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Senior Housing Properties Trust (NYSE:SNH)

Citi Global Property CEO Conference

March 06, 2013 11:30 AM ET

Executives

David Hegarty - President and COO

Rick Doyle - Treasurer and CFO

Analysts

Question-and-Answer Session

Unidentified Analyst

Good morning, everyone. Welcome to the final 11:30 session here in Citi’s 2013 Global Property CEO Conference. This session is for investing clients only and if media or other individuals are online, please disconnect now.

We are pleased to have with Senior Housing Properties, David Hegarty and Rick Doyle. I will turn over to you guys for opening remarks and back to me for Q&A.

David Hegarty

Great, thank you all for joining us and coming to this, thank you Citi for inviting us, it’s our first Citi Conference for us presenting at and so I am sure many of you do know our company, Senior Housing Properties Trust or SNH is the fourth largest health care REITs. We had about $5.3 billion of assets so that’s a quite big gap between first three and ourselves.

About two-thirds of our portfolio is the private pay senior living type properties such as assisted independent living and assisted living and Alzheimer care, and then another third of the portfolio is medical office buildings. We have the highest private pay percentage in our portfolio of all the healthcare REITs and that’s by design over the last 10 years or so. We have not bought a nursing home or government dependent facility in fact we have been selling down, so we are about 94% private pay which given the current events and the government and so on it’s a good place to be.

We have approximately 400 properties in our company with about 260 of them being single living properties and 125 medical office buildings, and our medical office buildings about two-thirds of them are what we considered on-campus or affiliated with the major hospital systems in the country. And our focus really is to invest and offer an attractive yield with the ability to grow our cash flow each year or maintaining a conservative payout ratio in a conservative balance sheet. We have increased dividend every year since 2001 and we hope and expect to continue to do that going forward while maintaining a mid-80% of FFO payout ratio and it’s for the introduction and I will turn back to Manny for any questions you have and start the ball rolling.

Unidentified Analyst

We will start out a question we have asked each management team today. What do you think is the most value creating opportunities that you have as the market is not attributing much value for?

David Hegarty

I think the one area of our portfolio that is appreciated for the growth potential is the portfolio that is comprised of RIDEA type assets; about 13% of our NOI cum properties, senior living properties, where we own the assets, lease it to a taxable RIET subsidiary and hire a third party manager, but we get to keep the bottom line of the operations to the property. And these assets were originally built or acquired by such names as Marriot, Hyatt, the Forum Group, Bell Partners and several others so they are very high quality assets designed to be, to accommodate the private pay senior out there.

Now one of the things that we competed against the larger three health care RIETs. We were successful in acquiring these assets. And so people questioned why, how could we compete against big three, given their cost of capital and so on. But one of the things that was different about these transactions was an existing management. It was not going to stay on and they were getting out of the business so a new operator, a new buyer had to bring in a new management team. So we were able to offer competitive pricing, surety of closure and deliver a management team at the same time as the capital.

So they didn't have to have a tri-party negotiation for the operations as well as the real estate. So we believe that. It gave us a little bit of an edge to win these transactions. And we believe that these properties themselves have significant upside potential, particularly they call them the V assets which was the highest product. It’s 75% independent living and 25% assisted living.

And so during the recession, the independent living felt the impact the most of this senior living space, so this portfolio was about 94% occupied priced for the recession. It had dropped down to a low of just under 84% occupancy. We bought them when they were a little over 85% occupancy and we have no reason to believe that they can't get back up to that low to mid 90% occupancy levels.

One of the things that but you have to appreciate though is that because there is a change in management that there is a transition period, so normally you have a quarter or two of transition just from that. But then also during the diligence we identify all the CapEx needs and we target that we want to fix everything right away upfront so we get the benefit as soon as possible down the road. So we are in that transition period right now 2013, we'll be pumping CapEx into the properties and really bringing them up to be extremely competitive, if not top of the market. There's one right here in Hollywood that we visited yesterday, it said 97% occupied and it's the highest it's ever been since it existed. So again I think that's not appreciated in the value of our portfolio.

Unidentified analyst

Is there anything other than the CapEx infusion that assets need or they need to change to get from the 84 or 85 to 90 plus?

David Hegarty

Well there's definitely operational things you can do, I mean the CapEx, what's interesting about this community is a major CapEx project is going on right now, but I think it's in a way they're being operated that you can get them back up into the 90% occupancy because of targeted marketing, typically (inaudible), large chains which have a centralized marketing division at the headquarters and do mass mailings and figure that people will come because of the name recognition or brand recognition. Well, what each of these communities are doing now is forgetting that concept and it's the business, a local business at the end of the day, so they're out there marketing to the local organizations and recruiting and finding their niche what that market needs and filling that niche and I think it'll be a pretty quick rebound and we'll see the improvement in numbers.

And beginning with the first quarter of 2013, will be the first period that we'll start reporting same store performance senior living properties and we'll be able to talk more detail about how they're performing and what the potential is.

David Hegarty

Any questions from the floor?

Unidentified analyst

With such a large proportion of private pay assets, do you see sort of a top end lay where people just don't feel comfortable paying more than a certain amount or do you think it’s actually easier to push rate on a private where people get to choose where they want to be and maybe what they're paying?

David Hegarty

Well I think right now there's such a underserved market for private pay senior living that I don't see real top figure that we're anywhere near it, at the present time, and I don't envision that for several more years. I do think that maybe one of the issues with the whole looking big picture of private pay senior living is that, it caters to private pay more affluent people, so as a society there's a big need for middle income to lower middle income people and there are very few products that fit that void, so I think as a society there is going to have to be some changes down the road, but right now I think that people need the services; with the pickup in the economy, in the housing market and actually the labor market has a big impact on this because with the high end employment rate, they are available to take care of their elderly parents, and the elderly parents gets in some money that take care of their expenses. So it’s a win-win for the two of them. But once the economy picks up and then people go back to work, mom or dad have to go somewhere and then they have the resource to help pay for that care. So I think again, that will add more demand for the private pay. I don’t see a cap on the rates for at least a couple of years.

Unidentified Analyst

May be you talk about your acquisition pipeline for this year and further as you go.

David Hegarty

I am sorry.

Unidentified Analyst

The acquisition pipeline for 2013, and maybe even 14, 15 as well.

David Hegarty

Well let’s see. Last year we set $300 to $400 million and we have surpassed that. It was about $480 million or so. This coming year again we are saying $300 to $400 million should be our bread-n-butter transaction. There is always an opportunity for a larger transaction out there but your guess is as good as mine, whether we would be in a good position to win that or how much we should stretch for it.

Unidentified Analyst

And as well all the, your goal for the private pay senior housing or is that a mix of…?

David Hegarty

I envision probably more than half will be medical office, and I think that’s mostly because of the number of opportunities out there. The medical office business is highly fragmented and has tremendous amount of investable real estate, and our target market is basically $10 million to $50 million per transaction. I think once we get a $100 million or higher we will start to attract more attention, we will get more competitive. We may or may not win that senior housing, same thing is that, maybe one community can be $50 and we will win some of those, but I guess there is just not as many opportunities.

Unidentified Analyst

Can you talk a little bit about medical office fundamentals and leasing?

David Hegarty

Well there is a lot of change in the medical office space. I think it’s very positive for investors in this space. The push up of the demand, the baby boom is 10,000 a day turn 65 and they use three times as much healthcare services as the younger population. Also the way that the industry is developing, people are forming more of these kind of peer organizations, they’re encouraging healthcare to be provided on outpatient basis as much as possible, it used to be 65% inpatient 35%, any objective is to get that totally reverse to make it predominately outpatient, so that creates more investable opportunities and Obama Healthcare should also increase demand.

A lot of what we’ve been buying is satellite locations for major healthcare systems. So, in our Aurora transaction, we have 10 properties that are in the Greater Milwaukee Area and that’s just because bringing the care out to the consumer and done on outpatient basis. So, I think the fundamentals are very good for the next several years and maybe that challenge will be finding new or smarter MOBs. Today, I think there is probably, we personally don’t do development, we do expansion and so on but we don’t do ground up, but I do think there is opportunity for people who can do ground up development out there.

Unidentified Analyst

If you compare the same store NIO growth you know that on a sustainable basis you'd expect over the next couple of years, what different is that in your MOB portfolio relative to the seniors?

David Hegarty

I believe certainly for the next three to five years that there will be greater growth potential in seniors just because the consumer doesn’t have to leverage to negotiate as hardly and the demand is such that we had to take it all or leave it basically, so I think it’s would be a higher percentage there.

Medical office is kind of funny space because you can’t push it too hard. Physicians don’t like to relocate. Most physicians lend up serving out of the location for most of their professional career, but you need them and they need you, so you will more likely get CPI type increases or something in the 2% to 3%.

Sometimes, there will be situations like we have our price medical office building outside our two towers in LA, people the see the sign at our medical center or attached to see the sign, is 130 different tenants in the building and its 100% full at the waiting list all the time, so we’re able to put through 5% to 7% rate increases current rentals are going for $70 a foot for new deals, and there is a nothing that I can do that I have to be there and we can charge it because sometimes on campus MOBs have such a times for hospital that they cannot push rates that’s much so the hospital will object, and so they are going to be more limited to CPI type increase and so on whereas if you own it, if you have a free market then you are able to push through the higher REITs.

Unidentified Analyst

Who are the typical sellers of those associated with the hospital group type MOB especially portfolio, is it the hospital themselves or are they private owners?

David Hegarty

It’s more private owners whether it would be the physicians themselves a group. In our Aurora transaction, Aurora acquired the satellite locations that had physicians in them and there was a buyout of the physicians group and then the physicians stayed there and the hospital leases the properties from us, so it’s really the physicians in that case but often there are developers, local property companies and so on.

Unidentified Analyst

What are the big risks that you are concerned about?

David Hegarty

About medical office or Senior Housing Management?

Unidentified Analyst

In your business?

David Hegarty

In our business?

Unidentified Analyst

Just the top of that, the major risks?

David Hegarty

As I see more like headline news as far as, as much as we tried to minimize our exposure to Medicare or Medicaid, we are healthcare by name so if Medicaid get flashed or whatever I can see as getting some collateral damage even though I don’t think it would be a material impact to our bottom-line that’s one risk.

I think probably five years down the road or so, there could be over building in certain markets of Senior Living and I see that because today the lenders are not really, they are very choosey about who they are financing for development and there is not a lot of development going on, it’s about 1% to 2% of the inventory out there in development right now.

But at some point, you know we see CMBS market will become more fluid, banks will be able to offload the debt so on and they may become more go out on a risk curve more so, I think the developers are all waiting on sidelines with plan with development for all over country. So I can envision certain markets being over-developed in a five year or so from now. There is a lot of movement going on but I think fundamentally again it’s very compelling. To have the services, people are a little concerned about it if there are enough doctors and professional staff to care for everybody that want services. But again we don’t know all over the country, why they are fragmented so, I think you can have situations but I don’t think of a blanket problem.

Unidentified Analyst

Just might be an acquisitions question; if you look at the cost of capital of not only yourselves but other small cap healthcare rates that cost has improved significantly over the last six to 12 months. Firstly, how do you think about your current cost of capital versus acquisition opportunities and then secondly how are you competing against some of the other smaller cap health care rates?

David Hegarty

Well, we always say that sizes has it’s plus and minuses and where we are at $5 billion compared to the big three at over $20 billion, their cost of capital is obviously significantly cheaper than ours so we don’t really compete against them, all that much. We try to stay within that $10 to $15 million target for investments, that’s because it gets much bigger, it is going to attract more attention to cap rates could be driven down and we really can't compete. For the most part, we view our cost of capital pretty much in the sixes now, the debt is cheaper, and our equity is expensive. So we really can't go quite below seven for cap rate for investing.

And again if I would even go seven or low sevens, unless we start upside potential in the growth side of things, so all of our acquisitions for last year have been at an average of about 8% high sevens. And I think that is going to still be our target cap rates at high sevens and low eights and you can get those from the one-off in very small portfolio deals. So our competition tends to be the private equity REIT's and a few of the public REIT's but not many, not all that often, so now we have been winning our fair share of those transactions. It's very challenging to like Health Trust of America required a lot of assets and then reduced the dividend, when they listed their shares. So it's very tough to compete against that type of approach, but there's enough inventory out there to win those.

Unidentified analyst

Earlier you mentioned that with the exposures that 13% now of your portfolio, is it sort of proportional, is there going to be another 13% of that 50% that you're targeting or do you think there'll be more or less in that?

David Hegarty

We envision bringing the Medical office building up as a percentage of our portfolio, about third now and I envision most likely hitting 40%, whether we get to 50% I'm not sure, but at least 40%, Medical office building side, senior living will probably stay about the same. Our idea is 13% today, I don't envision that getting much, I don't even know if we'll get to 20%, but that's probably about the maximum we will do.

Unidentified analyst

Maybe just in terms of at the operator level, was there a lot of vertical and regional operators, what's your view on potential consolidation for some of those operators and is there any way that you can be involved in potential industry consolidation.

David Hegarty

Yes, a lot of the way we have grown has been through helping consolidate the industry and back, one of our largest tenants is Five Star Quality Care, we created Five Star, and they're about 44% of our portfolio today. They were as high as 72%, we brought it down and we're going to continue to bring that down, but what's interesting is that it kept that way because we had a highly successful formula and it was acquiring regional operators around the country and so kind of consolidating up there. I still think that it's interesting, it's a world of haves and have-nots so I think that's the REITS, clearly have a cost to capital advantage significant, the smaller regional guys can only grow to a point, but then they start competing against the REIT. So I do believe that we'll help consolidate some of those operators. And I think that's yet to come, most of the big players have already been spoken for with the RIETs.

Unidentified Analyst

The industry, the seniors housing industry or atomic village whatever you want to call it in 1970s had a big phase of development and then in the late 1990s there was another big phase of development as well. With fundamentals improving rapidly at the moment, the housing market starting to improve. Do you envisage another wave of development or is it going to be much more measured through this cycle.

David Hegarty

Well I would like to say we have learned from the past, but I am not sure. I do envision there will be a wave of development. The demographics have picked up some much I am hoping that they can absorb the new inventory and you will have certain markets that people are targeting. One of the things that had happened before like, say we probably have been through, at least three cycles, just since the mid-1990s, I know it’s property type; and originally the worst really was when people wanted to build these 60 unit to 100 unit buildings, because they could be built fast and I would say it's like Mac Donald's and Burger King. Everybody has the same demographic studies and say I have to be there. And then you end up across the street to each other and neither one can't fill each other up.

Now I think that of, that’s pretty much sorted it out in the last several years there has been virtually no new construction. So I believe that a lot of the extra capacity has been absorbed now. And it is still little ways off before development will really start to ramp up. So I do think we have a window. That’s why one of the reasons why we have been late to the game in getting into the RIDEA structure. Because our first preference would be a triple-net lease arrangement, but the competitive landscape has made it such that if you want high-quality assets, you pretty much have to bid on a RIDEA structure. And it’s a safe thing to do probably today because the next several years is very compelling. But five years from now or seven years from now, if we go through our cycle and so on, and in a RIDEA format you get the downs as much the ups. But I think that, a risk out there, hopefully management.

Unidentified Analyst

Is that one of the reasons why you sort of your RIDEA 13% at the moment and it seems like you are going to keep RIDEA around those levels, maybe a little bit hard proportion of the portfolio?

David Hegarty

It’s like how much of a bet do you want to make on the fundamentals and, we like them but I am not willing to bet the store on it, so I think 20% is probably the max that I can envision.

Unidentified Analyst

Maybe we can give David a little break and Richard you can discuss the balance sheet and capital needs and funding for 2013?

David Hegarty

Sure, this past January as you know, we issued equity and we’re able to pay down our $750 million credit facility to zero. We had about 190 million outstanding at the end of the year so today there is really no capital need, immediate needs to go out there. The equity issuance was oversubscribed by many, so we took out a little more than we really need that time to fund pending acquisitions, so we do have some cash on hand still from that.

We expect, I think as Dave mentioned 300 million to 400 million of acquisitions during the year and a line of credit matures 2015 and a cost of life plus 160, so today there is no really immediate capital need if to that we really have no near term maturities due over the next few years. Our next major maturity would be our senior notes due in 2016.

We have $250 million due then, so our debt maturities are manageable over the next few years to get to 2016.

Just to add to at the end of the year our total debt book capitalization was about 43% and doing the equity offer in January allowed us to bring that down to higher 30%, 37%, to 38% and one of our messages going, doing a debt deal or equity deal, we're comfortable now in the 40% to 45% of debt and we felt to refinance our line of credit that time when you put strain on that equity and we thought we’d do equity then built up the line of credit and that the time when needed, you know, we have ability on that (inaudible).

Unidentified Analyst

Just two quick questions, one is the for Rick, could you just (inaudible) about the dividend policy and the (inaudible) (inaudible) obviously is very high, being one of the highest in the space that’s one and two (inaudible) David as you mentioned the supply or risk potential in five years in the senior housing space, (inaudible) for example over next few year we’ve been those supply ramp up here, so could you have (inaudible) better in terms of what will be the difference between those two industries and more like regulatory concerns or funding concerns in terms of there is a lag in between, these two (inaudible) segments, thank you.

David Hegarty

I will address that first and then Rick can (inaudible) dividend and so on. To build the facility, you have get permitted land and so on and then approvals which can take six months to year depending where part of the country you are in and then it’s going to take another year or so to develop the facility and then you have sought the facility so that’s probably a good couple of year process from start to finish and right now it’s the funding, the bank still are not willing to finance construction so with the number of equity, people want to try to participate but without the leverage they are not willing to do it. So that is just slowly coming in and I think that’s why I foresee it has being several years out before, they can really have a meaningful bite into the supply demand imbalance but I think that’s the main reason for the lag.

Rick Doyle

In regards to your dividend question now. We have been successful increasing our dividend over the past 10 years very successful. We just raised in third quarter of 2012 that’s quite a different analysis (inaudible) $0.39 per share and it is reviewed on the quarterly basis by the board and they look at the sale ratio, the FFO payout ratio and I guess (inaudible) payout ratios and we have been successful on keeping those payout ratios or the FFO payout ratios like mid-80s, so each quarter it has been reviewed and when we can we will increase the dividend.

Unidentified Analyst

With that we wrap ups with three rapid fire questions that each management team gets to answer. What will same store NOI growth be for healthcare REIT sector in 2014?

David Hegarty

I would say approximately 3% to 5%.

Unidentified Analyst

If you have to, what property sector other than your own, would you personally invest in today?

David Hegarty

I would say probably the regional malls.

Unidentified Analyst

And finally, do you expect to see more or less public companies in your property sector one year from today?

David Hegarty

I guess more now.

Unidentified Analyst

Okay with that we wrap it up and see everyone here next year.

David Hegarty

Thank you.

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