Earnings Call Transcript - CHCT Q3 2023

Operator, Operator

Welcome to Community Healthcare Trust's 2023 Third Quarter Earnings Release Conference Call. On the call today, the company will discuss its 2023 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 at 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 1, 2023, 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 the 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 in its SEC filings. The company undertakes no obligation to update forward-looking statements, whether as the 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 Dave Dupuy, CEO of Community Healthcare Trust.

David Dupuy, CEO

Thank you. Good morning, and thank you for joining us today for our 2023 third quarter conference call. On the call with me today is Bill Monroe, our Chief Financial Officer; Leigh Ann Stach, our Chief Accounting Officer; and Tim Meyer, our EVP of Asset Management. Our earnings announcement and supplemental data report were released last night and furnished on 8-K, and our quarterly report on 10-Q was filed last night. Additionally, an updated investor presentation was posted to our website last night. The third quarter was busy, both from an acquisition standpoint and also from an operations standpoint. During the quarter, we acquired 7 properties with a total of approximately 177,000 square feet for a purchase price of approximately $51.7 million. The properties were 99.8% leased, with leases running through 2038, and anticipated annual returns of approximately 9.1% to 10.37%. Subsequent to September 30, we acquired 2 medical office buildings in a single transaction for a purchase price of $7.1 million. The properties were 96.8% leased, with leases running through 2031. From an operations perspective, our weighted average remaining lease term remained stable at 7.1 years. Occupancy decreased from 91.7% to 91%. That decrease can be attributed to a GenesisCare lease rejection occurring in the quarter. As it relates to GenesisCare, we had one lease rejection during the quarter at a 46,000 square foot building in Fort Myers, Florida, in which GenesisCare was the sole tenant. When coupled with the lease in Asheville rejected in the prior quarter, the two leases represent 57,000 square feet and have seen good leasing activity at both locations. As of September 30, 2023, GenesisCare was the sole tenant in 5 of our properties and a tenant in 2 of our multi-tenanted properties, representing approximately 1.9% of our gross real estate properties, or approximately 62,000 square feet. Based on recent court filings, the GenesisCare bankruptcy timeline has been extended with the auction currently scheduled for today, November 1. We and our outside counsel continue to monitor the situation closely, and our asset management team is prepared to engage quickly as the bankruptcy process progresses. As it relates to our pipeline, the company has 7 properties to be acquired after completion and occupancy for an aggregate expected investment of $166.5 million. The expected return on these investments should range from 9.1% to 9.75%. We currently expect to close on these properties throughout 2024 and 2025. We continue to have many properties under review and have term sheets out on several properties with indicative returns of 9% to 10%-plus. We anticipate having enough availability on our credit facilities and through our banking relationships to fund our acquisitions, and we expect to continue to opportunistically utilize the ATM to strategically access the equity markets. To wrap up, we declared our dividend for the third quarter and raised it to $0.455 per common share. This equates to an annualized dividend of $1.82 per share. We are proud to have raised our dividend every quarter since our IPO. That takes care of the items I wanted to cover. So I will hand things off to Bill to discuss the numbers.

William Monroe, CFO

Thank you, Dave. I will now provide more details on our third quarter financial performance. I'm pleased to report that total revenue grew from $24.8 million in the third quarter of 2022 to $28.7 million in the third quarter of 2023, representing 15.8% annual growth over the same period last year. When compared to our $27.8 million of total revenue in the second quarter of 2023, we achieved 3.3% total revenue growth quarter-over-quarter. And on a pro forma basis, if the acquisitions we completed during the third quarter of 2023 had occurred on the first day of the third quarter, our total revenue would have increased by an additional $757,000 to a pro forma total of $29.5 million in the third quarter. From an expense perspective, property operating expenses increased by approximately $670,000 quarter-over-quarter to $5.5 million, primarily as a result of properties acquired during the period, but also due to seasonal increases in HVAC repairs and utilities expense caused by the hot summer months. General and administrative expenses decreased from $3.8 million in the second quarter of 2023 to $3.6 million in the third quarter of 2023. This decrease was driven by the one-time increase in employer Medicare taxes paid in the second quarter from the vesting of our former CEO and President's shares. Interest expense increased from $4.1 million in the second quarter of 2023 to $4.6 million in the third quarter of 2023 due to the increase in borrowings under our revolving credit facility to fund acquisitions as well as slightly higher interest rates under our revolving credit facility during the quarter. Moving to funds from operations. FFO increased from $13.8 million in the third quarter of 2022 to $15 million in the third quarter of 2023, or 8.9% growth year-over-year. FFO decreased from $15.9 million in the second quarter of 2023 to $15 million in the third quarter of 2023, and on a per diluted common share basis over these periods, FFO declined from $0.62 to $0.58 per share. But it is important to remember, our second quarter 2023 FFO included a $700,000 or $0.03 per share net casualty gain from insurance proceeds received related to one property that was vandalized. Adjusted funds from operations, or AFFO, which adjusts for straight-line rent and stock-based compensation, totaled $16.4 million in the third quarter of 2023, which compares to $15.4 million in the third quarter of 2022, or 6.9% growth year-over-year. On a per diluted common share basis, AFFO was $0.63 in the third quarter of 2022 and also $0.63 in the third quarter of 2023. AFFO for the second quarter of 2023 was $16 million. So our AFFO grew by 2.4% quarter-over-quarter. And finally, on a pro forma basis, if the acquisitions we completed during the third quarter of 2023 had occurred on the first day of the third quarter, AFFO would have increased by approximately $443,000 to a pro forma total of $16.9 million or $0.65 per diluted common share. That concludes our prepared remarks. Joe, we are now ready to begin the question-and-answer session.

Operator, Operator

At this time we will take our first question, which will come from Connor Mitchell with Piper Sandler.

Connor Mitchell, Analyst

So you guys have done a great job of finding your compensation with all stock. But just thinking about as you hire new talent for the company going forward, can you provide any updated thoughts on how the mix of cash versus stock compensation would look? And then how might that impact G&A given the all stock was, I believe, a 2x multiplier versus cash without the multiplier?

David Dupuy, CEO

Connor, thanks for the question. I hope all is well. So as it relates to cash versus stock mix, we are in the process now of working with the Compensation Committee and the Board to look at, along with our compensation consultant, to evaluate the need for compensation. And that process is ongoing. So I can't give you any guidance on that yet, Connor. I think it's safe to say that there will be some mix of cash and stock going forward. But again, we're in the early stages of evaluating how that's going to work and what that's going to look like. And we're just, at this point, not prepared to disclose any details on that. And my guess is, at some point in the next, I don't know, 6 months or so, that will be disclosed.

Connor Mitchell, Analyst

Yes, of course, of course. And then maybe looking at a different topic. The build-to-suit opportunity, given what's going on in construction lending and banks pulling back, do you see maybe some weakening from the core group of developers and the merchant and entrepreneurial developers? And then along with that, would you guys be comfortable stepping in to maybe fund some developments? Or would you rather let the developments take place and then acquire once it is leased up and stabilized?

David Dupuy, CEO

So what I would say is, we have a core group of banks that we've worked with for years that actually like to go in, fund these development projects with our takeout upon certificate of occupancy. And even though there's some level of pressure we've seen broadly within the banking community, those types of deals continue to work for the banks that have done business with us in the past. As far as your second question, would we be open to doing some of those development projects or funding some of those development projects ourselves? We would certainly take a look. I think our preferred vehicle is for our bank partners to fund those projects, and then have us take those projects out. There's no question just given the overall cost of debt, those projects have become a little bit more expensive for our development partners. And I think they're working with their lenders and, frankly, their construction budgets to make sure that they can develop projects more quickly and more efficiently to help counteract the increase in debt. But with the folks that we're working with now, we haven't seen a significant change. Obviously, we're looking at that very closely. And if things evolve or change, we can adapt as well. But our preferred method is to work with our partner banks, and that's kind of what we intend to do going forward.

Operator, Operator

And our next question will come from Rob Stevenson with Janney.

Robert Stevenson, Analyst

Dave, where was the coverage on the two rejected GenesisCare assets versus the remaining assets? Just trying to get a feel for if there was a major difference between the profitability of those two centers and the others?

David Dupuy, CEO

Yes. This gives me a chance to take a step back and describe the two facilities. In Asheville, as we mentioned in our last call, we encountered the first lease rejection because we were in the process of terminating the lease with the tenant, who had chosen not to continue services at that site. We were not surprised that the lease was rejected as part of this process, although we were disappointed that the termination and settlement were not resolved beforehand. So, as for Asheville, they were not offering care at that facility at the time. The other location in Fort Myers was primarily an administrative space for GenesisCare. We are disappointed that this lease was also rejected, but again, it was not entirely unexpected given the circumstances. The remaining leases we hold are all for clinics that provide cancer care to patients, which we believe are more stable than the others. However, we do not receive financial statements on a center-by-center basis, so I can't provide coverage levels for you.

Robert Stevenson, Analyst

Okay. How confident are you in re-tenanting those two assets and any others you might get back compared to selling them vacant and moving on? How are you managing those options?

David Dupuy, CEO

Well, as I said in the prepared remarks, we're getting good leasing activity at both the Asheville and Fort Myers locations. So we're actively looking to re-lease those spaces. So we feel good about those. We have also done market studies at the other locations just to determine kind of what the market rents are. And I think our teams feel very good about being able to move quickly to re-lease those spaces to the extent we need to. But we also have done some views and made sure that those tenants are actually providing health care in those locations, and they are. And so our hope and our expectation is whoever the next buyer is for these assets, those leases would continue to move forward under the new ownership.

Robert Stevenson, Analyst

Is there anything in particular about the Fort Myers asset that lends itself to medical back office? Or could that just as easily be tenanted to a law firm or a financials firm or some other sort of non-medical tenant that then would not probably fit with your portfolio long term?

David Dupuy, CEO

Yes, we are considering all options regarding that. Ultimately, depending on the end user, we might determine that it isn't the right fit for our portfolio. However, we are certainly engaging with various types of users. There is nothing inherently special about it being in the health care sector, even though we are in discussions with both potential health care tenants and other types of tenants.

Robert Stevenson, Analyst

Okay. That's helpful. And then while we're on the subject, any other sort of watch list tenants of note that you're focused on that are becoming more delinquent or that you're worried may not meet their rent obligations over the next quarter or two?

David Dupuy, CEO

We have a watch list that we actively manage, and it typically includes around 8 to 10 tenants at any given time. While the names may vary, we don't see any significant concerns related to specific sectors. It's a normal part of the real estate business to handle some delinquent tenants. Overall, our receivables are in excellent condition, and we feel confident about our position with our tenants. Nothing substantial has changed in the past quarter or two.

Robert Stevenson, Analyst

Okay. And then last one for me. Bill, how are you thinking about debt financing over the next 6 months? Is it just fund on the line and leave it there? Is there some other debt, be it term loans or some floating to fixed swaps that's attractive to you today that you would put in place over the next quarter or two to push the term out and replenish the line? How should we be thinking about that?

William Monroe, CFO

With our revolver balance currently outstanding at the end of the quarter at $48 million, we have $102 million of availability under that revolver. And so I think, certainly, over the next 6 months, we will look to continue to use our revolver as our primary debt financing mechanism and certainly appreciate the support of all of our banks in that facility. So nothing on the near-term horizon. But certainly, we continue to monitor the debt markets. Our next maturity isn't until 2026, and so feel fortunate that there's no near-term maturities. But certainly, we will continue to monitor the markets. And if there is an opportunistic opportunity to further extend maturities, we certainly will look at that.

Operator, Operator

Our next question will come from Wesley Golladay with Baird.

Wesley Golladay, Analyst

I just wanted to follow up on the plan for Genesis. It looks like you have some action to re-lease the space, but maybe talk about your long-term plans for this asset? Would it be to lease it up and sell it? And just curious if this was part of a bigger deal, and if that's how you got the back-office space in the first place?

David Dupuy, CEO

Thank you for the question, Wes. Yes, this was a portfolio acquisition that the company made around December 2020. As part of a portfolio, sometimes you acquire an asset that you might not typically pursue if it were a standalone. This is true for the asset in Fort Myers. Our primary focus as a firm is on health care-related assets, and it's well-known that this is our business focus. If Fort Myers doesn't align with that focus in the long term, we may consider selling that property. We're open to all options. We're currently seeing positive activity at both locations. While good activity doesn't guarantee immediate leases, we believe both are appealing in their markets. We hope to secure leases quickly. However, back-office space for health care providers isn't a priority for us, and we wouldn't have made that acquisition if it weren't part of a larger transaction.

Wesley Golladay, Analyst

Got it. Yes, that all makes sense. How have your conversations changed with potential sellers with the recent rise in interest rates? Have they changed at all?

David Dupuy, CEO

Yes, from an activity perspective, it's been encouraging. We're observing increased engagement in the marketplace. Capital is crucial, as everyone on this call is aware, and it holds significant value for us as well. We're optimistic about the discussions we're having with potential sellers and believe this activity will lead to promising acquisition opportunities. We're experiencing strong engagement on both sides of our business. As is widely known, we're assessing assets represented in the brokerage market while also having productive conversations with potential client companies. Although these discussions haven't yet resulted in specific purchase and sale agreements, we feel that the positive dialogues are a good sign for our acquisition efforts moving forward. Additionally, due to the current high interest rates, competition from smaller buyers, such as those engaged in 1031 exchanges or other smaller real estate funds, has become more challenging, making it harder for them to secure financing in this environment. As an all-cash buyer, we believe we have a substantial advantage in the marketplace right now, allowing us to be selective, and we're identifying a lot of promising opportunities.

Wesley Golladay, Analyst

Got it. And can you give a clarification? When you set the cap rates, they always have a typical range, is this due to nondisclosure reasons, or is there something that can actually change the actual cap rate at the time of the deal is finally closed?

David Dupuy, CEO

Yes. What are you referring to specifically, Wes?

Wesley Golladay, Analyst

Can you provide a range for the cap rates? You mentioned having $166 million in deals at a certain range for the cap rate rather than a specific figure. Is there a reason you can't share more precise information, perhaps because the seller prefers to keep the official cap rate undisclosed? I'm trying to understand what factors might lead to the variations you mentioned.

David Dupuy, CEO

That is a range of cap rates based on the purchase and sale agreements we have. They range between 9.1% and 9.75%. Some are at the higher rate and some are at the lower rate. We just don't specify which are which.

Operator, Operator

Our next question will come from Jim Kammert with Evercore.

James Kammert, Analyst

Just to double check, the remaining leases with Genesis, talking between the second and third quarter supplements, it's about 2.8% of ABR. Does that sound about right?

David Dupuy, CEO

I think the remaining leases consist of 7 leases that represent 1.9% of our gross real estate properties. Is that your question?

James Kammert, Analyst

No, I was ABR average base rent is about 2.8% of rents.

David Dupuy, CEO

I'm not sure we've disclosed that amount. I have to look.

James Kammert, Analyst

That's fine. I will do that. Regarding the companies on the watch list, I'm curious about how much of the ABR is covered by either unit-level or a combination of parent or guarantor financial reports. How do you assess and maintain the watch list, and identify which tenants may be potential problems?

David Dupuy, CEO

The watch list is created based on tenants who may be delaying payments or making special requests regarding their leases. The situation varies because we have over 260 tenants, making it difficult to provide a general overview of the specific issues involved. Most of these tenants are in our multi-tenant buildings, which account for a small amount of square footage. We are very focused on maintaining communication and resolving any issues. For smaller tenants in these buildings, we typically do not receive their financial statements. However, if there are issues with a larger tenant, we may have access to their financial statements for discussion. Overall, it is challenging to generalize the situation, but most discussions with tenants on the watch list involve those that occupy less space and do not provide substantial financial information. They are usually smaller tenants in the medical office buildings we manage.

James Kammert, Analyst

No, that's fair. I appreciate it. I wasn't. But what percentage of ABR is covered where you actually do get reported financials? I mean is 50% of the tenant ABR, do you receive financials for that amount or less or more?

David Dupuy, CEO

I've never calculated that amount. I don't have a good answer for you.

Operator, Operator

And with no remaining questions, we will conclude the question-and-answer session. I would now like to turn the conference back over to Dave Dupuy for any closing remarks.

David Dupuy, CEO

We really appreciate the questions. We appreciate everybody on the phone and look forward to talking to everybody again in the new year. Thank you.

Operator, Operator

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