Business context and reporting period
Senior Housing Properties Trust (the registrant named in this filing; the request identifies the company as Diversified Healthcare Trust) filed this unaudited Form 10-Q for the quarter ended September 30, 2018. It owned 443 properties in 42 states and Washington, D.C., across medical office buildings (MOBs), senior living communities and wellness centers. The results below compare the third quarter and first nine months of 2018 with the same periods in 2017. Dollar amounts are in millions unless stated otherwise.
Financial and operating performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $279.0 | $266.7 | $831.9 | $796.2 |
| Net income attributable to common shareholders | $45.8 | $34.4 | $405.4 | $82.6 |
| FFO attributable to common shareholders | $116.7 | $95.7 | $347.0 | $286.1 |
| Normalized FFO attributable to common shareholders | $100.2 | $104.0 | $312.2 | $315.9 |
| Net operating income (NOI) | $163.0 | $162.0 | $497.8 | $487.5 |
- Revenue increased 4.6% in Q3 and 4.5% year to date. Common-shareholder net income rose 33.1% in Q3 and was substantially higher year to date, but the nine-month comparison includes significant property-sale gains and fair-value gains on equity investments.
- Nine-month net income included a $261.9 gain on property sales and $85.6 of unrealized gains on equity securities. Q3 included $35.1 of unrealized equity-security gains. These items materially distinguish GAAP earnings from recurring property performance.
- Normalized FFO per diluted share was $0.42 in Q3 versus $0.44, and $1.31 for nine months versus $1.33. FFO per share was $0.49 and $1.46, respectively. The declared distribution was $0.39 per share per quarter.
- NOI increased 0.6% in Q3 and 2.1% for nine months. NOI as a share of revenue was approximately 58.4% in Q3 versus 60.7% and 59.8% year to date versus 61.2%; this ratio is a calculated operating measure, not a GAAP margin.
- Operating cash flow was $286.0 for nine months, down from $334.6. Management attributed the decrease primarily to paying a $55.7 business-management incentive fee in January 2018. Investing activities provided $136.9, compared with $123.9 used in 2017; financing activities used $314.3 versus $203.3.
- At September 30, cash and cash equivalents were $47.7, with a further $108.3 of restricted cash. The restricted balance included $94.3 of sale proceeds held in trust and expected to be released in November 2018. The $1.0 billion revolving facility had $195.0 outstanding and $805.0 available; outstanding borrowings were $165.0 as of November 5.
- Debt carrying amounts were approximately $3.70 billion: $195.0 revolving borrowings, $548.1 term loans, $2,215.9 senior notes and $745.3 secured debt and capital leases. The filing states the company was in compliance with debt covenants. Interest expense was $45.4 in Q3 and $133.8 year to date, up from $40.1 and $124.4.
Material changes versus prior periods
- MOB revenue grew 8.7% in Q3, largely from acquisitions; comparable-property NOI increased just 0.9%. MOB occupancy was 95.6%, versus 95.8% a year earlier.
- Triple-net senior-living rent fell 4.6% in Q3 and 1.8% year to date, reflecting property sales and a transfer to managed operations. Reported senior-living occupancy declined to 83.3% from 84.6%; triple-net rent coverage fell to 1.13x from 1.22x.
- Managed senior-living Q3 revenue rose 7.1%, but NOI decreased 3.5% as operating expenses increased 10.3%. At comparable managed properties, Q3 NOI fell 10.5%, with higher staffing, maintenance and room-turnover costs among the cited factors.
- General and administrative expense rose to $31.0 in Q3 from $19.9, including $18.8 of estimated incentive fees. The estimated nine-month incentive fee was $50.7; actual 2018 fees, if any, were to be determined after year-end under the management agreement.
- The company sold three Sunrise-leased senior living communities for $313.0 in aggregate, recognizing $260.0 of gains, and sold two additional properties for approximately $21.9. It also issued $500.0 of 4.75% senior notes due 2028, using net proceeds primarily to repay revolving-facility borrowings.
- Adoption of accounting guidance for equity securities moved fair-value changes into earnings, contributing to reported unrealized gains. Management said adoption of the new revenue standard did not materially affect revenue recognition.
Outlook, risks and notable items
- Management said available operating cash flow, cash and revolving-credit capacity should meet operating costs, capital needs, debt service and distributions for the next 12 months and foreseeable future. This is management’s assessment, not a quantified earnings or FFO forecast; the filing provides no specific financial guidance.
- Two MOB tenants, together representing approximately 2.3% of annualized rental income, were expected to vacate 527,000 square feet in Q2 2019. Releasing the space could take time and require significant capital.
- Five Star was the largest tenant and manager of managed senior-living communities. Its leases contributed 18.6% of Q3 revenue; its leased properties represented 27.0% of real-estate investment cost. Five Star rent coverage was 1.05x and occupancy was 81.4%, down from 1.15x and 83.0% a year earlier.
- Two third-party senior-living tenants defaulted, prompting lease terminations, property transitions to Five Star management and $5.1 of nine-month impairment charges. The Colorado transition occurred in November 2018.
- Management cited senior-living oversupply, competition, seniors choosing home-based care, and rising labor costs as pressures on occupancy, rents and tenant performance. It also warned of potential Medicare and Medicaid changes, even though approximately 97% of nine-month NOI came from properties whose revenues were primarily private-pay.
- Floating-rate debt exposed the company to LIBOR increases. A one-percentage-point increase was estimated to raise annual interest expense by approximately $7.5 based on outstanding floating-rate debt at September 30; the effect would be larger if the revolver were fully drawn.
- The filing describes significant related-party relationships involving RMR LLC, Five Star and affiliated entities, including management agreements and incentive fees. It also identifies potential conflicts of interest and reliance on Five Star’s ability to pay rent and operate properties.
- The board declared a $0.39-per-share quarterly distribution in October, expected to be paid in November. The filing cautions that future distributions are not assured and could be reduced or eliminated.
Important facts for investors to verify
- Separate recurring performance from the $261.9 property-sale gain and equity-security fair-value gains; assess normalized FFO and property NOI trends.
- Monitor Five Star’s rent coverage, occupancy, rent collections and financial capacity, given its tenant and operator concentration.
- Track senior-living occupancy, lease coverage and operating costs, particularly staffing and labor availability.
- Assess the timing, leasing prospects and capital needs for the 527,000 square feet of MOB space expected to be vacated in 2019.
- Review debt maturities, floating-rate exposure, covenant headroom and the sustainability of the $0.39 quarterly distribution against recurring cash flow and capital requirements.
- Evaluate the restricted-cash release, tenant-improvement commitments, property transition costs and related-party management fees, including the final 2018 incentive fee.