Senior Housing Properties: I'm Not Chasing Yield

About: Senior Housing Properties Trust (SNH), Includes: RMR
by: Brad Thomas

In this article, I will explain why I continue to avoid owning shares in Senior Housing Properties.

I am becoming increasingly skeptical of the conflicts of interest between the various RMR-managed entities and the cozy lease arrangements between Senior Housing and Five Star.

I don’t know about you, but I don’t think Mr. Market has priced in a dividend cut yet.

If I want to invest my hard earned capital in Senior Housing, I can simply fly to Las Vegas and put it all on RED (odds are 47.37% in roulette).

A few days ago, I wrote an article titled I Am Not In The Yield Chasing Business, Are You?, and I explained,

"It's always best to proceed with caution when your hard-earned money is on the line. So focus on dividend safety much more than dividend yield. After all, the world is stressful enough and my goal here, as always, is to help REIT investors sleep well at night."

In that article, I was referring to not only investors who are chasing yield but also REITs. More specifically, Monmouth Real Estate (MNR) and UMH Properties (UMH). Both invest in REITs, but instead of owning a diverse basket of high-quality REITs, these two companies have invested in speculative high-yielding REITs.

I pointed out that "Monmouth owns six out of eleven REITs that are not on my BUY list and five of them are on my Strong Sell list," and UMH "holds a few 'sucker yields' including CBL Properties (NYSE:CBL), Government Properties, Select Income (SIR), Senior Housing Properties (SNH), and Washington Prime (WPG)."

Although the securities portfolio is modest (MNR has ~$171 million invested in common shares, and UMH has ~$116 million in common shares), my angst has more to do with the lack of discipline. I simply cannot rationally recommend UMH or Monmouth as a BUY (or even Strong Buy) knowing that these companies are investing in REITs that I'm avoiding (i.e. Strong Sells).

As a REIT writer - and not an activist REIT investor - the best way for me to voice my concerns is through Seeking Alpha. My goal is not to short either Monmouth or UMH, but instead to voice concerns such that management will recognize the risks for owning shares in high-risk REITs. In this article, I will explain why I continue to avoid owning shares in Senior Housing Properties (SNH).

Photo Source

Let's Start with Management

Before I begin on the business model, let me remind you that Senior Housing has no employees, the company is externally-managed by RMR Group (RMR), which provides management services to four publicly traded REITs (as of 12/31/2018), three real estate related operating companies, and three other real estate related businesses.

As of January 2019, The RMR Group had approximately $30.1 billion of total assets under management, including more than 1,700 properties, and employed over 600 real estate professionals in more than 30 offices throughout the United States; the companies managed by The RMR Group LLC collectively had over 52,000 employees.

RMR has a stable revenue base from recurring management fees, anchored by 20-year agreements and 20-year Property Management Agreements with the managed equity REITs.

The business management revenues principally consist of annual fees based on 50 bps multiplied by the lower of: (1) the historical cost of real estate, or (2) total market capitalization. The property management revenues principally consist of annual fees based on 3.0% of gross rents collected at certain managed properties. The business management incentive fees are equal to 12% of value generated in excess of benchmark index total returns per share, subject to caps.

Source: RMR Investor Presentation

Recently, Government Properties and Select Income REIT (SIR) merged to form Office Properties Income Trust (OPI), on December 31, 2018. The transaction eliminates cross-ownership and the co-dependence on financial results between GOV, SIR, and ILPT. OPI focuses on owning office buildings primarily leased to single tenants and high credit quality tenants such as government entities. In addition to these four REITs, RMR owns three related operating companies:

Source: RMR Investor Presentation

Now, let's connect a few dots here….

As the above chart illustrates, RMR has an economic interest in the following entities:

Source: RMR Investor Presentation

RMR derives revenues from these REITs and operating businesses, so essentially, RMR has a stake in Senior Housing and also a stake in Five Star (FVE). RMR is essentially a CASH COW, and the business model is fueled by diverse sources of revenues from multiple businesses and a wide range of real estate properties located throughout the U.S.

Over the course of the company's history, the enterprise has proven its ability to grow fee revenues. The balance sheet has zero debt and positions RMR well for possible future expansion.

Source: RMR Investor Presentation

Sounds great, right?

Senior Housing Business Model

Senior Housing's senior living portfolio consists of 443 properties located in 42 states and Washington, D.C. As noted above, the largest senior living tenant, Five Star, is also the largest tenant of the REIT and derives around 26% of its overall revenue from Five Star's communities.

Source: Senior Housing Presentation

Keep in mind that SNH's concentration with Five Star has decreased substantially since my previous article when Five Star derived around 45% of revenue for Senior Housing. Here's a snapshot of Senior Housing's overall property mix.

Source: Senior Housing Presentation

As Trapping Value pointed out in December,

"Five is now dangerously close to falling below 1.0X rent coverage and its publicly traded stock also looks like a full-blown horror show. It stands to reason that the current rent payments by Five may be in jeopardy pretty soon."

Beyond Five Star's dangerous rent coverage, I am becoming increasingly skeptical of the conflicts of interest between the various RMR-managed entities and the cozy lease arrangements between Senior Housing and Five Star. As viewed below, Five Star's lease obligations are substantial: total annual minimum rent payable under leases was $209.7 million as of December 31, 2017 (balance sheet as of 9/30/18). Source: Five Star Presentation

Five Star's agreements and relationships with Senior Housing and RMR may create conflicts of interest or the appearance of such conflicts of interest. These companies have significant commercial and other relationships with the Managing Director, Adam Portnoy, RMR and others related to them, including:

• The substantial majority of the senior living communities that Five Star operates are owned by Senior Housing.

• Senior Housing owns 8.4% of Five Star's outstanding common shares as of December 31, 2017.

• RMR LLC, a subsidiary of RMR Inc., provides management services to Five Star and Senior Housing and pays RMR fees for those services based on a percentage of revenues.

Senior Housing may terminate leases, management agreements and pooling agreements in certain circumstances, including if Senior Housing does not receive certain annual minimum returns on the subject properties or for uncured material breach. Five Star's business is substantially dependent upon its continued relationship with Senior Housing.

Source: Yahoo Finance

It's clear that Senior Housing is working hard to diversify its business model so that Five Star is not the largest operator in the portfolio. Here's a snapshot of Senior Housing's portfolio compared with other healthcare REITs:

Source: Senior Housing Investor Presentation

However, Senior Housing has the largest (percentage) exposure in senior housing (37%), and unlike Ventas (VTR) with best-in-class exposure, Senior Housing has enhanced exposure to one weak tenant. And, it only takes one torpedo to sink the ship.

The Dividend is at Risk

Now, let's take a closer look at Senior Housing's growth profile as illustrated below:

Source: FAST Graphs

As illustrated above, Senior Housing has done an admirable job of maintaining its dividend through multiple recessions. However, the company has not increased its dividend in a number of years (since 2013 has paid $1.56 per share annually). And as you can see below, Senior Housing's payout ratio in 2018 (based on FFO per share) was dangerous: 96%.

Source: FAST Graphs

On an AFFO basis, the dividend is at a higher risk, over 108%, suggesting that this REIT is a "sucker yield."

Source: FAST Graphs

As viewed below, FAST Graphs has forecast a dividend cut (analyst estimates) for 2019 and 2020.

Source: FAST Graphs

I don't know about you, but I don't think Mr. Market has priced in a dividend cut yet… and I would be careful jumping into that frying pan when you know that it's gonna most likely burn you. Keep in mind that Senior Housing announced a regular dividend of $0.39 per common share ($1.56 per share per year), so there has been no sign from management of a possible cut.

But it's my job to steer you from the losers and ultimately help protect your REIT investments at ALL costs. And that's one of the reasons that I decided to SELL my shares in Monmouth and UMH, because I could not stomach owning Senior Housing indirectly. Here's how UMH and Monmouth have performed, relative to Senior Housing:

Source: Yahoo Finance

As you can see, Vanguard Real Estate (VNQ) has outperformed UMH, Monmouth, and Senior Housing, and this suggests that you're better off owning a diversified basket of REITs (like VNQ) than trying to market time stocks. On the other hand, by owning a portfolio of high-quality stocks that consistently increase their dividends, investors can expect to outperform the averages and sleep well at night.

Finally, always remember to consider management - it really matters. This means that you should pay close attention to the management incentives and be skeptical when it comes to selecting stocks outside of your circle of competence. That also applies to REIT management, and there's no reason for REITs to invest in other REITs unless there's a competitive advantage for doing so. If I want to invest my hard earned capital in Senior Housing, I can simply fly to Las Vegas and put it all on RED (odds are 47.37% in roulette).

In conclusion: Don't Chase Yield.

Author's note: Brad Thomas is a Wall Street writer and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos and be assured that he will do his best to correct any errors if they are overlooked.

Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking.

Disclosure: I am/we are long VTR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.