Logo of jester cap with thought bubble.

Image source: The Motley Fool.

Diversified Healthcare Trust (NASDAQ:DHC)
Q2 2020 Earnings Call
Aug 6, 2020, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the Diversified Healthcare Trust Second Quarter 2020 Financial Results Conference Call. [Operator Instructions]

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

Michael Kodesch -- Director, Investor Relations

Thank you. Welcome to Diversified Healthcare Trust's call covering the second quarter 2020 results. Joining me on today's call are Jennifer Francis, President and Chief Operating Officer; and Rick Siedel, Chief Financial Officer and Treasurer. Today's call includes a 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 Healthcare 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 DHC's present beliefs and expectations as of today, Thursday, August 6, 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 NOI. 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.dhcreit.com. 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.

Jennifer F. Francis -- President And Chief Operating Officer

Thank you, Michael. Good morning and welcome to our second quarter 2020 earnings call. Over the past several months, the COVID-19 pandemic has driven elevated levels of uncertainty and disruption to both the economy and the commercial real estate industry. The impact on our business, tenants, communities and colleagues has been profound and has resulted in an extremely challenging operating environment. I'd like to thank the hard-working employees at the RMR Group and Five Star Senior Living. These are unusual times, and it's comforting to witness the dedication of these people and their commitment to superior service delivery while working tirelessly to handle the unprecedented challenges associated with the current climate.

While our country manages through the crisis that has disrupted every facet of our society, we're utilizing our entire platform to optimize resources and expertise in ways that mitigate risks associated with the virus, which we believe is paramount to providing value to all stakeholders by focusing on delivering sustainable long-term results. As expected, COVID-19 took a toll on our performance in the second quarter, with impacts felt most strongly across our senior living portfolio. I'll spend time this morning discussing the senior living portfolio and how our operating partner has reacted to the pandemic. We'll also discuss the strength of our office portfolio segment with its strong rent collections and rent deferral statistics and how our operating manager has been working to contain operating expenses during the crisis. In the second quarter of 2020, DHC's normalized FFO attributable to common shareholders was $0.24 per share, well above consensus estimates but a decrease of $0.10 per share from the prior year quarter due to the effects of COVID-19 as well as our restructuring transaction with Five Star.

I'd like to begin today's portfolio performance review by discussing recent trends and providing commentary with regard to our Office Portfolio segment, which represents approximately 60% of DHC's NOI of the second quarter 2020. This portfolio contains close to 12 million square feet, comprised of roughly 7.1 million square feet of medical office buildings and 4.5 million square feet of life science properties with a weighted average remaining lease term of 6.1 years and same-property occupancy for the quarter of 93.8%. In light of conditions and work-from-home orders during the second quarter, leasing in our portfolio experienced an expected slowdown. We entered into 60,000 square feet of new and renewal leases with 5.2% roll up in rents, a weighted average lease term of six years and with leasing costs of approximately $2.02 per square foot per year. As I said, the slowdown in leasing was expected as many tenants took a wait-and-see approach to their business and space needs. We believe that this will likely lead to a backlog of deals as COVID-19-related treatments and vaccines progress, as the prevalence of the pandemic eventually wanes and as the sustained broader economic reopening develops.

Our investment case for ownership of medical office and life science assets remains unchanged. In the long term, the growth of the aging U.S. population will continue to drive increases in demand for healthcare services. Advances in technology and telehealth with an aligned payer system for reimbursements will attract and retain this aging population as their need for services increases, creating growth in the value of medical office real estate. Despite COVID-related disruptions, investment in life science assets are proving to be one of the most resilient property types as businesses in the industry are commonly deemed essential. Venture capital funding for the life science industry has surged in recent quarters with second quarter 2020 reporting a 53% increase over the prior year quarter due to the industry's role in the research development and the manufacturing of treatments and vaccines. As a result, real estate owners with life science exposure have witnessed continuing strong demand for their space. Looking at our Office

Portfolio results compared to the same quarter last year, we reported a 1.1% decrease in same-property NOI and a 2.3% decrease on a cash basis. The decrease in NOI was largely due to parking revenue, which was down approximately $1.5 million from the prior year quarter as work-from-home orders drastically decreased volumes in our parking garages. Excluding this decrease in parking revenue, same-store NOI for the Office Portfolio segment would have been up 1.2% and up 10 basis points on a cash basis year-over-year, in part due to RMR's property management group's focus on reducing operating costs as utilization of our buildings decreased by implementing procedures to ensure unnecessary expenses were mitigated. These efforts resulted in total operating expenses that were down 2% compared to the prior year quarter due to savings in controllable expenses such as utilities, cleaning and repairs and maintenance. During our first quarter call, we reported that DHC had granted rent deferrals equal to $1.7 million in the Office Portfolio segment, representing only 0.4% of the annualized revenue from this segment.

As of August 3, these numbers have grown only modestly as we've granted rent deferrals for a total of just under $2.4 million in the Office Portfolio segment or only 0.6% of the annualized revenue from this segment. We also granted deferrals to one wellness center tenant and one triple-net senior living tenant. We're interested in the success of our tenants' businesses and continue to believe that partnering with our tenants that are experiencing financial challenges will provide support for their businesses and ultimately provide for greater assurances for collection in the long term, thus preserving our tenant relationships, retention and portfolio stability. The majority of relief requests have come from our medical office tenants and only a handful from our life science tenants. From a monthly trend perspective, there was a significant decline in rent deferral requests in June and July. Our wellness center portfolio, which represents 3.3% of second quarter NOI, has faced considerable pressure since the beginning of the pandemic as state-imposed closures weighed on tenant's ability to pay rent.

We previously noted that we granted a quarter of rent deferral for one tenant in this portfolio, which is a high-quality company that we expect will meet rent obligations following the deferral period. Our other wellness center tenant is currently in default and subject to the tenant curing its default, we are evaluating a wide range of alternatives for the assets associated with leases. We're also having regular discussions with our triple-net senior living tenants where we've agreed to defer partial rent from one tenant. These properties had rent coverage of 1.66 times as of the first quarter of 2020 and represented approximately 6.6% of our second quarter NOI. One of DHC's highest priorities remains the health and well-being of the residents at our senior living communities. As of July 31, approximately 4.5% of our resident population across our managed and leased portfolio had tested positive for COVID-19. In our SHOP portfolio, roughly 43% of the residents that tested positive have since recovered as defined by the CDC guidelines. Five Star's earnings call is scheduled for this afternoon at 1:00 p.m. Eastern, and we encourage you to listen to its senior leadership discuss their COVID-19 response, phased reopening plans and updates on their companywide initiatives.

Looking at the second quarter 2020 SHOP results, total average occupancy for the quarter, inclusive of all 241 communities, was 78.7%, which was down 400 basis points from the prior quarter. As of July 31, our total SHOP portfolio occupancy was 76.1%, which was down 130 basis points from June 30 reported occupancy of 77.4%. Due to restrictions intended to prevent the spread of COVID-19, including a decrease of in-person tours and limitations on nonessential visitors to our communities, like other senior living operators, Five Star is experiencing significant challenges in attracting new residents to our communities. On a comparable basis, our same-property SHOP segment average occupancy was down 610 basis points from the prior year and approximately 420 basis points from the prior quarter. This sequential decline equates to roughly 32 basis points of lost occupancy per week, which is slightly ahead of our previous expectation of 40 to 50 basis points of occupancy declines per week announced in the first quarter call in May. Average monthly rate for the same-property SHOP segment was down 1.7% from the prior year quarter.

As a result of these occupancy and rate declines, same-property revenues were down 8.5% compared to the prior year quarter pro forma results. We note that we did not include the $7.3 million of CARES Act funds we received in our revenue figures as these amounts were accounted for in our other income line. Approximately $6.8 million of these CARES Act funds were included in second quarter same-property shop EBITDARM, which was down 23.5% from the prior year quarter. Our operator has remained focused on areas of the business within its control, optimizing resources on hand and diligently regulating expenses. On a pro forma basis, same-property wages and benefits in our SHOP portfolio were up just 0.7% from the prior year quarter, while repairs and maintenance, food and contract labor were down 22%, 9.2% and 17%, respectively. Despite seeing substantial increases in supply costs related to PPE, same-property operating expenses in our SHOP segment were down $3.1 million or 1.3% year-over-year driven by cost controls. While Five Star employee investment initiatives were impacted by the pandemic during the second quarter, they were still able to make significant advancements in engagement and retention initiatives.

As of June 30, Five Star recruited and hired over 6,600 team members this year, including 35 new executive directors and five new regional directors. Since our last earnings call, we completed an additional $8.7 million of asset sales, bringing our dispositions total to $334 million since the program began. Today, we have properties under agreement to sell with negotiated proceeds totaling approximately $232 million. It is still our intent to sell assets and as I've stated on previous calls, we expect to resume our sales campaign when markets stabilize. As a final item of note, the RMR Group recently published its inaugural sustainability report. And we encourage you to read through the analysis for insights and underlying data on how it is reducing cost for us and its other managed REITs and managing to long-term sustainable performance through commitment to ESG initiatives. You can find links to the report on our website.

I will now turn the call over to Rick to provide for further financial commentary.

Richard W. Siedel, Jr. -- Chief Financial Officer And Treasurer

Thank you, Jennifer, and good morning, everyone. We ended the second quarter with approximately $78.5 million of cash on hand, $1 billion of available capacity on our revolver, and our next debt maturity is not until December of 2021. During the second quarter, we issued $1 billion of senior notes due in 2025 but callable after two years. We used the proceeds from this issuance to repay the $250 million term loan that was scheduled to mature in June of 2020 and paid off the amounts outstanding on our unsecured revolving credit facility. We also amended our credit and term loan agreements to provide us with additional flexibility to weather the pandemic. Specifically, these amendments changed the way certain of our financial covenants are calculated and provided some additional cushion in exchange for a 50 basis point increase in the interest rate through the amendment period.

As a result of these actions, we believe we have addressed all liquidity concerns related to the pandemic and are looking forward to moving forward with many of the investments we previously expected to defer in order to position the company for a stronger recovery as we emerge from the pandemic. While the pandemic has slowed our deployment of capital, we are still actively investing capital into our portfolio to maximize value. In the second quarter, we spent $37.6 million, of which $16.1 million was considered recurring and included building improvements in both our Office Portfolio and managed senior living communities and tenant improvements and leasing costs in our Office Portfolio. The remaining portion of our capital expenditure is $21.5 million was spent on redevelopment capital projects. This included $14.9 million of redevelopment capital in our Office Portfolio primarily related to two projects: the redevelopment of our life science campus in Torrey Pines and the recently completed repositioning of a 140,000 square foot medical office building in Washington, D.C.

We have also started preliminary work on the repositioning of two assets in our life science portfolio, one in Lexington, Massachusetts and one in Tempe, Arizona, and added new disclosure about these projects in our supplemental. We invested approximately $6.6 million of redevelopment capital in our SHOP segment as COVID-19 related visitor restrictions continue to limit our ability to spend capital inside many of our communities. Lastly, I wanted to touch on rent collections, which continue to be strong. In our Office Portfolio specifically, 99% of our contractual rents due were collected during the quarter and subsequent collections are trending in line with prior months. That concludes our prepared remarks.

Operator, please open up for line for questions.

Questions and Answers:

Operator

[Operator Instructions] And our first question comes from Jason Idoine of RBC Capital Markets. Please go ahead.

Jason Idoine -- RBC Capital Markets -- Analyst

Hey, guys. I had a question on your expectations for the SHOP occupancy. So I know last quarter, you had said the 40 to 50 bps per week decline. I know it came in a little bit below that. So I'm wondering what was the driver that led to that being a little bit better than expected. And then if you could also touch on how that's trended throughout July, maybe trends at the beginning of July versus the end and what your expectations are through the rest of the quarter.

Jennifer F. Francis -- President And Chief Operating Officer

Thanks, Jason. It's a good question. Yes, our occupancy drop was lower than expected, and I think it's been trending along the same line, maybe even just a little bit lower in July. This is all really dependent on the pandemic and how it continues through the country. It's interesting, we've got 50% of our cases are in seven states. And so and they're the seven that you would expect. They are the states that were California, Texas, Florida are the major ones. And so depending on what happens with the virus around the country, hopefully, we'll continue to see the occupancy declines decrease. Got any other question?

Jason Idoine -- RBC Capital Markets -- Analyst

Got it. And yes, it does. And then one of the other things that you mentioned was it sounds like you might be seeing a little bit of pricing pressure in the SHOP portfolio. In some of those states that are maybe more stabilized, are you seeing operators more disciplined on pricing? Or what are you seeing as these assets try to rebuild occupancy?

Jennifer F. Francis -- President And Chief Operating Officer

Yes, I think it varies. Five Star has definitely been more disciplined on pricing. A lot of the move-ins or the majority of the move-ins are need-based. And so you can be a bit more disciplined on pricing in that situation. I think we are seeing other operators start to offer concession to attract residents, Five Star has been resistant. There's been we've got revenue management in place throughout all of our communities. And so we're really trying to stick pricing to not reduce it.

Jason Idoine -- RBC Capital Markets -- Analyst

Okay. And then last one for me. So you mentioned that, as expected, the office leasing slowed down. I guess I'm wondering what would be the catalyst for it to pick back up or if you guys are already seeing it pick back up. And also, when would you expect those parking revenues and those utility expenses to maybe normalize?

Jennifer F. Francis -- President And Chief Operating Officer

Well, the parking the utility revenues will normalize as folks start coming into the office. And I think the same can be said for the parking revenues. We've actually already started seeing increase our drop in parking revenues was mostly based on two properties, the property that we have in the Seaport District of Boston and the Cedars property on the West Coast. And we're already starting to see an increase in parking. I think that a lot of the parking in Cedars is it's the people that work in the building, it's the people that are visiting, the doctors in the building. But a lot of the parking is also people that are visiting folks that are in the hospital at Cedars. And so those visitation restrictions need to open up a bit out there before the parking really starts to come back.

In Boston, I think that we're going to see an increase in parking as the labs have been pretty fully utilized during the crisis, but the office space people have been working from home. As they start coming back into the office, we'll probably see more parking because these people are resisting even public transportation, so more people will drive in. As far as leasing goes, we've got a very large pipeline of deals. We've got about 1.5 million square feet of deals in the pipeline. We're definitely starting to see tour activity pick up around the country. So I'm hoping that some of the we're seeing new deals and getting LOIs or RFPs for new deals around the country. So I think it's starting to pick back up.

Jason Idoine -- RBC Capital Markets -- Analyst

Thanks. Sure.

Operator

Our next question comes from Bryan Maher of B. Riley FBR. Please go ahead.

Bryan Maher -- B. Riley FBR -- Analyst

Great, thanks and Jennifer, really appreciate the very comprehensive overview you put forward, really good. When we look at I want to think about the assets that you have for sale, the 24 for the $232 million. Without getting overly specific, can you talk about what types of assets are included in that? And you talked about still ramping up sales further. What's the current goal from here?

Jennifer F. Francis -- President And Chief Operating Officer

So the properties that we have under agreement are really a mix. It's actually pretty representative of the portfolio, the whole the long list that we had originally put together, you've got some MOBs, you've got a number of senior living communities. So it's really a good mix of properties. And then the goal, we're sticking to our $900 million of dispositions, so we really are going to wait for the capital markets to open back up. I think things are starting we're getting the feeling that things are starting to open back up. But I think we need to see some evidence of that before we really hit the market.

Bryan Maher -- B. Riley FBR -- Analyst

Okay. And then when we think about the portfolio mix in general, which has really moved pretty quickly now to about 60% office for NOI, where do you think that that settles in? Or are we about where you want to be, 60-40? Or is MOB pushed further closer to 70?

Jennifer F. Francis -- President And Chief Operating Officer

I think that we've well, I mean, I think that the reason that our 60% NOI in our Office Portfolio segment is because of the impact of COVID-19 on our SHOP portfolio. And so as those SHOP results turn around, that number could go up. We've talked about wanting to grow our office our MOB and life science portfolio, and I continue to say that, though, we're really not in the acquisition market today and don't expect it will be for some time. I think that at this point, we're really focusing on our existing portfolio and hoping to be able to spend capital in a way that will be accretive, and as we've talked about. I mean we've been a little bit precluded because of COVID-19 from doing that.

Bryan Maher -- B. Riley FBR -- Analyst

Okay. And then last from me. You referenced cost control is helping to offset increased costs, I guess, associated with PPE. Can you elaborate on what types of cost controls generally? And is there any more room there?

Jennifer F. Francis -- President And Chief Operating Officer

Sure. Both Five Star and the property management group within RMR have pretty strong strategic sourcing departments. And so I think that they're both doing a good job mitigating expense increases that way. Obviously, there are the variable expenses associated with the drop in occupancy. But they both groups have been looking hard at ways that they can control costs, cleaning and we talked about utilities. Trying to think if there's anything else. But they're just very focused. There's in the SHOP portfolio, there are room turns are going to be down as we're precluding people from coming into the communities. And so there's going to be some expense savings there as well.

Bryan Maher -- B. Riley FBR -- Analyst

Okay, thank you. That's all from me.

Operator

Thank you. Our next question comes from Vikram Malhotra of Morgan Stanley. Please go ahead.

Wilma [Phonetic] -- Morgan Stanley -- Analyst

Thanks for taking the question. This is Wilma on for Vikram. I just thought you had mentioned earlier the $7 million in CARES Act costs that you had received. I was just wondering if you could provide that on a per property basis. And then if you had any expectations of your property, just giving any type of aid in the future.

Jennifer F. Francis -- President And Chief Operating Officer

So the money that we received was based on 2018 Medicare building, and so that's specifically skilled nursing. So it was allocated it wasn't allocated evenly across properties. It was distributed on a per bed basis. So it's hard to talk about, we have properties that are so diverse. So it went more specifically to properties that had skilled nursing beds in them. And then as far as what we expect in the future, it's hard to know exactly where the government is going to settle on additional stimulus. I know it's being hotly debated now. There are certainly a lot of groups lobbying for additional monies to be targeted to senior living, and I hope that they succeed, but it's hard to speculate.

Wilma [Phonetic] -- Morgan Stanley -- Analyst

And then last question for me on what have Five Star and other operators kind of said about organizationwide bans just as we kind of see a second wave or I guess, first wave for some states? Are they planning on doing another organizationwide ban? Or will it be more partial dependent on locations? Just some color on that would be helpful.

Jennifer F. Francis -- President And Chief Operating Officer

Yes. I mean I think it depends on the active cases in the communities. It's interesting that in my prepared remarks, we talk about our 4.5% of the residents tested positive. That's a cumulative number. Now currently, in our SHOP portfolio, only about 1.5% of the residents have active cases or tested actively tested positive. I think that the operators are going to have to be very careful and selective about bringing new residents in. And I think testing is going to be vitally essential. There's a lot of talk now about once the test once the vaccine is out, who's going to get access to that vaccine. And I hope that it's the senior living communities that get access to it because their residents are most at risk.

Wilma [Phonetic] -- Morgan Stanley -- Analyst

Thank you so much.

Operator

[Operator Instructions] And our next question will come from Aaron Hecht of JMP Securities. Please go ahead.

Aaron Hecht -- JMP Securities -- Analyst

Morning, guys, thanks for taking my questions. Wondering on the occupancy side, are you seeing broad-based declines or the and this is for the SHOP portfolio. Are you seeing declines occur when cases break out or is it when markets start to have concerns over COVID that occupancy declines? Just kind of wondering on the timing of demand in markets relative to when you're seeing the virus show up.

Jennifer F. Francis -- President And Chief Operating Officer

Yes. I mean I said earlier, 50% of our cases are in a good portion of our cases are in seven states. And I think that the occupancy, new move-ins are still, continue to be a need-based. And so I think that it's a hard question to answer. You have very few people that are moving in because of a lifestyle choice. And so I think that it really is dependent upon the pandemic and how it continues to if cases continue to grow throughout the country. It's a hard question to answer because we just don't have insight as to what's going to happen with the pandemic over the next several months.

Aaron Hecht -- JMP Securities -- Analyst

Right. And then it looks like a couple of the dispositions you guys did this quarter were on the senior housing side. What's pricing looking like there today? Were those deals signed before COVID really hit any communities, kind of insights there on where the market looks like it's at today? And is the buyer pool changing for assets?

Jennifer F. Francis -- President And Chief Operating Officer

The pricing was as we expected. We've talked about overall cap rate of about 7% on all of our on our dispositions to date. The pricing was pre-COVID pricing. These were all properties that we had under agreement before the pandemic really hit. So it's and I would say that the buyer for we're not really in the market right now. So it's hard to know. But I think that the buyer pools the buyers that are out there right now are less the institutional buyers and more regional.

Aaron Hecht -- JMP Securities -- Analyst

Yeah. All right, thanks for your time.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Jennifer Francis for any closing remarks.

Jennifer F. Francis -- President And Chief Operating Officer

Thank you, and thank you for joining us on our second quarter earnings call. We hope you all stay well.

Operator

[Operator Closing Remarks]

Duration: 34 minutes

Call participants:

Michael Kodesch -- Director, Investor Relations

Jennifer F. Francis -- President And Chief Operating Officer

Richard W. Siedel, Jr. -- Chief Financial Officer And Treasurer

Jason Idoine -- RBC Capital Markets -- Analyst

Bryan Maher -- B. Riley FBR -- Analyst

Wilma [Phonetic] -- Morgan Stanley -- Analyst

Aaron Hecht -- JMP Securities -- Analyst

More DHC analysis

All earnings call transcripts

AlphaStreet Logo

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.