Diversified Healthcare Trust (DHC) 2016 Q3 法說會逐字稿

Good morning, and welcome to the Senior Housing Properties Trust third-quarter financial results conference call.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Brad Shepherd, Director of Investor Relations. Please go ahead.

Thank you. Welcome to Senior Housing Properties Trust call covering the third-quarter 2016 results. Joining me on today's call are David Hegarty, President and Chief Operating Officer, and Rick Seidel, Chief Financial Officer and Treasurer.

Today's call includes a presentation by Management followed by a question and answer session. I would like to note that the transcription, recording, and retransmission of today's conference call are strictly prohibited without the prior written consent of Senior Housing.

Today's conference call contains forward-looking statements within the meaning of the Private Securities 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, Friday, November 4, 2016.

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 operation, or normalized FFO, and cash-based net operating income, or cash NOI.

A reconciliation of these non-GAAP figures to net income and 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 any forward-looking statement.

Additional information concerning factors that could cause those differences is contained in our filings with the SEC. Investors are cautioned not to place undue reliance upon any forward-looking statements. I would now like to turn the call over to Dave.

Thank you Brad, and good morning, everyone, and thank you for joining us today on our third-quarter earnings call. Earlier this morning we reported normalized funds from operations, or normalized FFO, of $0.45 per share for the third quarter, a decrease of $0.01 per share year-over-year.

This quarter was transitional for S&H as well as the industry as asset dispositions and industry trends negatively impacted the results. However, we expect that these dispositions and recent transitions will improve our portfolio's future results.

In the third quarter, we continued to focus on adding value through internal growth, more efficient operations, and attractive long-term financing. We believe investors appreciate and support our strategy as confirmed through the performance of our common stock which has produced a total return of over 55% through the first three quarters of this year.

Highlights for the third quarter were that we grew consolidated same property cash NOI by 2.1% year over year, in July closed on a $620 million attractive ten year fixed-rate financing, allowing us to term out a majority of our outstanding borrowings under our $1 billion revolving credit facility. We sold four medical office buildings and one skilled nursing facility for a total of $20.4 million, bringing our year-to-date total dispositions to approximately $30.2 million.

We pre-paid $92 million of mortgages with a weighted average interest rate of approximately 6% per annum, and subsequent to the quarter end pre-paid $42.5 million in mortgages at 6.5 % per annum. Also subsequent to quarter end we acquired one MOB for $18.5 million, bringing our year-to-date total acquisitions to approximately $207 million.

In addition, we agreed to acquire two private pay senior living communities for $18.6 million which we believe -- which we expect will close by year end. We did have some offsetting challenges which we will discuss during the course of this call. Our portfolio is comprised of well-diversified, private pay focused healthcare real estate which is designed to benefit from overall healthcare trends.

In the third quarter, approximately 41% of our NOI was attributable to triple net leased senior living communities, 15% to managed senior living communities, 41% to medical office buildings, and the remaining 3% triple net leased to wellness center operators. In the third quarter we increased our total portfolio net operating income over the prior year by $2.3 million or 1.4%. This total NOI increase is related mainly to investment activities in each of our portfolio segments.

The external growth in the triple net senior living portfolio is primarily the result of the sale leaseback transaction for seven senior living communities in June and was partially reduced by unfortunate defaults resulting in the transition of two triple net leased senior living communities to our managed senior living portfolio during the year. The impact of converting these triple net leased assets to managed assets was a decrease in our quarterly NOI of approximately $400,000 year over year.

However, since the transition, the properties are turning around and are well on their way to becoming stabilized and more profitable. In our MOB portfolio, our acquisition and disposition activities resulted in net increase of $1.2 million in NOI year over year.

Now I would like to discuss our results within each segment. Our triple net leased senior living portfolio continues to perform very well with same store cash NOI increasing 1.9% year over year. The triple net senior living portfolio had a combined occupancy of 85.3% and rent coverage of 1.33 times for the 12 months ended June 30, 2016. The coverage ratios of our leases remains strong and very consistent with prior quarters.

We have seen occupancy impacted by new competition in certain markets within our leased portfolio, but our tenants have responded by controlling costs and increasing rates in markets where they can, and investing the necessary capital at the communities to remain competitive. We continue to be comfortable with our tenants' ability to cover the rent due to us.

Our managed senior living portfolio same-store cash NOI decreased 2.9% year over year. Occupancy declined 60 basis points in the same-store portfolio over the prior year, but we saw a slight increase in total revenue. Declines in occupancy were more pronounced in the skilled nursing units within our CCRCs, where skilled nursing revenue was down just over $1 million this quarter over the prior year quarter.

This is due to trends in Medicare reimbursement and growth of managed care programs, and several skilled nursing units were out of service during the quarter due to refurbishment. In fact, one community, a skilled nursing wing, is being completed converted to assisted living and memory care units. We were pleased to see increases in independent assisted living revenues at our buildings, which more than offset the decrease in skilled nursing revenue.

This increase demonstrates that our operators continue to push IL and AL rates where they can to combat nursing and other operating challenges. Expenses were up on a same-store basis 1.3% year over year, primarily in employee benefit costs, real estate taxes, and management fees.

We continue to invest capital in and find opportunities to grow our managed senior living communities. Our operators are committed to increasing profitability during this time of increased competition through revenue-generating initiatives, controlling costs, investing in human capital, and furthering the programming that makes them the providers of choice in our markets. We are encouraged that we have seen a meaningful increase in census as we progress into the fourth quarter.

The medical office buildings in our MOB portfolio remained well occupied this quarter with overall occupancy at the end of the third quarter of 95.9%. Occupancy in that same-store MOB portfolio increased 30 basis points to 96.3%. Same-store cash NOI increased 20 basis points year over year as a result of net leasing activity in the quarter offset by slightly higher year over year nonrecoverable expenses.

Turning to our acquisition of disposition activities, subsequent to quarter end, in October we acquired one MOB in Ohio occupied by a publicly traded medical device manufacturer at an 8.25% cap rate, or $18.5 million. This acquisition brings our total acquisition volume to approximately $207 million year to date. We also agreed to acquire two private pay senior living communities in Illinois with 126 units for $18.6 million that will be triple net leased at an initial rental rate of 7.5%. This acquisition is subject to customary closing conditions, but is expected to close before year end.

In the third quarter, we sold four MOBs located in Oklahoma and one skilled nursing facility in Wisconsin for a total of $20.4 million. Our year to date dispositions total is now $30.2 million at an average cap rate of approximately 12%.

At September 30, we had one MOB located in Pennsylvania and one former memory care building at a senior living community located in Florida classified as held for sale. The intention of our dispositions program is to enhance the overall asset quality of our portfolio and our internal growth potential going forward. While these dispositions were diluted from the short term, they achieved these two goals by pruning the portfolio of non-core assets.

We continue to monitor the investment opportunities in the senior living and medical office markets and are being disciplined to maximize our risk-adjusted return. Acquisition activity for the foreseeable future will continue to be modest with individual properties and small portfolios, and funding expansion improvement within our portfolio. I'd like to now turn it back over to Rick to provide a more detailed discussion about financial results for the quarter.

Thank you, Dave, and good morning, everyone. We are pleased with what we were able to accomplish in the quarter to improve the quality of our portfolio and improve our financial position through the utilization of attractively priced long-term financing. These actions along with the performance in each of our segments resulted in normalized FFO of $105.7 million or $0.45 per share, a decrease of 2.2% compared to last year. We also declared a $0.39 per share dividend in October that will be distributed to shareholders on November 17, 2016.

Rental income for the quarter increased $6.6 million, or 4.2% from the third quarter last year to $165.5 million. This increase is primarily due to the acquisitions of two office buildings and eight triple net leased senior living communities since July 1, 2015, partially offset by the sale of five skilled nursing facilities and four MOB during the same period. On a same-store basis, rental income increased $3.4 million, or 2.2%. This increase is largely attributable to increased escalation income in our MOB portfolio, as well as increases in rental income related to capital improvements at certain of our communities within our leased senior living portfolio. As a reminder, consistent with recent non-GAAP reporting guidance, we will recognize all the percentage rent related to our triple net leased senior living communities in the fourth quarter for both our GAAP and non-GAAP performance measures.

Residence fees and services revenue from our 68 managed senior living communities increased 2.1% compared to the third quarter 2015 to $98.5 million. This increase is primarily attributable to our acquisition of one managed senior living facility and the two transitioned triple net leased properties into this portfolio along with an increase of 1.1% in our average monthly rent of $4,208. These increases were partially offset by a decrease in occupancy from last year. The decline in occupancy was most pronounced in the skilled units within our CCRCs, resulting in a decrease of over $1 million of revenue year over year. This decrease was partially attributable to beds being out of service as we continued to transform the units into higher-margin, rehab to home units an partially attributable to changes caused by Medicare ACOs or managed care programs.

Property operating expenses from our MOBs and managed senior living communities increased 6.6% in the third quarter to $103.3 million compared to the same period last year, primarily due to the acquisitions and the transition communities I just mentioned. On a consolidated same-store basis, property operating expenses increased to $3.9 million. This increase was primarily attributable to increased employee health benefit costs and real estate taxes in our managed senior living communities and increases in operating expenses at our MOBs, particularly real estate taxes which were largely recoverable from our tenants.

General and administrative expenses increased $1.8 million, or 17.4% to $12.1 million this quarter compared to the third quarter of last year, primarily as a result of increase in business management fees and stock-based compensation incurred in Q3 of 2016. Much of these increases are related to changes in the market price of our shares which is up 53% year to date as of September 30, 2016. With G&A at 4.6% of revenues for the quarter, SNH continues to benefit from the efficiencies of our management structure and remains one of the more efficient companies in the healthcare REIT sector particularly when considering the size of our portfolio.

We recorded non-cash impairment charges totaling $4.6 million in the third quarter of 2016 related to two buildings. The first was a skilled nursing facility that was formally leased to five star that was sold during the quarter and the second related to our planned disposition of a former memory care building at a managed senior living community that was classified as held for sale at September 30. We expect proceeds totaling approximately $5 million from the sale of these two properties classified as for sale at the end of the quarter.

Interest expense increased 11.4% to $43.4 million this quarter compared to the third quarter of 2015. The increase was a result of us closing the $620 million ten year interest-only secured financing in July, along with the $200 million term loan closed at September of 2015 and the $250 million $30 year senior notes issued in February of 2016. These increases were partially offset by repayments of $250 million of our senior notes in November of 2015 and $168 million of mortgages that had encumbered six of our properties at an average interest rate of 5.72% since July 1, 2015.

But July financing, tiered by two class A life science buildings located in Boston's Seaport district, allowed us to term out the majority of the outstanding borrowings under our revolving credit facility. At the end of October of 2016 we pre-aid another $42.5 million of mortgages that had encumbered eight more of our properties at an average interest rate of 6.54%. We recognized $659,000 of dividend income from our equity investment in the RMR group during the quarter. We expect dividend income to run at this amount per quarter going forward for the foreseeable future.

In the third quarter we invested $5.3 million into revenue-producing capital improvements at our triple net leased senior living communities, for which we will earn an 8% return on the amount funded. Our recurring capital expenditures for the third quarter totaled $12.2 million and included $3.8 million at our MOBs for building improvements, $3.9 million on MOB tenet improvements and leasing costs, and $4.5 million at our managed senior living communities.

We also spent $7.4 million on development and redevelopment capital projects, with the vast majority of it being spent at our managed senior living communities. These projects include major renovations intended to reposition a property in its market or give our communities a competitive advantage to new supply that we see entering the market. At September 30, 2016 we had $40.8 million of cash on hand and $786 million available on our $1 billion revolver.

Our total debt to gross assets at the end of the third quarter was 42.9% and debt to adjusted EBITDA was 6.0 times on a trailing 12 month basis. We are comfortable with our leverage ratios where they are given the quality of our portfolio and the significant amount of liquidity we have available to us.

I'll now turn the call back over to our operator to open it up for questions.

Thank you, sir.

(Operator Instructions)

Juan Sanabria, Bank of America Merrill Lynch

Good morning, guys. Just looking at your triple net coverage ratios that you give on page 32 of your [sock], just quickly, are those EBITDAR or EBITDARM coverage levels? And if you could provide the four different Five-Star ones that you used to disclose?

Those are on an EBITDARM basis and part of the reasoning for that is the fact that the management fees sometimes, using 5% is a rule of thumb that people often use, but many times the real cost of managing might be 2%, 3% or 4%.

I can speak to the change in the disclosure and not breaking it out. I think it is important to remember that Five-Star leases all have cross default provisions, there's corporate guarantees in place. They are all backstopped by the real estate that Five Star owns and operates on its own account.

So we really think about it as consolidated coverage, which is the same way we think about Sunrise, which also has four leases with us. So this quarter we would have had to add a fifth line for that new math to lease, for that sale leaseback transaction we just did. And it would have only had two days of activity in it and it did not make sense. So we sat back and said, we should just simplify this presentation and report it as a consolidated number.

It is more meaningful to us that way and we don't think breaking out the details added much to users of our financial statements either. I don't have the detail in front of me but I can say the number just ticked up a little bit on a consolidated basis. I don't think any of the leases moved significantly.

I think had we presented in detail, the fifth lease would have looked a little funny because it was two days of prorated activity. But overall we are still comfortable with Five-Star's coverage where it is at 1.23%.

And just to clarify, that is after management EBITDAR with R not ending with M, correct?

That's before management fee.

Before, okay. Those coverage levels before management fees and before CapEx seem pretty low? You said you feel that the rent is safe, but what are you assuming for CapEx as a deduct, like a pro forma coverage post-CapEx for those assets?

Well, in all of our leases we have a mechanism where we can fund the CapEx if they wish us to. So like in Five Star, we fund most of their long-term capital items, so within our typical underwriting, like we are spending about -- between $1,200 and $1,500 a unit on our private [pacing] and living.

Most underwriting would assume anywhere between $750 to $1,500. Again we push it on the tenant and we use our own estimates.

So you pay their CapEx but then you get, I am assuming -- what did you say, 8% return?

We do, that is correct. We generally get an 8% return on CapEx improvements that we fund. But it is important to remember that they do handle all of their maintenance CapEx, all of the regular things that operate the facility. Generally where they come to us is for the more improvement-type projects that will enhance the community on a much longer term.

Sorry, that confused me a little bit. So you are funding the maintenance CapEx? Or they are?

They are. The tenants fund all of the maintenance CapEx. If they have a more substantial project, that is really more of a building improvement, that is where they generally would come back to us and ask us to fund it. And we are happy to invest further in our communities and make sure the work gets done and generate a return on that investment.

Okay. And then any update on what you guys are thinking about on the Vertex asset? We have seen a bunch of transactions, large-scale (inaudible) post acute, which is arguably a lot more risky and some pretty meaningful senior housing transactions, do you think a building of this quality in a major metropolitan city would be fairly easy to JV yourself? Any update?

Only that it is still on the table and we are still having a number of discussions. There are a number of interested parties, but we are not in a position in the moment to get any specific on it.

Okay. And then just lastly, any comments on what you guys are seeing in terms of new supply? Both on your triple net senior housing and your (inaudible) Brookdale or sounding the alarm I think pretty loud on the secondary supply -- supply in the secondary markets. Any thoughts going into 2017?

I think we've definitely seen the impact of new supply. We have already seen new openings within 5 miles at about 18% of our communities this past year. The [nik] data covers the majority but not all of our markets, and when we scrubbed the nik data, we do see some construction in the pipeline, but we do believe it will be manageable.

The nik data tells us that about 33% of our communities have new supply, bulk new construction together with openings in the past 12 months. So we are hopeful that we have already seen a majority of the new competition, but believe it will be manageable on a go-forward basis.

(multiple speakers)

I was just going to say, big picture, looking at this quarterly results, one thing that jumped out at us and we try to make a point in our presentation, was the fact that we have a number of properties that have full services. Full CCIC services with [IOAL] and a skilled nursing unit, typically.

This quarter we had a drop in revenue of over $1 million in Medicare A inpatient revenue, primarily from those types of communities. As I said some of it is due to the new refurbishments going on at a number of communities, but also a significant piece, particularly in Florida, is lost revenue due to managed care programs. So really the private pay senior living side has actually done very well during this quarter.

And as we mentioned, in Q4 to date we are seeing a noticeable improvement consensus. So a number of programs that have been implemented over the last couple quarters we believe are bearing fruit, and I would say our properties are doing, on the senior living side, pretty well.

Just to clarify, did you say, you threw out two numbers there, 18% of the assets were facing new supply or 33%?

No, 18% has already seen new supply. When we look at the data and look at the new openings within the past 12 months, 18% of our communities already have -- that is baked into our current numbers. We do see some more coming, and when we combine new supply with the recent openings, it gets up to just under 33% of our communities.

Thank you.

Vikram Malhotra, Morgan Stanley.

Just want to understand the managed properties a bit more, just on expenses? It seems like a bunch of expenses have been taken out and you have been able to control cost over the last few quarters? I am just wondering them here on, how much more is there, how much more rationalization can there be? And what are your expectations over the growth trajectory over the next two quarters?

I think we definitely did see increased operating expenses this quarter. We mentioned in our prepared remarks that real estate taxes impacted both senior living and our MOB portfolio. Real estate taxes in total were up $2 million year over year.

And a lot of it on the MOB side is recoverable, but on the managed side, one of the things we noticed is that the timing of our real estate tax appeal tends to move the needle on talking about a portfolio of 65 assets. We also, in the managed senior living business, saw increased health benefits costs this quarter. Largely a function of a small number of extraordinarily high individual claims that wind up increasing overall cost beyond what we normally see.

These costs were up about $800,000 this quarter compared to last year. So to your point, the operators did a great job offsetting a lot of it through labor efficiencies and trying to manage overtime through the vacation season, but it definitely had an impact on our results.

On a go-forward basis I do not think we see a ton of structural changes. I think the more you focus on managing labor and focusing on supply chain efforts, the more momentum that effort gets. And I think it will continue to become cultural, and we are hopeful to continue to see savings and growth and NOI there. But I think we generally talk about targets of 3% to 5% growth in the managed business, and we think that is probably still appropriate.

Again, there certainly has been some headwinds with both competition and again, a couple of the unique operating expense issues.

In your market, as you look at the investor supply both on the net lease side and the managed side, just based on what you are seeing in terms of new construction, any sense of when you could see all that hit as actual inventory and a source of competition?

I am encouraged that we have already seen it opening already at 18% of our buildings. Our current numbers already reflect some of that new supply where the units are open, and the operators are actively trying to fill them up. So there is certainly more coming, we are aware of that, but we believe it will be manageable.

Okay, great. And lastly on the portfolio? You have seen some of your peers, we've seen some large transformative transactions, and we have also seen a lot of different buyers come to the table? Any sense of are you looking at the portfolio now today given what pricing is, and the buyers we have seen? Any sense -- any coloring you can do to improve your overall metric?

I think you know we are selling off some selective assets over the course of time. In the near term, I don't see a major shift like some of the peers have done, some major repositioning of their whole portfolio. We don't see us doing that in a major way, but I think individual assets again we periodically sell down our [snip] position and a few underperforming properties?

On the MOB side again a number of the transactions being done in the marketplace are being done at cap rates in the 5% and low 6%. And we realize that is not a price range we can compete in at the moment. I think we are looking at other selective situations that make a lot of sense for us.

That is why I think our acquisition path will be modest, thus we don't need a tremendous amount of capital at the moment. We have, frankly done our best when we stayed out of the hot markets, and gone in when there is a hiccup in the economy or the market, and we have capital available to go in and take advantage of that. So we are trying to exercise discipline, and more or less stay on the sidelines but be somewhat in the ballgame.

Okay, thank you very much.

Nick Yulico, UBS

Thanks. Good morning. Just going back to the leases with Five Star? I guess first question is, how come you don't report the coverage as of September 30 there is financial data on Five Star out?

It is out. It came out yesterday. It is important to remember they are a separate public company. We don't have their data on a real-time basis.

And in the past on occasion we reported before them, and we also have other operators who we don't have their data by the time we report. So I think you see that trend in the whole industry where everyone is one quarter behind just because of the practical side of it.

Okay, so looking at Five Star's actual financials, they have had negative operating cash flow for nine months this year. How should we think about their ability to still pay your rent and how this ultimately ends up? Or is there a rent cut that needs to happen to help out Five Star? Because it seems like the only other option Five Star has would be to sell real estate that they own to help their cash flow. And yet that is being prevented it looks like, tied to this activist campaign against Five Star right now.

Well Five Star is going through a transition period. One of the things that as I mentioned for us, the Medicare A impact of $1 million to us, times four is $4 million a year. If you extrapolate that onto Five Star somewhat they are changing the business strategy to minimize the Medicare business and focus more on the private pay [debt], to expand that.

So they are transitioning. They did have a rough quarter this quarter but I think there are a lot positive things that over time will get them back to cash flow positive on a regular basis. But as you said, they currently sit on about $50 million in cash and have a completely available revolving credit facility of another $100 million and they own about 26 properties, I believe, on the balance sheet.

If they want to sell some assets here and there that is their choice, but I think it is their choice anyway. So we are comfortable that they need some time to work through their stuff but they should be okay.

And then just where is -- is there an actual default threshold on the leases?

Not a [comment] as a certain level of performance. Also when you delve into the details, I think if you took out, say the bottom 3% or 5% of their portfolio and close them, sold them, whatever, their coverage ratios would materially improve. So it is up to them to determine when to sell those properties or do something with them.

And they need our consent obviously, but we are likely to consent to something like that. So I think they could improve their results by eliminating some of their problem properties.

Okay. I guess just last question. There are mortgages attached to some of these specific individual leases? Remind us what is the amount of these mortgages, from looking at your debt summary and the supplemental? And then also if there is any, you mentioned a cross default provision on the leases? Is there also any cross default that applies to the mortgages as well?

You are still talking about specifically Five Star leases (inaudible) or just in general?

Yes, the Five Star leases. I know Five Star discloses that they have the separate leases because they are actually specific mortgages tied to separate leases. You mentioned cross default provisions in the leases. Is there also cross default that attaches to the mortgage?

No. Those are full properties, what we described as Lease 3, and those are all predominantly CCICs and private-pay communities that are secured by Fannie Mae financing. They are non-recourse loans so there would not be a cross default on that. It is not tied to that specific operation of the property.

Okay. Sorry, where is it on the debt summary page? Which mortgages under the secured debt summary are the ones that are the Five Star mortgages?

It is the one secured by the pool of 17 assets.

That is the only mortgage, and that is across various leases? Or only on Lease 3?

They are pooled into Lease 3.

Okay. Thanks for the help.

Tayo Okusanya, Jefferies & Co.

Good morning. I am just trying to understand this loss of revenue from the Medicare part A side? Again your skilled nursing, when you take a look at your portfolios it's such a small piece of your portfolio, I guess I am just surprised about the magnitude of that number? I am really trying to understand what is going on there?

Right. It has happened pretty quickly, and what is happening is, in the standalone skilled nursing facilities, the properties we own are more your traditional long-term care nursing homes that typically have a fair amount of Medicaid and very little Medicare and little private pay. So I think they are pretty much stable operations, generally.

But within the PCSC properties, we have, there is often 40 or 50 beds that are for skilled nursing. And those normally have been shorter term rehab stays or it could be a little longer term. But what has happened is particularly in the state of Florida, a lot of the managed-care programs are now directing people to go straight to home and skipping the skilled nursing and maybe having some home healthcare to follow up.

So that has really bypassed a lot of the rehab units that we have in our CCRCs. So what is happening is we are making some changes as far as developing a relationship and having better electronic medical records, which then could be provided to allow our system to try to draw in more referrals and things like that. As well as we do have -- (multiple speakers). We probably have 100 units across the system that are just out of commission because of refurbishments.

So when I take a look at your property mix that you put on page 29 of your supplemental, where are you sticking the skilled nursing stuff that is being impacted? Is that being stuck under [sniff], is that part of the 3%?

No. It is not. The 3% there is predominantly skilled nursing or facilities that are primarily -- most of their revenue comes from government [services].

Predominantly what I see is assisted living it would be in the assisted living bucket?

Correct. Where we are we are seeing this impact are our larger CCRCs. We could have 100 units of IL, 250 units of AL and like Dave mentioned, 40 or 50 sniff beds. From our perspective, that is a predominantly private pay facility but there is still some exposure to Medicare.

So in that example, you would put in the AL bucket in this chart?

Correct.

Okay, now I understand why I am not seeing it, that is helpful. So that is number one. Then number two, you talked a little bit about G&A? That part of it was impacted by your stock price doing so well this year? I am curious, is that because you just have to do more higher expenses paid? Does it tie back to the management fees that RMR gets paid? What is that increased tied to the increase in your share value?

It is a little bit of both. As you know, our business management fees are based on the lower of historical cost or market cap. And as a result we actually paid a lower fee based on market cap from the third quarter of 2015 through Q2 2016. So year to date through September 30, our stock was up 53%.

So we've now switched back to paying fees based on historical cost which has an increase in our G& A. Also because of our management structure our share-based comp is predominantly issued to non-employees because they are employees of RMR. And as a result of issuing shares to non-employees, we actually recognize expense based on the vesting-date fair value, not the grant-date fair value like most companies would.

So as our stock price increased, so did our comp expense. I think it is on page 14 of our supplemental, you will see a fairly sizable increase in our non-cash stock comp expense.

That is helpful. And then just back to Five Star and some of the commentary that was made earlier on? When you see the Company generating $5 million of EBITDA a quarter, but yet they have a CapEx budget each year of $40 million?

I am just kind of curious again, yet they are trying to make all these efforts to improve fundamentals, but are they forced to suddenly defer CapEx which in my mind would put their assets at a competitive disadvantage in several markets where there is increasing supply? I just trying to wonder when you talk to them, how are they trying to manage those two dynamics? They're trying to conserve cash, but at the same time trying to be offensive to kind of stave off some of the increased competition?

They are spending significant amounts of capital and they are full steam ahead. I do not think they are holding back on any capital. So they have to do it to obviously compete against the new product that is coming online. A good amount of it is capital that would be financed through us.

So its not coming out of their pocket per se, but it is being financed at an 8% rate. And then what is also interesting is that a lot of properties where there is significant capital was being spent on it, then you can turn to your residence and demonstrate that you spent the money, now we will raise your rates by 5%, 6%, 7%.

It goes down a lot easier and in fact we often find that census increases during a major construction project because people become involved in what is going on in the community and they like seeing it. And it actually benefits the community to see the construction going on.

You are not worried that they continue to have negative cash flow from operations? And at a certain point it is like, why do you keep putting money into a Company that keeps losing money?

Because these major projects that we're aware of, we expect to bear fruit. They're just going through a transition period right now. I think it will benefit them in the longer term.

Okay. Thank you.

(Operator Instructions)

Todd Stender, Wells Fargo Securities

Thanks. Good morning. My first couple questions are on the MOB side? You experienced pretty favorable rental rate on renewals, $37.00, any color there? Any specific things you can point to? Is it a mix of gross leases and triple net?

Yes. The new leases -- certainly we have constant roll over at the Cedars-Sinai powers there and renewals today are in the $76 to $78 a foot range. In general, we are experiencing very positive rent rollovers. What we do have that is also impacted our numbers is the fact that we do have a couple properties that are still in a free rent period that we would expect to burn off before year end, and that would help us beginning 2017 in January. But other than that I think just a blended average has really pushed that rental rate up.

Thanks, Dave. And then any color on re-leasing spreads, whether you want to highlight Cedars-Sinai or just the portfolio in general?

I would say in general, during this particular quarter I think it has been flat. We have had some very good progress out there in California and a few other markets, but I think we have experienced some issues in rolling over rents in upstate New York or Albuquerque. Which offsets that, so in the aggregate. Unfortunately it was a net, but we have been seeing generally 3% to 5%.

Thanks. And Rick, you mentioned property tax increases on the MOBs and your ability to recover some of that? Is there a general rule of thumb or how much do you actually recover, maybe on a percentage basis from tenant?

I don't have that in front of me. It is a pretty high percentage. I think we are largely able to recover most of it. From what we saw this quarter. But it is a high percentage and it -- the structure of our leases does impact a little bit. We do occasionally have to wait until base year resets or something like that but I guess you could probably go 80%-plus on recovery.

And then I think it was a previous question, and Dave you addressed this sort of I guess? Looking at Vertex, and I guess as a possible candidate to sell into a JV, why is that on the table? I guess I would consider it one of your premier assets. Why not look across the portfolio, particularly with Five-Star exposure, where you could reduce there? Maybe that would help with lowering concentration and help your valuation to ultimately tap the equity market?

I think with the Vertex property, our intent is to diversify our risk. We have already encumbered it with debt so we should realize some of the value within that property. And it also, to some degree it hurts us in the sense that it is -- the rent there is flat for five years and then there is a significant bump, about 10%.

And so it definitely hurts our same-store growth story. But with regards to the senior housing side, and frankly we have seen very little interest on our side from JV potential partners. I am pleased to see that some of our peers have broken through that and enticed them [partly] so that might be in our future down the road. At this point we have not found receptive parties to that side.

Okay. Thank you.

You are welcome.

Ladies and gentlemen this concludes our question-and-answer session. I would like to turn the conference back over to Dave Hegarty for any closing remarks.

Thank you all for participating in today's call and we hope to see many of you at the NAREIT Conference in a couple weeks out in Phoenix. And then have a good weekend. Thank you.

And thank you, sir. And thank you everyone for attending today's presentation. You may now disconnect.