Business Context and Reporting Period
Universal Health Realty Income Trust is a healthcare-focused REIT that owns or invests in acute-care hospitals, behavioral-health hospitals, medical and office buildings, free-standing emergency departments, childcare centers and specialty facilities. This unaudited Form 10-Q covers the three and nine months ended September 30, 2022, with comparisons to the same periods in 2021.
As of November 1, 2022, the portfolio included 76 real estate investments or commitments in 21 states. UHS and its subsidiaries remain a significant related-party tenant and provide the Trust’s advisory services; UHS-related tenants generated approximately 41% of consolidated revenue in both the quarter and first nine months of 2022.
Financial Performance and Position
| Metric | Q3 2022 | Q3 2021 | 9M 2022 | 9M 2021 |
|---|---|---|---|---|
| Revenue | $22.2 million | $21.2 million | $66.5 million | $62.8 million |
| Net income | $4.8 million | $5.3 million | $15.5 million | $17.6 million |
| Basic EPS | $0.35 | $0.39 | $1.12 | $1.28 |
| Diluted EPS | $0.35 | $0.39 | $1.12 | $1.27 |
| FFO | $11.8 million | $12.6 million | $36.4 million | $38.0 million |
| FFO per diluted share | $0.86 | $0.92 | $2.64 | $2.76 |
| Net cash from operations | Not provided | Not provided | $34.5 million | $36.2 million |
- Net margin was approximately 21.9% in Q3 2022 versus 25.2% in Q3 2021, and approximately 23.3% for the first nine months versus 28.0% in the prior-year period.
- Interest expense was $2.8 million in Q3 and $7.4 million for the first nine months, compared with $2.3 million and $6.6 million, respectively, in 2021.
- Cash and cash equivalents were $8.1 million at September 30, 2022, down from $22.5 million at December 31, 2021.
- Net real estate investments and the UHS financing receivable totaled $533.5 million at September 30, 2022, compared with $520.6 million at year-end 2021.
- Total liabilities were $375.7 million and total equity was $233.6 million at September 30, 2022.
- The Trust declared and paid $0.71 per share in third-quarter dividends and $2.125 per share for the first nine months. Operating cash flow exceeded dividends paid by approximately $5.2 million for the first nine months.
Debt, Liquidity and Capital Resources
- The $375 million revolving credit facility matures July 2, 2025. Borrowings were $290.1 million, letters of credit were $3.1 million and available capacity was $81.8 million at September 30, 2022.
- Non-recourse mortgage debt was $50.3 million, net, versus $56.9 million at December 31, 2021. The Trust repaid a $5.1 million mortgage in June 2022 using revolver borrowings.
- Two non-recourse mortgages totaling approximately $9.3 million mature within the next twelve months. Management intends to repay one with revolver borrowings and refinance the other.
- The Trust was in compliance with all credit agreement covenants. Total leverage was 42.8%, secured leverage was 6.3%, unencumbered leverage was 41.6% and fixed-charge coverage was 4.6x.
- Interest-rate swaps with aggregate notional amounts of $140 million had a net fair-value asset of $12.5 million. Management estimated that a 1% change in interest rates would affect net income by approximately $1.5 million, after giving effect to the swaps.
- Investing cash outflows included $13.6 million for acquisitions and $16.7 million for real estate additions, including construction of Sierra Medical Plaza I. The project cost is estimated at $34.6 million, with $16.9 million incurred through September 30, 2022.
Material Changes Versus the Prior Comparable Period
- Revenue increased 4.5% in Q3 and 5.9% for the first nine months, primarily from consolidating Grayson Properties, the Wellington Regional Medical Center lease renewal, and the UHS asset exchange involving Aiken Regional Medical Center and Canyon Creek Behavioral Health.
- Net income declined $496,000 in Q3 and $2.1 million for the first nine months. Drivers included the loss of revenue from the vacant Chicago specialty hospital, higher interest expense, and the absence of a $1.3 million real estate sale gain recognized in 2021.
- FFO declined $816,000 in Q3 and $1.6 million for the first nine months.
- Interest expense rose primarily because average revolver borrowings increased and the average effective borrowing rate increased to 3.71% in Q3 2022 from 1.73%, and to 2.61% for the first nine months from 1.68%.
- Three specialty facilities in Chicago, Evansville and Corpus Christi remained vacant. The Chicago lease expired December 31, 2021, resulting in approximately $1.1 million of operating expenses during the first nine months of 2022 without corresponding rental revenue.
- The Trust acquired two medical office buildings in 2022 for approximately $13.4 million in aggregate. No property divestitures occurred during the first nine months of 2022.
Outlook, Commentary, Risks and Unusual Items
Management stated that operating cash flow, cash, available revolver capacity and capital-market access are expected to provide sufficient resources for operating needs, capital expenditures, acquisitions, debt requirements and REIT distributions for the next twelve months. Future dividend levels will depend on operating results, capital commitments, debt repayments and REIT distribution requirements.
- Revenue and cash flow are materially concentrated in UHS. UHS-related tenants accounted for approximately 41% of consolidated revenue in 2022, and UHS also serves as the Trust’s advisor and employs all of its officers.
- UHS hospital leases include renewal, purchase and right-of-first-refusal provisions. Nonrenewal or property purchases by UHS could reduce future revenue if replacement tenants or investments are not secured on comparable terms.
- Healthcare tenant performance is exposed to COVID-19 developments, labor shortages, higher temporary staffing costs, supply-chain pressures, reimbursement changes, regulatory requirements and payer-mix changes.
- Inflation and rising interest rates may increase tenant costs, borrowing costs and construction costs, potentially affecting rent payments, property values, acquisitions and lease renewals.
- The three vacant specialty facilities may require continuing operating costs and potentially significant renovation or demolition expenditures. Management estimated approximately $900,000 of aggregate operating expenses for these facilities during the final three months of 2022.
- The Sierra Medical Plaza I development is expected to open in the first quarter of 2023. Its master flex lease with UHS covers approximately 68% of rentable space initially and is subject to reduction as third-party leases are executed.
- The Trust has no salaried employees; officers are UHS employees, creating potential related-party conflicts of interest. The Advisory Agreement was renewed for 2022 on unchanged terms.
Important Facts for Investors to Verify
- Whether UHS tenants maintain rent payments, renew leases and exercise any purchase or substitution rights, particularly for hospital and emergency-department properties.
- The refinancing or repayment of the mortgages maturing in December 2022 and January 2023, and the effect of higher rates on revolver interest expense.
- Progress, total cost, leasing and opening timetable for Sierra Medical Plaza I.
- Occupancy, operating costs and any disposition or redevelopment plans for the three vacant specialty facilities.
- The sustainability of the $0.71 quarterly dividend relative to operating cash flow, capital spending, acquisitions and debt maturities.
- The effect of healthcare labor shortages, inflation, reimbursement policy, COVID-19 developments and UHS operating performance on tenant credit quality and rental revenue.
- Compliance with credit facility covenants and the remaining $81.8 million of borrowing capacity, including the impact of future borrowings on leverage and liquidity.