Diversified Healthcare Trust (DHC) 2014 Q3 法說會逐字稿

Greetings ladies and gentlemen, and welcome to the Senior Housing Properties Trust third-quarter 2014 conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Miss Kim Brown, Director of Investor Relations. Please go ahead.

Thank you and good afternoon everyone. Apologies for the delayed start today. I understand we had some issues with the toll-free number. So again, apologies for starting late here.

Joining me on today's call are David Hegarty, President and Chief Operating Officer, and Rick Doyle, Treasurer and Chief Financial Officer. Today's call includes a presentation by management followed by a question-and-answer session.

I would also note that the transcription, recording and retransmission of today's conference call are strictly prohibited without the prior written consent of Senior Housing.

Before we begin, 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 other securities laws. These forward-looking statements are based upon Senior Housing's present beliefs and expectations as of today, November 3, 2014. 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, or SEC.

In addition, this call may contain non-GAAP numbers, including normalized funds from operations, or normalized FFO. A reconciliation of normalized FFO to net income and the components to calculate AFFO, CAD or FAD are available in our supplemental operating and financial data package found on our website at www.SNHREIT.com.

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 filings with the Securities and Exchange Commission. Investors are cautioned not to place undue reliance upon any forward-looking statement.

Now, I would like to turn the call over to Dave.

Thank you, Kim, and good afternoon or good morning as applicable to everyone, and thank you for joining us on today's earnings call.

Earlier this morning, we were pleased to report normalized funds from operations, or normalized FFO, of $0.44 per share for the third quarter, up nearly 5% from $0.42 per share for the same period last year. Our portfolio performed well during the quarter, particularly our medical office buildings and triple net leased senior living segments.

I'd like to begin by discussing our medical office building portfolio, which now accounts for 42% of our net operating income, or NOI. Overall, our MOB segment is comprised of 98 properties with 122 buildings. We have over 9.1 million square feet generating quarterly NOI of approximately $56 million. Overall occupancy was up an impressive 60 basis points to an industry-leading 95.6% compared to the same period last year. At our 92 same-store medical office properties, cash NOI for the third quarter compared to the same period last year increased a healthy 2.6% to $34 million with occupancy remaining at 94.9% year-over-year.

With our high occupancy and retention rate, there was limited leasing activity during the third quarter. We executed new leases and renewals of only 78,000 square feet for an average net annual rent of approximately $38 per square foot on a GAAP basis with a weighted average lease term of over six years. We are very pleased with the recent leasing activity and the overall performance of our MOBs.

Now turning to our senior living portfolio, our triple net leased senior living properties continue to perform well as same-store rental income increased 2.3% year-over-year. The increase is due to improvement in financings, increased rent at some of our smaller tenants, and increases in percentage rent. As expected, overall rental income of our triple net leased senior living properties actually decreased 3.2% year-over-year. The decrease was due to the sale of the two rehab hospitals at year-end as well as four senior living facilities since July 1, 2013.

Looking at the performance of our individual operators, Five Star's 184 leased communities had combined occupancy of 84.3% for the 12 months ended June 30, 2014. Five Star filed its 2013 10-K in September and as of December 31, 2013, rent coverage ratios were 1.3 times and in line with our expectations. Rent coverage ratios for 2014 are not currently available. However, we are very comfortable with Five Star's operating performance and rents are being timely paid and in a consistent fashion.

The four properties we leased to Sunrise Senior Living had occupancy of 92% and rental coverage of 2.0 times. The 18 properties we leased to Brookdale Senior Living had occupancy of 94.6% and rental coverage of 2.5 times. Our triple net leased senior living properties leased to private regional operators had occupancy of 85.5% and rental coverage of 1.9 times.

Moving on to our managed senior living portfolio, during the quarter, the portfolio generated $17.9 million of NOI, which represents approximately 13% of total Company NOI. We were pleased to report increase in occupancy, rate and revenue at the 39 same-store properties. Occupancy increased 80 basis points to 88.1%. Average monthly rates also increased to approximately $4,200 per month with room for more growth, and revenues increased 2% on a same-store basis. However, our same-store NOI for 39 communities was flat quarter-over-quarter and same-store margins decreased 50 basis points to 22.5%. While these results came in below our expectations, it was directly related to an increase in operating expenses, many of which were one-time in nature, particularly real estate tax true-ups and an increase in self insurance claims. Despite the setback on the expense side this quarter, these communities continue to perform very well and we expect a rebound in our same-store results in the fourth quarter.

Today, we have a total of 44 very high quality managed communities with over 7,000 units. As of today, we've completed two accretive medical office building acquisitions, including the Texas Center for Athletes for approximately $33 million, and the Vertex buildings for approximately $1.1 billion. Since July 1, we've entered into two agreements to acquire two private pay senior living communities in Wisconsin, which has been a growing and strong market for SNH over the past several years. As previously reported, one is a 52-unit assisted living community known as Jackson Crossing located in Jackson, Wisconsin for approximate $7 million. The other is a larger community known as Coventry Village located near Madison for approximately $40 million. Coventry Village is comprised of two buildings and has 176 units of independent living, assisted-living and memory care units. We intend to acquire both properties using our taxable REIT subsidiary before the year-end.

(technical difficulty) announced an agreement to acquire a portfolio of 23 Class A medical office buildings for approximately $539 million. The properties contain 2.2 million square feet, are 100% occupied with a weighted average lease term of 9.5 years. The assets and tenants are of the highest quality. The average age of the portfolio is just 10 years, and the tenants are equally as impressive given that 72% are investment-grade rated, 24% A rated, and the remaining do not have debt or are one notch below investment grade. And the benefits of this portfolio to SNH shareholders are numerous.

First, it strengthens and diversifies our MOB assets and tenants. It also lengthens our weighted average lease term to over eight years. It decreases our Five Star tenant concentration to one-third of our NOI compared to over 40% a year ago, and it increases our already industry-leading percentage of private pay assets.

The purchase price of $539 million includes the assumption of approximately $30 million of mortgage debt. The closing is currently anticipated to be in the first quarter of 2015 and we expect to fund the balance using our cash on hand and our revolving credit facility.

Long-term, we expect to finance this acquisition with the appropriate mix of debt and equity, depending on market conditions. And the acquisition is contingent upon the completion of select income REITs, acquisition by merger with Cole Corporate Income Trust. We view this as a very positive and unique acquisition opportunity as portfolios of such high quality do not trade very often, and when they do, it tends to be a very competitive process. Year-to-date, SNH has successfully pursued and won deals that add to the quality of our portfolio, diversify our rental income, increase the percentage of private pay assets, and improve the security of our cash flows to support dividend distributions.

And with that, I'll turn it over to Rick to provide more a detailed discussion of our financial results.

Thank you, Dave, and good afternoon everyone.

For the third quarter of 2014, we generated normalized FFO of $89.6 million, up from $78.8 million in the third quarter of last year. On a per share basis, normalized FFO for the quarter increased 4.8% to $0.44 per share, up from $0.42 per share for the same period last year.

Rental income for the quarter increased $26 million to $138 million. The increase is primarily due to external growth from investments in six medical office buildings for approximately $1.2 billion offset by a reduction in rental income due to the sale of the two inpatient rehab hospitals and four senior living communities since July 31, 2013. $55 million of rental income was derived from our senior living leased communities while $78 million was derived from our medical office buildings.

Looking at our managed senior living portfolio, residence fees and services increased nearly 6% to $79 million during the third quarter. The increase primarily relates to acquiring five managed senior living communities for approximately $60 million since July 1, 2013.

Property operating expenses for the quarter increased to $82.7 million due to external growth from acquisitions of $1.3 billion as we added five managed senior living communities and six MOBs to our portfolio offset by $110 million of dispositions since July 1, 2013. Approximately $22 million of property operating expenses were derived from our medical office buildings and approximately $51 million was derived from our managed senior living communities.

As Dave mentioned, our property operating expenses at our managed communities increased this past quarter primarily due to true-ups on real estate taxes and a spike in self insurance claims. We expect our managed expenses to decrease sequentially and show improvement in our same-store results for the fourth quarter.

General and administrative expenses for the quarter were $10.4 million compared to $7.8 million for the same period last year. The increase primarily relates to the property acquisitions offset by the dispositions over the past year. At 4.8% of quarterly revenues, SNH continues to maintain a G&A expense as a percentage of revenues at or below its healthcare peers.

Interest expense increased 23% to $36.2 million this quarter compared to the same period last year. The increase in interest expense was expected as a result of the issuance of $650 million of unsecured senior notes in April, the assumption of $15.6 million mortgage debt related to the Texas MOB acquisition in April, and the term loan of $350 million which we closed in May, offset by the repayment of $36 million of mortgage debt on June 1.

Subsequent quarter end in October, we prepaid at par a $14.7 million loan incurred in connection with certain revenue bonds that were scheduled to mature in December of 2027 that had an interest rate of 5.875%. In addition, we prepaid a mortgage note covering one property with a principal balance of approximately $11.9 million and an interest rate of 6.25% that was scheduled to mature in May of 2015.

During the third quarter, we reported a loss from discontinued operation from $557,000 compared to income from discontinued operations of $1.2 million in the third quarter of 2013, a differential of approximately $1.8 million which we do not exclude from our calculations of normalized FFO. Our discontinued operations for the third quarter included operating results of two MOBs. One MOB was vacant and sold in September for $675,000 and the other and final MOB to be sold had a lease expiration in late June and is currently 90% vacant. In the fourth quarter, we are forecasting another loss from discontinued operations. However, we expect it to be less than half of the loss reported in the third quarter.

Subsequent quarter end, in October, we sold two assisted-living facilities and one skilled nursing facility for approximately $8.8 million. Year-to-date, we have sold three MOBs, three assisted-living communities, and three skilled nursing facilities. Currently, we have four senior living communities and one medical office building with an aggregate net book value of approximately $7.7 million classified as held for sale, the majority of which we expect to sell over the next couple of quarters.

Moving to the balance sheet, since July 1, we have closed on $1.2 billion of MOB acquisitions, invested $23.8 million into revenue producing capital improvements at our leased senior living communities. During the quarter, we also spent $3.2 million on tenant improvement and leasing costs. Our recurring capital expenditures included $1.8 million, or $0.20 per square foot, at our medical office buildings, and $2.5 million, or approximately $350 per unit, at our managed senior living communities. We also incurred approximately $4.2 million of development and redevelopment capital expenditures primarily at our managed senior living communities, which is in line with our expectations.

At September 30, we had $81 million of cash on hand, $1.7 billion of unsecured senior notes, $659 million of secured debt and capital leases, and a $350 million unsecured term loan. In addition, our $750 million credit facility is currently fully available. SNH's balance sheet and liquidity remain strong and in line with our peers with debt to total book capitalization of approximately 48% and adjusted EBITDA to interest expense at 3.5 times. As Dave mentioned, we are pleased with our year-to-date results and acquisitions activities, and we'll continue to look for ways to enhance shareholder value.

With that, Dave and I are happy to take your questions.

(Operator Instructions). Juan Sanabria, Bank of America.

Good afternoon guys. I was just looking. On the MOB side, I notice you took out some disclosure on the releasing results. Could you give us the results on new leases, renewals and the weighted average for the quarter on a cash basis that you used to provide?

Yes. We did provide that in prior quarters and actually indicated in our earnings call that we weren't really comparing apples to apples, and it wasn't indicative of our MOB portfolio as a whole. We thought reporting the increase on a cash basis there was more indicative of our portfolio. And we are very happy with our results for the quarter. As you can see, we had a positive result on our MOBs for the third quarter.

On the stuff you had to release, did you get a positive spread, negative spread on a cash workout basis, whatever you can share?

If we are doing with the calculations as we did it in the past, it would still go down a couple of percentage points. But once again, it's 78,000 square feet and 9.1 million square feet of our portfolio. So --

Could you just remind us what the issue was that you don't think that is indicative of the market to market of the portfolio?

We were comparing what the new rates were while the old rates were the base rates plus escalations was one of the calculations that didn't -- we weren't comparing apples to apples. The old rates had escalations in there.

Plus, this quarter, we had a situation too where a tenant took over more space but their rental rate on a pure per square foot base went down. But overall they took over several more thousand square feet in the building that was vacant. So it actually is a positive to us, that the building is more occupied. But just on its surface, it would indicate a couple percent decline in per square foot rent.

Okay. And then on the acquisitions that you've announced you've agreed to that you are going to do under the right deal structure but haven't yet closed, can you just give us a sense of the cap rates you're going to pay on a cash basis?

Right. The cap rates are in the low 7s% for that, after a 3% management fee.

Okay. And you expect those to close before year-end?

We do.

Okay. And then just a last question, just on the development and redevelopment spend. I think you noted you had $4 million of spend this quarter. How much is left to spend and over how long? And what is your view I guess in addition to that on the dividend and when we could expect an increase, given the accretion that you guys are expecting on Vertex but on an FFO per share basis, it doesn't seem to have increased that much, at least on a quarterly basis.

So, I'll start with the CapEx first. Yes, we did redevelopment and development CapEx of about $4.2 million here in the third quarter. We expect that to be probably a pretty good run rate over the next few quarters as we are continuously looking at our managed senior living communities and to any improvements where we see necessary to keep up in the marketplace.

In regards to the dividend, the board still reviews our dividend on a quarterly basis, and they are looking at the payout ratios on an FFO basis as well as a CAD basis. We don't believe -- we believe that the CapEx going into these properties are going to improve the bottom line and not hurt any chances of the board increasing the dividend. So, we expect the board to review the dividend at the end of the fourth quarter, beginning of next year and just look at it as they always do.

Okay. So, the CapEx would not necessarily you think impact the decision to increase or hold (multiple speakers)

Not at the run rate that we are on. Not on the run rate that we are on.

Okay.

We feel the CapEx that we're putting in here will help out the bottom line. And also like you mentioned Vertex, we closed that in the middle of the second quarter, and that should also help on the accretion of our bottom-line.

Okay, great. Thank you.

Vikram Malhotra, Morgan Stanley.

This is Landon Park on for Vikram. Really just a couple of questions. So on the CCIT deal, are there any concerns around the closing of that deal, just given sort of share price? And on the assets that you're acquiring, are you going to keep all the assets or are there some that you think are maybe non-core to your business that might dispose of?

Currently, everything is on as scheduled. We are looking forward to acquiring these assets. Our deal is definitely contingent upon Fern and Cole's transaction getting consummated. But everything we've seen is that Cole is representing that they have their own separate accounting department, auditors, corporate systems, and everything else. So, I guess there's no reason to believe that they would not consummate their transaction. So, we expect to acquire all these assets that were -- 23 that were previously disclosed. And we are pleased with them because of the credit quality of the long-term leases and the quality of the buildings. So, I don't really see any change in that.

Okay. So none that you've earmarked yet. And then, just on the MOB side, it looked like the leasing costs maybe jumped up a little bit this quarter on the new leases especially. I was just wondering if there's anything driving that in particular.

One of the things that's put into those costs is leasing commissions. And when we execute the leases, you book 100% of that into that cost. The TI dollars actually have not been spent, for the most part, there is still some that was spent. but I'd say commissions is the biggest component.

But is there a reason that it went from an average of about $4.00 to $8.00 this quarter?

Let's see. I think a good part of it is a property we have in New York that we've expanded and added more space to and extended the lease term by a significant amount.

Okay.

And I think that's the main reason I'd say.

All right. Perfect. Thank you very much, and congrats on the quarter.

(Operator Instructions). Nick Yulico, UBS.

It's Ross Nussbaum here with Nick. I just want to follow up on the question that Juan Sanabria asked, because I'm, frankly, perplexed by your answer, which is you took out the disclosure on the releasing spreads in your MOB portfolio because you thought it was apples and oranges. But it doesn't sound like apples and oranges to me. It sounds like exactly how every single REIT that I'm aware of reports cash releasing spreads. They look at the prior, the final year cash rent; they look at the first year cash rent on the new lease. What am I missing? Is that what you guys were doing before?

A good part of it is the fact that operating expense and so on are in the old numbers and not in the new numbers. That shows a decline. A lot of times too when we buy the buildings, we are buying them with a little bit term left. And then if we redo a lease, say a 10-year lease, we may take a dip down to end up with a total GAAP return with steps in the lease that will exceed the old rent, but it would appear as a step down. So we just found that there were so many components to that that distorted the picture, like or ended up -- we are very pleased with this quarter's growth in the MOB portfolio, and it's NOI. But you know, we just found that if you were to look at just that statistic on a standalone basis, it's going to show that outperformance is declining and when in reality it's actually doing quite well. It truly is a very small piece of the pie this quarter with 78,000 square feet on a 9.1 million square foot portfolio.

I get that. Every other REIT in the industry finds a way to report that statistic and you guys take it out. It just doesn't seem, frankly, very investor-friendly if every other REIT deals with similar issues.

We would be happy to revisit it ourselves internally and look at it again. We kept coming back to it that it's -- we didn't think it was indicative of the quality of the portfolio and our real activity. So -- and frankly, if you look at our healthcare peers, I don't believe generally in our healthcare peers that they are providing this data. I think you do find it in office REITs, and maybe one of the medical office REITs, but I don't believe in general you find it amongst the healthcare REITs.

I would encourage you to take another look at it. Thank you.

Vikram Malhotra.

It's Landon again. I just had a quick follow-up on your TRS. What do you feel is the outlook for that part of the portfolio? I know you had a difficult comp this quarter, and it looks like you have a difficult when next quarter, so just getting a sense of are there any markets you're concerned about or what you think on that side?

I think we are very pleased with the performance on the revenue side of the equation, and so we've really beefed up the asset management side of things to stay on top of the expense side and work those expenses down. So, we are constantly on top of the manager on that.

But as far as markets, particularly like in Florida, we expect to significantly push rates down in Florida, which should further enhance the revenue side of the equation.

I'm sorry, you said push rates down?

No, push rates up. I'm sorry. I'd say I'm not -- there's no market -- if you were to ask about any markets where I have any concern is Phoenix. I'd say amongst our TRS assets, the Phoenix market is the weakest of the portfolio. And that's going to take a longer time to improve from here. But everything else in the portfolio looks to be doing very well.

And how do you expect the growth rate I guess to trend over the next 12 months?

I think the longer-term same-store growth rate in this portfolio should be probably in the more 4% to 6% range. And I expect the expenses to improve in this next quarter, and the revenues will continue to improve. So I expect certainly we will get back to more of that mid or to higher single-digit range.

All right. Great. Thank you very much.

Collin Mings, Raymond James.

Good afternoon. Thanks for taking my question. Just going back really quickly to the MOB portfolio and the leasing environment there, can you talk a little bit more about maybe what type of escalators you're getting now, recognizing again what's kind of turning over in the portfolio is still a small percentage, but maybe the type of escalators you're getting on the leases now versus what's in the existing portfolio? Or just given kind of, again, the positive commentary around the MOB portfolio and the same-store NOI growth, I think it would be useful to get a little more color on what you're seeing in the ground, especially, again, given that those metrics were taken out of the supplemental?

Yes. We're getting about 2% to 2.5% increases at the MOBs. There's definitely the demand, so I would say the occupancies are holding up very strongly. And we're trying to execute as long leases as possible. And so we are typically in the five- to seven-year range for leases. Again, it's across the whole portfolio and 9 million square feet, so it's tough to generalize. But if you were to take the multitenanted medical office buildings like the Cedar Sinai, there you tend to be more in the three- to five-year range. And the escalators there are closer to 1.5% in 2%. Some of the other properties we have, we're able to achieve a little better increases. But I think, from an occupancy standpoint, we're very strong, and we're trying to push rates.

Okay. And then maybe just in context of the Vertex deal and the pending MOB deal you have, how much do you see as far as the portfolio, how much of the mix could come from MOB assets looking forward as far as from an NOI perspective? Is there a level to your comfortable with or would like to bring the portfolio to on that front?

Yes. We were at 42% this past quarter. I think with the other -- the portfolio we will be taking on, that will bring us up into the high 40s%. But I think 50%/50% is a nice blend between the senior living as well as the medical office performance. I don't want to balance it one way or the other too much of that.

Okay. And then just real quickly guys, can you maybe touch on, again, we've seen a lot of cap rate compression across the healthcare REIT sector obviously over the last six, 12 months. Can you just put a little bit more color on that and what you guys are seeing and how you think that is by kind of property type?

From what I can tell, the cap rates are staying down pretty low in there. I don't see them really changing that much, given that there is still a considerable amount of capital on the sidelines still trying to participate in investing in the space. So I would say again for class A product, you're in the high 5s% to mid 6s%. I think you have portfolio premiums, senior living, again, truly Class A, large properties will command that high 5%, low 6% cap rates. I think individual assets, you still can achieve cap rates in the 7s% to 8s%. And the medical office building is pretty much the same thing. Cap rates are staying down there.

Again, there are obviously a number of transactions that have occurred out there, even on the skilled nursing side. New levels are being achieved with the Omega transaction of the mid to high 6s%, that's skilled nursing. We are seeing senior living in the holiday portfolios that are trading, again, those are 5s% to 6s%. So it's pretty aggressive out there right now.

Okay. Does that lead you guys to think about being a little bit more aggressive on the capital recycling front, or -- I know they're going to keep you pending sales, a few assets held for sale. But could we see an acceleration in that? Or just any thoughts on what that maybe means for your strategy as far as acquisitions or dispositions going forward?

Right. Well, we're always monitoring the portfolio. Historically, we've been selling off the assets that either are experiencing trouble today or we foresee down the road trouble, and those are now in discontinued ops. We're going to continue to monitor that portfolio. I think there will be some opportunistic opportunities to sell off some of the nice performing properties, but, again, it's case-by-case, and we are looking for opportunities like that.

Okay. Thank you for the additional details. And I would just reiterate the comment that it would be great to see that rent roll disclosure back in the supplemental.

Okay.

Ladies and gentlemen, at this time, I would like to turn the floor back to management for closing comments.

All right. I want to thank you all for joining us today. And we will be at NAREIT the rest of this week, so I hope to see a lot of you there. In the meantime, have a good day. See you then. Thank you.

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.