Good morning, and welcome to the Diversified Healthcare Trust third quarter 2022 conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Michael Kodesch, Director of Investor Relations. Please go ahead.
Good morning, and welcome to Diversified Healthcare Trust call covering the third quarter of 2022 results. Joining me on today's call are Jennifer Francis, President and Chief Executive Officer, and Rick Siedel, Chief Financial Officer and Treasurer. Today's call includes a presentation by management, followed by a question-and-answer session. I would like to note that the transcription, recording, and retransmission of today's conference call are strictly prohibited without the prior written consent of Diversified Healthcare Trust or DHC. Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based upon DHC's present beliefs and expectations as of today, Thursday, November 3rd, 2022.
The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission or SEC. In addition, this call may contain non-GAAP numbers, including normalized funds from operations or normalized FFO, EBITDA, net operating income or NOI, and cash basis net operating income or cash basis NOI. Reconciliations of net income or loss attributable to common shareholders through these non-GAAP figures and the components to calculate AFFO, CAD or FAD are available in our supplemental operating and financial data package found on our website at www.dhcreit.com. Actual results may differ materially from those projected in any forward-looking statements. Additional information concerning factors that could cause those differences is contained in our filings with the SEC. Investors are cautioned not to place undue reliance upon any forward-looking statements.
Now, I'd like to turn the call over to Jennifer.
Thank you, Michael, and good morning. Thank you for joining us on today's third quarter conference call. I'd like to begin the call by reviewing this quarter's highlights. Same property Cash Basis NOI in our office portfolio segment increased 4.7% year-over-year and 1.2% compared to the second quarter. While it was a challenging quarter in terms of shop segment expenses, on which we'll provide more detail shortly, our operators drove a meaningful improvement in shop occupancy compared to the second quarter, with an increase of 110 basis points for the total portfolio, representing our sixth consecutive quarter of occupancy growth.
We ended the quarter with over $800 million of cash and limited near-term debt maturities, providing us the liquidity necessary to continue with our plan to invest in our SHOP segment communities to drive this portfolio towards stabilization. Starting with our office portfolio segment, the 4.7% year-over-year same property Cash Basis NOI growth is indicative of the strength and quality of our Medical Office and Life Science assets and the leasing results we continue to achieve. Leasing velocity in the third quarter remained generally in line with our three-year quarterly average as we executed over 220,000 sq ft of new and renewal leases with average roll-up in rents of 2.4% and a weighted average lease term of 5.8 years.
Today, our weighted average lease term for the entire office portfolio segment is approximately 5.8 years. Only one tenant represents more than 3% of annualized revenue in this segment. Advocate Aurora Health represents approximately 7.7% of the office portfolio segment's annualized revenue and has a remaining lease term of over nine years. From an operating expense perspective, over 90% of our portfolio of Medical Office and Life Science assets have expense recovery structures in place where the tenants are responsible for increases in expenses either fully or over a base year, largely sheltering this segment's results from the current inflationary environment. We believe our combination of strong assets with high utilization rates, favorable lease structures, and tenant diversification is critically important in the current macroeconomic environment.
While same property occupancy decreased slightly during the third quarter to 90.2%, there was no significant vacancies driving this result. Our leasing pipeline now contains over 1.2 million sq ft of potential leasing, over 40% more than our Q2 pipeline. Potential transactions with new or expanding tenants account for 67% of this pipeline, the majority of which we expect would result in roll-ups to prior rents should we get these deals over the finish line. We're making progress on our redevelopment projects in our office portfolio segment and will continue to evaluate opportunities across our portfolio where redevelopment will generate a significant uplift in asset value while providing strong returns. Turning to Senior Living. Nationally, Senior Living is recovering from the devastating effects of the pandemic on our industry as occupancy continues to improve. Fundamentally, supply and demand trends are supporting this recovery.
The number of Senior Living units under construction is at its lowest level since 2015, with inventory growth moderating to just 1.4% year-over-year. From a demand perspective, we expect the environment to continue to grow more favorable. Based on available census data, the 80+ demographic is projected to increase an average of 3.7% per year over the next two years, compared to the 2% compounded annual growth rate over the last five years. This accelerated growth in the target demographic should continue to provide recovery tailwinds while new supply remains modest. Within our portfolio, we benefited from this recovery as occupancy increased at its fastest pace in over a decade. Starting with our same property portfolio, average occupancy increased 120 basis points from the second quarter to 75.3%.
We've seen steady improvement following the changes made at AlerisLife, which include considerable investment within their sales and marketing functions in the implementation of a community incentive program that rewards teams for occupancy growth and expense containment. For the 107 community non-same property portfolio, average occupancy increased approximately 80 basis points from the second quarter, and this portfolio is now up 660 basis points from the prior year. While the operators of our SHOP segment were able to grow average occupancy by 110 basis points from the last quarter, while also growing revenue 9.7% year-over-year, these strong gains were negated this quarter by elevated costs. In the third quarter SHOP results were adversely impacted by Hurricane Ian.
While the majority of our communities in the Southeast region were largely unaffected by the hurricane, we had one 380-unit community in Fort Myers, Florida, that sustained significant damage. This community is out of service while building repairs are underway, and we expect to reopen the community in phases starting at the end of this month. More than half of the residents previously living in this community temporarily moved to nearby DHC owned communities, and we expect demand to be sizable for the community once repairs are complete. Expenses during the third quarter were also elevated due to inflationary pressures, primarily affecting food costs, utilities, and labor. Access to labor and wage inflation have been and will continue to be the biggest challenges facing the Senior Living industry.
We saw increases in agency staffing expense this quarter as our operators worked to meet the increased care demands that came with the portfolio's occupancy growth. Overall, our operators continue to push to stabilize their workforces by improving their recruiting and retention strategies. As a result, we've seen decreases in turnover, the average time to fill positions, and the number of open positions across our portfolio compared to the second quarter. As we continue to grow occupancy, we expect to hit certain occupancy thresholds where our operators will see improved labor efficiencies in their staffing levels. Even with those efficiencies, we expect increases in wages and benefits to continue to challenge our ability to return margins to pre-pandemic levels. I'll now turn the call over to Rick Siedel to provide details on our financial results.
Thanks, Jennifer, and good morning, everyone. For the third quarter, we reported Normalized FFO of -$0.06 per share. Adjusted EBITDA in the third quarter was $35.8 million. Our consolidated Cash Basis NOI decreased approximately $13.2 million from the second quarter, with $12.2 million of that decrease coming from the SHOP segment, which included a $7.5 million decrease in the same property SHOP communities and a $4.7 million decrease in our non-same property portfolio. The decrease in our same property portfolio was attributable to a variety of factors that I would classify broadly into three categories. The first is the increased expenses related to inflationary pressures and included higher rates for things like labor, utilities, and food.
These expenses accounted for $5 million of the NOI decrease and should be recaptured through higher rates charged to residents in the future. The second category of expenses, approximately $5.2 million, is the result of the current lease-up strategy and includes costs for marketing, training, sales incentives, and apartment turns. The final category that impacted our same property SHOP communities was the $3.8 million of costs related to Hurricane Ian. These three categories of expense increases were partially offset by same property revenue increasing $6.5 million as a result of higher occupancy and rate. Our non-same property SHOP NOI decrease was largely attributable to just five communities with a high percentage of Skilled Nursing units. Consistent with industry trends for the skilled space, these communities recognized substantially higher costs during the quarter, primarily related to agency staffing.
Our operators are very focused on this and have plans in place to reduce the use of agency labor in our communities. Interest expense of $46.9 million represented a decrease of approximately $9 million from the second quarter following the $500 million redemption of 9.75% senior notes in June. This redemption reduces our annual interest expense by approximately $49 million. In July, we prepaid a mortgage note due to mature in October on two Senior Living communities for approximately $15 million. At quarter end, we had total outstanding debt of $3.1 billion, and net debt of $2.3 billion was equal to just 29% of gross assets.
Aside from the $114 million partial repayment of the revolver scheduled for January 2023, we have no significant maturities until 2024, and we have almost $5.8 billion of unencumbered gross real estate assets. At quarter end, we had over $800 million of cash and restricted cash on hand, which we plan to use for capital investments and debt repayment. In the third quarter, we spent $70 million on capital expenditures across our portfolio, which included approximately $52.9 million of capital improvements within the SHOP segment and $16.9 million of capital was deployed in the office portfolio. During the first three quarters, we spent approximately $195 million on capital improvements across the portfolio.
Based on projects previously underway and starting in the fourth quarter, we anticipate spending approximately $115 million for the remainder of the year. As we've discussed previously, investing in our portfolio is a priority for us, and we continue to develop plans to improve our properties in order to grow occupancy, push rental rates, and enhance the overall value of our portfolio. That concludes our prepared remarks. Operator, please open up the line for questions.
We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question is from Bryan Maher with B. Riley Securities. Please go ahead.
Good morning, Jennifer and Rick, and thank you for all those comments thus far. A few from me. On the Hurricane Ian, can you drill down a little bit more on the actual damage to the property? I think you said you're gonna start reopening in phases later this month, but how long will it take to fully reopen the property?
Morning, Bryan. Thanks for the question. The damage was fairly extensive. I mean, there was a sizable surge, and as a result, our first floor was flooded. It's also the IL portion of that building is a tower that sustained some damage. We had some rooftop units that are not on top of the roof anymore. There's a sizable amount of work to do. We think the AL building can be reopened by the end of the month, and we're tracking that way. The IL building will take us a little bit more time. Probably, you know, best guess is probably middle of 2023. You know, the positive in this is there's probably an opportunity to move it upmarket a little bit.
It's a good building and a good market, but you know, we're gonna be smart about the capital that gets put back into the building as we restore it.
I'm sure that there were no, you know, injuries or issues in that regard, like you were able to move people out well in advance of the hurricane hitting.
Yes, absolutely. The team is expert at evacuating when they need to. You know, everyone was safe and sound. It's really just loss of, you know, some property, and it'll get restored. It's nothing that can't be restored. It's pretty amazing to see how the team rallies to make sure the residents are well cared for in these situations.
Got it. As it relates to insurance proceeds or deductibles, you know, can you give us a little color on what you're seeing? I know it's still early innings.
Yes. The deductible is largely accounted for already. I think a lot of the future spend will be the capital that we use to restore the building. It probably won't have much of a P&L impact on a go-forward basis.
They are still working through exactly what needs to be done there so that, you know, we still don't have a complete idea of the cost associated with, you know, getting the building back online.
I got it. Good to hear from you, Jennifer. Thank you.
Good morning.
Maybe shifting gears to SHOP expenses, and I think that you, I couldn't write fast enough, talked about the Skilled Nursing Facility, you know, being the lion's share of that. You know, what type of plans internally are you developing to, you know, get this under control such that this, you know, we're not talking about this, you know, two or four quarters from now? I mean, you know, how dire is it? How addressable is it? Maybe steps you're taking, you know, at the present.
Well, I think, you know, as Rick said, Bryan, there were three categories of expense, you know, expenses that were pretty high this quarter. You know, for Skilled Nursing and Assisted Living, and I think it's been clear that the industry is recovering. The needs-based is recovering more quickly than choice-based Senior Living. As they grow occupancy, they need to bring on folks to care for the residents. While we are pushing our operators to grow occupancy, if they can't bring staffing on quickly enough to care for those folks, they need to bring agency on. They're, you know, on the Skilled Nursing operators, they're very focused on bringing regular employees in so they don't have to tap into agency.
It's gonna be a continuing challenge. I think they're doing a good job. This quarter they were hit particularly hard with agency. We're hoping with everything they're doing to attract employees that this will subside in quarters to come.
Got it. Maybe shifting gears a little bit to how you're balancing your spending, which is, you know, significant on CapEx. I know you have over $800 million in cash, but, you know, when you look from the outside in and you see sizable CapEx spending, the purchase of the Fremont property near San Francisco in August, I believe it was, versus, you know, liquidity needs and maturities down the road. You know, you're not spending like you're a stressed REIT, and yet your shares are trading that way. You know, what comfort would you give to investors who maybe are a little perplexed by what they're seeing?
Yeah. You know, we're extremely focused on growing EBITDA. And you know, as we've said a number of times, and we've talked about it before, Bryan, that getting EBITDA to grow. You know, this company really has an EBITDA issue. Our plan to grow EBITDA is to invest capital. Capital is not the golden ticket, so it can't be just capital. The operators need to do everything they can to turn their operations around, and we think they all have very good plans in place to do that. But without the investment in the communities, they will have a hard time recovering. This month was an anomaly in expenses. We expect that we'll continue to be able to push occupancy, but we have to invest in the communities in order to do that.
You know, a question we get a lot is, you know, are the SHOP communities, you know, damaged or in bad locations or, you know, there's an issue with them relative to new supply? Can you talk a little bit about, you know, the facilities you've owned? You've owned them for a while. You know, in general, have the communities around them grown positively? You know, and for those that maybe haven't, you know, the market's grown away from that particular facility. You know, are those the ones that you sold over the last couple of years? If you can kinda help us think through that would be great.
Yeah, that's a good question, Bryan. You hit on it toward the end of your question. We really did cull this portfolio of communities that we did not think would be successful moving forward. The portfolio that we're left with is a good portfolio. You know, we started 2020 with a plan to spend a lot of money in capital in 2020 and 2021, and the pandemic delayed that. I think we started a little bit behind the eight ball in that we were delayed in the deployment of capital. I think this portfolio's occupancy would be higher now, if we had been able to deploy that capital in 2020 and 2021 as planned. You know, now we're deploying it, you know, just delayed by a couple of years.
We feel very good about the ability for this portfolio to recover.
Okay. Just maybe two more quick ones for me and maybe for Rick. You know, the covenant issue and the incurrence test, you know, I know you guys don't have a crystal ball on how quickly SHOP, you know, occupancy recovers and expenses decline and EBITDA grows, but, you know, what's kinda your best guess that, you know, you hit the threshold such that you can be back in the market, you know, refinancing debt?
It's a good question, Bryan, and I agree. I mean, it's really been hard to forecast when the SHOP portfolio will really turn around. We are really pleased with some of the progress we've seen. We are making progress on occupancy, for example. We would like to see a little bit more of a shift. This quarter we added a lot of residents on the Assisted Living Memory Care side and not as many on the Independent Living side, which is typically higher margin. There's definitely still some work to do. We need to move occupancies up. We do think some of the inflationary costs will persist. We're gonna have to push higher rates to offset that. The timing of all that is still up in the air.
We've had some of the new operators transition to January first increases versus anniversary dates, so we do think there's some tailwinds come Q1 because we will be pushing rates probably in that 10%-ish range, possibly higher if inflation continues. Budgets are being worked through right now. Overall I'd say all of the operators across the board really believe there's a lot of opportunity. It's hard to tell you when that incurrence test will turn around exactly because there's a couple of moving pieces. You gotta remember that it's done on a pro forma basis, and we don't have a particular refinancing deal in front of us right now in order to do the math. If we focus on increasing the EBITDA, you know, it'll happen sooner rather than later.
Great. Just one last quick one. On the cash, the $800 million cash, I know that, you know, a lot of it's kinda earmarked over the next year and some's being held as cushion, but I'm assuming that you guys are starting to collect some pretty sizable interest income off that with money markets now, you know, kind of in the 2.5%-3.5% range. You know, shouldn't we start to see that on the income statement and, you know, that partially starts to buffer your otherwise, you know, not insignificant interest expense?
Yes, absolutely. You see this quarter we had $4.1 million of interest and other income on the P&L. Yes, you're right. I mean, that is pretty substantial. It'll likely increase as rates keep going up, but it is offset by, you know, the amount outstanding on the revolver. I wouldn't. Again, the balance sheet is what it is and we're moving forward and we've got, you know, $5.8 billion of unencumbered gross assets that are available. We still think we've got the flexibility we need. We are entirely focused on growing EBITDA right now to get it back to where it needs to be.
All right. Thank you. That's all for me.
Thank you, Bryan.
Again, if you have a question, please press star then one. Please stand by as we poll for questions. This concludes our question and answer session. I would like to turn the conference back over to Jennifer Francis for any closing remarks.
Thank you, operator. We're working hard to maximize the value of our assets through capital investment, redevelopment and continued execution with leasing and occupancy growth. With a sizable amount of cash and few debt maturities until 2024, we believe we have both the time and the flexibility to capitalize on favorable healthcare industry fundamentals and to continue investing in the recovery of our SHOP segment. Finally, we look forward to seeing many of you at Nareit in San Francisco this month. Operator, that concludes our call.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.