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Capital Senior Living (NYSE:CSU)

Q2 2013 Earnings Call

August 06, 2013 11:00 am ET

Executives

Lawrence A. Cohen - Chief Executive Officer and Vice Chairman

Ralph A. Beattie - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Analysts

Darren P. Lehrich - Deutsche Bank AG, Research Division

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

John W. Ransom - Raymond James & Associates, Inc., Research Division

Dana Hambly - Stephens Inc., Research Division

Operator

Good day, and welcome to the Capital Senior Living's Second Quarter 2013 Earnings Release Conference Call. Today's conference is being recorded.

The forward-looking statements in this release are subject to certain risks and uncertainties that could cause results to differ materially, including, but not without limitation, to the company's ability to find suitable acquisition properties at favorable terms, financing, licensing, business conditions, risks of downturns in economic conditions generally, satisfaction of closing conditions, such as those pertaining to licensure, availability of insurance at commercially reasonable rates and changes in accounting principles and interpretations among others, and other risks and factors identified from time-to-time in our reports filed by the Securities and Exchange Commission.

At this time, I would like to turn the call over to Mr. Larry Cohen. Please go ahead, sir.

Lawrence A. Cohen

Thank you, and good morning. Welcome to Capital Senior Living's Second Quarter 2013 Earnings Release Conference Call. I'm very pleased to report continued positive results for the second quarter, as we recovered from the effects of the flu season in the first quarter. Second quarter same-community occupancies increased 50 basis points, revenue increased over 13% and CFFO grew 15% from the second quarter of the prior year.

I am also pleased to report that we are further enhancing our private-pay revenues through a repositioning of our 2 continuing care retirement communities. After considering a number of alternatives, including a sale of these owned communities, we decided that a reconfiguration of the services we offer will enhance CFFO, improve operating metrics and enable meaningful gains in shareholder value.

Complementing our organic growth is a robust pipeline that allows us to continue our disciplined and strategic acquisition program that increases our ownership of high-quality senior living communities in geographically concentrated regions and generates meaningful increases in CFFO earnings and real estate value. We differentiate Capital Senior Living as the value leader in providing quality seniors housing and care at reasonable prices. We are well-positioned to make meaningful gains in shareholder value as a substantially private-pay business in an industry that benefits from need-driven demand, limited new supply and an improving economy and housing market.

In the second quarter, we completed the acquisition of 2 senior living communities in Missouri and Indiana for a combined purchase price of approximately $25.4 million. These transactions are expected to add CFFO of $0.03 per share, increase earnings by $0.02 per share and increase revenue by $5 million. These communities were financed with an aggregate of approximately $19.1 million of nonrecourse mortgage debt, consisting of $14.5 million of 12-year debt with an interest rate of 5.3% and bridge financing of approximately $4.6 million with a variable interest rate of approximately 4%. The bridge loan is for a community that we are converting from independent living to assisted living. And once licensure is complete, we'll be refinanced with permanent financing.

We have scheduled closing dates on approximately $65 million of additional transactions consisting of high-quality senior living communities in regions with extensive existing operations. Subject to completion of due diligence and customary closing conditions, these transactions are expected to close in the third and fourth quarters.

During the first 6 months of the year, we have completed or agreed to acquire approximately $100 million of high-quality senior living communities with an expected effective cash-on-cash return on equity of more than 17%. We are conducting due diligence on additional transactions consisting of high-quality senior living communities in regions where we have extensive existing operations. Subject to completion of due diligence and customary closing conditions, we expect to acquire these additional communities in the fourth quarter of this year.

Now I'd like to review our operating activities. I am pleased to report that in addition to the success we are experiencing with our acquisition program, we are also achieving strong operating results with gains in occupancy and net operating income. We benefit from our proprietary expense management systems, our community-based empowerment philosophy, our operating strategy to provide value to our senior living residents and our geographically concentrated operating platform. We believe we are different from other companies in our peer group with our sole focus on the substantially all private-pay senior living business, capitalizing on the competitive strengths in operating communities in geographically concentrated regions and profiting from our competitive advantages as a larger company with economies of scale and proprietary systems operating in a highly fragmented industry that continue to generate excellent results.

We are enhancing our private-pay revenues through the repositioning of our 2 continuing care retirement communities with space being converted to other private-pay use. We expect the reconfiguration to enhance CFFO by approximately $0.02 to $0.03 per share. While these 2 communities are being repositioned, same-community results for these 2 communities will be excluded. At communities under management, excluding these 2 communities, same-community revenue in the second quarter of 2013 increased 3.2% versus the second quarter 2012. Same-community expenses increased 2% and net operating income increased 4.7%. Our same-community occupancies increased 50 basis points from the comparable quarter of the prior year.

Second quarter occupancies recovered from the effects of the flu season in the first quarter. I am pleased to report that assisted living occupancies grew 70 basis points from the end of March to the end of June, while independent living occupancies decreased 20 basis points from the beginning to the end of the second quarter. Overall, independent and assisted living occupancies increased 30 basis points during the quarter. Slightly lower independent living occupancy during the second quarter reflects the remnants of the first quarter flu season as communities were recovering from the effect of quarantines and other flu-related activity that stopped prospects from touring and delayed leasing. We anticipate solid occupancy growth in the third and fourth quarters, which are typically our strongest quarters.

Deposit-taking is robust and we have a very strong move-in schedule for August. I am extremely encouraged for the occupancy growth in the second half of this year as we currently have more than 115 net deposits that we expect will move into our communities during the third quarter. Second quarter 2013 same-community average monthly rents were 2.5% higher than the second quarter of 2012. Sequentially, second quarter same-community average monthly rents increased 90 basis points. Our 50 basis points growth in occupancy and average monthly rent growth of 2.5% compared favorably to NIC MAP data with reported second quarter occupancy growth of 20 basis points and rate growth of 1.8% in the top 100 metro areas.

Industry fundamentals continue to be strong with demand continuing to outpace supply. NIC MAP reported favorable supply-demand trends for independent and assisted living communities with lower trailing 12-month construction starts as a percent of supply for the second quarter of 2013. As we discussed on our first quarter earnings call, we were able to review with the NIC MAP staff construction starts in Dallas and Houston and compare them to our existing communities. I am pleased to report again that none of the construction currently underway in these 2 cities is competitive with any of our Texas communities. This confirms that our value strategy with average monthly rents of $3,043 acts as an economic barrier to entry for new development with replacement costs averaging in excess of $175,000 per unit. Rents would have to be about 50% higher than current levels to generate a reasonable return on the cost of development, indicating the opportunity to realize significant rent growth before we expect to see new construction in most of our markets.

With strong industry fundamentals and improving economy and housing market and virtually no new supply in our markets, we believe that our occupancies can continue to grow to an optimal level of 92% to 93%, leaving tremendous opportunity for additionally organically driven CFFO growth and increases in our real estate values. The number of our consolidated communities increased from 88 in the second quarter 2012 to 101 in the second quarter 2013. Excluding the 2 CCRCs being repositioned, financial occupancy of the consolidated portfolio averaged 86.7% in the second quarter of 2013, 40 basis points higher than the second quarter of 2012. Average monthly rents in the second quarter of 2013 increased 3.4% over the second quarter of 2012.

Our positive results demonstrate that our team, with its disciplined focus and attention to detail, is successfully executing our operating strategy. Successful senior living operations require well-located communities with the right on-site team supported by strong regional and corporate resources. We are fortunate to continue to recruit and retain many of the best operations and sales and marketing professionals in the senior living industry.

I'd now like to discuss our growth initiatives. We are excited that our growth as seniors housing is a need-driven product with very limited new supply. Demographic demand growth is driven by an aging population. These favorable demographic and supply-demand trends should allow for continued occupancy and rate growth.

During the second quarter, we increased our operational focus with a reorganization of our operations department. In June, we promoted 5 Executive Directors to District Operational Managers and promoted 2 Regional Managers to Regional Operating Center Officers. This reorganization provides us with more effective regional oversight of our existing portfolio and can accommodate an additional 35 to 40 communities as we continue our growth.

In addition, we launched a new branding strategy for Capital Senior Living during the second quarter that involves an integrated marketing program, including a refreshed corporate logo, enhanced marketing content, a new responsive website and a new color palette and image scheme. Our new responsive website was designed to make searching for senior living communities easier than ever. The complete makeover of our branding strategy and website unites the company's 104 communities under 1 corporate identity and facilitates the assimilation of newly acquired communities in a consistent manner. I am pleased to report that our Web-based lead generation has already increased 36% and is expected to increase further as our online reputation and search engine optimization take hold.

We're also benefiting from an investment in cash flow-enhancing renovations, refurbishments and conversions of units to higher levels of care. These initiatives, combined with the operating leverage in our prudently financed business, are expected to increase our revenues, margins and cash flow. Each 3% increase in average monthly rent generates approximately $10.4 million of incremental revenue. Every 1% improvement in occupancy is expected to generate $3.5 million of revenue, $2.5 million of EBITDAR and $0.06 per share of CFFO. We have had much success in converting units to higher levels of care to meet the needs of our residents and allow them to age in place, as well as generate excellent financial returns to our company.

We are in the process of converting 210 units of independent living to assisted living. When stabilized, these new conversions are expected to add approximately $3.4 million of incremental revenue and $2 million of EBITDAR. We are also reviewing conversion opportunities at another 10 communities, which if feasible, would increase levels of care at approximately 300 units beginning later this year, with the potential to further increase revenue by nearly $4 million.

As we execute our strategic business plan, we are enhancing our geographic concentration with expanded care to residents, maximizing our competitive strengths and lowering our cost of capital. Our strategy is focused on generating attractive returns, enhancing free cash flow and maximizing shareholder value. We have completed $213 million of acquisitions since the first quarter of 2012, which are expected to generate in their first year of operations CFFO of $0.38 per share and more than a 17% initial cash-on-cash return on invested equity.

Our discipline in making acquisitions is evident by the fact that since August 2011, we acquired approximately $300 million of properties after evaluating in excess of $2 billion of acquisition opportunities. Our primarily off-market acquisition focus continues to yield a robust pipeline. We have scheduled closing dates for approximately $65 million of acquisition transactions involving high-quality senior living communities in regions with extensive existing operations. We have completed due diligence on a number of transactions, which would have closed in the second quarter but for seller requirements, such as their ability to pay off existing loans, that have placed the closings into the third quarter. When completed, these acquisitions are expected to be accretive to CFFO in earnings and lead to further improvement in EBITDAR margin and operating metrics. We are conducting due diligence on additional transactions consisting of high-quality senior living communities in regions where we have extensive existing operations. Subject to completion of due diligence and customary closing conditions, we expect to acquire additional communities in the fourth quarter of this year.

During the first half of 2013, we submitted more offers and signed more agreements in both number of transactions and dollar volume than during the first half of 2012. This activity in the first half of the year puts us ahead of schedule in executing our disciplined accretive acquisition plan to acquire approximately $150 million of acquisitions in 2013, which we believe we can fund with our cash balances and cash flows generated by our operations. This is in addition to the $38 million of acquisitions we completed in December of 2012, which would have been 2013 transactions but for the requirements of sellers to close in 2012 to take advantage of lower capital gain rates.

Our EBITDAR margin reflects the benefit we derive from executing on our acquisition strategy. We are able to leverage our geographically concentrated operating platform and benefit from economies of scale, our group purchasing program, proprietary proactive expense management systems, risk management and insurance programs, as well as our focused marketing plans to integrate acquisitions in a highly accretive manner. Our success in acquiring high-quality senior living communities on attractive terms validates Capital Senior Living's competitive advantage as an owner-operator with a geographic focus, able to successfully assimilate acquisitions with minimal incremental costs. And our liquidity and balance sheet are solid, allowing us to have the capacity to comfortably fund our working capital, maintain our communities, retain prudent reserves and have the equity to fund future acquisitions.

We are well positioned to add to our success. And I am optimistic about our future, as I am confident in our team's ability to continue our successful execution of a well-conceived strategic plan. We expect continued significant growth in CFFO, earnings and owned real estate that will lead to a meaningful increase in shareholder value. Our fundamentals are strong. And I am excited about the company's prospects as we benefit from our substantially all private-pay strategy in an industry that is benefiting from need-driven demand, limited new supply and an improving economy and housing market.

I would now like to introduce Ralph Beattie, our Chief Financial Officer, to review the company's financial results for the second quarter of 2013. Ralph?

Ralph A. Beattie

Thanks, Larry, and good morning. I hope everyone has had a chance to see the press release, which was distributed last night. In the next few minutes, I'm going to review and expand upon highlights of our financial results for the second quarter and first 6 months of 2013. A copy of the press release is available on our corporate website at www.capitalsenior.com. And if you would like to receive future press releases by email, there's a place on our website for you to provide your email address.

For the second quarter of 2013, the company reported revenue of $87.2 million, compared to revenue of $77 million for the second quarter of 2012, an increase of $10.2 million or 13.2%. Resident and health care revenue increased from the second quarter of the prior year by $9.7 million or 12.9%. We consolidated 101 communities on our income statement this quarter versus 88 in the second quarter of the prior year. Financial occupancy of the consolidated portfolio averaged 85.9% in the second quarter of 2013, compared to 85.8% in the second quarter of 2012, an improvement of 10 basis points. Excluding the 2 continuing care retirement communities that are being repositioned, financial occupancy of 86.7% increased 40 basis points compared to the second quarter of the prior year.

Average monthly rent was $3,043 per occupied unit in the second quarter of 2013, an increase of $75 per occupied unit, 2.5% higher than the second quarter of 2012. On a same-community basis, excluding the 2 CCRCs being repositioned, occupancies were 50 basis points higher than the second quarter of 2012 and same-community average rents were 2.5% higher. On a same-community basis, revenues increased 3.2% versus the second quarter of 2012, expenses increased 2% and net income grew 4.7%. As a percentage of resident and health care revenue, operating expenses were 59.9% in the second quarter of 2013, compared to 59.4% in the second quarter of 2012.

General and administrative expenses as a percentage of revenues under management were 5.2% in the second quarter of 2013, excluding transaction costs of approximately $0.4 million in the quarter. Expenses this quarter were once again impacted by an abnormally high level of medical claims. The company is self-insured for the cost of employee and dependent medical benefits and purchases stop-loss protection. Without a doubt, this self-insurance program significantly reduces the company's health insurance costs. Occasionally, expenses are higher than average in a particular quarter as a few claims approach stop-loss insurance thresholds. Health care cost in the second quarter of 2013 exceeded the second quarter of 2012 by approximately $0.5 million. We are encouraged by the fact that the months of June and July have been more in line with historical averages.

Adjusted EBITDAR for the second quarter of 2013 was approximately $30.1 million and adjusted EBITDAR margin was 34.5% for the period. Excluding the 2 CCRCs being repositioned, EBITDAR margin for the second quarter of 2013 was 36.4%. Since the first quarter of 2010, over a 3-year period, revenues have increased 82%, EBITDAR has increased 122% and EBITDAR margin has grown by 650 basis points.

Adjusted net income for the second quarter of 2013 was $1.1 million or $0.04 per share, excluding nonrecurring and noneconomic items reconciled in the press release. Adjusted CFFO was $9.5 million or $0.34 per share in the second quarter of 2013, compared to $8.2 million or $0.30 per share in the second quarter of 2012, an increase of approximately 15%. The cost segregation study completed earlier this year is expected to offset all federal income taxes of 2013 and approximately $0.18 per share of CFFO will be realized as the company generates taxable income in future periods.

Moving to the first half results. The company reported revenue of $173.4 million, an increase of 16.2% in the first half of 2012. Adjusted EBITDAR was $60.5 million for the first 6 months of 2013, an increase of $7.1 million or 13.3%. Excluding the 2 communities being repositioned, EBITDAR increased $8 million from the first half of the prior year and EBITDAR margin was 36.7%. Adjusted net income was $2.9 million or $0.10 per share in the first half of 2013 and CFFO was $19.2 million or $0.69 per share, an increase of $4.3 million or $0.14 per share from the first 6 months of 2012. CFFO increased to 28.4% versus the first half of the prior year.

The company ended the second quarter for 2013 with $30.5 million of cash and cash equivalents, including restricted cash. As of June 30, 2013, the company financed its 51 owned communities with mortgages totaling $381.3 million at interest rates averaging 5.23%. All of the company's debt is at fixed interest rates except 1 $4.6 million bridge loan at a variable rate. This bridge loan is for a recently acquired community that is undergoing a conversion and will be refinanced with permanent debt once licensure is complete. The company has no mortgage maturities before the third quarter of 2015. Capital expenditures for the quarter were approximately $3 million, representing $2 million of investment spending and $1 million of recurring CapEx. If annualized, the company spent approximately $400 per unit on recurring CapEx in the quarter.

We'd now like to open the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we will first go to Darren Lehrich with Deutsche Bank.

Darren P. Lehrich - Deutsche Bank AG, Research Division

Two areas of questions. First, just as it relates to occupancy trend, and then secondly, on the CCRC repositioning. So on volumes or occupancy, I guess, I heard your commentary pretty clearly. You had a nice recovery in assisted living, and that certainly makes sense given the impact from the flu. I guess, just around independent living, can you just expand a little bit more on maybe some of the softness that you think you might be seeing there? And just as it relates to the move-ins and deposits that you have for Q3, how that's progressing in IL specifically?

Lawrence A. Cohen

Okay. It's Larry. First of all, let me address the IL situation. As we talked last quarter, we had obviously a very high attrition in the first quarter caused by the flu epidemic. Luckily in the second quarter, we saw attrition drop from 44.4% in the first quarter to 40% overall. The biggest drop was in our IL/AL communities, which dropped from 43% in the first quarter to 34.9% in the second quarter. On the other hand, we saw a 39% attrition rate in independent living in the second quarter, compared to 37.5% a year ago. So we did see additional attrition in the quarter that caused the reduction in occupancy. I would say that I'm extremely couraged by what we're seeing in deposit-taking at both independent living and assisted living. I do think that the softness in independent living was caused by attrition and still, I think, relates to the flu from the first quarter. So we are very confident that we'll see a nice recovery in both independent living and assisted living. And the deposit-taking across-the-board is pretty even as far as the gains in both levels of care. So we think that the second half of the year -- it's interesting, I went back to look at the company's history in the last 3 years on same-store. And since 2010, we've had a robust recovery of occupancy in Q3 and Q4, which we expect to occur this year as well. We always have the fourth quarter as our highest occupancy level. Obviously, there's seasonality in this business that was heightened because of the flu in the first quarter. But if you go back the last 3 years, we saw gains of occupancy on a same-store basis in Q3 of 120 basis points in 2010. We saw a gain of 110 basis points in 2011. We saw gains in Q3 of 90 basis points -- I'm sorry, it was 60 basis points last year. And then we saw even better gains in the fourth quarter. So we're looking at a strong second half of the year, which is very typical. This year, we experienced 115 more move-outs in the first quarter same-store than we had -- actually, 100 more move-outs in the first quarter this year than we had last year. And that was because of the flu. And obviously, it's the remnants of that phenomenon that has kind of delayed the leasing. But we feel we're back in stride for the second half of the year.

Darren P. Lehrich - Deutsche Bank AG, Research Division

That's helpful. And then just in terms of the attrition, you're not seeing any increase at all as it relates to move-outs from hardship or just assets being down, more financial reasons?

Lawrence A. Cohen

No. We've really seen an improvement in the financial wherewithal of our residents over the last couple of years. Unfortunately, the move-outs are typically caused by death or higher level of care to a very, very large percentage. So it's very much health-related.

Darren P. Lehrich - Deutsche Bank AG, Research Division

Got it. And then if I could, I just -- I wanted to make sure I'm understanding the repositioning of the CCRC. So Ralph, did I hear you right that there was about a 2 point margin impact from that? Is that what this ended up being in the quarter? And then I guess, as we think about this in the progression of work that you have ahead of you. How long do you think it will take? What kind of impact on consolidated occupancy and rate growth do you think it might have as we think about the next 2, 3, 4 quarters?

Ralph A. Beattie

Darren, you did understand correctly that if we had removed these 2 CCRCs from our results for the second quarter, the EBITDAR margin would have been almost 2 percentage points higher. So clearly, they've been a drag on our operating performance. And this repositioning is expected to improve that. It's going to take a couple of quarters before those results are fully realized. We are going to make investments in these communities to improve those operations along with the repositioning. And we expect that by the time we get through with that, these operating metrics will be much more similar to the rest of the portfolio. But I would say that during the next few quarters, while we're not going to classify these as discontinued operations, we're going to continue to report the results in our consolidated financial results. We will exclude them from our same-store trends so that all of our occupancy rate and margin trends will exclude them during the repositioning phase.

Lawrence A. Cohen

And Darren, I think the timeline right now, we're seeking approvals, working with families on the repositioning at these communities. We are hopeful that for 2014, it will probably result in an increase in cash flow of $0.02 to $0.03. So we do think that we'll start to see a benefit beginning probably the first quarter or second quarter of 2014.

Darren P. Lehrich - Deutsche Bank AG, Research Division

Got it. And then just so I'm clear, we didn't see any of this impact in Q1. Is it correct that all the activity, the repositioning began in Q2? And can you maybe just describe the timeline of when that started?

Lawrence A. Cohen

Yes. We went through a process earlier this year to look to sell these 2 properties. We received about 5 or 6 offers. We selected one potential buyer. We were disappointed with their due diligence and the price at which they came back after their due diligence on the property. Before we started the process, we actually had a plan B, which was the repositioning of the property by enhancing the private-pay revenue. And we decided that we can probably double the value of the property from what the offer was by executing this plan. So while we were hopeful that we would have the proceeds to be reinvested in another transactions, we think that the more prudent measure would be to reposition, reconfigure the use of the buildings. We think by doing that, it will enhance our cash flow. And what's interesting, we believe that the strategy could actually double or triple the value of this property from the offer that we ended up receiving through the process.

Operator

And next, we go to Daniel Bernstein with Stifel.

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

I just want to understand, did you actually close any units in those CCRCs this quarter? Did you actually start the repositioning in...

Lawrence A. Cohen

We started the repositioning. We've been working on approvals. We actually did not close them, but there was absolutely disruption in services through the process that it went through. So hence, we've decided to remove them because we did begin the process. There was disruption, but nothing has been closed. That will -- most likely, those changes will take place the second half of the year.

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

Okay. So there was a little bit of an impact on margins in the business in the second quarter. Okay. Because that -- I guess, my next question was going to be if you pulled out the health care, the high health care claim cost, your margins were still about like 40.5%, somewhere in there. And what else was in the margins? But was that all the CCRCs? Was there anything...

Lawrence A. Cohen

Well, it's also revenue. It's interesting, Dan, if you go back to your numbers and assume that our revenues were your revenues with our actual operating expenses, our margin would be below your projections. So it's not just the expenses. It's also the fact that the revenue was lower for the quarter.

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

Right, okay. The expenses were held -- you didn't fire anybody?

Lawrence A. Cohen

No.

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

And you kept the employees and...

Lawrence A. Cohen

Exactly. And there will be some -- obviously, that's part of this process. We have plans in place for retaining employees during this process. So there will be some expenses that will continue second half of the year as we transition the buildings.

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

Okay. Did sequestration -- obviously, those units in the CCRCs are not a large part of your portfolio. But did that 2% sequestration on April 1 impact you at all during the quarter?

Lawrence A. Cohen

Not much. Our revenue from those 2 properties from Medicare is probably about -- I guess, in total about -- it's about, I guess, $3 million a year. So it's insignificant in the total base. What's happened there quite frankly, which is probably a bigger kind of fundamental issue of what's happening in the skilled nursing and the CCR world is the hospitals are no longer discharging their patients to our community. They're keeping them or directing them to their own facilities. That's really where we saw the change. It wasn't sequestration. We're just seeing a marked change in the discharge patterns of the local hospitals to these 2 CCRCs.

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

Okay. No, the repositioning makes a lot of sense to me here. The other question on the IL properties. IL seems to be acting a little bit more like AL in terms of the impact from the flu. Are you seeing -- it's hard to tell, I guess going back many years. But are you seeing that, that creep-up in acuity in IL is kind of filtering in through to the occupancy when you have a harsh flu season? I'm just trying to understand, is IL acting like AL-lite and people are just a little bit more frail and being affected by the flu a little bit more?

Lawrence A. Cohen

Definitely. We have, for many years now, been renting space in our communities to home health care companies, therapy rehab. We have visiting physicians. We have a very active program that is run by third parties in our communities to several residents. What we saw kind of during the financial downturn is the price point became very compelling for independent living. People were coming in a little later, a little frailer. We saw -- it's interesting, if you go back on our properties over the last 3 years, we had sequential increases, significant increases in IL occupancies, really starting in the second quarter 2011, that ran all the way through the end of last year. And the first time we saw a drop was in the first quarter, which was very much flu-related, and then we saw the remnants carry over into the second quarter. But the good news is that we're seeing the pickup come back. The other interesting corollary is our rate growth has actually been on a percentage basis higher over the last 2 years in independent living than assisted living. So we see independent living as being a very viable alternative for residents. Obviously, there's about a $1,200 differential in our portfolio between independent living and assisted living rents. But as you pointed out about the frailty level, you'll note that we have also taken advantage of this attrition to now go back and implement conversion plans that were delayed as these properties were full. So we're actually taking advantage of the flu season and the attrition that's happened this year to now review another 10 properties that were kind of we had plans delayed because of properties that were 90%, 95% occupied. We're now going back and looking at licensing part or all those buildings later this year.

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

Okay. I guess, so that means maybe for IL, we should expect a little bit more of a -- when the occupancies -- from thinking about [indiscernible] like to 2014 and beyond, that the first half of the year is going to end up being maybe a little weaker in occupancy relative to history and the second half is maybe going to be a little bit stronger. You're going to see a little bit...

Lawrence A. Cohen

Second half has always been stronger. But I'll tell you, this flu was the anomaly. If you go back last 3 years, we had some very nice -- I mean, sequential gains in IL occupancy on same-store basis is running 70 basis points, 100 basis points, 80 basis points, 20, 70, 130. But the highest was Q4. But this dropoff that we saw this year was unusual. We obviously had a very active and prolonged flu season. But you're right, if you go back and look at our same-store results, and I think that's true for the industry, this industry does perform better in the second half of the year.

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And some of the health care REITs have been talking about the rising interest rate bringing out some sellers. I'm not sure that applies to you because you're going after some of the smaller, one-off market transactions. Are you seeing any change in seller -- in your sellers' motivations as a result of the rising interest rates? Or is it kind of business as usual for you?

Lawrence A. Cohen

Well, business has picked up. It's interesting. I kind of commented earlier, in the first 6 months of this year, we actually submitted offers twice the level of offers that we submitted in the first half of 2012. And we had more offers accepted and we have more transactions both in dollar volume, as well as number of transactions. And the pipeline is very continuous. But the motivations we're seeing for these one-off type deals doesn't seem to be really interest rate-driven. It's much more family situations, local family businesses selling. But we had definitely seen a marked increase in deals this year, some of which might relate to interest rates. But most of the sellers we're dealing with and many of them are -- it was interesting. The transaction that we're converting now from IL to AL was a gentleman that we bought a property from 18 month ago. He came to us early in this year because he needed the cash for another investment. That precipitated that transaction. 2/3 of the transactions that we are completing are off-market and a number of them are actually sales with sellers that we've dealt with previously.

Operator

And we will take our next question from John Ransom with Raymond James.

John W. Ransom - Raymond James & Associates, Inc., Research Division

My sharp reading skills see that T-bills are up 100 basis points or so off the bottom and your financing costs are still cheap, but they're not as low as they were. How is that factored in, if at all, to your price talk in the market and your expected returns?

Lawrence A. Cohen

Expected returns are going to continue -- at current interest rates, remain above 17%. So we're very, very pleased with that. John, it's interesting. We developed a strategy to acquire properties at the end of 2010 when Fannie, Freddie financing was averaging 6.5%. We ended up buying properties at 100 to 200 basis points higher than we expected and borrowed money at 200 basis points plus lower than we expected. What's very interesting is expectations from sellers really hasn't changed as interest rates have risen. They're still -- and if I look at the metrics of the transactions we're scheduled to close currently, the quality assets are better. They're higher margins, higher average rent, very stable occupancies. But the cap rate and kind of returns are almost identical to what we've been buying over the last 2 years. Now we're disciplined. We could have acquired $500 million of properties in the first 6 months of this year if we just wanted to grow for the sake of growth. And that's just in the regions in which we operate. So there's a quite bit out there. But we are really maintaining a discipline to self-fund these transactions with our internally generated cash flow and cash balances, making sure that -- I mean, we've terminated a number of transactions that were under contract in the first half of the year in due diligence. So the interest rate environment may have caused more activity vis-à-vis just deal flow. But sellers' expectations really haven't changed much. And quite frankly, just observing other transactions in the market that we're seeing on a smaller scale doesn't really change buyers' expectations either. I think the interest rate environment today is still historically low. I think cap rates in this industry still are higher than other asset classes. And the other phenomena that I'd like to talk about, which no one really addresses, is if interest rates continue to grow, cash flows in this business will grow exponentially because we serve a senior on fixed income, that for years now has received no return. Darren asked a question about financial move-outs, which we saw quite a bit in 2010, 2011. We're no longer seeing that, and we still are able to maintain with residents getting no return on their investment 2.5%, 3% rent growth. Historically, this industry would get 4% to 5% rent growth. And if you compound that out over time, the cash flows on properties at a higher rate of growth in average multirate will more than compensate for any change in interest rate. So we think that this is an asset class that performs extremely well because there is need-driven demand, limited supply and really is almost insensitive to modest changes in interest rates.

John W. Ransom - Raymond James & Associates, Inc., Research Division

Okay. Secondly, and this is for Ralph, I think. As you think about the next 2 quarters, how should we think about the CFFO growth from the second quarter? When you factor in occupancy improvements and layering in acquisitions and CCRC repositioning, anything else you want to call out?

Ralph A. Beattie

In terms of the growth rate, CFFO growth this quarter was 15% over the second quarter of 2012. I would expect the rate to be stronger than that in the third and fourth quarters with some occupancy growth, some rate improvement. So I think that looking back, we'll see the second quarter of 2013 as possibly the lowest rate of CFFO growth in 2013.

Lawrence A. Cohen

The other thing is that these transactions have been -- closings have been pushed back because of seller needs. So as we close transactions in the next 30, 60 days, we'll start to see the benefit in the third quarter. And they really manifest in the fourth quarter. So that will supplement the organic growth. So unfortunately, we can't time the closing of the acquisitions as perfectly as the models would like. But we feel that we're very much on target -- in fact, ahead of schedule, to hit our goal for the year. And we'll start to see more contribution. The $25 million that we completed in the second quarter were again in the second half of the quarter, which normally you don't have that impact in the second quarter. So that, too, will build upon what we are seeing from deposit-taking and moving schedules of improved occupancies for the second half of the year.

John W. Ransom - Raymond James & Associates, Inc., Research Division

What's a reasonable number to think about for a 3Q closings, in terms of revenue acquired?

Lawrence A. Cohen

Sorry, John, say it again?

John W. Ransom - Raymond James & Associates, Inc., Research Division

For your third quarter upcoming, so I just decided to get the fourth quarter models...

Lawrence A. Cohen

Yes. I mean, we had $65 million of transactions scheduled to close. I'd say that probably all but one transaction will either close in the third quarter or early October. There's one transaction that will close end of October because of a seller requirement. So I think that if you think about the pipeline and the closing schedules, we're looking at most of the transactions being complete by the end of September or early October.

John W. Ransom - Raymond James & Associates, Inc., Research Division

And think about a 4:1 ratio of price to revenue, something like that?

Ralph A. Beattie

I think, John, if we look at our models right now, that $65 million of acquisitions would generate about $17 million of annual revenue.

Lawrence A. Cohen

And the kind of returns on that would be very consistent with what we've seen before as far as CFFO. And again, it's really -- I think of it, really it's probably around -- if you do the math, it's probably 85% will close in the third quarter and 15% will be a fourth quarter closing.

John W. Ransom - Raymond James & Associates, Inc., Research Division

And just if we pulled the CCRC out, say, for the first half of last year, first half of this year, if we pull those 2 assets out, do you have an idea of kind of CFFO growth or just color? You did put it in discontinued ops. It's a little hard to get the pro forma exactly. But again, we were a little surprised with the magnitude of the falloff in 1Q to 2Q. And we were just wondering [indiscernible] just for that with the 2 CCRC effects.

Lawrence A. Cohen

Well, the CCRC, if we had completed this reposition a year ago, would've generated -- is that half year?

Ralph A. Beattie

No, that's annualized.

Lawrence A. Cohen

About -- we would have had $800,000 of incremental cash flow.

John W. Ransom - Raymond James & Associates, Inc., Research Division

For the half year?

Lawrence A. Cohen

For a full year.

John W. Ransom - Raymond James & Associates, Inc., Research Division

For a full year. Okay.

Lawrence A. Cohen

That's, that $0.02 to $0.03 we're talking about.

Ralph A. Beattie

So the $800,000 is a pretax number. If you tax-effect that, it's between $0.02 and $0.03 per share, just by not having them.

John W. Ransom - Raymond James & Associates, Inc., Research Division

Yes. And then could you also just -- occupancy exiting the quarter versus entering the quarter?

Lawrence A. Cohen

Yes. As I mentioned, we saw the end of the quarter on occupancy 30 basis points higher than the beginning of the quarter, of which 70 basis point gain was in assisted living and we lost about 20 basis points in independent living.

Operator

[Operator Instructions] And we will go next to Dana Hambly with Stephens.

Dana Hambly - Stephens Inc., Research Division

Just to clarify, the CCRCs, they were negative contribution to EBITDAR for the quarter?

Lawrence A. Cohen

A higher level of care that we're talking about is what we're focusing on.

Dana Hambly - Stephens Inc., Research Division

Okay. And do you have -- do you know what the occupancy in the first quarter was x those 2 CCRCs?

Lawrence A. Cohen

I think occupancies in the first quarter x those 2 properties was -- I believe it was around 80% -- 85.5%.

Ralph A. Beattie

I think that's right in my report here.

Dana Hambly - Stephens Inc., Research Division

So it was 85.9%...

Lawrence A. Cohen

By 85% on same-store.

Dana Hambly - Stephens Inc., Research Division

85%. Well, consolidated, it was 85.9%. Is that right?

Lawrence A. Cohen

Consolidated was 85.9%, yes.

Dana Hambly - Stephens Inc., Research Division

Okay. So I'm saying -- then the second quarter is 85.9%. And if you had stripped out those 2 properties, it was 86.7%, right, in the second quarter of this year?

Lawrence A. Cohen

That's correct, yes.

Dana Hambly - Stephens Inc., Research Division

I'm just trying to get what's the comparable number to that it 86.7% in the first quarter of this year, if you have it. If not...

Ralph A. Beattie

It was probably around 80 basis points higher than that, Dana.

Lawrence A. Cohen

Overall, it was 87.1%. Consolidated, it was 87.4%.

Dana Hambly - Stephens Inc., Research Division

Okay. All right. And on the -- so Larry, so you can fund all your remaining acquisitions, assuming you get to the $150 million target on balance sheet that didn't require that you might -- you weren't counting on selling those 2 properties to fund any of that?

Lawrence A. Cohen

We were not. We have enough cash on the balance sheet and cash flow that's generated over the second half of the year that should give us sufficient funds to complete these acquisitions.

Dana Hambly - Stephens Inc., Research Division

Okay. All right. And just lastly, for me, I know, health care costs continue to be challenging. That's really beyond your control. I keep -- talk of some of your other baked costs just compensation, food, utilities, et cetera?

Lawrence A. Cohen

Food has been really very, very well controlled. We're running right now year-over-year on food less than 1% growth. We have a very effective food purchasing program that we've instituted years ago and it's got another, I think, 3, 4 years to run on an existing contract. So that's been very, very well maintained. There's been no pressure on wages. Obviously, it's interesting in Texas, it's going to be 106 today, if anybody would like to join us. So utility bills will start to kick up. But July was a little cooler than usual. So we might benefit a little bit on utilities. We always have a little higher utilities in the third quarter, but the heat really didn't pick until this past week. So we may get some benefit there. But that being said, we have fixed contracts on electricity at $0.05 a kilowatt hour in Texas and other big-league states. So we don't really see much pressure on expenses. Again same-store expense growth year-over-year was 2%, which is a nice number. It was lower than the first quarter because of lower attrition. So I think we will continue to maintain the discipline we have on expense management to control expenses that we have previously. And the other only number that I can think of for this quarter that might have some jump as it typically happens in the third quarter, utility costs because of the heat, particularly in the Central Southwest.

Operator

And it appears there are no further questions in the queue. At this time, I would like to turn the conference over to our presenters for any final and closing remarks.

Lawrence A. Cohen

We thank you again for participating in today's call, and welcome you to give Ralph or myself a call if you have any further questions. We wish you a good day and look forward to speaking again on the third quarter conference call. Thank you, all.

Operator

And that does conclude today's conference. We do thank you for your participation.

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