Diversified Healthcare Trust (DHC) 2017 Q3 法說會逐字稿

Good afternoon, good morning, and welcome to the Senior Housing Properties Trust Third Quarter 2017 Financial Results Conference Call. (Operator Instructions) Please also note, today's event is being recorded.

At this time, I'd like to turn the conference call over to Mr. Brad Shepherd, Director of Investor Relations. Sir, you may begin.

Thank you. Welcome to Senior Housing Properties Trust call covering the third 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, Thursday, November 9, 2017. The company undertakes no obligation to revise or publicly release the results of any revision to 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, 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 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 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 to our shareholders, analysts and other interested parties joining this call. We're pleased to report and discuss our third quarter 2017 results.

Today, we reported normalized funds from operations, or normalized FFO per share, of $0.44 per share, which was $0.01 shy of the third quarter 2016 normalized FFO per share. We've noted previously that on a temporary basis, the joint venture we completed in the first quarter of 2017 would reduce our quarterly FFO by up to $0.03 per share per quarter until we can accretively reinvest the proceeds. We were able to partially mitigate some of this dilution by refinancing a large amount of expensive mortgage debt prior to the third quarter.

Additionally, our cash same-store operations stabilized sequentially and produced year-over-year growth, despite the challenges presented by Hurricanes Harvey and Irma. In regard to the hurricanes, we were fortunate that we experienced very minimal damage to our properties. In fact, we incurred less than $1 million of hurricane-related costs at our managed senior living communities and medical office buildings.

Now specific highlights of the third quarter, where we grew consolidated cash NOI by 1.2% and consolidated same-store cash NOI by 50 basis points; achieved MOB occupancy greater than 95% for the 14th consecutive quarter; continued to generate over 97% of our revenues from private pay properties; amended our $1 billion revolving credit facility, extending its maturity to 2022 and lowering the interest rate; amended our $200 million unsecured term loan due in 2022, lowering the interest rate; invested $14.7 million of CapEx in our triple net senior living portfolio that will generate $1.2 million of additional rent under the terms of our lease agreements; acquired one life science MOB located in Maryland for $16.2 million; received BOMA 360 awards for operational best practices at 2 of our medical office buildings, in addition to the ones we received earlier this year.

Subsequent to the quarter end, we acquired 2 MOBs for approximately $39 million; entered into agreements to acquire 2 life science MOBs for approximately $71 million; and finally, today, we announced that we've entered an agreement to acquire 6 senior living communities from Five Star Senior Living for approximately $104 million and plan to add them to our managed senior living portfolio when acquired. Approximately 42% of our NOI in the third quarter was attributable to triple net leased senior living communities, 14% 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, our total portfolio of cash NOI increased $1.9 million or 1.2% compared to the third quarter last year. This increase was equal to the results of the NOI growth from our triple net leased senior living portfolio as well as acquisitions made in our medical office building portfolio.

Our triple net leased senior living portfolio continues to produce consistent growth, with same-store cash NOI increasing 1.5% in the quarter compared to the third quarter last year. This increase is a result of the $43.4 million refunded to 3 different tenants for capital improvements at our communities since the beginning of the third quarter of last year.

The triple net leased senior living portfolio had occupancy of 84.3% for the 12 months ended June 30, 2017, which was down 30 basis points from the 12 months ended March 30, 2017. Rent coverage was 1.26x for the 12 months ended June 30, 2017. This is a slight decrease from 1.27x coverage we reported last quarter. And while our overall coverage declined slightly this quarter, the coverage of our Five Star leases remained flat. We are pleased that the coverage health steadied this quarter, particularly while significant capital projects were underway at many of our leased communities.

Our managed senior living portfolio same-store cash NOI decreased 3.8% or approximately $870,000 year-over-year. In the quarter, we saw an increase in average monthly rates of 80 basis points, offset by a decrease of 90 basis points in occupancy compared to the prior year. We saw an encouraging trend of increasing monthly occupancy throughout the quarter. This trend continued into October, where average daily census was up about 70 basis points over our third quarter average. The modest increase in revenue we saw was offset by a 1.3% increase in total same-store senior living operating expenses. Half of this expense increase year-over-year was the result of a $500,000 real estate tax abatement we received at a senior living community in Dallas in the third quarter of 2016.

We've continually appealed real estate taxes, and to the extent we're successful, it will impact our same-store results. The remainder of the increase in operating expenses can be attributed to costs associated with Hurricanes Harvey and Irma, with the majority coming from labor-related overtime. We have 1 community in Houston, 11 communities in Florida, 11 communities in Georgia and 5 communities in South Carolina that were impacted by the hurricanes one way or another. Between the 2 hurricanes, we incurred about $0.5 million in overtime labor-related costs and another $150,000 in cleanup-related costs. We expect to have an additional $150,000 of cleanup and damage-related costs in the fourth quarter.

Our exposure to the 2 hurricanes was limited. We feel very fortunate that our communities fared so well through these disasters. We attribute this good fortune to our operators being well prepared and much of the new capital investments in the communities being compliant with the best practices in hurricane-prone areas.

Operationally, the 3 properties with the largest decrease in NOI year-over-year are 2 of our rental CCRCs located in Fort Myers, Florida and Laguna Hills, California and 1 independent living facility located in Dallas, Texas. As Rick will explain later when he discusses our capital expenditures in more detail, these 3 properties are currently undergoing major renovations intended to better position themselves in their respective markets. But in the near term, these renovations are a disruption to operations, especially when marketing to new residents.

As a reminder, we do not remove properties that may be considered unstabilized, undergoing renovations or repositioning from our same-store performance, which may make our results not comparable to many of our peers. Had we adjusted for the prior year tax abatement and the hurricane costs, our same-store results this quarter for our managed portfolio would have reported an increase in same-store cash NOI of $280,000, or 1.2%.

With regards to investment activity in our managed senior living portfolio, today, we announced that we've entered an agreement to acquire 6 senior living communities with approximately 600 units from Five Star Senior Living for $104 million. And we'll add them to our managed senior living portfolio. The 6 properties are located in Alabama, Arizona, Indiana and Tennessee. They're currently 91% occupied and have potential for future development, including one significant shovel-ready independent living expansion at a great community that already offers assisted living and (inaudible) care. This is located within a large age-restricted 55-and-over planned retirement community.

Turning to our medical office building portfolio. Our medical office building portfolio same-store cash NOI increased 90 basis points year-over-year and overall occupancy at the end of the quarter was 95.8%. This is the 14th consecutive quarter that our medical office portfolio has reported occupancy north of 95%, which is indicative of the quality and stability of this portfolio.

Tenant retention for the third quarter was 73%, bringing our year-to-date retention to just over 80%. Retention for the quarter was affected by the vacancy of 80,000 square feet of space previously occupied by a life science tenant in a southwest suburb of Boston. This tenant had occupied a total of 315,000 square feet in 3 separate buildings that were acquired in 2015 by another life science company, and the leases on this space expired in July of 2017. Our team was able to renew the tenant in 2 of the 3 buildings when the tenant vacated the third building. This vacancy had a quarterly impact of approximately $200,000 year-over-year. We have had a very strong interest in the vacated space with -- from several potential tenants. However, we will likely see this as a variance in our life science portfolio for a quarter or 2 going forward until it's relet.

We had one other decrease worth noting on a comparable cash NOI basis in our life sciences portfolio this quarter. We were successful in renewing a 200,000 square foot tenant, but we agreed to 2 months of free rent. While these 2 situations accounted for approximately $570,000 reduced cash NOI year-over-year, we should be able to recover this in future quarters and are extremely pleased with the fact that these tenants renewed an approximately 430,000 square feet of space with no downtime associated with the leases and far less tenant improvement dollars than it would have been for new leases.

As I talk about the leasing details of our life science portfolio, I'd like to point out that in our supplemental this quarter, for the first time, we separate the performance of our life science building from our traditional medical office buildings. Our investment in life science buildings now accounts for approximately half of our total $3.6 billion that we invested in medical office buildings. So while we manage our MOBs and life science buildings as one segment, we've provided additional disclosure relating to the performance of the 2 product types to increase transparency and create a better understanding of our portfolio.

We also had 3 traditional medical office buildings that brought the MOB portfolio cash NOI down by approximately $1.1 million year-over-year. However, we expect all 3 of these properties' negative performance will reverse in the fourth quarter as a result of new leasing and timing.

As I mentioned earlier, our investment activity in our MOB segment has increased lately. In the quarter, we acquired 1 MOB located just outside of Washington, D.C. for $16.2 million. And subsequent to quarter end, we acquired 2 Class A MOBs for a total of $38.7 million and entered into agreements to acquire 2 Class A life science MOBs for $71.1 million.

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

Thank you, David, and good afternoon, everyone. Our normalized FFO was $104 million for the third quarter or $0.44 per share, and we declared a $0.39 per share dividend subsequent to quarter end.

Rental income for the quarter increased $2.8 million or 1.7% from the third quarter of last year to $168.3 million. This increase was primarily due to rents from the 2 triple net leased senior living communities and 3 medical office buildings we acquired since the end of the second quarter of 2016.

Resident fees and services revenue from our managed senior living communities totaled $98.3 million for the quarter, which was a modest decline compared to the same quarter last year, as increases in average monthly rates were offset by decreases in occupancy and changes in acuity mix.

Property operating expenses from our MOBs and managed senior living communities increased 1.3% in the third quarter to $104.7 million compared to the same period last year.

Within our managed senior living portfolio, the $650,000 of hurricane-related costs and the $500,000 real estate tax increase at one property that Dave mentioned earlier explains the majority of the consolidated year-over-year property operating expense increase. Our MOB portfolio's property operating expenses remained well controlled, with the year-over-year increase primarily attributable to the acquisition of the 3 properties since last year. Our MOB portfolio fared very well through the hurricanes this quarter, with less than $100,000 of repairs and cleanup expenses.

General and administrative expenses decreased $245,000 or 2% this quarter compared to the third quarter of last year, excluding the $8 million accrual this quarter for the estimated business management incentive fee. The incentive fee accrued this quarter is based on SNH's total return in comparison with the SNL US REIT Healthcare Index from the beginning of 2015 through the end of the third quarter of 2017. SNH outperformed the index by 4.7% over that period. SNH's total return was 10% compared to the 5.3% total return for the index. The annualized estimated incentive fee for 2017, as calculated at the end of the third quarter, was $29.4 million, up $1.3 million from the prior quarter's estimate, due to our relative performance this quarter against the index. We have accrued $22 million year-to-date. This incentive fee accrual may increase or decrease over the remainder of the year depending on how SNH performs relative to the index.

Interest expense decreased $3.3 million or 7.7% this quarter compared to the third quarter of 2016. We had a $5.5 million decrease in interest expense this quarter relative to 2016 as a result of the prepayments of mortgage debts prior to this quarter totaling $437 million, with a weighted average interest rate of 6.5%. This was offset by an increase of $1.5 million of interest expense from our revolver, which have weighted borrowings of $452 million at 2.5% this quarter compared to weighted borrowings of $280 million at 1.8% in the same quarter last year. As we announced on our last earnings call, in the third quarter, we amended our $1 billion unsecured revolving credit facility, reducing the interest rate by 10 basis points and extending the maturity to January of 2022, as our existing facility had been scheduled to mature in January of 2018. At the same time, we also amended our $200 million unsecured term loan that matures in 2022 to reduce the interest rate payable by 45 basis points. The annual savings from these amendments, based on our loan balances at the end of the quarter, would be approximately $1.9 million.

At September 30, we had $28.9 million cash on hand and $471 million outstanding on the revolver. Our total debt to gross assets at the end of the third quarter was 41.1%, down from 42.9% 1 year ago, and debt to adjusted EBITDA was 5.9x, down from 6.1x a year ago.

In connection with the acquisition of the 6 Five Star Senior Living communities, we expect to assume approximately $33.7 million of mortgage debt and fund the remainder of the purchase with cash on hand and proceeds from the revolver.

In the third quarter, we spent $31.3 million on capital expenditures, of which $12 million or approximately 38% is considered recurring. It includes building improvements, leasing costs and tenant improvement at our MOBs and managed senior living communities. The most significant of these recurring items included replacement of a number of roofs -- rooftop units and significant HVAC upgrades at a number of our MOBs that we expect will serve our tenants for years to come. In our managed senior living portfolio, the recurring CapEx was related to unit upgrades and elevator modernizations as well as upgrading life safety and IT systems. The remaining portion of our capital expenditures, $19.3 million, was spent on development and redevelopment capital projects. The majority of this, $14.7 million, was for funding of projects within our larger triple net leased senior living portfolio, which will increase the annual rents due from our tenants. Some of these projects will be a temporary drag on our rent coverage metrics as the expanded communities need to be restabilized, but in the medium to longer term will add value for our tenants and for SNH.

The remaining $4.6 million was primarily spent on our managed senior living portfolio. In our managed senior living portfolio, we recently finished 4 major capital projects and currently have an additional 4 ongoing major renovations intended to improve our communities and give them a competitive advantage in their respective markets.

We mentioned on our last earnings call that our senior living community outside of Chicago had a grand reopening in July, and we've seen a noticeable increase in occupancy there. Two other projects, our rehab-to-home unit in Scottsdale and a multimillion-dollar renovation at one of our premier independent living facilities in Dallas, have been completed and hosted grand reopenings in October. We have been anticipating the completion of these projects and are enthusiastic about the future performance of these communities.

The 4 major ongoing renovations in our managed portfolio are located in Yonkers, New York; Laguna Hills, California; Deerfield Beach; and Fort Myers, Florida. These 4 properties were responsible for the substantial majority of the managed redevelopment CapEx spend during the third quarter.

Our performance in the third quarter of 2017 was very stable despite the challenges that the senior living industry faced. Our management team continues to focus on investing our properties, compete with new competition and changing demands in our markets without the need for us to make significant portfolio transformations or changes to our strategy.

For the first 3 quarters of this year, SNH produced total shareholder returns of 9.5% compared to 6% for the SNL US REIT Healthcare Index and 3.6% for the [RMD]. With a dividend yield above 8%, we still believe we trade at a multiple that does not reflect the relative value with a conservative risk profile of a high-quality portfolio.

With that, I will now turn the call over to the operator for questions.

(Operator Instructions) And our first question today comes from Tayo Okusanya from Jefferies.

Could you talk a little bit about the cap rates on the recent acquisitions?

Sure. Well, with regards to the recently announced transaction with Five Star, each of those properties was independently valued, and their cap rate ranges between 7% and 7.5% for those assets. And with regards to the medical office buildings and life science properties, the cap rates are in the mid-8%, to one is as high as about 13%. But generally, the average is close to about 9%.

Again, those cap rates are meaningfully higher versus what you're kind of seeing some of your peers buying assets at. Could you kind of talk a little bit about what's causing that difference? Is it just because they were kind of not heavily marketed transactions? Is it the quality of the portfolio?

Sure. For one thing, they're one-off individual properties. And through our acquisitions group, we see 99% of the properties available for sale across the country in this area. And these particular ones, there might have been something with the lease term being a bit shorter than some we could get financing for, for a couple of our relationships. They -- for instance, one of the properties in Overland Park, Kansas is a clinical research lab for -- with a company called Quintiles, and they are a publicly traded A-rated company, and it's a long-term lease for about 9 years. So they're kind of unique situations, and we've found that we have been successful in many more offers that we've made lately. And so I envision the acquisition pipeline to pick up.

Got you. Then just one more for me, if you don't mind. Now the Five Star transaction, given you guys are doing it as a RIDEA transaction, could you talk about what the potential upside is you expected from the portfolio? I notice it's already 91% occupied. So when you kind of think about the stabilized same-store NOI growth out of that portfolio, what are you kind of expecting from it?

Sure. Well, for one thing, these properties, we believe that we can put some additional capital into the properties and achieve better rates and, to some degree, occupancy. In addition, we believe that there's one significant community in Tennessee that they would -- well, we agreed with them to build a 91-unit independent living community on the premises and that is a significant capital investment. And so we believe that we would get the benefit of the upside with that. And so we would hope that we could achieve another 50 to 100 basis point increase in return over the next couple of years from our investments in these assets.

Our next question comes from Juan Sanabria from Bank of America Merrill Lynch.

It's [Kevin] on for Juan. I just have a question relating to the first question. Basically, since you guys have been acquiring MOB assets, the kind of shorter leases -- shorter lease terms, I guess, what is your confidence on the current MOB re-leasing market as far as rent per square foot goes moving forward?

Well, we are very confident in re-leasing our renewal of existing space within the medical office building area. It seemed like on a national basis, I'd say the average is running around $24 to $28 a foot. But since these particular investments we're looking at, we evaluate the market that we're acquiring it within and the downside risk or opportunity risk of re-leasing it should that tenant not renew there. So we're trying to pick up Class A assets. The one I just mentioned in Overland Park is a Silver LEED-rated building. So I guess, I would expect the re-leasing to be very positive very likely. And we believe that the rents in place are below market in our situation.

Our next question comes from Michael Carroll from RBC Capital Markets.

David, can you talk a little bit about the agreement by the 6 Five Star communities? Do you know what Five Star's plans with that cash is?

Sure. Well, for one thing, in Five Star's case, I think the -- it's -- from their perspective, it's a positive that they can reap some value out of these assets from cash because they're certainly not getting the valuation in their stock price. And then what they're going to -- they virtually have no debt to prepay down. We're going to assume some debt as part of the transaction. But the cash is going to be reinvested into the existing portfolio that they have. As you know, they come to us typically for a lot of the capital and rent goes up by normally about 8% on the amount funded. This would allow them to invest some of their own cash without seeking capital from us on some of it. And then just -- they've done a lot of extensive investing in medical -- electronic medical records and other IT systems, and this allows them to continue to roll out those programs. Rick, I don't know if you have anything you want to add to that.

Yes. No, I think that's right. I think Five Star is going to continue to invest in their profitability initiatives and make sure that they're well positioned. They still own 20 communities after this, along with all the properties that they lease from us and other landlords. From our perspective, it was a good deal, very stable assets, 91% occupied. And because Five Star has managed them before, there's virtually 0 transition for us here. So we're excited about some of the expansion opportunities within this portfolio and looking forward to getting those underway.

Okay. Then how much does it cost for their electronical -- or electronic medical records program? Seems like they've been -- or that you sold your last round of assets to fund that with them. Or is this more going into their property levels?

This is continuing to roll out that program. I believe they're spending several millions of dollars per quarter just putting in all the -- I mean, per year, I'm sorry, in all of the skilled nursing facilities as well as the skilled nursing units within the CCRCs and, again, some of the more traditional IT software. So it's an ongoing project, and I believe they've rolled that out in about more than half the facilities at this point.

Okay. And then just last question. How much capacity do you see you have out there to go out there and acquire more assets? I mean, are you done after the senior housing deal and then the MOB deals? Or are you going to go out there and be more aggressive?

Based on the cap rates we've had, I wouldn't say we've been particularly aggressive. I mean, I think a lot of success has to do with being patient and continuing to evaluate every deal that's out there. And our underwriting team certainly stays busy. But I think we still have plenty of capacity based on what we see in the pipeline right now. With all the balances possibly a little higher than it has been in the past, but with our equity price trading where it is, there's not a lot of appetite for that. We do have some other options. We can look to refinance some long-term debt. We can look to sell assets either into a JV or outright. So I think we've got a number of options, but we also have some time. I mean, the -- taking a good, hard look at the pipeline, we're not particularly concerned about where we are from a liquidity perspective.

Several of the transactions are not likely to close until just about year-end '17 or throughout the first quarter of '18.

That's right.

(Operator Instructions) Your next question comes from Bryan Maher from B. Riley FBR.

You just touched a little bit upon one of my questions, which is your appetite for doing more of the Vertex-type deals. And how many assets in the portfolio are big enough for you to contemplate doing a JV? And not dissimilar to what GOV is doing what kind of upgrading their portfolio with selling off some of their lower-end stuff, would you consider doing that as well?

I think that's all on the table for us to consider. The -- I mean, Vertex was an unusual transaction and, obviously, a $1 billion size transaction. So I don't envision us doing any acquisitions of that size or nature in the foreseeable future. But I do see that we have both the senior living side of the business as well as the medical office and life science side. So I could envision taking some of the senior housing assets and potentially putting them into a JV as opposed to the -- as opposed to life science and medical office. But I think we do have assets. Cedars-Sinai Towers in L.A. would be another example an asset that would yield us several hundreds of millions of dollars of new fresh capital. But I think -- I'd say right now, those are options that we have available to us. I think we try to keep our structure as straightforward and simple as possible. And we do have some flexibility in our balance sheet to do debt issuances or even a small amount of secured debt if we chose to. And with regard to asset sales, I think we do look at selling assets. I think historically, it's been smaller amounts. I could see -- envision maybe $50 million or something like that, but that's another option for us to consider. It's not out of the question.

And then just as kind of a follow-up. What are you seeing in the way of seller motivation? Is it picking up with where we saw cap rates decline to -- for some of the bigger portfolios earlier this year? Or has it been stable? What are you seeing from the seller community?

I think a couple of things. One is that a number of investors made investments in properties and added value several years ago and took advantage of the weaker economy. And now that the properties are leased up, I think they just want to capitalize on selling it. Some transactions want to close by year-end because of concerns about potential tax changes, like maybe the 1031 rules may be revised in certain circumstances. Although at the moment, we seem to be pretty safe. But there's all kinds of -- tax rules are in flux at the moment, and we're finding a few motivated sellers who really want to push for year-end closings. I think that's the main thing. Capital -- I'm sorry, senior living business, I think, right now, people are concerned about lending sources and refinancing risk and things like that. So that's driving some people to sell sooner than they would have preferred to.

(Operator Instructions) And at this time, I'm showing no additional questions. I'd like to turn the conference call back over to management for any closing remarks.

And I'd like to thank you all for joining us on today's call, and I look forward to meeting up with several of you at NARI Conference down in Dallas next week. Have a good day. Bye-bye.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your lines.