DIVERSIFIED HEALTHCARE TRUST quarterly report, Q3 FY2022

Full document

Diversified Healthcare Trust — Q3 2022 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2022. DHC is a healthcare REIT with medical office and life science properties, managed senior living communities (SHOP), and other healthcare real estate. At quarter-end it wholly owned 379 properties and held interests in two joint ventures.

Financial performance

  • Q3 revenue: $322.9 million, down 4.3% from $337.4 million. Rental income fell to $64.0 million from $101.4 million, primarily reflecting properties moved into unconsolidated joint ventures and properties taken out of service. Residents’ fees and services rose 9.7% to $259.0 million.
  • Q3 earnings and property operations: Net loss attributable to common shareholders was $81.5 million, or $0.34 per share, versus a loss of $89.3 million, or $0.38 per share, a year earlier. NOI was $33.8 million, down 52.6%. Office Portfolio NOI was $31.1 million; SHOP NOI was negative $5.8 million.
  • Nine-month results: Revenue was $946.7 million, down 9.5%; net income attributable to common shareholders was $49.5 million, or $0.21 per share, versus a loss of $191.1 million, or $0.80 per share, in 2021. The 2022 result included a $322.1 million gain on property and joint-venture interest sales. Nine-month NOI declined 46.2% to $122.8 million.
  • Adjusted REIT measures: Nine-month FFO was negative $79.4 million and Normalized FFO negative $46.5 million (negative $0.33 and $0.20 per share, respectively). Q3 Normalized FFO was negative $14.2 million, or negative $0.06 per share. These are non-GAAP measures and are not cash flow measures.
  • Cash flow: Nine-month operating cash flow was negative $36.9 million, compared with negative $13.2 million in 2021. Investing activities provided $483.7 million, mainly from joint-venture transactions; financing activities used $662.9 million. Cash and restricted cash totaled $800.8 million at period-end, including $691.0 million unrestricted cash and $109.8 million restricted cash.
  • Balance sheet and debt: Total assets were $6.07 billion and total liabilities $3.37 billion. Debt and finance-lease carrying amounts included $700.0 million drawn on the revolving facility, $2.32 billion of senior notes net, and $40.9 million of secured debt and finance leases. Senior notes’ aggregate principal was $2.35 billion; the revolver was fully drawn.
  • Distributions: DHC paid $0.01 per share quarterly during the first three quarters of 2022 and declared another $0.01 distribution after quarter-end.

Material changes and operating trends

  • Office Portfolio occupancy was 85.9%, down from 91.3% a year earlier; comparable-property occupancy was 90.2% versus 91.4%. Comparable office NOI increased 3.7% in Q3, despite substantial reported portfolio declines after joint-venture deconsolidations and other portfolio changes.
  • SHOP occupancy rose to 74.7% from 71.3%, and average monthly rate increased to $4,509 from $4,234. Higher revenue did not offset labor, insurance, food, energy, and other operating cost increases; SHOP’s Q3 NOI turned negative.
  • In January, DHC sold interests in 10 medical office and life science properties into the LSMD joint venture, retaining 20%; in June, it sold a further 10% interest in the Seaport joint venture, retaining 10%. These transactions drove much of the reported property gain and cash proceeds.
  • DHC redeemed $500 million of 9.75% senior notes due 2025 in June, paying a premium and recording a $29.6 million extinguishment loss. It also repaid mortgage debt and acquired a California life science property for about $75.1 million.

Liquidity, outlook and risks

  • The amended credit agreement extended a fixed-charge-coverage covenant waiver through December 31, 2022, imposed restrictions including a $400 million annual capital-expenditure limit and a $200 million minimum-liquidity requirement, and reduced the revolver commitment to $700 million. DHC reported compliance with other covenants, subject to the stated waiver.
  • DHC’s debt-service coverage ratio was below the 1.5x threshold for incurring additional debt. The revolver’s capacity is scheduled to fall to $586.4 million in January 2023, requiring a $113.6 million repayment. The facility matures in January 2024.
  • Moody’s downgraded DHC’s senior unsecured debt rating to Caa1 in September 2022. Higher ratings-based borrowing costs, rising floating rates, refinancing access, and covenant compliance are material liquidity risks.
  • Management said it believes available sources will meet operating, capital, debt-service, and distribution needs for the next 12 months and beyond. This outlook is subject to operating performance and financing availability. DHC expected 2022 capital expenditures to exceed 2021 levels but remain below the credit-agreement cap; it also expected to spend about $32.4 million of estimated leasing obligations over the next 12 months.
  • Key uncertainties include inflation, labor shortages and costs, rising interest rates, supply-chain disruption, recession risk, COVID-19 effects, senior-living occupancy and profitability, tenant defaults, and redevelopment costs and timing. Hurricane Ian-related costs of $4.1 million were recorded in Q3, with additional losses still under evaluation. A tenant was in default on leases covering six wellness centers; DHC was recognizing rent only as received and continued to incur property costs.
  • LIBOR was expected to be phased out for existing contracts by June 2023; the revolver’s benchmark is to transition as provided in the credit agreement, potentially increasing interest costs. DHC also disclosed significant related-party relationships with RMR and AlerisLife.

Investor verification priorities

  • Confirm the status of the covenant waiver after December 31, 2022, the debt-service coverage ratio, and the plan and funding source for the $113.6 million January 2023 revolver paydown.
  • Assess whether operating cash flow, liquidity, and access to refinancing can support debt service, capital needs, and distributions while the revolver is fully drawn.
  • Track SHOP margins and occupancy alongside labor, insurance, food, and energy costs; review the hurricane-loss estimate as it develops.
  • Verify rent collections and recovery prospects for the six defaulted wellness-center leases, as well as the effects of office occupancy and portfolio deconsolidations on recurring earnings.
  • Separate recurring operating performance from the joint-venture sale gain, debt-extinguishment charges, and unrealized AlerisLife investment losses when evaluating results.