Community Healthcare Trust Inc Q2 FY2022 Earnings Call

Welcome to Community Healthcare Trust 2022 Second Quarter Earnings Release Conference Call. On the call today, the company will discuss its 2022 second quarter financial results. They will also discuss progress made in various aspects of its business. Following the remarks, the phone lines will be open for question-and-answer session. The company's earnings release was distributed last evening and has also been posted on its website. 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, August 3, 2022, 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.

Good morning, and thank you for joining us today for our 2022 second quarter conference call. On the call with me today is Dave Dupuy, our Chief Financial Officer; and Leigh Ann Stach, our Chief Accounting Officer. As is our normal process, our earnings announcement and supplemental data report were released last night and filed with an 8-K, and our quarterly report on Form 10-Q was also filed last night. In addition, an updated investor presentation was posted to our website last night. The second quarter was again busy from an operation standpoint, and again, a little slow albeit better than the first quarter from an acquisition standpoint. As I indicated last quarter, we continue to have five different properties, or significant portions of them, that are undergoing redevelopment or significant renovations with long-term tenants in place when the renovation or redevelopment is done. Our occupancy has risen above 90%, and we have seen a continued pickup in leasing activity. We continue to be encouraged by the activity we see on the part of health care providers. Our asset managers have been busy controlling expenses while maintaining tenant satisfaction. Our weighted average remaining lease term ticked up slightly at just less than 8 years. During the second quarter, we acquired one property with a total of approximately 37,700 square feet for a purchase price of approximately $23.5 million. This property was 100% leased with the lease running through 2037 and an anticipated annual return of approximately 10.25%. The company has three properties under definitive purchase agreements for an aggregate expected purchase price of approximately $23.4 million and expected returns of approximately 9.0% to 9.72%. The company is currently performing due diligence and expects to close on these properties in the second half of the year. The company continues to have signed purchase and sale agreements for five properties to be acquired after completion and occupancy for an aggregate expected investment of $117.5 million. The expected return on these investments should range up to 10.25%. We expect to close on one of these properties in the fourth quarter of 2022 and the other four throughout 2023. We continue to have many properties under review and have term sheets out on several properties with anticipated returns of 9% to 10%. We anticipate having enough availability on our credit facilities to fund our acquisitions, and we expect to continue to opportunistically utilize the ATM to strategically access the equity markets. On another front, we declared our dividend for the first quarter and raised it to $0.4425 per common share. This equates to an annualized dividend of $1.77 per share. And I continue to be proud to say, we have raised our dividend every quarter since our IPO. I believe that takes care of the items I wanted to cover. So I will hand things off to Dave to cover the numbers.

Great. Thanks, Tim, and good morning, everybody. I am pleased to report that total revenue grew from $22.7 million in the second quarter of 2021 to $24 million in the second quarter of '22, representing 6% growth over the same period last year. Revenue for the first quarter of '22 was $23.5 million, representing 2.4% growth quarter-over-quarter. On a pro forma basis, if the '22 second quarter acquisition had occurred on the first day of the second quarter, total revenue would have increased by an additional $302,000 to a pro forma total of $24.4 million in the second quarter. From an expense perspective, property operating expenses remained flat quarter-over-quarter at $4.1 million. G&A increased from $3.3 million in the first quarter to $3.6 million in the second quarter, or 8.9%. Increases in G&A were driven primarily by increases in employee and deferred compensation expenses as well as increases in travel and professional fees expense. Interest expense increased from $2.6 million to $2.8 million, or 4.9%. This increase was due to increased borrowings under our revolving credit facility to fund acquisitions as well as an increase in floating interest rates. I am pleased to report that funds from operations, FFO, for the second quarter of '22 grew to $13.7 million from $13.5 million in the first quarter of '22, representing 1.5% growth quarter-over-quarter. On a per share basis, FFO increased from $0.56 per diluted share in the first quarter of '22 to $0.57 per diluted share in the second quarter of '22, an increase of 1.8%. Adjusted funds from operations, or AFFO, which adjusts for straight-line rent and stock-based compensation, totaled $15 million in the second quarter of '22 compared with $13.9 million in the second quarter of '21, or 7.6% growth year-over-year. On a per share basis, AFFO increased from $0.58 per diluted share in the second quarter of '21 to $0.62 per diluted share in the second quarter of '22, or 6.9%. Finally, AFFO for the first quarter of '22 was $14.8 million, representing a 1.1% increase quarter-over-quarter. On a per share basis, AFFO increased from $0.61 per diluted share in the first quarter of '22 to $0.62 per diluted share in the second quarter of '22. And on a pro forma basis, if the second quarter acquisition had occurred on the first day of the second quarter, AFFO would have increased by approximately $271,000 to a pro forma total of $15.3 million, or $0.63 per diluted share. Anyway, that's all I have from a numbers perspective. Danielle, we are ready to start the question-and-answer session.

The first question comes from Sheila McGrath of Evercore.

Tim, I was wondering, you mentioned that you have capital that you're investing in redevelopment. I was just wondering if you could give us some insight on how much capital is being invested, what kind of return and the timing so we could add to our models?

It's approximately $8.5 million, and it will be spread out over probably the next 4 quarters. And it's in five projects that we already have leases for. These are being done specifically for existing tenants. So does that provide any detail?

Yes. Yes. And what kind of yield? Like is it similar like 10%? Or is it...

It's in the 9% to 10% range.

Okay. Great. And then on the acquisition this quarter, I'm assuming that was from your largest tenant since their exposure moved up, the rehab facility. Just wondering if that opportunity came about given your relationship? Or was it like a widely marketed transaction?

No, it's part of our relationship. Last quarter, we had six of these under purchase and sale agreement, and we closed on one of them. So now we've got five. It's an existing relationship that's part of one of our clients.

Okay. Great. And last question. The dialysis letter, LOI, that you have, potentially over $60 million. Just curious, are there major hurdles to get that to purchase or definitive agreement? Or just where that stands in the process?

They are identifying properties. As I mentioned last quarter, they received funding and are now active in the market, acquiring the operational side, which enhances our capability to engage in real estate transactions with them.

The next question comes from Alexander Goldfarb of Piper Sandler.

First of all, good to see the pipeline expand. So that's a good thing. Just a few questions, Tim. First, as far as the funding goes, you referenced line of credit. You also referenced the ATM. You guys still trade at a good premium to NAV. So that's positive for accretion. But just given the disruption in both the equity markets and debt markets, how do you see your funding going forward, at least as long as we're in the current scenario?

Thank you for the question. We don't believe the situation has changed significantly. We are investing at caps above nine, and we've observed that the market has opened up substantially, even after the initial 75 basis point increase from the Fed. We expect it will open up even more with the second 75 basis point increase. Much of the funding that others had is no longer available at the cap rates we are purchasing at. Therefore, we foresee our market expanding significantly. If we assess our funding costs for both equity and debt, it remains very advantageous to buy in the 9% to 9.5% range. Our overall strategy remains the same. We intend to maintain the debt in the range of 30% to 35% of total capitalization and utilize the ATM to counterbalance it, as we believe the stock is worth $60. While I dislike selling stock at its current level, the reality is that we can generate significant profits.

Okay. And then that leads into the second question, which I think you partially answered. But from a lot of the other REITs in other sectors, apartments, retail, office, industrial, what have you, there's a lot of disruption going on in the transaction markets, just given what's going on in the cost of capital. And a lot of the people have said that transaction markets have really slowed down and almost come to a stop, if you will. That doesn't sound like it's the case in your markets, or maybe it is. So maybe just a bit more color on what's going on in the product that you transact in? And as you just described, is it just that, yes, a lot of deals are going to stop, and therefore, you're the recipient? Or as you look at your own pipeline, the deal flow has noticeably stopped because sellers are pulling back in general?

No, actually, it's the opposite. We have observed a significant increase in our potential pipeline. Last year's fourth quarter and this year's first quarter saw a notable slowdown in that pipeline. However, following the first 75 basis point increase, we noticed a resurgence in our pipeline. We expect that there will be further growth since there is often a delay in how sellers respond to the trends in the capital markets. There may still be some disconnect because buyers face higher costs of capital, prompting them to seek higher cap rates while sellers still hold onto their previous expectations. Nevertheless, we've already seen a significant increase and anticipate more growth. We believe the fourth quarter will return to the deal flow levels we experienced before the pandemic. Therefore, we are quite optimistic about the current situation and what it means for our future.

The next question comes from Rob Stevenson of Janney.

Tim, any property type looking more attractive to others in the marketplace today when you're sourcing stuff outside of the stuff that's already under contract?

We continue to receive that question, and we are very opportunistic. I don’t think we have ever believed that one specific property type is better than another. For a while, we were seeing a significant number of behavioral facilities, and although that has slowed down a bit, we are now seeing more medical office buildings, particularly multi-tenanted ones, in the last couple of months. All property types have appealing qualities if they meet our criteria, so we don’t favor one type over another.

Okay. Are there any known move-outs or downsizings in the 2023 lease expirations at this point?

I'm not as tied into the 2023 lease expirations. I'm sure there are some that will end up moving out. Again, I think our historic retention rate is 85%, 90%. So we anticipate 10% to 15% of expirations to move out in any given year. But we have a fully pledged leasing effort on both vacancy, and the asset management people have already started on working on the 2023 expiration. So we feel very comfortable with where that is. And as I mentioned, the leasing activity that we've seen from health care providers has picked up substantially. As noted, we picked up 40 basis points in our occupancy, and we anticipate that continuing north over the next several quarters.

Okay. And then last one for me. Dave, did you guys buy back some stock in the second quarter? Page 9 of the supplemental shows the second quarter share count that's on a weighted average basis, is about 100,000 below what the first quarter was.

No, there were no share buybacks at all. We didn't issue any shares. That's just how the shares are calculated. And because the stock price was down, the share price calculation decreased slightly, which is what you're observing.

The next question comes from Dave Rodgers of Baird.

Wanted to ask on the redevelopment assets. I guess two questions there. Should we anticipate leases to commence then on those spaces by the end of 2023? Is that your expectation? Or will there be a delay or a lag before that happens? And can you remind me what percentage of the vacancy of the portfolio that that redevelopment portfolio of companies today or account for today?

We expect that all of those will be completed, with rent starting sometime in 2022 or 2023. By the end of 2023, rent should have commenced for all of those. That answers the first part of your question. Regarding the second part, to be honest, I'm not sure. I've never really considered it that way. My guess would be around 20 basis points or something like that, but it's just a guess. We've never looked at it in that manner.

Okay. Maybe I can follow up on the square footage of redevelopment or something similar, if you have that number. But other than that, my question would be about deploying new capital. With the tighter capital market, are you seeing existing customers come to you for expansion projects or more capital that you can invest in the existing portfolio to achieve returns that might be beneficial as well as the acquisition?

Well, we've kind of seen that over the last 6 to 8 months, and that's what's generated these renovation and redevelopment projects. Will that continue? My gut reaction is it's a good possibility that, that will continue. We've got several discussions now ongoing with probably 30,000 to 50,000 square feet of space with that type of project. So we're hopeful and we're very happy to invest new money in the existing properties and look forward to doing that.

The next question comes from Michael Lewis of Truist Securities.

I wanted to follow up on Sheila's question about the dialysis program. Is there any expectation for when you'll be putting capital to work in that program? Additionally, are you making progress on other investment pipelines similar to that one? I know you've mentioned that in the past.

We have been a bit disappointed with the time it has taken to invest capital in the dialysis program. However, we remain confident that it will happen, as it is still a strong tenant. We currently have four or five projects underway with them, but this specific initiative is taking longer than expected. Initially, they needed to finalize their private equity funding, which they have now completed, and they are currently searching for new opportunities. We believe it will come to fruition, but I have stopped predicting a timeline, which is why I didn't mention it in my comments today. Regarding your other question, yes, we are pursuing several different relationships, but it has been challenging. As I mentioned in previous calls, during the pandemic, we could not progress these relationships. The projects we had started remained stagnant for a time because of restrictions on visits and conversations — everyone was focused on other priorities. Now, as they shift their attention to growth, we are re-engaging in discussions, but these take time to develop. We don’t have any new announcements at this moment, but we are actively working on it and aiming to expand that aspect of our business.

Okay. Great. And then lastly for me, I saw you have $28 million of properties under exercisable purchase options that have not been exercised. Do you expect any of those options to be exercised and maybe share kind of what the pricing is, that might help us understand the likelihood of exercise?

We really don't expect that, and particularly now that the cost of capital for everybody is going up. And basically, I think the majority of those are exercisable at an initial purchase price plus an inflation rate to the purchase price. So if interest rates were still zero, my answer might be different. But with interest rates going up and the cost of capital for everybody increasing, we really don't expect any of those to be exercised.

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

Thanks, everyone. We appreciate you taking the time to spend with us, and we'll talk to you next quarter.

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