Business Context and Reporting Period
Universal Health Realty Income Trust is a healthcare-focused REIT that owns or invests in hospitals, free-standing emergency departments, medical office buildings, childcare centers and related facilities. The portfolio comprised 66 investments in 20 states at March 31, 2017. The filing covers the unaudited three months ended March 31, 2017, compared with the three months ended March 31, 2016.
UHS and its subsidiaries are a significant related party: a UHS subsidiary serves as the Trust’s advisor, all officers are UHS employees, and three hospital facilities are leased to UHS subsidiaries. UHS-related hospital leases represented approximately 23% of consolidated revenue in the first quarter of 2017.
Financial Performance and Position
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $17.750 million | $16.226 million | +$1.524 million, approximately 9.4% |
| Income before equity income, interest and gain | $5.964 million | $5.541 million | +$423,000 |
| Net income | $31.562 million | $4.428 million | +$27.134 million |
| Basic and diluted EPS | $2.32 | $0.33 | +$1.99 |
| Funds from operations | $10.814 million | $10.211 million | +$603,000 |
| FFO per diluted share | $0.80 | $0.77 | +$0.03 |
| Net cash from operating activities | $9.494 million | $9.094 million | +$400,000 |
Revenue increased primarily from higher non-related-party base rentals and tenant reimbursements, including contributions from properties acquired in 2016. The operating margin before equity income, interest and the gain was approximately 33.6% in Q1 2017 versus 34.2% in Q1 2016. Net income and GAAP EPS were significantly affected by a nonrecurring $27.2 million gain related to the purchase of a minority interest in Arlington Medical Properties, LLC and the subsequent disposition of St. Mary’s Professional Office Building. FFO, which excludes this gain and adds back depreciation and amortization, increased approximately 5.9%.
| Balance-sheet metric | March 31, 2017 | December 31, 2016 |
|---|---|---|
| Total assets | $502.379 million | $524.750 million |
| Net real estate investments | $444.655 million | $447.240 million |
| Cash and cash equivalents | $4.067 million | $3.930 million |
| Restricted cash | $11.253 million | — |
| Line of credit borrowings | $169.900 million | $201.500 million |
| Non-recourse mortgage debt | $103.004 million | $114.217 million |
| Total equity | $214.104 million | $191.277 million |
The Trust paid $8.9 million of dividends, or $0.655 per share, in Q1 2017 versus $8.6 million, or $0.645 per share, in Q1 2016. Net cash generated by consolidated and unconsolidated property operations was approximately $10.1 million, exceeding dividends by approximately $1.1 million.
Material Changes, Transactions and Capital Activity
- In March 2017, the Trust acquired the remaining 15% minority interest in Arlington Medical Properties, LLC for $7.9 million and participated in the disposition of St. Mary’s Professional Office Building.
- The disposition generated approximately $57.3 million of net proceeds, including repayment of a $21.4 million member loan. Approximately $11.3 million was held in restricted cash by a qualified intermediary for potential Section 1031 replacement-property acquisitions.
- The transaction produced the $27.2 million net gain recognized in Q1 2017.
- There were no acquisitions during Q1 2017. The Henderson Medical Plaza was completed and opened in April 2017; $10.8 million had been invested as of March 31, 2017, against a total development commitment of up to $21.1 million.
- Investing cash flow was $42.3 million provided in Q1 2017, compared with $16.8 million used in Q1 2016, primarily because of the St. Mary’s disposition.
- Financing cash flow was $51.7 million used in Q1 2017, reflecting $31.6 million of credit-facility repayments, $11.2 million of mortgage repayments and $8.9 million of dividends.
Debt, Liquidity and Outlook
The Trust had a $250 million revolving credit facility scheduled to mature in March 2019, with a one-year extension option. At March 31, 2017, borrowings were $169.9 million, letters of credit were $2.7 million and available capacity was $77.4 million. The applicable LIBOR margin was 1.625%, and the commitment fee was 0.25%.
Management stated that all credit agreement covenants were satisfied and believed compliance would continue even if the full facility were drawn. Reported covenant measures included total leverage of 44.3% against a limit below 60%, secured leverage of 16.1% against a limit below 30%, unencumbered leverage of 40.3% against a limit below 60%, fixed-charge coverage of 3.6x against a minimum of 1.50x, and tangible net worth of $191.372 million against a $125 million minimum.
Fourteen consolidated non-recourse mortgages totaled $103.0 million at March 31, 2017. Near-term maturities included approximately $20.2 million in April 2017, $4.5 million in June 2017 and $6.7 million in July 2017. Subsequent to quarter-end, the $20.2 million Peace Health loan was repaid using the credit facility, the Summerlin Hospital Medical Office Building III loan was refinanced with a $13.2 million mortgage at 4.03%, and management stated it intended to repay certain other maturities using the credit facility.
Management expected operating cash flow, cash, available credit and access to capital markets to fund operations, capital expenditures, acquisitions and dividends for the next twelve months. No specific earnings or revenue guidance was provided.
Risks, Contingencies and Unusual Items
- Revenue and operations are materially dependent on UHS. The three acute-care hospital leases run through December 2021, with renewal and purchase options; nonrenewal, renegotiation or property purchases by UHS could reduce future revenue.
- UHS also serves as advisor and employs the Trust’s officers, creating related-party and potential conflict-of-interest considerations. Advisory fees were $866,000 in Q1 2017 versus $767,000 in Q1 2016.
- Healthcare reimbursement changes, Medicare and Medicaid reductions, regulatory developments and possible changes to the Affordable Care Act could affect facility operators and property values.
- Real estate competition, occupancy and rental-rate pressures, interest-rate changes, refinancing requirements and access to capital markets may affect liquidity and returns.
- The FTX MOB Phase II joint venture had approximately $5.3 million of non-recourse debt scheduled to mature in August 2017; the Trust may need to provide financing or equity depending on refinancing results.
- The Trust’s four unconsolidated LLCs/LPs had $28.2 million of aggregate non-recourse mortgage debt and may require additional funding for capital expenditures, leasehold improvements or refinancing, although management described them as generally cash-flow sufficient.
- The $27.2 million gain materially inflated GAAP net income and EPS; FFO provides a more relevant view of recurring operating performance but is a non-GAAP measure.
Investor Verification Checklist
- Reconcile recurring earnings and FFO excluding the $27.2 million Arlington/St. Mary’s gain.
- Verify the post-quarter-end refinancing and repayment of near-term mortgage maturities.
- Monitor UHS lease renewals, purchase options and UHS financial condition because of the concentration of revenue and advisory relationship.
- Assess whether the $77.4 million of credit capacity remains adequate after refinancing, acquisitions, development spending and dividends.
- Track the use of the $11.3 million restricted 1031-exchange proceeds and whether additional 2017 acquisitions are completed by the applicable deadline.
- Review the sustainability of dividends relative to recurring operating cash flow and FFO rather than reported GAAP net income.