Business Context and Reporting Period
Universal Health Realty Income Trust is a Maryland REIT investing in healthcare and human-service real estate. The filing covers the fiscal year ended December 31, 2018, with quarterly information included for the fourth quarter. As of February 27, 2019, the portfolio comprised 69 investments in 20 states: six hospitals, 55 medical office buildings, four free-standing emergency departments and four preschool or childcare centers.
UHS-related tenants generated approximately 30% of consolidated 2018 revenue, and UHS subsidiaries also provide the Trust’s advisory services. The Trust had no salaried employees as of December 31, 2018.
Key Financial Metrics
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Revenue | $76.2 million | $72.3 million | Up 5.3% |
| Net income | $24.2 million | $45.6 million | Down $21.4 million |
| Basic and diluted EPS | $1.76 | $3.35 | Down $1.59 |
| Funds from operations | $45.0 million | $42.2 million | Up 6.6% |
| FFO per diluted share | $3.28 | $3.10 | Up $0.18 |
| Cash flow from operations | $42.9 million | $46.0 million | Down $3.1 million |
| Dividends per share | $2.680 | $2.640 | Up $0.040 |
| Net real estate investments | $437.7 million | $446.4 million | Down $8.7 million |
| Total assets | $483.8 million | $490.0 million | Down $6.3 million |
| Total indebtedness | $261.3 million | $256.4 million | Up $4.9 million |
Revenue growth primarily reflected contributions from medical office buildings acquired in 2018 and 2017 and increased activity at other properties. Income before equity income, interest and unusual items was $26.7 million, compared with $24.0 million in 2017. Net income was materially affected by non-recurring items; the filing does not provide a directly comparable recurring net margin.
- Cash and cash equivalents were $5.0 million at year-end, compared with $3.4 million in 2017.
- The $300 million revolving credit facility had $196.4 million outstanding and $103.6 million of available capacity at December 31, 2018. It matures in March 2022, with two potential six-month extensions.
- Non-recourse mortgage debt was $64.9 million, compared with $75.4 million in 2017. Consolidated debt totaled approximately $261.7 million including the credit facility and mortgage debt.
- Management reported compliance with all credit covenants. Total leverage was 41.3%, fixed-charge coverage was 4.3x and tangible net worth was $181.2 million, versus covenant thresholds of less than 60%, greater than 1.50x and at least $125.0 million, respectively.
- Interest expense was $10.0 million. Management estimated that a 1% change in interest rates would affect net income by approximately $1.4 million, after giving effect to interest-rate caps.
Material Changes Versus the Prior Comparable Period
- Revenue increased 5.3%, but net income declined 46.9% because 2017 included a $27.2 million gain from the Arlington transaction involving the St. Mary’s Professional Office Building.
- FFO increased despite the net-income decline, primarily because FFO excludes gains and other non-recurring items and benefited from a $1.7 million lease termination payment, business-interruption insurance recoveries and higher property-level income.
- Hurricane Harvey restoration was substantially completed by the second quarter of 2018. The Trust recorded approximately $4.5 million of insurance recoveries in excess of property damage write-downs and $1.2 million of business-interruption recoveries in 2018.
- The Trust acquired the Beaumont Medical Sleep Center Building in Southfield, Michigan for approximately $4.1 million. No properties were disposed of in 2018.
- Cash flow from investing activities shifted to a $8.0 million use in 2018 from $39.5 million of inflow in 2017, when the Trust received approximately $65.2 million of net proceeds from the St. Mary’s divestiture.
- Lease renewals covering approximately 17% of rentable square footage at significant medical office properties were completed in 2018. Renewed rents decreased approximately 3% on a weighted-average basis versus expiring rents.
Outlook, Commentary, Risks and Unusual Items
The filing provides no formal earnings or revenue guidance. Management stated that operating cash flow, cash, available revolver capacity and access to capital markets were expected to provide sufficient resources for operating, investing and financing requirements for the next twelve months, including REIT distributions.
- Two hospital tenants provided notice that they did not intend to renew leases expiring in May and June 2019. The affected properties represented approximately 2% of consolidated revenue in each of 2016–2018. The Vibra Hospital property was expected to be vacated; discussions continued regarding a possible short-term lease for the Encompass Health rehabilitation property.
- Three UHS acute-care hospital leases expire in December 2021 or December 2026. UHS has renewal, purchase and rights-of-first-refusal provisions, creating potential future revenue concentration and conflicts of interest.
- UHS-related tenants represented approximately 30% of 2018 consolidated revenue, while the three UHS acute-care hospital leases represented approximately 21%. UHS also owns 5.7% of the Trust and controls the advisory relationship.
- Hospital and healthcare tenants are exposed to Medicare and Medicaid reimbursement changes, healthcare reform uncertainty, value-based purchasing, staffing shortages, competition, regulatory compliance and litigation. Adverse tenant performance could reduce rent payments, bonus rents, property values and lease renewals.
- The revolving credit facility is primarily variable-rate debt based on LIBOR. The filing notes that LIBOR is expected to be phased out after 2021. Two $30 million interest-rate caps were scheduled to expire in March 2019, and management planned to replace them with swaps or caps.
- The Trust’s REIT status requires distribution of at least 90% of taxable income. Failure to maintain REIT qualification could result in corporate-level taxation and reduced cash available for dividends and debt service.
- Net income included $1.7 million of lease termination revenue, $4.5 million of hurricane insurance recovery proceeds in excess of property write-downs and $1.2 million of hurricane business-interruption recoveries. These items should not be treated as recurring operating earnings.
- The amended and restated advisory agreement became effective January 1, 2019. It retained the 0.70% advisory-fee calculation and eliminated an incentive-fee provision that had never generated a payment.
Important Facts for Investors to Verify
- Review the full 2018 financial statements and reconcile GAAP net income with FFO, including all hurricane, lease termination and prior-year transaction effects.
- Monitor renewal, re-leasing and capital requirements for the Encompass Health and Vibra hospital properties and quantify any 2019 vacancy exposure.
- Assess refinancing risk associated with the $196.4 million revolver maturity in 2022 and the Trust’s exposure to variable interest rates and LIBOR transition.
- Evaluate UHS concentration, lease renewal and purchase options, related-party advisory fees and potential conflicts of interest.
- Review tenant and property-level occupancy, coverage ratios and reimbursement trends, particularly for the hospital portfolio. The combined hospital coverage ratio declined to approximately 7.0x in 2018 from 7.5x in 2017.
- Confirm the effect of 2019 adoption of the new lease standard on the balance sheet, including recognition of right-of-use assets and liabilities for 14 ground leases.
- Review UHS’s separate SEC filings for its litigation, investigations, regulatory matters and financial condition, because these matters may materially affect the Trust.