Diversified Healthcare Trust (DHC) — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise. The filing is unaudited.
Business context and reporting period
DHC is a healthcare-focused REIT with medical office and life science properties, managed senior living communities, and other healthcare-related properties. At quarter-end, it owned 416 properties in 38 states and Washington, D.C., including 24 properties classified as held for sale.
Results are materially affected by the January 1, 2020 restructuring of arrangements with Five Star Senior Living. DHC replaced leases and prior management arrangements for Five Star-operated communities with management agreements, and now reports the communities’ resident revenues and operating costs directly. As a result, the large year-over-year revenue increase is not a like-for-like growth measure.
Key financial metrics
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Total revenue | $442.5 million | $266.3 million |
| Net income attributable to common shareholders | $9.7 million; $0.04 per share | $30.1 million; $0.13 per share |
| Funds from operations (FFO) attributable to common shareholders | $91.3 million; $0.38 per share | $80.4 million; $0.34 per share |
| Normalized FFO attributable to common shareholders | $69.3 million; $0.29 per share | $88.2 million; $0.37 per share |
| Net operating income (NOI) | $125.9 million | $149.1 million |
| Cash from operating activities | $56.3 million | $41.5 million |
| Cash and restricted cash, quarter-end | $85.2 million | $54.8 million |
Q1 2020 GAAP net income included a $22.9 million gain on lease termination, a $9.9 million unrealized loss on Five Star shares, and $11.2 million of asset impairment charges. Normalized FFO excludes the lease-termination gain and certain transaction and debt-extinguishment items. Net income attributable to common shareholders fell 67.6%; Normalized FFO fell 21.5%. NOI declined 15.6%.
Revenue rose 66.2%, primarily reflecting the Five Star restructuring and the inclusion of managed-community resident revenues. Residents fees and services increased to $332.0 million from $108.0 million, while rental income declined to $110.5 million from $158.2 million. SHOP NOI fell 22.8% to $48.1 million; Office Portfolio NOI fell 7.0% to $66.1 million. Comparable Office Portfolio NOI increased 0.8%, while comparable SHOP NOI decreased 21.6%.
GAAP net margin was approximately 2.2% of revenue, versus approximately 11.8% in Q1 2019; these comparisons are affected by the restructuring and unusual items. The filing does not provide a single comparable operating margin measure.
Balance sheet, debt and liquidity
- Total assets were $6.70 billion and total liabilities were $3.92 billion at March 31, 2020. Total equity was $2.79 billion.
- Balance-sheet debt carrying amounts included $585 million drawn on the revolving credit facility, $449 million of term loans, $1.82 billion of senior unsecured notes, and $694 million of secured debt and capital leases. Stated principal debt was approximately $3.67 billion, including $620 million of joint-venture mortgage debt.
- At March 31, DHC had $69.5 million of cash and $415 million available under its $1.0 billion revolving credit facility. By May 6, revolver borrowings had risen to $775 million and availability had fallen to $225 million.
- The $250 million term loan was due in June 2020, with an option to extend six months subject to conditions and a fee. The $300 million senior notes due in December 2021 were the next stated maturity thereafter. DHC redeemed its $200 million notes due 2020 in April, using cash and revolver borrowings.
- Operating cash flow increased year over year, while investing activities used $26.6 million and financing activities provided $3.3 million. Property improvements and acquisitions were partly offset by $16.9 million of property-sale proceeds. DHC paid $35.7 million in shareholder distributions during the quarter.
Material changes, outlook and risks
- COVID-19: Management warned of lower senior-living occupancy and higher labor, supply and protective-equipment costs, along with disruption to some medical office and wellness-center tenants. As of April 30, 46 properties had reported confirmed cases involving 350 residents or tenants and approximately 196 operator or tenant employees.
- Rent deferrals: By May 4, DHC had approved $4.8 million of rent deferrals for tenants whose leases represented approximately 8.5% of annualized rental income. Repayment is generally scheduled in 12 monthly installments beginning September 2020.
- Capital conservation: DHC reduced its quarterly common distribution to $0.01 per share, announced April 2, and expected to defer up to $150 million of planned non-essential 2020 capital investments. Future distributions could remain reduced or be suspended.
- Credit and covenant exposure: S&P downgraded DHC’s issuer rating from BB+ to BB and unsecured debt rating from BBB- to BB+ in March; Moody’s placed the senior unsecured rating under review for downgrade. Borrowing costs increased effective April 1. DHC reported covenant compliance at March 31 but warned a prolonged downturn could pressure compliance and liquidity.
- Asset sales and impairments: DHC recorded $11.2 million of impairments, mainly on properties held for sale. Three properties were sold after quarter-end for $47 million; as of May 6, 27 properties were under sale agreements for approximately $164 million. Management cautioned that sales could be delayed, fail to close, or occur below carrying value.
- Five Star restructuring: Five Star’s management fee is generally 5% of community gross revenue, plus a possible incentive fee. The change in arrangements is expected to make DHC’s senior-living results more variable. DHC held approximately 33.9% of Five Star and measured that investment at fair value; its quarter-end value was $29.7 million.
- Other risks: Risks include tenant defaults, weaker senior-living demand, continued expense increases, refinancing and floating-rate exposure, possible covenant waivers, asset-value declines, and related-party conflicts. Management stated that COVID-19’s ultimate financial impact could not be determined.
Important facts for investors to verify
- How post-restructuring SHOP occupancy, resident rates, costs and NOI trend on a comparable basis, especially as COVID-19 effects develop.
- Whether deferred rents are collected as scheduled and whether additional tenant relief is requested or granted.
- Liquidity after the April note redemption, the June term-loan maturity, and any further revolver draws; also confirm current covenant headroom and financing costs.
- Whether the planned property sales close, their proceeds relative to carrying values, and any additional impairment charges.
- The sustainability of the $0.01 quarterly distribution and the actual timing and scope of deferred capital spending.
- Five Star’s operating and financial condition, the value of DHC’s Five Star investment, and the fees and governance implications of the management relationship.