National Health Investors Inc (NHI) 2016 Q1 法說會逐字稿

Welcome to the National Health Investors first-quarter 2016 conference call.

(Operator Instructions)

A quick reminder, today's conference is being recorded, Friday, May 6, 2016. It is now my pleasure to turn the conference over to Colleen Sullivan. Please go ahead.

Hello, everyone. Welcome to the National Health Investors conference call to review the Company's results for the first quarter of 2016. On the call with me today is Eric Mendelsohn, President and CEO; Roger Hopkins, Chief Accounting Officer; John Spaid, Executive Vice President of Finance; and Kevin Pascoe, Executive Vice President of Investments.

The results as well as notice of the accessibility of this conference call on a listen-only basis over the Internet were released this morning before market opened and the press release that's been covered in the financial media. As we start, let me remind you that any statements in this conference call, which are not historical facts, are forward-looking statements.

NHI cautions investors that any forward-looking statements may involve risks or uncertainties and are not guarantees of future performance. All forward-looking statements represent NHI's judgment as of the date of this conference call.

Investors are carefully urged to carefully review disclosures made by NHI in its periodic reports filed with the Securities and Exchange Commission, including the risk factors and other information disclosed in NHI's Form 10-Q for the quarter ended March 31, 2016. Copies of these filings are available on the SEC's website at www.sec.gov or on NHI's website at www.nhireit.com.

In addition, certain terms used in this call are non-GAAP financial measures, reconciliations of which are provided in the Company's earnings release and the Company's tables and schedules, which have been filed on Form 8-K with the SEC. Listeners are encouraged to review those reconciliations provided in the earnings release, together with all other information provided in that release. I will now turn the call over to Eric Mendelsohn.

Thank you, Colleen. Hello, everyone, and thank you for joining us. I'm excited to say that NHI is off to a stellar start in 2016. We have quite a bit to talk about today with over $142 million of investments year to date. These investments speak to NHI's ability to grow and create value for shareholders.

A big part of that is forming partnerships with high quality operators who are committed to providing exceptional care. We are very proud of our operating partners and I am excited to say that we formed a new relationship with the Ensign Group.

The Ensign Group has over 16 years of skilled nursing and senior living operating experience. They currently operate over 200 healthcare facilities along with other healthcare lines, such as home healthcare agencies and urgent care clinics across 14 states.

Their balance sheet and operating metrics are solid, last quarter reporting over $1.3 billion in annual revenues with great corporate credit. We are excited to have them as a partner and look forward to working with them.

We also recently closed a mezzanine construction loan with the purchase option with Senior Living Communities, which Kevin will tell you about shortly. Before we get into the details of our recent transactions, I will turn the call over to Roger to discuss the quarterly financials. Roger?

Thanks, Eric. Hello, everyone. For the first quarter of 2016, normalized AFFO was $1.16 per diluted share while normalized AFFO was $1.04 per diluted share, which represents a 2.7% and a 5.1% increase, respectively, over the first quarter of 2015. Normalized FAD for the first quarter increased $1.07 per diluted share, which is a 3.9% increase over the first quarter of 2015.

These results reflect the timing and volume of investments made in 2015 and 2016, particularly our construction loans and new development activity which are being funded monthly throughout 2016 and into 2017. We announced our purchase of $118.5 million in skilled nursing facilities and a new 15-year lease with the Ensign Group after March 31.

Our revenues for the first quarter increased 5.9% over the same period in 2015. Our interest expense increased to $10.3 million in the first quarter, due mainly to our terming out of $100 million of borrowings on our revolving credit facility to higher fixed rate private placement debt in November 2015.

Our general and administrative expenses for the quarter were $2.9 million, or 4.9% of our revenue and declined approximately $900,000 compared to the first quarter of 2015, due mainly to lower non-cash compensation expense related to stock options granted to all employees and directors.

Due to the immediate vesting of the portion of stock options granted during the first quarter of 2016, our non-cash compensation expense was $980,000 during the first quarter, whereas it is expected to be approximately $250,000 in each of the next three quarters.

We currently expect our general and administrative expenses to be in the range of $2 million to $2.5 million per quarter for the remainder of 2016. In March, we completed the previously announced sale of one skilled nursing facility to our tenant in Idaho for proceeds of $3 million, and a gain of $1.6 million. This gain is offset for tax purposes by our current dividend return of capital.

Moving on to our construction loan and development activity. We continue to fund our mortgage and construction loans for Timber Ridge, a premiere entrance-fee community in Issaquah, Washington. We have funded $98.9 million thus far and estimate we will fully fund our $154.5 million commitment by the end of this year.

As we have previously disclosed, we estimate that we will receive repayment on our construction loan in 2017, leaving a mortgage loan balance of $60 million, for which we have scheduled a 10-year maturity. In our $55 million development program with Bickford to construct five new assisted living and memory care facilities, we have funded $25 million as of March 31, with approximately $20 million to $25 million to be funded by the end of 2016 with the remainder in 2017.

In the first quarter, we reported a 5.9% increase in our quarterly dividend to $0.90 per share, or $3.60 on an annual basis. We currently estimate our dividends for 2016 will result in a normalized FFO payout ratio in the low 70% range and a normalized AFFO payout ratio in the high 70% range.

Moving on to guidance for 2016. At this point, we have no change to our guidance ranges given in February. Our expectations for our investment pipeline remain on track and the financing arrangements by which to fund them. We do not include an estimate of investment volume in our guidance range.

We estimate normalized FFO in the range of $4.82 to $4.88 per share, and normalized AFFO in the range of $4.29 to $4.33 per share. Our Board of Directors has consistently incentivized management and employees to achieve increasing normalized AFFO per share and the regular dividend per share by competitive benchmarks in relation to our peers. We have been able to meet and exceed these benchmarks for each of the past five years and have exceeded the average of those metrics for our peer group of diversified healthcare rates during that period.

Our normalized results for 2016 include expected non-cash charges to net income of approximately $14.5 million, or $0.37 per share, in the second quarter related to our transition of the master lease of 15 skilled nursing facilities from Legend Healthcare to the Ensign Group. For accounting purposes, we are required to write-off accumulated straight-line rent receivables and intangible assets related to the termination of the purchase option previously held by Legend.

There is no purchase option in the current lease with the Ensign Group. I will now turn the call over to John, who will discuss the capital plan and balance sheet metrics.

Thank you, Roger. The execution of our 2016 capital plan continues on track and in line with our expectations. Or balance sheet metrics for the quarter ending March 31, 2016, were: net debt to annualized EBITDA at a conservative 4.1 times; weighted average debt maturity at seven years; a weighted average cost of debt at 3.73% ; and our fixed charge coverage ratio at 5.7 times. Turning to our revolver, as of March 31, we had $56 million outstanding with an available capacity of $494 million.

Moving on to the ATM. We did not make use of the ATM during the first quarter. During the fourth quarter of 2015, we monetized certain securities held for investment and converted our LTC preferred stock to 2 million shares of LTC common stock. We then sold one million of the common at an average price of $42.16 per share.

As of March 31, 2016, we continued to own 1,293,000 shares of LTC common stock. Interest rates continued to supply -- support a favorable equity and debt market for us, with a yield on the 10-year US Treasury declining through the first quarter.

As we move forward with our 2016 capital plan, we intend to fund our future pipeline investments using cash from operations, proceeds from the revolver, proceeds from further LTC stock sales, proceeds from privately placed unsecured debt, and proceeds from additional ATM issuances. The timing of mix between these sources will be based upon the timing of our needs and future market conditions. With that, I will now turn the call over to Kevin Pascoe, who will cover our portfolio details and new investments.

Thank you, John. As Eric mentioned earlier, we are very proud of our operating partners. They demonstrate a passion for caring for others as well as the drive to be the best provider in their respective markets. This translates into quality outcomes for their customers and ultimately, financial success.

This is demonstrated in the credit quality of our tenants and the portfolio coverage ratios. With respect to our overall portfolio, the EBITDARM coverage ratio is 1.96 times. Our skilled nursing coverage is a robust 3.05 times and our senior housing portfolio is steady at 1.25 times.

National HealthCare Corporation, which accounts for 19% of our cash revenue, continues to be a strong performer with corporate cash coverage of 3.87 times. As a reminder, NHC accounts for half of our skilled nursing revenue and enjoy some of the strongest credit metrics in the public healthcare sector.

Holiday retirement represents 16% of our cash revenue. As a result of recent management changes, we have met with the new management team at Holiday and continue to monitor the portfolio closely. The occupancy on the portfolio remain consistent at 90.9% for the quarter.

The EBITDARM coverage ratio was 1.21 times at quarter-end and portfolio metrics have been steady so far into 2016. Our relationship with Senior Living Communities accounts for 16% of our cash revenue.

The SLC portfolio has an EBITDARM coverage of 1.19 times on a trailing 12-month basis as of quarter end. SLC increased occupancy each quarter during 2015 and occupancy is held up in 2016.

Typically, second to third quarter each year is the best sales months and initial indicators are positive so far this year. The Bickford joint venture accounts for 13% of our cash revenue and the same-store portfolio EBITDARM which now includes two additional properties moved over from Focus Properties is up 7.9% sequentially and up 3.9% from the same quarter in 2015.

We are pleased with the improvement this quarter but are still very mindful of competitive wage and benefit pressures facing the industry. Occupancies continue to improve; revenue per unit is strong; and four of the five development projects are underway, with three expected to open by the third quarter, and the remaining site is planned to break ground soon.

Moving on to new investments. In March, we entered into a $14 million construction mezzanine loan agreement with Senior Living Communities for the development of a senior housing community in Daniel Island, South Carolina, near Charleston. The loan has an annual interest rate of 10% and maturity of five years.

The loan will be funded monthly and is expected be fully funded by the end of 2016. Construction on the community has begun and is expected to be completed by the end of 2017. Wellmore Daniel Island will have 186 units consisting of 90 assisted living units, 48 memory care units, and 48 skilled nursing units. NHI will have a purchase option on the property once the operation has stabilized.

Turning to the recent Ensign transaction. In April, we purchased eight skilled nursing facilities in Texas for $118.5 million. The facilities have a total of 931 beds and were operated by Legend Healthcare. Legend sold all of their current operations to Ensign and NHI has agreed to enter into a new 15-year master lease.

The lease includes a total of 15 former Legend facilities. It has an initial annual lease payment of $17.75 million plus an annual lease escalator based on inflation. The lease has two five-year renewal options and also includes a corporate guaranty from Ensign. Upon entering into the new lease, the purchase options held by Legend were terminated and NHI sold two of its existing facilities to Ensign.

These two Texas facilities, totaling 245 beds, were sold for $24.6 million; the net acquisitions and dispositions bring NHI's investment in the 15 facilities to approximately $211 million. In addition, and as a part of the transaction, NHI has committed to purchase four skilled nursing facilities in Texas from Legend for $56 million and lease them to Ensign. The facilities are in various stages of development and the purchase window for the first facility will open in early 2017.

Turning to our pipeline, our pipeline remains very active with a healthy level of senior housing and skilled nursing opportunities under review and we continue to receive off-market opportunities from our existing client base. With that, I will hand the call back over to Eric.

Thank you, Kevin. NHI is off to a strong start as we head into the second quarter of 2016. I'm very excited about the Company's growth profile as we continue to partner with high-quality operators and execute on our strategy for growth, combined with low leverage.

With that, we will now open the line for questions.

(Operator Instructions)

Juan Sanabria, Merrill Lynch.

Just a quick question on the Ensign transaction. If you look at the incremental amount of capital committed, the implied yield is a bit lower than you would have expected sub-7%. How should we think about that?

Does that imply that the rent coverage may be on existing portfolio that was in place with Fundamental had a weak coverage that the rest is to be adjusted somehow or you were just willing to pay higher price, or lower yield for the net incremental investments?

Juan, this is Eric. The way - and it was Legend as opposed to Fundamental; the way we thought about that deal was you had a higher yielding existing rent stream and the new buildings that were coming in were at a market and competitive rent rate to account for Ensign's better credit, public company status, and national footprint.

So when you blend the two together, that's how we look at it. You also have to remember that we eliminated a purchase option with Legend, which was essentially an overhang on that revenue stream. So all of those factors together went into the 8.4% rent rate.

Can you comment on the coverage on the portfolio with Fundamental prior to the transaction and how you valued that purchase option in the transaction?

Well, we don't comment on specific-operator level coverage with Legend. The purchase option value was based on, if I recall correctly, I'm looking at Kevin here, the purchase option was at fair market value purchase option so it would have been the difference between fair market value and our basis in the property.

There was a split in the option as it was originally contemplated. So we were sharing in 50% of the difference between our basis and fair market value. So they were getting a very good deal on that purchase option and then clearly, an income stream would be going away.

Okay. And Kevin, I think you touched on this on the wage deal, but the expenses seem to jump pretty significantly. Is there any sort of timing issue or is that just really wage pressure coming through? And how should we think about that going forward or maybe if it was impacted by some of the new properties or the Focus Properties going into the overall same-store pool?

The expenses would have jumped because the same -- the Focus Properties coming over, there is still an element of wage pressure which we've talked about over the last couple of quarters. I think if you look at a sequential quarter, the expenses actually ticked down which was good. A lot of that had to relate to some of -- benefits and some of the other -- some one-time type adjustments that were in last quarter.

So it's still something that we were focused on. But as I mentioned on the call, we are pleased to see the sequential quarter improvement but still very mindful of some of the elements that they're facing which have not -- I would not characterize them as subsiding yet.

Just one last follow-up from me. Just on skilled nursing, we've had some public commentary by Kindred and HealthSouth about volume pressures and maybe some of that going from skilled nursing to home health. With your new discussions with Ensign, given that they do have a home health business, what are they seeing and what are your general thoughts on that?

It is something that we are thinking about as well. I can't speak for Ensign specifically in terms of where they are with that. But we are seeing volumes go down, or at least length of stay go down on the Medicare side but they are able to supplement it with home health.

And they're looking at various business lines to make sure that they are being able to track the patient and deliver the quality outcomes for that patient and not have the recidivism or some of the other issues that would cause problems for them. It is definitely something that would -- they were focused on.

I would add to that, Juan. With larger operators like Ensign and with NHC, once you're in their ecosystem, whether you were treated in the building or with their home health or pharmacy or hospice, you still remain in the ecosystem. So whatever revenue stream is leaving the building could still get picked up by an Ensign or a NHC entity after you are outside of the building.

Thank you.

Jordan Sadler, KeyBanc Capital Markets.

I wanted to just follow-up on the acquisition pipeline. What you are seeing out there in terms of activity and in terms of pricing?

This is Kevin. I would say pricing is still consistent. We are still seeing a fair amount of activity in the market for both senior housing and skilled nursing. But yields are -- it kind of depends on which markets you are looking at. If you are larger MSAs, your primary markets, I would say the yields are still kind of near -- they're kind of all-time lows, if you will.

But in some of the secondary markets, there is a little bit of relief which is a lot -- of where a lot of our communities are, so we feel like there's some decent purchasing opportunities out there for us and it's something we continue to work and evaluate our pipeline with. Very -- opportunities in both skilled and senior housing but in all markets; we are not drawing any bright lines in terms of what markets we're looking at, right at this point.

Okay, and then what is your appetite on the senior housing side? Obviously, you have made some new investments here but I'm just curious what the level of appetite is, given where we are in the cycle? And Eric, you can refresh us on what your view of where we are in the cycle is for senior housing.

Well, I think this cycle is getting long in the tooth and we are still looking for senior housing. That's our favorite product but I would point out that the majority of the transactions that we are pursuing are from our existing stable of operators and we very rarely win in an auction scenario. That is not our favorite way to grow.

Those aren't the kind of deals that we usually end up succeeding with. So when you see a senior housing transaction, it is going to be with an existing operator that's uncovered an opportunity in their market that makes sense for us. We still continue to keep dry powder. You will notice our leverage is a low 4.1 percentage of EBITDA and that gives us the opportunity to stretch if we find a good value.

With 35% of your portfolio in discretionary senior housing, how -- are you looking to be opportunistic from an asset management perspective, given Kevin's comments regarding pricing being near record highs, cap rates at record lows, and your commentary of the cycle being long in the tooth?

We are opportunistic. I mean there are still values out there that we're finding. If you have a good operator you can sometimes pick up a building that has substantial upside. The difference being as a REIT, we don't want to buy on forward pro forma earnings. We want to buy on in-place trailing earnings and sometimes that disqualifies us right out of the gate. We're just not willing to budge on that disciplined approach to underwriting.

But I guess on the other side of things, on the disposition side, you're not looking to mitigate downside, per se, in terms of cash flows or properties that are -- seem more susceptible to or at higher risk to seeing some downside here cyclically?

So are you -- I'm not sure I understand (multiple speakers)

Did you sell anything?

That's where -- okay. That's the punch line. We actually did sell one building this quarter that was an older SNIP building. We sold it to the tenant.

And then we had sold also (multiple speakers) --

I am thinking senior housing. Would you sell a senior housing asset today?

I would. I would if it were one that we thought was past its prime and was taking too much attention from the operator. When I was at Emeritus, there was a constant churn between bringing in new buildings and selling older buildings that were either CapEx hogs or in markets that had drifted. Sometimes the right side of town changes over the years and you could have a building that is 15 or 20 years old that ends up being on the wrong side of town.

And there's always a market for those buildings. So that is a constant conversation we have with our operators. As a REIT, we are reluctant to sell buildings, but sometimes it makes sense.

Okay. I am not sure I 100% follow that last line of thinking that you're a REIT so you're reluctant to sell buildings but, I will continue. The other question is just regarding the Holiday coverage that you reported in the quarter. I think, Kevin, 1.21 times EBITDARM?

That's correct.

Is that what you said? Do you have that on a EBITDAR basis and what would that coverage look like after CapEx and maybe just how that is trending?

We don't talk about or we don't give EBITDAR coverages on our customers. But generally, I would say that it translates to 0.1 to 0.2 on a coverage when you flow-through management fees and some element of CapEx to the properties. And it has been -- in terms of how it is trending, it has been essentially flat over the last couple of quarters.

Okay. And are you concerned that property cash flows will go down at all or cyclically? Or are you kind of comfortable that it will be maintained or grow from here the next 12 to 24 months?

Well, Jordan, as you probably know, Holiday had some turnover in their C-suite. We have flown out and met with management face-to-face and listened to their updated business plan and projections so for the time being, we are willing to give them the benefit of the doubt and they seem very focused on improving the performance of the portfolio so, too soon to tell.

And for Jordan, for what it's worth, as I mentioned in my comments, so far in 2016 their metrics have been consistent. Like Eric said, too soon to tell but it's -- there is no trend developing, at least not to the negative.

Chad Vanacore, Stifel.

I am looking at shop portfolio and looked like it had a nice rebound from the fourth quarter. Can you add some color into how that portfolio increased its occupancy so much? (multiple speakers)

A portion of that is the moving over of the Focus Properties; that does include one construction facility so there would be some lease up within the number. But then they just -- they have had steady occupancy over the last quarter and so it's -- a part of that is moving the buildings over and part of it is just additional volume in the buildings.

Okay, but even your Focus Property looked like it had improved; is that right? (multiple speakers)

Yes, well, so that's the -- now that's one building, whereas it was three. So, again, it is taking out the construction from there. The one that is left is a fairly stabilized building; it's just new to the portfolio which is why it is in Focus so once it becomes stabilized and is in the portfolio for five quarters then we will move it over.

All right. Thanks, Kevin. And just staying with the same-store shop, revenue per unit increased 3.3% year over year but was flat sequentially. Why didn't we see any sequential rate growth and then is there any discounting involved there to gain occupancy?

No. There is not discounting and that is a philosophical belief for Bickford. What they are seeing within the portfolio is they take care of a higher acuity resident typically so what -- and they have had a -- some more turnover over the last couple of quarters. So they're moving in healthier residents and more acute or frail residents have moved out. That's why it's kind of -- looks like it is stagnating is because you have a lower acuity resident moving in so there is less charges associated with that.

Okay. So it's a more ancillary service related.

Yes. Level of care.

Okay. That's right. So also on the NOI growth 3.9% on those same-store portfolio; is that a reasonable assumption going forward or should we expect expenses to increase or moderate from here?

Well, Chad, as a former operator, I hesitate to predict growth. Just when you think things are going great, someone will quit or a building will, you know, have an admission ban. So we are pleased with the performance. It is trending in the right direction and --

Chad, what I would add there is a lot of our growth in the buildings we have performed very well. Margins are great. With some of the expenses admittedly, there is a little bit of compression but a lot of our growth has been coming through the developments. And those continue to move forward and we are very excited about those. So we see growth in the relationship in total is one thing I would say.

Right. And, Chad, I have said this before on other calls. We are a good example of the flip side of development and oversupply. These are the new buildings and these are the buildings that are filling up faster. So at least for the time being, we seem to be on the right side of the new supply issue.

All right, well, thanks for your time this morning.

Thank you.

John Kim, BMO Capital Markets.

Eric, you mentioned with Ensign transaction, willing to pay premium to have a high-quality public partner adding to your existing NHC relationship; is this part of a defined strategy to grow with some of these more national diversified operators?

Well, we have a couple of public companies that we do business with. Brookdale is one of them; NHC is one of them, now Ensign. I know that it gives the Street comfort to have visibility into our tenants but short answer to your question is no. I am not pivoting the focus of NHI to go after large publicly traded companies.

It is really a function of an opportunistic transaction where we had a tenant that was interested in exiting based on our visibility at industry conferences and just calling on potential customers, we knew that Ensign was interested in growing in Texas. So Kevin was able to do some matchmaking and it worked out really well. So our focus is still smaller regional operators and that's where most of our growth comes from.

So what kind of cap rate differential are you underwriting for like an Ensign versus regional operator X for the same portfolio?

This is Kevin. I don't know that I have a defined answer for you. As Eric mentioned, this was opportunistic. There was an element of market rent associated with these but there is some, definitely Ensign attracts a premium. Their balance sheet is fantastic. So we would -- there is a premium associated with it but I would be hesitant to give you a defined number. But I would think that it would probably be at least worth 25 to 50 basis points, if not maybe a little more.

Okay. Can you elaborate on Legend's decision to exit these assets? Are they completely exiting this business or just this region?

So, this is Kevin. They have exited for the time being. They are -- they have evaluated other business opportunities. I think they're taking the -- some time to reset at this point and figure out what they want to do going forward. I can tell you it's not their intent to start up a new skilled nursing company to go compete with Ensign or NHI's buildings and we have protections to that effect.

Okay. There was a discussion on another call of a few MOB portfolios out in the market. Do you have interest in any of these?

We continue to kick tires of MOB portfolios but companies like DOC and MPW have a competitive advantage given their ability to raise equity and fold that into existing systems. So we're still looking for the right fit on MOB and specialty hospital. But we're not going to do anything crazy just to get into the market.

What would constitute the right fit, generally speaking?

I have described this before. We are looking for our own Lillibridge, if you will. A smaller MOB company that has its own platform. Part of the problem with MOBs is they tend to have more moving parts in terms of tenant mix and you need a certain type of platform to navigate those buildings as there is change-over. Maybe you would have one or two floors changing every couple of quarters and you need to secure new tenants and negotiate new leases.

So that takes a special type of platform that we don't have at the moment, frankly. The ideal candidate would look like a company that had five or 10 buildings, that had a development pipeline or relationship and, of course, as long as I am dreaming, the buildings are on campus with single tenant master leases.

Okay. And then finally, on your mezz book, it has been growing pretty consistently. How big are you comfortable having this part of your portfolio?

Well, we have certain limitations under our lending agreements with how much non-core investments we can do. Certainly, mezz is a non-core investment. I would say we're probably comfortable in the $100 million to $120 million range and there's a conscious constant churn with that so, for example, we have mortgages that are paid off almost every quarter, it seems like.

So that number will go up and down as projects get completed and new ones come online. Keep in mind that a lot of these mezzanine loans are really just getting our foot in the door with a purchase option. For example, Timber Ridge in Issaquah, Washington, once that building is complete, and that is a traditional mortgage, it is not a mezz loan but once that building is complete, we have an option to buy it.

Same with the loan that we just announced on Daniel Island. That is another foot in the door and another option to purchase senior housing once it's stable.

Great. Thank you.

Thank you.

Rich Anderson, Mizuho Securities.

I wanted to just pile on a little bit on my pal, Jordan Sadler's questions. You said you were reluctant to sell assets as a REIT. Can you answer why you're reluctant to sell assets because you're a REIT?

Well, Rich, I hesitate to sell because I am giving up income stream. My investors expect our AFFO to go up every year and our dividend to increase every year. So if I am selling a building, theoretically, I'm going in the opposite direction. We do sell buildings. We've sold a couple every year. It's something we do; it's just not my favorite thing to do.

Okay. And then also on the topic of coverage. Kevin, you -- I didn't quite understand. You said Holiday goes from 1.2 to 1.1. Is that what you said on the EBITDAR; I didn't quite understand your response on that question.

What I was trying to communicate is on a -- when you are thinking DARM to DAR a coverage ratio, there is usually somewhere between 0.1 and 0.2 reduction from the DARM to get to a DAR ratio, dependent on what your assumptions are for management fee and CapEx.

Got it. There's a title in there somewhere but I guess the real problem is these -- a lot of even senior living is kind of really testing the par value in terms of coverage when you kind of fully load it with CapEx and everything else. I mean, it's been a question of mine for other calls, healthcare REIT calls.

Where you stand? Why are -- why should people be comfortable with a basically companies giving away all of their profits to you? How long can a situation like that last? And does it mean you have to start thinking about changing your rent escalators and all that sort of stuff.

Rich, this is Eric. One of the things we try and do when we enter into a transaction is protect a seller against the impulse to sell absolutely all of the value in the building together with the operations. That isn't always a message that gets through and I think that you can see a lot of instances where you've had private equity exit and they don't really care what the remaining tenant has to pay and they don't think about the escalators because they won't be there.

So you'll see with our customers and our purchases that we'll pay a slightly higher cap rate and that is allowing the seller, our customer, to retain a bigger piece of the cash flow and a cushion, if you will, against further rent increases. And then finally, I can tell you from my days at Emeritus, that even in the darkest days of the recession, we were able to squeeze out a 1% or 2% increase in the resident rents enough to more than cover whatever rent escalations we had with our landlords.

Okay so putting Holiday aside, because I understand there is a transition that's going on there but senior living at 1.19 EBITDARM coverage. I mean, you are expecting that number to go up? The net of property profits versus your rent escalators there?

We would. Yes, our expectation is over time for that coverage ratio to expand. We knew going in that it was on the lower end of where we want it to be in terms of -- going in coverage ratio but for various reasons, we believe that, that will expand over time. They are, as I mentioned before, they are expanding -- or their occupancy is going up so service fee revenue increased over 2015.

As they continue to lease up, that will continue to go up which will help and then just through the sales of the entry fee, that will help. Furthermore, we are doing some development on several of the campuses where they add units. So that helps both the service fee line, the occupancy line and the entry fee line. So there is a plan in place there for that to expand over time.

Okay. And then Kevin, same with you, the development loan with senior living, is that real cash that you book? It's a development property so do you book that into your income statement right away? I don't know if there's some accounting that doesn't provide -- allow you to do that. Or do we see that pretty quickly as that loan is funded?

Rich, this is Roger. Yes. We record that as we are funding it and we are earning interest on that, so that would be in our P&L. (multiple speakers)

Okay. Dumb question sometimes gets really great answers. And then just generally on recent activity and development activity, referencing page 6 of your supplemental, is there any way to kind of get an idea of what the run rate, quarterly run rate should be off of some of those investments?

I know Ensign is a post-second quarter event, but how should we think about getting -- capturing all of the investing that you have done in the second quarter? Is there a way? Can you give some color about how we should do that, just from a mid-quarter timing perspective?

I will tell you, Rich, this is Roger again. Internally, we project that we are funding Life Care Services or Timer Ridge and Bickford just ratably each month. We don't have good visibility on how much on the draw amounts and so in our guidance and in our internal forecast we just do it ratably each month.

All right. And then last question. Can you comment on the star ratings for NHC and the rest of your skilled portfolio and any color you can give on where the average is and where the problems might be?

We actually looked at that recently. The average for the portfolio (multiple speakers) --

NHC? Is this NHC, Kevin?

The whole portfolio was 3.6% and NHC was just above that average.

Okay, and when you do that do have a percentage? Can you offer a percentage of the portfolio, that sub-3%?

It was a small percentage, to be quite honest with you. One second here. When we look at it, we've got two operators, three buildings that are below three-star.

Three buildings, two operators. Okay.

Well, I take that back. There is -- when we average it across the portfolio so I would have to add that caveat. So some that have -- within a portfolio, there is going to be some that are below a three-star. But just taking the average across each customer, the star ratings that we have are very solid. Our operators do a fantastic job and we are very pleased with that.

Okay, good enough. Thanks very much.

Thank you, Rich.

(Operator Instructions)

Todd Stender, Wells Fargo.

Just to stick with you, Kevin. Can we hear further details on the purchase option for the Daniel Island facility? You mentioned you can purchase it upon stabilization, which is pretty standard. I just want to see, can you purchase it prior to that or after? It's just helpful to hear how the endgame shapes up after you make a construction in mezz loans.

The way it's constructed currently is once they average 90% in occupancy for a period of time that's when the option gets triggered. If they elect to sell it before then, clearly, we have a seat at the table. But the true option is triggered once they get to 90%. And then from there, we have a predetermined lease formula and coverage that we would be stepping into based on their performance at that time.

Does that get folded into a master lease already?

Yes. The thought would be that we already have a relationship with senior living communities and that it could easily be folded into our lease. It doesn't necessarily have to be that way but I think that is the easiest for the relationship and continues to add coverage to our lease and is a much easier outcome for both sides.

And then because this is a combination facility, so to speak, we're comfortable with the coverages for skilled versus assisted living, when it's combined like this is it literally a weighted average rent coverage? How do you look at that?

We look at it as a bit of a weighted average. In this instance, we prescribed a [1.25] lease coverage after a management fee and CapEx. Just from an underwriting process, that's what we would be going in, which gives the -- from an absolute perspective, gives the -- that single community very strong cash flow.

And that seems like it's on the lower end. Is that a function of at the high barriers of, say, a Daniel Island around that Charleston area? What goes into that low coverage?

Well, I would suggest to you that if you looked at senior housing and some of the market comps, that the coverage is a lot lower than that. We're seeing deals between 1.0 and 1.10. So if you blend that with -- even if you blend that with skilled nursing, I think you're probably below that 1.25 level.

Okay. And then just shifting gears, looking at your marketable securities bucket, it dropped again this quarter. Can you just talk about some of the changes you have made? Is there a philosophical change to invest in other REITs' stocks, for example, under your leadership, Eric?

Hi, Todd. We still have the same message that I have been preaching since I took on this role and that is, our investors don't expect us to buy other REITs' stocks. They want us to invest in property and other opportunities.

So the LTC stock remains on the table and it is likely that, that would get sold before we issued any of our own equity. We didn't sell any this quarter but we do have depreciation available this year that would shelter any gains so it is definitely something we think about a lot. And it has gone up quite a bit so we like that, too.

There are no further questions at this time.

All right. Well, thank you, everyone, for joining us today and we will talk to you all next quarter.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.