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Aviv REIT (NYSE:AVIV)

Q2 2014 Earnings Conference Call

August 05, 2014, 01:00 PM ET

Executives

David Smith - Managing Director, Investor Relations and Capital Markets

Craig Bernfield - Chairman and Chief Executive Officer

Steven Insoft - President and Chief Operating Officer

Mark Wetzel - Chief Financial Officer and Treasurer

Analysts

Emmanuel Korchman - Citi

Paul Morgan - MLV

Vikram Malhotra - Morgan Stanley

Michael Knott - Green Street Advisors

Juan Sanabria - Bank of America

Michael Carroll - RBC Capital Markets

Andrew Rosivach - Goldman Sachs

Operator

Good day, and welcome to the Aviv REIT, Inc. second quarter 2014 conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. David Smith. Please go ahead, sir.

David Smith

Good morning, everyone. Earlier today, we issued a press release providing an update on Aviv's second quarter 2014 results. If anyone has not reviewed a copy, you may retrieve it by visiting Aviv's website at www.avivreit.com under Investor Relations.

To begin today's call will be Craig Bernfield, Chairman and Chief Executive Officer; Steven Insoft, President and Chief Operating Officer; and Mark Wetzel, Chief Financial Officer. They will provide a brief overview, and then we will open the call to your questions.

Before we begin, we'd like to remind participants that the matters we will be discussing today include forward-looking statements. And as such are subject to risks and uncertainties, including those that we have discussed in filings made by Aviv REIT, Inc. and Aviv Healthcare Properties Limited Partnership with the SEC, which identify important risk factors that could cause actual results to differ materially from those expressed or implied by the forward-looking statements.

We do not undertake any responsibility to update any forward-looking statements provided during this conference call. Also discussions during this conference call will include certain financial measures, including adjusted EBITDA and AFFO that were not prepared in accordance with Generally Accepted Accounting Principles.

Reconciliations of those non-GAAP financial measures to the most directly comparable GAAP financial measures can be found in our earnings release today. These measures should be considered in addition to not as substitute for measures of financial performance reported in accordance with GAAP.

At this point, I'd like to turn the call over to Craig Bernfield for his opening remarks. Craig?

Craig Bernfield

Thanks David. Good afternoon, and welcome to Aviv's second quarter 2014 earnings call. I will provide opening remarks and a review of our second quarter highlights as well as our acquisition activity. Steven Insoft, our President and COO, will provide an overview of our portfolio performance as well as our reinvestments in new construction activity. And Mark Wetzel, our CFO and Treasurer, will discuss our financial results.

The strength and depth of our management team has continued to produce strong portfolio performance and a significant volume of attractive investments. We are taking advantage of our access to capital and the market opportunity, completing $314 million of investments year-to-date, already the most we have ever produced in a calendar year.

We continue to acquire high-quality SNFs, with knowledgeable and experienced operators, at attractive valuations, cash yields and coverages, all consistent with our track record.

We are pleased with our second quarter performance and we remain on track to deliver significant earnings growth with the following highlights from the quarter: $82.7 million of SNFs acquisitions at a blended initial cash yield of 9.8%; $8.4 million of property reinvestment and new construction; AFFO of $26 million or $0.44 per share, an increase of 7% over Q2 2013; adjusted EBITDA of $39.5 million, an increase of 25% over Q2 2013; $211.7 million of net proceeds raised through the issuance of 9.2 million common shares; and a new $600 million unsecured revolving credit facility.

We're already off to a great start in the third quarter with $110.5 million of investments. As Mark will discuss in details shortly, we are reaffirming our 2014 AFFO per share guidance of $1.89 to $1.93.

I'm now going to provide an overview of our Q2 and Q3 acquisition activity. We have continued our strong track record of growth with the closing of $193 million of acquisitions in seven transactions, totaling 16 properties in six states, comprised of the following. In the second quarter, we completed five transactions acquiring 10 properties in four states with five operators for $82.7 million at a blended initial cash yield of 9.8%.

In the third quarter, we have already completed two transactions acquiring six properties in two states with two operators for $98.2 million, along with two land parcels and entitlement for $12.3 million for two new ALFs and one addition with 256 units and a total approximate cost of $70 million. These transactions include a $16.2 million SNF acquisition at an initial cash yield of 10% and an $82 million ALF acquisition at an initial cash yield of 8%.

The 16 properties we brought consisted of 14 SNFs and two ALFs, consistent with our primary investment strategy of focusing on investing in post-acute and long-term care skilled nursing facilities. An important part of our investment strategy is the repeat business we do with our existing operator relationships.

All of the acquisitions in the second and third quarter were with existing operators Trillium, Fundamental, Providence Group, Trinity, Diversicare and Maplewood. These acquisitions enhanced our tenant and state diversification, and were strategic for the growth of the operators. We will continue to execute our strategy of follow-on transactions with existing operators that have a track record of performance with us.

Our most recent acquisition was an $82 million acquisition of two assisted living facilities and one skilled nursing facility in suburban Boston and the center of Cape Cod. The properties are tipple-net leased to existing operator, Maplewood Senior Living, an operator of 12 facilities in three states, at an initial cash yield of 8%, which increases to 8.5% in year two.

All of Maplewood's properties are triple-net leased from Aviv. These properties are located in high barrier to entry markets with strong demographics, with revenues for occupied room of approximately $6,000 consistent with Maplewood's overall portfolio.

We were able to achieve attractive yield relative to the quality of the asset, as a result of our ability to acquire the portfolio in an off-market transaction. This acquisition is an excellent example of our ability to acquire high-quality senior housing properties with experienced operators at attractive valuations.

Our pipeline is also strong. We are working on a significant number of identified acquisitions, including transactions that we have sourced, transactions that were brought to us by our operators and transactions that were brought to us by industry contacts that want to work with Aviv. We continue to source acquisitions that are not widely marketed or that we are able to negotiate directly with the seller. And these off-market acquisitions enhance our ability to produce meaningful returns.

We are really excited about the growth we've achieved year-to-date, already significantly exceeding the $239 million of investments we completed in 2013. We feel we are in a great position to grow, given our liquidity, access to capital and cost of capital.

Steve will now review our portfolio performance as well as our property reinvestment and new construction activity.

Steven Insoft

Thank you, Craig. And thank you everybody for joining our call today. At the end of the second quarter, we owned 304 properties diversified across 29 states and triple-net leased to 39 operators. Our properties are leased to some of the largest and most experienced operators in the country and our top-10 operators represent 68% of our rent.

We remain committed to owning a portfolio diversified by operator and geography. Daybreak remains our largest tenant with 12.9% of our rent, and Texas remains our largest state with 20% of our rent. We continue to have strong rent coverage and we are now reporting our coverages to two decimal points.

Rent coverages for the entire portfolio for the 12 months ending March 31, 2014, were 1.87x EBITDARM and 1.48x EBITDAR. Rent coverage for our SNF portfolio for the 12 months ending March 31, 2014, was 1.83x EBITDARM and 1.43x EBITDAR. These are materially consistent with the coverage we reported last quarter.

Our operators' occupancy Q-mix and margins for the 12 months ended March 31, 2014, were consistent with last quarter. Occupancy was 78.2% and Q-mix was 47.3%. The EBITDAR margin for the total portfolio was 15.2% and 14.2% for the SNF EBITDAR margin. We continue to have a small amount of our rent expiring in the near-term, with only 2.5% of our rent expiring through the end of 2016 and our average remaining lease maturity is eight years.

The Medicare and Medicaid reimbursement environment remain stable and positive. For Medicaid for fiscal 2015, 11 of our 29 states increased their SNF Medicaid rates between 0.1% and 4%; 17 of the 29 states in our portfolio cap rate is the same; and only one state, Kansas, which accounts for about 2.6% of our rent re-based at this rate.

For Medicare, last Thursday the government finalized rates for fiscal year 2015, which begins on October 1. Consistent with the preliminary rule, SNFs will receive a net 2% increase. We've seen stability in SNF Medicaid and Medicare rates over long periods of time and expect this to continue going forward.

We continue to invest in our properties through our strategic property reinvestment and new construction programs. During the second quarter, we invested $8 million into our portfolio. As you know, we achieved yields on these investments consistent with those on our acquisitions.

Our property reinvestment and new construction initiatives have been and will continue to be an important part of our business, as it is designed to provide our operators with best-in-market real estate that will be competitive over the long run.

Subsequent to the end of the second quarter, Diversicare, our eighth largest operator took over the operations of Ridgecrest Healthcare, and Mission Healthcare, our tenth largest operator took over [ph] Heidi Healthcare. These transactions involve five of our properties, which represent approximately 1.3% of our in-place rents.

These transactions strengthened our portfolio by increasing the credit quality of our master leases with Diversicare and Mission. The rent over the 10 year term of these leases will increase slightly, but we did occur one-time charge that Mark will discuss shortly.

As we have emphasized, we continue to actively asset manage our portfolio. On an ongoing basis, we look for opportunities to reinvest, reposition and from time-to-time sell assets in order to add value to our portfolio.

With that, Mark will now review our financial results in detail.

Mark Wetzel

Thanks, Steven. I plan to update you on three main areas today, our 2014 second quarter results, our balance sheet activity, and our 2014 guidance for the remainder of the year.

Total revenues for Q2 were $43.2 million, an increase of 23% compared to Q2 of 2013. This growth was driven primarily by our strong acquisition activity.

G&A for Q2 totaled $6.3 million compared to $5.4 million sequentially in Q1 of 2014. This increase was materially attributable to our annual share grant to our Board of Directors and bonus accrual resulting from our growth consistent with our compensation program. Our 2014 guidance now assumes approximately $22 million for the year versus $21 million that I noted on the Q1 call.

Adjusted EBITDA for Q2 was $39.5 million compared to $31.6 million for the second quarter of 2013, an increase of 25% based on the pace of acquisitions.

Interest expense for Q2 totaled $12 million, down $100,000 sequentially. During the second quarter, we took a reserve of $3.5 million resulting from the [ph] Heidi transactions, as Steve noted, with $3.2 million relating to working capital loans. Additionally, we recorded a $1.4 million straight-line rent write-off related to the termination of the leases.

Q2 2014 AFFO was $26 million as compared to $21.2 million in Q2 of '13, a 23% increase. This growth similar to our revenue and EBITDA growth was driven by our acquisitions.

On an AFFO per share basis, we reported $0.44 per share versus $0.46 per share in Q1 of '14. April common stock equity offering to fund our growth, obviously affected this drop, as the denominator increased from 51.2 million shares to 59.4 million shares sequentially.

Moving on to the balance sheet. We had an exciting quarter to position us for future growth. In April, we had our first secondary common stock offering raising net proceeds of $212 million. As I discussed on the Q1 call, our financing strategy was to emphasize unsecured financings, expand our unencumbered asset pool and maintain credit metrics consistent with an investment grade rating and the financing flexibility that comes with that, as we continue to grow.

With that strategy in mind, in May, we replaced a secured $400 million line of credit with a new unsecured $600 million line of credit. We extended the maturity two years, lowered our annual admin fee, lowered our unused fee, and lowered our pricing rate by over 60 basis points depending on the leverage where we are at.

The various standard covenants remain consistent with other REITs. We now have relationships with 14 banks and established relationships with three new national banks. As of June 30, our total debt was $666 million, of which 98% was unsecured and 100% is at a fixed rate.

Our weighted average interest rate is 7% with an average maturity of 6.1 years. Our net debt to annualized adjusted EBITDA was 3.9x at quarter end, down from 5.0x at the end of the first quarter. As we grow the portfolio, we expect to maintain a net debt to EBITDA at or below 5x.

We ended the quarter with $49 million of cash and $600 million of line availability. As of today, we have $10 million of cash on hand, $90 million outstanding on our line of credit, at floating rate just over 2% and $510 million of line availability.

As Craig mentioned, we are reaffirming our 2014 AFFO annual guidance of $1.89 to $1.93 per share. As a reminder, we set this guidance range back in February without any future acquisition or capital events. On our first quarter call in May, we reaffirmed our guidance, in spite of issuing $9.2 million or 19% additional common shares in early April in connection with our $212 million equity raise.

The full year impact of our $285 million of acquisitions completed year-to-date is approximately $26 million, $8 million more than in 2014, due to the timing of acquisitions. We may have an opportunity to refinance the $400 million of unsecured bonds, with a coupon of 7.75% in February of '15, and we will take advantage of this opportunity, if we can achieve meaningful savings.

Operator, we will now open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) We'll take our first question from Emmanuel Korchman from Citi.

Emmanuel Korchman - Citi

Mark when we look at your guidance, can you just remind us, does the additional couple of quarters that we have here now, do those include investments, new investments or not?

Mark Wetzel

Yes. The acquisitions that we have acquired today, offset by the equity raise, basically keeps us inside of that range.

Emmanuel Korchman - Citi

But there are no additional beyond what's been announced through 2Q or through 3Q?

Mark Wetzel

Through today.

Emmanuel Korchman - Citi

So everything through today is in and no new ones beyond that? And then on the bond refinancing, would you be issuing capital in 2014 in anticipation of taking that on in '15 or do you think that it will be sort of timed on top of each other?

Mark Wetzel

I think of game-time decision on when acquisitions occur. We have a lot of availability on our line right now, Manny, so I think we can run with that for a $200 million. And then as we look to where interest rates are in the fall, whether we go out early, whether we wait till February and just do 400-plus to perm that out would be our thought process.

Emmanuel Korchman - Citi

Maybe a question for Steve or Craig. Looking at your sort of off-market strategy versus fully-marketed deals, how big do you think the valuations spread is at the moment?

Craig Bernfield

That's a great question, thanks. It's very difficult to determine precisely. I think if you just look at our overall investment activity, call it, since the IPO or even year-to-date, it tends to average out on off-marketed deals. We've seen some creep maybe from 10-plus a little to high-nines.

And I think it's hard to make generalizations, because when you're locked in because of opportunity dealing directly with the seller, for example, you're focusing on his objectives. But also were communicating our overall goal of having healthy coverage, which you can't have, if you're overpaid.

So we're triangulating the sellers objective with our tenants objective as well as our yields expectation. So I think that you end up and this is really a slag just to try and give you more of an answer than the non-answer I have already kind of given you.

I think if you just look at our activity, it's probably 9.5 to 10.5 in the deals that are not widely marketed or that we're negotiating directly with the sellers. And I think you see some cap rates pressure once you're working on a deal where there are a lot of bidders, especially the larger deals where you're not only dealing with multiple bidders, but you're dealing with some of our public peers and that tends to drive the pricing up a bit.

Hard to say, this year, Manny, because there hasn't really been a single real sizeable deal that's been publicly announced by the REITs, so I am happy to elaborate, if you feel I didn't answer your question, but I tried to be as precise as I could be.

Emmanuel Korchman - Citi

Just maybe a different sort of question on the vein. Do you see any kind of attributes or characteristics of the types of sellers that are willing do an off-market deal? Just thinking more broadly, you think that everyone would want the biggest universe of bidders for their deal, especially if you tell me they could get better valuations.

So is it that they're looking for security of close, which is again something I assume that pretty much every bidder could probably achieve or are there other things that those sellers are looking for that they've come to you or to one of your relationships and they would bring that to you versus going to a broker and getting sort of the most money?

Craig Bernfield

It's very much focused on timing and certainty of close. And when we say, not widely marketed, what we mean is there maybe a local broker and there could be other bidders, but it's usually a black box. It's not, as though you go to an auction house and you get to see who else is bidding on the property.

I would say it's common, probably most common where we're in a not widely marketed situation, but a broker is involved and we, if none of the other public REITs are there, we have this big advantage of having our checkbook and a balance sheet that's easy to verify, as well as our track record for closing, not renegotiating deals during diligence, et cetera, so that matters a lot.

And the other thing that you have to keep in mind is that there are a lot of smart sellers that have a good sense of what their properties should be worth from time-to-time and because there is an operating business going on, if it's a widely-marketed process that takes a long time, it can create a lot of disruption at the operating level. And if there is disruption, occupancy drops off, they get a bad survey, because they took their eye off the ball, then all of a sudden that extra time that the process resulted in, could end up undoing this transaction.

So we swoop in, say listen, we'll pay you, try to get you a fair price. We might, in a bigger deal be a little bit more flexible on our yield expectations. But we're dealing with very sophisticated people that have a sense of what the market is, even if they're not doing a beauty pageant. And I think, Steve, wanted to answer this as well, Manny, because it's a great question.

Steven Insoft

The one other phenomenon that we see time and time again, especially in the SNFs space as opposed to perhaps senior housing, which is a less mature industry is there are a lot of the operators, especially those that are entrenched in their markets and community, see the going forward operator as a continuation of their legacy. They're willing to trade what they've had perceived quality around that operator, so often times in exchange for price as those folks remain in their community after the sale takes place.

Mark Wetzel

And Manny, I would say, for the group, that actually Steve articulated something that's extremely important. In the deal flow, we have seen this year, for example, and deals we're looking at, there is a real generational shift where you have kind of owner-operators that have been running their businesses for a couple of decades, they understand that the market is strong and there's capital out there, good valuations. And maybe Junior doesn't exist to takeover the business.

And it's a big moment in time for that owner-operator. And in many situations, it's as obvious as you might think the guys are selling their businesses, but they're not moving from their community, and they care who that next operator is, because they want their legacy of care to be preserved. So that stable of high-quality operators that we have in our community really enhances our ability to make a difference on the acquisition front.

So I would think very much about that comment that Steve made as a very powerful explanation for why we have been able to execute on Main Street as successfully as we have.

Operator

And we'll take our next question from Paul Morgan from MLV.

Paul Morgan - MLV

So just a little more on acquisition side I guess. Can you talk about within your pipeline, I mean you've done some private pay deals recently, I just want to get a feeling for within your pipeline, is it still overwhelmingly SNFs or how should we think about kind of the second half of the year's transactions between SNFs and ALFs?

Craig Bernfield

Paul, it's another good question. I hope maybe we could plant you to ask this question on every call. We're really dedicated to the SNF sector. We think that the biggest opportunities, both volume, as well as quality, it happens to be in the asset class that we are most experienced, and more importantly where we really know the operator community.

So I think if you did look at our internal proprietary pipeline, you would see, I would say, very little non-SNF and disproportionate SNF. But keep in mind, as the deals get larger, there are often both SNF and ALF components when an owner-operator is selling their business.

Many of our operators are capable of, and do operate assisted living facilities as well. So when we have an acquisition that has both, we have a stable of operators that we can turn to that have the capability of taking the entire portfolio, but most definitely the strongest part of our pipeline is with regard to the SNFs in geography that we have experienced or that we desire today.

Paul Morgan - MLV

And then on the SNF coverage, it ticked down a little bit sequentially and I'm wondering as you rolled in the first quarter, weather into the numbers, whether that had an impact or if there is any other color you can provide there?

Steven Insoft

Couple of things. One is as you know we're not reporting same-store coverages, so as we grow faster there is a little bit of market pressure for us on that. It's not a large delta quarter-over-quarter. And we have rolled in the fourth and final quarter of sequestration that sort of started on April 1, 2015 and that is now over and we'll be rolling out those quarters.

Paul Morgan - MLV

So there's no particular component you identified being associated with the weather in the first quarter?

Steven Insoft

The only thing I'd also remind you, Paul, is that we are showing it now to two decimals for little bit more clarity. So I just want to make sure that everybody is interpreting that as a 10 basis points jump in coverage.

Craig Bernfield

And based on our conversations with our operators, which happen regularly, we haven't seen like a sea change. I think the team was smart to decide to go out that extra decimal point, because I think it could be misleading some times to the good or the bad and we think it just provides you guys with more precise information, but our coverages have been very consistent this year and if you go back to '13 and '14 year-to-date, we haven't seen big changes.

Paul Morgan - MLV

I always like extra decimal places, so thanks for that. And just lastly on the guidance and G& A. So if I understand correctly, it's basically just the increase in the G&A guidance is just due to the stock-based comp coming higher than what you thought, as of your guidance in May? Is that right?

Mark Wetzel

Well, it's primarily the short-term bonus accrual, but there is other little items that make up the most of the million dollar swing, but it's roughly that.

Operator

And we'll take our next question from Vikram Malhotra from Morgan Stanley.

Vikram Malhotra - Morgan Stanley

Just quickly on that guidance question. How much of just kind of change in timing of acquisitions kind of played into that? And what are your expectations for the second half? Could it be more backend weighted or is it more likely to be more even?

Mark Wetzel

Specific to G&A or specific to the guidance?

Vikram Malhotra - Morgan Stanley

The guidance?

Mark Wetzel

Well, obviously you have step up to hit the midpoint. So yes, the acquisitions every -- the day we close these things, it basically falls to the bottomline minus the interest on the line of credit. So it's definitely backend loaded with a huge pickup '15.

Craig Bernfield

And part of it is just we're making decisions based on our experience. We have a lot of experience that extends much longer than our tenure as a public company, and while we wouldn't guide you guys to assume a certain amount of additional acquisition activity, I would expect based on the pipeline and the number of opportunities that we're going to have a good second half of the year. And we'll have an opportunity, I think probably maybe at the most meaningful point in year on our next earnings call, we'll have a lot more clarity that we can share about where we are for the second half of the year.

Vikram Malhotra - Morgan Stanley

And then just on going back to the GAAP rate question. You've had a bit of the spread also to some of your peers, part of it could be mix, geography, et cetera, but when you're looking out at some of the relationship deals, kind of what deals are you saying, okay, they may fit your quality criteria and/or such deals that are at certain cap rates where you're saying maybe there is some issue with the deal itself? So the question more is in terms of kind of the range of cap rates you're seeing from the relationship pipeline?

Craig Bernfield

This is Craig. I'm going to let Steve answer this in his own way. There isn't as much consistency as I think the capital markets would either expect or would like to better understand. It's a lot of smaller and medium size deals and it doesn't function like the public equity market.

You've got people in Florida that have five or 10 properties that are looking to exit. You've got people in Portland, Oregon who are trying to do the same thing and there are either phoning a friend that refers them to us or they're using a broker and the broker calls whoever he calls, and there just isn't a lot of rhyme or reason other than as we provide in our press releases, in each case that we try to show not only what we paid, even at the lease rate, et cetera. And I think the geography plays into it.

I think the ability to source deals directly with the seller is a critical way to be able to pick up some extra yield or coverage, because we're not overpaying for the property. And that happens in part, because we've got a great business development team that is out looking for deals, because we've got a lot of operators, who we feel are qualified to run additional properties. And we're also getting to that local markets, because our operators are looking in their own backyard, to see who might be selling or who might be interested to sell if they were approached.

So it is common for us to get a phone call from one of our operators, saying, hey, we've got a deal, can you guys get behind us, blah, blah, blah. And I think again, if you just look at the yields that we've reported on all of our investments, I think you'll see a fair amount of consistency. And I think in our earnings release, we give the detail transaction-by-transaction.

And I think the thing that stands out is that, it's geography, kind of all over the place; it's deal size, $5 million to $50 million bucks; and the yields are really not in as wide margin as maybe we've seen in the past, maybe the goalpost are getting narrower. But we're still seeing a lot of activity consistent with the valuations that we've announced year-to-date and last year. Steve, why don't you?

Steven Insoft

As far as flexing though in terms of where we might cutoff from a risk standpoint, its facts and circumstance based, because if we can add up one of our asset to an existing master lease with a qualified operator, who's got a delineable track record of success, that's a risk we might be willing to take. That in our business is always the toughest underwriting element to the operator. There is where we sort of draw the pipelines. We need folks who've got an experienced track record.

The real estate, the physical plant in the markets are far easier to quantify. And generally for money you can fix the real estate to physical plant and bake it into your acquisition pricing. So again that risk profile will generally have a bright line around who the operators, are we back.

Vikram Malhotra - Morgan Stanley

And then just one real quickly, if you could remind us, I think the occupancy in certain of your markets I think the GAAP widened on the negative side versus the state average. Specifically for Ohio, is there anything specific happening there?

Steven Insoft

As I said it for one of the earlier, I think when Manny was on the phone, one of the challenges we have is we don't report on a same-store basis. Ohio for example is a market we've been extremely active in. Did a project in the fall with Diversicare Health Properties, when we purchased and it was a property where we're shrinking the bed counts, so we can do some major renovations to the buildings.

And things like that will impact one particular state census, because we might be growing there more rapidly than in other states. Other than that I would not read too much into the overall census within a state variant from quarter-to-quarter.

Craig Bernfield

And what I would add to that is we also, again, to try and get you guys as much information as we possibly can about the underlying metrics, I would look more at the consistency of the operator margins than I would at the occupancy. Because you could have a dip in occupancy, but you could have your revenues going up, because of the profile of the residents with some of those short-term residents producing more revenue versus the long-term stay.

So there is a lot of kind of mixing bowl, when you look at the profitability of the operators. And that's why we started, I think right after the IPO we started using the operator margins. And I would tell you as we look at investments, as we assess our own portfolio, we are looking at the margins that are being produced on the properties that we're acquiring. And we're trying to say, is there a real opportunity here, because we have an operator who is operating in the same state and is running at a better margin.

And as Steve said, if we look at operator real estate market and when we're doing that side-by-side with an operator that we know and we can comfortable with their underwriting to compare to our own, it become a lot easier to assess. So I think the metrics that we report are all helpful. I would just say, as we run the business, the one that least meaningful is occupancy.

Operator

And our next question comes from Michael Knott from Green Street Advisors.

Michael Knott - Green Street Advisors

Just wondering if you can walk through and help us understand, why the operator write-off that you had on the working capital loan and straight-line rent, why that was a surprise to you? And are there more of those in the portfolio lurking around? I think the market, this morning, is penalizing you guys a little bit here for your results and the guidance. So just curious if you can give us a little more color there, and any comments would be helpful?

Craig Bernfield

I'm going to let Steve talk about the facts and circumstances of the transitions, but if the stock is up, sounds like a good buying opportunity. But Steve, why don't you talk about facts and circumstances, and Mark can talk about the financial reporting side of the change in operator.

Steven Insoft

I mean the consolidation of two of our operators into two of our larger operators, wasn't really a surprise to us. We don't really speak in advance, just like acquisitions. We don't really talk about these consolidations in advance of when they happen. And some times they'll have financial reporting into our non-cash impacts far beyond any practical or economic impact.

In this particular case, we had two smaller local operators, one in the Metro Cleveland area and one in the Madison, Wisconsin area, who benefited tremendously from putting those portfolios into two of our larger more broadly diversified portfolios.

In one particular case, largely, in the Ohio matter, there was an outstanding loan that we chose to reserve against, remains uncertain as to what the collectability is, but for that going forward, we thought it would be the overly conservative thing to do in reserve against the loan that was outstanding.

But the consolidation we see as a net credit benefit to the company, over the 10-year leaseholds, those are going to be incrementally more rent over time with far better credit profile. So we see it as a credit positive event for the portfolio. And Mark, if you want to add some color to the debits and credits, go ahead, but I think that sort of encompasses the why.

Mark Wetzel

I mean there was a working capital loan, we took the reserve against it, it doesn't mean we're not expecting to get payment at some time in the future. Obviously, when you switch operators, we wrote-off the straight-line rent. So those are the kind of the two components that flush through the P&L this quarter.

Craig Bernfield

And I think the only other thing that you mentioned is kind of do we have more of this lurking in the portfolio, I would say at the present time, nothing will happen again. Yes. I would say we view it more as opportunity than problem. If one of our larger operator is having a difficult time, that's a different story.

But if some of our smaller operators, if they trip and they fall, and they don't have the working capital to kind of write it back to better performance or we don't feel that they are the right operator to achieve better performance, because of the collaboration, a working relationship, we're usually able to get somebody in the family to come in and take over. And even if there is some short-term disruption either economic or financial reporting, we're looking out at the next 10 years and saying, we just created a better outcome.

Michael Knott - Green Street Advisors

And if I can make a suggestion, I would suggest in the future, if something like that happens, you guys beef up your written disclosure a little bit. I think the market was left to wonder why the AFFO guidance shrunk so much this morning. And then it took I think 20 minutes at least for you guys to talk about it on the call. So I just would especially to the extent it's non-economic, which it kind of sounds like or there are some other side benefits that you just mentioned to credit, et cetera. I would just encourage you to put those out there earlier and maybe in writing, in the future.

Just on acquisitions, I guess what's your -- I know you've talked a lot about it, it's lumpy and it's not as programmatic, the opportunities as we and the capital markets would like. But what's sort of the right level that you guys are thinking about as a successful outcome for you guys on an annual basis? What sort of success versus not a success, in terms of how much you can acquire in a given year, given your cost of capital?

Mark Wetzel

I look at this year and say, we've already had a successful year. We had a successful year last year. In any given year, if I'd look at the last five years, we're going to be easily done 2x or 4x of what we did, but we had great years and every one of those years. We invest in a disciplined way and its good at this more investments that we feel very good about the dynamic of the operator, the real estate, the markets and the valuation.

It so happens that this year and I think this has been true in our more than three-decade history, when we have access to more capital, we're able to invest more and we do invest more, because the market opportunity is so big and it's so deep. And there are very few deal the kind of large portfolios that get widely marketed by an investment bank that those of us on this call have heard of. That's really the exception.

So, it's very difficult, because the acquisition market is so dislocated and fragmented. It's our business strategy of having the people inside our company that know how to go out and interact with the people that are trafficking in the properties that we like to own in the parts of the country. We like to own them, because we have operator relationships.

And we also strategically, and that's why I would just say strategically as opposed to programmatically, we strategically are also using our best and largest operators as finders, if you will, because they're empowered by the relationship and our willingness to back them with the capital. So we've got all those guys out all over the country, trying to find the deals that aren't being bid up by a large process.

I think while we are going to continue to advice you that the acquisition flow could be lumpy, if you really look at the fourth quarter, the first and the second quarter, I think what you're seeing is more consistency about volume. Whether we will be able to continue to increase the volume or to maintain that pace is just something that we'll talk to you about every quarter and give you the best assessment we can.

But it's not a bottomless pit. We most definitely do not think we're anywhere near the bottom of sourcing opportunities on Main Street, and being one of the premier investors in the country and having the access to capital. Let alone a cost of capital advantage that frankly we haven't even needed to use to be able to make the deals that we've made, and we could get more aggressive. We could to a smaller extent choose to lower our coverage expectation, maybe lower our yield expectation, and based on what we think is still a material level of accretion, we might move the needle to move the volume.

We haven't done that yet, but one of the reasons we went public was ultimately, not only to have a cost of capital advantage, but to use that in the marketplace, when that spread was significant enough, where some times you give some of it to the seller to be able to produce more accretive deals.

I know that's a lot of words as oppose to just saying expect $150 million a quarter from us, but give us some time, as a public company, with all of the resources available to us now, with the revolver, having done our first bond deal since the IPO; we did our equity raise since the IPO. We kind of have graduated through these natural milestones in our evolution. But I think we feel that we're locked and loaded at the perfect time to take advantage of the consolidation opportunity.

Michael Knott - Green Street Advisors

So if I marry those comments with some of the things you said earlier about second half of the year looking better, it sounds like there might be more to talk about on the next call or two? Appreciate the extended decimal points on the EBITDAR coverage disclosure. We had sort of perhaps improperly inferred that the last quarter on skilled nursing was 1.5 and today you reported 1.43. It's on a rounded basis. That sounds like a 0.1 decline. But Steve, I think you mentioned earlier maybe it was only a couple of basis points or maybe it's not even that. Are you comfortable giving the last quarter to two decimals just so we have it?

Steven Insoft

Yes. It's 3.3 basis points delta.

Operator

And we'll take our next question from Juan Sanabria from Bank of America.

Juan Sanabria - Bank of America

I was just hoping you could give a little bit more detail on the results and kind of the moving pieces relative to last quarter on an AFFO basis? I guess what I'm struggling with is it sounds like the straight-line rent charge and the loan receivable write-off were really non-cash, and so from an AFFO basis it should have really no impact. So was the delta, the negative delta versus the first quarter on a per-share basis really all about the difference in timing or the equity raise versus the acquisitions or was there any other one-offs that we should be thinking about to normalize on a go forward basis?

Mark Wetzel

On a per-share basis the denominator for sure affected the second quarter. If you look at the face of the P&L, it's roughly a $3.5 million reserved and the add backs to AFFO is only $3.2 million. So it's roughly $300,000 of Q2 rent that we did not add back to AFFO. So that did reduce revenues. The timing of acquisitions post, we do really didn't close anything post earnings call at Q1, and then the G&A increased for the quarter. Those were the primary three things.

Juan Sanabria - Bank of America

And so based on that comment of the $300,000 not added back, is that the decrease in cash revenue as a result of re-tenanting the properties? I think you said the GAAP revenue stayed the same or higher. Just hoping you can comment on that?

Mark Wetzel

Yes. For the couple of months during Q2 it centered around the cash rents for those transition properties.

Juan Sanabria - Bank of America

Can you talk about like a percentage number that the cash rents went down as a result of the re-tenanting? And maybe the difference in coverage levels as well would be helpful?

Mark Wetzel

I think specific to the dollars for the quarter, it was $200,000, but specific to a percent --

Steven Insoft

One way to look at it for, over the 10 years the net rents will go up. Over the next year you're probably going to see a shrink of about $100,000 to $125,000, depending upon the timing of certain events.

Juan Sanabria - Bank of America

That's an annual number?

Steven Insoft

Yes. It's an annual number. Mark was talking about some frictional revenue loss we had.

Craig Bernfield

The new operators took over with only a smaller difference in the rents under the previous lease. There wasn't a big haircut. There was a small difference. And as Steve said, it's a small difference at this point in time. If you look forward 10 years, it catches up and we actually end up in a better spot. But more importantly this was about credit quality and enhanced performance by the asset, and again we're only talking about five of our 300-plus properties.

It was more strategic than it was a negative effect. I think almost zero impact. And I can't emphasize enough what we're able to substitute an operator, who is doing their best and providing the care that doesn't have the working capital or scale to be able to handle some blips in performance. When we're able to substitute one of those guys for one of our larger better capitalized operators, then when there is a dip in performance, if there is, we're not like suffering or dealing with it. They are dealing with it. That's the value of the triple-net lease.

And over time, and I think Steve mentioned this in his prepared remarks, our top 10 operator have about 70% of our rents, not all of those top 10, but most of those top 10 are the guys that are running 40, 50, 100 buildings. And if they have a blip at two of their buildings, it doesn't impact us in a direct way.

When you're in a situation like with Ridgecrest, where they operated three properties, two of them were ours. The operator is a good guy, we're still in good relations with them, but he just couldn't handle a dip in performance, and that good relationship that we have with them afforded us the ability to execute a smooth transaction, where Diversicare was able to take over. Increase their presence in Ohio. Achieve better performance with the assets. And over time, I think we'll see that in the coverages.

But again we're only talking about -- I wouldn't think that the news about these five properties would or should be regarded as material event in our quarter, and we're talking about these things, even though they have minor impact financially, because we want you to understand how we're running the business. And it's very difficult to predict just like the acquisition flow. But we have fewer and fewer smaller local operators in the portfolio, and that's just an evolution in the industry.

Juan Sanabria - Bank of America

Are you guys looking at opportunities to invest in mortgages as opposed to actually owning the underlying asset? And if so, what are the characteristics you look for there and preferences between the two and why so?

Steven Insoft

Great question, by the way, because for those of you who followed the healthcare REIT space for the last couple of decades, you'll know that the interest in mortgage financing has sort of fallen-in out of vogue. We do a mortgage financing from time to time, we've got a couple of them on our balance sheet.

We generally do them, as what I would call, tax sensitive accommodations for some of our larger operators, when taxes become an issue and they don't want to trade the actual asset. Let me say, all else being equal, it is a less desirable investment for us. I like the downside protection in equity ownership far more than I do in mortgage financing. It won't be a critical part of our business plan, but you might see them popup from time to time.

Craig Bernfield

Less so from our existing operators, as opposed to an investment opportunity that might be presented to us, because the deal for the operator is looking for debt, as opposed to a triple-net lease financing vehicle. But it certainly is something that we would consider, but it's absolutely not a focus of our growth strategy.

Operator

We'll take our next question from Michael Carroll from RBC Capital Markets.

Michael Carroll - RBC Capital Markets

Craig, I guess how much floor space do you have when replacing a tenant? I mean is it like a three-month thing, a six-month thing?

Craig Bernfield

It's a great question. I would say, it happens most often, Mike, when we have a situation that our asset management teams has been following closely an operator who's had a negative trend in their performance. So we, in addition to a formal quarterly call, that our asset management team has with the operators.

If the operator, whether it's, again, less so about occupancy, but if you just look at their overall coverage, as the coverages declining, we're working with them to try and understand whether it's a blip or whether the property needs modernization to be competitive in the market or if they had an operating issue with care, and they got a bad survey caused their labor go up, was it a moment in time or was it a trend, or was it just like the operator can't do better.

If we get to the point, where our asset management team feels that we don't have confidence that the operator is going to be able to turn things around and achieve better results, this conversation about replacing them with somebody else is something that I would say to answer of your question directly, is something that we might be watching over a six-month period, but from the moment we decide to make a change, and this is why I'd ask you to think about it, because we're monitoring the performance of all of our operators, when they're doing well and when they're not doing well.

So we are very much on top of the trends, obviously except to the extent of the lag in data, kind of almost quarter behind, but once our team has decided that the best interest of the asset and the residents is for change in operator, I would think about three months being the amount of time it takes to actually implement the change.

Our guys usually know who in the operator stable we might phone. If we think it's a time sensitive situation, we might just pick one guy to look at the asset or group of assets, if we're not worried about the sustainability of their ability to pay the rent over the next few months. If we feel good about that, we might ask three or four people to look at it, but not in the way, and it really triangulates back to the question we got earlier about acquisitions and dealing with sellers directly.

There is a lot of sensitivity at the facility level, when you start announcing that there is going to be a change for obvious reasons. 70% of the cost structure of the operator is labor. And people get nervous about who their boss is going to be or whether they're going to get to keep their job, it could create disruptions. So we do tend to move very fast and have the ability to move fast once we make a judgment.

Steven Insoft

The other thing I would add is there is from time-to-time, especially for those of you who followed us over the last few years, what I call a fair amount of M&A activity in the Opco space, so you will hear over time us talk about transitions that have really nothing to do with anything other than Opco M&A.

We've had operators in the past who simply sell their businesses and these are success stories, but they still will have a financial reporting implication, because to the extent there's a new lease, I still have to write-off the straight-line rents. So again it's going to be facts and circumstances, we'll make sure we give on the investor community a fair amount of color around these situations, but let's not assume there are always going to be distressed situations, some times there are success situations.

Craig Bernfield

Yes. Mike, I would say, that point that Steve made is really important. In fact, it might even be new material in our office. But it's really good new material. That when you see our sellers market, like we're in, where you see cap rate compression, yield compression, it's happening, that consolidation, it's happening at the operator level as well, where one of our operators might be trying to buy another operator who could be in our portfolio and it could be in somebody else's portfolio.

And if we're ultimately in a position to say, yay or nay to the change in operator, it would normally result in an upgrade in credit quality, not necessarily rent or cash flow, but we would not ever permit our leases to be flipped to an operator that we didn't think was at least as good. But I think Steve is right, Mike, your question is really excellent.

I think it's a trend to be aware of. I would say in the next 18 months, you're going to hear us and other people talking about change in operator, when it was precipitated by the operator to take advantage of the market, or maybe they're just old and tired like I am. And they call one of our guys and say, we hired a middle market investment banker, and we're going to try and sell our portfolio. And we'd say, good luck, if we can help as long as it's not a troubled situation that we think needs to be -- that we need a new operator more quickly.

I think Steve is just very right on here that you're going to see a lot of the -- and you won't see most of it, because it's happening on Main Street. And as we know, only about 12% of the skilled nursing facilities in this country are owned by the public REITs. So you see a lot of this. We see a lot of it and hear a lot about it outside of our portfolio some times, might that you guys will never hear if it's just a Main Street transaction, but its most definitely going on what Steve was going.

Michael Carroll - RBC Capital Markets

So within, I guess you're not looking at anybody right now to replace. So we can expect the next six months nothing, I guess, this instance won't occur again?

Craig Bernfield

I think the best I could say is not at this time. If there were somebody that we were really concerned about, we would be open with you and say that we've got a situation or two.

But listen, we're managing a big business with a lot of moving parts and pieces and it's nice to have that diversification with having 40 operators, but it's also 40 operators and to assume that we won't have one or two that are experiencing difficulties that any point in time, it's really the way in which, and this where I think our management makes the biggest difference and that relationship with the operator is instrumental is the ability to get clear reliable information from the operator about the performance and to collaborate on a change, if a change is warranted.

So I would say that as we sit here today, I wouldn't expect us to be talking to you about a situation like this at the end of the year, but I can't tell you that won't be that way.

Operator

And we'll take our last question from Andrew Rosivach from Goldman Sachs.

Andrew Rosivach - Goldman Sachs

Guys, I'll just call you. Let's wrap it up, thank you.

Craig Bernfield

Andrew, come on I'm disappointed. You got to do better than that.

Andrew Rosivach - Goldman Sachs

No, it's okay. We're already over an hour. I'll just give you a call. Thank you.

Steven Insoft

Thank you.

Craig Bernfield

Thank you very much. Well, there is no other question. We really appreciate your interest and thanks for listening to the call. And as Andrew just mentioned, please feel free to call any of us with follow-up question you may have.

Operator

And once again, ladies and gentlemen, that does conclude today's conference. We appreciate your participation today.

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