenues that we would get the growth in revenue, percentage of that growth in revenues over the course of the remaining lease term, but then the leases aren't due for another, I don't know, 15 to 20 years.

Okay. But you do start participating in 2006?

That is correct.

All right. Thank you.

You're welcome.

We'll take our final question from Rick Murray with Raymond James.

Good afternoon, guys.

Hi, Rick.

Two quick questions. One, Dave, just wanted to touch back on your comments with regard to your seeing your operators find the ability to raise rents, or rates a little bit. To what extent are they being, finding the ability to do so on a year-over-year basis?

And the second question is just more of a technical item. What was the $3.7 million item that came through the acquisition line on the cash flow statement?

Okay. On the first item I think you're talking about the underlying tenant's ability to raise rents to its residents at the properties?

Right.

Most of the properties where the occupancy levels are, say, 85% or higher, for the most part residents in existing units for renewal are seeing 4 to 5% regular rent increases, annual increases.

We're seeing a bit higher increase for units that are turning over to people, newcomers off the street. In some cases I've heard as high as up to 8%, some of the rental rates have gone up by. So that's sort of an indication of what's happening on the revenue side.

With regards to the $3.7 million that you're seeing on capital additions. What that is, is those are ongoing tenant improvements that we funded during the quarter. We didn't really feel like we appropriately calling them acquisitions, because that's ongoing items and it's not increasing unit capacity and so on. When we funded the $3.7 million rent goes up by 10% of the amount funded.

Was that funding to Five Star?

Yeah, that was predominantly funded by Five Star.

Thanks.

You're welcome.

Mr. Hegarty, I'll turn the conference back over to you for any final and closing remarks.

Thank you very much, everyone, for joining us this afternoon.

Before we go I just want to let you know that we will be presenting at the Bear Stearns Global Credit Conference in New York City on May 18th and the NAREIT Institutional Investor Forum in New York City on June 9th. We look forward to meeting with the investment community at these conferences as well as having an opportunity to update you on SNH during the next second quarterly conference call. Thanks, and have a good day.

Thank you. That does conclude today's teleconference and thank you all for your participation. At this time you may all disconnect.