National Health Investors' (NHI) CEO Eric Mendelsohn on Q2 2016 Results - Earnings Call Transcript

| About: National Health (NHI)

National Health Investors Incorporated (NYSE:NHI)

Q2 2016 Earnings Conference Call

August 05, 2016 12:00 PM ET

Executives

Colleen Sullivan - Director, IR

Eric Mendelsohn - President & CEO

Roger Hopkins - CAO

John Spaid - EVP, Finance

Kevin Pascoe - EVP, Investments

Analysts

Chad Vanacore - Stifel Nicolaus

Jordan Sadler - KeyBanc Capital Markets

Juan Sanabria - Bank of America/Merrill Lynch

Rich Anderson - Mizuho Securities

John Kim - BMO Capital Markets

Todd Stender - Wells Fargo Securities

Operator

Hello everyone. This is Colleen Sullivan, Director of Investor Relations. Welcome to the National Health Investors Conference Call to review the Company’s Result for the Second Quarter of 2016. On the call with me today is Eric Mendelsohn, President & CEO, Roger Hopkins, Chief Accounting Officer, John Spaid, Executive Vice President of Finance and Kevin Pascoe, Executive Vice President of Investments.

The results as well as notice of the accessibility of this conference call on a listen-only basis over the Internet were released this morning before market opened in a press release that’s been covered by the financial media. As we start, let me remind you that any statements in this conference call which are not historical facts are forward-looking statements. NHI cautions investors that any forward-looking statements may involve risks or uncertainties and are not guarantees of future performance.

All forward-looking statements represent NHI’s judgment as of the date of this conference call. Investors are urged to carefully review various disclosures made by NHI in its periodic reports filed with the Securities and Exchange Commission, including the risk factors and other information disclosed in NHI’s Form 10-Q for the quarter ended June 30, 2016. Copies of these filings are available on the SEC’s Web site at www.sec.gov or at NHI’s Web site at www.nhireit.com.

In addition, certain terms used in this call are non-GAAP financial measures, reconciliations of which are provided in the NHI’s earnings release and related tables and schedules, which has been filed on Form 8-K with the SEC. Listeners are encouraged to review those reconciliations provided in the earnings release, together with all other information provided in that release.

I’ll now turn the call over to Eric Mendelsohn.

Eric Mendelsohn

Thank you, Colleen and welcome everyone. It’s hard to believe it’s been a year since the CEO management changed at NGI. For those of you who purchased stock on August 12th of last year, the day after the change was announced your return on investment has been over 30% based on yesterday’s closing price. During that same period, NHI has purchased 18 buildings and gained two new operating partners and has executed nearly 350 million of investments. We haven’t missed a beat over the past year and continue to stay focused on creating value for our shareholders.

I’m extremely pleased with the growth profile NHI offers investors. We’ve outpaced the peer group consistently over the past six years in growth of normalized FFO per share and dividends per share. Over the past 10 years, we have consecutively raised the dividend with an average annual increase over 5%, while keeping our dividend payout ratio low and outperforming both the S&P’s total return index and the MSCI U.S. REIT index.

The results for this quarter once again are representative of a strong growing company. Our normalized FFO increased 6.1% per share and normalized AFFO increased 8.9% per share, when compared to the second quarter of 2015. Our investment volume continues right on-track with over 337 million of new investments year-to-date and we continue to position the company for growth and value creation. A prime example of creating shareholder value can be seen in our recent announcement to restructure our RIDEA portfolio with Bickford to a triple-net lease. The new structure and the financial impacts of this change will better position the company for predictable cash flows and maintaining an active development pipeline as we will discuss later in the call.

I’ll now turn the call over to Roger Hopkins to discuss the financial results for the quarter. Roger?

Roger Hopkins

Thanks, Eric. Hello, everyone. For the second quarter of 2016, normalized FFO was $1.22 per diluted share. Our normalized AFFO was $1.10 per diluted share, which represents the 6.1% and 8.9% increase respectively over the second quarter of 2015. Normalized FAD for the second quarter increased to $1.11 per diluted share, which is an 8.8% increase over the second quarter of 2015. These results reflect the timing and volume of investments made in 2015 and 2016 including $195 million in new investments since our last investor call on May 6th.

We expect to fund our existing construction loans and development activity each month throughout 2016 and to 2017. Our investments and commitments made in 2016 are listed in our Form 10-Q and listed also in our supplemental data report. Our revenues for the second quarter increased 8.7% over the same period in 2015. Our interest expense increased to $10.7 million in the first quarter, due mainly to terming out $100 million of borrowings on our revolving credit facility to higher fixed-rate private placement debt in November 2015.

Our general and administrative expenses for the quarter were $2.1 million, or 3.5% of revenue, compared to $2.5 million or 4.5% of revenue one year ago. Our non-cash compensation expense was $251,000 during the second quarter and is expected to be the same amount for each of the next two quarters. We currently expect our general and administrative expenses will remain in the range of $2 million to $2.5 million for each of the next two quarters. Our net income for the second quarter reflects the sale in May of two skilled nursing facilities to our tenant The Ensign Group for a gain of $2.8 million.

Likewise, our net income for the second quarter includes a gain of $23.5 million on the sale of the portion of our investment in LPC common shares, which we have held for over 15 years. These gains are expected to be offset for tax purposes in 2016, our current dividend return of capital. These gains were excluded in our normalized non-GAAP financial metrics.

As described in our first quarter conference call concerning the transition in May of our lease of 15 skilled nursing facilities from Legend to The Ensign Group. We will require for accounting purposes to write-off accumulated straight line rent receivables of $8.3 million and intangible assets of $6.4 million related to the termination of the purchase option previously held by Legend. There is no purchase option in the current lease with The Ensign Group. Our normalized non-GAAP financial metrics reflect these unusual and infrequent transactions.

For the first six months of 2016, normalized FFO was $2.38 per diluted share. Our normalized AFFO was $2.15 per diluted share, which represents a 4.4% and 7.5% increase respectively over the same period in 2015. Normalized FAD for the first six months of 2016 was $2.18 per diluted share, which is a 6.9% increased over the same period in 2015. These normalized results primarily exclude transactions previously described concerning gains on sales of real estate and marketable securities and non-cash write-offs related to our lease transaction to The Ensign Group.

Yesterday afternoon, we announced the signing of a letter of understanding with our joint venture partner and affiliate Bickford Senior Living to convert our 32 property RIDEA senior housing portfolio to a triple-net lease structure. NHI will acquire Bickford's 15% interest in the property company for approximately $25.1 million and Bickford will acquire NH’s 85% interest in the operating company for $8.1 million. In a few minutes, Kevin Pascoe will discuss the rationale for the planned transaction and the associated benefits to both NHI and Bickford. A more complete disclosure of the transaction will be made to coincide with the closing of the transaction estimated by the end of this year.

In addition, putting this large portfolio on a steady and predictable course of lease income without the large fluctuations often occur in underlying facility operations is important to our shareholders. Our historical investment in real-estate covered by the joint venture is over $281 million yielding current year contractual rent of $25.4 million or 9% plus 3% annual escalators. This income stream will continue under the new triple-net structure. After the closing of the transaction NHI will no longer made partnership distributions for Bickford. In 2015, we distributed $2.3 million in cash to Bickford.

As for our construction loans and real-estate development activity, we continue to fund our mortgage construction loans to an affiliate of life care services for the expansion of its entrance-fee community in Issaquah, Washington named Timber Ridge. We have funded $112.7 million thus far and estimate we will fully fund our $154.5 million commitment by the end of this year. As we have previously disclosed, we estimate that we will receive repayment on our construction loan in 2017. Leaving the mortgage loan balance of $60 million for which we have scheduled a 10-year maturity.

In our $55 million development program with Bickford to construct five new assisted-living and memory care facilities, we have funded $34.5 million as of June 30 with approximately $15 million to be funded by the end of 2016 with the remainder in 2017. This morning, we announced that our third quarter dividend will be issued at $0.90 per share, for shareholders of record on September 30, 2016. We currently estimate our total dividends for 2016 will result in a normalized FFO payout ratio in the low-70% range and a normalized AFFO payout ratio in the low-80% range.

Moving on to guidance for 2016. We have increased and tightened our guidance ranges based upon the successful execution of new investments made during the second quarter and the expectation of additional investments for the remainder of 2016, in the financing arrangements by which to fund them. We currently estimate normalized FFO in the range of $4.84 to $4.88 per share, and normalized AFFO in the range of $4.36 to $4.38 per share.

We do not include an estimate of investment volume and our guidance range. Furthermore, our guidance range does not include the accretive impact of the plan transaction announced yesterday with Bickford. As we cannot estimate the closing date of the transaction though it is expected to occur by the end of 2016.

I’ll now turn the call over to John Spaid, who will discuss the capital plan and balance sheet metrics.

John Spaid

Thank you, Roger. We continue to successfully execute our 2016 capital plan. Our balance sheet metrics for the quarter ending June 30, 2016 were net debt to annualized adjusted EBITDA at 4.4 times, weighted-average debt maturity at 6.8 years, weighted-average cost of debt at 3.51%, and our fixed charge coverage ratio at 5.8 times.

Turning to our revolver, as of June 30th, we had 191 million outstanding with an available capacity of 359 million. Proceeds from our revolver since year-end 2015, were used upon our investment pipeline to keep through 2016. Looking at our marketable securities, during the second quarter, we continue to sell our position LTC common stock. In Q2, we sold 834,660 shares leaving us with the balance of 459,140 shares as of June 30th.

During the second quarter, we made use of NHI’s ATM registration initiatives 714,666 shares at an average price of $71.30 per share providing the company with 50.2 million in net proceeds. Proceeds from our ATM and LTC common stock sales were used to pay down the revolver. In July, we were rate locked with a private placement lender for $75 million an eight year term debt at a 3.93% interest rate. We expect to close on the loan in the third quarter.

As we move forward on our 2016 capital plan, we will continue to evaluate our capital source options including further revolver use, private placement debt, bank term loans, convertible debt and additional ATM equity issuances. We view our ATM program as an effective way to match fund our smaller acquisitions by exercising control over the timing and size of equity proceeds. We believe the ATM provides NHI with a more favorable cost to equity as compared to larger follow-on offerings.

With that, I will now turn the call over to Kevin Pascoe, who will cover portfolio details and new investments.

Kevin Pascoe

Thank you, John. Looking at our portfolio, the EBITDARM coverage ratio was 1.93 times, our skilled nursing coverage is a strong 2.97 times and our senior housing portfolio remained steady at 1.23 times. National Health Corporation continues to be a strong performer with a 3.8 times corporate cash coverage and is currently 16% of our cash revenue. Our relationship with Holiday Retirement accounts for 15% of our cash revenue. Occupancy for the quarter was 91.4% and the EBITDARM coverage ratio was 1.19 at quarter end. The occupancy trend for the second quarter remained positive and the portfolio closed the quarter with average occupancy of 92.5%.

The Bickford relationship accounts for 15% of NHI’s cash revenue. The same-store portfolio EBITDARM had solid improvement over the prior quarter and the same quarter in 2015 as expense pressures leveled off. One of the five new development projects opened during the third quarter and received strong reception in the market. Two more development are expected to open by the end of the year and the remaining to our expected to open in the second and third quarters of 2017. We continue to be very happy with our relationship with Bickford. They excel in their respective markets and we look forward to continuing to grow with them.

Converting RIDEA to triple-net helps Bickford cleanup their balance sheet making them a stronger partner, solidifies NHI's returns eliminating the variability of operational cash flows and still provides growth for both NHI and Bickford through construction opportunities. To that end we have also agreed to a new development project with Bickford under a loan structure where NHI has a favorable purchase option at stabilization. This structure will preserve solid returns for NHI similar to what it had on the RIDEA and also incentivize Bickford for the value creation and the developments.

Senior living communities represents 14% of our cash revenue the EBITDARM coverage for SLC is 1.16 times on a trailing 12 month basis as the first quarter ends. Second quarter saw improved entry fee cash flow and July was a strong sales month as well. As discussed last quarter we signed a new lease with Ensign on 15 skilled nursing facilities formally operated by Legend Healthcare. These communities transitioned to Ensign effective May 1st. This relationship represents 9% of NHI's cash revenue and is bolstered by Ensign's corporate fixed charge coverage ratio in excess of 2 times.

Moving on to new investments in June we announced the acquisition and lease of two entrance fee CCRCs from affiliates of East Lake Capital Management for $56.3 million, the communities are subleased to Watermark Retirement who operates 40 senior housing communities in 21 states and has been an established operator of CCRCs. The lease has a term of 15 years with initial yield to NHI of 7% with annual escalators of 3.5% in years two through four and 3% thereafter. The communities have an EBITDARM lease coverage ratio in excess of two times. NHI has committed up to an additional $10 million for capital improvements in particular expansion of the communities over the next 2 years.

Also during the quarter we announced the exercise of a purchase option to acquire five assisted living and memory care facilities owned and operated by Bickford Senior Living for 87.5 million. The acquired facilities have a total of 277 units, a combined average occupancy of 92% and has EBITDARM lease coverage is 1.35 times based on an initial annual lease rate of 7.25%. NHI has committed 2.4 million for capital expenditures and expansion of the existing facilities, the funding of which will be added to the new lease space. The lease has an initial lease term of 15 years plus two five-year renewal options. The annual lease escalator is 3% and NHI has purchased option on the fixed Bickford facility was relinquished.

Subsequent to the quarter NHI expanded this relationship with senior living management with a mortgage loan and corporate loan totaling 24.5 million to fund SLN's purchase of five communities in Florida. NHI will receive an 8.25% coupon on the loans and get a participating interest in the properties. This gives NHI upside in the value of the communities and positions NHI to purchase the communities should SLN elect to sell. Our pipeline remains very active with a healthy level of opportunities under review from various asset classes and we continue to receive off market opportunities from our existing client base and referral sources.

With that I will hand the call back over to Eric.

Eric Mendelsohn

Thank you, Kevin. We continue to stay focused on positioning the company for high quality growth and ultimately for creating shareholder value. With that we'll now open the line for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Chad Vanacore with Stifel. Please go ahead.

Chad Vanacore

Hi. Good morning. I was actually hoping that you give us a little more color on the RIDEA to triple-net lease conversion. What are the mechanics involved there and is there a mark-to-market somewhere?

Kevin Pascoe

Chad, this is Kevin, good morning. As I mentioned in the prepared remarks, this is just an opportunity for us to stabilize our cash flows with Bickford through the triple-net lease. I would tell you that we looked at market comps in terms of valuing the portfolio and would be consistent with how we have underwritten portfolios in the past and consistent with the deal that we’ve announced recently.

Chad Vanacore

What about on the new triple-net lease. What kind of coverage have those leases been underwritten too?

Kevin Pascoe

Again, it would be similar to what you have seen in our senior housing portfolio. If you look at our supplemental which is -- I believe it was 1.23 times on the EBITDARM coverage, it will be consistent with that.

Chad Vanacore

And then does this change your pipeline, your development pipeline at all?

Kevin Pascoe

No, it doesn’t. We are still full speed ahead with Bickford as I mentioned. We are very happy with them as a partner and continue to -- we will continue to grow with them. As I mentioned, we’re doing a more -- next project is a alone that we’re doing with them where we have a purchase option. So we’re continue to add to the relationship overtime then continue to look for high quality opportunities to develop and it’s definitely something we intend to be a big part of.

Chad Vanacore

Then with the thought process on converting now just trying to be stabilized future of rent flow volatility or was there something else that drove you to do this now?

Eric Mendelsohn

Chad, this is Eric. Frankly, when you look at the history of our RIDEA, the returns that we were getting were very similar to traditional lease. So we think, we figured out a way to get to a hybrid where we have a traditional lease in place and then we have a development program that provides those ups and the types of returns that people look for when they think of RIDEA.

Operator

Our next question comes from the line of Jordan Sadler with KeyBanc Capital Markets. Please go ahead.

Jordan Sadler

So I guess, I’m trying to understand the same thing on Bickford. I think the way that the Bickford joint venture was structured originally by prior management was intended to somewhat follow the fundamental elements of the triple-net lease. Right, so it was performing similarly, somewhat, I think somewhat by design. But what was it -- and I guess what you would assume is that the expectation was that the joint venture would ultimately for permit upside in the event of a stronger upturn and potentially may be align yourselves with your partner to a little bit of a greater extent. So what part of that, were you looking to change or it was just was misstated previously?

Eric Mendelsohn

Jordan this is Eric. I don't know that anything was misstated previously I think your characterization of the RIDEA is accurate and I can tell you from my perspective coming from an operations background that operations and the revenue from operations is lumpy and episodic and as a REIT what we've done is we've traded some of that upside for stability uncertainty and frankly we've also helped our partner the Bickford’s by strengthening their balance sheet with this transaction they will be able to pay off some legacy debt and co-invest to a greater extent in some of the new developments that we're doing. So economically they are going to come out of this stronger and better positioned and we like that whether you are a tenant or a joint venture partner it's always good to have strong partners.

Jordan Sadler

I get that. And especially in a partnership I mean to better capitalize your partner make some sense but I guess it's partly coming at the expense of your shareholders right and your shareholders’ capital on some level. And I guess you could look at it the other way and say well your shareholders have a better partner and better credit. So, I recognize that they're somewhat closely tied.

Eric Mendelsohn

Jordan let me [Multiple Speakers] Jordan I [Multiple Speakers].

Jordan Sadler

I am not sure what the shareholders are getting out of it that and that the Bickford's end up being better capitalized?

Roger Hopkins

Jordan this is Roger. I do want to point out that we distributed $2.3 million to Bickford last year and the unpredictability really comes on the OpCo side of things. Now by design we have been reinvesting the income in the OpCo in newer buildings and those newer buildings are doing great. So, if we take out the variability of the OpCo bottom-line which affects our FFO and AFFO and really focused 100% on a triple net structure and still have the development pipeline and the ability to make loans and have purchase options and set rents that is truly the best of both worlds. So there is really no detriment to our shareholders in fact it's a very accretive transaction based upon the numbers I just gave you. And you will see more specifically that accretion as we close this transaction and we provide some pro forma information as if the transaction had occurred previously. So it’s a very positive for NHI and its shareholders and it’s a positive for Bickford. So we -- I think [Multiple Speakers].

Jordan Sadler

Hi Roger, that helps. Can you give me the 2.5 million, thank you for pointing that out, is there a net cash flow impact to NHI that you can kind of give us a little color on. I mean I guess the net cash out the door is 25 minus the 8 right so you're paying incrementally 17 million.

Roger Hopkins

That is right.

Jordan Sadler

And your cash flow is it just the 2.5 million goes away?

[Multiple Speakers]

Roger Hopkins

As you could see in our 10-K last year December 31, we paid almost $2.3 million in cash distributions. So that was their share of course we paid NHI its share out of the prop-co and we've been very clear, we've been reinvesting excess cash flow from OpCo into newer facilities which have start up losses and you know lease up related losses up to stabilization. There's nothing unexpected about that, so the pro formas that will eventually supply pro forma implies as if, as if we had paid 25 approximately 25 million for the prop-co and had the associated interest expense and that sort of thing. So really once we get beyond the acquisition of their share of prop-co and their purchase of our share of OpCo this is still very accretive. We just wanted to be able to point to something that you might be able to latch on to and that was the cash that we paid that they were entitled to. Now certainly that's not a predictor of 2016 or 2017 or years after but this is a very profitable portfolio and this adequately incentivizes Bickford over and above their lease payment to be able to retain their income that they're entitled to as the tenant. So this is a bit of a variation.

Jordan Sadler

Can you remind us of the management fee, is the management fee 5%?

Kevin Pascoe

It was a -- this is Kevin, it was a flat 5%.

Jordan Sadler

Okay. Thank you for that. Eric can you, is this transition -- should we take away from this that you're a little bit more cautious near-term or maybe more than a little bit more cautious on RIDEA or at least on the ops and the outlook?

Eric Mendelsohn

I wouldn't read too much into this, RIDEA is a very case-by-case type of structure in the universe of structures, we would be open to future RIDEAs under the right circumstances with the right partner. And frankly a lot of people that approach us for RIDEA really would prefer to do a joint venture on real estate, so you may see JVs on the real estate but not on the operations going forward. We have these types of conversations with clients all the time.

Jordan Sadler

Okay, that's helpful. And then just, I guess the last one with Roger back to you on the guidance. Was there in that small bump, was there some portion related to an acquisition that wasn’t already contemplated or what was not previously contemplated?

Roger Hopkins

As we have described our initial guidance as well as our adjustment now are based upon circumstances that exist and that we feel confident about. We feel confident about our investment pipeline, but also the means by which to finance that. So we want to get the best picture we possibly can, update it through today. Excluding the impact yesterday of the announcement regarding the RIDEA, which is accretive, we just don’t know and that will close, but we expect it will by the end of the year.

Jordan Sadler

I guess I was asking what is coming in a little bit better that caused you to tweak it get higher. Is it the financing assumptions you’re saying?

Roger Hopkins

It’s really a mixture of big volume and timing of what we have been able to close and what we expect to close and the associated financing. We’ve been using our ATM this year to help pay down our revolver as we close acquisitions. So it’s a very straight forward way in which we’re able to take down acquisitions at that time and then refinance them on a more long-term basis afterwards.

Operator

Our next question comes from the line of Juan Sanabria with Bank of America/Merrill Lynch. Please go ahead.

Juan Sanabria

Hi, thanks for your time guys. Just on, I think you mentioned sort of in line coverage of a mid-12 to mid-13 on an EBITDARM basis. My understanding is most of the deals in the market are sort of at that level post management fee. So I’m just wondering, were you comfortable having the lower coverage relative to market or is there any renegotiation of rents or. And just why having you’ve been able to quantify that the accretion, I mean that the deal is announced, I get the timing could be later in the year, but there is just a lot of confusion as to the rationale without knowing the impacts, it’s just a little confusing?

Kevin Pascoe

Hi Juan, this is Kevin I’ll start with the rent question. There is no renegotiation on rent, the rent that we have in place in between the operating company and the property company is staying in place, we are just buying out Bickford’s portion of the property company. So there is no renegotiation there, it’s just one where the rents have been set they’re growing into those rents with the new developments. So we would expect to see that improve overtime.

Eric Mendelsohn

And Juan, this is Eric. In terms of quantifying the returns, we have modeled the returns and they are certainly accretive Roger has pointed to a number of the rent number that we received last year, that’s likely very similar to what we’re modeling. But there is HUD debt on these properties. There is Fannie debts those lenders can take many, many months to approve a transaction of this nature. So we’re not comfortable publishing any type of financial impacts at this point until we have a date certain for closing. And again you know my policy being the new guy I’d rather under promise and over deliver. So we want to be cautious about broadcasting what the impacts would be.

Juan Sanabria

And how should we think about how you thought about the valuations implied for the OpCo or sorry for the PropCo relative to the trailing 12 month EBITDAR it is just -- I am not sure how those values were arrived at?

Kevin Pascoe

Juan this is Kevin again. As I had briefly mentioned before I would just point to you other transactions that we have done recently in terms of the cap rate on the lease payment and that was kind of a basis point for negotiation with Bickford to reach agreement on both the operating side and the property side.

Juan Sanabria

So could you -- what's the lease payment relative to or how does that compare to the EBITDARM that you guys have been generating on the RIDEA pool may be I missed that Roger has mentioned it earlier.

Roger Hopkins

You are talking of the existing, the current lease payment?

Juan Sanabria

Yes, I am just trying to get a sense of what was the NOI that was captured rather devaluation and how does it differ from the EBITDARM that the five options were generating that you disclosed?

Roger Hopkins

So the -- I will give you a number. Now the current contractual rent is 25.4 million from the OpCo to the PropCo and so what Kevin is saying is we valued that PropCo based upon what we've done similar recent deals and obviously this is a large portfolio. And so, what is falling out is really the way of the equity in that particular PropCo and in the OpCo and that's roughly how the numbers are falling out they are pro rata share. That's not telling you exactly what that cap rate is but I can tell you that we're using a similar cap rate and we just recently did a deal with Bickford on five option properties you've seen that deal we have a lease right of 7.75% on that one. So, there is not a whole lot of difference in the valuation of this large portfolio compared to the five we just did.

Operator

Our next question comes from the line of Rich Anderson with Mizuho Securities. Please go ahead.

Rich Anderson

Thank you. And I guess you didn't expect to create such a controversy today with this, but I am going to say that this the quarter of the REITs giving a big bear hug to their tenants given genesis and now this so we'll figure it all out in the end, but I guess Eric the question for you is, does this just come down to basically de-risking and simplifying the arrangement with Bickford I mean is that really the value that you're contemplating longer term?

Eric Mendelsohn

That's one way to look at it so to speak we could put the RID in RIDEA that it does lower the risk profile and gives us more certainty and we still get to keep the goodies which are the development pipeline and the pops that we'll get along the way from that.

Rich Anderson

But when you inherited this as CEO did you always kind of look at the arrangement with Bickford and think it was just a little bit too confusing for people to understand what the whole preferred payment and all that sort of stuffs?

Eric Mendelsohn

Well as you know I had cheat sheet prepared for people when I explained it, and you're right, it was a bit complex but coming from Emeritus where we had complex joint venture arrangements with Blackstone and others. And in the universe of structures this was not unusual to me.

Rich Anderson

Okay. And then if I could just gears to Ensign Group, they did report a reduction in their Medicare census this quarter, I'm wondering if that resonated with you at all and if that is maybe a negative signal for everything that's going on with the value based payments and alike, if you can comment on their fortunes this quarter?

Kevin Pascoe

Rich, this is Kevin. It's definitely something we are cognizant of and we'll continue to make sure we're watching what's going on in that space, we’re still very happy with them as our new tenant there in our Texas buildings that they took over from Legend and it is something that we'll be mindful of, but feel like we have a very strong partner there and very happy to have them as a partner.

Rich Anderson

So Kevin, I mean is there any, there's no hold up, no hesitation from you at all when it comes to Ensign or does this give you any level of pause for the short-term as you kind of figure this all out?

Kevin Pascoe

Again, we feel they are a very strong partner, very happy to have them, think that there may be some seasonality involved as well. But there is, it is something we're mindful of and we'll continue to watch, not only with Ensign but just in the field space generally.

Operator

Our next question comes from the line of John Kim with BMO Capital Markets, please go ahead.

John Kim

I had a question on senior living, so you said the EBITDARM coverage declined to 1.16 and you said in the past that the EBITDAR coverage would probably about 10 to 20 basis points lower than that. So given that they're probably barely covering rents with cash flow how sustainable is this before you need to address it?

Kevin Pascoe

Hi John, this is Kevin I just want to be clear. Are you talking about senior living communities?

John Kim

Yes.

Kevin Pascoe

Yes. So, as we have discussed on the prior calls is, some a little bit of seasonality with entry fees and they're lumpy if you will. So there's been a little bit of that, they had a huge sales month last year which kind of rolled out of the trend. And then they're having more consistent entry fee volume this year. So you’re seeing a little bit of an aberration on large sum rolling out and more consistent sums rolling in. What I can tell you is that the second quarter was really strong, third quarter is shaping up really nice and we're happy with the relationship there, and they continue to develop on the campuses that they have those units are selling through and we’re seeing again very good interesting volumes and a little bit more consistent so far, it is not that I can sit here and say they can -- it will continue to be consistent, because we know the nature of them is lumpy, but they’re covering the lease payment and there is no, we’re very happy with the position they are in.

John Kim

Okay. And then look at your total portfolio coverage, it’s 1.92. How important is it to maintain a high one coverage or maybe above two times coverage. Given you made comments about having more predictable cash flows going forward?

Eric Mendelsohn

Well, I would say that it’s, we find a lot of comfort in the coverage that we have within portfolio. I think it’s very strong, very happy with the relations we have and the coverages they have. So it’s clearly a focus for us and something that we’re mindful of the underlying coverages in the portfolio. So I would say that it is to be above two is not a number that is, if it goes below that is anyway detrimental that still very strong coverage and something that we’re very pleased to have.

John Kim

Okay. Question on the Bickford transaction, can you just discuss the price paid for the management platform and how you determined that price?

Eric Mendelsohn

For OpCo?

John Kim

Yes for OpCo, EBITDA multiple, I mean we could probably back into it. But I’m just trying to figure out from how side. How you kind of valued it?

Eric Mendelsohn

Yes. What we looked at was a valuation on the enterprise. And then kind of backed into a property multiple based on the rent we have in place and the remainder fell to the operating company maybe and there is negotiation involved with our partner there. But that’s kind of the general way that we approach this.

John Kim

And what does that translate into as far as like EBITDA multiple?

Eric Mendelsohn

We haven’t disclosed the multiple.

John Kim

Would it be…

Eric Mendelsohn

Bigger than a bread box.

John Kim

Would it be similar to the cap rate obtained from the assets or a lower multiple, I would imagine?

Eric Mendelsohn

The -- well I guess what I want to make sure, we don’t do is mix up cap and multiple, but if you are just talking multiples, the multiple for the operating company would be a higher multiple than the property.

John Kim

Okay. I would have thought it would’ve been lower.

Eric Mendelsohn

Well yes you’re right. Now I’m the one who switched up, the cap rate in the multiple, but yes. The multiple for the property would be higher than the multiple for the OpCo.

John Kim

Yes.

Eric Mendelsohn

The cap rate for the OpCo would be higher than the cap rate for the property.

Kevin Pascoe

And John one of the peculiarities of that valuation is that OpCo for the past several years has had losses by design, because we’ve cloud all the profits back into new developments which are bearing fruit now. So there was some degree of modeling and some degree of backing out those losses in order to arrive at a valuation. So if you were to drill down into that it would probably be a head scratcher but that was our approach.

John Kim

Okay. And then finally on your tenant purchase options have now increased to 12.9% of your annualized rent and I know this is exercisable over many years, but can you just remind us how you determined the price pay paid by the operator when they exercised the option?

Eric Mendelsohn

Well, usually the purchase option is embedded in the lease and they come in all shapes and sizes. So for example, our Brookdale's purchase option that they have on their properties is different than the Legend purchase option which we dealt with earlier in the year which is different than NHC purchase option which is years in the future. So, I wouldn't say you would have to review each of the leases which some of them are publicly filed and others are not, but they are all different. I can tell you based on my experience with Emeritus where we were exercising purchase options with landlords that typically there is a fair market value criteria that is paid for the lease basis based on the original purchase price of the lease plus the rent pumps and that's usually your baseline and then there might be some sort of profit sharing if there is a large difference between that basis and fair market value and whether or not that profit sharing occurs and at what split is subject to negotiation. And I can tell you further that there is a big difference in leverage of that negotiation when an operator brings the buildings to a REIT or vice versa. So those are the type of factors that affect purchase options.

Roger Hopkins

And this is Roger I will just add that aside from these fair market value purchase options where there may be a split of the upside between the tenant and NHI there are the fixed price purchase options that he also referred to and so we have a few of those. So, altogether we don't have that my options, but generally those two models would be the dominant type.

John Kim

So the market based options is that taking into account where interest rates and cap rates are at that time if cap rates compress 200 basis points five years from now is it taking into that account or is it based on what you said more about the income?

Roger Hopkins

Well, it's going to be based up on the fair market value at that time and there is generally a process which could involve multiple independent valuations if there is a disagreement on value, but that would take into account all the factors at that time. And so in our schedule which we provide in the supplemental data report those first option windows don’t open for several years to come and it's a very low percentage of our revenue.

John Kim

And so what's the difference between the market-based options and the fixed price options? I mean [Multiple Speakers] as far as the percentage of the total purchase options?

Roger Hopkins

We don't break that down and I wish I could remember. Eric mentioned NHC we do have a portfolio of seven buildings in the northeast, where there is a fixed price option on those. And I believe the small portfolio that we have formerly with Emeritus now with Brookdale had a fixed price on that.

Eric Mendelsohn

Ironically, John, I negotiated that purchase option when I was at Emeritus. So, now, I'm on the other side of my own purchase option.

John Kim

Were you negotiator?

Eric Mendelsohn

Yes.

Operator

Our next question comes from the line of Todd Stender with Wells Fargo. Please go ahead.

Todd Stender

Thanks guys. Just as a reminder, did the original Bickford RIDEA structure have an out like this where it could be converted to triple net lease by either party?

Kevin Pascoe

Hey Todd, this is Kevin. No, it did not. There wasn't any indeed or any kind of option like that, this is just a negotiation between the partners.

Todd Stender

And is that something you'll probably look at going forward if you do consider RIDEA, maybe have something of clause that could be converted by either party?

Kevin Pascoe

I would just say that it’s too soon to tell. As Eric mentioned, we haven't written off any structure going forward. So, it'll just be taken on a case by case basis and see what the merits are of that opportunity at that time.

Todd Stender

Sure. And then, just looking at the broad picture, just want to get a sense, are there broader implications for the Company, if we layer in the balance sheet. You know went from zero debt to call it moderate debt. Is the board looking at everything now; are they considering little more derisking now that you have the high risk portfolio of balance sheet but is there more implications just beyond this Bickford change that we can see?

Eric Mendelsohn

No, I wouldn't read too much into this. This is -- one deal does not a new direction make. And I would just say that this is some internal housekeeping that probably makes a lot of people’s lives easier; I'm looking at Roger, because the RIDEA was getting to the point where we would need to make a decision about consolidating it on our books. So, there were some selfish workload considerations in the background as well. So, we're still open to RIDEA under the right circumstances.

Roger Hopkins

Todd, this is Roger. You've been following us for many years, and it's interesting that we started this relationship with Bickford with the purchase of five buildings. And now, we have 32 in the RIDEA; we have five that we bought recently, outside the RIDEA, five under development. So, it's been a tremendous relationship that we've had over the past five or six years, and it’s just grown and grown. And we have the mechanism now to continue that growth through the structure of construction loans and purchase options and resets of rents. And so, it’s just perfecting what we’ve been doing over the past five or six years in this relationship. And as Eric said in his press release yesterday, the close relationship here cannot be overstated. It’s really been a great vehicle and a great relationship.

Todd Stender

Thanks Roger. Can I stick with you? When we see that Ensign write-off of around 15 million but the bulk of which is non-cash; what is the cash portion, how much cash is being written off?

Roger Hopkins

It was all non-cash. And we have allocated with our specialists, not just internally but using outside valuation experts, there have been a value of $6.4 million assigned to their purchase option, which went away. You recall that we bought eight buildings from them in April. The purchase options went away; in May, we transitioned those leases to Ensign. So, in the same quarter, we were writing off that allocation of $6.4 million and a straight line rent receivable. And so both of those were required by GAAP. So, we showed those on the P&L and obviously normalized those in our non-GAAP metrics.

Todd Stender

That’s very helpful. And just finally, I don’t know, if I missed this. Did you guys give an update on holiday, any coverage occupancy or any current feelings about the independent letting portfolio?

Kevin Pascoe

Hey, Todd, this is Kevin. We discussed it briefly. We mentioned that the occupancy for the quarter improved and that the coverage on the portfolio is steady.

Operator

We do have a follow-up question from the line of Juan Sanabria with Bank of America Merrill Lynch. Please go ahead.

Juan Sanabria

Hi guys. Just a quick follow-up question. When you guys talk about the deal being accretive, is that on an FFO basis or on a FAD or free cash flow or after CapEx and after straight line basis where -- I’m just wondering, if there is any -- if the deal is just accretive because of some straight-line renting of the rents now with Bickford?

Roger Hopkins

No. When I point to the cash distribution -- this is Roger. When I point to the cash distributions that our partner Bickford was entitled to, I would have you to think more in terms of AFFO and FAD. There was a straight-line component to their lease, which impacts FFO, but that’s really not our focal point; it’s more on AFFO and FAD. And we’ll give more details certainly when we provide the pro forma as this transaction had occurred January 1 of 2015, because we show obviously comparative financial statements in our 10-Qs. And you’ll be able to see what that pro forma accretion would have been. Again, we don’t make predictions of the future. And it’s a little bit more difficult than if we were just entering a new lease and we could look at the spread over cost of capital to pay for it and we could be more precise about accretion. It’s not quite that simple. But, we’re trying to provide all the information and tools that we can to project it for ourselves and that you can do it as well in your model. And we will do that later.

Juan Sanabria

And just a follow-up question on how you valued the PropCo. If you take the $25 million and the 15%, it implies $167 million for the entire asset base, but you're generating rents of $25 million. It seems like the cap rate is double, 15% of what a normal market transaction is. And so, I am just confused as to how you're saying that's a market cap rate or market value?

Kevin Pascoe

Juan, this is Kevin. What I would direct you to there is we have debt on the portfolio, both NHI allocated debt and agency debt. So, that $25 million represents their equity in the PropCo.

Juan Sanabria

How much debt is there?

Roger Hopkins

We haven't disclosed that.

Eric Mendelsohn

We don't disclose PropCo on individual basis in any of our filings. So, we have…

Juan Sanabria

On the call.

Eric Mendelsohn

No. But in our models, we value the entire RIDEA and then we have debt to HUD, Fannie; PropCo has intercompany debt with NHI Corporate. And so, Kevin said it exactly right that their equity, their pro rata equity we believe currently would be valued at around $25 million.

Operator

There are no further questions registered.

Eric Mendelsohn

Thank you everyone. And we’ll look forward to seeing you at the various conferences we all meet at, and on the next conference call.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participant and I ask that you please disconnect your lines.

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