Earnings Call: Q2 2020

Aug 24, 2020

Good morning, ladies and gentlemen, and welcome to the Northwest Healthcare Properties Real Estate Investment Trust Second Quarter 2020 Results and Conference Call. At this time, all lines are in a listen only mode. Following the presentation, we will conduct a question and answer session. This call is being recorded on August 24, 2020. I would now like to turn the conference over to Paul Della Lana. Please go ahead. Thank you, operator, and good morning, everyone. I appreciate you joining us today. I'm joined by Bernard Claret, the REIT's President Shailen Chande, the REIT's Chief Financial Officer and Peter Riggon, the REIT's Chief Operating Officer. Together, we are pleased to share with you our results for the Q2 of 2020. But first, I'd like to point out that during today's call, we may make forward looking statements as defined under Canadian Securities Law. While such forward looking statements reflect management's expectations regarding our business plans and future results, they are necessarily based on assumptions that are subject to uncertainties and risks, which could cause actual results to differ materially. We direct all of you to the risk factors outlined in our public facts. The defensive nature of the REIT's healthcare real estate portfolio that is 97.3% occupied with more than 80 percent of revenues provided directly or indirectly by public health care funding has resulted in the REIT's operating results and portfolio valuations not being significantly impacted by COVID-nineteen. During Q2 2020, 97.6 percent of the REIT's revenues on a proportionate ownership basis were either collected or subject to formal deferral arrangements. And results for July 2020 are broadly consistent with these figures. The REIT's deferral arrangement span 379 tenants, representing approximately 4% of annual gross rent, with the majority of the arrangements in the REIT's Canadian and Australasian portfolios. During the quarter, the REIT did not recognize any significant provisions for uncollected rent and expects outstanding rent to be fully collectible. The impact of COVID-nineteen continues to affect countries unevenly, with some countries progressing through Phase 3 openings, while others struggle to control the wave of the pandemic. Nonetheless, signs of a return to normalcy are beginning to emerge, as evidenced by the restart of elective surgeries in most of the REIT's global markets. That said, significant backlogs have built up over the course of the pandemic, with one estimate pegging the global backlog of surgeries at more than 28,000,000 basis. In the UK alone, waiting lists have grown by more than 4,000,000 people to 8,000,000. And in Australia, approximately 500,000 people were added to waiting lists. As a result, we believe that pent up demand exists and it will spur a strong recovery for the healthcare industry and by extension healthcare real estate. Specifically, as it relates to our hospital operators, we believe they are well positioned to participate in increasing volumes to alleviate this backlog. Similarly, many of our tenancies in our medical office buildings are expected to see increased volumes in the months ahead, given the nature of the essential services with relatively inelastic demand that many of them provide. Before touching on transactional items, I wanted to announce the appointment of Craig Mitchell, currently the REIT's Chief Executive Officer of Australasia to the role of President. He will replace Bernard Crotty, who is retiring from the REIT after 15 years of leadership, most recently through its Vital Health Care Trust subsidiary, where he will continue as a Northwest representative on its Board. In addition to support accelerating growth in Europe, the REIT has hired Tim Blackwell as Executive Vice President, Funds Management and Marco Mosselman as VP and Country Head Netherlands, both new positions within the REIT's management team. Additionally, the REIT is also announcing the appointment of Ms. Stephanie Kingsmill to its Board of Trustees effective September 8. Ms. Kingsville is an experienced executive who has served in a wide range of roles in the insurance, asset management and real estate business of Manulife Financial Corporation. Amongst her roles at Manulife, she was Executive Vice President, Human Resources for the company's global workforce. Additional experience that is valuable to Northwest at this time of ongoing international expansion. Ms. Kingsmill was named 1 of the 100 Most Influential Women in Canada by the Women's Executive Network. She holds a Bachelor of Commerce degree from Queen's University and has her ICD designation from the Institute of Corporate Directors. She will replace Doctor. David Naylor, who will resign concurrently from the Board to focus on a number of urgent public health initiatives related to COVID-nineteen pandemic after almost 7 years of service to Northwest and its predecessor entities. On behalf of Northwest, we welcome Ms. Kingsville to our Board and wish Doctor. Naylor and Mr. Crotty success in their new endeavors, noting their many contributions to the growth and success of the REIT over the past years. During and post quarter end, the REIT also made notable progress on its long term strategic priorities, including the acquisition of a strategic U. K. Hospital portfolio. On August 21, 2020, the REIT completed a $452,000,000 acquisition of our portfolio of 4 hospitals located in Greater London, England. The properties are 100% leased on a long term inflation index basis to Aspen Healthcare, a leading English hospital operator. The London portfolio was acquired at a 6.2 percent going in capitalization rate and funded with $223,000,000 term loan and a $125,000,000 expansion of the REIT's revolving credit facility in addition to existing resources. The addition of the London portfolio is strategically important as it increases the scale of the REIT's U. K. Portfolio to more than $620,000,000 and positions it for further growth in partnership with the region's leading healthcare operators. It also diversifies the REIT's U. K. Operator mix and brings its focus into major UK health care markets. And lastly, it provides the REIT with an attractive portfolio with which to seed future U. K. Joint venture, which is a priority for the business. During the quarter, we also advanced our European joint venture. And in conjunction with our previously announced €3,100,000,000,000 European JV initiative, the REIT entered into a binding agreement subject to regulatory clearances with GIC, Singapore Sovereign Wealth Fund, to pursue pan European healthcare real estate opportunities together. We are pleased to be expanding our partnership with GIC into Europe. The joint venture will benefit from a high quality initial portfolio and leverages NorthWest's significant regional presence with a goal to building the leading pan European healthcare real estate platform. We also completed strategic asset sales previously identified. And year to date, the REITUS completed 3 of its 4 key initiatives, generating more than $130,000,000 in net proceeds, while adding $273,000,000 of fee bearing capital. During the quarter, the REIT advanced the remaining disposition transaction, namely the sale of 70% of its $470,000,000 German and Dutch triple net portfolio, which will be used to seed the European JV. The seed portfolio has been expanded by $196,000,000 to include an additional 5 assets in the Netherlands and is expected to close in Q3 2020 subject to customary closing conditions. And lastly, deleveraging. With the acquisition of the London portfolio expected to temporarily increase the REIT's leverage, REIT remains committed to deleveraging strategy and achieving investment grade credit metrics through its target proportionate leverage of 45% and net debt to EBITDA ratio of 8x over the next 12 months. For the quarter, our results were in line with our expectations, noting the above deleveraging, including annualized quarterly funds from operations of $0.92 per unit on a normalized basis, implying a payout ratio of 87%. Earnings accretion from recent investment and financing activity was as expected, although foreign exchange movements saw the Canadian dollar appreciate by approximately 3.7% over the last quarter relative to the REIT's average foreign currency exposure, which continues to impact earnings. In fact, over the last 12 months, we estimate the relative strength of the Canadian dollar has reduced annualized AFFO by approximately $0.05 per unit. In the context of a lower for longer Canadian interest rate environment, we expect these trends may begin to ease and NOI in 2020, providing a tailwind to the REIT's future earnings. Net asset value decreased by approximately 1.2% to $12.37 per unit, driven again primarily by a higher Canadian dollar relative to the REIT's foreign currency exposure, with property values largely stable. In terms of liquidity, the REIT is well positioned with $84,000,000 of cash and available credit post the closing of the UK acquisition and pro form a the completion of the European seed portfolio sale, which is expected to close in the Q3. This is expected to increase to more than $350,000,000 as the REIT cedes its current UK portfolio into a future UK JV. The REIT has also completed repayments or renewals in respect of all 2020 maturing debt obligations on favorable terms and is now taking proactive steps to refinance normal course 2021 maturing facilities. Operationally, our results, which are derived from an expanded 183 property, dollars 6,600,000,000 healthcare infrastructure portfolio, tenanted with leading operators, primarily on long term inflation index leases, were on plan. Inherent strengths of the portfolio were reflected in the REIT's Q2 2020 year over year source currency cash recurring SPI NOI growth of 2.9%, largely driven by contractual rent indexation and underpinned by a 97% occupancy rate and a weighted average lease term of more than 14 years. In all regards, a highly defensive portfolio. Segmentally, I note the following. Our 8 hospital properties in Brazil, 7 of which are tenanted by industry leading Rigidor, have continued to operate, but with adjustments for COVID related activity as the major cities in Brazil deal with a challenging COVID environment. The REIT is also focused on gaining traction with additional high quality operators in Brazil and sees a very constructive market in that regard. The Canadian MOB portfolio was impacted by COVID-nineteen to varying degrees as some services, such as non emergency dental and physiotherapy were temporarily suspended because of government and or industry mandated shutdowns or by physician distancing guidelines. But the majority of tenants either continue to offer services in their premises or provided government funded virtual care either from their premises or remotely. Approximately 11% of the tenants were granted rent deferrals, which were typically for the equivalent of 2 months of gross rent and have an average repayment period of 8 months. In exchange for the deferral, approximately 50% of tenants agreed to lease extensions. In aggregate, the REIT granted rent abatements that totaled less than 1% of the region's gross rent. In the majority of these cases, tenants agreed to extend their leases by an average of approximately 32 months in exchange for any abatement. Leasing activity in Canada has remained robust with 89% 54% of the region's annual budgeted renewal and new leasing activity, respectively, completed. This level of activity resulted in a 91% effective renewal rate for the quarter. Occupancy for the region was on plan at 92.3%. In Europe, our hospital tenants and large clinic operators have performed well. In Germany, the government provided financial incentives for the conversion of some facilities or a portion of facilities for COVID related demand that took effect at a number of our properties. The postponement of elective surgeries and the curtailing of certain rehabilitation services resulted in select clinics in Germany and the Netherlands experiencing reduced patient demand, resulting in short term rent deferrals being granted, but generally with short term repayment plans. No such deferrals were granted to our U. K. Hospital operators where most private hospitals, including ours, had their capacity requisition and paid for by the National Health Service or NHS, so they could provide bed supply to help the NHS manage healthcare needs during the pandemic. That arrangement has been extended until at least October 31, with the government recently announcing an additional £10,000,000,000 investment towards reimbursing private operators to provide care in the years ahead in order to relieve pressure on long waiting lists that have swelled during the pandemic. In Australia and New Zealand, to varying degrees, governments also secured access to many private hospital beds, again providing underlying financial support to most of our operators while their revenues were curtailed with fee postponement of certain care, especially elective surgeries. In some cases, that support was insufficient, so we have entered into short term rent for all arrangements. However, even in these cases, a majority of rent was still collected each month. Across the REIT's global markets, all of our properties have remained open and operational during the pandemic. Because the effects of the pandemic are uncertain, there can be no assurance that there will not be any further disruptions to our tenants in the future. However, based on the resiliency today, we are confident that the portfolio is well positioned to continue to perform even in these challenging times. I'm pleased with the progress made during the quarter, which advanced a number of the REIT's key long term strategic objectives and also produced solid operating results despite the disruption and conflicting priorities caused by the COVID-nineteen pandemic. With deep relationships, best in class regional operating platforms and strong access to public and attractively priced private capital, the REIT is well positioned to continue executing on its strategy. We have almost $5,000,000,000 in capital available in our JVs to pursue new opportunities as they arise and expect to find both generational and opportunistic possibilities over the balance of 2020. I'll now ask the operator to open up the call for questions. Thank you. Your first question comes from Tal Woolley at National Bank. Please go ahead. Hi, good morning everybody. Good morning, Tal. Just wanted to ask on the fee line this quarter. So like from your disclosures, you've billed about $11,000,000 in the first half, and you sort of continue to dive into that $35,000,000 run rate. So should we be expecting that fee income to significantly increase in the back half of the year? Hi, Tom. It's Paul here. Yes, I think that's right. The major difference in the a little bit the first, but more the second quarter to prior years was slightly less transactional activity. And obviously, with the completion of our European JV and the related tea portfolio as well as plans for our UK JV likely expected through the balance of the year, we do see meaningful activity levels coming. So I think a lot of that already booked and planned as well as some pretty near term items that we expect to add to the mix. So very much yes. Shailen, I don't know if you'd add anything to that in terms of more precision. Yes, Paul, I think that's fair. The other comments I'd add there is you would note that on a year to date basis, the proportion of base fee income has actually increased quite materially and really coming out on the back of significant deployment of capital in the latter end of 2019 early 2020. As we look forward through the remainder of the year, we expect that activity based income to start to restore to 2019 levels. Okay. And then on Page 30 of your investor update presentation, you sort of outlined how you come to you sort of do you provide a chart breaking down how you see the valuation of the manager changing for the $275,000,000 in Q2 2019 to pro form a all of the future transactions on the count to about $725,000,000 Can you walk through how you arrived at the $725,000,000 What sort of evaluation approach that you're using to get there? Yes, Paul, happy to jump into that if you'd like. Please. Great. Okay. Yes, Tal, thanks for calling this out. And clearly, the growth of the asset our global asset manager has been a very significant component of the business over the last 12 to 18 months. If we look back about a year ago at Q2 2019, the business had about $3,500,000,000 of committed AUM into JV or into JV initiatives and that was underlying the $275,000,000 valuation pinned on about $35,000,000 of stabilized fees. As we look through our Q2 2020 valuation, which I'd highlight is $525,000,000 that's really a function of very substantial increase in AUM year over year from that $3,500,000,000 to about $8,400,000,000 of committed facilities today in respect to both our Australian core hospital JV, our investment and the Vital platform as well as the European JV of $3,100,000,000 So the real growth in the year over year in that valuation has been driven by underlying increases in AUM and an increase in stabilized freeze from about $35,000,000 to $60,000,000 As I look through the valuation metrics that we think about that underpin that $525,000,000 valuation and the $8,400,000,000 AUM, It's really looking at our stabilized fees, applying, I'd say, a market based EBITDA margin against those fees, we'd estimate to be between 60% 70%. And then valuation multiple that we believe is conservative in the context of perpetual JV relationships in the range of 13 to 15 times on the multiple side. So that gets you to the current valuation of $525,000,000 dollars The further growth to $725,000,000 that you called out is really layering in, I'd say, the term initiatives that we've spoken to both around expanding our existing and potential new Australian JV relationships And then also growing leveraging our current portfolio in the U. K. Into a broader U. K. Healthcare fund. So we do see path over the near term of growing our AUM from $8,500,000,000 to about $12,000,000,000 and thereby increasing related fees and EBITDA to drive that further $200,000,000 of growth. Okay, great. That's helpful. And then just on your collections too, just to make sure I'm comparing these right to some of the other names I cover. So you quoted a 97% -ish collection rate that was taking deferrals into account. So if I think of like as a percent of build rent, it looks like it might be around 93. Does that square with your math? Shailen or Peter, did you want to speak to that? Yes, Tal, I can take that at a high level. Yes, it does. In terms of our overall quarter cash collections, if you want to think about it that way. We came in just over 90% and then with about 3% or 4% attributable to deferral arrangements on a consolidated basis, which as we know in Paul's introductory remarks relate very primarily to the Canadian and Australasian portfolios, where we've engaged with 3 79 tenants or so, representing 4% of gross rent in formal deferral arrangements. Okay. And then I guess you talked about wanting to take advantage of generational or opportunistic deals that could materialize through this period, safe to say that we should be expecting the majority of your acquisitions going forward to really come via the joint venture or should be fed through the joint ventures and that you're probably not going to be taking 100% of assets onto your own balance sheet that much going through this period. Is that the goal here? Correct. Yes, that's very much the plan. And has there been any thought to like Canada sort of the only place where you're not running JVs like this? Has there been any thought to like maybe employing the same strategy you've employed around the world with the Canadian assets? Yes. So a lot of thought, I think. As you all have noted, I think we have prioritized Europe, I think, very much coming into the year. And so certainly, now the Europe and U. K. Is our near term focus. But I think as we look down the line, we see this model being suitable in all geographies. And so certainly, as we start to think about the Americas, which is the only geography now without any JV arrangements, it will be very much a key focus for us in 2021. Okay. That's great. Thanks very much, gentlemen. You're welcome. Thank you. The next question comes from Chris Couprie from CIBC. Please go ahead. Good morning. Just following up on Tal's question regarding the kind of the generational opportunities. I'm assuming you're talking about Europe. Is that right? And then just in terms of if we try to think about how competitive that process might be, given the success you and others have had in this kind of area, are there any more people looking at this space? So a couple of things. I think we see opportunities in really generational ones coming around the world. I would just say that our focus to the earlier comments will be to leverage our existing JVs, which are both in Australia, New Zealand and now broadly across Europe. So I think we see good opportunities in all of those markets and certainly generational ones with our existing operating tenants and partners starting in each of those markets. So just call that out for a level of precision. I think to pay hold on themes, Chris, that we've mentioned earlier, I continue to see healthcare as coming relatively well positioned through this difficult moment. So our view is that if we look more broadly into real estate asset classes that there are a number of them that have significant challenges and certainly mid to longer term implications in front of them. And so when we talk to our investment partners thinking about new healthcare real estate opportunities, it screens really well and we've seen that with GIC most recently, but there are a number of active discussions that we're having with other partners that build on those themes. So I would think that if that's representative, yes, there are meaningful institutional partners and other types of capital investors starting to more seriously consider the asset class. I think that's not necessarily an entirely new theme, but one that's accelerating. But I think whether many of those investors or even in some cases competitors lack our scale or the operating platforms that we have to be able to or relationships that we have to be able to deploy capital in the many ways that we do it. So, while I think there's going to be more capital formation into healthcare real estate, I think we're still pretty well positioned to be able to offer the services and scale and the relationships to be able to execute well in each of our markets. So that would be a quick answer to it. But for sure, we are seeing the themes of healthcare real estate screening very positively across the market. And the good news is, we're in big markets where there's lots to do and we don't have to do everything to have meaningful opportunities. I'd call out, for example, Australia, where in our core JV, we've invested 2.5 $1,000,000,000 over the last 18 months with our partner there, and we see a very similar trajectory looking forward as an example, and we've got committed capital to do that. So those would be the general themes. And then now with Europe coming on and certainly with a pan European mandate in front of us, we see many, many opportunities in each of our core markets and we'll start to look at a number of adjacent markets as well. The UK as an example, we've just added to the mix in 2020 and already we have a sizable portfolio there and sizable set of relationships that I think offer the ability to build on. So those are themes that we're focused on as we look down the line. But yes, the big trend for sure is that I think as an alternative asset class maybe perhaps becoming mainstream, we're starting to see healthcare screen pretty positively across the investment universe out there and so lots of people thinking about it. Okay. Thanks for the color. And then just 2 quick ones. Number 1, the upsizing of the European seed portfolio. Can you just maybe talk to kind of how that timing came about? And then just second, just from a maintenance perspective, the sequential change in the Canadian NOI, is that basically all parking revenue? Okay. So, 2 quick themes. To the European JV, yes, so very much building on my earlier comments. Our mandate broadened over the course of our discussions. And as we work through the market related, the market specific education and onboarding process, we agreed to add our Netherlands portfolio to the mix, which is quite complementary to the original German portfolio that we had identified. So that happened quite naturally. And I think really just builds on those bigger themes that I said that investors are looking for bigger and broader strategies, or at least the ones we're talking to. So it lined up nicely with what we were hoping to achieve. So I think that's specific to how that C portfolio grew. Timing is, I mean, we are in closing right now. So I think in reality, it's really just customary conditions, and we expect it to close broadly in Q3. Nothing exotic about that. So that's pretty much locked in at this point. Moving back to Canada, yes, the vast majority of the Q2 sort of revenue miss, if you will, was around that variable income stream, particularly parking and a small number of our tenants that are service oriented like cafes and other things. So I think not a surprise when for a period of time there wasn't as much activity happening in our buildings. That level of activity has already started to pick up significantly as things have started to reopen. And so we're seeing a very quick return to traditional levels certainly permanent dislocations in our Canadian portfolio or others in either Germany or Australia where we have multi tenant properties, they're fully back up and running at historical levels of activity. So we have pretty quick and sharp recovery. Thanks. I'll turn it back. Thank you. The next question comes from Saram Srinivas from BMO. Please go ahead. Good morning, Paul, Charlene and Barnet. I mean, first of all, congratulations guys. This is a tough quarter and you guys obviously accomplished a lot of things on a strategic initiative. So congrats on that. My first question is primarily on the London Hospital portfolio. Does portfolio have any brownfield opportunity in terms of development? Yes, I think development in London and expansion in London is always tricky. So certainly, there are a number of planned capital expansions that we're aware of. And I think we're just starting to get our EQ up around the operator and their plans and priorities going forward. But certainly, we could see and we've historically guided that sort of 5% to 10% of our portfolios typically are in some form of battlefield expansion. And I would expect that those metrics, again, subject to London planning, if you will, would be quite consistent. And as we are starting to see the emergence from some of the pandemic restrictions and in particular how the NHS is encouraging public capacity and all of the existing private capacity or public demand, I should say, and the backlog to be channeled through a number of our operators. We think that, that will add to that theme. So I think starting off, certainly that 5% to 10% expectation, which is consistent across our portfolio, is probably a good starting point, but we'll be working to refine that. And if anything, it might end up on the bigger side given that NHS moment and some of the backlogs and the plans to work through the private system as we see it. So those would be a couple of themes there. Thanks for the color, Paul. That was really great. I'm looking at the cap rate. I know like you guys disclosed it's about 6.2% on this and the broader portfolio, I guess, we're at about 6.5%. And I know you mentioned in the presentation that the market is around 5%. So when you do end up transferring this portfolio to the JV, would that be at market rate or would that be at the rates you acquired? Yes, very much at market. And yes, we do see some nice value creation opportunities into the portfolio. I think it's one of the reasons that we took the chance to invest at this moment in this specific portfolio, and those are certainly near term focuses for us as we see, again, all of these themes play out and certainly high interest in particular in London hospitals and the demand and opportunity trends there. That's awesome, Paul. And I think finally, probably going back to COVID-nineteen and the impact it's had on the MOP side, do you think it's going to probably have an increase in terms of like cleaning expenses or any pandemic related expenses that we should be providing for in the future? Yes. We do, of course. And I think we've been able to manage sort of between slightly lower activity levels, at least in the quarter and perhaps coming through the operating expense line to date with a plan that those will increase as we look through the balance of the year and into next year in order to accommodate for traffic flows. I'd call out though that the vast majority of our leases and the 99.9% of our revenue is on a net basis. And so even with slightly rising costs, most of them will be passed through to tenants as part of that. So obviously, delivering these things efficiently and for value is the area of focus for North West as we think about that. And we have a strong history, I think, in being able to deliver relative value through our operating business, which, as you know, is a very significant part of the Northwest platform with in house property and leasing and asset management amongst other things. So yes, we're quite focused on that and highest levels of throughput safely, I guess, as we exit sort of the COVID moment. Thank you. The next question is a follow-up from Tal Woolley at National Bank. Please go ahead. Hi. Just had a couple of quick questions about credit markets. I don't know, Shailen, perhaps you can speak to this. Any big changes in your various markets in terms of like credit availability from before the pandemic to after? Hi, Tal. Yes, I'd give you just a general comment to that, which would be no. I'd highlight that we were able to refinance all of our 2020 debt maturities as planned, I would say, in our initial budgets in a pre COVID environment. While we did at the early onset of the pandemic see credit spreads widen out a little bit, We found the availability to be the markets to be quite liquid. And if anything, spreads specifically post quarter end, we've seen tighten up to kind of where they were pre pandemic. And then obviously, in the broader backdrop in the macro environment with overall reducing base rates in, I'd say, every region globally. We've, if anything, seen a slight tightening of overall borrowing costs. Okay. And I think it was late last year, you were sort of starting to talk about targeting the ability to issue unsecured debentures. Can you talk at all about sort of where you stand on that process and what are the numbers you kind of think you need to hit on the balance sheet side for the rating you want to get? Yes. Thanks, Alan. I'd highlight that our strategy very much remains intact around achieving investment grade metrics. We view entry level into BBB low ratings around that sub-fifty percent loan to value. But perhaps more importantly, given the importance of management fee streams in our business, about 8x proportionate net debt to EBITDA. We'd highlight that as we progress throughout the year on our various initiatives, including the completion of the sale on the European UK JV and seeding of that portfolio, we very much see our metrics tracking to those two targets. In terms of where the discussions sit today, we're very much at the early stages of those discussions looking for our numbers to track a bit more tightly to those specific targets and then commence a more formal discussion. Okay, that's great. Thanks very much. Thank you. There are no further questions. You may proceed. Thank you, operator. I think that's all from NorthWest for this Q2 2020 conference call. So I wish everyone a good day. Thank you very much. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and we ask that you please disconnect your lines. Enjoy the rest of your day.