DIVERSIFIED HEALTHCARE TRUST quarterly report, Q3 FY2016

Business context and reporting period

This is Senior Housing Properties Trust’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2016. The supplied metadata names Diversified Healthcare Trust, but the filing identifies the registrant as Senior Housing Properties Trust. The REIT owned 431 properties in 42 states and Washington, D.C., across senior living communities, medical office buildings (MOBs) and wellness centers.

Key financial metrics

Unless otherwise noted, amounts below are in millions of dollars; comparisons are with the same 2015 period.

Revenue grew 3.4% in Q3 and 7.2% over nine months. Operating margin was approximately 26.8% in Q3 versus 30.3% a year earlier; nine-month margin was 27.6% versus 31.4%. Net income fell 27.0% in Q3 and 14.0% over nine months. Nine-month FFO rose despite the GAAP earnings decline; FFO and Normalized FFO are non-GAAP measures and are not cash flow or liquidity measures.

• Cash flow: Nine-month operating cash flow was $342.4 million, up from $320.8 million. Investing used $231.8 million, compared with $1.20 billion in 2015; financing used $107.5 million, compared with $909.0 million provided in 2015. Cash and equivalents were $40.8 million at quarter-end.
• Liquidity: The $1.0 billion revolving facility had $215.0 million drawn and $785.0 million available at September 30. The company reported $6.3 million of restricted cash separately.
• Debt: Balance-sheet carrying values included $215.0 million on the revolver, $546.9 million of term loans, $1.722 billion of senior notes and $1.169 billion of secured debt and capital leases. Total liabilities were $3.991 billion. Debt fair value exceeded carrying value for senior notes and secured debt. The company said it was in compliance with debt covenants.
• Property operations: Q3 NOI was $160.6 million, up from $158.3 million. Senior living occupancy was 85.8% overall versus 86.4%; MOB occupancy was 95.9% versus 96.0%. Triple-net senior living rent coverage was 1.33x versus 1.36x.

Material changes versus the prior comparable period

• Q3 revenue gains in all major lines were outweighed at the operating-income level by higher property operating costs, depreciation and impairment. Interest expense increased to $43.4 million from $39.0 million.
• Managed senior living NOI declined 2.9% in Q3 to $23.7 million; comparable-property NOI also fell 2.9%. Occupancy eased, while operating costs rose, including higher Five Star management fees under amended arrangements effective July 1, 2016.
• MOB revenue rose 4.8% in Q3, but property operating expenses increased 14.4%; comparable-property NOI declined 0.6%. MOB interest expense increased following new secured financing.
• Nine-month impairment charges were $16.9 million, versus a $0.1 million impairment reversal in 2015. Charges included write-offs following lease defaults and reductions in carrying values of properties sold or held for sale. The 2016 period also included a $4.1 million gain on sale of a skilled nursing facility.
• Debt financing changed materially: the company issued $250 million of 6.25% senior notes due 2046 and obtained $620 million of secured financing at a weighted-average fixed rate of 3.53%, using proceeds partly to repay revolver borrowings. Nine-month real estate acquisitions were $188.5 million, versus $1.13 billion in 2015.

Outlook, commentary, risks and unusual items

• Management said available cash, revolver capacity and operating cash flows should fund operations, debt service, capital spending and distributions for the next 12 months and foreseeable future. This is management’s expectation, not a guarantee; no earnings or FFO guidance was provided.
• The quarterly distribution remained $0.39 per share; a further $0.39 distribution was declared after quarter-end. Nine-month distributions paid were $277.8 million, below operating cash flow but significant relative to earnings and capital needs.
• Five Star was the largest tenant: its rent represented 19.1% of Q3 revenue, and leased properties were 29.7% of real estate investment cost. Five Star also managed 63 communities for the company. The filing highlights related-party relationships with Five Star and RMR, and notes that negotiated terms may not be equivalent to arm’s-length terms.
• Senior living occupancy, resident rates and tenant finances face pressure from economic uncertainty and new competing developments. Medicare/Medicaid policy and regulatory changes may increase operator costs; the filing describes new long-term-care requirements and potential reimbursement impacts.
• Floating-rate debt exposes earnings to LIBOR increases. A 100-basis-point increase was estimated to raise annual floating-rate interest expense by about $7.7 million at quarter-end borrowings, or $15.5 million if the revolver and term loans were fully drawn, before other effects.
• Pending or subsequent events included a proposed acquisition of two Illinois communities for about $18.6 million, an October MOB acquisition for about $18.5 million, and October mortgage prepayments. Completion of certain transactions remained conditional.

Important facts for investors to verify

1. Confirm the filing entity and reporting history: this 2016 filing is for Senior Housing Properties Trust, notwithstanding the metadata’s Diversified Healthcare Trust name.
2. Assess Five Star’s ability to pay rent and manage properties, including the effect of its occupancy, rent coverage, financial condition and the company’s tenant concentration.
3. Review debt maturities, refinancing access, covenant headroom and the consequences of higher interest rates; the revolver was due in January 2018, with a conditional one-year extension option.
4. Evaluate whether operating cash flow can sustain the distribution while funding property improvements, leasing commitments, debt repayments and acquisitions.
5. Examine the impairment assumptions, defaulted leases and held-for-sale assets, as well as the durability of managed-community and comparable MOB operating performance.
6. Review related-party agreements and governance safeguards, including the revised Five Star pooling and management arrangements and the company’s relationship with RMR.