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A High Yielding REIT

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February 04, 2014 – Comments (0) | RELATED TICKERS: LTC

Board: Value Hounds

Author: LeKitKat

LTC is a health care REIT specializing in senior housing, and skilled nursing facilities. They don’t have medical office buildings or senior properties they manage themselves through other operators or SHOP. SHOP is an RIDEA policy that allows a REIT to own and operate a certain percentage of its properties. These are becoming an important part of REIT business that allows long-term growth at a faster pace than rent increases. The SHOP segments will decrease margins but make up for it with higher growth. LTC doesn’t have these.

LTC’s primary senior housing and long term care properties include skilled nursing properties (SNF), assisted living properties (or ALF), independent living properties (or ILF), memory care properties (or MC) and combinations of those. SNF and assisted living are lower margin personnel intensive businesses and SNF is seeing a downturn in occupancy. While margins and empty beds are not strictly LTCs problem, they will see tenants pack up and leave if reimbursement declines and beds go unrented. That is already happening to most health care REITs and they are seeing SNF occupancy falling.

Skilled nursing provides rehab and care including meds and IVs for patients not sick enough for acute care hospitals but not well enough to take care of themselves. To that end, skilled nursing needs adequate staffing with health care professionals who come with margin crunching salaries. Reimbursement can be heavily dependent on government funding that puts more pressure on margins. SNF are seeing a decline in admissions and REITs are seeing occupancy go down.

Assisted living facilities are for seniors that require some help with activities of daily living (ALDs) but are generally well enough and competent to spend time alone and unsupervised. Services are usually available 24 hours a day and include personal supervision and assistance with eating, baths, and medication. Again, ALFs are dependent on higher levels of staffing than an ILF, raising costs and lowering returns. While this is not directly LTCs problem, it does impact their tenants and eventually occupancy levels.

Independent living facilities (retirement communities) offer a community and some defined less intensive levels of service -- laundry, housekeeping, dining options/meal plans, exercise and wellness programs and transportation. They are the backbone of most SHOP segments with better margins and less dependence on Medicare and Medicaid.

Memory care facilities specialize in patients with Alzheimer's disease and other dementia. Purpose built, freestanding memory care facilities are an attractive alternative for private-pay residents affected by memory loss. Residents require a higher level of care and more assistance with ADLs than in assisted living facilities. They must have staff available 24 hours a day to respond to problems.

LTCs biggest investment is in 100 skilled nursing facilities at 56% of total investments. Assisted living is 37% with range of care the only other significant investment at 4.3%. They don’t have any RIDEA or senior housing owned and operated by LTC.

Four largest operators and over 10% or revenue and mortgage interest

1) Extendicare and ALC collectively lease 37 assisted living properties (1,430 units) that are 6.2% of total assets ($51,825,000). Extendicare/ALC contribute 10.6% of rental revenue and interest income from mortgage loans. ALC is on the shakiest footing with declining occupancy and danger of violation of debt covenants. LTC management was confident ALC would continue to meet obligations and not default. ALC went private mid-2013 and we don’t have any filings to see what they are up to. That makes them something of a black box and a concern since they are 10.6% of revenue. ALC lost money the last reported Q May 2013.

2) Brookdale leases 35 assisted living properties (1,414 units) that are 6.2%, of assets worth $52,067,000. Brookdale is 10.6% of rental revenue and interest income from mortgage loans.

3) Preferred Care operates 27 skilled nursing properties and two range of care properties owned and mortgaged by LTC. The 27 properties have of 3,354 beds and 49 assisted living units. They occupy 6.0%, ($50,735,000) of assets and pay 10.4% of revenue and interest income from mortgage loans

4) Senior Care Centers is a privately held company with an amended and restated master lease agreement that includes four skilled nursing properties previously operated by Senior Care. Under the new lease agreement, Senior Care leases nine skilled nursing properties with a total of 1,190 beds owned representing 12.6%, or $105,881,000, of l assets and 11.2% of rental revenue and interest income from mortgage loans.

Summing it up

•These four lease 31% of the LTC assets. We need to be wary of ALC defaulting

•They are responsible for paying on and taking care of $260 million in property out of $834.3 million in un-depreciated buildings. That’s 31% of the LTC leasable assets. This can be a good thing with responsible, successful operators. It exposes LTC to big downside risk if one of them moves out entirely or goes bankrupt.

•The four operators provide 42.8% of the revenue. That does get my attention and presents some risk. Only 12% of the portfolio will be dealing with lease expirations in the next three years. After 2019, 61% of leases will need renewal. The leases are 99% triple net.

[See Post for Tables]

By comparison, Ventas SNF occupancy was 79.7% and down from 82% one year ago and SNH was at 78.9% down from 80.4% one year ago. The trend has been down.


TC’s portfolio of owned properties are structured with leases

Leased pursuant to non-cancellable leases

--initial term is generally 10 to 15 years????weighted average remaining
--lease term is 8 years

All leases are triple net

--requires the lessee to pay additional charges including all taxes, insurance, assessments, maintenance and repair (capital and non-capital expenditures), and other costs necessary in the operation of the facility

Most leases provide for a fixed minimum base rent, annual rent increases, and many also include renewal options

Near-term lease maturities

--one in 2013 with annualized GAAP rent totaling $0.5 million four in 2014 with annualized GAAP rent totaling $13.0 million ???three in 2015 with annualized GAAP rent totaling $1.1 million

Payer source

Private pay 58.8%
Medicare 15.8%
Medicaid 25.4%


IMO Ventas is better placed with 84% of revenue classified private pay. Government reimbursement is restrictive at some of the lowest rates in the health care industry (Medicaid is especially low) and while it usually gets paid reliably, it is subject to annual cuts at worst and at best, very small increases.

Basic FFO is the most directly comparable measure across REITs for looking at a payout ratio, but FAD is probably a better estimate of what is sustainable. Any way we look at the ratio, it’s not high in 2012 compared to other REITs I have looked at. I usually consider anything below 80% less likely to get whacked with some margin of safety. Several REITs I looked at are in the 90%+ range and less appealing.

Neither a borrower nor a lender be

LTC does some borrowing and a fair amount of lending and seems to make affair spread on the difference. Shakespeare notwithstanding, both the borrowing and the lending look like an acceptable part of doing business as a REIT

LTC took on additional debt after September and. sold $70.0 million 3.99% senior unsecured notes with maturity November 20, 2021 to Prudential Investment Management. The proceeds will pay down the unsecured revolver.

In October, they borrowed $86,000,000 and used it to fund a mortgage loan secured by 15 skilled nursing properties in Michigan. The details of this mortgage are discussed under mortgage originations. This is the loan they are paying down and rolling into notes. The credit facility costs them LIBOR+1.25%. LIBOR is low now at 0.57% but it floats and 3.99% due in seven years may save them some cash if rates rise. Before repayment LTC had $154,000,000 available for borrowing.

Senior Unsecured Notes

As of September 2013 and December 2012, LTC $185,800,000 senior unsecured notes with a weighted average interest rate of 5.2% and an additional $100,000,000 through October 2014.

LTC has two additional notes sold to Prudential. October 30, 2013 -- as of November 4, 2013, they had $50,000,000 outstanding in senior unsecured notes from July 2010 at 5.74% and $50,000,000 from July 2011 at 4.8%.

LTC is one of the lowest leveraged REITs I have looked into. However, lower debt levels tend to mean higher share dilution from equity financing and LTCs share count has increased 48% since 2010. Diluted shares now stand around 37 million.


SNH
Debt/EV 31.8%
Debt/gross assets 41.0%
Debt/EBITDA 4.4x

VTR
Debt/EV 32.0%
Debt/gross assets 47.0%
Debt/EBITDA 5.3X

HCN
Debt/EV 35.0%
debt/gross assets 45.3%
Debt/EBITDA 6.5x

Bonds Payable

September 2013 LTC had $2,035,000 multifamily tax-exempt revenue bonds that are secured by five assisted living properties in Washington. The interest is variable and reset weekly and matures during 2015. For the nine months ended in September weighted average interest rate was a low 2.9%. During that nine months LTC paid $600,000 principal payments.

Rates on their borrowings are fairly low and create a good spread between borrowing interest rates and mortgage lending rates for them. Plus they have extremely conserve debt levels at present.

Mortgage originations

At September 30, 2013, their mortgage loans had interest rates ranging from 7.0% to 13.6% and maturities from 2014 to 2022. In addition, some loans contain guarantees, provide for facility fees and have 20-year to 25-year amortization schedules. The majority of the mortgage loans provide for annual increases in the interest rate based upon a specified increase of 10 to 25 basis points.

During the last nine months LTC funded $2,816,000 under a $10,600,000 mortgage and construction loan with a remaining commitment of $5,165,000. LTC collected principal payments of $1,429,000 in 2013 and $2,010,000. They also collected $2,846,000 plus accrued interest from the early payoff of three mortgage loans secured by three skilled nursing properties.

In October 2013, LTC did a big $124,387,000 mortgage loan with a third-party operator secured by 15 properties and 2,092 skilled nursing beds in Michigan. The loan is for a term of 30 years and bears interest at 9.53% for five years, then escalating annually by 2.25%. Payments are interest-only for three years, after which the borrower will make interest payments along with annual principal payments of $1,000,000. The loan agreement provides for additional forward commitments of $12,000,000 for capital improvements at 9.41% for the first twelve months.

The borrower has a one-time option between the third and twelfth years to prepay up to 50% of the then outstanding loan balance without penalty.

On the September balance sheet, LTC held $41 million in mortgage receivables net of allowance of $411,000 for doubtful accounts.

For LTC the money just goes round and round from debt to mortgage originations and in the end it looks like the get a nice spread.

New deals

•development commitments totaling $19,553,000 with an existing operator to fund the purchase of land and construction of two free-standing memory care properties in Colorado-- two parcels of land for $2,050,000

•a pipeline agreement with this same operator to finance any senior housing development projects or acquisitions originated by the operator through May 2018

•sale of six skilled nursing properties located in Ohio with a total of 230 beds for an all cash purchase price of $11,000,000-- $2,619,000 gain on sale

•sold a 47-bed skilled nursing property in Colorado for $1,000 and recognized a $1,014,000 loss on sale

•completed the construction of a 60-unit memory care property in Colorado opened in July 2013

•completed the construction of a 120-bed skilled nursing property in Texas replacing a skilled nursing property in the existing portfolio. All the residents were relocated from the old property to the new property

•purchased four parcels of land in Michigan for $1,163,000.

•purchased a 120-bed skilled nursing property in Florida for $14,402,000 included in a master lease at an incremental initial cash yield of 8.75%. The operator currently leases four properties with a total of 596 beds/units. The new master lease will contain all five properties with a total of 716 beds/units and have a GAAP yield of 10.7%. The initial lease term is 10 years with two 5-year renewal options and annual rent escalations of 2.2%.

NAV

The NAV at various cap rates.

7.0% $42
7.5% $41
8.5% $39

Current price is $38 and that tells me the market may consider this one to be a little higher risk or at least that’s how I tend to think of cap rates. They are like the discount you apply to risky small caps and those are higher than blue chip stalwarts. LTC is a very small player compared to VTR and its outsized dependence on government funding raises the risk. They deserve a higher discount rate.

There are some positives about LTC:

• Low debt ratios
• Low payout ratios
• Steady dividend
• High yield at 5.6%
• Price near 52-week low
• Busy doing deal
• Good mortgage business

Some negatives

• FFO/price on the high side at 20.4x
• High Medicare Medicaid payer percentage
• No SHOP
• High percentage of skilled nursing and the trending lower
occupancy for SNF
• ALC unknown state of finances may put them at risk for default.
• Four operators control almost 43% of revenue
• Substantial share dilution

Not sure I am a buyer at these levels. I do like the yield and the payout ratios. The low debt is a plus.

If you guys have some insights into them and good cases for buying please post them.

 

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