DIVERSIFIED HEALTHCARE TRUST annual report, FY2013

Business context and reporting period

Entity discrepancy: The supplied filing is Senior Housing Properties Trust (NYSE: SNH), not Diversified Healthcare Trust. It is a fiscal-year 2013 Form 10-K for the year ended December 31, 2013, filed March 3, 2014; the financial statements are audited.

SNH was a healthcare-focused REIT with 375 properties in 40 states and Washington, D.C., including senior living communities, medical office buildings (MOBs), and wellness centers. Its portfolio had $5.3 billion of undepreciated property carrying value. The filing reports 265 senior living communities, 100 MOB properties and 10 wellness centers; a separate portfolio table excludes held-for-sale properties and lists 371 properties.

Financial and operating highlights

Rental income was $459.4 million, while resident fees and services were $302.1 million, up 64.1% as acquisitions and the shift of communities into managed operations expanded that business. Total reported expenses were $496.9 million. The filing does not present a single company-wide gross margin; its property-level NOI measure is non-GAAP.

Segment results were mixed: triple-net senior living NOI declined 3.9% to $237.2 million, with occupancy falling to 85.3% from 86.1% and rent coverage to 1.38x from 1.42x. Managed senior living NOI rose 51.2% to $68.3 million, principally reflecting acquired and transferred communities; comparable-property occupancy improved to 91.2% from 87.9%. MOB NOI increased 8.8% to $138.4 million, but comparable-property NOI declined 4.1%, and comparable rental income declined 2.2%. Wellness-center NOI was $17.6 million.

Material changes versus the prior comparable period

• Growth in revenue and operating cash flow accompanied portfolio expansion; SNH acquired 12 properties for approximately $202.8 million during 2013 and issued 11.5 million shares, raising about $262.1 million net.
• Net income included a $37.4 million gain on property sales, offset by $45.6 million of impairment charges. Impairments included $37.6 million on four MOB properties classified as discontinued operations and charges on senior-living properties held for sale.
• Quarterly results were uneven: 2013 revenue ranged from $186.9 million to $200.3 million; net income ranged from $5.6 million in Q2 to $72.2 million in Q4. Q2 included $32.3 million of impairment charges; Q4 included a $36.3 million gain on sale of the two rehabilitation hospitals.
• Debt declined year over year, and a September 2013 revolver amendment extended maturity to January 2018, reduced the spread to LIBOR plus 130 basis points and lowered the facility fee to 30 basis points. Year-end revolver borrowings were $100 million; February 28, 2014 borrowings were $170 million.

Outlook, risks and unusual items

Management said cash, operating cash flow and financing resources should cover operating costs, debt service and distributions for the next 12 months and foreseeable future. SNH intended to continue quarterly distributions, but provided no earnings or FFO guidance; the board retains discretion over future distributions.

In February 2014, SNH agreed to acquire a Boston MOB, principally leased to Vertex Pharmaceuticals, for approximately $1.125 billion, subject to closing conditions. It had an $800 million term-loan commitment, expected at LIBOR plus 140 basis points, but financing was conditional and could change or be unavailable. Failure to close in certain circumstances could forfeit a $50 million deposit. SNH expected closing in the first half of 2014.

Five Star was SNH’s largest tenant and managed its senior living communities. It represented approximately 42.1% of annualized rental income and 40% of property investment; the portfolio table attributes 42.7% of NOI to Five Star-leased properties. Five Star had announced it would restate 2011, 2012 and the first two quarters of 2013, identified a material weakness in financial reporting controls, and had not filed its Q3 2013 10-Q at the time of SNH’s filing. SNH warned that Five Star’s financial difficulties could impair rent payments, operations and SNH’s access to capital markets.

Other key risks include healthcare reimbursement and regulatory changes, weaker occupancy or rent coverage, tenant concentration, interest-rate and refinancing exposure, real-estate impairments, and conflicts arising from related-party arrangements with RMR and Five Star. SNH reported compliance with its debt covenants at year-end. Ernst & Young gave unqualified opinions on the financial statements and internal control over financial reporting; SNH reported no legal proceedings.

Most important facts for investors to verify

• Confirm the intended issuer: this filing covers Senior Housing Properties Trust (SNH), not Diversified Healthcare Trust.
• Track Five Star’s restated financials, covenant status, liquidity, rent coverage and ability to meet lease and management obligations.
• Verify whether the Vertex acquisition closed, how it was financed, and the resulting leverage, interest expense and property contribution.
• Assess the status and sale proceeds of held-for-sale properties, including whether additional impairments or rent reductions followed.
• Compare normalized FFO and operating cash flow with the $1.56 annual distribution, while noting that FFO is non-GAAP and distributions may include return of capital.
• Review debt maturities, revolver usage and covenant headroom; approximately $410 million of principal was scheduled to mature in 2016.