Business Overview and Operational History: Established in 1999 as a REIT organized under Maryland law, DHC has evolved into a significant player in the healthcare real estate sector. The company's initial focus was on owning and operating medical office buildings, senior living communities, and other healthcare-related properties throughout the United States. In its early years, DHC pursued a strategy of growth through strategic acquisitions, expanding its reach across various healthcare real estate segments and diversifying across different care delivery and practice types, as well as property locations.
By the mid-2000s, DHC had established itself as a notable presence in the medical office and senior living sectors. However, the company faced significant challenges during the Great Recession, which impacted its operations and financial stability. In response, DHC underwent a restructuring process to navigate the economic downturn and healthcare industry disruptions.
Following the recession, DHC implemented a portfolio repositioning strategy, focusing on higher-quality assets and expanding its footprint in the medical office and life science property segments. The company also enhanced its senior living operations by partnering with experienced managers to oversee its communities. Despite experiencing some fluctuations, DHC managed to achieve steady growth over the subsequent decade.
The COVID-19 pandemic in the early 2020s presented new obstacles for DHC, particularly in its senior living properties. The company worked closely with its operators to implement safety protocols and mitigate the impacts on its communities. Throughout this period, DHC continued to make strategic divestitures and reinvestments to optimize its portfolio.
As of September 30, 2024, DHC's portfolio consists of 368 properties located in 36 states and Washington, D.C., including 25 properties classified as held for sale and three closed senior living communities. This diverse asset base is valued at a gross book value of $7.2 billion.
DHC's portfolio is organized into two primary reporting segments: Medical Office and Life Science Portfolio, and Senior Housing Operating Portfolio (SHOP). The Medical Office and Life Science Portfolio segment comprises medical office properties leased to healthcare providers and life science facilities primarily occupied by biotech and research tenants. As of September 30, 2024, this segment had 99 properties with a total of 8.19 million square feet. The SHOP segment consists of managed senior living communities that offer residential living, care, and other services to their residents. As of September 30, 2024, this segment had 232 properties with a total of 25,150 units.
In addition to its owned properties, DHC holds equity interests in two unconsolidated joint ventures, the Seaport JV and the LSMD JV, which own additional medical office and life science properties across five states, totaling approximately 2.2 million rentable square feet.
Navigating Market Challenges and Operational Initiatives: The healthcare industry has faced various challenges in recent years, including the impact of the COVID-19 pandemic, rising inflation, and labor market constraints. DHC has proactively addressed these headwinds through strategic initiatives aimed at improving the performance and positioning of its portfolio.
During the third quarter of 2024, DHC reported mixed financial results, primarily attributed to its SHOP segment. While the company achieved a 32.6% year-over-year increase in consolidated SHOP net operating income (NOI), the quarter was impacted by slower-than-expected occupancy growth and higher seasonal expenses, salaries, and wages. In response, DHC has initiated a comprehensive review of its SHOP portfolio, evaluating factors such as performance metrics, community density, synergy opportunities, and operator relationships. This process has led to the expansion of DHC's disposition program, with the company targeting the sale of 32 underperforming SHOP communities comprising 2,422 units.
On the Medical Office and Life Science side, DHC completed 83,000 square feet of new and renewal leasing activity during the quarter, with a weighted average rent roll-up of 4.8% and a weighted average lease term of 7.4 years. However, the segment saw a 150-basis-point decline in same-store occupancy, primarily due to a known vacancy in North Carolina. To address this, DHC is actively managing its portfolio, exploring select dispositions and implementing targeted asset management strategies to improve occupancy and lease-up.
Financials: During the third quarter of 2024, DHC reported mixed financial results. The company achieved a 32.6% year-over-year increase in consolidated SHOP net operating income (NOI). However, the overall performance was impacted by slower-than-expected occupancy growth and higher seasonal expenses, salaries, and wages in the SHOP segment.
For the most recent fiscal year ended December 31, 2023, DHC reported total revenue of $1.41 billion and a net loss of $293.57 million. The company's operating cash flow (OCF) and free cash flow (FCF) for the same period were both $10.48 million.
In the most recent quarter (Q3 2024), DHC reported revenue of $373.64 million, representing a year-over-year growth of 4.8%. This increase was primarily due to higher residents fees and services from the SHOP segment, partially offset by lower rental income from the Medical Office and Life Science Portfolio segment. The net loss for Q3 2024 was $98.69 million. Operating cash flow for the quarter was $21.13 million, while free cash flow was $108.85 million.
Breaking down the Q3 2024 performance by segment, the Medical Office and Life Science Portfolio generated $52.90 million in rental income and had a net operating income (NOI) of $27.83 million. The occupancy rate for this segment was 80.8% as of September 30, 2024, with a weighted average remaining lease term of 4.9 years.
The SHOP segment generated $312.00 million in residents fees and services revenue and had a net operating income (NOI) of $27.43 million. The occupancy rate for this segment was 79.4%, with an average monthly rate of $5,200 per occupied unit as of September 30, 2024.
Additionally, DHC's non-segment portfolio, which includes triple net leased senior living communities and wellness centers leased to third-party operators, generated $8.73 million in rental income and had a NOI of $8.68 million for Q3 2024.
Liquidity and Capital Management: As of September 30, 2024, DHC had $256.5 million in cash and cash equivalents, providing the company with ample liquidity to fund its operations and strategic initiatives. The company's debt-to-equity ratio stood at 1.44, while its current ratio and quick ratio were both 10.18.
DHC's financing strategy to address the $440 million in senior unsecured notes maturing in June 2025 has evolved, as the pace of agency financing has been slower than anticipated. The company has pivoted to engage with multiple lenders, aiming to secure the most competitive terms available to refinance this debt. DHC is actively engaged with GSE agencies and has broadened its strategy to include financing of smaller tranches and tapping diversified financing sources from institutional real estate lenders along with the agencies.
To further strengthen its balance sheet, DHC is actively pursuing property dispositions, with 28 properties currently under agreements or letters of intent for an aggregate estimated gross sales price of $348 million. Approximately $302 million of these proceeds are earmarked to partially redeem the company's $940 million senior secured notes due in January 2026, highlighting DHC's commitment to deleveraging its capital structure.
It's worth noting that the company's $450 million credit facility, which was fully drawn as of December 31, 2023, was repaid and terminated on December 21, 2023.
Outlook and Risks: Despite the mixed results in the third quarter, DHC remains cautiously optimistic about the long-term outlook for the healthcare real estate sector. The company believes that favorable supply and demand dynamics in the senior living industry, coupled with its strategic portfolio optimization initiatives, will enable its SHOP segment to generate improved returns over time.
However, DHC acknowledges the risks posed by the ongoing economic and market uncertainties, including high inflation, labor shortages, and potential recessionary pressures. The company's ability to effectively manage its capital expenses, navigate regulatory changes, and maintain occupancy levels across its portfolio will be crucial in weathering these challenges.
Additionally, DHC's reliance on third-party managers and operators for its SHOP communities introduces operational risks that the company must closely monitor and address through rigorous oversight and collaboration. The company's success in executing its strategic dispositions and refinancing initiatives will also be essential in strengthening its financial position and driving long-term value creation.
In light of recent performance, DHC has revised its guidance for the full year 2024. The company has lowered its SHOP NOI guidance to $102 million to $107 million, down from previous projections. This adjustment takes into account additional insurance and remediation costs from recent hurricanes negatively impacting Q4 results, as well as a new target occupancy slightly below 80% at year-end. DHC has also reduced its full-year 2024 CapEx guidance to $180 million to $190 million, which includes $130 million to $140 million for SHOP CapEx.
Conclusion: Diversified Healthcare Trust has demonstrated its resilience in navigating the complex healthcare real estate landscape. By leveraging its diversified portfolio, strategic initiatives, and proactive capital management, DHC is positioned to capitalize on the evolving healthcare industry trends and deliver sustainable value for its shareholders. As the company continues to optimize its operations and strengthen its financial footing, investors will closely monitor DHC's ability to navigate the prevailing market uncertainties and unlock the full potential of its healthcare-focused real estate platform.