Diversified Healthcare Trust (DHC) Earnings Call Transcript & Summary

Good morning, and welcome to the Diversified Healthcare Trust Second Quarter 2026 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the call over to Matt Murphy, Manager of Investor Relations. Please go ahead.

Good morning. Joining me on today's call are Chris Bilotto, President and Chief Executive Officer; Matt Brown, Chief Financial Officer and Treasurer; and Anthony Paula, Vice President. Today's call includes a presentation by management, followed by a question-and-answer session with sell-side analysts. Please note that the recording and retransmission of today's conference call is strictly prohibited without the prior written consent of the company. 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 beliefs and expectations as of today, Tuesday, August 4th, 2026. 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. net operating income, or NOI, and cash basis net operating income or cash basis NOI. A reconciliation of these non-GAAP measures to net income is available in our financial results package, which can be 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. And finally, we will be providing guidance on this call, including NOI. We are not providing a reconciliation of these non-GAAP measures, as part of our guidance because certain information required for such reconciliation is not available without unreasonable efforts or at all, such as gains and losses or impairment charges related to the disposition of real estate. With that, I would now like to turn the call over to Chris.

Thank you, Matt. Good morning, everyone, and thank you for joining our call today. DHC delivered impressive second quarter results that exceeded analyst estimates, highlighted by continued operating momentum across the portfolio. The strategic changes we have implemented within our SHOP segment over the past year continue to drive improved profitability. As I will highlight shortly, we believe there is meaningful upside to our current results as new initiatives we are implementing with our operators gain traction. Turning to the quarter. After the market closed yesterday, DHC reported normalized FFO of $39 million or $0.16 per share and adjusted EBITDAre of $82 million. Consolidated NOI increased 20.4% year-over-year to $84 million. Beginning with our SHOP segment, same-property NOI increased 37.2% year-over-year to $52 million. This was driven by a 160 basis point increase in same-property occupancy to 83.1%, a 6.2% increase in average monthly rate and continued margin expansion. These strong results highlight solid business plan execution by our senior housing partners. Given that operator transitions were completed in late 2025, DHC remains in the early innings of benefiting from more regionalized community oversight and shared best practices. Our agreements are structured to ensure mutual success and our continued margin expansion clearly demonstrates the effectiveness of this approach. Turning to our outlook, we are pleased to reaffirm our recently raised full year guidance and continue to identify additional growth initiatives as we make our way through the year. As we progress, however, the key contributors of our NOI growth continue to evolve alongside the rapid ramp-up of our operators. As Matt will highlight, while average occupancy and corresponding revenue are pacing slightly below our initial 2026 projections, the profitability of each occupied unit is currently outperforming our original underwriting. To be clear, the pacing in occupancy gains is strictly a function of timing, and we continue to see steady month-over-month improvement. This is largely attributed to the foundational work of rebuilding local leadership and sales teams in conjunction with the operator transitions and establishing essential infrastructure across the transition portfolio. This process made meaningful progress throughout the second quarter. Simultaneously, our profitability outperformance is being driven by an accelerated capture of higher acuity care levels and the rapid realization of expense synergies by our operators, resulting in notable improvements in RevPOR and expense expectations. As such, the temporary moderation in our top line volume is being fully offset by the structural margin enhancements. This dynamic directly protects our bottom line, validates our transition strategy and continues to position our assets for sustained long-term growth. Looking ahead, we are focused on additional opportunities to improve performance across our SHOP segment. Following the success we have achieved from the new operator agreements, we are currently renegotiating our contracts with our legacy operator base to bring them more in line with our upgraded operator framework. Specifically, these new contracts will transition our legacy partners to a highly aligned fee structure. This includes lower base fees, coupled with a tier fee structure tied directly to annual operational outperformance. Furthermore, the updated agreements will introduce tighter, more disciplined cost controls to ensure baseline efficiency. We expect the new contract to provide immediate cost savings of close to $2 million annually before consideration of further growth driven through the incentive fee structure. These updated agreements are expected to commence in January 2027. We continue to make progress on the repositioning opportunities we discussed last quarter. As a reminder, we identified 16 SHOP communities with the potential to convert closed skilled nursing wings or floors into high-demand independent living, assisted living and memory care units. We plan to initially spend approximately $20 million on 6 of these communities, which will add roughly 150 units to our SHOP portfolio. Importantly, given that we are currently absorbing the carrying costs of these closed wings, completing these conversions will transition carrying cost headwinds into revenue-generating units, providing further uplift to our SHOP margins and overall profitability. We believe these projects represent an attractive use of DHC's capital and should generate unlevered mid-teens returns, while also improving the overall marketability of these communities. We anticipate the initial phase of construction to begin later this year with the first deliveries of these new units coming online in the second half of 2027. Turning to our Medical Office and Life Science portfolio, during the second quarter, same-property occupancy increased 110 basis points year-over-year to 95.8%. Leasing activity remained healthy with approximately 477,000 square feet of new and renewal leasing at a 6.7% rent roll-up and a weighted average lease term of 7.1 years. Same-property NOI in this segment was $24.1 million, essentially flat with last year. As discussed in prior quarters, we have 3 known vacates representing roughly 4.6% of the segment's expiring annualized revenue. Two of these tenants vacated effective July 1st, representing 3.5% of annualized revenue and 213,000 square feet, with the remaining tenant vacating effective December 1st. We plan to market for sale one of these properties representing 150,000 square feet and are actively marketing for lease the 2 remaining properties. We look forward to providing updates on the progress of each of these next quarter. Turning to capital allocation and the balance sheet. We ended the quarter with approximately $267 million of liquidity and materially improved our leverage over the past year to 7.1x net debt to EBITDA from 8.7x. We have also significantly improved our interest coverage and strengthened our outlook with the rating agencies. With DHC's large-scale capital recycling program substantially complete, our focus is squarely on improving operations, reducing leverage and identifying the best uses for our growing free cash flow. What makes our investment thesis so compelling today is that our path to substantial earnings growth is entirely organic with significant upside already embedded within our existing portfolio. Beyond maintaining liquidity for high-return internal projects such as our SHOP redevelopments and continued deleveraging, our strengthening balance sheet provides flexibility to evaluate broader strategies to enhance shareholder returns, including revisiting the dividend, which the Board reviews quarterly. In conclusion, our second quarter results demonstrate meaningful progress on improving operations, driving SHOP NOI margins higher and strengthening our financial position. We remain confident in our outlook for the remainder of 2026 and continue to believe the actions we have taken over the past 2 years will continue to deliver strong returns and create value for our shareholders. With that, I will turn the call over to Anthony.

Thank you, Chris, and good morning, everyone. During the second quarter, our consolidated same-property cash basis NOI was $83 million, representing a 20.2% increase year-over-year and 9.3% increase sequentially. These increases were driven by continued robust growth in our SHOP segment as same-property NOI increased 37.2% year-over-year and 17.3% sequentially. Our operators continue to be a major factor in driving the improvement in SHOP NOI by managing expenses, while also increasing occupancy and pricing. As an example of this disciplined expense management, we work with our operators to procure new food and beverage contracts. These new contracts have led to menu optimization and reduced fees. We anticipate annualized cost savings of $14 million to $16 million, of which approximately $8 million is expected to be recognized this year and is included in our revised guidance provided in June. Same-property expense [ core ] decreased 170 basis points sequentially and grew just 150 basis points year-over-year, which is in line with our revised full year guidance assumptions that Matt will highlight shortly. During the quarter, same-property occupancy grew 70 basis points sequentially and 160 basis points year-over-year. We also continue to see strong momentum in pricing with same-property average monthly rate increasing 100 basis points sequentially and 620 basis points year-over-year. DHC shares continue to deliver among the highest total shareholder returns across all REITs in the U.S. over both the past 1-year and 3-year measurement periods. Year-to-date alone, DHC stock price has appreciated 81.7% versus an 11% gain in the S&P 500 and a 23% gain in the MSCI U.S. Healthcare REIT Index. As a result of this outperformance, our second quarter G&A expense includes approximately $10 million of incentive management fees. Second quarter G&A also includes $2.3 million of noncash share-based compensation, more than half of which represents a onetime expense for the accelerated vesting of previously granted share awards with the remainder consistent with prior year periods. Excluding the incentive fee in these noncash items, G&A expense was $7.1 million for the quarter. During the quarter, we invested $25.8 million of capital, including $19.1 million into our SHOP communities and $6.7 million into our Medical Office and Life Science portfolio. Our year-to-date spend of $47.6 million represents a reduction of $18.4 million or approximately 28% when compared to the same period in 2025. Our capital expenditures are in line with our expectations. And as a result, we are reaffirming our 2026 recurring CapEx guidance of $100 million to $115 million. Now I'll turn the call over to Matt.

Thanks, Anthony, and good morning, everyone. As highlighted by Chris and Anthony, our second quarter results continue to show the cash-generating ability of our business, embedded growth in our SHOP segment and reduced leverage. At quarter end, we had total liquidity of $267 million, including $117 million of cash and our undrawn $150 million secured revolving credit facility. Net debt to annualized adjusted EBITDAre was 7.1x at quarter end, a 1.6x year-over-year and 0.7x sequential leverage reduction. This was driven primarily by continued strong performance in our SHOP segment and over $600 million of asset sales completed since the beginning of 2025. We expect our leverage to continue to decrease given the favorable trends at our senior living communities and primarily fixed rate debt profile. Adjusted EBITDAre to interest expense improved meaningfully to 2.2x from 1.4x in the prior year. As a reminder, our next debt maturity is not until February 2028. With growing SHOP NOI, decreasing leverage and a portfolio of over $4 billion of unencumbered assets, we believe we have numerous options available to us as this maturity approaches. In June, we increased each of our SHOP NOI, adjusted EBITDAre and normalized FFO guidance by $10 million at the midpoint. Today, we are reaffirming this guidance as follows: total NOI of $307 million to $323 million, including $185 million to $195 million of SHOP NOI, adjusted EBITDAre of $300 million to $315 million and normalized FFO of $0.56 per share to $0.62 per share. While our SHOP NOI guidance remains unchanged, we have updated our assumptions as follows: occupancy growth of 200 basis points, a reduction of 100 basis points; revenue growth of 6.6%, a reduction of 140 basis points, partially offset by average monthly rate growth of 5.5%, an increase of 20 basis points. These revenue changes are offset as we have seen meaningful expense control from our new operators. Assumptions include operating expense growth of 2.5%, a reduction of 200 basis points and expense core growth of 1.5%, a reduction of 70 basis points. Our second quarter results were consistent with the outlook we laid out when we raised guidance in June, and today's reaffirmation reflects that performance combined with our expectations for the remainder of the year. Our second quarter SHOP same-store NOI of $52 million included a onetime benefit of approximately $1.5 million related to expenses that we do not expect to see repeated in Q3. These expense onetime benefits contributed 50 basis points of margin in the quarter. We are encouraged by our results so far in 2026, particularly the continued growth in SHOP NOI, which is tracking towards the high end of our June guidance. Our new operators continue to drive margin expansion through a combination of revenue growth and expense discipline, and we remain confident in the years ahead. That concludes our prepared remarks. Operator, please open the line for questions.

[Operator Instructions] The first question will come from Michael Carroll with RBC Capital Markets.

Chris, I know you touched on this in your prepared remarks, but I wanted to know if you can give us some additional color on why the SHOP top line is tracking below your expectations. It sounds like this is mainly driven by just the lower occupancy uptick. Is just -- are you just seeing a slower trend in the key leasing season that's driving that? Or is there something more temporary or one-off that's holding that back at least here in the near term?

A lot of it is just kind of more attributed to kind of the transition noise. I think one thing that's important to note is when these communities were transitioned, it wasn't uncommon that many of the operators took on kind of the existing operations infrastructure and team members. And over the course of the last 6 months have continued to kind of rework that. And I think where it's most relevant with respect to the portfolio is in kind of the sales teams and those programs. And so those are largely now in place, and we're seeing kind of the benefit of some of that occupancy flow through as we've seen in the Q2 results. But nonetheless, the pace of where we think that growth will occur is going to be somewhat muted. And so this isn't a function in our view of hitting kind of certain occupancy levers -- levels. It's just a kind of a delay in the timing of that ramp-up. And so I think overall, we remain bullish on our outlook for driving occupancy across the portfolio and again, kind of have the tools and the resources in place to do that.

Okay. Then what's the lower RevPOR driven by? Is this just that -- is it kind of tied within the occupancy uptick? Or did you have to also be a little bit more judicious on increasing rates to your existing residents because of these transitions?

Well, total RevPOR is actually increasing. So that in itself is not going down. I think maybe total revenue is what you're referring to, where there's a decrease, and that's tied to the occupancy. Where we're getting kind of better RevPOR throughout the portfolio is outside of just kind of work that's being done and opportunities identified through driving occupancy, there's also seeing -- we're also seeing kind of a good pace and uptick in other ancillary revenues in the level of care, which is driving outsized results with respect to how that informs RevPOR. And so I think that will continue to pace accordingly. And then as occupancy ramps, we'll start to recapture that incremental revenue.

Okay. Great. And then on the ExPOR side, I know that has been reduced or improved. And I think you kind of highlighted just these new group contracts that these new operators have been able to obtain. I mean, kind of within guidance kind of moving into '27, is there more benefit related to that? Or is this kind of a good baseline and they've already seen the benefits of getting to those new contracts and the new ExPOR run rate is a good base kind of growing going forward?

I think for now, the new guidance is a good run rate at least through the end of this year. We are expecting additional synergies as we move into 2027, both in the new operators and even in some of the legacy operators with expected changes to the management contracts for those. But we are -- for 2026 seeing significant savings in dietary. We've seen maintenance come down significantly, and that's a function of the CapEx we've put into these communities over the last several years and then some other wins we're seeing in contract labor, et cetera.

[Operator Instructions] The next question will come from John Massocca with B. Riley.

Maybe starting off with the new management agreements that are going to start in 2027 that you announced. Is there opportunity as you're thinking longer term for additional agreement changes? Or does that pretty much encompass the entire portfolio once that's in place?

Once that's in place, that will encompass the entire portfolio. So really, just to kind of go back a little bit, this is all of the agreements outside of those that were transitioned with the Aleris contract. So that will be the balance of 80-plus communities. And I don't anticipate any major changes to the contracts in the near term. There are additional opportunities we're evaluating that is more related to kind of the operators and kind of how we think about opportunities there. But the contract itself, I think, would roll forward in any particular type of relationship.