Q3 2020 Diversified Healthcare Trust Earnings Call

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Good day and welcome to the diversified healthcare Trust first quarter 2020 financial results Conference call.

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I'd now like to turn the conference over to Michael Kodesch Director of Investor Relations. Please go ahead.

Thank you welcome to diversified healthcare trust call covering the third quarter 2020 result, running.

Joining me on today's call are Jennifer Fred the President and Chief operating Officer, and Rick Sidel, Chief Financial Officer and Treasurer.

Todays call includes the presentation by management, followed by a question and answer session.

I would like to note that the transcription recording and retransmission of today's conference call are strictly prohibited without the prior written consent of diversified health care Trust or DHC.

Today's conference call contains forward looking statements within the meaning of the private Securities Litigation Reform Act of 1995 and other securities laws.

These forward looking statements are based upon the age sees present beliefs and expectations as of today Thursday November five 2020.

The company undertakes no obligation to revise or publicly release the results of any revision to the forward looking statements made in today's conference call other than through filings with the Securities and Exchange Commission or SEC. In addition, this call may contain non-GAAP numbers, including normalized funds from operations or normalized FFO EBITDA EBITDARM and.

Cash basis, net operating income or cash basis and Hawaii.

Reconciliations of net income or loss attributable to common shareholders to these non-GAAP figures and the components to calculate AFFO CAD or fad are available in our supplemental operating and financial data package found on our website at Www Dot DHC re Dotcom Act.

Actual results may differ materially from those projected in any forward looking statements additional information concerning factors that could cause those differences is contained in our filings with the SEC.

Investors are cautioned not to place undue reliance upon any forward looking statements now I'd like to turn the call over to Jennifer.

Thank you Michael and good morning, welcome to diversified Healthcare Trust third quarter 2020 earnings call.

In the quarter, we saw the continuation of the COVID-19 pandemic and its significant effect on our senior housing operating portfolio.

As we see increased new cases in the United States. We are appreciative of the steps that are operator has taken to ensure the ongoing safety and well being of the residence Inn employees in these communities.

Im pleased that our intentional diversification of our holdings to include a large medical office and life Sciences portfolio and steps taken earlier in the year to enhance liquidity have helped us to withstand the challenges that the senior living industry is facing during these unprecedented times.

Related line items account for an approximate $19 million decrease in Normalised SFO from our shop segment.

Or eight per share when compared to the second quarter.

We expect that expense pressures to persist in the near term and to dissipate as the pandemic Wayne.

In the past, we've seen that sacrificing right for occupancy has led to longterm revenue deterioration.

Now with our support five-star remains committed to optimizing revenue rather than managing to occupancy.

While we acknowledged that a commitment to this strategy may way on near term results. We believe we will be better positioned in the future compared to communities that are offering material rent reductions in order to grow occupancy.

Five stars currently working with additional referral sources to attract new residents to grow occupancy without undermining right.

We've seen a resulting 35% increase and leaves in the third quarter with conversion rates consistent with pre pandemic rates.

Third quarter move ins increased 31% over the second quarter, though move out exceeded move in.

The impact of this COVID-19 related to occupancy loss resulted in same property shop portfolio revenues that were down $13 million from the second quarter are approximately five per share and normalized FFL.

Same property revenues were down 11, 6% from the prior year driven by a decline an average occupancy to 76, 3%, partially offset by a 20 basis point increase in right.

<unk> same property shop average occupancy was down 355 basis points or approximately 27 basis points per week.

Looking ahead, we expect operational headwinds to persist.

While 97% of our managed communities are currently open for admissions. The majority of residents moving into our communities today are largely needs based although we believe there is pent up demand from those seniors that are deferring their move in decisions.

While utilities were seasonally higher relative to the second quarter. There were additional co formulated with utilities expenses in the third quarter driven by greater use of HPC systems to filter air and provide for safer office environments.

These decreases were partially offset by $700000 increase in parking over the second quarter as use of our garage is in the seaport district of Boston and at the Cedars Sinai Medical office property increased as utilization of those of space in those buildings increased.

During our second quarter call, we reported that DHC had granted rent deferrals equal to $2.4 million in the office portfolio segment as of August Threerd, representing only 0.6% of the annualized revenue from this segment.

As of November 2nd deferrals have fallen by just under $600000 to $1.8 million or <unk>, 0.5% of annual revenues as a result of renegotiation of our number of leases that were renewed for additional term in exchange for some form of deferral.

As previously previously mentioned, our wellness center portfolio, which represented 3.8% of third quarter and Hawaii had one tenant defaults at the start of the second quarter. We continue to work with this tenant on its arrearages and its plan to become current on rent.

Our triple net senior living portfolio, which represented 9% of our third quarter and aligned continues to perform.

There have been no new rent deferrals outside of the partial rent deferrals granted for one tenant that was announced during our first quarter call.

These properties had rent coverage of 1.63 times in aggregate as of the second quarter of 2020 compared to 1.66 times in the first quarter.

Since the beginning of the third quarter, we completed at $61.4 million of asset sales, bringing our disposition total to approximately $390 million since the program began.

Today, we have properties under agreement to sell with negotiated proceeds totaling approximately $167 million.

I will now turn the call over to Rick to provide details on our financial results. Thanks.

Thanks, Jennifer and good morning, everyone.

Since jennifer's explain the causes of change in Hawaii that impacted our normalized FFO I wanted to touch upon some of the other activity in our income statement.

In the third quarter, we recognized approximately $64 million of impairment charges largely related to 10 senior living communities, we identified for closure and our sales.

These communities incurred $4 million of operating losses during the third quarter of 2020, and we and our operator concluded our portfolio would be stronger without continuing to operate these communities.

We also recognized a reduction in Hawaii totaling $6.2 million during the third quarter related to a Medicare billing matter. The five stars compliance program discovered related to a skilled nursing unit at one of our senior living communities.

This reduction was recognized as a $4 million decrease in resident fees and services revenue and a $2.2 million increase in property operating expenses for the expected penalties and other costs related to this matter.

Interest expense was $58.1 million for the third quarter of 2020 up $13.3 million year over year and $14.1 million sequentially from the second quarter.

These increases were primarily due to the $1 billion of senior notes issued in June of 2020, offset by lower revolver and term loan interest.

The June notes issuance was done to enhance our liquidity and we ended the third quarter with approximately $82 million of cash on hand, and the full $1 billion of available capacity on our revolving credit facility.

Our next debt maturity is not until December of 2021.

We have ample liquidity, we continue to invest capital in our existing portfolio.

Despite the pandemic in the third quarter, we spent $45.1 million on capital expenditures, an increase of seven and a half million dollars over the second quarter.

Approximately $25.4 million of our third quarter spend was considered recurring and included building improvements in both our office portfolio and shop segment and tenant improvements and leasing costs in our office portfolio.

The remaining portion of our capital expenditures was spent on redevelopment capital projects.

This included $14.8 million of redevelopment capital in our office portfolio, primarily related to the redevelopment of our life Science campus and Torrey Pines.

We invested only $5 million of reading Redevs redevelopment capital in our shop segment.

As koby 19 related visitor restrictions continue to limit our ability to spend capital inside many of our communities.

Lastly, I want to touch on rent collections, which continued to be strong in our office portfolio over 99% of our contractual rents do were collected during the quarter and in October.

That concludes our prepared remarks, operator, please open up the line for questions.

We will now begin the question and answer session.

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At this time, we will pause momentarily to assemble our roster.

Our first question comes from Vikram Malhotra with Morgan Stanley. Please go ahead.

Hi, Thanks for taking the questions.

Maybe just what would be nice to just get your thoughts on that.

The metrics as the shelf metrics.

Going into sort of the fourth quarter.

The you in your view the puts and takes sort of an occupancy you mentioned the you know your views on risk for but how do you think about.

You know the intersection between sort of ready for an.

An occupancy going into the fourth quarter, especially as you know covert gets has continued to increase and into the flu season is on us.

Thanks Vikram for your question.

We're expecting occupancy to continue to decline.

No I said that we had occupancy declines of 27 basis points per week and were expecting.

That to to slow a bit, but we think it will be still you know in the.

24, 25 basis points per week.

Hi, Jeff.

We are still in the middle of a pandemic.

And we're working hard five star is working hard to attract.

Residents to the communities and it's really a combination of confidence.

The confidence of prospective residents that they'll be safe in senior living communities. In five star has worked very hard to with their protocols and infection control to ensure that residents do feel safe that combined combined with the approval availability distribution and public.

Acceptance of an effective vaccine I.

I think well will be but what.

Drives change and and stops this decrease in occupancy.

Okay that makes sense and then I guess just on the on the penalty maybe you can just get a bit more in give us a little bit more color or kind of how.

That was discovered and you know kind of what what are you doing going forward to kind of may be remedied that as.

As well as maybe just a broader topic around operator diversification something I guess you know in the past you've talked about its potentially a a goal, but just kind of how you think about those two issues.

Hi, Vikram. This is this is Rick maybe I'll take a stab at that the first piece on the on the Medicare penalty.

You know I think we all know healthcare is highly regulated and therefore, it's important that senior living providers have strong internal plans program.

We believe five stars compliance program is effective and can identify and address potential issues timely.

And that's really what we've seen here.

The Oh, Gee and CMS have a process for providers to voluntarily disclose and refund any overpayments.

And that's really what's happened here. So so five stars compliance program detected an issue.

And we have dealt with the issue. So this is I believe the first time our shop portfolios had this I mean, it's somewhat common in the in the healthcare space.

But there are a lot of procedures and controls in place to avoid this to correct anything before it's a problem.

And we're confident that that will continue in place.

On Vikram on operator diversification you know we have a great deal of faith in five star and you know that their senior management team in turning five star around they've been extremely focused on cobot containment and avoidance.

But I think it's important to point out that.

Five star was was in the midst of other turnaround when the pandemic hit and while they have folks that are very focused on COVID-19. They still have a core group of people in the corporate office, who are focused on the turnaround so were not likely to diverse.

Hi away from five Star what I'd say is how we will.

Will diversify would be continuing to to move into medical office and life Sciences at some point. So that's that that's how we diversify our portfolio.

Okay Fair enough and just last one if I may.

But whether the vaccine announcement, then that venture distribution you know as it is it is it three months away six or 12 months. You know eventually we do get the vaccine and Alco P. occupancy stabilizes somewhere in the next three to six months.

But as you as you look to sort of rebuild the port rebuild the funding, but fundamentally I'm. Just wondering how you think about kind of occupancy versus rent and you alluded to this in your comments, but what we're seeing today versus maybe in the next year or how do you look to sort of fill back up.

Oh youre the occupancy that you've lost.

I think that that.

Five star continues to work with referral sources.

To to.

The attract potential residents to the communities they've hired a director of marketing who will help with that endeavor.

It's converting those those leads into move ins and so I think that again, the fact that they've been very focused on the safety of their residents will will help them.

Also they've they're very focused on providing that exceptional revenue I mean, sorry resident experience and and so I think that that also.

Well hell up and and.

And then they'll be concessions, but we don't see concessions as being reduced rent because that that just.

You know deteriorates profits and so or profitability, so I think that they'll be coming.

Concessions that are offered such as you know free rent upfront to try to attack attract residents.

Okay, great. Thank you. Thanks.

Our next question comes from Brian Meredith B. Riley Securities. Please go ahead.

Yes, good morning, and certainly a lot of information to unpack here, but.

Thanks for that kind of building on that occupancy question you know once we get a vaccine.

Can you give us an idea of how quickly you think occupancy can ramp back up given that you made the comment that you are seeing you know building demand out there that that's not showing up yet, but but there so what would be the pace of occupancy that operate do you think.

You know, it's hard to know exactly what the pace will be Brian, but what I would say is we're seeing an increase in move ins already it's just that move outs have.

Exceeded move ins so.

You know, it's hard to say exactly how how quickly will reoccupy, but but I think that that was the focus that five star has on.

Leads and the and working with referral sources I think that it will the bill increase.

You know it at a good clip.

The in <unk> can you give us some idea on.

On those competitors that are cutting rate you know how much are they cutting 5%, 10% 20%.

I think it's all over the board I think that there are folks that are are being very aggressive to to grow occupancy, but we just think that's a very dangerous. It's a slippery slope. So we're not gonna not going to head down that road.

Okay, and shifting gears to Torrey pines and congratulations for you know wrapping that up here you talked a little bit about the initial lease and the roll up in rent I think you might have said it was 20% maybe I wrote that down a lot but.

But how does that equate to what your free redevelopment expectations were for that property.

You did not write it down wrong. It is close to a 20% roll up in rent. We were when we first started working on I'm running the numbers for this potential redevelopment I think we were talking 5% to 7% roll ups in rents.

And the market has strengthened.

Every quarter, we hear about the occupancy gain.

Growing you know they can see tightening up and.

And there's just there are a lot of life sciences tenants in that market looking for space and so our pipeline is strong and we hope to continue to see these to be strong roll ups.

Okay and last for me and I don't know maybe this is for Rick.

You guys have now like almost a billion to one up liquidity and I know you took down that that big you know nugget and in the middle of the summer do you think you took down too much debt at the higher rate and what if any are opportunities to cut into that I think I read a footnote that you.

You can't prepay that until 2025, but is there something that you can do you know with all this liquidity or do you just have plans for it or you just need it as comfort for the next two to three quarters, Togo cobot wage.

Thanks, Brian I think so the the billion dollars of senior notes that we issued in June were five year non call too. So we do have the ability to take them out after two years and.

And we did that for the for the flexibility we didn't know how long the pandemic would go if this were to drag on for two years, we'd be really thankful that we didnt have a two year maturity on that but at the same time, it's fairly expensive and we're looking forward to refinancing it at lower rates.

So I think you know at this stage in the game not knowing you know if and when a vaccine will be available when confidence for seniors to go back into senior living communities, well, we're really rebound.

You know I think our position is better safe than sorry.

We like having that additional liquidity right now we are still investing in our properties. It is again a bit of a challenge to get into some of the senior living communities, but we are taking care of as much of the you know historically deferred capital as possible.

Again, I think we our next debt maturity isn't until December of 2021, but we do have the ability to take it out at par in June so.

So that's something that we'll look to do to reduce interest expense a bit.

But again given the circumstances it feels good to have a lot of liquidity available to us.

Okay. Thank you. Thank you.

Our next question comes from Michael Carroll with RBC capital markets. Please go ahead.

Yeah can you talk a little bit of bounce the referral services that you are using within your shop portfolio right. Now I guess two are those services and what's the incremental cost to use those and I guess why start using them now or why won't you use human three to six months ago.

It's it's something that we've been they were using them three months ago, I think that they're getting more than the referrals have had increased leads are up 35% over this the second quarter, you know six months ago.

I'm not sure that anybody was moving in or very few people, who are moving in our move ins where need space and we we felt like they didnt need the reef referral sources at that point, it's it's companies like a place for mom.

And the you know the fees are.

One one month's rent or so.

Okay. So these are new relationships. These are relationships that you just need to go on more as of now compared to the early part of the paradigm is that correct well I would say in the early part of the pandemic that we find start really wasn't using these referral sources they were.

Getting leads or you know getting occupancy or perspective residents through other sources.

Just more and more of the typical sources that a place for mom or some of these referral sources I think historically have been.

You tend to have gotten a shorter length of stay people tend to use those referral sources. When there. They are really in trouble and ours ours are looking for quick help for someone who who really needs. It.

I think that's changed a bit throughout the pandemic and so they are finding that the leads that they're getting are are better leads than they used to get from these referral sources.

Okay, and then what type of concessions are you offering within the portfolio right now and I guess, maybe how does that differ between your assistant living your memory care in your aisle product I mean are you offering more concessions in that aisle in active adult products, just because it's slower judean and those residents don't necessarily need to do that.

Right No that's right that's exactly right.

People moving into memory care, and assisted living or really needs based and so there are less concessions necessary in those two functions separately independent living and and active adult it it's free rent up front.

So how much free rent or are you willing to offer and I guess, how does that compare against some of the competition in the market and the mean or other competitors offering a free rent you are there actually offering lower face rates.

It varies across the portfolio and it varies per market, but but its a combination <unk> where we're.

Really working to not lower our face right, but to offer one or two months free rent.

I think that some competitors are offering lower rates and maybe a shorter free rent period.

So net effective might be the same but we find that that yeah.

Our I think our average length of stay now has.

It's increased actually and that's about 28 months or so and and so with that longer length of stay having a reduced face rent just different base rate doesn't doesn't work, we'd rather see it free rent up front and then move on to the to a higher face rate.

Okay, and then can you talk a little bit about your your occupancy trend obviously, it's moderating a bit did that continue in October can you give us what's the October occupancy declines is there an expectation that this trend will continue to moderate in the fourth quarter. There is an expectation that it will continue to moderate.

Well.

We don't really give guidance, but I think that we've been talking about maybe a 24 basis point drop per week move ins are up but unfortunately move outs or are.

Our Uh huh.

Mitigating that those move in.

Okay. So can you give us the actual occupancy decline in October do you have that.

I don't have the that number in front of me.

Okay.

And then I guess last question you talked a little bit about the expense trends I mean, I think it was lower in the second quarter, just because of lower health care costs, What's your employee base, but higher in the third quarter.

I guess should that normalize in the fourth quarter or how should expenses be trending or what's a good run rate there.

Yes.

Mike I think will continue to to see.

Expense pressure during the pandemic.

Just within the health care costs I mean, so much of it was related to covert testing.

Think five stars Don you know 146000 coven tests over the last few months you know obviously the testing for the employees is on us generally unless they're covered by someone else's insurance, which seems.

Likely.

We also had a number of team members that that had that contracted virus immediate care and that not certainly added there.

There was also as you can imagine a number of doctors appointments that has been deferred from Q2 and everything was shutdown and some of that got rescheduled to three.

I believe we expect that to continue.

At least through the fourth quarter were hopeful that it will moderate a bit as well as the pandemic Wayne Mike.

I think its probably safe as to expect the expenses to stay relatively consistent you know aside from the the.

The Medicare penalty that we booked and things like that.

Okay. Thank you.

Thank you.

Your next question comes from Kyle I'll start with clear Securities. Please go ahead.

Great. Thanks for taking the questions and good morning.

So.

Regarding the a the updates on the nine dispositions for a little over 60, more 61 million and that the 21 properties that are under agreement to sell for little over on and 65 million can can you provide some additional color maybe on the make up of the season and what the timing expectations are for.

The properties that are under agreement to sell.

Sure. It's a mix of properties out of our office portfolio segment and senior living so it's it's it's really spread across those two segments.

And our expectations for closing.

Our.

All by year end now some of those might slip into the first quarter, but for the most part were thinking year end.

Close, okay got it and and longer term I'm, sorry, if I missed this but how should we think about the goal for total dispositions can can you talk about maybe the percentage of the current portfolio, you're targeting or maybe a dollar value go I'm just trying to get a sense of the cadence so over the coming quarters.

Sure you know, we still have a disposition goal of 900 million in total and so.

No. We're just we're really waiting for the the pandemic you know for a vaccine that's available in.

You know distributed and accepted bye bye folks in the country before we start actively marketing we are always in conversations with brokers about these these properties. The brokers that we've hired who are kind of on hold right now as to when the right time to hit the market is we think it's not.

Right now I'm, so it's likely going to be you know I'm, hoping.

Probably you know maybe second quarter of next year early second quarter.

Got it and I'm not make sense and.

And lastly, it it sounds like the life science portfolio continues to be a tailwind which is great can you talk about the continued demand among life science tenants that you're seeing and maybe any additional interest you received for the Torrey Pines development in particular.

Yeah. It's you know the life Sciences portfolio continues to be very strong as does our medical office portfolio. The life Sciences portfolio same store or same property. It's about 97% occupied we have an incredibly robust pipeline for the Torrey pines.

Property in the life Sciences market it.

<unk> continues to be.

Very strong across the country, obviously and you know most pronounced strength in the Boston, Cambridge, San Francisco, San Diego markets.

But you know.

We just we see just ongoing success in that portfolio.

Okay understood great well that's it from me thanks for all the updates here. Thank you.

Okay, and if you'd like to ask a question. Please press Star then one.

Our next question comes from Joshua Dennerlein with.

Bank of America. Please go ahead.

Hey, good morning, Jennifer Rick and good morning.

I guess, you mentioned new balance and senior housing was elevated I'm curious what what you are seeing some kind of primary drags that within your portfolio.

Well.

No. Unfortunately move outs are generally, especially.

You know during the pandemic move outs are all.

Our generally because of the need for a higher level of care.

Or from.

People passing away.

Okay. Okay, Yeah, all right it sounds interesting comment because I thought.

Thought some other operators, so I'll move downs kinda to decline.

And then your leverage is is elevated kind of how do you. How do you guys think about why bridge going forward and how did the sales play into that.

Like or should we expect it to kind of continue to drive that gross sales or does it declined it comes down.

No. So when we think about leverage.

We're we're going to be paying down debt or.

The asset sales is certainly a piece of that but.

Leverage will naturally come down as income comes comes back up I mean, we're clearly at depressed EBITDA levels at this point.

Just given the pressure in our in our shops segments. So.

No I think with time as as the senior living industry comes back our leverage will naturally ticked down and that again some of our programs as far as well.

Looking to maximize value and sell some assets when weve always maximize value, we're getting out of certain assets that we.

Yes, I don't have the same confidence in anymore, well will help with that so.

Again, I think we like many are temporarily elevated and they will come back down overtime.

Thanks, Greg and then I'm curious on if you can provide any color around that.

Cap rates for the sales you've completed since July one we need how bad would have compared to like a good pandemic cap rate.

Any kind of color on a.

Go forward cap rates would be amazing.

Sure you know, where we've been saying that the portfolio disposition, we expect about a seven cap for that so that whole portfolio and weve been trending at around that maybe a little less in the most recent sales yeah. Some of these.

Sales.

Are are tend to be more.

Based on a per unit sale as opposed to kind of doesn't make sense to talk about cap rates for some of them, but when when you combine all of all of the dispositions, where we still are hovering right around a seven cap.

Okay. Thanks, guys appreciate that.

Huh.

This concludes our question and answer session.

I would like to turn the conference back over to Jennifer Sanchez for any closing remarks.

Thank you and thank you for joining our call today, we look forward to seeing many of you at the upcoming virtual Navy conference in two weeks.

Operator that concludes the call.

The conference is now concluded thank.

Thank you for attending today's presentation you may now disconnect.