SNH: Worth a Bite?
Board: Real Estate Investment Trusts
Health care REITs (HCRs) could probably be best invested in as a basket. All of them seem to make good sense as opportune investments in a convincing demographic trend – old people. We are all getting there and while nursing homes and assisted living may not be part of our current game plan, for 70% of us it may become reality at some point.
Not all health care REITs are created equal. As luck would have it, I started with Ventas that may be close to the gold standard for HCRs. By comparison, SNH is smaller, has more challenging liquidity issues, perhaps pays out a bit much for acquisitions, and has fewer acquisition opportunities as the real estate market gets fluffier and bubblier. However, it is not without its charms and could make a reasonable contribution to a basket of HCRs.
Senior Housing Properties trust--SNH
SNH is a health care REIT that owns senior housing and assisted living properties, skilled nursing facilities and medical office buildings. They are selling their two rehab hospitals that were 2% of the property mix for $90 million and a $30 million gain on sale. The remaining properties are in 40 states and Washington, D.C. with a preponderance in Florida and California. The carrying value of their properties is $5.3 billion. Senior housing is around 64% of this asset value.
SNH has both independent living and assisted living units. Independent living requires residents to be capable living independently without nursing care and help with activities of daily living.
Assisted living typically has one-bedroom units with private bathrooms and efficiency kitchens. Services bundled usually include three meals per day in a central dining room, daily housekeeping, laundry, medical reminders and 24-hour availability of assistance with the activities of daily living -- dressing and bathing. Professional nursing and healthcare services are usually available at the property on call or at regularly scheduled times.
Independent and assisted living are 60% of the investment property mix and triple net and managed senior housing was 71% of revenue for the first 9 months of 2013. Managed properties (sometimes called SHOP) were 40% of revenue and 60% of NOI.
Five Star is the manager for 40 of the SNH senior properties. Occupancy at the Five Star properties is 84%; Sunrise is 93%; Brookdale is 95%. The SNH owned/managed properties have an occupancy of 87%. While occupancy for the triple net properties does not directly affect SNH revenue, it does indicate that the operators are reasonably successful keeping rooms filled and are likely to remain profitable and continue their tenancy. I would like to see the SNH managed/operating properties at higher occupancy since this does directly impact earnings. Ventas SHOP portfolio was 92% occupied.
The SNH SHOP portfolio had NOI margins of 23% down from 26% in the same quarter 2012. These are far below VTR margins at 32%. Same store SHOP revenue increased by 5.6%. Per management, the margins are going to be lower because a percentage of SNH RIDEA assets are 75% independent living and 25% assisted living. Independent living has far better margins and lower expenses. The properties that are more heavily assisted living will see margins in the neighborhood of 20% to 25% instead of the 30% to 40% margins independent living properties return.
The property weightings are similar to Ventas with senior housing as the biggest percentage of assets and revenue/NOI. SNH also has property that they operate through Five Star and as with Ventas this provides an opportunity for higher organic growth that has the potential to exceed triple net lease rent increases.
The biggest advantage in the business mix for both Ventas and SNH is the percentage of private pay compared to government reimbursement from Medicare and Medicaid. Tenant revenue from private pay is around 82% and NOI is 94%.
Skilled nursing provides nursing and healthcare services similar to those available in hospitals, without the high costs associated with operating rooms, emergency departments or intensive care units. A typical purpose built nursing home includes rooms with one or two beds, a separate bathroom and shared dining facilities. Licensed nursing professionals staff nursing homes 24 hours per day. SNH has 47 facilities and 5,000 beds. SNF are 4% of investments and 3.8% of NOI.
Medical office buildings (MOBs)
The MOBs are office and commercial buildings operated as medical offices for docs, clinics and labs. Others are the MOBs are the back offices for health insurance companies and hospitals. SNH owns 8 million square feet and MOBs are 31% of investments, 30% of NOI and 27% of revenue for nine months.
These have gymnasiums, strength and cardiovascular equipment areas, tennis and racquet sports facilities, pools, spas and children's centers. Professional sport training and therapist services are often available. Wellness centers market themselves as clubs and members pay monthly fees. These 10 properties are 3% of investments.
The leases for senior living communities and wellness centers are triple-net leases requiring the tenants to pay rent, all operating expenses, to indemnify SNH from liability, maintain the leased properties at their expense, remove and dispose of hazardous substances and to maintain insurance.
The leases for the office buildings are both triple-net and modified gross leases where SNH is responsible for paying operating costs and maintenance. They charge tenants for some or all of the property operating costs in addition to rent. A small percentage of office leases are unfortunately full-service leases – they get fixed rent and pay no reimbursement for costs. I can’t find the number that rent under these terms but we have to hope it is as a very small percentage. It’s a great deal for tenants and probably not as profitable as a straight triple net since costs are going to create margins and margins mean lower bottom line earnings.
In Q3 SNH acquired five properties for $101 million. Four were private pay senior living communities with 306 units located in Georgia and Tennessee ($51 million) and were added to the managed senior housing portfolio.
The fifth property was 105,000 square foot biotech laboratory building in Boston for $50 million. This property was leased to Perkin Elmer Health Services -- a subsidiary of the publicly traded Perkin Elmer—investment grade with a $4 billion market cap. The lease is for a 15-year initial term.
The weighted average cap rate on these acquisitions was 7.9%. The cap rates for the senior housing was in the low 8%s versus the MOB, which is 7% to 7.5%.
•SNH has four properties under agreement for a total of approximately $27 million
•One senior living community with 68 assisted living units located outside of Madison, Wisconsin for $12 million
•Three properties that are a healthcare system affiliated medical office building portfolio,approximately 63,000 square feet in Orlando, Florida for $15 million
•These properties should close during the fourth quarter.
The acquisition environment for SNH is mainly small single opportunities in contrast to the much larger transactions Ventas can fund. Rather than being able to muster billions to make acquisitions, SNH targets deals in the $250 million to $300 million range. In 2011 they spent $1.1 billion and called it an opportunistic year. On average they seem to spend $600 million or slightly less yearly for properties.
From the CC:
So I think it's a challenge to win some of the larger transactions and this environment because I think pricing is getting a little bit frothy but -- while we're still trying to hold the line on our investment parameters.
Real estate acquisitions for the first nine months totaled $149 million. The cash flow from operations was an impressive $248.2 million and with acquisitions of $149 million and $37 million in real estate improvements SNH managed free cash flow of $62.2 million. Nine-month dividends were $215.6 million. Free cash flow in REITs is never meant to cover
distributions. It’s nice if it does. VTR had CFFO of $835.4 million and $1358 million in real estate and was free cash flow negative. That doesn’t make a REIT insolvent. Because they distribute 90% of their earnings they retain little for capital spending and require regular capital raises to fund capex. It’s the nature of the beast so it makes little sense to look at them like a C corp. What you do need to take into account is the debt levels, dilution and access to credit.
Debt and liquidity
SNH is a step below Ventas but is investment grade. Moody’s rates them Baa3 and S&P has a BBB- rating for them.
SNH debt obligations are outstanding are
1) $750,000 unsecured revolving credit facility
2) unsecured senior notes, including:
(a) $250,000 rate of 4.30% due 2016
(b) $200 rate of 6.75% due 2020
(c) $300,000 rate of 6.75% due 2021
(d) $350,000 rate of 5.625% due 2042
(3) $684,615 mortgages secured by 51 properties with maturity dates from 2013 to 2043. The 51 mortgaged properties had a carrying value of $950,736.
The SNH unsecured revolver was amended and gives them $750 million up to $1500 million through 2018. They lowered the rate from LIBOR +1.6% to LIBOR +1.3%. The blended rate appears to be higher than Ventas (3.7%) with most of the notes at 5.6% or greater. Likewise the revolver is 0.3% higher than Ventas rate. This no doubt reflects the slightly lower credit ratings
Interest expense declined 3.3% to $29.4 in Q3 yoy. They prepaid a mortgage note encumbering two properties totaling $13.6 million with a weighted average interest rate of 6.5%.
In Q3 they paid down $230 million of secured debt at a weighted average interest rate of 6.4%, and assumed $77 million of secured debt at a weighted average interest rate of 6.1%. From this we can see that their interest rate is considerably higher than the 3.8% blended rate Ventas borrows at.
SNH had $52.3 million cash and equivalents and $625.0 million available to borrow under the revolver at the end of Q3. In order to continue acquisitions they will use cash balances, the revolver, net proceeds from property sales, equity or debt securities and the cash flow from operations. This is the way REITs and MLPS and LLCs grow since they distribute the cash to investors. It’s the nature of the beast for a tax-advantage business.
The company has 19 properties held for sale, including 10 senior living communities with 744 units, two rehabilitation hospitals with 364 licensed beds and seven MOBs with 831,499 square feet. They are selling these properties because they are in unattractive markets. In aggregate, the 10 senior living communities that are held for sale get a majority of their revenues from Medicare / Medicaid reimbursements so this is a very astute move. All 10 of these communities are leased to Five Star.
[See Post for Tables]
SNH is less leveraged than VTR and that’s good since they have higher costs of borrowing and with their small size, will be competing against bigger dogs for properties. SNH needs acquisitions to grow and debt levels will have some room to expand.
Third quarter segment results
The triple net leased senior living had occupancies at 85% and coverage ratios were about 1.4x. Occupancy for the trailing five quarters was essentially flat for the independent assisted living assets and skilled nursing continued to see occupancy drop. Skilled nursing declined from 80.4% to 78.9% year-over-year and is affected by the weak operating environment and decline in skilled nursing census. The Medicare sequestration has put pressure on coverage ratios. Ventas SNN occupancy has also dropped year-over-year and we might be seeing an industry wide trend. SNH and Ventas are making strides diluting out these government reimbursed facilities.
The triple net leased senior housing had occupancy of 84.2% and strong rental coverage of 2.0 times. Coverage is down from last year due to the addition of five new communities with the new tenant that came on at approximately 1.2x coverage, as well as declines in Medicare rates at the skilled nursing assets.
The 40 managed senior living communities (6800 units) generated $17.2 million of NOI and 15% of total company NOI. Occupancy at the 40 communities was 87.3% with the 25 same store communities at 90.8% (+2.7% yoy). Same store NOI increased 10.8% and same store margins increased to 27.8% from 26.5%. SNH feels there is room to continue to grow occupancy and to push rates and margins at these properties.
Medical offices (116 buildings with over 7.8 million SF) had NOI of $34 million -- up 1.9%. Occupancy was up 1.7% to 95%. The 103 same store MOB occupancy was 94.7% down 30 basis points from last year, and NOI was $30.2 million down 8.3% from last year. The declines are primarily from a handful of lease terminations that will be eased over the next few quarters along with lower rental rates on certain renewals.
Revenue from rentals was $112 million down 1.3% from last year. The decline was due to the transfer of 10 previously triple net leased communities to the managed senior properties during the third and fourth quarters of 2012.
Revenue from senior living and offices was nearly evenly split at $57 million from leased senior living communities and approximately $51 million from MOBs.
Managed residence fees and services revenue was $75 million including the acquisition of six managed senior living communities and the transfer of the 10 leased communities to the managed portfolio since July 1st, 2012.
Total revenue was $187.3 million for the quarter up 20%. Net income increased by 49% and was helped by lower expenses especially early extinguishment of debt that was expensed last year.
Value or not? More value than not
SNH is not suitable to be the massive solid foundation of an HCR portfolio structure. That honor would (for now) go to Ventas. Ventas is not a deep value at current prices and is at best fair valued to slightly premium priced and as such may need to be eased into slowly and in small bites. The VTR yield is 5.1%.
SNH is selling at a slight discount by my less than perfect NAV calculations The NAV/share is $24 and the SNH price/share is currently $22.21. Assumptions for the NAV were a cap rate of 7.5% (VTR was calculated with 7%) and market value of property was $5509 approximately 6% appreciation over acquisition value. The price/FFO is 13x and slightly less than VTR at 14x.
The risk is higher with SNH. They are smaller with less borrowing capacity and higher costs of debt. Any downturn will hit them harder than the bigger broader Ventas. At present the assisted living/skilled nursing is crushing the managed property margins. The flip side is there is room to improve as they sell off these properties.
SNH pays out a much larger percentage of FFO and dividend raises will be less likely unless FFO appreciates consistently and it has not been spectacular this year. Q3 was positive but Q1 and Q2 saw growth decaling.
Because of the lagging FFO, the payout ratio reached 95%. Ventas pays out around 72% to 73%. A payout of 95% leaves very little room for absorbing a disappointing quarter and maintaining the dividend.
Lastly I am not a big fan of the office space leased outside of triple net structure. The non-reimbursable expenses hurt margins and because there is no separate quantification, it’s not possible to know what percentage of the square footage is under these terms.
The share dilution is high.It may need to stay that way if SNH needs equity to raise capital to make deals.
There are some positives making SNH portfolio-worthy at least as a supporting player.
The dividend yield is high at 7.1% and trading at near a 52-week low that was $21.66 (now at $22.21). If they can keep NOI and revenue on an even keel, the dividend should at least be maintained. Because of the high payout ratio, I don’t expect raises. The loss of capital is always a concern with a smaller less well-capitalized REIT and it could test 52-week lows if earnings and FFO fall off and the dividend is lowered. The yield does tend to put a floor under it.
Debt is staggered and at moderate levels.
SNH is extremely attractive in their aggressive moves away from Medicare and Medicaid. In the recent quarter they claim 94% of NOI is from private pay. This could become a problem if economic conditions deteriorate to the point that private pay can’t pay for senior housing. By my calculations, they get around $3700 per room per month and since that is around $1800 less than Ventas, they could be the low cost alternative.
While higher risk, the higher yield and the SNH emphasis on private pay senior housing and triple net MOBs makes SNH a candidate for a supporting role in the search for income.