Second quarter earnings reports are not done yet, but the majority of the companies and REITs have reported. We were obviously not expecting a good quarter, but given the trend lines from March through June, the results could have been worse. In fact, for many companies it appears as if the worst is behind them. Or maybe it is better said that the bad news is getting less so. Let’s just say, the fat lady has not completed her song yet.
Before we get into some of the specifics of the two largest REITs, which happen to have the largest seniors housing operating portfolios, we do have some observations from the companies reporting. First, it appears that labor costs have declined for many of the companies that have lost a significant amount of their census. Fewer residents mean fewer people to care for and feed.
While understandable, in theory, all we had heard was that companies had to pay “hero’s pay” to keep employees on staff, sometimes at a 10% to 20% premium. Somehow, that wage premium should have been more than the lower expense of a few housekeepers, food servers and CNAs off the payroll. Plus, bringing meals to the rooms, constant temperature taking and other COVID-19 related tasks would seem to demand more staff. Perhaps labor costs were a bit less also because staff left and were not replaced quickly. Who knows?
The other trend was that capex went down in the second quarter. In many states, outside workers were not allowed into buildings, and most expansion or renovation plans were put on hold until the pandemic ran its course. Unfortunately, it is still running. Obviously, capex would be the first thing to be cut, but the longer we go with this pandemic, and the longer we go with deferred maintenance and needed renovations, the less competitive those communities will be, especially the older ones compared with the newer ones.
Another trend, at least with some companies, is that they are experiencing lower COVID-related costs today than three months ago. While this makes sense when we hear that 93% of Welltower’s seniors housing operating properties (533 of them) have had zero positive cases in the past trailing two weeks, and only 11 of them had three or more, we did expect that a certain amount of COVID expenses would remain in place for quarters to come, especially for nursing facilities.
We have assumed the safeguards would become the new normal, especially with the flu season just around the corner and the current national spike in COVID cases and deaths. New estimates of potentially 300,000 deaths by December 1 means that roughly the same number in the next four months as in the previous four, which all had hoped was behind us.
In addition, the occupancy levels of the operating portfolios at Welltower and Ventas, which are substantial and should be representative of the country as a whole, are worse than what NIC has been reporting. Admittedly, Welltower’s and Ventas’ largest operators tend to have community concentrations on either coast and in major metro areas, which were the hardest hit by the virus in March through May.
This leads us to believe, and we have said this before, that the secondary markets had been somewhat spared from the ravages of the virus in their communities. That was, at least, until the past six to eight weeks when the spikes have appeared in other areas, and places like the hard hit-New York metro market have gone to a 1% positive case experience, with anything under 5% considered to be “okay.” But now the new school year is upon us.
As you will recall, Ventas waited to cut its dividend until mid-June as management wanted to base the decision on the financial performance of its providers and tenants. Let’s just say, the cut was a prudent decision and was already baked into the share price back then, so little damage other than to ego.
The second quarter was tough for its RIDEA operating partners. Based on 340 same-community results, overall occupancy declined year over year by 670 basis points to 79.7% in the second quarter. That, however, doesn’t tell the whole story. The 41-community Canadian portfolio outperformed the U.S. portfolio (as it has for a while), declining 430 basis points to 89.2% in the second quarter. The remaining 299 same communities in the U.S. suffered a 710-basis point decline year over year to 78.2%, with the largest decline coming from the 181 communities in “primary markets,” which plunged 780 basis points to 77.5%.
These are average occupancy rates for the second quarter 2020, so the “spot” occupancy rates would be lower as of June 30 and today, given trends. The U.S. portfolio’s same community net operating income dropped by 45.5% to $72.6 million, while the Canadian portfolio declined by a smaller 21.9%. This is all horrible news, but largely expected. The share price actually went up because trends with tours, move-ins and move-outs have been improving since the depth of the pandemic crisis, the same thing we have been hearing from others. In addition, VTR’s Holiday Retirement portfolio had been improving, as has its Eclipse Senior Living portfolio, which had been a real drag on earnings prior to the pandemic.
Ventas’ largest senior living tenant, Atria Senior Living, saw its operating margin drop from 32% a year ago to 22.6% in this most recent quarter. But, its performance in July was better than both June this year and July a year ago, so its operations also appear to be on the mend. And let’s not forget all the structural changes from triple net leases to RIDEA with Holiday, Brookdale Senior Living and Capital Senior Living. The expectation is that Ventas will be able to ride the census and cash flow wave, maybe starting in late 2021, just as some REITs did in the first half of the last decade.
Welltower’s seniors housing operating portfolio saw similar census declines. From February through July, occupancy dropped by 640 basis points to 79.4%. The good news is that each monthly decline has slowed since April, and the weekly decline seems to have plateaued at about 10 basis points each week. Management does expect the decline to continue in the third quarter, by about another 125 to 175 basis points, but they were losing that each month in the second quarter.
The REIT’s total SHOP same-community net operating income declined 24.5% year over year, driven largely by its major partner, Sunrise Senior Living. Sunrise’s NOI dropped nearly 40% from the fourth quarter of last year to the third quarter. We do know it got hard hit by COVID in some locations, but given the overall quality of its locations, we expect the bounce back to be faster than in some secondary markets. In contrast, Belmont Village and Sagora Senior Living performed relatively well, with their NOI dropping just 1.6% and 3.0%, respectively, from last year’s fourth quarter.
It is fortunate that both Ventas and Welltower had diversified into the medical office and life sciences real estate sectors because, even though their returns are lower, they have outperformed seniors housing and care during this pandemic, thus softening the blow. It is also fortunate that they both have triple net leases, since the collection of rents have been well over 95%, and in some cases close to 99%. Not bad for the worst economy and health crisis in 100 years.
Ventas management indicated that while they are always looking at acquisitions, they will be prioritizing medical office and life science properties and will be very selective in seniors housing, if they do any acquisitions at all in our sector. Meanwhile, management at Welltower believes this may be a once in a generation opportunity to buy seniors housing at significant discounts to replacement value (we agree) in an environment when new development has slowed dramatically just as demographic demand will kick in during the next several years (or at least in a few years).
