DIVERSIFIED HEALTHCARE TRUST annual report, FY2016

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Business context and reporting period

The supplied filing is the 2016 Form 10-K of Senior Housing Properties Trust (SNH), for the fiscal year ended December 31, 2016—not a filing under the name Diversified Healthcare Trust. The filing reports annual results; it also includes unaudited fourth-quarter data.

SNH was a healthcare real estate investment trust with 433 properties in 42 states and Washington, D.C.: 304 senior living communities, 119 medical office properties and 10 wellness centers. Its strategy was to earn rental income and returns from managed communities and pursue additional property investments.

Financial performance and position

  • Revenue: $1.058 billion, up 5.9% from $998.8 million in 2015. Rental income was $666.2 million (+5.6%); residents’ fees and services were $391.8 million (+6.5%).
  • Profit: Net income was $141.3 million, or $0.60 per share, versus $124.0 million, or $0.53 per share. Operating income was $303.1 million. Net margin was approximately 13.4%.
  • Property operations: NOI, a non-GAAP measure, was $658.2 million, up 6.0%; NOI margin was approximately 62.2%, broadly unchanged. FFO was $443.7 million ($1.87 per share), and Normalized FFO was $446.4 million ($1.88 per share), compared with $429.7 million ($1.84 per share) in 2015. Management cautions these non-GAAP measures are not substitutes for GAAP results or operating cash flow.
  • Cash flow: Operating cash flow was $426.8 million, versus $405.5 million. Investing activities used $292.9 million, compared with $1.213 billion in 2015, largely reflecting lower acquisition activity. Financing activities used $139.8 million; shareholder distributions totaled $370.5 million.
  • Liquidity: Cash and cash equivalents were $31.7 million, with $673.0 million available on the $1.0 billion revolving facility at year-end. Management said available resources and expected cash flows should cover operations, debt service and distributions for the next 12 months and foreseeable future.
  • Debt: Consolidated indebtedness was $3.714 billion; debt to total gross assets was 43.4%. The company reported $327.0 million drawn on its revolver and $550 million of term loans. The revolver matures January 15, 2018, with a conditional one-year extension option. It reported compliance with debt covenants at December 31, 2016.
  • Distributions: Common distributions remained $0.39 per share quarterly, or $1.56 for the year. Normalized FFO per share exceeded declared distributions per share; actual cash needs, capital spending and debt restrictions also affect distribution capacity.

Material changes versus the prior comparable period

  • Revenue rose 5.9% and NOI rose 6.0%; growth reflected acquisitions, rent increases and higher managed-community revenue.
  • Managed senior living NOI increased 10.0% to $98.6 million, but segment net income fell 66.5% to $6.4 million, mainly as depreciation and amortization rose 34.5%, with impairment also recorded. Comparable managed-community occupancy declined to 87.2% from 88.1%.
  • Triple-net senior living rent coverage declined to 1.31x from 1.35x; occupancy declined to 85.1% from 85.6%. Comparable MOB NOI rose 1.3%; MOB occupancy was 96.5% overall.
  • Interest expense increased to $167.6 million from $150.9 million. The company issued $250 million of 6.25% notes due 2046 and obtained $620 million of secured financing at a 3.53% fixed rate, while repaying mortgages and reducing revolver borrowings.
  • 2016 included $18.7 million of impairment charges and a $4.1 million property-sale gain. In 2015, net income included a $38.4 million non-cash loss tied to the distribution of RMR Inc. shares. Fourth-quarter 2016 revenue was $274.3 million and net income was $42.9 million; fourth-quarter 2015 net income was $9.5 million, affected by that non-cash loss.

Outlook, risks and unusual items

  • Management provided no numerical earnings or revenue guidance. It stated that liquidity should be adequate for the next 12 months and expects to continue quarterly cash distributions, subject to Board discretion, financial results, capital needs, debt covenants and REIT requirements.
  • Tenant and operator concentration is material: Five Star was responsible for approximately 31.5% of annualized rental income and operated approximately 48.7% of property cost. Five Star has not been consistently profitable, creating potential rent-collection and managed-property return risk.
  • Senior-living occupancy and rent coverage weakened, and the filing cites new-community competition, delayed moves by seniors, labor and insurance costs, and operators’ ability to provide quality care as risks.
  • Healthcare regulation and Medicare/Medicaid reimbursement changes could affect tenants and operators. Approximately 97% of 2016 NOI came from properties where most revenues were derived from private resources; the remaining 3% came from properties primarily reliant on Medicare and Medicaid.
  • Interest-rate increases could raise costs on floating-rate debt. A 100-basis-point increase was estimated to add about $8.8 million to annual interest expense on year-end floating-rate borrowings.
  • SNH had no employees and relied on RMR LLC for management. Related-party relationships with RMR LLC, Five Star and affiliated entities create conflicts-of-interest risks; management agreements have continuing 20-year terms and potentially substantial termination fees.
  • Management reported effective disclosure controls and internal control over financial reporting; Ernst & Young issued unqualified opinions on the financial statements and internal controls. The company reported no litigation expected to have a material adverse effect.

Most important facts for investors to verify

  • Confirm the issuer identity: this filing is for Senior Housing Properties Trust (SNH), despite the request metadata naming Diversified Healthcare Trust.
  • Review Five Star’s current financial condition, lease coverage, rent-payment capacity and operating performance at SNH-managed communities.
  • Check the 2018 revolver maturity and extension conditions, debt maturities, covenant headroom and refinancing costs.
  • Assess whether recurring cash generation supports distributions after interest, property improvements and other capital requirements; compare GAAP cash flow with FFO and Normalized FFO.
  • Review the assumptions behind 2016 impairments, property valuations, tenant occupancy and rent coverage, and the company’s related-party management arrangements.