Diversified Healthcare Trust (DHC) 2018 Q2 法說會逐字稿

Good morning, and welcome to the Senior Housing Properties Trust Second Quarter 2018 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 second quarter 2018 results. Joining me on today's call are Jennifer Francis, 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 without the prior written consent of SNH are strictly prohibited.

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 SNH's present beliefs and expectations as of today, Tuesday, August 7, 2018. SNH 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. Reconciliations of net income attributable to common shareholders to these non-GAAP figures and components to calculate AFFO, CAD or FAD are available on our supplemental operating and financial data package found on SNH's 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 Jennifer.

Thank you, Brad, and good morning, everyone. Thank you for joining us on SNH's second quarter 2018 earnings call. In this quarter, Senior Housing Properties Trust delivered stable property-level operating results, growing year-over-year same property cash NOI by $1.3 million or just under 1% combined with cash NOI growth from quality acquisitions adding an additional $4.1 million.

We continue to experience headwinds in our senior living portfolio from the increased competition in the industry, but will remain focused on recycling capital from dispositions into life science and medical office property acquisitions to help offset the impact these challenges have on our results.

In the second quarter, life science and medical office properties for our MOB segment represented approximately 42% of our consolidated cash NOI, and we hope to continue to grow both property types as a percentage of our entire portfolio.

Our MOB segment same property cash NOI increased 1.8% in the second quarter compared to last year. And total occupancy at the end of the quarter was 95.7%, which was up 30 basis points sequentially. During the quarter, we executed 106,000 square feet of new leases and 88,000 square feet of renewal leases. These renewals averaged a 3.5% roll-off in rent and a weighted average lease term of 6.2 years.

Speaking into the performance of our MOB segment. Same property cash NOI in our life science properties increased 1.2%, and our traditional medical office properties increased 2.5%. Our traditional medical office portfolio's performance in the second quarter was driven by leasing and rent growth throughout the entire portfolio.

We did see noticeable growth in a few of our stronger markets where we have concentration of buildings such as Austin and Phoenix. Our triple net leased senior living portfolio continues to produce consistent growth with same-store cash NOI increasing 1.9% in the quarter compared to the second quarter last year. This portfolio had rent coverage of 1.18x for the 12 months ended March 31, 2018, which was down from the 1.20x reported in the prior quarter. This decrease in coverage was expected, given the continued headwinds caused by new supply and wage pressure caused by a strong economy. Our reported coverage also reflects the impact of a tough flu season discussed last quarter.

Our managed senior living portfolio same property cash NOI decreased 4.6% in the quarter compared to the second quarter last year. Occupancy increased 10 basis points on a same property basis and residents fees and services remained flat.

Looking deeper into the revenue detail. Independent living revenues increased 5% and assisted living revenues increased 1.1%. Conversely, skilled nursing revenues from the health care units within our CCRCs decreased enough to offset these increases, causing revenues to be flat year-over-year.

Property operating expenses in the managed senior living portfolio increased 1.3% on a same property basis, the majority of which was related to increased wages and benefits along with higher unit turnover costs spread across nearly the entire portfolio associated with the new move-ins that are driving the increases in our IL and AL revenues.

We're pleased by the improved performance at several of our managed senior living properties where we have invested capital over the past 12 to 18 months. Most notably, one of our largest CCRCs, the Premier Residences of Yonkers in New York, achieved close to 30% cash NOI growth in consecutive quarters.

Turning to our investment activity in the second quarter. As previously reported in November 2017, we entered into a purchase agreement with Five Star to acquire senior living communities from them. During the second quarter, we completed this transaction, acquiring the 2 remaining properties for a gross purchase price of $23.3 million, including the assumption of $16.6 million of debt. In May, we sold the last of the 4 senior living communities as part of a deal with Sunrise Senior Living announced in January.

In June, we sold 2 senior living communities in individual transactions. The first was an assisted living community sold for $15.4 million that was leased to a private operator who exercised their purchase option. The second was a skilled nursing facility sold for $6.5 million that was leased to Five Star. These property sales resulted in a gain of $80.8 million.

I'd now like to turn the call over to Rick to provide further discussion of our financial results for the quarter.

Thank you, Jennifer, and good morning, everyone. I'm going to touch on some of the second quarter financial highlights beyond what Jennifer just covered.

Starting with our balance sheet. We ended the second quarter with $30.7 million of cash and $108.7 million of restricted cash on hand. $94.3 million of that restricted cash represents the majority of the proceeds from the sale of our fourth Sunrise Senior Living community. These proceeds are being held for SNH's benefit and are available to fund acquisitions as part of a like-kind exchange, but are considered restricted for accounting purposes.

We had $64 million outstanding on our $1 billion unsecured revolving credit facility, leaving us with $936 million of drawing capacity at quarter-end. Our reported debt-to-adjusted EBITDA was 5.9x, and debt-to-gross assets was 41.2%. Adjusting for the restricted cash related to the Sunrise sale, debt-to-adjusted EBITDA was 5.7x and debt-to-gross assets was down to 40.6%. Between our cash and borrowing capacity on the revolver, we continue to believe we have ample liquidity and are very well positioned for growth.

In the second quarter, we spent $18.5 million on capital expenditures, of which $8.8 million is considered recurring and includes building improvements, leasing costs and tenant improvements at our MOBs and managed senior living communities. The remaining portion of our capital expenditures, $9.7 million, was invested in development and redevelopment capital projects, the majority of which was spent in our managed senior living portfolio.

I mentioned last quarter that we expected expansions and renovations to ramp up throughout the remainder of the year and that we could spend $50 million on development at our managed senior living communities and MOBs in 2018. This quarter's development expenditures were largely in line with that expectation, and we are pleased with the progress made on some of these projects despite the challenges associated with a tight construction market.

In addition, we funded $10.1 million of projects within our triple net leased senior living portfolio, which has increased the annual rents due from our tenants by approximately $800,000, a 7.8% return on our investment.

Subsequent to quarter-end, we declared a $0.39 per share dividend for the second quarter of 2018, and with a yield over 8%, we still think SNH provides a compelling investment opportunity.

Lastly, I want to provide a little more color on a few lines of our income statement that Jennifer didn't already cover that resulted in normalized FFO attributable to common shareholders of $104.8 million or $0.44 per share for the second quarter, a slight increase from the $103.6 million of normalized FFO attributable to common shareholders reported last year.

General and administrative expenses for the second quarter included $17.6 million of estimated business management incentive fees. The incentive fee accrued in the second quarter is based on SNH's total return in comparison to the SNL U.S. REIT Healthcare Index from the beginning of 2016 through the end of the second quarter 2018. SNH has outperformed the index by 38.3% over this period with a total return of 47.1% compared to the index of 8.8%.

The incentive fee is capped at 1.5% of our equity market capitalization, which equates to an estimated annualized incentive fee for 2018 of $63.9 million as calculated at the end of the second quarter. This incentive fee accrual may increase or decrease over the remainder of the year depending on how SNH performs relative to the index.

Excluding the estimated business management incentive fee, general and administrative expenses decreased 5.7% this quarter compared to the second quarter of last year. The decrease is a result of lower business management fees paid to RMR, which were based on market capitalization rather than historical cost of our real estate, saving SNH $1.1 million during the quarter.

Interest expense was up 9.8% to $44.8 million this quarter compared to the second quarter of 2017. The net increase of $4 million was a result of the following: the $500 million of 4.75% senior unsecured notes issued in mid-February and increased rates on our floating rate debt, partially offset by savings from our prepayments of mortgages in 2017 and 2018 with a weighted average interest rate of 6.6% and lower weighted borrowings on our revolver.

That concludes our prepared remarks. Operator, please open up the line for questions.

(Operator Instructions) The first question comes from Drew Babin of Robert W. Baird.

A question on the smaller dispositions of the SNF asset and the assisted living asset in the second quarter. Although they're small, I was hoping you could provide the yields on those just for comparability purposes.

So on the assets that had a purchase option, just to note that that's the only purchase option that we have in any of our leases. It was an 8.6% cap. On the other 2 we talked about -- we've talked about Sunrise, so people know that was a 4% cap. On the skilled nursing facility, it was a 5.9% cap. But I think the important number to think about is that Five Star gets a rent reduction by 10% of the proceeds on that.

Okay. And I guess, a related question. Looking at your triple net SNF portfolio, there's been some private activity or private bid in that space recently. And I was just curious it -- would a disposition or a JV of that portfolio be something that's worth looking at? And I guess, is your pipeline of reinvestment opportunities robust enough right now to justify something like that?

Yes, I think that our reinvestment opportunity pipeline is certainly robust to consider something like that. As part of the asset management plan that I talked about last quarter, we're looking at all of our assets. We are looking very closely at the skilled nursing facilities within our managed portfolio, doing a highest and best use study across the portfolio to better understand if there is another better use for those. So we are looking pretty closely at the skilled nursing assets and units.

Okay. And then one last question for Rick on the balance sheet. The unsecured term loan on the floating rate obviously picked up a little bit from the first quarter to the second quarter. And I guess, would there be -- are there any options for fixing that being evaluated? Or you're kind of comfortable with your overall floating rate debt exposure and willing to let that fluctuate on its own?

I think we're pretty comfortable right now where we are. We'll have the 10-Q published later today. And I think the interest rate sensitivity, a full percentage point is only $0.02 a share, and I don't see the rates increasing a full percentage point anytime soon. But again, we are opportunistic. We'll continue to talk with our banking partners and see what's out there. I know there was a couple of other deals in the market recently. So it is something that we look at. We also don't have a lot of secured debt. Some of those rates are pretty attractive.

So again, we've got a lot of flexibility, I think, but we do have just a ton of capacity on our revolving credit facility right now. And again, the team is actively looking to redeploy some of the capital we've recycled. So we'll look at it for -- to fix it out for long-term options, but again, very comfortable with where we are today.

The next question is from Bryan Maher of B. Riley FBR.

You talked briefly in last question regarding your pipeline. Can you give us a sense of kind of how deep that is? And I'm assuming it's predominantly MOB and life science. And then secondarily, how quickly do you think you act on that?

Sure. Our pipeline is -- we don't have a lot in the pipeline right now. Our acquisitions group is an incredibly active group. They look at everything that hits the market on the MOB life science side and senior living. We are focusing on life science and MOB, and we're looking at everything. We don't have anything under agreement right now, but we are pursuing a couple of opportunities. And we'll keep looking hard. We definitely want to deploy capital. So...

And who are you seeing out there as the MOB sellers? And what does the supply pipeline look like, what you're seeing, for new builds?

Well, we definitely -- there are developers that are out in the market selling. There are physicians' practices that are selling MOBs. What was the second part of your question?

I just want to know what the supply pipeline was like maybe as a percentage of existing assets as far as what you guys are seeing.

I don't -- I'm not sure that I have a percentage of existing assets. I don't have that answer. There's -- it's not -- there's not a huge number of assets that are hitting the market. We sit down weekly and go through all of the properties that are being considered, and there's -- we probably talk about 6 or 7 a week that we're writing or thinking about writing up. A few of those will follow [lag], just because they don't make sense for us, the buildings are too old or they are on-campus as opposed to where -- our preference is off-campus or farther away from the hospitals.

And then lastly on the senior living side, who are the buyers out there in the marketplace now? It seems like there is a decent amount of talk amongst owners of selling or thinking about selling? But who is on the other side of that table?

I think it's private equity that tend to be the buyers right now.

Yes. I think we've seen most of the REITs have been pretty disciplined and been on the sidelines, while the senior housing space faces the headwinds that it's faced. I know that's what we go through internally when we talk about MOB versus senior housing.

I guess, one -- that leads to kind of one more from me. When we talk to our hotel companies that we cover, it seems like supply is kind of peaking here around 2% or low 2% level. When you look at the senior living supply growth that's coming to the market and that's coming into the market, do you get the sense that it's peaking? Or do you think there's still more to come for a couple years?

It's hard to imagine. I mean, the NYXData, they talk about the annual inventory growth is still outpacing absorption. Construction starts, I think, are down. They've been down this quarter and last. But I don't know if that's enough to be a trend. I'd love to -- I hope that it's slowing down. But again, I think we need another quarter or 2 of data to really determine whether those 2 quarters are a trend.

The next question is from Michael Carroll of RBC Capital Markets.

This is Jason here with Mike. We were wondering what SNH's outlook is on the Five Star coverage ratios. And what potentially your team could be doing? And what the operators could do to drive those metrics higher?

Well, I've talked a lot when I've been -- we've been out and about about our asset management team and really taking a look at all of our assets that are leased and managed to better understand what we can do. I spent a minute earlier on the call talking about doing highest and best use studies within our managed portfolio, looking at the skilled nursing and understanding if those were the best uses for those, that space. I think deploying capital to redevelop assets that are facing fierce competition in the markets, and there's lots of competition in the market. And that's both senior living and MOB life sciences, but we're deploying a good amount of capital into the portfolio to keep pace or to compete head-on with the competition. And I think we're going to continue to do that.

Great. So is it fair to say that the recent SNF sales should help improve coverage?

Absolutely. I mean, Jennifer just mentioned that the sale of that one SNF within Five Star's portfolio was done at around 5.9%. But again, because of the contract and the terms in place, they wind up with a 10% of proceeds rent reduction. So that lowers the rent a little bit. We'll need to go and redeploy the proceeds, but it certainly helps them a small amount from a coverage perspective. And again, they can be opportunistic and look at other assets in the portfolio to do something similar. We would encourage them to do that. I think these questions are a lot easier to answer when their coverage is higher. But again, they are laser-focused right now on just stabilizing the senior housing operations or senior living operations. And again, they do a great job caring for people, and we're just looking for them to clean up the bottom of the portfolio a little bit, and it should lift all boats.

They're also spending a lot of time focusing on their employees and making sure -- bringing employees up within the organization. Obviously, unemployment is at 3.9. It's hard to keep -- to get and keep employees, but they are doing a lot to bring people up and to fill those [ED] positions. And I think just growing their business and strengthening their core business, because again, they're a great operator. But just making sure that they're plugging the holes that might be coming to keep the business strong.

The next question is from Juan Sanabria of Bank of America Merrill Lynch.

This is Kevin on for Juan. I was hoping you could give us an update on, I guess, the variety of MOB, senior housing kind of renovation CapEx projects you guys have on -- going on right now as well as just kind of an update on just the general progress in that area.

Sure. On the MOB side, we've got some building repositionings. We've got a building in MOB down in Washington, D.C., that we're doing a complete reposition of. Interestingly enough, I was looking at the stats and saw that this quarter, they did a 10,000 square-foot lease or close to 10,000 square-foot lease there. And we're able to push rents 20%. And so that's really just with the story of the improvement, and they've started on the work.

But so repositioning of MOBs, we've got a building down in suburban Pennsylvania that we're working on repositioning. And then in -- on the managed -- the TRS portfolio, we've got about 7 projects that are underway. And there are a range of projects. They range from about $1.5 million to about $25 million. So it's a wide range. Again, looking at a -- we're looking at these and our operator is looking at the portfolio and trying to figure or come up with plans on how to grow independent assisted living units or reposition the assets to keep up with competition.

And I think on the lease side, I think Five Star has always got about 12 or so properties or projects that they've got underway at any one time. And again, they're -- it's mostly repositioning assets, either a heavy reposition or a freshen to keep up with competition.

Okay. And then, I guess, this is still on Brookdale's coverage. That was -- is that from the addition of, I guess, more CapEx expansion funding? Or is that from, I guess, the supply environment affecting operations more so?

We did fund CapEx. So that does erode the coverage. We are still pretty comfortable with their coverage at over 2x.

The next question is from Todd Stender of Wells Fargo.

Rick, I think you said you'll deploy about $50 million of capital improvements this year. Did I get that number right?

Yes. Between the managed senior living communities and the MOBs, that's about where we expect to be for the year.

What's the breakout for each of those 2 buckets? And do you have different return expectations for each one?

Interestingly, the breakout seems to change somewhat regularly. I think last quarter, we were probably in the $10 million on the MOB side and $40 million on the managed side. That shifted a little bit. Again, I mentioned in the prepared remarks that it is a fairly tight construction market, getting the right number of bids and everything else. I mean, we've got relationships around the country to get the work done. But in order to go through the process the way we want to go through and have enough competitive bids, some of the projects is bogged down a little bit and others have accelerated. Where we have capacity, we're moving forward.

So I think the MOB numbers come up a little bit, where we've been able to accelerate some of that. And I think some of the managed slowed down a bit. So we're still net-net about the same number, but it's probably $15 million to $20 million on the MOB side and a little bit less on the senior living side. I'm sorry, what was your second question?

Return expectations, is that about what a cap rate would be or a little -- you need a little more juice in your return for those?

Interestingly, there's usually a little bit more juice. We're usually high single digit or double digit, frankly. And again, that's why we've been so aggressive about investing in CapEx, because the return is better than what you see out there in the acquisition market with some of the compressed cap rates.

Okay, great. And then just shifting to life science just on the acquisition criteria, we've seen you guys acquire in Q1 cap rates of, I believe, there were 2 acquisitions, 8.5% cap and then a mid-9%. Is the stuff you're looking at about that range? And then is this all single tenant, in general, that you'll be acquiring?

It's not that. We've been -- what we've been looking at on the life sciences side is below that. I'd say we're seeing cap rates kind of a little above or a little below a 6% to really get into the markets. We've been looking at buildings this quarter that are in the markets that are heavily concentrated in the life sciences. And so the cap rates are going to be a bit compressed in those markets.

Would that be in the Cambridge or even out West South Francisco kind of areas?

Well, Cambridge is tough. There's not a huge amount that's trading in Cambridge, and it would be hard for us to get a 6% cap in Cambridge. But in the markets around Cambridge, there are some -- there are properties trading. And then yes, down in Southern California, we're looking at assets down there as well.

The next question is from Vikram Malhotra of Morgan Stanley.

So you referred in your remarks and maybe in the press release about growing certain segments while paring down exposure. And just sort of -- you took sort of a 2- to 3-year view. Can you give us a sense of how you think it shapes up for the company?

Well, we're very opportunistic in our acquisitions. And so we have been saying and continue to say that we're going to focus on life science and medical office properties. And so I can see that, that percentage of our portfolio would grow considerably. It's hard to know what exactly is going to hit the market and what we'll be successful in acquiring. So again, we are looking at senior living communities when they hit the market, but we're just much more focused on life science and MOBs. So it's hard to say what percentage we're going to be at even at the end of the year, never mind 2 or 3 years.

Okay, fair enough. And then just thinking about the senior housing space, and of course, there is a question on coverages. Can you maybe update us or remind us, as you look at the portfolio on an EBITDAR basis, where are we -- kind of what percent of the portfolio is below 1x?

There's not a lot in the portfolio that's below 1x. We're currently working with one small private operator. We also transitioned another property from a private operator into the TRS this past quarter in the managed portfolio. We -- generally, our leases are positive. A lot of our leases are master lease and lumped together. So just as a function of that, there may be some individual properties that the operator should look to move on, but for the most part, the leases are positive.

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

Thank you for joining us on our second quarter earnings call. I look forward to seeing many of you at our upcoming investor conferences. Have a nice day.

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