Business Context and Reporting Period
Universal Health Realty Income Trust is a healthcare-focused REIT investing in hospitals, medical office buildings, rehabilitation and behavioral-health facilities, sub-acute facilities, and childcare centers. This Form 10-K covers the fiscal year ended December 31, 2011, including fourth-quarter results. As of February 29, 2012, the portfolio comprised 54 investments or commitments in 15 states: seven hospitals, 43 medical office buildings and four childcare centers.
UHS remained the principal tenant and advisor. UHS accounted for 59% of consolidated revenue in 2011, and leases on UHS hospital facilities represented approximately 55% of consolidated revenue. UHS leases are generally guaranteed by UHS and cross-defaulted.
Key Financial Metrics
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Revenue | $29.5 million | $28.9 million | Up 2.1% |
| Net income | $73.8 million | $16.3 million | Up $57.5 million |
| Diluted EPS | $5.83 | $1.33 | Up $4.50 |
| Funds from operations | $32.5 million | $32.6 million | Down $0.1 million |
| Adjusted FFO | $33.0 million | $32.6 million | Up $0.4 million |
| Cash flow from operating activities | $21.4 million | $23.0 million | Down $1.7 million |
| Dividends paid | $30.7 million | $29.9 million | Up $0.8 million |
| Dividends per share | $2.425 | $2.415 | Up $0.010 |
Reported net income was heavily affected by nonrecurring items: a $35.8 million gain on property divestitures, a $28.6 million gain from purchasing minority interests in LLCs, and a $5.4 million impairment charge. Accordingly, reported net income and EPS are not representative of recurring operating performance. FFO, a non-GAAP measure, was substantially unchanged.
| Balance-sheet and liquidity metric | December 31, 2011 |
|---|---|
| Total assets | $370.9 million |
| Net real estate investments | $288.6 million |
| Cash and cash equivalents | $11.6 million |
| Total indebtedness, including debt premium | $174.8 million |
| Revolving credit borrowings | $77.2 million |
| Non-recourse mortgage and other notes | $97.7 million |
| Available revolver capacity, net of letters of credit | Approximately $59.3 million |
| Outstanding letters of credit | $13.5 million |
The new $150 million revolving credit facility matures in July 2015. The Trust reported compliance with all covenants, including debt-to-total-capital of 29%, debt-service coverage of 39.13x, and debt-to-cash-flow of 1.33x. Approximately $36.9 million of consolidated fixed-rate debt was scheduled to mature in 2012, and the Trust expected to refinance or otherwise fund these maturities.
Hospital leases generated approximately 65% of 2011 revenue. The weighted-average hospital coverage ratio was approximately 5.5x, compared with 5.1x in 2010. Portfolio average effective rent per square foot declined to $23.73 from $24.08, reflecting pressure in the medical office portfolio.
Material Changes Versus the Prior Comparable Period
- Revenue increased modestly, but recurring performance was broadly stable: FFO declined slightly and operating cash flow decreased.
- The Trust acquired four medical office buildings in Texas and Georgia for an aggregate purchase price of $47.8 million, funded partly with assumed debt. The properties contributed approximately $1.8 million of 2011 revenue and approximately $474,000 of net income, excluding transaction costs.
- The Trust acquired the remaining minority interests in 11 previously majority-owned LLCs for approximately $4.4 million and began consolidating them. This produced a $28.6 million non-cash fair-value gain and materially increased reported assets and debt.
- Eight LLCs divested medical office properties during the fourth quarter, generating approximately $33.8 million of net cash proceeds and a $35.8 million gain.
- A $5.4 million fourth-quarter impairment charge was recorded on the Sheffield Medical Building in Atlanta due to lower rental and occupancy expectations and increased competition.
- Net interest expense increased by $463,000, driven by higher average borrowings and a higher effective rate on the revolving facility. Average revolver borrowings rose to $67.8 million from $52.9 million.
- The advisory fee paid to UHS increased to $2.0 million from $1.9 million. The advisory agreement was renewed for 2012 on the same terms, including a fee of 0.65% of average invested real estate assets.
Fourth-Quarter Results, Outlook and Risks
Fourth-quarter revenue was $8.7 million and net income was $62.6 million, including the $28.6 million LLC fair-value gain, the $35.8 million divestiture gain and the $5.4 million impairment charge. Fourth-quarter net income before gains and impairment was $3.6 million.
Management stated that operating cash flow, cash, available revolver capacity, and remaining ATM equity capacity were expected to provide sufficient resources for the next 12 months, including REIT-required distributions. No formal earnings or revenue guidance was provided.
- UHS concentration is the principal credit and tenant risk. UHS’s higher leverage following its acquisition of Psychiatric Solutions could affect its ability to meet lease obligations.
- Healthcare reimbursement changes, including potential Medicare reductions of up to 2% annually beginning in 2013 and continuing Medicaid reductions in several states, could weaken tenants and bonus rents.
- Hospital lease expirations are concentrated in 2014 and 2016. Four UHS hospital leases expire in those years, although renewal options and UHS guarantees apply.
- Medical office occupancy and rental rates remain exposed to local competition and economic conditions. The Sheffield impairment and several below-market renewal expectations demonstrate property-level pressure.
- The Trust depends on capital markets, refinancing, its revolving facility and potential equity issuance to fund acquisitions, commitments, debt maturities and dividends.
- Unconsolidated LLCs had approximately $101.8 million of non-recourse third-party debt and the Trust had approximately $16.1 million of remaining equity and debt financing commitments.
- Three California LLC properties lacked economically acceptable earthquake insurance. The Trust also faces ordinary real estate, tenant default, regulatory, litigation, REIT qualification and related-party conflict risks.
Subsequent events included the January 2012 acquisition of PeaceHealth Medical Clinic for approximately $30.4 million, including assumed financing, and the February 2012 divestiture of Canyon Springs Medical Plaza for approximately $8.1 million of net proceeds and an estimated $7 million gain.
Important Facts for Investors to Verify
- Reconcile reported 2011 net income and EPS to recurring FFO and adjusted FFO, excluding the $64.4 million of aggregate gains and the $5.4 million impairment.
- Review UHS’s financial condition, lease guarantees, renewal options, purchase rights and the effect of UHS concentration on future dividends.
- Confirm refinancing progress for the $36.9 million of 2012 debt maturities and the July 2015 revolver maturity.
- Monitor occupancy, lease expirations, renewal spreads and impairment indicators for the medical office portfolio, particularly Sheffield and properties with 2012 expirations.
- Assess whether operating cash flow and recurring FFO adequately support the $2.425 per-share annual dividend after capital expenditures, LLC funding requirements and debt repayments.
- Track the $16.1 million of remaining LLC financing commitments, $13.5 million of letters of credit and approximately $101.8 million of non-recourse debt at unconsolidated LLCs.
- Review the accounting and comparability effects of consolidating 11 LLCs and divesting eight LLC properties during the fourth quarter.