Diversified Healthcare Trust (DHC) reported 21Q3 normalized FFO of –$0.04 per share, compared with 21Q2’s $0.05. The loss came despite a 40 bp improvement in SHOP occupancy. Operating costs remain high and senior living operators are discounting resident rates more because of the slow improvement in occupancy industry-wide. DHC’s Office portfolio’s 21Q3 performance met expectations.
During the quarter, DHC granted first mortgage liens on 61 office properties with aggregate gross book value of $1.0 billion to lenders on its $800 million revolving credit facility, which is fully drawn. Since its debt service coverage remains below the required 1.5 times minimum, the Trust is prohibited from incurring new debt under both the revolver and its public-traded unsecured debt issues. It ended the quarter with $794.7 million of unrestricted cash.
With its crimped profitability, its inability to borrow and the continual need to invest in its properties, DHC is almost certainly laser-focused on repaying or refinancing the high cost 9.75% Senior Notes as soon as possible after the $1 billion issue becomes callable in June 2022. This would best be accomplished, in my view, by raising debt and equity in the public markets. However, with the slower trajectory of improvement in the SHOP business, DHC may not be able to raise enough an optimal amount of equity in a public offering by mid-2022.
As an alternative, the Trust may consider a joint venture of its office portfolio. This type of financing is similar in concept to the recent offer that its sister REIT, Industrial Logistics Properties Trust (ILPT) made for Monmouth Real Estate Investment Corp. (MNR). While DHC’s shares would probably still benefit from such an alternative financing, the new joint venture equity would have a prior interest in the net income of the Office Portfolio, which could limit the recovery potential on DHC’s stock. A joint venture may also present internal funding challenges, since less of the Office Portfolio’s cash flow would be available to fund corporate and SHOP needs. Equity-friendly refinancing challenges are why DHC’s stock continues to languish, even though the bond market still anticipates that the 9.75s will be called in June 2022.
As a result of the disappointing 21Q3 results and likely slower pace of improvement in SHOP, I have reduced my normalized FFO estimates to –$0.05 for 2021 (from $0.10 previously) and $0.15 for 2022 (from $0.26). Likewise, I am reducing my price target to $6.50 per share from $7.40, in recognition that a large public equity offering may be more difficult to complete. Given the current share price of $3.45, I am maintaining my BUY rating on the stock.
This is a summary of my report dated November 15, 2021. Reach out to me to obtain a copy of the full report.
November 16, 2021
Stephen P. Percoco
16 W. Elizabeth Avenue, Suite 4
Linden, New Jersey 07036
© 2021 by Stephen P. Percoco, Lark Research. All rights reserved.