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Diversified Healthcare Trust (NASDAQ:DHC) Q1 2024 Earnings Call Transcript

Diversified Healthcare Trust (NASDAQ:DHC) Q1 2024 Earnings Call Transcript May 7, 2024

Diversified Healthcare Trust isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, and welcome to the Diversified Healthcare Trust First Quarter 2024 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the call over to Kevin Brady, Director of Investor Relations. Please go ahead.

Kevin Brady: Thanks, Nick. Good morning. Joining me on today's call are Chris Bilotto, President and Chief Executive Officer; and Matt Brown, Chief Financial Officer and Treasurer. Today's call includes a presentation by management followed by a question-and-answer session with sell-side analysts. Please note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company. Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other Security Laws. These forward-looking statements are based upon DHC's beliefs and expectations as of today, Tuesday, May 7, 2024. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's call other than through filings with the Securities and Exchange Commission or SEC.

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In addition, we will be discussing non-GAAP numbers, including normalized funds from operations or normalized FFO, net operating income or NOI, and cash basis net operating income or cash basis NOI. A reconciliation of these non-GAAP figures to net income is available in our financial results package which can be 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. And finally, we will be providing guidance on this call, including SHOP net operating income or SHOP NOI.

We are not providing a reconciliation of these non-GAAP measures as part of our guidance because certain information required for such reconciliation is not available without unreasonable efforts or at all, such as gains and losses or impairment charges related to the disposition of real estate. With that, I will turn the call over to Chris.

Chris Bilotto: Thank you, Kevin. Good morning, everyone, and thank you for joining our call. Last evening, DHC reported first quarter results that reflect operating and financial improvements across our portfolio. On today's call, I will provide a high-level overview of DHC's first quarter financial and operating results along with key strategic initiatives that underpin our guidance. Later, Matt will review first quarter financial results and provide additional detail related to our strategy to strengthen our capital and liquidity profile. First quarter financial results reflect continued improvement within our SHOP segment, consecutive mark-to-market rent growth within our Medical Office and Life Science segment, along with continued advancement of targeted strategies for financing, capital deployment and operator transitions.

General market fundamentals supporting favorable trends for healthcare and senior housing, along with the senior housing construction supply-demand imbalance continue to be a bright spot as we advance through the year. Relative to the year-ago period, our same property cash basis NOI increased 9.5% as a result of the strong performance within our SHOP segment. We credit our positive performance to several factors, including our community investments, our dedication to operator excellence in this segment and the favorable tailwinds in the healthcare industry. On the financing side, we remain active with our efforts targeting secured financing on select Medical Office, Life Science and SHOP properties to improve liquidity and repay the 2025 debt maturity, which Matt will provide additional details on momentarily.

Turning to our first quarter SHOP performance, strong results are demonstrated by our revenue increase of 10% over the year-ago period supported by a 200 basis point increase in occupancy and a 6.8% increase in total RevPOR. These results reflect consistent improvements across independent living, assisted living and memory care. On a sequential basis, revenue increased 4.7%, primarily driven by rate increases that occurred within the first quarter at our Aleris managed communities along with increases within our level of care. Notably, NOI margin increased 180 basis points and 260 basis points on a year-over-year and sequential quarter basis, respectively. While we are pleased with our progress, with our performance, we retain an active asset management philosophy to support continued opportunities across our communities.

This includes rationalization of further operator changes consistent with the 13 communities we transitioned earlier this year. As a reminder, these transition communities contributed negative EBITDA of $3.2 million during 2023, and for the first quarter, negative EBITDA of $920,000. With the completion of the transition, we expect to see meaningful improvement of operating and financial performance for the back half of the year. Additionally, we will assess specific dispositions and future acquisitions focusing on densifying our presence in certain markets. With this, we anticipate benefiting from sales and cost synergies as well as providing broader options for residents. With respect to our capital refresh and renovation projects, we are advancing refresh projects in 23 of our SHOP communities that are expected to be completed in Q4.

These refresh projects, mostly cosmetic upgrades and FF&E replacement. Estimated costs for these projects are $25.7 million or roughly $6,600 per unit and we are targeting an ROI of 8% to 10% when stabilized. With respect to major renovations, in the first quarter, we completed the renovation of our community in Arlington Heights, Illinois, totaling $5 million or $17,800 per unit, with additional qualifying renovations underway at two of our communities. Major renovations generally include base-level refresh work along with changes to the acuity mix, amenity enhancements and other potential NOI drivers where we believe a minimum ROI of 15% is achievable upon stabilization. These refresh projects are a continuation of our business plan to improve our communities having completed similar scale renovations at more than 90 communities since 2021.

A seasoned real estate professional inspecting a property with the company’s branding in the background.
A seasoned real estate professional inspecting a property with the company’s branding in the background.

We expect these improvements to better position our communities as a top choice for current and future residents, drive occupancy and contribute to continued NOI growth and margin expansion. As provided with our prior call, our 2024 SHOP full year guidance outlook remains generally unchanged, which Matt will speak to in more detail. Turning to highlights for the Medical Office, Life Science and Wellness Center portfolio. We ended the first quarter with 102 Medical Office and Life Science assets consisting of 8.5 million square feet with same-store occupancy of 89.8% and a weighted average lease term of 5.5 years. Notably, we leased approximately 101,000 at weighted average rents that were 11.5% higher than prior rents for the same space, which represents the third consecutive quarter of double-digit positive rent roll ups.

Within our Wellness Center portfolio, we completed a five-year renewal for three of our wellness centers in Albuquerque, New Mexico, totaling 130,000 square feet, including a 7.5% rent roll up and no leasing capital. As of quarter end, our 10 wellness centers are well covered at 1.67 times with a WALT of 15.9 years. As discussed on our prior call, we are proactively working through opportunities supporting current vacancies along with our known vacates. The change in occupancy from the fourth quarter was primarily driven by known vacates with two tenants totaling 225,000 square feet and located in Kansas City and Chicago MSAs. In 2024, tenants representing roughly 4.1% of our expiring annualized revenue are anticipated to vacate with moveouts staggered throughout the year.

We retain an active leasing pipeline for new and renewal activity reflecting close to 650,000 square feet, which includes 372,000 square feet of potential net absorption. Subsequent to quarter end, we signed new and renewal leases totaling 55,000 square feet for a weighted average lease term of close to five years and a roll up in rent. Also within our Medical Office and Life Science segment, we sold one vacant property during the quarter located in Phoenix, Arizona for $3.6 million. In addition, we are currently marketing for sale eight properties totaling over 800,000 square feet, which includes two properties currently under agreement for 159,000 square feet and the remaining six properties are in various stages of marketing. We expect the sale of these properties to have a positive impact on occupancy and NOI, and estimate proceeds of $50 million to $60 million in the event we are successful transacting on these dispositions.

Before I turn the call over to Matt, I want to make you aware of the recent publication of the RMR Group's Annual Sustainability Report. The report highlights insights, accomplishments and data regarding our manager's commitment to long-term ESG goals. We are proud of the progress made to strengthen DHC sustainability practices and enhance our ESG transparency and disclosure. You can find the links to the complete report as well as the DHC specific tear sheet on our website at dhcreit.com. I will now turn it over to Matt.

Matthew Brown: Thanks, Chris, and good morning, everyone. Normalized FFO for the first quarter was $3.5 million or $0.01 per share and included $20.7 million or $0.09 per share of non-cash amortization associated with a zero coupon secured bond issued in December. The $20.7 million of quarterly amortization remains our quarterly run rate for 2024 resulting in a $0.36 drag on full-year normalized FFO per share. Excluding this non-cash amortization, normalized FFO increased $0.06 per share sequentially, mainly driven by continued improvement in our SHOP segment. Our consolidated same-property cash basis NOI was $63.6 million, representing a $5.5 million or 9.5% year-over-year improvement. The changes by segment are as follows: SHOP same property cash basis NOI was $25.3 million, representing an increase of $7.7 million or 43.6%.

The increase was driven by an improvement in occupancy and average monthly rate partially offset by higher operating expenses. The increase in expenses from the prior year was primarily due to an increase in salaries and benefits and higher insurance costs partially offset by lower contract labor expenses. Our strong performance in SHOP was partially offset by a $1.1 million or 3.6% decline in same property cash basis NOI in our Medical Office and Life Science portfolio. This decline was primarily due to lower revenue related to vacancies that we highlighted on last quarter's call. Turning to liquidity, financing strategies and capex, we ended the quarter with $207 million in cash. Our financing strategies for 2024 remain unchanged and are summarized as follows: First, we are targeting a Q2 issuance of CMBS debt ranging from $175 million to $200 million secured by certain of our unencumbered Medical Office and Life Science properties.

Second, we expect to issue secured fixed-rate debt with select SHOP communities. The use of proceeds from these financings will be used to fund capital investments in our portfolio and to repay our $500 million of notes maturing in June 2025 that have an interest rate of 9.75%. Therefore, we expect more than 200 basis points of interest expense reduction from these refinancings. The June 2025 notes become pre-payable without penalty in June of this year, and we expect to begin making prepayments during the second quarter. Finally, we continue to evaluate properties across the portfolio for disposition to improve our liquidity profile and improve operating results. We invested $26 million in the first quarter, including $8 million in our Medical Office and Life Science segment and $11 million in our SHOP segment.

We expect to accelerate our investments as the year progresses. Prudent investments in our senior living communities is a key initiative to continue driving the NOI recovery. Our capex guidance for 2024 has reduced slightly to $240 million to $260 million and our SHOP capex guidance of $190 million to $200 million remains unchanged, although the first quarter was a slow start to the year. In summary, first quarter results reflect the strength of our underlying portfolio and continued momentum in the SHOP segment supported by higher occupancy and rates. We are well positioned to capitalize on industry tailwinds by executing on our strategy and achieving our full-year objectives. Turning to our outlook for 2024, we are reaffirming our 2024 SHOP NOI guidance of $120 million to $140 million and introducing Q2 SHOP NOI guidance.

While our Q1 results fell just short of forecast, we remain confident in our full year guidance as we expect the majority of the growth to come in the second half of the year. With that said, we expect Q2 SHOP NOI guidance of $26 million to $31 million. I would also like to note that more details about our 2024 SHOP NOI guidance will be provided in our investor presentation that will be published in the near future. As we are now providing quarterly and full year SHOP NOI guidance, we are no longer going to issue the monthly SHOP results releases, given the volatility in results from month to month which can be caused by many factors, including the number of days in a given month. That concludes our prepared remarks. Operator, please open the line for questions.

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Bryan Maher with B. Riley Securities. Please go ahead.

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