CareTrust REIT's (CTRE) CEO Gregory Stapley on Q2 2016 Results - Earnings Call Transcript

| About: CareTrust REIT (CTRE)

CareTrust REIT (NASDAQ:CTRE)

Q2 2016 Earnings Conference Call

August 09, 2016, 1:00 PM ET

Executives

Gregory Stapley – President and Chief Executive Officer

William Wagner – Chief Financial Officer

David Sedgwick – Vice President, Operations

Mark Lamb – Director, Investments

Analysts

Jeff Gaston – KeyBanc Capital Markets, Inc

Seth Canetto – Stifel Financial Corp.

Jonathan Hughes – Raymond James

George Clark – RBC Capital Markets

Duncan Brown – Fargo Securities

Paul Morgan – Canaccord Genuity

Operator

Welcome to CareTrust REIT’s Second Quarter 2016 Earnings Call. Listeners are advised that any forward-looking statements made on today’s call are based on management’s current expectations, assumptions and beliefs about CareTrust’s business and the environment in which it operates. These statements may include projections regarding future financial performance, dividends, acquisitions, investments, returns, financings and any other matters, all of which are subject to risks and uncertainties that could cause actual results to materially differ from those expressed or implied here. Listeners should not place undue reliance on forward-looking statements and are encouraged to review the company’s SEC filings for a more complete discussion of factors that could impact results as well as any financial or other statistical information required by SEC Regulation G.

In addition, CareTrust supplements its GAAP reporting with non-GAAP metrics, such as EBITDA, adjusted EBITDA, FFO, normalized FFO, FAD and normalized FAD. When viewed together with its GAAP results, the company believes that these measures can provide a more complete understanding of its business, but they should not be relied upon to the exclusion of GAAP reports. Except as required by federal securities laws, CareTrust and its affiliates do not undertake to publicly update or revise any forward-looking statements where changes arise as a result of new information, future events, change in circumstances or for any other reason. Listeners are advised that the company filed its 10-Q and accompanying press release yesterday. Both can be accessed on the Investor Relation section of CareTrust’s website at www.caretrustreit.com. A replay of this call will also be available on the website.

At this time, I would like to turn the call over to Mr. Greg Stapley, CareTrust’s Chairman and CEO.

Gregory Stapley

Thanks, Ashley and thanks everyone for being on the call today. Good morning. With me are Bill Wagner, our Chief Financial Officer; Dave Sedgwick, our Vice President of Operations, who joins us by phone from our East Coast office; and Mark Lamb, our Director of Investments. During the second quarter and since we continued our steady march towards the achievement of our long-term goals for CareTrust, as promised, we put all the funds raised in our $100 million follow-on that came at the end of March to work closing $82 million of the $97 million in acquisitions we had under contract at that time and adding more. Since April 01, we’ve deployed over $120 million, split about 58%-42% about seniors housing and skilled nursing assets all with the blended going yield of 9.1%.

We also expanded our tenant portfolio of 15 distinct operators and on acquisitions with two of them that strengthened our master leases with those tenants. And even with the $120 million of capital deployment, together with the [indiscernible] offering, we’ve reduced and held our current leverage from 5.7 times in February to just over 5 times on a debt-to-EBITDA basis and are up 36% on a debt-to-enterprise value basis now which is well within our target ranges of 4.5 times to 5.5 times and 30% to 40% respectively. This growth has further reduced our tenant concentration with Ensign, our former partners in Blue Chip principle tenant, from virtually 100% two years ago to about 56% of run rate revenue today. We remain very positive on their capabilities, commitment and quality.

You may have noticed that they reported last week that a few of their newest acquisitions are proving to be more challenging than expected. We’ve seen them overcome similar challenges in the past. They know exactly what to do and they appear to be doing it with a sense of urgency that’s always been the hallmark of their high accountability, culture and operating model. Most importantly for our investors, we don’t expect to see any material weakness in their most mature facilities which are the ones in our portfolio. In fact, their preliminary report to us on their Q2 performance indicates the coverage for Ensign portfolio has actually grown from 2.05 at year-end to 2.07 at 3.31 and now at 2.11 at June 30th.

With the acquisitions last quarter and since, we’ve now crossed the $100 million milestone in run rate revenue. And the acquisition pipeline which as we predicted went a little soft in Q1 and early Q2 has come surging back. We’re seeing a good combination of both portfolios and one-offs so we believe it can help us beat last year’s capital employment mark of $233 million. We are committed to doing that as long as we can do it with great operators and good markets with yields that gives us superior spread over our weighted average cost of capital. This discipline has served us well to-date and we remain committed in building a diversified and well covered portfolio that will produce solid returns through both good times and bad.

This discipline has also allowed us to increase our guidance. Mark, Bill and Dave will fill in more details on all of this momentarily, so I’ll just conclude by telling you that we’re excited about our growth and our progress to-date and we are more optimistic than ever about CareTrust’s future. Dave will first briefly address our new operator relationships as well as some broader industry dynamics and opportunities; then Mark will provide some details on our growth and pipeline; and Bill will conclude with the financials. Dave?

David Sedgwick

Thanks, Greg. Our Q2 deals continue to build on the same foundation and strategy we followed since our start, making smart investments in quality asset with exceptional operators at above average yields. The analytical process obviously goes into great detail but our underwriting discipline always begins and ends with choosing the right operator. In Q2, we welcomed two new operators to the CareTrust portfolio; Premier Senior Living and Cascadia Healthcare. We look forward to growing with both of these groups. Premier has senior housing operations in five states and their CEO, Wayne Kaplan has been a pioneer in assisted living. Cascadia Healthcare is an Idaho based up and coming skilled nursing company that we know very well. Owen Hammond and his partners are fellow Ensign Group alumni.

They’ve got the combination of talent, mission and sophistication we look for in new operating companies. That’s a combination that is more important now than ever in the always dynamic skilled nursing environment. Speaking of the environment, some outside observers see skilled nursing’s ever evolving reimbursement models as a significant headwind, we don’t. Remember, it’s not long ago that we were operators ourselves. And like the exceptional operators in our portfolio, we see the expansion of managed care, bundled payments and other value based payment systems as positive opportunities to gain market share and distinguish the great providers from the rest. It’s an attempt to [indiscernible] that’s long overdue and it will benefit better providers.

Remember also that our primary reason for CMS’s efforts to improve efficiencies in post-acute care is to mitigate an expected significant increase of older patients on the healthcare system in the near future. So while overall length of stay may drop, patient volumes will eventually rise. We believe that the best operators will capture a disproportionate share of the volume, both now and in the increasingly merit based future. Fortunately for skilled nursing operators, CMS gives the industry plenty of time to prepare for such changes. For example, CMS recently announced the CJR the lower extremity drug replacement pilot program that went into effect in limited markets in April, will expand next year to include femoral and hip fractures. They also announced a new pilot program for cardiac rehab patients to be at next summer. The markets selected for the program expansion haven’t been announced yet, but this is more than enough time for good operators to get ready.

Our operators are prepared for these changes and more. As our tenants strengthen their clinical programming, little down their length of stay, reduce the readmission rates and communicate better up and down the care spectrum, they are gaining market share and seeing overall performance improve. And please note, at the same time that CMS is expanding the value based payment pilots, they’ve also announced 2.4% increase to the Medicare rates for the fiscal year 2017, one of the healthiest increases we’ve seen in years and this also pertains[ph] good banks for good operators. So to conclude, we’re in regular communication with our tenants about what we and they are seeing on the ground and their local markets. And even though we happen to do more in the seniors housing side lately, we remain bullish on skilled nursing. Our plan is to continue taking advantage of our size and operating experience to invest in best in class operators in both asset classes who are equipped and thrive for years to come. Mark will now give some color on our pipeline.

Mark Lamb

Thanks, Dave, and hello, everyone. After $69 million first quarter that produced several new quality tenant relationships, we followed with $77 million in the second quarter that grew both the portfolio and the tenant roster even further. And we have already added another $43 million in Q3 all at a blended going in yield including transaction costs of 9.1%. As Greg mentioned, 58% of the new rental revenue from these investments will come from senior housing assets with the balance from new skilled nursing investments. You’ll recall that we raised just over $100 million in a well received equity follow-on right at the end of Q1. We have now put all those funds in mortar work even though one of the investments we had preannounced at that time $50 million single asset deal that was part of the $97 million contract did not pan out. We like the asset and the operator but ultimately chose not to pursue it due to concerns [indiscernible] in our property and tenant level due diligence.

A reflection of the discipline, Greg just mentioned. Nevertheless, we’ve replaced that deal with several others and our growth trajectory continues unabated. For example, in the quarter we did tack-on deals for a couple of existing tenants, a two building acquisition in Cincinnati for our operator Pristine Senior Living and the sale leaseback with existing tenant Twenty/20 management after it stabilized its Bedford Virginia which it acquired a while back from the non-profit. We then entered two new states, North Carolina and Michigan picking up a total of six senior housing properties with Premier Senior Living as Dave just mentioned. Finally, as Dave also mentioned, we picked up a SNF Boise and leased it to Cascadia and since we have done another deal with them, just after quarter end.

As for the pipeline, it continues to fill, please remember when we quote our pipe we only quote deals that we are actively pursuing, which meet our superior yield and coverage underwriting standards that you are accustom to seeing from us. And then only if we have reasonable level of confidence, so we can lock them up and close them. We normally have around $100 million under serious consideration at any time, as we sit here today, that number is about 20% higher.

Like our recent acquisitions, the pipe includes a healthy mix of both senior housing and SNF assets. While pricing remains aggressive for both skilled nursing and senior housing, we continue to find one-off and small to mid-sized opportunities that fit our underwriting criteria, including a higher investment hurdles we pushed throughout the end of 2015. In addition, we know that some of the large skilled nursing and senior housing operators are churning their portfolios and we believe, there may be a few hidden gems in those dispositions that are better suited for best-in-class local and regional operators that we like to work with.

So as Greg said, we continue to be optimistic about our chances of closing few more transactions by year-end and we’re starting to load the fight for early 2017. For the record, as we speak to you today, CareTrust has 149 properties in 20 states and we are actively working with brokers, sellers and operators to source additional opportunities for growth nationwide.

And with that, I’ll hand it to Bill.

William Wagner

Thanks, Mark. For the quarter we are pleased to report that normalized FFO grew by 95% over the prior year quarter to $15.5 million and normalized FAD grew by 88% to $16.5 million. Normalized FFO per share grew by 6.6% over the prior year quarter to $0.27; normalized FAD per share grew by 2.5% to $0.29. Given our most recent dividend of $0.17 per share, this equates to a payout ratio of 63% on FFO and 59% on FAD, which again represents one of the best covered dividends in the healthcare REIT sector. In yesterday’s press release, we increase our 2016 guidance. As you’ll recall, our last quarter’s guidance included the March equity offering and the projected $97 million of investments then under contract. We ended up closing on $82 million of these investments, we terminated one $15 million deal on diligence and we’ve added another $43 million since quarter end, all as Mark previously discussed. We are now projecting normalized FFO per share for 2016 to be between $1.08 and $1.10 and normalized FAD per share to be between $1.15 and $1.17.

This guidance includes all investments made to-date, including the ones closed after quarter-end and relies on the following assumptions; one, no additional investments nor any further debt or equity issuances this year. Our outstanding balance on a revolving line today is $103 million. Two, no rent escalations for any of the leases that would normally adjust in the last half of the year; previously we did not include the bump in Ensign’s rent but on June 01, the rent increased on an annualized basis from $56 million to $56.5 million.

And our total rental revenues for the year are now projected at approximately $92.2 million. Three, improved performance at our three operated independent living facilities which are now projected to do $300,000 in NOI this year. Four, recognition of interest income of approximately $600,000, down from $900,000 in 2015 because of the accounting rules limit the amount that we can recognize on one of our preferred equity investments which capped out in the second quarter. We recently closed on a new $2.2 million preferred equity investment which would bring in about $100,000 in the backhalf of the year.

Five, interest expense of approximately $23.8 million which includes the $326,000 write-off of deferred financing fees associated with the pay-off of the GE debt last February. In our calculations, we have assumed a LIBOR rate of 1%. That, plus the current grid based LIBOR margin rate of 185 bps on the revolver and 205 bps on the seven year term loan make up the floating rates on our revolver and term loan. Interest expense also includes roughly $2.3 million of amortization of deferred financing fees. And six lastly, G&A continues to be projected at between $9 million and $10 million which equates to just under 10% of total revenues. G&A also includes roughly $1.6 million of amortization of stock comp. These amounts do include costs associated with our 404 implementation as we did trip the market value test at quarter end and we will need to comply with 404 this year.

As for our credit stats, on a run rate basis as of today following our Q3 acquisitions, our debt to EBITDA is approximately 5.1 times, leverage is about 36% of enterprise value, and our fixed charge coverage ratio is about 4.1 times. We also have $5 million of cash on hand. Lastly, and as Greg mentioned earlier, in addition to the ratings upgrades we got from S&P in March, during the quarter, we also got the anticipated uprates on both our corporate and bond ratings from Moody’s which obviously helps lower our cost to capital over time.

And with that, I’ll turn it back to Greg.

Gregory Stapley

Thanks, Bill. We hope this discussion has been helpful for all of you. We’re grateful for your continued interest and support. And we would be happy to answer any questions you might have. Ashley?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. Our first question comes from Jordan Sadler of KeyBanc Capital Markets. Your line is open.

Jeff Gaston

Hi guys. This is Jeff Gaston on for Jordan. How are you doing today?

Gregory Stapley

Hey, Jeff.

Jeff Gaston

Hi. My first question is regarding the SNF transaction market, on the Ensign call, their management team was talking about how pricing is getting aggressive and they have had to pull back a little bit, and you mentioned in your prepared remarks that you’re seeing some aggressive pricing as well. Can you give a little more color around that and sort of where you see opportunities?

Mark Lamb

Sure. This is Mark. We’re seeing – it’s really kind of a mix bag, if you look at geographically, that’s probably the best way to look at it. Florida, California, Mid-Atlantic, Northeast, Northwest are really very, very kind of aggressive. You’ll find – states kind of higher barrier to entry markets there. So, kind of on a portfolio basis, we’re seeing some stuff and typically it’s going to trade at a premium, but there are small kind of one-off and single asset sales that are still out there that can be found, it’s just a matter of going out and finding them and figuring out as they hit our underwriting and pricing metric. So overall, there is a decent amount on the market and it is fairly aggressively priced, but there are some gems in there that we have found and think that we will be able to continue to find going forward.

Jeff Gaston

Okay. You said, I think you mentioned that your pipeline is about $120 million, and then it’s a healthy mix. Could you sort of give any more color on the mix, I mean is it 50-50 with a little more towards SNFs or senior housing?

Mark Lamb

Yeah, it’s probably slanted a little more, call it 60-40 SNF to senior housing. Obviously this is a little bit of a moving target since we quote transactions that are far enough or long that we feel very comfortable and this can change at any time. We even in the past have seen transactions, buildings or deals that we’ve bid on and may be have washed initially that have come back around. So it’s a little bit of a moving target and this is kind of where the snapshot is today.

Jeff Gaston

Okay. Thanks. And then I guess one last quick question, year-to-date I think your deals have closed around 9-9.1% initial cash yield. Are you, I guess in the context of aggressive pricing, are you seeing deals sort of in that range now or are you anticipating that comes down a bit? Any color you could provide around that would be helpful.

Gregory Stapley

Jeff, this is Greg. We’re still seeing deals that are up in that range and as we mentioned in our last call, at the end of the year, we pushed our underwriting standards up a little higher than they have been last year and so, that’s really what we are looking out. The 9.1 year scene is probably mostly a reflection of the fact that we’ve got a larger mix of seniors housing in the portfolio latterly than skilled nursing, and I think last year we were closer to 9.3%. But no, to answer your question, we’re finding plenty of stuff that’s worth looking at and that we think we can close. Interestingly, while some of the pricing is aggressive, it seems like there’s a lot of sellers out there who’s just on fishing expeditions who are throwing out big numbers, see what sticks and we just stick to our discipline. And in some cases, it goes to somebody else, and that’s okay and in some cases, it goes to nobody, they just decide to keep them and in other cases, they come down to our price and we’ve seen some of that come down to our price to our benefit and we expect that to continue.

Jeff Gaston

Awesome. Thanks a lot. That’s all I had this afternoon.

Operator

Thank you. Our next question comes from Chad Vanacore of Stifel. Your line is open.

Seth Canetto

Hey this is Seth Canetto on for Chad. How are you guys?

Gregory Stapley

Good.

Seth Canetto

First question, I just wanted to get some more color on your larger deals at the end of ‘15 beginning at ‘16 specifically Pristine and Trillium in Ohio and Iowa. Are those guys performing as expected, can you give some additional color there?

David Sedgwick

Yeah, this is Dave, and actually just touch base with Rich Mason at Trillium yesterday, and just high level feedback from him was very, very positive. Their census in Q2 and revenue in Q2 was higher than they were anticipating, it’s one of the best Q2s they’ve experienced since been an operating company. And so, we’re really happy with how that’s going and then in Pristine, we did the two add-ons in the Cincinnati area and those are also on track. They are going to do quite a bit of CapEx renovation work in those two buildings which was always part of the plan when we acquired those and that’s what they’re preparing for…

Seth Canetto

Okay, great. And then just thinking about how you guys look at your relationships with operators, it seems like you have a good mix but would you rather grow and expand existing relationships or are you still trying to continue building new ones or how do you guys really view that?

Gregory Stapley

This – go ahead, Dave.

David Sedgwick

Oh sorry, Greg. Yeah, we’re looking to do both, this is Dave. We’re still young and small enough to be on the lookout for more great operators in some of the markets where we haven’t grown yet. Luckily some of our operators are enthusiastic about going into new states, but depending on the deal, it might make more sense to enter a new state with an operator who’s already there. In some cases, it doesn’t --it’s not that big of a deal if the deal has enough scale where you’re basically acquiring the infrastructure. But yeah, we’re really looking for both, we’ve experienced both. We just added two new operators in Q2 and we’ve also grown with existing operators in Q2 and we expect that to continue to be the case for the foreseeable future.

Seth Canetto

Alright. Great. And then, when you guys mentioned, I think you ratcheted up your underwriting criteria little bit and in particular that one deal that you guys terminated. I guess could you provide any color on what you saw when you did your due diligence that made you want to not complete that deal?

Gregory Stapley

This is Greg. I think we can’t, even though I shouldn’t say, it really wasn’t about the dollars and cents. It came down to totality of everything, the asset itself needed a little more CapEx than we had anticipated, the operators, we actually looked at two different operators but that one very, very closely and actually worked very hard to pull them both in, we liked them both. But we did not like their corporate structures or the security that we were going to get for that deal. And so ultimately, we just decided to move on to greener pastures.

Seth Canetto

Alright, great. Then just one last question, this is just for my clarification on the Ensign portfolio coverage, you guys said there is no impact by the weak Q2 because you guys own their mature assets and they were just having trouble with their new ones, correct?

Gregory Stapley

I mean when they had their – on their earnings call, you can go back and listen to it, they indicated that the new acquisitions of which they’ve done a very substantial number, more than ever in their history, have been a distraction across the whole organization. So we heard that we were initially a little bit worried that may be ours have been impacted, so we went and asked them, show us where you are and we usually get their coverage numbers on a quarter lag, so we would normally be reporting just Q1 which had gone from 2.05 at the end of the year to 2.07. But we asked them for Q2 and they were able to generate it and it’s actually gone up to 2.11 now, which is a pretty solid jump for that portfolio. So even though they may be reporting that there was some distraction and impact beyond the new acquisitions that they are working very diligently on, we not only didn’t see it but we saw good performance in the facilities in our portfolio.

Seth Canetto

Alright. Great. That’s it for me. Thanks a lot.

Gregory Stapley

You bet.

Operator

Thank you. Our next question comes from Jonathan Hughes of Raymond James. Your line is open.

Jonathan Hughes

Hey good afternoon guys, actually it’s good morning on the West Coast. Question for Greg or Mark, you mentioned you’re on track your path last year’s $233 million of acquisitions. How should we think about that as we head into 2017? You said the pipeline is about $120 million, so should we be modeling some monthly dollar amount of acquisitions or say 10% growth in assets each year, just trying to get some more color there.

Gregory Stapley

Well Jonathan, it’s Greg and it’s so hard to answer to that question because the acquisition pipe is so lumpy. We do have a good solid $120 million worth – we’re working on, as we see here at the beginning of August, it’s really hard to tell on some of the larger deals, how soon they can close. Small deals we can close a little bit faster as a rule, I think we’ll make the 233, I can’t guarantee it and we could blow right by it if one of the larger deals that we’re working on closes. But there’s no way to tell you exactly how much to model through the rest of this year or for the beginning of next year because we don’t know what will fall and we can’t predict when it will fall. But we have been pretty steady and we’re optimistic that we’ll get those done and we’ll do it at the right time whenever that is for the deal.

Jonathan Hughes

Okay. Of the $120 million currently in the pipeline, I mean most of those are small deals or is there may be a portfolio deal closing that you felt comfortable including in there?

Gregory Stapley

There’s a big deal in there and we’re not close to closing it, we’re still – we’ve got proposals out, we’re in second round on a big deal that we feel - that we’re optimistic about and we’ll just see how that goes. There’s other stuff that could come in behind it as well that we’re closely tracking. So, it’s very fluid at this point and if it makes sense, we’ll do them. We’ve got plenty of access to capital, the team is rested and ready and there’s no reason why we can’t knock these down if the sellers are willing to do their part.

Jonathan Hughes

Okay. And then last quarter you gave some leverage guidelines but could you may be talk a little bit more about the types of debt financing you’re looking at whether it’s unsecured private notes, more bank debt or term loans. Obviously the term loan issuance was a pretty attractive price but also any color where you think you can price those deadest[ph] instruments in the current environment would be helpful.

William Wagner

Sure. Hi, Jonathan, it’s Bill. I think you will continue to see us utilize the line, the line is we have 400 million that we can take it up to. We also just in the Q2 closed on doing, we have the ability to issue under an ATM program now. We didn’t issue any in the second quarter but that on the small single – call it single and double type investments that we’re targeting, a mixture of the line as well as the ATM would be a good way for us to finance it and keep our leverage stats where we’d like them to be.

Jonathan Hughes

Okay. And as far as those one-off acquisitions, I mean would you target say 30-70 debt equity, use of line versus the ATM?

William Wagner

Yeah, I think those are pretty good right now, 70 equity, 30 debt.

Jonathan Hughes

Okay. And then just one more, looking at the sensitivity of your skilled nursing operators to Medicare, have you guys looked at this and kind of stress tested the portfolio. I know Ensign’s about 30% Medicare, for that whole company but what about the rest of the portfolio in terms of exposure to Medicare?

Mark Lamb

This is Mark. What I would tell you is the acquisitions that we did post-spin, most of those SNFs were largely Medicaid. And so the exposure to Medicare is going to be fairly limited, there are may be one or two that had a little higher of a quality mix census, but for the most part, almost every single acquisition target was 80 plus percent Medicaid. So, they’re in the process of building their Medicare census has not seen a decrease of it.

Gregory Stapley

I’ll just add to this, we had -- you probably heard the announcement yesterday that we -- four building portfolio in California Central Valley tenanted by a company called Covenant Care in Orange County. We know those guys fairly well, we spent about an hour on the phone with him yesterday and they report that while their length of stay has been steadily dropping through the latest changes in the reimbursement systems, their number of admissions and discharges has increased significantly and their Medicare days have stayed about the same. And we think that’s what are going to see with the more sophisticated, better quality operators. We’ve certainly have already seen it with Ensign, we’ll see now with Covenant Care about 50 building operator and to the extent we have more Medicare in the portfolio, we have sophisticated operators who know what they are doing and who will reach out and try and capture market share that way. So we’re not doing hard core analysis around it, but we are asking the questions and we are getting the answers and they are telling us that they are doing fine.

David Sedgwick

There’s really two things Jonathan, just to add that, this is David sort of mitigate the risk that – payments and those types of programs present one is the whole reason these are being introduced, which is the demographics that and narrowing of networks that those programs produced will continue to do what we’ve already seen at the Ensign Group which is will drive more market share to the better providers. So, we feel pretty good about where the Medicare census overall is headed. We’ve seen projections that show that in spite even with the EPCI initiative factored in that because of growing Medicare enrolment that the Medicare SNF days will continue to grow.

Gregory Stapley

And we’re filtering for those that sophistication, those capabilities as we look at an initiate new skilled nursing provider relationships.

David Sedgwick

And just to beat the dead horse, a part of our portfolio also is in rural markets where bundle payment initiatives are not a factor where CJR is not in play, where the cardiac rehab stuff will probably not take shape anytime soon. And so, that also gives those guys extra time to get read.

Jonathan Hughes

Thanks for all the color guys. That’s it for me. Appreciate it.

Gregory Stapley

Thank you.

Operator

Thank you. Our next question comes from Michael Carroll of RBC Capital Markets. Your line is open.

George Clark

Hey guys. This is actually George Clark on for Mike. Given that you acquire more senior housing assets than SNFs this quarter, are you kind of switching your focus more to senior housing or whether you just get opportunities that you guys take advantage of?

Gregory Stapley

Yeah, George thanks for being on. This is Greg. No, we are not switching our focus. We remain as ever as a classic agnostic and continue to go where we can find the best suggested returns. It just happens that this quarter, we found a fair amount of seniors housing that we really liked, it’s mid-market sort of blue collar stuff that we think has good long expected life and that’s what we did. Next quarter, that could be flipped and we could do largely skilled nursing and in fact, Q3 deals have already included a fair amount of that. So no change in focus or orientation.

George Clark

So you expect to kind of do the 60-40 split going forward just kind of – the pipeline?

Gregory Stapley

We’re just going to take it as it comes and we understand that there are some folks that would very much like to see us diversify that portfolio down and away from skilled nursing to some degree. But remember, we were nursing operators for many, many years and we feel very, very comfortable in that arena and feel like we can do a very good job of vetting skilled nursing operators, keeping up with changes in skilled nursing environment as we discussed today and making sure that the investments that we do, are good solid sound investments that will pay the rent.

George Clark

Alright. And then could you just provide an update of the coverage in your portfolio, just typically of Liberty and may be provide some color on the Covenant coverage ratios?

Gregory Stapley

I’ll just tell you that Liberty in particular, we closed on October 1 and we did so with full expectation that that portfolio’s coverage would dip as our operator Pristine takes that portfolio from what it was basically pure Medicaid shop that were heavily reliant on the Medicaid skilled work and making it a more modern high acuity Medicare HMO private focused mode. They are doing that very well but in order to do that, they have to ramp up staffing, they have to implement new systems, they have to invest in electronic medical records. And in doing all that so they have – in terms of their coverage covenant, they basically have a past for the first year. I talked to Chris Cook a great length on Friday and we’ve discussed among other things his coverage. He’s still well, well above 1.0, I think he’s above 1.1, but he’s actually doing everything that he promised to do and we expect him to do and he needs to do in order to set that portfolio well for good solid long-term success. The rest of our operators I mean you look at the Covenant Care assets four assets we just bought on Friday, the going in coverage on those was roughly 1.85, but we bought leases into place and those are going to be very, very solid for us and of course the Ensign coverage continues to decline. So, we’re pretty happy with where the coverages are. We expect to give you more color on those coverages on a regular basis as we start to publish supplementals in connection with our quarterly releases. We did a dry run this quarter in putting one together just to make sure we had all the bugs worked out and can produce these consistently and deliver a useful and user-friendly product and we feel very good that we expect to be able to start issuing supplementals in the quarter to have all that kind of data in. When we do, so you know, when we report coverages, we for the first year after an acquisition because some of the acquisitions we do it with tenant and we do expect them to change certain things in the acquisitions even though they are stabilized. We expect to just report the going in pro forma coverage for the first year until they start producing their own – until the new tenants start producing their own results. So, we’ll explain all that when the time comes but in the meantime, everybody’s rents coming in without any problem.

George Clark

Alright. Thanks guys.

Gregory Stapley

You bet.

Operator

[Operator Instructions]. Our next question comes from Duncan Brown of Wells Fargo Securities. Your line is open.

Duncan Brown

Hey guys. Question on something I wanted to talk about the rural portfolio, I wondered, Dave was talking about can you give us what percentage of your portfolio you would sort of describe as more of a rural than urban

Gregory Stapley

We would probably have to get back to you on that Duncan and we have to make some judgment calls in that. Nothing’s really completely out on the sticks, but there are some smaller markets particularly like the Iowa portion of the portfolio, but we’ve never actually broken that down and said this is metropolitan, this is rural.

Duncan Brown

Sure. Well may be to phrase it differently, I’m sorry, Greg I didn’t mean to cut you off.

Gregory Stapley

No problem.

Duncan Brown

I guess to phrase it differently, I think the comment was they have more time to implement some of the bundling requirements than the more urban locations. Do you have -- and if you need to get back to us then it’s fine, but do you have any sense of what percentage of that portfolio that would be that has more time than others? That question makes sense.

David Sedgwick

Well yeah it does make sense. I mean one way of answering is just looking at what we currently have that are in CJR markets. And what we have as of I think June 1 was we had 27 facilities in eight CJR markets and so the rest are not which- that’s a goalpost for you I guess.

Duncan Brown

That’s perfect, that’s helpful. And I guess some of it’s kind of – healthcare these days, tight labor market, or increasingly tight labor market do you hear anything from your operators on that front or any trends you care to highlight?

David Sedgwick

Yeah we do, starting really just last few days, we have heard that from our operators. We heard Ensign talk about it in their earnings call and they outlined I think it was Arizona, Texas, Idaho, Utah, California that they were seeing some labor pressures Trillium is seeing some as well for the first time just the last month. And what that kind of means in terms of dollars and cents, Trillium kind of agreed with our Ensign characterized it on their call which is what you normally see about 1% to 2% increase on labor cost a year and they would expect that to be slightly more now in those markets where they are feeling it.

Duncan Brown

Okay. But for you all then the thought process would be still very manageable even if it’s in that sort of 2% to 3% range, or 3% to 4% range just given the coverage ratios?

David Sedgwick

That’s right.

Duncan Brown

Great. And then last one for me last call you gave some interesting color around the star rating on the current portfolio I guess I’m curious the recent acquisitions that you’ve done, I wondered you guys what their star rating are I guess I’m just trying to get a sense of looking at M&A how important is that – how’s that factored into what you guys are thinking about?

Gregory Stapley

Duncan this is Greg. Every acquisition we’ve done in Q2 and Q3 to-date, every SNF acquisition we’ve done has been three star or above. Now it’s not to say that we wouldn’t buy one or two star and we need to get out again in some of those rural markets, star ratings matter far less than they do in more competitive markets. But we are again partnering with operators who understand the system and are maximizing it to their benefit.

Duncan Brown

Great. Thank you.

Gregory Stapley

Thank you.

Operator

Our next question comes from Paul Morgan of Canaccord. Your line is open.

Paul Morgan

Hi good morning. Bill you mentioned, you don’t include rent bumps that are having taken place in your guidance, are there any meaningful ones in the second half that aren’t being reflected in the range you gave?

William Wagner

Well all our leases coming up for rent bumps in the second half of the year are CPI based and CPI has been so low this year that we just chose not to put call it a minimum CPI in there for anyone.

Paul Morgan

Okay. So there’s nothing that’s not being reflected that might roll in the second half on a same store basis?

William Wagner

Well like the Pristine lease, is up for renewal on October 1, so that’s a $17 million lease and annualized rents so some small percent on that might matter a little to the numbers, but we just chose not to put it in there.

Paul Morgan

Okay. And then on the I think you said there was $103 million on the line of credit, is that the current number?

William Wagner

That’s right, as of today.

Paul Morgan

Where are you comfortable taking that before you look to term it out or take it down?

William Wagner

I’m very comfortable taking, putting another $100 million on it easy, that only gets us to $200 million up to $400 million that we have available.

Paul Morgan

Okay. Great. And then just thinking about your portfolio from a geographic perspective, you talked about moving into new states and I’m just wondering as you look across what you’ve got now and where you’d like to be, are there holes that are target markets for you? How much as you kind of look at acquisition opportunities is that a consideration versus just tuck-ins in the regions with your existing operators?

David Sedgwick

Well I’d say, as we’ve looked at couple 100 different deals this year and underwritten, we would love to be in the Mid-Atlantic states. We don’t have currently of a presence up in the Northeast and then even to an extent we’d like to grow our footprint in the Northwest. We have two really good operators, one being Cascadia and other being – that we would love to kind of grow that footprint even further. So those are states that we really, really like or those geographic regions but as you chase transactions there, the pricing certainly is more aggressive. So if it fits our criteria and it happens to be in one of those states, we would be all over it.

Paul Morgan

And then kind of the flipside of that then are there states where you have less appetite right now, because of your current exposure, because you don’t find the operating environment very attractive?

Gregory Stapley

Yeah this is Greg, Paul. The answer is yes. We have a fairly high concentration in Ohio right now, we’re being very careful about looking at adding more there in the near term. We also have identified a few states where the regulatory litigation environment is nauseous enough that we’re not terribly interested in going there. We haven’t completely redlined them but we see lots of deals there that we don’t really – haven’t really been interested in states like Kentucky for example. So, but most of the rest of the country is wide open for us and we’re looking at deals all over as Mark mentioned, we’ve underwritten over 200 deals already year-to-date and they keep flowing in.

Paul Morgan

And just kind of lastly on the SNF side, is there a decent overlap between those more targeted states and what you think might be coming to market from the other REITs and specifically may be relate to Genesis?

Gregory Stapley

We have seen a little bit of Genesis come to market the more interesting parts are in Ohio and as mentioned, we kind of didn’t feel like we have a lot of additional interest or capacity for that state being one of our larger now. We are waiting for the next wave to come out. We think that they have some outliers in the portfolio that could fit very nicely into some of the portfolios of our existing tenants and others that we know out there that we’d like to partner with. So, we’ll look when they come and see how they are. We don’t think that there’s anything inherently wrong with a lot of those Genesis facilities, we look at them and we would look at them on a facility by facility and market by market basis. And if we had an opportunity to re-tenant them particularly something for them have been difficult to manage because it’s really far from their homebase. That’s kind of an ideal situation in our view.

Paul Morgan

And these will be supplemental to the $120 million you said in your pipeline?

Gregory Stapley

Yes.

Paul Morgan

Okay.

Gregory Stapley

We’re not looking at anything from there right now.

Paul Morgan

Alright. Perfect. Thanks.

Gregory Stapley

Thank you.

Operator

Thank you. Our next question comes from Jonathan Hughes of Raymond James. Your line is open.

Jonathan Hughes

Hey guys, just had a quick follow up to Paul’s question, looks like there is a different lease structure between GAAP and cash rent on the $31 million portfolio closed in June. Could you shed any color there?

William Wagner

Yeah you bet. The deal that we did in Michigan with Premier included one facility that was in lease off mode so we gave them bit of a concession the first, I guess it was six months to a year, I don’t have it in front of me that in order to give them some room to lease that up. That’s why that’s different

Jonathan Hughes

Okay, so that should burn off beginning of next year and the gap in cash would be the same?

Gregory Stapley

That’s right and it’s just a one year and it does produce a – deal but it varies very slightly from what the actual cash yield will be starting in year two.

William Wagner

I’d probably look at it this way, in year one, rent is something, in year two, it bumps and then from lease years 3 to 15, it’s CPI based. So the accounting rules require us to straight lined that fixed bump over 15 years, so the gap and the gap in the cash in year two will be pretty closed but it will still be a little off. So you will see a straight line adjust in our FAD number going forward.

Jonathan Hughes

Okay thanks guys. I’ll follow it up offline.

Gregory Stapley

Thank you.

Operator

Thank you. And I’m showing no further questions in queue at this time. I’d now like to turn the call back over to management for any further remarks.

Gregory Stapley

Thanks, Ashley. Thanks everybody for being on today. You know where to find us if you have any other questions, we welcome your calls and look forward to seeing you next time when we’re on the road. Take care.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program. You may all disconnect. Everyone have a wonderful day.

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