Diversified Healthcare Trust (DHCNL) Q3 2015 Earnings Report, Transcript and Summary

Good morning and welcome to the Senior Housing Properties Trust Third Quarter 2015 Financial Results 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 conference over to Senior Vice President, Tim Bonang. Please go ahead, sir.

Thank you and good morning, everyone. Joining me on today's conference call are David Hegarty, President and Chief Operating Officer; and Rick Doyle, Treasurer and Chief Financial Officer. Today's call includes a presentation by management, followed by a question-and-answer session. I would also note that the transcription, recording and retransmission of today's conference call are strictly prohibited without the prior written consent of Senior Housing. Before we begin, I would like to state that 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 on Senior Housing's present beliefs and expectations as of today, November 4, 2015. 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 and cash-based net operating income or cash NOI. Reconciliation of these non-GAAP figures to net income and the components to calculate AFFO, CAD or FAD are available in our supplemental operating and financial data package found on our Web site at www.snhreit.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 would like to turn the call over to Dave.

Thank you, Tim and good morning, everyone and thank you for joining us on today's third quarter earnings call. Earlier this morning, we reported normalized funds from operations or normalized FFO of $0.47 per share for the third quarter, up 6.8% year-over-year. This was achieved through strong operating results and attractive financing activities during the quarter. On our second quarter call, I told you that the investment environment had become very expensive and our efforts will be focused on adding value through internal growth, more efficient operations and improving our financial flexibility. Our sequential and year-end performance improvements this quarter as a result of these actions and some of the major highlights of this quarter were that we grew normalized FFO per share year-over-year by 6.8%, further reduced our normalized FFO payout ratio to 83%, continue to lead the industry with 97% private pay portfolio. We grew consolidated same property cash NOI by 1.9%. We grew triple net senior living portfolio same-store NOI by 1.3%. We increased medical office building same-store NOI by 50 basis points and the cash NOI was essentially unchanged. We refinanced $200 million of revolver debt with a 7-year bank term loan at an attractive interest rate of LIBOR plus 180 basis points. We expanded the capacity under our revolving credit facility by $250 million to $1 billion credit facility. We acquired two private pay senior living communities, leased to third parties on attractive terms and returns on investment. We increased our managed senior living same-store NOI an industry leading 11%. As we have done on prior calls, I will review the results of our various business segments and recent acquisition and investment activities, then Rick will follow to discuss our financial information in more detail. Starting with our triple net leased senior living properties. We had 232 leased senior living communities generating quarterly NOI of $64 million, which represents approximately 41% of total company NOI for the third quarter of 2015. These communities performed very well and were in line with our expectations as the same-store rental income increased 1.3% year-over-year. This increase is primarily due to the revenue producing capital improvements made in our properties over the past year. Within the triple net senior living portfolio, Five Star's 178 leased communities had combined occupancy of 84.5% and rent coverage of a solid 1.2 times for the 12-months ended June 30, 2015. The four properties we leased to Sunrise Senior Living had occupancy of over 92% and rental coverage of two times. The 18 properties we leased to Brookdale Senior Living had occupancy of 92.5% and rental coverage of 2.7 times. Our other triple net leased senior living properties leased to 13 private regional operators had average occupancy of 85.7% and rental coverage of 1.7 times. As you can see, our leases are well covered and we are pleased with the performance of our operators. Now turning to our medical office building. We had over 11.3 million square feet generating quarterly NOI of $65 million, representing approximately 41% of the total company NOI for the quarter. At September 30, our MOB segment was comprised of 121 properties with 145 buildings and the overall occupancy was in industry-leading 96%. In our 98 same-store medical office building properties, our NOI for the third quarter increased 50 basis points compared to the same period last year to $56.6 million, an increase of approximately $300,000. Although occupancy declined 50 basis points to 95.1%, rental income increased over $2 million. The increase in rental income relates primarily to the increase in rental rates, escalation income and parking income. This was offset by $1.8 million of increases in real estate tax expense, repairs and maintenance expense and other direct costs of operating these properties. Now turning to our managed communities. At September 30, we had a total of 65 managed senior living communities with more than 8,600 units generating over $24 million of NOI during the third quarter which represents approximately 15% of total company NOI. At our 44 same-store communities, the NOI grew 11% year-over-year and same store margins increased 220 basis points to 24.8% from 22.6% last year. These communities generated a $1.1 million increase in revenue which was primarily driven by an average monthly rate increase of 1.8% in excess of lost revenues from occupancy declines. Same-store occupancy declined 40 basis points sequentially and 100 basis points year-over-year to 87.2%. In addition to excellent revenue growth, we also experienced a decrease in property operating expenses of 1.5%, or approximately $900,000, primarily due to decreases of real estate taxes, health benefits as well as an overall decrease in other direct costs of operating these communities. We realize that these are extraordinary results. An increase in revenue alone represents a 5.9% growth in same-store NOI. We also experienced lower healthcare insurance cost this period due to lower volume of claims and employees switching to less expensive plans this quarter compared to the same period last year. During the quarter we also received real estate tax abatements which without these onetime abatements, our same-store NOI growth would have been 9.7%. Both healthcare insurance costs and real estate taxes fluctuate each quarter and we will continue to appeal real estate tax assessments on any and all property taxes that we believe are inflated. And for the full year 2015, we expect same store NOI to achieve 4% to 6% growth year-over-year. Moving on to our acquisition and investment activities. In light of the frothy acquisition environment, we remain disciplined in our underwriting and had modest new investments during the quarter. In September we acquired one senior living community with 87 assisted living units leased to a third party operator for ten years for $27 million and assumed mortgage debt of approximately $12 million with a weighted average interest rate of 6.2%. This acquisition was the last remaining community to be acquired as part of the portfolio of 38 senior living communities from CNL Lifestyle. Also in September, we acquired a newly-built senior living community with 84 private pay assisted living units located in Georgia for approximately $18 million. And this community is over 90% occupied and it's leased to an existing third party tenant for 15 year and the rest is set at an initial cap rate of 7.5% with 2% annual increases thereafter. In summary, very pleased with the performance and quality of our portfolio. We will remain very selective and disciplined for the remainder of the year, given that cap rates continue to be compressed across the whole healthcare spectrum and our focus is on furthering our relationships with existing operators, continuing to seek internal growth opportunities including expansions and renovations at our communities and other opportunities to enhance investment returns while maintaining a very strong balance sheet. And with that I will turn it over to Rick to provide a more detailed discussion of our financial results.

Thank you, Dave and good morning everyone. For the third quarter of 2015 we generated normalized FFO of $111.4 million, up 24% from $89.6 million in the third quarter of last year. On a per share basis, normalized FFO for the quarter increased 6.8% to $.47 per share compared to the same period last year. Rental income for the quarter increased $21 million to $159 million. Increase is primarily due to external growth from investments in 23 medical office buildings and 20 leased senior living communities we acquired since July 1, 2014. This was offset by a reduction in rental income due to sale of two MOBs in six senior living facilities during the same period. Residents' fees and services revenues from our 65 managed senior living communities properties, increased over 21% to $96 million compared to the third quarter of last year. The increase is primarily due to acquiring 22 managed senior living communities since July 1, 2014, is an increase on the average monthly rental rate. Property operating expenses from our MOBs in the managed senior living communities increased 17% in the third quarter to $97 million compared to the same period last year due to external growth from acquisitions as we added 22 managed senior living communities and 23 MOBs to our portfolio since July 1, 2014. General and administrative expenses remain flat year-over-year at $10.3 million due to the increase in business management fees this quarter compared to the same period last year, offset by the benefit of expense controls and lower stock grant expense. At 4% of quarterly revenues, SNH continues to maintain a G&A expense as a percentage of revenues at or below its healthcare payers. Interest expense increased 7.7% to $39 million this quarter compared to the same period of last year, primarily as a result of assuming approximately $181 million of mortgage debt encumbering 19 properties with a weighted average interest rate of 4.6% since July 1, 2014, increased borrowings outstanding under our revolver in our new $200 million term loan which closed on September 2015. This increase was offset by the repayment of mortgage debt encumbering 15 properties with a total principal balance of approximately $113 million in a weighted average interest rate of 5.9% over the past year. Subsequent to quarter-end, we prepaid two mortgages with maturity dates in January 2015, encumbering one property with an aggregate principal balance of $52 million in a weighted average and annual interest rate of 5.6%. In this morning, we prepaid all of the $250 million of our 4.3% unsecured senior notes scheduled to mature in January 2016. Moving to the balance sheet. During the third quarter we acquired two senior living communities for approximately $46 million and assumed $12 million of debt on one of these communities with an interest rate of 6.2% and invested $8.2 million into revenue producing capital improvement at our leased senior living communities. During the quarter we also spent $3.6 million on MOB tenant improvements and leasing cost. These costs can vary significantly quarter-to-quarter depending on when we execute certain leases and the characteristics of those leases including the length of lease terms and the amount of square footage. Our recurring capital expenditures for the quarter included $2.3 million at our medical office buildings and $3.1 million at our managed senior living communities. We also incurred approximately $5.2 million of development and redevelopment capital expenditures, primarily at our managed senior living communities. Also during the quarter we sold two leased skilled nursing facilities for approximately $1 million and currently we have two leased skilled nursing facilities with 257 living units in a net book value of approximately $5 million classified as held for sale which we expect to sell by the end of the first quarter 2016. In September we closed on a new $200 million unsecured term loan that matures in September 2022 with an interest rate of LIBOR plus 180 basis points. This term loan has an accordion feature under which maximum borrowings may be increased up to $400 million. We used the net proceeds on the term loan to repay a portion of the amount outstanding under our revolving credit facility. Also in September, we partially exercised the accordion feature under our revolving credit facility to increase commitments to $1 billion. At September 30, we had $61 million in cash on hand, $468 million outstanding on our revolving credit facility, $1.7 billion of senior unsecured notes, $739 million of secured debt and capital leases and $550 million of unsecured bank term loan debt. As the nature of the balance sheet and liquidity remains strong in line with our peers, with debt to gross book value of real estate assets of approximately 47% in adjusted EBITDA to interest expense at 3.9 times. As discussed on previous calls, we are comfortable with our leverage ratios in the mid-40s to the low 50% range. Subsequent to quarter-end, we declared a cash dividend of $0.39 per share and our normalized FFO payout ratio for the third quarter decrease to 83%, which means our dividend is well covered. And as you heard today, the portfolio is performing very well and the balance sheet is in excellent condition with no meaningful debt maturities in the next few years. For the foreseeable future, we will continue to focus our efforts on internal growth by funding expansions, generating strong operating results and implementing greater expense controls for our senior living in MOB properties. With that, Steve and I are happy to take your questions.

[Operator Instructions] The first question comes from Daniel Bernstein with Stifel. Please go ahead.

I guess, I want to understand a little bit more about the occupancy drop sequentially in the Senior's housing operating portfolio. Just if you could talk a little bit more about how that look month to month, was there a few number of properties that were an issue or was there a broad issue, say impact from construction? Just trying to understand a little bit more about the occupancy that's going on there.

Right. Well, the occupancy is a function of pretty much all of that as you mentioned. Everything is on the margin. And we have a couple of properties that certainly had a drop in occupancy due to either new competition opening up nearby or just change in executive director or different things like that. So I would say about half the portfolio actually had an increase and the half had a modest decrease. And I guess the markets that seem to have the toughest time are the southwest markets, Arizona and Texas. Most of the Texas, that’s usually new, new supply coming on line, particular memory care. But in the southeast etcetera, and in California we are having excellent results. So net-net it's down but it's a bunch of small things and just a couple of properties.

Was there any -- is there any, say, dip in September or recovery in September. Or you have any information how the portfolio has performed so far in October? Just trying to get a sense of whether that's bottomed out or if there is still some of those properties, geographies that you talked about are going to continue to struggle. Just trying to -- thinking forward a little bit as to how the portfolio might perform.

Well, I guess, right now, we have seen the results. Not the economic results but just occupancy results for the month of October and for our portfolio they are virtually unchanged from September. So they are holding their own. And also what I feel [indiscernible] that we have a number of properties that underwent significant capital investment and that impacts occupancy for a period of time. But I can't point to any one thing, I can't say it all with supply or anything broad based like that.

Are the units that were taken offline, are those back online now, or is there a certain timeframe we should think about maybe units coming back online where disruptions are decreasing?

Frankly, we keep all those stats in the numbers but not the -- the units don’t change but occupancy do go down because of the major construction going on at our facilities that might cause a wind, let's say. We have two or three projects that are undergoing major renovation, an elevator replacement, things of that nature that result $10 million to $20 million per property. But we don’t adjust that statistic for that.

Okay. But is there a timeframe we should think about where those impacts and disruptions might decrease?

The impact -- well, yes, certainly at those particular properties, we would expect the things to improve from here. It's just we have a portfolio of 400 properties and...

We are continuously upgrading these properties, Dan, so this correction may stop this quarter or next quarter in a couple of properties. But then there are other properties that are starting up too.

Okay. And then in terms of expenses, it doesn't seem like you have much in the way of expense or labor growth, but if you could talk a little bit, one of the hot topics that seems to come up in almost every earnings call now whether it's the operators or the REITs, is wage pressure. And so if you could talk a little bit about what wage pressure you may be seeing in that portfolio, if at all, or any unusual turnover of executive directors that may be related to construction in certain geographies. Just trying to understand, you had a good year-over-year drop in expenses but I want to also think about whether there is any pressures going forward?

Salaries themselves have gone up very modestly and we are not really seeing and overall increase in pressure for wages. So I don’t see it. Certainly in the next couple of quarters I don’t see any meaningful increase in pressure on wages. Other expenses, as Rick mentioned in the prepared remarks, the real estate taxes and health insurance claims and things like that are a little more volatile and unpredictable. But we continue to look for up to, is to push down of real estate taxes through appeals of assessment and things of that nature. What is interesting is the health benefits has actually seen a decline in cost due to improved claims, fewer claims but also people switching to lower cost...

Less fixed rent coverage plans. Yes.

Rent coverage.

Okay. And given where the stock price is, I just want to get some thoughts on what strategic options or capital options you thought about? Have you thought about buybacks of the stock or decreasing leverage given the difficult acquisition environment? Something to, give people a reason to move the stock price higher off of what now looks like 52-week low today. What should we be thinking about, or what are your thoughts on where the stock price is and how you get it up from here? What options you have to give an incentive for people to buy the stock?

I think we have to really express our message better. We are not pleased at all with obviously the stock price. We are looking at, possibly from assets sales, but historically the asset management group we have does a very good job of monitoring the portfolio and evaluating the performance of all of our assets and identifying properties that we need to make decisions whether they can be fixed in the foreseeable future or whether are properties that we would want to sell because they are underperforming. We rarely sell our best performing asset because then you turn around and buy things in the market. That’s tough, or we could use some of the proceeds to look at a stock buyback program. I think we are always evaluating different options for us to consider. Right now w are -- no, I think we are in actually pretty good place as far as the portfolio is doing, excellent. We have mentioned that we are focused. We think the external environment for acquisitions is crazy and our focus is really on what we can do to enhance our existing portfolio. So not doing acquisitions or growing in this environment externally is in our view is not a bad thing.

The next question comes from Tayo Okusanya with Jefferies. Please go ahead.

Congrats on a good quarter. It's good to kind of see some of the operating trends really moving in the right direction. But your stock unfortunately is not, I'm not quite sure why. But anyway, a couple from me. First of all, the line of credit. The balance as of 3Q of the debt prepayments you're making in 4Q, the number is starting to move up. How do you kind of think on a longer term basis about putting some permanent financing in place to reduce the balance on the line of credit and how does equity play into that mix?

Sure. Our plan is to continue to use debt financing to bring that down. We will also -- we have no plans today, especially at these equity prices to go the equity market, Tayo. So I just want to make that clear too. Right now--

Okay. So you don't mind being a little bit -- although your leverage ratios are still pretty low relative to your peers, you don't mind adding a little bit of additional leverage.

We are going to add leverage. I think right now our leverage is the average of our peer group too in the healthcare space. What we do have too is we are paying down debt this past 30 days, say in October, where we have no meaningful maturities due for several years, that helps us out. So I think we will monitor the capital markets, the unsecured debt markets and we will try to hit it at the right time to bring down our revolver balance. And then as Dave mentioned earlier, we are also looking at asset sales. You know our asset management group monitors it and evaluates the performance and if we can do anymore asset sales, we have two right now as held for sale, and that may help us bring down leverage.

Got it. Okay, that's helpful. Then second about just the [indiscernible] portfolio. Realizing it's a relatively small portfolio and so results, at least same store results can be fairly volatile quarter-over-quarter. How are you thinking kind on a stabilized portfolio, how it should perform over the next 12 to 18 months and if you can make any comments about some of the oversupply issues that everyone is talking about. That would be helpful.

Right. Well, with regards to, as you mentioned, 15% of our portfolio which is less than many of our peers, but that portfolio did very well this quarter. We mentioned in our prepared remarks that the rest of -- for this year we expect it to be in the 4% to 6% year-over-year growth. I would expect comparable, maybe a little, tone it down a little bit to 3% to 5% for next year. But I expect the revenues to continue to improve. Occupancy is probably and likely overall to remain flat and expenses seem to be very much under control and looking for opportunities to improve on that.

Okay, that's helpful. And just one more from me. Now that RMR has filed with the SEC, any comments you can kind of make about, again -- you're selling 10% stake in the company, ultimately how you expect to kind of dividend some of these shares out.

Right. Well, as I understand the process, they are still filing it with the SEC and have not been declared effective. So at this point, I really can't comment on what's contained in the prospectus or its impact on us. Or we maybe deem that as marketing. So I can just refer you to the filings that are with the SEC at the moment and everybody can look them up and see them.

The next question comes from Vikram Malhotra with Morgan Stanley. Please go ahead.

You alluded towards the end of your call that going forward there are internal opportunities for improvement and you're going to be investing in the business in the form of just capital expenditures. I'm just kind of wondering, just on the [indiscernible] assets and senior housing in general, can you give us -- I know you have given us the maintenance numbers broken out, but I'm just wondering the total CapEx that you've been putting into the assets over the last four quarters and what your plans are for the next 12 months, maybe on a per unit basis would be helpful?

Yes. On a recurring basis we usually, we average about $1000 to $1500 per unit on an annual basis and I think we have been on line with that quarter-over-quarter. And then as Dave mentioned earlier, the special projects at certain of the communities that we might be just enhancing to keep up with the marketplace overall. And we have been spending on the senior living communities around $4 million to $5 million per quarter on those, for the RIDEA and leased.

So $4 million to $5 across the whole...?

Yes.

And then -- sorry, go ahead.

Vikram, I would just add one comment to that. With our various operators, we always try to work with them to look for opportunities to expand their existing communities. So we have additional commitments out there, Brookedale, Five Star, the core of our private senior living operator, to do expansions, major renovations. And for all of that we received a return of at least an 8% initial return on those. So those are the types of things that in the aggregate, I would say on an annual basis, it's probably about $60 million to $80 million.

Okay. And then so it seems like the development, redevelopment spend that you have in your supplement, most of that is senior housing. In terms of not maintenance but just one time expenses, one time CapEx.

Yes, that’s correct.

Yes. That’s correct.

Okay. And then, so just looking forward on the medical office side, you obviously had, I think occupancy fell a bit and your cash NOI was sort of flattish. Where do you think you can take occupancy, say over the next 12 months or in your mind what is structurally peak occupancy for your assets?

Well, you know we are at 96% or so occupancy, it's very difficult to improve much upon that. So I think the occupancy can be pretty consistent. Maybe modestly improved. We have a pretty mature portfolio other than say, Vertex, and the difficulty is to moving the needle on it, certainly on a cash basis, is that, say like Vertex, Vertex has three rent steps in the least. Each rent step is five years apart. So for five years, other than escalatable income and parking revenue income increases, otherwise that’s going to be flat for the five year period. And then you get a significant, about 8% or 9% increase in rent at that time. So that’s makes it a little difficult on a cash basis where the gap would reflect a much more positive story. We have properties like Cedars-Sinai continue to push the limits at $78 a foot rent and seeing about 2% to 3% rate increases year-over-year. Other properties of the portfolio, I mean we only did 1% of our square footage was -- or, excuse me, new leases are renewed this quarter. So it's very hard to move the needle with that type of activity. So I expect still a modest increase in revenues and the best we could do is try to make an impact on the expense side. This quarter our real estate taxes which is the biggest expense line item increased along, was about $1.2 million of which a good part of that is escalatable and pass back eventually. So I think we would still probably look to ultimately get to a place with around 2% growth on the MOB component.

Okay. And then that’s primarily just escalator driven. I am assuming your escalator is in that 2% range.

Yes, we did. We have over 600 different tenants and think about 250 properties. So it varies across the board. But we do have a number of escalators in many of leases.

Okay. And then just one last one on the balance sheet. Just two quick things. On the -- I you issued maybe $200 million or so of notes in September at LIBOR plus, was it 180 or 200. Today if you were to issue ten-year notes, kind of can you give a sense of what pricing you would see? And then I think you gave us dividend coverage, was it on FFO basis? If I am not wrong, do you know what it would be on an FO basis?

So on a ten-year, it's watch or wait every day. It could go up and down. So we expect around a 5% rate on a ten-year note for us. That could be the high 4s to the low 5s area range for us. We mentioned on the phone, on our script that normalized FFO payout ratio has decreased to 83% for the third quarter.

But on a CAD basis...

CAD basis it's around the mid-90s and everybody really calculates that differently and we put all the components on the supplemental to calculate that. But it's around the mid-90s which came down since last quarter 3 or 4 basis points.

The next question comes from Todd Stender with Wells Fargo. Please go ahead.

You touched on your recent disposition activity. Do you guys have a more formal program set up, just want to get a sense of what percentage of the portfolio could be teed up for sale, say over the next 12 to 24 months?

We are evaluating it on a regular basis but we have not made a formal public announcement of what we are evaluating considering selling.

Okay. And can you share what some of the rent metrics, the rent coverage metrics were for some of the recent asset sales. And I think Ricky mentioned one is teed up for sale for Q1. Any coverages you can share just to see directionally how that's going to impact the current portfolio

Usually they get a rent reduction on the net proceeds on the leased facility between 8% and 10%, of the net proceeds would be the rent reduction and like.

Yes. And as far covarage, I mean it really, it would enhance the coverage at the property -- on the leases that the property is being sold from. Because these are typically money losers.

Yes.

The property.

So you would expect the coverage to slightly, at least slightly, improve.

That’s helpful. How about the Iowa and the Wisconsin properties? Were they occupied and if so, how much time was left on the leases?

Iowa was not occupied and Wisconsin was occupied but it was roughly, I believe around 60% or 70% occupied and losing money, so without the ability to really turn those around in near-term.

And these are leases that have 10 years remaining on them.

Okay. That’s helpful. Thank you. And just to go back towards the balance sheet, accessing capital by tapping the term loans you certainly prove you have broad access to the debt markets. And we've seen some of the other, a lot of the other REITs actually obtain ATMs in the last couple of quarters as well as tapping DRIP programs. Have you guys looked at broadening your access to the equity markets, so you're not so contingent on doing overnights?

Well, I guess even on an ATM program that these price levels would not be attractive to us. So I think for the foreseeable future, equity is out of the picture. It's not attractive whatsoever, at these levels. So I think just through asset sales and with the payout ratio getting lower too, we are generating surplus cash flow to continue to pay down debt or look at other options. But right now we are not actively looking at those types of equity alternatives.

Okay. Thanks, Dave. And just finally, I know you have briefly touched on the RMR distribution coming up. Can you just give us a reminder of how much you do own of the RMR shares and how much you plan to distribute to SNH shareholders?

It would be 17% and then half of that would be distributed. So we would retain 8.5% within SNH.

So it's a $60 million investment. Do I have that right?

Yes. It was a $50 million investment.

The next question comes from Michael Carroll with RBC Capital Markets. Please go ahead.

Can you guys talk a little bit about your Five Star [lease] [ph]? The coverage seems to have declined a little bit. Is that a trend or is there any non-recurring items coming through those numbers?

There are some items going through the numbers but the numbers that we utilize in the coverage ratios are unaltered, they are just the raw numbers from the operating side of the properties. And the way those -- we have four master leases that have different maturity dates such that they would be accounted for as operating leases rather than capital leases. But there are cross defaults, they are cross guaranteed and a corporate guaranteed from Five Star. So internally we really focus on the aggregate coverage ratio. Lease number one has taken a dip this quarter but if you were to pull out really just a couple of properties, you would be back about 1.2 times coverage and that would positively affect the whole portfolio too.

Are those potential asset sales that could occur to improve that coverage ratio?

They are. They are on the shortlist for consideration for it.

Okay. And in the lease number one, are those mostly senior living assets or are there are skilled nursing facilities in there. I know you have a small -- I think you might still have a small exposure to SNF.

Yes. The skilled nursing facilities in each of these number one, two and four. So they are spread out between three of those leases.

Quite a small amount?

Yes, we own, probably in those, maybe around 30 skilled...

That’s right. We have 30 altogether leased to Five Star and spread out between the three leases.

The next question comes from Dan Altscher with FBR. Please go ahead.

I appreciate the comments around not wanting to raise equity here. I think everyone appreciates that. And access to debt market like we talked about before, term-loan, got that taken care of. For future though, are we thinking more continuation of term loans, bank market, or maybe return to the unsecured market and have a more formal bond issuance.

Yes. We are going to monitor all of our options. Right now we probably leaning towards monitoring that debt unsecured notes market and jump on that when the market is ready.

Okay. Got it. I think Vikram also discussed payout ratio in his questions. And notably it has come down. As we are thinking about next year, that is the idea to keep our payout ratio, keep it in the low 80% range. After all the work that’s been done or maybe talk about trying to bring it up a little bit back into the mid-80s on a FFO basis.

We are in an interesting sort of dilemma here because payout ratio is low. It's come down. And under normal circumstances, we would be having a discussion about increasing the dividend at this time because we have always maintained that. We should be paying out the most that we are comfortable paying out to our investors. And historically it's run around 84%, 85%, 86% of FFO, in the lower 90s on a AFFO or CAD basis. So we actually could increase the dividend if we wanted to at this time. But we just look at the stock price, it's performance in the yield that it's currently offering investors. And we don’t believe that raising the dividend would be a prudent move to make at this time. So it's an interesting situation we have.

Okay. Got it. Okay. That’s loud and clear. And then just a really, just a small housekeeping item. The small impairment charge in the quarter is only, maybe like $100,000 or so. But can you just tell us what that was?

We had a couple of sales during the quarter where we had to write back impairments that we took in previous quarters. So it was actually a write up to account for the sale value or the sale price for those communities.

The next question comes from Juan Sanabria with Bank of America Merrill Lynch. Please go ahead.

Excellent pronunciation. Just a question on G&A. With the change in the RMR structure in the contract, what should we be thinking of G&A going forward, and apologies if you hit this in the prepared remarks.

Yes. No, that’s a good question. G&A, as I said in the prepared remarks, remained kind of flat quarter-over-quarter. If the business management fee expense increased, the G&A side would decrease as a result of the amortization of the deferred gain we recorded and other liabilities in connection with the RMR acquisition. But we also had lower, our stock price has decreased too so equity compensation we granted in September 2015 was lower than the equity comp we granted last year. So that had a benefit for us in our G&A. And overall professional fees we paid this quarter was a little less than we paid in prior periods. So there were some factors in there. I see our G&A increasing with acquisitions as it had in the past and as our stock prices increase, G&A may increase with that too.

Except since our expectation is that no investment to be modest, it probably won't go much from that.

Good run rate in the third quarter.

Got you. And then just going back to Vikram's question about the CapEx on Senior's housing and RIDEA. Was the $4 million to $5 million per quarter that you highlighted across RIDEA and the triple-net senior housing platform, included in the 1000 to 1,500 units annually spend? Or was that -- what bucket is that in? Is that maintenance CapEx or is that a redevelopment kind of CapEx that was captured, that succeeded $80 million annual number?

Yes. We have a capital expenditure page on our supplement and you will see that we spend, recurring capital expenditure there at managed senior living community at about $1000 to $1500 per unit. That’s recurring capital expenditures for me. And then we have development, redevelopment that we would be doing about $4 million to $5 million per quarter. The majority of that is at our managed senior living community. And then we also have, as Dave explained, we have capital expenditures at our leasing and living communities, Five Star and other tenants, that we get a return on. And that’s not included in this page 20 or summary of capital expenditure because we get a return on those capital expenditures. That could be above $50 million to $60 million annually.

Okay. And then do you guys get a -- what do you budget for returns for that $4 million to $5 per quarter on the RIDEA CapEx? Or is that more just to keep the companies competitive?

It's really to keep them competitive in the market in there and this way you can really increase rate of those communities and hopefully increase occupancy and then it hits our bottom line.

Right. We do do internal returns on those investments and then also we do believe our capital, that won't be able to increase revenues and returns. Those we look for about 10% return on investment before we decide to invest in that.

Okay. And just lastly, you guys have been running high on the leverage for a couple of quarters now at least. Your cost of capital relative to the peers has been challenged. Why haven't we seen a formal disposition program? What's the hold up?

Well, we have a lot going on but the, - I think some of the challenges that we certainly don’t want to sell some of our best investments and its more, certain non-strategic assets such as the skilled nursing component. We have always indicated that we are -- want to exit that line of business. We are down 3%. We have been selling individual medical office buildings and small portfolios. And we are going to continue to focus on that and look for more opportunities to do that. But....

So what would you point investors to as a catalyst then, to kind of improve the cost to capital? What can get people excited because it sounds like there is not going to be a big disposition program. Is it just the fundamental slowly improve?

Well, this year the summer and fall have been focused on looking at improving the internal operations and incrementally improving our bottom line. The FFO growth has been pretty stagnant the last couple of years and we view that as the -- probably a number one area that we need to grow the FFO. And then we have the ability to increase the dividend but that’s going to be a quarter by quarter decision whether we increase it. So we have been less focused on, I guess deleveraging the balance sheet or doing other things.

Yes. We will just keep our focus on the internal growth opportunities and we will continue to look at our bottom line. We need to just keep on showing that we can grow our FFO quarter-to-quarter which we have been in 2015, and still deliver safe and secure dividend.

Right. And on today's call we are not prepared to announce a big plan but it's not to say that’s not under discussion internally.

The next question comes from Jonathan Hughes with Raymond James. Please go ahead.

Most of mine have been answered but just have one more. I know you have already talked about your SHOP portfolio and commented on new supply, but I don’t I heard a quantified exposure, quantified number of exposure of that segment to new construction. Do you have that number available?

No we didn't -- we have not quantified it and for several reasons. One is, our whole shop portfolio represents only 15% of our portfolio. So we want to keep it in proportion of its impact on us. And also we do see a lot of numbers passed around in various reports and other REITs and so on but at the end of the day, we are still confound to being a local business. And we have properties in the same market, like San Antonio is probably the most overbuilt market or expected to be in the country. And frankly, our assisted living is doing just fine, in the upper 80s, lower 90s for occupancy, but memory care is being impacted at 60% occupancy. It’s specific to memory care, not generally. And if we are down four residents in Houston or something where, I am not going to say that it's due to overdevelopment. And so we have not gone through market by market and specified what is due to oversupply and where our greatest exposure is. I can tell you generically, as I mentioned, Arizona and Texas are probably the weakest markets and Florida is still thriving, California is thriving, and most of the southeast is thriving. But our greatest increase in our numbers this quarter came from properties in the southeast but I can point to a couple of properties that are hurting in southeast. So I frankly don’t believe in making a widespread comment about where the market's positive vibe is going to affect us.

Okay. I mean I think 15% of your NOI is pretty meaningful. So I would find that helpful. That’s it from me, guys.

The next question comes from Ross Nussbaum with UBS. Please go ahead.

I'm scratching my head a little bit because at the beginning of the call, you had made some comments about how frothy the acquisition market was. I think you actually use the word crazy. And at the same time you talk a little bit about dispositions but doesn't sound like you've got a major wave coming. And then I look at your stock price and you're trading it, call it eight times FFO, nine times AFFO, on our numbers over a 9% implied cap rate which could be in excess of 30%, 35% below NAV. I guess for the life of me, I can't understand why you're not going out and selling a whole bunch of properties and buying back your stock at a substantial discount. And the only reason that I could possibly think of that why you're not doing that, is your external advisor doesn't want to see lower fees. Can you help me explain what is preventing you from just going ahead and doing exactly that, selling assets and buying back stock?

We have a number of discussions on our front and it's just we are not in a position yet to announce anything and I think we will continue to discuss it...

Look at our assets to see where the opportunities are.

A number of extremely valuable assets and is frustrating that, it's probably naive to do. We have to do something to demonstrate the underlying value of the properties because if you just pass through our portfolio, the Vertex building we just bought 1.5 year ago, I am sure cap rates in the Boston Sea Port have dropped another 100 basis points and we are finding that our parking derived revenue and others have meaningfully moved up. So we are not going to sell a jewel like that. You look at Cedars-Sinai, 100% full all the time. Rental rates, it's actually going up to the upper 70s. So that could probably be sold for sub-5 cap rate but it's a crown jewel. It's part of our company makeup. So we would -- it's one of those assets that we would never sell and we have a number of those which go through our portfolio. So we are not going to sell the crown jewels and the smaller ones aren't going to amount to a lot of money.

I guess I don’t understand that comment because you guys have over $9 billion of assets, at least on our numbers. I mean I would think that out of $9 billion of assets there would be, at least a couple hundred million dollars of assets that would make sense to sell and use those proceeds to buy back stock. But...

We are not going to -- Ross, we are monitoring our whole portfolio and we are just not announcing anything and if opportunities come up where we feel that it's time to do it, we would.

Okay. The other question that I had, is the transaction with RMR, their listing, is that a 100% definitively going to happen or in light of your share price decline, the share price decline of your sister companies, is there any talk of unwinding that and going back to the drawing board?

No. In fact, I mean as a matter of fact that it actually has happened back in June. So this is the [listing] [ph] of the shares and it's going through the process. Actually RMR's investment in SNH has materially decreased since June and our investment with RMR is still very valuable. So, no, that’s not going to be unwound.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Dave Hegarty for any closing remarks. Please go ahead, sir.

Right. Thank you all very much and we look forward to seeing many of you at the upcoming NAREIT conference in a couple of weeks. Have a great day. Thank you.