Good day, ladies and gentlemen, welcome to the Sabra Health Care REIT Second Quarter 2018 Earnings Conference Call. This call is being recorded. I would now like to turn the call over to Michael Costa, EVP Finance. Please go ahead, Mr. Costa.
Thank you. Before we begin, I want to remind you that we will be making forward-looking statements in our comments and in response to your questions concerning our expectations regarding our acquisition, disposition, and investment plans, and our expectations regarding our future financial position and results of operations. These forward-looking statements are based on management's current expectations and are subject to risks and uncertainties that could cause actual results to differ materially, including the risks listed in our Form 10-K for the year ended December 31st, 2017, and in our Form 10-Q that was filed with the SEC yesterday, as well as in our earnings press release, included as Exhibit 99.1 to the Form 8-K we furnished to the SEC yesterday.
We undertake no obligation to update our forward-looking statements to reflect subsequent events or circumstances, and you should not assume later in the quarter that the comments we make today are still valid. In addition, references will be made during this call to non-GAAP financial results. Investors are encouraged to review these non-GAAP financial measures, as well as the explanation and reconciliation of these measures to the comparable GAAP results included in the Financials page of the Investor section of our website at www.sabrahealth.com. Our Form 10-Q, earnings release, and supplement can also be accessed in the Investor section of our website. With that, let me turn the call over to Rick Matros, Chairman and CEO of Sabra Health Care REIT.
Thanks, Mike, and thanks for joining us, everybody. After I make my comments, I'll turn the call over to Talya Nevo-Hacohen, our CIO, and she'll turn it over to Harold Andrews, our CFO, and then we'll go to Q&A after that. To kick the call off, I just want to note that our guidance is affirmed. We'll likely be adjusting it probably on the third quarter call, as we have a little bit more clarity, which we should have at that point on the timing of the Senior Care Centers sales process, and I'll update everybody on that a little bit further into the call. CMS issued their final rule affirming the October 1st 2.4% market basket increase and the implementation of PDPM in October of 2019. The final rule was consistent with the proposed rule, so both obviously good news for the skilled nursing space.
Moving on to our acquisition pipeline. It's lighter than usual at this point, a little bit over $200 million. Almost all of it is senior housing, and a lot of the product that we're seeing on the senior housing side is not stabilized product. We're also seeing deals come back because they're being retraded. None of which at this point is leading to an expansion in cap rates. Hopefully, that will happen as these trends continue which we expect to see. In terms of skilled nursing, we're not seeing much in the way of skilled nursing deals. While operators are obviously buying all the assets that Sabra and some of our peers are selling, they seem to be holding on to the good assets that they currently operate in.
I think everybody in the space is seeing the light at the end of the tunnel and want to hold on to these assets to get some upside. The assets that we do see in the skilled nursing space, we dismiss out of hand. The way we work our pipeline is if we're willing to do any level of work on it at all, it goes into the pipeline. We see where it takes us. The skilled nursing deals that we've seen to date have been pretty unattractive, even from a turnaround perspective, so we dismiss them out of hand. That said, we do expect to see more come into market. It's just a little bit hard to tell when.
I think with all the changes in the reimbursement model, we're going to start to see the smaller, traditional long-term care providers determine that it's in their best interest to get out of the business. That will provide some opportunities for our operating partners to grow and for us to grow with them. We also continue to see private equity. Despite the retrading that we're seeing and some of the recycled deals, we continue to see private equity bid on senior housing properties at prices that we think are just much too high with forecasts that we think are not achievable. That's sort of the environment that we see today. Moving on to operating metrics. Our skilled nursing occupancy has now moved up two quarters in a row. That's obviously a good thing.
It's ticked up only incrementally, obviously, but I think given the decline over the last few years, having two sequential quarters where occupancy has increased is obviously a good thing. Our skilled mix moved up much more dramatically, 70 basis points to 39.1%. We think a good sign that we're getting closer to the bottom here. Our EBITDA coverage was slightly down to 1.27. Other than Senior Care Centers, we don't see any trends with our operators that cause us any concern, and we've been very consistent, I think, all along over these past few quarters, talking about the fact that, at least from our perspective, that we may not be at bottom, but we're close to bottom, and I think some of the decline in coverage, which is pretty minimal in almost every case, and the minimal increase in occupancy go to that.
I'll make a couple of comments about some of our operators. In terms of Signature HealthCARE, we're seeing an upward trend over the last couple of months in coverage and performance, and I think that's to be expected. It's been a rough couple of years for those guys, and getting to the conclusion of the restructuring really was a huge diversion for the management team. These past six to eight weeks is really the first opportunity they've had a long time to focus on nothing but the business. We feel good about that. In terms of Avamere's performance actually has been very consistent. Their problem is the buildings that they have in Washington State, which has exceedingly low Medicaid rates, and as much as 25% of the operators of facilities in the state of Washington are in some real trouble.
Avamere's strategic focus is, given the size of the company and the strength of the company, and they're a very healthy company, that they're going to basically wait this out and hopefully benefit from some of the fallout that will occur with some of the other operators. They were expecting or hoping that there was going to be an increase in Washington State Medicaid rates as a result of the struggles the operators are having, but that didn't occur. They also have a presence in Oregon, and Oregon unexpectedly is increasing Medicaid rates by 5% both this year and next year. That's going to help the Avamere portfolio overall, even though they'll continue to have some issues in Washington for a while.
In terms of Cadia, we're pleased with the progress that they're making transitioning the other facilities that they've taken over for us, but they are still going through a transition, so we expect it to be another several quarters before their coverage starts to improve. That said, it's pretty strong as it is. There are some event-driven things with some of our operators, but there are no sort of consistent trends that cause us any concern. In the case of Enlivant, they've recovered very nicely off of the first-quarter flu season. The last couple of months have been their two best months that they've had, not just since we've owned them, but their two best sequential months since they acquired that portfolio.
We don't think that over the course of the whole year, regardless of the uptick, that they'll completely compensate for the hit they took with the flu in the first quarter, but on a run rate basis, they look really good and are right on plan in terms of meeting our expectations. Our own managed portfolio is performing well overall with occupancy at 92.1%, and Talya will provide some more detail on that when I turn the call over to her. Want to talk about Senior Care Centers just for a minute. We've moved on to another buyer. We started losing confidence in the buyer that we had been talking to close the deal, and we have the construct of an offer with a buyer that we have a relationship with. This is a buyer who was our largest buyer of Genesis assets.
We've closed two tranches of Genesis assets with them. We feel much better about going down the path with this particular buyer rather than the previous buyer. That said, we've been talking about this for quite some time, now we're getting some other offers locked in as well. There are offers outside of the Genesis buyer who is a private equity buyer, and we've never disclosed their name at their request. The other interested parties are all parties that everybody on this call would know. At this point our bent is to really try to work through this with the private equity buyer that has closed the Genesis assets with us. There seems to be very good interest in the portfolio. We still expect this to be a 2018 event, although clearly it'll be more towards the end of the year than before then.
One other comment I just want to make about Genesis, they had a good earnings call, we're pleased to see that for them. On a pro forma basis, their fixed charge coverage is actually 1.22, that's pro forma for the restructuring, not the 1.20 that we reported. We reported their actual fixed charge coverage. One final comment, that's on Holiday. I think everybody saw the coverage there with the New Senior deal and the restructuring there. That pulled New Senior out of the guarantor sub that we are in and some of our peers are in, that improved their coverage to 1.15. With that, I will turn the call over to Talya.
Thank you, Rick. I will provide some color about the operating results and statistics for our managed portfolio. First, I'll address the properties in Canada, those in the U.S., breaking out the wholly owned properties from the 172 joint venture properties managed by Enlivant and co-owned by Sabra with TPG. Sabra owns 10 homes in Canada, eight of which are independent living and two of which are assisted living and memory care communities. Sienna Senior Living manages eight independent living properties in Ontario and British Columbia and one assisted living community in Ontario. Sienna's focus has been on building and retaining occupancy and engaging with the local community in each location to solidify the property's position in the community.
In the second quarter of 2018, the nine properties managed by Sienna saw a 90.3% occupancy compared to 91.9% occupancy in the preceding quarter, with a decline attributable primarily to fluctuation in occupancy in one building which was not fully offset by occupancy pickups at the other eight communities. However, traffic is strong coming out of the winter months and has increased in the spring and summer months due to special events and focused marketing efforts. Sienna achieved a 37.7% cash net operating income margin compared to 40.6% in the preceding quarter, slightly higher than budgeted for the quarter, reflecting Sienna's ability to manage expenses. Moving to the U.S., where we have 14 wholly owned properties with two operators, Enlivant and Pathway to Living. Results at the wholly owned Enlivant portfolio, 11 communities located in Pennsylvania, West Virginia, and Delaware, surpassed expectations in the second quarter of 2018.
We are seeing robust increases in occupancy with a strong pull-through to net operating income. Average occupancy rose 140 basis points to 94.1%, compared with 92.7% in the preceding quarter, which was itself a 110 basis point increase over the prior quarter. This is 600 basis points higher occupancy than was forecast for the portfolio to achieve through 2021. Revenue per occupied unit increased to $5,090 a month, which is 2% higher than the preceding quarter, and cash NOI margin was 29%, which is 2.2% higher than the prior quarter and more than 4% higher than budgeted. In January 2018, Sabra also acquired a 49% interest in a joint venture with TPG, which owns 172 properties in 18 states across the United States, all managed by Enlivant. The Enlivant JV properties had a solid quarter with higher rates driving revenue.
Average occupancy for the quarter was 80.5%, essentially flat compared to the preceding quarter. What has happened subsequent to quarter end is important to note. As of the end of July, spot occupancy was 82%, which is a pickup of 150 basis points. Importantly, after a tough flu season that drove move-outs, move-ins have increased by 375%, creating leasing momentum heading into the second half of 2018. Revenue per occupied unit was $4,061 per month, rebounding from the slight dip in the prior quarter and nearly back to Q4 pre-flu season revenue. Cash NOI margin was 23.8% compared to 25.8% in the preceding quarter, driven by increased medical and workman's comp claims and a cost associated with new leadership positions. We continue to see positive trends in the Enlivant portfolio, which has exposure across the country.
172 communities include results of communities in stronger markets, as well as more challenging markets experiencing wage pressures or oversupply. In sum, we believe that the Enlivant team has the talent and the tactics to improve the operations of this portfolio as a whole. I will now turn over the call to Harold Andrews, Sabra's Chief Financial Officer.
Thanks, Talya. For the three months ended June 30th, 2018, we recorded revenues and NOI of $166.3 million and $162.7 million respectively, compared to $64.7 million and $60.3 million for the second quarter of 2017. These increases are due predominantly to revenues and NOI generated from the properties acquired in the CCP merger and the Enlivant transactions. FFO for the quarter was $104.5 million, and on a normalized basis was $109.7 million, or $0.61 per share. FFO was normalized to exclude $5.5 million of capitalized costs related to our preferred stock issuance that we wrote off in connection with the June 1st, 2018 preferred equity redemption. This write-off was reflected as additional preferred stock dividends in our current quarter statement of income. Additional normalizing items during the quarter included $0.4 million of CCP merger and transition-related costs and a net $0.8 million recovery of doubtful accounts and loan losses.
This normalized FFO compares to $36.4 million, or $0.55 per share, in the second quarter of 2017, a per share increase of 10.9%. AFFO, which excludes from FFO merger and acquisition costs and certain non-cash revenues and expenses, was $98 million, and on a normalized basis, after the exclusion of similar items as normalized FFO, was $102.8 million or $0.57 per share. This compares to normalized AFFO of $35.2 million or $0.53 per share in the second quarter of 2017, a per share increase of 7.5%. For the quarter, we recorded net income attributable to common stockholders of $193.6 million, compared to $18 million for the second quarter of 2017. G&A costs for the quarter totaled $9.3 million and included the following: $0.3 million of CCP-related transition costs and $2.7 million of stock-based compensation expense. Recurring cash G&A costs were 3.4% of NOI for the quarter.
We expect our quarterly recurring cash G&A run rate to be approximately $5.4 million per quarter through the end of 2018. During the quarter, we recognized a $0.7 million recovery of doubtful accounts and loan losses, which were primarily related to the collection of $1 million of previously reserved receivables from the guarantors of our former Forest Park Medical hospital investment. This was offset by $0.3 million of general reserves related to straight-line rental income and loan losses. The $1 million collection of Forest Park Medical receivables is excluded from our normalized FFO and normalized AFFO. To date, we have collected $2.2 million, all of which was excluded from normalized FFO and AFFO. We expect to collect an additional $4 million to $5 million over the next several quarters. Our interest expense for the quarter totaled $36.8 million, compared to $15.9 million in the second quarter of 2017.
Included in interest expense is $2.5 million of non-cash interest expense, compared to $1.7 million in the second quarter of 2017. As of June 30th, 2018, our weighted average interest rate, excluding borrowings under the unsecured revolving credit facility and including our share of the Enlivant joint venture debt, was 4.18%. Borrowings under the unsecured revolving credit facility bear interest at 3.34% at June 30th, 2018, an increase of 21 basis points over the first quarter of 2018. We recognized an aggregate net gain on sale of real estate of $142.9 million during the second quarter of 2018 as a result of the sale of 32 skilled nursing facilities and four senior housing communities. During the quarter, we made investments of $57.2 million, with a weighted average initial cash yield of 7.59%, including $41.9 million invested in four senior housing communities with an average cash yield of 7.7%.
These investments were funded with cash held and borrowings under our revolving credit facility. As of June 30th, 2018, we had total liquidity of $362.6 million, comprised of currently available funds under our revolving credit facility of $324 million and cash and cash equivalents of $38.6 million. In addition, restricted cash as of June 30th, 2018, included $174.4 million held by exchange accommodation title holders, which may be used to fund future real estate acquisitions. We were in compliance with all of our debt covenants as of June 30th, 2018, and continue to maintain a strong balance sheet with the following pro forma credit metrics, which incorporate, among other items, aggregate CCP rent reductions of $28.2 million and the $19 million Genesis rent reduction. Net debt to adjusted EBITDA of 5.53 times. Net debt to adjusted EBITDA, including unconsolidated joint venture debt, 5.99 times. Interest coverage of 4.14 times.
Fixed charge coverage of 3.88 times. Total debt to asset value, 50%. Secured debt to asset value, 8%, and unencumbered asset value to unsecured debt of 216%. On June 1st, 2018, we redeemed all 5,750,000 shares of our Series A preferred stock at a redemption price of $25 per share, plus accrued and unpaid dividends, for an aggregate payment of $146.3 million. As a result of the redemption, the company incurred a charge of $5.5 million related to the write-off of the original issuance cost of this Series A preferred stock. On August 8th, 2018, the company announced that its board of directors declared a quarterly cash dividend of $0.45 per share of common stock. The dividend will be paid on August 31st, 2018, to common stock holders of record as of the close of business on August 18th, 2018. Finally, a quick update on the Genesis asset sales.
We made great progress toward completing the Genesis asset sales this quarter, closing on 27 property sales and generating gross proceeds of $235.9 million. Currently, Genesis represents 5.4% of our annualized cash NOI. This is down from 8.5% in the first quarter. Of the remaining 19 facilities we are selling, five are currently under a contract for sale with expected total gross sales proceeds of $40.4 million, and 14 are under letter of intent with expected total gross sales proceeds of $75.8 million. These anticipated sales, together with the previously completed Genesis sales, are expected to trigger residual rents to us of $10.4 million per year. Our agreement with Genesis provides for residual rents to be paid to Sabra for 4.28 years following the sale of each facility. We expect all but one of these sales will occur over the remainder of 2018.
The expected delay of one being due to a potentially longer HUD approval process. Ultimately, we expect to have total continuing cash rents from Genesis, including residual rents generated from the sold assets, of approximately $20.8 million, or 3.7% of our current annualized cash NOI. With that, I will open it up to Q&A.
Certainly. Ladies and gentlemen, if you have a question at this time, please press star then one on your touchtone telephone. If your question has been answered and you'd like to remove yourself from the queue, please press the pound key. Our first question comes from the line of Juan Sanabria from Bank of America. Your question please.
Hi, good morning.
Hello.
Hi, just hoping you could talk a little bit about senior care. I saw that you switched the disclosure to corporate guarantees. I was hoping maybe if you can provide the facility level coverage, and if you have it, the bed count as well.
Yeah. You're right, we are now presenting the fixed charge coverage versus the individual facility level coverage. As you can imagine, with the fixed charge coverage at around 1.02, I think, is where we're at right now. The facility level coverage is now a little bit below 1 times.
Yeah. Juan, just to give you a little bit more color in terms of sort of our take on the company, even though coverage has been low for quite some time, it was consistent. In other words, it wasn't getting better, it wasn't getting worse. They were just sort of plodding along, it's clearly the instability and lack of management that's been going on for months now. They just finally hired a CEO 5 weeks ago, has clearly impacted the business. Even though they had added a senior operator last fall, the execution wasn't happening. What we saw in the last couple of months in terms of the performance just further strengthened our resolve, if you will, to move the portfolio out. Hopefully, the new CEO will be able to turn things around.
I think given all the instability in the company and how it's impacting their performance, and typically when new CEOs come into situations like that, there's going to be further shakeup. At least that's always been my experience. While we certainly hope that he'll get things turned around, we're just not willing to wait it out at this point. There are way too many advantages to us to move the Senior Care portfolio out. As we've talked about reducing our exposure in Texas, getting our skilled exposure, and along with the Genesis sales, to a point where it'll actually be lower than it was before the CCP merger. For us, it doesn't change our path. It just reinforces that we were on the right path to begin with.
Okay. Are you still contemplating financing the purchase for a potential acquirer?
Yeah. That was the construct that we were looking at with the previous buyer, and it's the construct that we're still looking at. We like the idea of providing some seller financing for a couple of reasons. One, it'll still reduce our exposure dramatically, but give us much better debt coverage than the operational coverage that we see today. It buys the new owner time to take the portfolio to HUD. Otherwise, the sales process would be a lot longer. Obviously it allows us to manage the impact on earnings and also manage the rate at which proceeds come in. We've got so many proceeds coming in from Genesis to be able to space this out, since we obviously need to redeploy all these proceeds. That allows us to manage that process as well.
Okay. Just curious on your comments about stabilization and skilled nursing, but at the same time, you juxtaposed that saying you expect a shakeout with the change to PDPM from some existing long-term owners. How are those two kind of statements aligned with seemingly some distress coming with some long-term owners, but being positive on the long-term implications of PDPM?
I think most of the tenants that we have and our peers have aren't your sort of traditional mom-and-pop tenants. I think most of the tenants that we all have, then if you look at Ensign and a couple of the other guys out there, these are smart operators that have been preparing for the future, have been moving up the acuity scale, have strong skilled mix. You all don't have very much visibility to the traditional mom-and-pops, which is still a pretty decent percentage of the overall skilled sector. You just don't have that much visibility there. In terms of what you do have visibility to, which are the tenants that all the REITs have, and Ensign and Genesis, there's a separation there. You shouldn't see that fall out with the tenants that we all have.
Again, there's going to be a tenant here or there that's still working through stuff. As I said, we're not quite all the way there yet. In terms of the opportunities that our guys will have to acquire some of these older traditional facilities that they'll then modernize, both from a physical plant perspective and modernize from an operational perspective, I think that'll be a good opportunity. Does that make sense?
It does. If you wouldn't mind, one last quick one. Do you have the EBITDA coverage for Avamere, the facility level?
It's slightly below. I don't have it off the top of my head, it's just slightly below the fixed charge coverage.
Thank you.
It's still pretty solid. There's no issues with those guys on the
Thank you. Our next question comes from the line of Jonathan Hughes from Raymond James. Your question please.
Hey, good afternoon, or I guess good morning out there, but thanks for taking my questions. Ricky, you did touch on the investment landscape at the start of the call and mentioned the Senior Care potential buyer. Would that be a single portfolio deal or piecemeal? Over the next several quarters, would you be open to selling those 38 properties to multiple parties if that one single buyer didn't take them all?
Yeah, no, that's a great question. It's a single portfolio deal. The reason we haven't chosen yet to run a process is because there just seems to be a lot of interest in the single portfolio. If for some reason we started believing that we wouldn't get a single portfolio deal done, the reason to run a process would be exactly that. Running a process would allow us much more easily to break the portfolio up into, say, three or four pieces, whatever it happens to be, similar to what we did with Genesis. If you think about Genesis, that's exactly what would happen with Senior Care. Clearly, if we can sell the entire portfolio in one piece, we can get that done more quickly than with a greater certainty of closing than if we're selling it in multiple tranches.
Okay. Just looking at coverage at Senior Care, it's about one time. Say if you sold that on some implied market level, say, at 1.3 or 1.4 times coverage, that would suggest, say, like $400 million to $500 million of potential proceeds. Is that the right way to think about it or in the ballpark of reasonable expectations, if you can comment on that?
Sure. I think as we had talked about before, we were seeing offers and prices that were very attractive given where assets trade in Texas, and we still feel like the offers that we're looking at are also very positive. I think part of the challenge that we've had, and we're continuing to work through, is identifying where those operations should ultimately be relative to a stabilized management team, in order to determine an appropriate value. Your thinking is right in that analysis. The question is, given that the performance that they've had in their operations to date, identifying where the proper run rate is going forward, and that's part of what we're working through with the new buyers we're talking to.
Yep. Okay. Thanks for that color. Just one for Talya on Enlivant, I'm sorry I didn't get all the numbers taken down that you mentioned, but it sounded like you were saying occupancy within that JV is three years ahead of underwriting. Did I hear that correctly?
Occupancy in the wholly owned properties is well ahead of what was budgeted for now and for several years, as you just said.
That's not the joint venture.
Not the joint venture. The joint venture is basically had a dip with the flu season and has emerged from that blip and has actually recovered healthily. Subsequent to the close of the quarter, they've actually moved up an additional 150 basis points to 82% occupancy there.
The JV is basically where we expect them to be. It just took a little bit longer because of the flu season, the owned portfolio is ahead of where we thought it would be.
Okay. Got it. Thanks for clarifying that. Sticking with the JV, just one more and then I'll hop off. I know there's a path to 100% ownership there over the next couple of years. Could that timeline move up? Obviously, as you've got these proceeds coming in from Genesis and potential Senior Care Centers sale, if your views on that industry or that we're kind of bottoming and bouncing along, wouldn't maybe gaining full ownership earlier, and catching more of that upside make sense given you're going to have all these proceeds coming in?
It's certainly a possibility.
The only thing I would add to that, Jonathan, is that if you'll remember, there is a floor in what we'll pay for that. To some extent, if you were to trigger it really early, you're going to be having a lower yield until you achieve that higher level. There's that piece to consider. It's not like we're immediately going to capture every bit of upside based on performance today, if that makes sense.
Yep. Okay. All right. Thanks for the color. Look forward to hearing more next quarter. I'll jump off.
Thanks.
Thank you. Our next question comes from the line of Chad Vanacore from Stifel. Your question, please.
All right. I've just got one for you there, Rick. You've come out, you've shown some relative enthusiasm for skilled nursing, but maybe a little more cautious on the senior housing side, we'll say. Now, are you expecting skilled nursing operators to improve performance in the second half of 2018 versus the first half this year? Where do you see the largest gains? Is it occupancy rate, managing costs, or something else that we're not considering? What do you think is really going to drive the improvement?
I don't think we're going to see it in 2018. I've been consistent, I think, all along saying that this is a 2019 event, and it could be a couple of quarters into 2019. There'll be some incremental improvement because of the market basket. We always love October in that business because it's a 31-day with no months, and it's the first month you get the market basket, you capture it all. That's our favorite month of the year. Other than that, I think it's more an event or an improvement that we'll see next year. Plus, you're going to have all the operators preparing for the transition to PDPM. I think it's the latter part, the second half of 2019. The improvement's going to be, I think, primarily in occupancy.
I think the industry by and large, does a really good job and always has done a good job controlling costs. Obviously, labor's been an issue, but labor's always been an issue. It's exacerbated by the fact that you don't have a business. At 90% occupancy, it's dropped down to the low 80s. There's sort of nowhere to hide when your occupancy is that low. As occupancy starts to improve next year, that will make it easier to manage labor expenses, just because you'll have more of that revenue to work with. In terms of rate, that's probably more of a 2020 event simply because PDPM is going into effect October 1st of 2019.
In the fourth quarter of 2019, we should start to see some changes in mix and rate as a result of that. You're really not going to have a full impact of that, obviously, until you get to 2020, because it's only one quarter in 2019. To recap, we see improvement coming in 2019, probably a couple of quarters into 2019, or we think things will continue to stabilize as we've been seeing up to that point. The initial improvement will come from occupancy. The secondary improvement after PDPM goes into place will be on mix and rate.
All right. That's a great answer. Thanks.
Yeah.
Thank you. Our next question comes from the line of Richard Anderson from Mizuho Securities. Your question, please.
Thanks. Good morning.
Is this a 14 question, Rich?
That's fun. Yeah, it's good music. I enjoyed it for closing out earnings. If I could maybe draw another comparison between what you've done with Genesis HealthCare and what you're thinking about doing with Senior Care Centers. The sentiment towards skilled nursing has, at least that, has gotten better over the past six to 12 months. How would you describe your conversations for Genesis HealthCare assets that have yet to close, that you're still negotiating relative to those that happened in 2017, and how is that playing into your process with Senior Care Centers? Do you find that people are a bit more sanguine towards the space and that's helping pricing to some degree?
Yeah, I think it's fair to say that because most of the buyers are buyers that are already in the business, they're either operators on the ground or they're finance sources like the one that we referred to that we're working with, that are affiliated with other operating entities, so they understand the business really well. Compared to 2017, where we had no idea what was going to happen with reimbursement, there was all that conversation about RCS-1, which we thought was an improvement, but was, as it turns out, much more complex than PDPM is going to be. Now that we are where we are in the latter half of 2018, even with some of the slippage in coverage that you saw, really across the space, pretty much this earnings season, it's really slowed down quite a bit.
People see that, they understand the business, they know it, so they feel more positive about it. I think in terms of Senior Care Centers, they see a business that, even all those positives aside, should organically benefit from stronger management. If you add those other positives to it that are more a function of what's happening in the environment, then that makes that portfolio more attractive than I think it would have been in 2017.
Okay. You mentioned private equity has been aggressive towards senior housing, which has sort of locked you out of some of those deals. Would you be able to make a statement similar, or is there anything to extrapolate to the skilled nursing side as it relates to private equity, or that's just a completely different animal for them?
Yeah, I think it's a completely different animal. I don't see anything there.
Okay. That's all I need to hear. As far as the timing of senior care, to what degree are you I understand that you had a buyer in place, but are you also, perhaps not that you're dragging your feet, but you also want to line up a use of proceeds. To what degree are you sort of a participant or sort of dictating the process because you as a REIT, you want to make sure that you have a use of proceeds, at least to some degree, lined up over and above the seller financing idea?
I wouldn't say we're dictating the process. We certainly have a preference, and in terms of which buyer we're focusing on currently, a buyer that is more amenable to the structure that we want, which does allow us to manage earnings better or manage proceeds coming in as a point of those proceeds. We prefer to work with that buyer. That said, we want to move the portfolio out, and that's the number one priority. We're not going to be sort of stubborn about it, and if it turns out that the best buyer is a buyer that just wants to buy the whole thing for cash, then we wouldn't dismiss that because we prefer to sort of manage this whole thing better. I think we have an opportunity to manage it better.
Look, most everybody is going to want to take this to HUD, because as you know, the long-term rates are just phenomenal. Unless someone's really got that kind of access to cash to pay you for all cash and can live with that for a while, because the HUD process it could take nine months, it could take 15 months. It's always a matter of when, not if, but when measured in HUD standards, it's like a dog's life. To the extent that we can be helpful, which also obviously helps us, we'd like to do it that way.
Okay, last question for Harold. When you think about Genesis and the residual rent that you're going to book in the next four-plus years, does it actually work out from a value perspective better for you? You get lesser proceeds, but you get this income stream over the next four years. I'm wondering if $15 million less proceeds is less value. I imagine it is. I imagine it works better for you as a company to have those residual rent and lesser proceeds from the sales at the point of the event. Is that a true statement?
I think you could definitely make that argument, Rich, that's precisely why we structured it that way, because our negotiation with Genesis was they had an ask of a rent cut, we knew that that rent cut was going to get them to the coverage they were looking for. We felt like there was some risk there that our ability to exit assets at that coverage. We said, "We'll give you that rent cut now, but what we're going to ask in return is that we don't take any risk on selling assets. We're going to be basically made whole from any lower purchase price we get because buyers want more coverage." The intent was to, at least at a minimum, make it us neutral. I think you could make an argument that it's actually a positive to us, yes.
Yeah. Okay. That's what I thought. Okay. Thank you.
Thank you. Our next question comes from the line of Omotayo Okusanya from Jefferies. Your question, please.
Yes. Good morning on the West Coast. Question for you, Rick. You take a look at the NIC's data and where occupancies are kind of industry-wide. You kind of just take a look at that occupancy, you make some assumptions about mix and things like that, and it just strikes me that there has to be a lot of SNFs out there, or SNF operators who are just not making any money at this point. When you take a look at that, I guess, you're talking about things getting better in 2019, but when I take a look at just that number, it just strikes me that there should be a fair amount of mom, whether it's mom and pops or whoever it is, who are currently in a lot of trouble that may not make it to 2019. Do you think that's a fair statement?
I think a couple of things, Tayo. I look at that SNF data with a little bit of skepticism from NIC only because this is a really unusual year in terms of the flu season. Historically, senior housing gets slammed by the flu, and skilled nursing operators benefit from the flu. I think as everybody now knows, this strain was so bad, I think, we hear that only 20% of the people that received vaccinations actually worked. For the first time this year, we saw skilled nursing operators restrict admissions rather than admit these patients because of their high level of concern that admitting these patients would cause basically an epidemic, and they'd lose control of their back door. We've never seen that before. We think that the decrease in occupancy, I think they showed sequential occupancy decrease in fourth quarter, first quarter.
We think it was because of the flu season. I'm not sure that you're going to continue to see that. We'll see, obviously. In terms of the mom and pops, yes, I agree with you. I'm not sure you're going to see a bunch of little bankruptcies, because most of these guys have little or no debt service. You're going to see them selling their facilities because you're absolutely correct. It's still a high percentage, the mom and pops could still be a third of the industry. That is a legitimate component of the NIC data that brings the numbers down, and it's hard to see those guys making any money. I think it's been getting worse every year because if you think about it, these are primarily Medicaid shops.
Going back to, what, 2006 or 2007 was the last time that you saw Medicaid rate increases. I'm talking on an aggregate basis. It's obviously different in every state. Prior to 2008, you were still seeing 3% Medicaid increases kind of all over the place. Since then, it's been anywhere, it was sort of flat through the recession, and it's sort of 1%-1.5% on an aggregate basis across 50 states since then. When you look at your costs increasing and you're not doing much in the way of rehab or complex nursing or anything like that where you're going to get more Medicare and at higher rates, you're trying to exist on a declining revenue base with your costs increasing. I think the fact that for a lot of these mom and pops, it's a generational business.
They've owned these assets for a really long time. They don't have much of anything in the way of debt service. That's allowed them to survive. This shift to PDPM, it's a big shift, right? You're talking about you're going to change how you're doing business, the mix of business, how you bill. You've got to make software changes. Really it's considerable If you think about an operator who just has run things one way forever and ever, it's really a lot to think about. I just think that's going to create, as I said, more opportunity, and these are the guys that are going to be, I shouldn't say going under, but getting out of the business, however that happens.
Got you. All right. That's helpful color. Thank you.
Yeah.
Thank you. Our next question comes from the line of Daniel Bernstein from Capital One. Your question, please.
Hi. Good morning.
Hey, Dan.
Hi. You have a lot of buyers looking at your assets in the senior care side. The pricing seems to be probably pretty good out in the market right now, still. Cap rates haven't backed up. Does it make you want to go ahead and kind of reevaluate your portfolio even further and maybe sell some more assets at this point?
No, not really.
Beyond what you've already announced.
No, I get it. Not really. We have operators that are looking at selling some individual assets within their portfolio, where Avamere may sell or close a building. You've got Wingate is in the process of moving four of their assets, actually, to another operator. We actually may wind up retaining those, but with a different operator. We've got a number of those situations where it's just sort of tweaking existing portfolios. As I look at our tenants as sort of a whole, we haven't looked at any particular tenant beyond what we've already talked about and said, we just don't think these guys can make it, or we're concerned about them making it, or we just don't want to wait as long as it's going to take for them to make it, we want to move them out of the portfolio.
I don't think, again, other than tweaking things here or there, which is as much the operator wanting to do it as it is us, I just don't see much else happening.
Okay. That's fair. On the pipeline, it sounds like it's mostly turnaround value add type of properties on the seniors housing side. I know maybe from the tone, it didn't sound like you were too interested in those assets. If you were, would you consider moving that to RIDEA structure? Should we expect maybe for you to do more RIDEA or some other kind of operating joint venture type of structure in the seniors housing space?
This is Talia. I would suggest to you that RIDEA is very situation specific. From our perspective, that could be an opportunity. There's nothing that we've looked at so far that we have seen and felt was worth the risk of turning into our RIDEA structure because we believe that there was a fairly achievable turnaround in a reasonable time horizon. A lot of the so-called value add and turnarounds are properties that have reached a not very robust occupancy level and revenue level because of the issues around oversupply, that is going to take time to resolve itself.
Okay. One last que-
And-
Sorry. Go ahead.
That's why I made the comment, I think in my quote in the press release, that the upside in senior housing, we think lags behind skilled nursing because you do have that oversupply issue, which outside of the state of Texas, just doesn't exist in skilled nursing. It's just going to take longer. Talya should have noted earlier, the other dynamic, I think to Talia's question maybe, the other dynamic that we really like is not just the increase in occupancy that we see in skilled nursing and the reimbursement system, but you're going to have continuing decline in supply. As some of these mom and pops continue to get out of the business and existing operators buy those facilities, they're going to have to modernize those facilities. When they modernize those facilities, they're going to be taking a lot of beds out of service.
You may buy a 45-year-old 100-bed facility. By the time you modernize it and have more semi-privates and privates and more common space, that 100-bed building may be 75 or 80 beds. You're going to see a lot more of that over the next few years. I think the demographic trend combined with the decline of supply bode really well for the skilled nursing space.
Are you going to be willing to take the risk to buy those Medicaid-heavy mom-and-pop assets and then put money into it right up front within a lease? Or are you thinking maybe you'll help fund operators via loans or some other kind of capital to get those assets to a right place and then maybe buy the assets later on? Just thinking about how over a couple of years how that consolidation might work.
I think we'd be willing to take the risk. One, I think we're pretty good at assessing that risk. For us, it's going to come down to There's not really an obsolescence factor to even an old skilled nursing facility if it's in the right market and has the right operator. Sometimes you go into those things and you may structure an earn-out or something like that so the operators can get in there at a lower rent, and then you have an opportunity to have a higher rent as the business improves. I don't see us, as we're sitting here today, funding an operator and then buying it later on. I think we go in with the operator, and watch them turn that around.
I think certainly for me, in my experience, and some of the other folks on our team who have been in the operating world for a long time, my whole career was built on turnarounds. We really like those kind of opportunities. We haven't seen very many good opportunities like that recently, but I think it's fair to assume that we may see more of those going forward.
Okay. Sounds good. I'll get back in the queue. Thank you.
Thank you. As a reminder, ladies and gentlemen, if you have a question at this time, please press star then one. Our next question comes from the line of Smedes Rose from Citigroup. Your question, please.
Hi, thanks. Earlier in the year, you had talked about potentially refinancing, I think, up to $700 million. It got kind of postponed, I think, due to a split rating. I'm just wondering if you could just talk about any recent conversations or upcoming conversations with the rating agencies, and maybe how you're thinking about refinancing opportunities at this point.
Yeah, sure. The answer is we definitely were looking at it back in November once we completed the Care Capital transaction. At that time, the market was such that we had our eye on being able to refinance our existing bonds and have some nice accretion from that transaction, given where interest rates were. Since that time, interest rates really haven't cooperated, both kind of on a macro basis, and it's improved somewhat here more recently, but also in some specific situations around some things that some of our peers, some issues they had around tenant coverages and things back in November that really forced us to put that on the back burner. It wasn't specific to being split rated that we pulled back.
I think where we're at today is, as we think about what's going to differentiate us further from some of the expectations that we're a skilled nursing REIT, which again, when our skilled nursing exposure was over 70%, it was pretty hard to argue that that was a comparison that should be made. I think the thing that we're looking at now is as we continue to divest some of our skilled nursing assets, based on recent conversations with the one rating agency who currently does not have us as an investment-grade rated company, today it will go a long way to getting us over that hurdle and become investment-grade, so we're no longer split-rated, and thereby remove that issue for investors such that we think we could have better execution and further differentiate ourselves from being a SNF REIT.
Our position right now is that we're going to be opportunistic, and we're continuing to have conversations with the agencies, as well as educating the high-grade investors to the Sabra story and the progress that we're making. Then we'll look for the opportunity to do so then, because again, we're not compelled to do anything here in the short term, given we've got a couple of years before those bonds come due. We think there's enough catalyst in our strategy that will allow us to further improve our spreads and our comparisons to some of our peer companies and get something done that'll be accretive.
Okay. Thank you. Appreciate it.
You bet.
Thank you. Our next question comes from the line of Lukas Hartwich from Green Street Advisors. Your question, please.
Thanks. Good morning, everybody. I just have a quick one. The gap between skilled EBITDARM and EBITDAR coverage has widened over the past couple quarters. I guess it looks like management fees are going up. Can you talk about that? Is that just noise, or is there something structural that's changing there?
No, there's nothing structural at all. There shouldn't be much noise there. Maybe we could spend some time with you offline and take a look at what you're looking, because nothing's really changed.
Okay. I will follow up. Thank you.
Yeah.
Thank you. Our next question comes from the line of Todd Stender from Wells Fargo. Your question, please.
Thanks. Rick, you made a comment on turnaround opportunities. Does that strategy work with the senior care portfolio? You might be taking a write-down should you sell it, what about if you swapped out the operator? Just getting a sense, if you like the real estate or maybe there's some CapEx you'd have to put in. Just your thoughts.
That's actually a really good question, we thought about it. Texas is one of the tougher skilled nursing states. We have other operators in Texas, and they're holding their own, which is in stark contrast, I think, to Senior Care Centers, they don't have as many buildings there. I think for us, look, if we sell this, some new operator goes in there and turns it around, kind of more power to them is really our attitude. You want to see everybody be successful in the business. I think for us, Texas is a big state for us. Even though there's a huge lobbying effort going on to have the Medicaid system change in the fall of 2019. It failed last time, even though I think the effort's good, we don't know what's going to happen there.
There continues to be new building going on in Texas. Maybe if we had 10% exposure there to the state and not 17% or 18%, whatever it is, we'd feel a little bit differently, it's just a lot of exposure to one state that's got some challenges. Again, it's a fair question because we have operators in Texas that are doing a lot better than Senior Care Centers. I think for us to get our skill mix back down into the mid-50s, gives us a lot more play, even in terms of skilled opportunities if we see some operators that we really like, so that we can do some more of those kinds of deals without it really impacting our exposure. I just think there's just too much benefit to us there.
If you go back and look at how well we traded before we ticked up this house, it's over 70%, even though we got a lot of other benefits out of all those transactions, we just think we're better off staying on that path.
Okay. Thank you. Just a high-level question. Private equity has proven to be the primary buyer of senior housing, especially what the REITs are disposing of. What changes that? What gets the REITs back in the market? It just seems like a longer cycle. Do we have to see operator distress within the private equity portfolios going into next year and beyond? Is it a cost of equity that the REITs have to get a better advantage of, and they have to work through all their dispositions so far? What brings the REITs back in and maybe pushes private equity out?
This is Talya. I'll tell you, I think on the private equity side, what pushes them out is at least two things. One is change in the cost of debt is going to make a difference on their leverage IRR outcomes. Two, I think that private equity has been behind a lot of the development initiatives, and I think that exits that don't meet expectations is going to have a significant chilling effect on ongoing investment by private equity. When that starts to really prove out in a significant fashion, we're still waiting to see that, but I think it's starting to happen. I think the REITs have been collectively on the sidelines watching this and waiting for it to play out, poised with pruned portfolios and ready to move forward more strategically at a better cost.
The other comment I'd make, Todd, in terms of your reference to cost of equity to the REITs, I don't really see that as a determining factor because the way private equity is valuing these businesses on future earnings that I think for most of us, we just don't see as realistic. That's not a cost of equity issue. I don't think even if all things were equal, that you would see the REITs paying up the way some of these guys are paying up, and not just on assets that are leasing up, but on stabilized assets that you look at them and there's no reason to believe that that hockey stick in revenue improvement's ever going to occur. I think the REITs are a lot more disciplined. I think that private equity just has a ton of money that they have to put to work.
I think it's more a matter of discipline on the part of us and our peers.
Okay. Thank you.
Thank you. Our final question is a follow-up from the line of Juan Sanabria from Bank of America. Your question please.
Hi, just two quick ones. Rick, the improvement that you expect in skilled nursing coverage in 2019, is that something fundamental driven mix shift, or is that more just climb back the lost occupancy from the flu this year?
It's occupancy and not necessarily clawing back from the flu. The occupancy's been dropping since like 2013. I think we're going to finally start to see some of the benefit of the demographic. I just think it comes in a little bit sooner to the skilled space than the senior housing space, just because of the health issue. If you go back to when the boomers were born and you sort of run that thing forward, it starts becoming apparent in terms of admissions, we think in 2019. It's not going to be a big wave. It's going to be incremental, but incremental, when you've got occupancy as low as it currently exists in the space, incremental's really a big deal because your costs are currently fixed. You have no levers left to pull. You have no place left to hide.
You get that extra patient or that extra two patients, and that's just a straight pull through to the bottom line. We're not anticipating a big new demographic wave, but we think there's going to be an incremental improvement from the demographic starting sometime in 2019 that will then continue on a regular basis.
Okay, then maybe just lastly, a question for Harold. Just curious as to why you guys don't deduct CapEx to arrive at the AFFO, and if you could just give us a sense of what you're budgeting from a CapEx perspective for the RIDEA portfolio.
Yeah, it's a good question, Juan. Historically, we've just not had any significant CapEx. We're going to take another look at our definition of an AFFO. I know a lot of people include CapEx because as it becomes more material, and it is something that we should consider. I think it's somewhere around $10 million a year is kind of our budget for the RIDEA portfolio with CapEx.
Yeah. It's just been a matter of circumstance, Juan.
Okay. That $10 million's your pro rata share for the joint venture?
No, that's the full amount. Our pro rata share would be half of that.
Okay. Thank you.
Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to Rick Matros, Chairman and CEO, for any further remarks.
Thank you. Thanks for joining us today. We appreciate it. As always, we're available for follow-up conversations. We're very accessible, and if we don't talk to you in the near term, we hope everybody enjoys the remainder of the summer. Thanks.
Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.