NHI ‘Relieved’ as 9 Properties Get New Operators, Acquisition Pipeline Grows

National Health Investors (NYSE: NHI) is pivoting to focus on acquisitions after a busy quarter that included nine distressed senior living properties transitioning to new operators.

“Transition properties can be distracting to our normal investment activity, so our rapid repositioning means we’re back to making accretive investments full time,” NHI CEO Eric Mendelsohn said Tuesday on the Q1 2019 earnings call for the Murfreesboro, Tennessee-based real estate investment trust (REIT).

The good news is that the pipeline of potential acquisition opportunities is robust, and the operator transitions did not significantly dampen first-quarter financial results, NHI executives stated on the call.

NHI posted normalized funds from operations (FFO) of $1.31 per share for the first quarter, which was slightly below analysts’ consensus estimates and down 3% year-over-year. Its adjusted funds from operations held steady year-over-year at $1.22 per share.

The nine operator transitions come on the heels of a rent reduction that NHI announced last January, involving a 25-property independent living portfolio operated by Winter Park, Florida-based Holiday Retirement. Through all these challenges, NHI has continued to keep its eye on the ball and make acquisitions — including a recently announced $10.8 million assisted living deal in Michigan — company leaders emphasized.

“We’re greatly relieved and proud of our performance this quarter,” said Chief Accounting Officer Roger Hopkins.

New operators in the mix

In total, NHI’s portfolio encompasses 232 facilities in 33 states, including 151 senior housing properties. The nine distressed buildings therefore make up a small proportion of the REIT’s investments, but these properties have been on the radar for several months as their performance deteriorated, they fell out of compliance with lease obligations, and began to weigh on earnings.

Five of the buildings are memory care communities that were leased to Dallas-based LaSalle Group and operated by Autumn Leaves, a management company under the same ownership as LaSalle.

During NHI’s Q4 2018 earnings call, Mendelsohn noted that LaSalle had fallen out of compliance with lease provisions and was behind on rent. Last week, LaSalle voluntarily filed for Chapter 11 bankruptcy protection, facing lawsuits from financial institutions, vendors and other entities, including NHI.

On April 16, the five NHI buildings transitioned from Autumn Leaves to a new operator, Chancellor Health Care. NHI already leased seven properties to Windsor, California-based Chancellor, which has a particular expertise in memory care, Mendelsohn noted. The seven communities were 94% occupied as of March 31.

Overall, Chancellor operated 11 communities prior to stepping in on the Autumn Leaves properties, and the company is embracing this as an opportunity to expand, Mendelsohn said. As of March 31, the five Autumn Leaves buildings had an average occupancy of 74.7%. They are generating cash flow above operating expenses but not enough to meet lease obligations, and so NHI at the moment is receiving 95% of cash flow, after management fees, pending stabilization.

These properties are located in Texas and Illinois, and NHI likes the underlying real estate and believes the markets — though experiencing some supply pressures — are sound. This is why the REIT has chosen to change operators rather than sell the buildings, despite the related challenges and financial burdens, executives said.

The same holds true for the other four buildings that have been transitioned to new operators. Three of these — known as the Regency portfolio — were formerly managed by affiliates of East Lake Capital Management. NHI and East Lake have been grappling for months over the fate of these buildings, including via legal claims and counterclaims that culminated in Regency vacating the facilities in December 2018.

One of these buildings, a 135-unit property Tennessee, is now being operated by Nashville-based Vitality Senior Living, a new partner for NHI. The REIT is receiving 95% of operating cash flow currently.

A Regency building in Charlotte, North Carolina, has been closed and is undergoing significant renovations. NHI has committed $3.1 million toward these upgrades, and anticipates that work will be completed in June 2019. Senior Living Communities is slated to operate. The Charlotte-based operator is NHI’s largest tenant, accounting for 17% of total rental income.

SLC is also temporarily operating the third Regency community, located in Indiana, but NHI is currently working on an agreement to bring in a different, permanent operator.

Finally, a 120-unit property in Wisconsin formerly operated by Landmark Senior Living now is being operated by BAKA Enterprises, another new operator in the NHI fold. BAKA is based in Appleton, Wisconsin and has a portfolio of 12 buildings in that state and Texas.

The current plan is to eventually put these nine properties into triple-net leases, although it’s too early to project what the terms of those leases will be, Mendelsohn said.

Acquisitions in the works

Looking ahead, NHI is eager to ink accretive deals. There has been a “large influx of activity” with most potential transactions being in private-pay senior housing, Executive Vice President of Investments Kevin Pascoe said on Tuesday’s call.

Historically, the firm has been focused on smaller deals rather than large portfolios, but is seeing variety in the pipeline and is open to any transaction that makes sense, he added.

Considering that NHI has not updated its guidance despite the pressures from the distressed property transitions, the company’s leadership likely believes they can do another $75 million to $150 million in acquisitions this year, Stifel analyst Chad Vanacore wrote in a note on the earnings results.

Currently, a few deals are past the letter-of-intent stage and are in due diligence, but there are no fully baked transactions to announce at the moment, Mendelsohn said Tuesday.

Some disposition activity is also in the works, with two buildings currently listed for sale. These buildings are operated by Bickford Senior Living, NHI’s largest assisted living tenant.

NHI also has a portfolio of nine communities operated by Brentwood, Tennessee-based Brookdale Senior Living (NYSE: BKD), the largest provider in the country. These properties have lease coverage of less than 1x EBITDARM, KeyBanc analyst Jordan Sadler observed in his note on the earnings.

Brookdale has an option to purchase these buildings at a fair market rate next year and has indicated it is likely to do so, Mendelsohn said. So, NHI likely will receive a cash payment that can be reinvested and also has a sizable deposit on these communities.

Rent coverage for Senior Living Communities deteriorated from 1.28x to 1.18x on a quarter-over-quarter basis, raising a flag for Capital One analyst Daniel Bernstein. NHI management attributed this to lumpiness related to SLC’s entrance fees. Bernstein noted that coverage for Bickford and Holiday remained stable and coverage for National HealthCare Corporation (NHC), another major tenant, improved.

NHI’s operators are subject to the supply and labor market headwinds that have affected the industry at large, which are weighing somewhat on coverage, Mendelsohn said. Operators such as Bickford are taking steps to keep occupancy up and expenses in check, and NHI is supporting these efforts, he added.

Overall, Mendelsohn echoed Hopkins’ relief that the operator transitions are underway and expressed that he is pleased with how NHI has executed during this period.

“It’s been heroic efforts to get back to even,” he said.