Diversified Healthcare Trust (DHC) — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. The filing also reports fourth-quarter results. DHC is a healthcare-focused REIT with 424 properties in 39 states and Washington, D.C., spanning medical office and life science properties, senior living communities, and wellness centers. Gross book value of real estate assets was $8.4 billion at year-end.
Financial performance and position
- Revenue: $1.040 billion, down 6.9% from $1.117 billion in 2018. Rental income declined to $606.6 million from $700.6 million; resident fees and services rose to $433.6 million from $416.5 million.
- Profit: Net loss attributable to common shareholders was $88.2 million, or $0.37 per share, versus net income of $286.9 million, or $1.21 per share, in 2018. Results included $115.2 million of impairment charges, $41.9 million of net losses on equity securities, and $39.7 million of property-sale gains. The prior year included $261.9 million of property-sale gains.
- Operating measures: NOI was $551.1 million, down 17.2% from $665.6 million. NOI as a share of revenue was approximately 53.0%, compared with 59.6% in 2018. FFO per share was $1.25 and Normalized FFO per share was $1.31, both below $1.59 in 2018; these are non-GAAP measures.
- Fourth quarter: Revenue was $256.0 million; net loss attributable to common shareholders was $51.7 million, or $0.22 per share. The quarterly distribution declared was $0.15 per share.
- Cash flow: Cash from operating activities was $265.8 million, down from $392.8 million in 2018. Investing activities provided $86.2 million, including $254.2 million of property-sale proceeds and $98.6 million from selling RMR Inc. shares, offset by $222.4 million of real estate improvements. Financing activities used $369.9 million. Cash and restricted cash ended the year at $52.2 million.
- Debt and liquidity: Consolidated indebtedness was $3.50 billion; net debt to total gross assets was 42.5%. DHC had $537.5 million drawn and $462.5 million available on its $1.0 billion revolving credit facility at year-end. Total assets were $6.65 billion and total equity was $2.88 billion. Management stated that expected cash sources were sufficient for operating and capital expenses, debt service, and distributions over the next 12 months and foreseeable future, subject to the risks described in the filing.
- Distributions: Declared distributions totaled $0.84 per share in 2019, down from $1.56 in 2018. On April 18, 2019, DHC reduced its regular quarterly rate to $0.15 per share, or $0.60 annually. The board retains discretion to change the rate.
Material changes versus 2018
- NOI fell 17.2%. SHOP NOI decreased 29.7% to $214.8 million, mainly reflecting reduced rent from Five Star under the restructuring agreement, dispositions, and higher operating costs. Office Portfolio NOI declined 4.4% to $272.7 million; comparable occupancy decreased to 93.9% from 94.9%.
- Senior living occupancy was approximately 85.0% for all SHOP properties, versus 86.1% in 2018; comparable-property occupancy was 85.7%, versus 86.3%.
- Operating cash flow declined, while impairments increased and property-sale gains were substantially lower. General and administrative expense fell to $37.0 million from $85.9 million, principally because no business-management incentive fee was recognized for 2019.
- DHC sold 46 properties in 2019 for aggregate sales prices of $260.8 million, excluding closing costs, and had 33 properties classified as held for sale at year-end. In February 2020, 52 properties were under sale agreements or in first- or second-round offer stages, with estimated aggregate sales proceeds of approximately $539.7 million; completion and pricing were not assured.
Restructuring, outlook, and key risks
- Effective January 1, 2020, DHC replaced its Five Star master leases and prior management arrangements with management agreements covering Five Star-operated senior living communities. DHC now bears the operating and capital requirements for communities formerly leased to Five Star, making their results more directly exposed to occupancy, labor costs, and operating performance. Five Star receives a 5% fee on gross revenue, expense reimbursement, and a capped incentive fee tied to combined community EBITDA.
- As part of the transaction, Five Star issued shares to DHC and DHC shareholders; DHC assumed $75.0 million of Five Star working-capital liabilities. DHC’s reported ownership of Five Star rose to 33.9% on January 1, 2020, and it expects to account for the investment under the equity method.
- Management gave no numerical earnings or operating guidance. It expects to invest further in senior communities to improve competitiveness and returns, and to pursue property sales to reduce leverage before resuming selective capital recycling. Outcomes depend on successful sales and property performance.
- Debt ratings were downgraded in 2019: S&P lowered DHC’s issuer rating to BB+ while reaffirming senior-note ratings at BBB-; Moody’s lowered its unsecured rating to Ba1. DHC had $200 million of 6.75% notes due April 2020 and a $250 million floating-rate term loan due June 2020, with an extension option subject to conditions. It expected to fund the notes maturity with revolving-credit borrowings and disposition proceeds.
- Other significant risks include Five Star’s ability to manage communities profitably, labor and insurance cost inflation, senior-living competition and occupancy trends, healthcare regulation and reimbursement, interest-rate and LIBOR transition risk, access to capital, property-sale execution, and potential conflicts arising from related-party management arrangements with RMR and Five Star.
- The company reported no litigation expected to have a material adverse effect. The auditor issued unqualified opinions on the financial statements and internal control over financial reporting; the critical audit matter was real estate impairment testing, which depends on estimates including market rents, holding periods, and capitalization rates.
Important facts for investors to verify
- Whether announced property sales close on expected terms and proceeds are used to reduce leverage.
- Post-conversion SHOP performance: occupancy, resident fees, labor and other costs, capital requirements, and Five Star’s management results.
- Liquidity and refinancing plans for the 2020 maturities, revolving-credit availability, covenant compliance, and any effects of further rating changes or floating-rate increases.
- Whether cash available for distribution supports the current $0.15 quarterly rate; compare distributions with Normalized FFO and cash flow rather than GAAP earnings alone.
- Assumptions and estimates behind the $115.2 million of 2019 impairments, and the potential for further write-downs or sale losses.
- Terms and governance of DHC’s related-party arrangements with RMR and Five Star, including fees, oversight, and conflicts of interest.