Diversified Healthcare Trust — Q2 2022 Form 10-Q
Reporting period: Three and six months ended June 30, 2022. Unaudited results; dollar amounts below are in millions unless noted.
Business context
DHC is a healthcare-focused REIT with medical office and life science properties, senior living communities, and other healthcare-related properties. At quarter-end it wholly owned 378 properties and held interests in two unconsolidated joint ventures. Its two principal reporting segments are Office Portfolio and senior housing operating portfolio (SHOP).
Financial performance
| Metric | Q2 2022 | Q2 2021 | H1 2022 | H1 2021 |
|---|---|---|---|---|
| Total revenue | $313.0 | $346.3 | $623.8 | $709.1 |
| Net income (loss) attributable to common shareholders | $(109.4) | $(34.2) | $131.0 | $(101.7) |
| Per-share net income (loss) | $(0.46) | $(0.14) | $0.55 | $(0.43) |
| NOI | $47.0 | $81.7 | $89.0 | $157.0 |
| Normalized FFO attributable to common shareholders | $(10.4) | $12.2 | $(32.3) | $18.0 |
| Cash from operating activities | Not reported quarterly in the presented cash flow statement | $(31.9) | $27.0 |
Q2 NOI was about 15.0% of revenue, down from 23.6% a year earlier; H1 NOI margin was about 14.3%, versus 22.1%. Q2 NOI declined 42.5%, with Office Portfolio NOI down 50.3% and SHOP NOI down 39.2%. H1 NOI fell 43.4%. Comparable-property NOI was more resilient: Office Portfolio declined 0.7% in Q2 and 1.0% in H1; comparable SHOP NOI rose 3.3% in Q2 and declined 2.0% in H1.
H1 net income included a $327.1 million gain on property/JV sales, principally the January contribution of 10 medical office and life science properties to a joint venture. By contrast, Q2 included a $29.6 million debt-extinguishment loss and a $10.2 million unrealized loss on AlerisLife shares. DHC reported a $30.0 million H1 debt modification/extinguishment loss. Thus, reported H1 profit does not reflect positive normalized FFO, which was negative $32.3 million.
Balance sheet, debt and liquidity
- At June 30, total assets were $6.15 billion, total liabilities $3.36 billion, and shareholders’ equity $2.79 billion.
- Cash and cash equivalents were $705.2 million; restricted cash was $163.2 million. The restricted balance included disposition/JV proceeds held as collateral and property escrows. DHC received $109.0 million from its Boston life science JV interest sale in July, after quarter-end.
- Debt on DHC’s balance sheet comprised $700 million drawn on its revolving facility, $2.315 billion of senior unsecured notes (net), and $57.0 million of secured debt and finance leases. The facility was fully drawn at June 30 and July 29. Stated principal debt obligations were approximately $3.15 billion, including $50.7 million of mortgage principal.
- The revolving facility matures in January 2024. Its borrowing capacity is scheduled to decline to $586.4 million in January 2023, requiring further repayment. The February amendment extended the fixed-charge coverage covenant waiver through December 31, 2022, reduced facility commitments to $700 million, raised the interest premium, and imposed a $200 million minimum-liquidity requirement plus restrictions on distributions, acquisitions, capital spending and additional debt.
- DHC’s debt-service coverage ratio was below the 1.5x threshold for incurring additional debt; it cannot incur additional debt until the ratio meets that level. Management said it believed DHC complied with other covenants, subject to the stated waivers.
- H1 investing cash inflow was $527.7 million, largely reflecting $643.9 million of net proceeds from property sales to a joint venture; financing cash outflow was $644.4 million, including the $500 million redemption of 9.75% notes. Total cash and restricted cash declined from $1.017 billion to $868.4 million.
Material changes and operating developments
- Revenue declined 9.6% in Q2 and 12.0% in H1. Rental income fell sharply as properties were deconsolidated into joint ventures and properties were disposed of; SHOP residents’ fees rose 2.7% in Q2 but declined 1.6% in H1.
- SHOP occupancy improved year over year: 73.6% versus 70.9% at quarter-end; average monthly rate was $4,480 versus $4,307. However, labor, insurance and other operating costs pressured margins.
- Office Portfolio occupancy was 88.1%, compared with 91.0% a year earlier; comparable-property occupancy was 91.2% versus 91.8%. Comparable Q2 leasing showed a weighted-average rental rate increase of 9.1% across new leases and renewals.
- DHC sold a 10% interest in its Boston life science JV in June, retaining 10%. In January it sold interests in a 10-property JV and retained 20%. In July it acquired a California life science property for approximately $82 million and prepaid a $15.3 million mortgage.
- The common distribution remained $0.01 per share quarterly ($0.04 annualized); DHC declared another $0.01 distribution in July. H1 distributions totaled $4.8 million.
Outlook, commentary and risks
No formal earnings or FFO guidance was provided. Management stated it believed available liquidity sources would be sufficient for operating and capital needs, debt service and distributions over the next 12 months, while warning that adverse conditions could undermine liquidity and covenant compliance.
- Management expected 2022 capital expenditures to exceed 2021 levels, subject to the $400 million annual limit under the credit agreement. It was redeveloping five Office Portfolio properties, with expected completion dates ranging from H2 2022 to 2025. Supply-chain disruption, inflation and labor shortages could delay projects or raise costs.
- Management cited continuing COVID-19 effects, elevated senior-living labor costs, inflation, rising interest rates and recession risk. These could affect occupancy, rent collection, operating costs, property values, financing access and covenant performance.
- Moody’s downgraded DHC’s ratings in February 2022. The company’s revolving debt is floating-rate; a one-percentage-point rate increase was estimated to raise annual interest expense by $7.0 million at the quarter-end balance.
- DHC continues to guarantee certain debt of its Boston life science JV despite deconsolidating that debt. It also disclosed extensive related-party relationships with RMR and AlerisLife, including management arrangements.
- The company reported no material changes to previously disclosed risk factors. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether operating cash flow, SHOP performance and normalized FFO improve enough to support the current distribution and ongoing capital needs.
- How DHC will meet the required reduction in revolver borrowing capacity in January 2023 and refinance or repay the facility at its January 2024 maturity.
- Progress toward the 1.5x debt-service coverage threshold and continued compliance with liquidity and other debt covenants as waivers expire.
- Whether occupancy, labor costs and operating margins improve, particularly in SHOP, and whether Office Portfolio lease rates translate into sustained cash NOI.
- Actual proceeds, restrictions and use of JV/property-sale cash, as well as returns and capital requirements for retained JV interests and redevelopment projects.
- The effect of further interest-rate changes, credit-rating actions, AlerisLife valuation changes and related-party arrangements on DHC’s financial position.