Community Healthcare Trust Inc Q3 FY2021 Earnings Call

Welcome to Community Healthcare Trust 2021 Third Quarter Earnings Release Conference Call. On the call today, the company will discuss its 2021 third quarter financial results. It will also discuss progress made in various aspects of its business. The company's earnings release was distributed last evening and has also been posted on its website, www.chct.reit. The company wants to emphasize that some of the information that may be discussed on this call will be based on information as of today, November 3, 2021, and may contain forward-looking statements that involve risk and uncertainty. Actual results may differ materially from those set forth in such statements. For a discussion of these risks and uncertainties, you should review the company's disclosures regarding forward-looking statements in its earnings release as well as its risk factors and MD&A and its SEC filings. The company undertakes no obligation to update forward-looking statements, whether as a result of new information, future developments or otherwise, except as may be required by law. During this call, the company will discuss GAAP and non-GAAP financial measures. A reconciliation between the two is available in its earnings release, which is posted on its website. Call participants are advised that this conference call is being recorded for playback purposes. An archive of the call will be made available on the company's Investor Relations website for approximately 30 days and is the property of the company. This call may not be recorded or otherwise reproduced or distributed without the company's prior written permission. Now I would like to turn the call over to Tim Wallace, CEO of Community Healthcare Trust Incorporated.

Good morning. Thank you for joining us today for our third-quarter conference call. I am accompanied by David Dupuy, our Chief Financial Officer; Leigh Ann Stach, our Chief Accounting Officer; and for the first time, Tim Meyer, our new Executive Vice President of Asset Management. Before we proceed, I want to congratulate Dave and his Atlanta Braves on their victory last night, as a longtime Atlanta resident and Braves fan, I appreciate the significance of this win. As usual, our earnings announcement and supplemental data report were released last night and filed in an 8-K, along with our quarterly report on Form 10-Q. Traditionally, the third quarter tends to be a bit slow in terms of operations and acquisitions. I would like to highlight a few points that may address some of your questions upfront. We encountered a couple of unexpected expenses in the property operating costs. First, utilities exceeded our budget significantly in the third quarter due to the summer heatwave affecting various parts of the country. Second, property taxes were unusually high as many local municipalities are taking aggressive stances on reassessments and tax rates. Our consultants advised increasing our accruals for the year, resulting in several quarters' adjustments being recorded in the third quarter for various properties. We expect to be reimbursed for most, but not all, of these expenses as the operating expense reimbursements are processed over the next few months. On the general and administrative side, we eliminated a position this quarter which will save us a few hundred thousand dollars annually moving forward. However, due to accounting rules, we had to write off several hundred thousand dollars of deferred compensation. This occurred even though there was no change in the legal contractual vesting requirements since we still hold the stock subject to future vesting. Additionally, as some of us are approaching retirement eligibility, we are required to amortize deferred compensation over the remaining time until retirement, even if we do not plan to retire at that time. This accelerated amortization has resulted in us expensing over $1 million more in deferred compensation this year than the legal contractual amortization would suggest, and this number will exceed $1.5 million next year. This is why we believe adjusted funds from operation is the best metric to evaluate our performance, as it excludes straight-line rent, which does not provide cash for dividends, and includes deferred compensation, which does contribute cash for dividends. As you know, we have an active ATM program in place. In the first quarter, we issued 139,216 shares of stock through this program at an average gross sales price of $48.63 per share, resulting in net proceeds of about $6.6 million with an approximate 3.63% current equity yield. During the third quarter, we acquired two properties totaling around 38,000 square feet for about $9.3 million. These properties were fully leased with leases extending through 2026, and we anticipate annual returns of around 9.03% to 9.37%. So far this quarter, through November 3, we have acquired one property totaling about 27,200 square feet for approximately $3.5 million, which was also fully leased with lease expirations through 2031, yielding an anticipated annual return of 9.3%. We currently have three properties under definitive purchase agreements for a total expected purchase price of around $12.3 million, with anticipated returns ranging from 9.3% to 9.7%. We are conducting due diligence on these properties and expect to close in the fourth quarter. Additionally, we have signed purchase and sale agreements for four properties discussed last quarter, which are to be acquired after their completion and occupancy for a total expected investment of $94 million, with expected returns reaching up to 10.25%. We plan to close on one of these properties in the first quarter of 2022 and the rest throughout 2022 and into 2023. Moreover, we have a signed term sheet for another ten new properties with a potential investment of about $60 million, anticipated to occur over the next 24 months. We continue to review numerous properties and have term sheets out on several with expected returns between 9% to 10%. We anticipate having sufficient availability in our credit facilities to support our acquisitions and will strategically utilize the ATM to access equity markets as needed. Our weighted average remaining lease term is stable at just under eight years, and occupancy remains approximately the same as last quarter. Leasing activity has increased, and we are encouraged by the engagement from healthcare providers. On a positive note, we declared our third-quarter dividend and increased it to $0.435 per common share, equating to an annualized dividend of $1.74 per share. I take pride in stating that we have raised our dividend every quarter since our IPO. I believe that covers the main points I wanted to address, and I will now hand things over to Dave to review the financials.

Great. Thanks, Tim. Good morning, everyone, and Go Braves. I am pleased to report that total revenue grew from $19.3 million in the third quarter of 2020 to $23.3 million in the third quarter of 2021, representing 20.2% growth over the same period last year. Revenue for the second quarter of 2021 was $22.7 million representing 2.5% sequential growth. On a pro forma basis, if all the 2021 third quarter acquisitions had occurred on the first day of the third quarter, total revenue would have increased by an additional $131,000 to a pro forma total of $23.4 million in the third quarter. As Tim mentioned in his comments, expenses increased in the third quarter. Property operating expenses increased quarter-over-quarter from $3.8 million to $4.1 million or 5.4%. As Tim discussed, the increase in property operating expenses is primarily driven by increases in property taxes and utilities expense. G&A expense for the third quarter increased quarter-over-quarter from $2.9 million to $3.2 million or 10.8%. However, as Tim mentioned previously, this increase was inflated in part by the approximately $200,000 noncash write-off of deferred compensation related to the elimination of a position. Adjusted for this one-time noncash expense, G&A would have increased 3.9% quarter-over-quarter. On the topic of stock-based compensation expense, I'd like to highlight a couple of new disclosure items we are now including in our supplemental materials. First, on Page 8, in addition to including the mix of G&A between cash and noncash, we are now disclosing those items as a percentage of revenue. You will note that the cash portion quarter-over-quarter has ranged between 5% and 6% of revenue and has trended down the last few quarters. Second, on Page 9, we are disclosing more detail around our amortization of deferred compensation. The table at the bottom of the page shows the GAAP required deferred stock compensation amortization included in G&A. We also show the amortization based on the actual legal vesting periods to show the acceleration of deferred compensation included in G&A. This acceleration is driven mostly by legal vesting dates that extend beyond retirement eligibility dates. And as Tim mentioned in his comments, this increase in stock-based compensation amortization will continue into future years. This is another example of why we believe adjusted funds from operations, which eliminates straight-line rent and adds back deferred stock-based compensation, is the best way to measure our performance. Finally, interest expense increased slightly from $2.7 million to $2.8 million or 1.9%. This increase was driven by slightly higher interest rates on our revolver. I'm pleased to report that funds from operations, or FFO, for the third quarter of 2021 increased to $13.2 million from $11.6 million in the third quarter of 2020, representing 14% growth over the same period last year. On a per share basis, FFO increased from $0.52 per diluted share in the third quarter of 2020 to $0.55 per diluted share in the third quarter of 2021, an increase of 5.8%. Meanwhile, FFO for the second quarter of 2021 was $13.3 million, remaining essentially flat sequentially. Adjusted funds from operations, which, as stated earlier, adjusts for straight-line rent and stock-based compensation, totaled $14.3 million in the third quarter of 2021 compared with $12 million in the third quarter of 2020 or 19.8% growth year-over-year. On a per share basis, AFFO increased from $0.53 per diluted share in the third quarter of 2020 to $0.59 per diluted share in the third quarter of 2021 or 11.3%. Finally, AFFO for the second quarter of 2021 was $13.9 million, representing 2.9% growth on a sequential basis. And from a pro forma perspective, if all third quarter acquisitions occurred on the first day of the third quarter, AFFO would have increased by approximately $103,000 to a pro forma total of $14.4 million. That's all I have from a numbers perspective. Danielle, we are ready to start with the question-and-answer session.

Tim, you mentioned in your release or actually in the investor deck, the term sheet for the dialysis partner. I just wonder if that's closer to being a finalized deal. Are there any other discussions with different partners beyond that relationship?

Is it closer to being a finalized deal? Yes. This will happen in stages over the next 24 months, unlike the inpatient rehab facilities where we were able to complete all the agreements at once. I don't expect there will suddenly be multiple deals at the same time; that’s not my anticipation. We are still having several discussions. Dave was out yesterday with one opportunity and has another lined up for next week. We have multiple prospects that we are working to bring to fruition.

Is the Head of Asset Management position new at the company? Is it a result of the company's growth, or can you provide a bit more detail on that?

Tim has been with us now for a couple of years. He was the Senior Vice President, and we gave him a promotion to Executive Vice President kind of in recognition that it is a bigger part of what we're doing now. As we grow, the asset management piece is a significant piece of what we're doing.

And my last question. We're a month into fourth quarter, you mentioned $12 million slated to close. Just wonder, are there any other transactions in the works that could potentially hit in fourth quarter?

We have already secured $3.5 million. Adding the $12.2 million brings our total for the fourth quarter to about $15.7 million, which we believe is very likely. There is another potential deal, but I won’t disclose that as a guarantee. Many have inquired about our total investments, and based on the notes, the announced purchase and sale agreements, and what we've already finalized, we estimate our total investment for the year to be around $108 million. This is slightly below our target of $120 million, but still within an acceptable range. As I mentioned, this business can be quite variable.

Dave, congratulations to you in Atlanta, especially considering what happened earlier this year. It must feel great to celebrate a baseball victory. Tim, returning to the stock topic, since your IPO, the all-stock compensation has been a key feature for you and has set you apart from your peers, fostering a strong alignment of interests. However, it is challenging to view it as anything other than an expense, because you and your team, including Dave, expect to receive stock as compensation. Without that, you would need to pay out in cash. I understand that NAREIT FFO has been a conflicting metric.

Alex, let me address that briefly because the issue with that idea is that while it may appear to be an expense, it is not a cash expense that impacts dividends. We are already benefiting from it because we have stock outstanding, and the stock is diluting the shares. Therefore, considering both the dilution of shares and amortizing that into an expense feels like a double hit.

Living in New York with a double taxation, I can sympathize. But let me ask the first question, Dave. As we look to the fourth quarter, you mentioned that there were some items on the expense side that you expect to be reimbursed in time. There was also this one-time accelerated $200,000 on the general and administrative expenses. What do you think is an appropriate run rate? As we consider our model, how should we adjust the operating expenses and general and administrative expenses for the fourth quarter compared to the third quarter, given that it seems like there were some significant items that impacted the third quarter?

Yes. I would say the $200,000 is obviously the key thing that we called out here because that was an elimination of a position, and it truly inflated G&A. I think if you just look at the trends, I think in general, the cash portion of G&A has been trending a little bit down, but that 5% to 6% cash portion, I think, is a good proxy for what we've been seeing over the last several quarters. And then as we've pointed out in the additional disclosures on Page 9, you kind of see how the acceleration of amortization is impacting us from a noncash perspective. So I think the combination of those two things should give you a good sense of where we'll be.

And I'd take the $200,000 out of the third quarter for that when you look at that.

Right. And on the reimbursement side? Yes. On the property operating expense side, there are fluctuations from quarter to quarter, and it has increased slightly. It may decrease a bit as well. This is mainly due to timing differences between when we pay expenses and when we receive payments from tenants. Unfortunately, I can't predict specific outcomes. However, if you examine the long-term trend, you will notice that these expenses typically fluctuate by 3% to 5% from quarter to quarter. Overall, we are confident about the reimbursement of these expenses.

And then the second question, Tim, is I understand the accounting and its impact, but given that you are larger and have strong discipline in acquisitions, and I believe you've mentioned before that you could potentially try harder to maintain that 9%, at what point would it make sense to increase the targeted range from $120 million to $130 million, maybe to something like $140 million to $150 million? So to step it up a little bit, not excessively, but increasing it slightly to help offset some of the heightened compensation expenses due to the retirement mandates of FASB, among other factors. Is this something you might consider, possibly increasing the pace of acquisitions a bit?

Let me put it this way. Our accounting has been consistent, and we have been delivering solid results for the past few years, since the start. We have been achieving good numbers, and our accounting practices have improved as we have needed to start amortizing assets more quickly. We are transparent about our approach. We do not have fixed targets and purchase based on what we deem appropriate. Our acquisitions have varied from around $88 million to $160 million. We aim to acquire assets we are confident in, which we believe can enhance our income and be beneficial. Our objective is to increase gross profits and widen the gap between our investments and our average cost of capital rather than simply adding more assets to our balance sheet.

As a New York Mets fan, I feel it’s necessary to express some support for the Braves since I work at SunTrust, now Truist. My first question is regarding the term sheet for the $60 million dialysis centers. This leads me to ask about the typical close rate once a term sheet is issued. Additionally, I noticed that you included information on the term sheet in the slide deck rather than the press release. Is this due to transaction uncertainty or other factors?

That's been our history from day one. We don't consider term sheets to be as reliable as signed purchase and sale agreements. In the last five years, we have only one signed purchase and sale agreement that we haven't closed. While our success rate with term sheets isn't quite as strong, it is still quite good. If we reach the point of signing a term sheet, the only things that could prevent us from closing would typically be unforeseen issues during due diligence. This makes it less likely for us to encounter problems compared to signed purchase and sale agreements. Historically, we have included purchase and sale agreements in our filings with the SEC, as opposed to those we simply provide to the SEC. The slide deck contains information we provide, while other documents are officially filed with the SEC.

You know Tim, you correctly pointed out that we failed to consider the no investments that you made year-to-date when we suggested that you were a little bit behind your investment pace. Those are included in the supplemental, but not in the property acquisitions table, of course. Could you maybe talk a little bit about no investments, the types of returns and deals, what the potential is to do more of those I think this other operating interest line is running at over $3 million a year now. So could you just talk a little bit about those types of investments?

All right. Well, those relationships are typically with existing tenants or clients, and we currently have two of them that we consider good businesses for loans for various reasons. Both are around $13 million each, totaling $26 million. They generally generate returns of 10% to 12%. I'm looking at Dave to confirm that. We expect they will be outstanding for 3 to 5 years, right?

Yes, I think that's right.

So do you anticipate any more of those deals? Or that would just be like a one-off as they come up?

It's not something that we market, but it's not something that we shy away from if we think it makes sense on an overall relationship basis and good for them, good for us. I mean.

Yes, sir. And then just lastly, on these deals that are set to close upon occupancy between the beginning of '22 and the beginning of '23, they're nice for us, for analysts and investors, I guess, because we have good visibility on the amount and the timing there and you provide yield expectation, which is high. So maybe talk about the risk return of those and if there are similar opportunities to do things like that on kind of a forward basis once they're completed, can that become kind of a programmatic thing? I know these 4 have been kind of out there for a little while. Do you think there's any potential to add to those types of investments?

Well, actually, before it was a client that we had already done 4 with, 3 with?

4.

We completed the projects and actually sold a couple of them ahead of schedule, generating significant profits. These are essentially what we refer to as our serial entrepreneurs—those who have previously managed and sold companies to larger corporations. After they finalize their work, we acquire them. Initially, I used to think that within five years, they would sell the company, but now it seems they may sell the properties within just a few months. Given the current market conditions, everything is happening rapidly. There is a risk-reward aspect to this; we are sort of acting as a mezzanine layer for them, enabling them to reach their goals much faster. With one client, for instance, we simply replicate the purchase and sale agreement, adjust the names and addresses, and complete the transactions. This streamlined process allows them to plan their growth more effectively, and it enhances our ability to plan our own growth as well. We have strong operational teams managing these projects, and even better operations in place should they sell the businesses. We see this as a mutually beneficial arrangement, and we are actively seeking more opportunities to establish similar relationships.

Yes, thinking about the potential for types of investments and opportunities, it sounds like potential for all of the above. Appreciate it.

The next question comes from Brian Maher of B. Riley FBR. Please go ahead.

Maybe asked a little bit different way on kind of acquisitions. Can you talk a little bit about what you're seeing in the seller expectations? I mean when we look at the housing market, it's insane where we live, how prices keep going up. Are seller expectations in your world also going up? And is that being impacted at all, to your view, on what's going on with inflation and labor shortages?

And let me ask a question. Are you calling from Florida now?

No, I'm actually calling from Lewes, Delaware. I was shopping for a home for my mother in law and the bidding wars are insane.

The bidding wars for residential housing in Nashville are intense. We have always focused on one-off transactions and there are various issues at play, such as conflicts between different ownership groups. We haven't experienced much resistance regarding cap rates for our activities. While overall healthcare cap rates are very low, some of our investments are evaluated without adjustments. Our approach is to invest each dollar only once and aim to achieve the best possible return. Rather than engaging in bidding wars for properties, we prefer to walk away from situations where the return isn't optimal.

Do you think there is potential for the increases in prices to allow for better rent roll-ups when you release your properties over the next couple of years?

What I've always said, and I think I'm going to stick to that, is we don't think that we're significantly over market or significantly under market in any of our in any of our leases. And I would not want anybody to start putting in their model significant increases in our rents as the rent rolls. But we do think that as rents roll, we will see some uptick in rents, particularly in certain markets. But it's a market-by-market type of situation. And there are some markets out there that are soft. There are some markets out there that are very strong from a rent standpoint.

The next question comes from Rob Stevenson of Janney. Please go ahead.

Tim, any of the 2022 lease expirations of consequence a known move-out at this point?

I don't think there are any significant issues. We probably have 10,000 to 20,000 square feet that may be vacated, and we're consulting with Tim Meyer for his insights on that. My initial impression is that we've been in touch with most of the tenants, and I believe we've communicated with all of them through the third quarter of next year, with some starting to move in the fourth quarter. We have a few vacant spaces, but that's typical in real estate; people need to move out for new leases to be signed. Overall, there's nothing we are particularly worried about.

And then the $3.5 million property you bought here in the fourth quarter is in the low 80s in terms of percentage leased. Is there ability to lease that up the remaining portion? Or is the return just high enough at that 83% leased or whatever that meets or exceeds your hurdle rates? How should we be thinking about a property like that when you buy it? Are you buying it to lease it up? Or are you buying it for what it is today?

I never buy a feature. I mean we bought it, whatever the cap rate was that we quoted on that property, I think it was like 9.3%, is an actual in-place NOI now. And so we're basically buying 17% of the building free. Now the good news is on that building is the reason that it's for sale, there were 6 doctors in the partnership that couldn't get along with each other anymore. And it's sitting not on a hospital campus, but I think adjacent to a hospital campus, and the hospital lease space in it as a physician group related to the hospital. And we believe that if you get the ownership of the way that it will be something that can be leased out.

This concludes our question-and-answer session. I would like to turn the conference back over to Tim Wallace for closing remarks.

Well, I would like to thank everybody for taking the time to spend with us this morning, and we look forward to talking with you all again in three months for the end of the year. Thanks so much.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.