Diversified Healthcare Trust (DHC) 2017 Q1 法說會逐字稿

Good day, and welcome to the Senior Housing Properties Trust First Quarter 2017 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.

Thank you. Welcome to Senior Housing Properties Trust call covering the First Quarter 2017 Results. Joining me on today's call are David Hegarty, President and Chief Operating Officer; and Rick Siedel, Chief Financial Officer and Treasurer.

Today's call includes a presentation by management, followed by a question-and-answer session. I would like to note that 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, May 5, 2017.

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 to this call, it may contain non-GAAP numbers, including normalized funds from operations or normalized FFO and cash-based net operating income or cash NOI. Reconciliations of net income attributable to common shareholders to these non-GAAP figures and the components to calculate AFFO, CAD or FAD are available on 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 statements. Additional information concerning factors that could cause those differences is contained in our filings with the SEC. Investors are cautioned not to place undue reliance upon any forward-looking statements.

I'd now like to turn the call over to Dave.

Thank you, Brad, and good afternoon, everyone. Thank you for joining us today on our first quarter 2017 earnings call.

In the first quarter, we resumed our strategy of disciplined capital allocation, highlighted by our first joint venture transaction. We continue to invest in our existing portfolio and selectively make accretive new investments. Today, we reported normalized funds from operations or normalized FFO of $0.46 per share, which is equal to the first quarter of 2016. However, our balance sheet is better positioned at the lower end of our leverage range. We continue to offer SNH investors an attractive yield of over 7%, backed by our stable high-quality portfolio and medical office buildings and senior housing communities.

Specific highlights of the first quarter were that we sold a 45% equity interest in our Boston Seaport assets at a very attractive price and formed a joint venture with a sovereign investor. We accrued consolidated cash NOI by 2.7% compared to the first quarter 2016, acquired 1 medical office building for $15 million, were awarded the Building of the Year award for greater Los Angeles from the Building Owners and Managers Association International for our Life Science MOB in Valencia, California; achieved BOMA 360 designations for our operational best practices at 3 of our medical office buildings; maintained our high occupancy of 96.4% in the MOB portfolio; maintained 97% of our revenues from private pay sources; and subsequent to quarter end, prepaid secured debt of $288 million with a weighted average interest rate of 6.7%.

Now our most significant accomplishment in the first quarter was the completion of the joint venture involving our trophy life science buildings located in Boston's Seaport District, with the sovereign investor, where we sold 45% equity interest for approximately $261 million.

In July 2016, we obtained $620 million of attractive 10-year debt secured by the same real estate, which has become part of the joint venture. We're very happy with the valuation of the properties, as it equated to a value of $1,059 per square foot and a 5.9% cash cap rate.

Historically, they've only been handful of transactions in the Boston area, with properties have traded at over $1,000 a foot. This was further validated when a newly developed 17-story Class A office building, about 1 block from our Seaport buildings, changed hands the week prior to our transaction at $866 per square foot. This transaction showed the value of a portion of our portfolio and reduced our concentration in this property, all while accessing cost-efficient capital used to reduce our leverage. SNH will retain majority ownership of this property, and therefore, will continue to consolidate the operating results in our financial statements.

Our total turnover for 2016 was an impressive 38% and our year-to-date total return through April was over 15%. We believe there's more potential as we feel SNH continues to trade at multiples that do not reflect the relative value or the risk profile of our portfolio, which today is comprised of well-diversified private pay focused healthcare-related real estate, that's designed to benefit from the aging demographic and related healthcare and life science trends.

In the first quarter, approximately 42% of our cash NOI was attributable to triple net leased senior living communities, 15% to our managed senior living communities, 40% to medical office buildings and the remaining 3% triple net leased to wellness center operators.

In the first quarter, we increased our total portfolio of cash NOI over the first quarter last year by $4.2 million or 2.7%. This increase is a result of the incremental cash NOI from our external investments of $3.4 million as well as an increase of $800,000 in our same-store cash NOI.

Our triple net leased senior living portfolio continues to produce consistent steady growth, with same-store cash NOI increasing 1.6% in the quarter compared to the first quarter last year. The triple net senior living portfolio had occupancy of 85% and solid rent coverage of 1.3x for the 12 months ended December 31, 2016. This is a slight decrease from 1.31x coverage that we reported last quarter and a 1.34x coverage we reported this quarter same time last year. The slight decline in coverage sequentially was mostly attributable to weaker performance in the skilled nursing operations at our leased rental continuing care retirement communities or CCRCs.

As we've mentioned in the past, our tenants are seeing challenges within the skilled nursing industry, including the effort led by the accountable care organization, to decrease lengths of stay as well as increasing options for care outside of the traditional nursing home environment. To combat these challenges, some of our leased CCRCs have ramped up renovations and have invested in electronic medical records systems to participate more in the managed care networks. Additionally, we've been prepaying a secured debt on these properties, which should allow our tenants to accelerate their capital expenditures.

Since the benefits of capital improvements usually lag the increases in rent from the funding of these improvements, we expect improved rent coverage from increased cash flows in the future.

Our operators continue to commit the resources for increasing profitability during this time of increased competition through revenue-generating initiatives, controlling cost, investing in human capital and enhancing the programming that makes them the providers of choice in our markets. We will continue to partner with our operator to identify growth opportunities within the portfolio and fund the capital necessary to achieve it.

Our managed senior living portfolio seems to have a cash NOI decreased 3.1% or approximately $700,000 year-over-year. Occupancy decreased to 110 basis points in the managed same-store portfolio over the prior year, and we saw an increase in average monthly rates of 1.8%. The first quarter is traditionally weaker than the fourth quarter due to seasonality, and we experienced a meaningful impact from the flu at this period. Despite these challenges, our independent living and assisted living revenue remained essentially flat on a same-store basis year-over-year.

Skilled nursing revenue, however, decreased over 5% year-over-year, due to unusually high number of move-outs during the quarter, attributable to the flu as well as the fact that SNF units being out of service.

In the fourth quarter of 2016, we closed a 43-bed skilled nursing unit at a CCRC in Arizona to convert it to a private pay assisted living, and there are several other properties that are undergoing significant renovation to their skilled nursing units, which are disrupting operations.

Out of the 60 properties that make up our same-store managed portfolio, 5 properties accounted for a decline in cash NOI of about $1.2 million, moreover, 30% year-over-year. These 5 properties are all facing new competition and are undergoing large renovations, which disrupt current operations, but will ultimately position the properties better in the respective markets once complete.

For the past year, we've been emphasizing that we're investing extensively in our existing portfolio to be competitive with new developments of senior living communities opening up in our markets. We've seen evidence of improvement as a result of our investments and our better performing properties this quarter. In fact, the 5 most improved properties in our managed portfolio offset the loss in NOI from those bottom 5 performing properties, and they've all undergone recent renovations.

Now the medical office building portfolio same-store cash NOI increased 0.8% year-over-year and overall occupancy at the end of the quarter was 96.4%. This is the 12th consecutive quarter that our medical office portfolio has reported occupancy north of 95%, proving the quality and stability of this portfolio. Approximately 75% of our tenants are investment-grade public companies or major health care system. Our tenant retention in the first quarter was 89%, and we were able to sign new leases to offset the nonrenewals.

As a complement to the quality of our MOB portfolio, several properties received awards in the first quarter from Building Owners and Manager Association International or BOMA. Our property in Valencia, California leased to Advanced Bionics, won the building of the year award in the 100,000 to 200,000 square-foot category. This building, along with 2 others located in Phoenix, Arizona and Buffalo Grove, Illinois, were awarded BOMA 360 designations for operational best practices in the commercial real estate industry. We believe this speaks to the high quality of services provided by our property manager, RMR Real Estate Services.

In the first quarter, we acquired 1 MOB for a purchase price of $15 million. This 117,000-square-foot MOB we purchased is located in Kansas City, this is substantially all leased to the University of Kansas Health System. The lease with the health system has over 10 years of term left, and the building was purchased at a 6.8% cash and 7.7% GAAP cap rate.

Following the execution our first joint venture this quarter, our acquisition strategy will remain the same. We'll continue to be very disciplined and look selectively at one-off acquisitions in small portfolios, unless something of greater size comes along that will be accretive to us based on the risk-adjusted return versus net cost of capital. We're still seeing several amount of deals and we'll continue to monitor the investment opportunities in the senior living and medical office markets.

Now I'd like to turn over to Rick to provide more detailed discussion of our financial results for the quarter.

Thank you, Dave, and good afternoon, everyone. Our normalized FFO was $108.4 million for the first quarter or $0.46 per share, and we declared a $0.39 per share dividend subsequent to quarter-end. This resulted in a normalized FFO payout ratio of 85% for the quarter, which is consistent with last year.

Rental income for the quarter increased $5 million or 3% from the first quarter of last year to $166 million. This increase is primarily due to our acquisitions of 4 medical office buildings and 9 triple net leased senior living communities since the beginning of 2016.

On a same-store basis, rental income increased $1.5 million or 1%. This increase was primarily attributable to rent increases related to our funding of capital improvement at certain of our triple net leased senior living communities and net leasing activity along with increased escalation income in our MOB portfolio.

As a reminder, we recognized 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, so we did not recognize any percentage rent in the first quarter.

Resident fees and services revenue totaled $98 million for the quarter. This represents an increase of $1.2 million or 1.2% over last year, largely attributable to the 3 communities added to the managed portfolio during 2016.

On a same-store basis, revenue at our managed senior living communities decreased 1%, compared to last year or $935,000 to $91 million for the quarter. Average monthly rates increased 1.8% year-over-year, while occupancy for the quarter decreased 110 basis points to 86.1% from 87.2% last year, due primarily to the challenges in the skilled nursing components of our CCRCs that Dave spoke about and the impact of the flu on our overall occupancy.

Property operating expenses from our MOBs and managed senior living communities increased 3.2% in the first quarter to $101 million, compared to the same period last year on a consolidated basis, and increased 1.2% on a same-store basis to $94.6 million. These increases were primarily due to increased real estate taxes and repairs and maintenance expenses. Our consolidated property operating expenses also included costs associated with newly acquired or recently transitioned managed senior living communities and MOBs.

General and administrative expenses increased $4.2 million to $15 million this quarter compared to the first quarter of last year. This increase reflects $3.3 million of estimated incentive business management fees accrued for Q1 of 2017. The remainder of the increase is largely attributable to higher business management fees directly related to the price appreciation of our shares, which were around 30% higher, on average, in the first quarter of 2017 than they were in the first quarter of 2016.

As a result of this increase, the first quarter of 2017 fees were based on historical invested capital, whereas the business management fees for the first quarter last year were based on our market capitalization.

The incentive fee accrued this quarter is based on SNH's total return in comparison to the SNL U.S. REIT health care index from the beginning of 2015 through the end of the first quarter of 2017. SNH outperformed the index by 210 basis points over that period.

SNH's total return was 8.2% compared to the 6.1% total return for the index. This incentive fee accrual may increase or decrease over the next few quarters, depending on how SNH performs relative to the index.

Interest expense increased 10.7% to $43.5 million this quarter, compared to the first quarter of 2016. The increase was primarily the result of the 10-year $620 million debt secured by the assets, now owned by our joint venture, and the issuance of 30-year bonds during the first quarter of 2016.

Our total debt-to-gross assets at the end of the first quarter was 40.5% and debt to adjusted EBITDA was 5.7x. With the execution of the joint venture this quarter, and use of proceeds to pay down our revolver balance, we now stand at the lower end of our debt range and have more financial flexibility to refinance other debt as well as fund future growth.

While we are excited about the joint venture, it will, on a temporary basis, reduce our quarterly FFO by up to $0.03 per share until we can accretively reinvest the proceeds.

Subsequent to quarter end, in April, we prepaid or notified lenders that we will be prepaying $297.2 million of mortgage debt with a weighted average interest rate of 6.7%. As always, we will continue to look for opportunities to pay off high interest debt and maintain a strong balance sheet.

During the quarter, we recognized $659,000 of dividend income from our investment in the RMR Group common stock. As a reminder, SNH holds approximately 2.6 million shares of RMR, valued at over $130 million. Owning these shares, further aligns interest with our external manager and has proven to be a good investment for SNH, as we had another $26.4 million of unrealized gain flow through other comprehensive income into equity during the first quarter of 2017.

In the first quarter, we invested $11.6 million into revenue producing capital improvements at our triple net leased senior living communities, for which we will generally earn an 8% return on the amount funded. The majority of these improvements relates to major renovations and additions to existing communities that we believe will improve our tenant's rent coverage once construction is complete and the communities are stabilized.

Our recurring capital expenditures, which include leasing commissions, tenant improvements and building improvements for the first quarter, totaled $8.7 million. This was approximately half of the fourth quarter of 2016, which illustrates how inconsistent the level of capital expenditures can be based on the timing of lease activities.

We also spent $9.5 million on development and redevelopment capital projects, with nearly all of it being spent at our managed senior living communities. These projects include major renovations intended to reposition our property in its market or give our communities a competitive advantage against new supply.

At March 31, we had $32 million of cash-on-hand and only $97 million outstanding on our $1 billion revolver. At the end of April, we drew approximately $287 million from our revolver to prepay secured debt on 17 of our leased CCRCs and 1 MOB.

I'll now turn it back over to the operator so we can prepare for questions.

(Operator Instructions) And our first question comes from Bryan Maher with FBR & Co.

Two questions. One, can you walk us through how that works with the flu impact? Is it one or two things: people don't move in or you're expecting to move in because the flu's going around? Or do you actually have people move out?

Right. Well, it has a multiple effect. First of all, the -- people move out either through to -- due to high acuity, so they're either going to hospital or unfortunately, passed away. So we had a significant increase in number of deaths that occurred this first quarter. And once you do have a reported case of flu in your facility, you have to notify the state. And as a result, you go into a quarantine mode and for -- it could be for several days or weeks that you are shut down from admitting new residents into the facility, so -- until you have clarification. So it has a multiple effect on your occupancy levels, and we did have a couple of properties during the quarter at one point or another stop admissions for a few days at least.

On the acquisition front, are you seeing any increase or decrease in the number of properties coming to market? And then also, what are you seeing on cap rates? I mean, we've seen some pretty low cap rates on some transactions over the past couple of months. And as it goes to what you're looking at, what are you seeing there?

Okay. Well, obviously, we look at senior housing product as well as medical office product. And on the senior housing front, there has been a modest amount of opportunities to consider. I'd say it's slower than it has been in the past, and we have not really seen any large portfolios for us to consider acquiring in that space, so I think we will continue to look at the one-offs and individual properties that complement our portfolio. And with regards to medical office building area, obviously, there's been a few botched transactions and the large one of Duke. Those portfolios are extremely competitive, and therefore, cap rates are very aggressive on those. So we look, window shop, but we really are not pursuing those highly priced portfolios. We do see a tremendous amount of individual assets and small portfolios in the medical office space too, so we acquired one last quarter, and I expect that we will be continuing to buy individual assets and small portfolios for the foreseeable future. With regards to cap rates, again, Class A product in both senior housing as well as medical office will continue to attract. Normally I would say in the 5 for cap rates or to low 6s. I think Duke is exceptionally low cap rate, and unless you have a truly crown jewel in different places. But -- so I think there are still a number of product trading out there in the high 6s, low 7 range, which is more likely we will be participating in.

And our next question comes from Michael Carroll with RBC Capital Markets.

David, just kind of after the last question, was the joint venture, I guess, that you agreed to complete on the Vertex building, how should we think about that changing your approach in new investments? Are you going to be more aggressive now that your leverage metrics have improved? Or it's going to kind of -- going to continue as you have been over the past several quarters?

Well, Mike, as you said, that certainly improved our leverage position on our balance sheet, and I think, now we have probably one of the lower ratios amongst the healthcare REITs, so that does give us a little more cushion to go out and be an acquirer. I would say we'll be modestly a little bit more acquisitive. We're not, as I mentioned in the last statement that we're not going to chase the 5s and low to mid-6 cap rate transactions, but I hope that we can sharpen our pencil a little bit more and still acquire a little bit more product. So I'd say we're going to be modestly more aggressive, my expectation.

Okay. And can you give us some color on how you guys are viewing your relationship with Five Star right now? It looks like those coverage ratios continue to slip a little bit, and given the tenant's results today, kind of what's your outlook for those coverage ratios? And where do you think they'll trend over the next 12 months?

Okay. Well, let me take two areas separately, the managed portfolio versus the triple net leased properties. We, both us and Five Star, have been investing extensively in the whole portfolio, and there is a lot going on within the portfolio, which is obviously very disruptive. At the end of the day, we expect that substantially all of those improvements will ultimately improve the performance of the properties and allow us to increase occupancy or them to increase occupancy and rates. Now I think there's also one thing that we've seen really a noticeable impact from is a lot of the Medicare changes that are going on with regards to the skilled nursing units within our CCRCs. We lease a number of CCRCs to Five Star, and we also have some in our managed portfolio. And as we've mentioned on the last couple quarters that we've seen a significant drop off in Medicare revenues, and that's pretty high margin business. And that won't necessarily come back until we've implemented some of the cosmetic changes as well as medical records and then the CCRCs can now participate more with the managed care networks and increase volume, and so on. Couple quarters ago, we reported it was a $1 million impact to just our portfolio, and it was a larger impact to Five Star, and I think that I -- again, we can't recoup those revenues, probably not entirely 100%, but a good chunk of that won't be -- we won't be able to recoup until we've invested all this capital and gone online with some of the healthcare systems. So I would expect that we're probably going to be at this level, maybe even take a dip, before we bounce back for coverage, but we're very comfortable with Five Star from their ability to pay the rent. And they have a fair amount of flexibility with $100 million line of credit, they own a lot of assets, about 25 properties that are unencumbered or financeable, and they did generate about -- I think it was about $3.8 million of EBITDA this past quarter. So we feel comfortable that they can pay the rent. It's just we're going to have to -- it just takes time to see the changes and the benefit from it.

Okay. And then I guess last question, just real quick, on the SNF renovations that you kind of mentioned. I mean, how many units or beds are you renovating today? And do you expect to do more of that? And how many of them have been completed so far?

It's ongoing. I would say -- I mean one of them was a conversion. We took 43 SNF units out of a facility in Arizona, it accounted for about $0.5 million of revenue, and we're converting them to AL memory care, so that's kind of a different conversion, and we're not going to expect that to come back in the form of SNF revenues, but we're comfortable where the project is going. There's a number of other properties that have conversions from kind of your traditional SNFs to more what Five Star brands is to rehab to home program, that they've had success with throughout the portfolio, where they have implemented those changes, so we're excited to get some of those units back online. Varying stages of completion, some are approaching the end and others are kind of just been taken down after running down the census a little bit. So I guess, it's hard to say, but we do expect it to pay off.

I would say, within our portfolio, we have about half a dozen locations that are undergoing that type of transformation. And certainly, Five Star, within their portfolio, again have another half dozen to 10 properties that are undergoing that type of conversion, so it's pretty significant.

And our next question comes from Drew Babin with Robert W. Baird.

Quick question on the managed senior living communities. It looked like revenues were down on the same property basis about 1% year-over-year, with rates up (inaudible) and occupancy down 110 basis points. Was there something in the numbers in terms of onetime fee or other income last year that would have made that revenue growth negative? Because it looks based on the same property math that you should have had some modest positive revenue growth in the quarter. I was just wondering what the accounting difference is there?

Sure. Well, I think it's important, average monthly rate the way we calculated is, it's revenue divided by occupied unit days to calculate an average daily rate and then we multiply that by 30 to get a monthly rate. So total revenue doesn't always change by just the difference between the changes in average monthly rate and occupancy for a few reasons: The first is just mix. A resident will pay more for a 1- or 2-bedroom suite then they will for a studio. So a higher occupancy percentage in our larger units will increase our rate, but overall, occupancy would be unchanged for that same resident. We could also have a change in the number of companion residents throughout the portfolio. This is where a companion resident moves in, we continue to count the same 1 unit as occupied, but we are able to collect additional fees. So you do see a little bit of fluctuation in rate that isn't necessarily tied directly to occupancy.

Okay, that helps. And then just one more question on the balance sheet side. I'm curious what your revolver balance is today after some of the debt retirement that you've done or are going to do in the second quarter. I mean, what plans to retire that balance might be? New bond or potentially more JV sales or things like that? I was just hoping to get kind of give a general outline of how you're thinking about that.

Sure. We had it down to $97 million at the end of the quarter and then, in April, we drew another $287 million to pay off some of that secured debt. So round numbers, it's a little bit under $400 million right now. Our revolver isn't due until January, so we'll probably -- we do have the ability to pay a fee and extend that another year, but we'll likely get started this summer to redo the revolver. And I think, with the interest rates where they are, I think we have a number of options from a refinancing perspective, but again, I think we have some flexibility with the balance sheet where it is.

(Operator Instructions) And your next question comes from Tayo Okusanya with Jefferies.

The JV -- I just wanted to clarify. Did you mention the potential dilution could be $0.03 of FFO a quarter or for the year?

That was per quarter.

That's per quarter. And does that also include the impact of you guys also paying down the debt, the 6.4% debt?

No, it's about $0.03 on just the Vertex buildings itself. We'll get a penny of it back by repaying that debt. But really, in order to grow FFO, we need to take those proceeds and reinvest them at higher cap rates.

Okay. Got you. Okay, so that's helpful. Then, second of all, I guess, one question that's kind of out there is, when we take a look at your operating metrics, whether it's this quarter or again, even historically, let me just kind of take a look at same-store NOI growth for your MOB portfolio, your shop portfolio, your triple net. Those statistics tend to lag some of your peers in each of those respective categories. And I guess, how do you get investors comfortable with the idea that your portfolio is capable of generating growth similar to your peer set?

Yes, well, Tayo, I think there's a couple of different pieces to that, obviously. The MOB portfolio itself, we have approximately 1,000 leases in total, and they're all -- we have gross leases, triple net leases and then modified gross. And it's an older portfolio, and so it's very difficult to compare it with the newer health care REITs that have brand-new properties with new leases in place with fixed increases. But I believe that we have made a lot of changes in the last couple of years, invested a fair amount of capital, and that you have -- and the growth leases will start to be able to push rates more. The triple net is likely to stay more or less the same. And then, you have situations like the Vertex buildings and wellness center leases and a few other number of other triple net leases, where their 5-year bumps that will kick in, in '18 and '19. So now on the lease renewals that we did this quarter, we actually have rent roll-ups of about 8.1% on our renewals, so we had a very, obviously, good quarter, but it's to show up going forward. Then with regards to the triple net, I think the triple net is likely to continue at the same levels, just because our percentage rent is tied to how much growth in revenues there are at the properties. And as we've often said in the past that the last thing we want to do is layer on 2.5%, 3% fixed rate increase to someone in this environment who's struggling to just stay even with competition. So I don't expect any meaningful change there. The RIDEA portfolio, I believe, all these investments will ultimately turn that performance around where we'll be able to push rates. As we said in our prepared remarks, 5 properties that we invested a significant amount of capital that's complete, we've seen a major increase in performance from those properties. So we're going to continue that program. So I think that's where we see probably the greatest potential going forward, but we have to get through this new supply competition right now to get there. So I think there's a few levers more so in the managed care, but we got to be a little more patient. And then on the medical office building front, that I believe there's more growth to be attained from that.

This concludes our question-and-answer session. I would like to turn the conference back over to David Hegarty for any closing remarks.

I appreciate you all joining us today, and look forward to meeting up with a number of you in the upcoming REIT conferences, especially NAREIT in June. Thank you, and have a good day. Bye-bye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.