The changes at this REIT are more than just cosmetic surgery for high yield NHPAP preferred stock holders.
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National Healthcare Properties Inc. (OTCPK:HLTC) is working hard to transform itself into a more investor friendly and actively traded REIT. As of 1/2/2025 the preferred stock issue tickers were renamed and they now trade on NASDAQ as National Healthcare Properties, Inc. 7.375% RED PFD A (NASDAQ:NHPAP) and National Healthcare Properties, Inc. 7.125% PFD SER B (NASDAQ:NHPBP). The HLTC common stock remains a thinly traded pink sheet issue, but BMO Capital Markets Corp. has been hired as a financial advisor to help with the planned move to a major exchange. Such a move may require selling additional shares to improve liquidity, help fund growth and re-establish a common stock dividend.
Fortunately for investors, the rebranding includes more than just cosmetic changes. HLTC completed a management internalization on 9/27/2024 that will enhance governance, save over $25 million annually and significantly improve preferred stock dividend coverage. The Outpatient Medical Facility -OMF- sector accounts for about 75% of net operating income and continues to deliver solid results with 94% occupancy and 2.2% annual rent increases. The Senior Housing Operating Properties - SHOP- sector accounts for 25% of net operating income and continues to recover towards normal operating results from the devastation caused by Covid. The SHOP recovery really accelerated in Q3. As noted on page 2 of the Q3 investor presentation:
"SHOP segment same store NOI improved by 23.3% from $7.0 million in Q3'23 to $8.6 million in Q3'2 driven by a 4.2% increase in average Occupancy"
Much of this impressive year over year SHOP improvement was driven by rapidly increasing occupancy in just the last quarter. From page 2 of the investor presentation:
"Quarter over quarter, SHOP Same Store revenue increased by 2.4%, from $51.5 million as of Q2'24 to $52.7 million in Q3'24".
SHOP occupancy has recovered to 77.6%, leaving plenty of room for additional increases. The increasing SHOP occupancy and rents at HLTC are consistent with national trends. This is confirmed by Q3 2024 data released from the National Investment Center for Seniors Housing & Care. Occupancy is trending higher with a 4.2% annual rent increase in Q3 2024. As National Investment Center CEO Aron Morton notes:
"The industry does not have enough senior housing options in the development pipeline to meet the growing demand from older adults, so construction needs to ramp up in a smart and measured way or we'll have a crisis on our hands".
This article makes the positive case for NHPAP and NHPBP. NHPAP offers an attractive 12.1% yield trades at a 39% discount to par. There are several potential catalysts for NHPAP to trade higher in 2025. These include improving operating results, cost savings from the management internalization, greater investor awareness due to the rebranding and an expected equity capital raise.
What is NHPAP?
NHPAP (formerly traded as HTIA) is a par $25 cumulative preferred issue with a 7.375% coupon. NHPAP now yields 12.1% at a recent price of $15.25. NHPAP is a perpetual issue, which means that the company is not required to call it. The company now has the option to call NHPAP at par. See the prospectus for additional details. The average daily trading volume is only 19K shares. Use limit orders and patience when trading. There is currently $99 million par value of NHPAP outstanding. NHPAP holders will NOT receive a k-1. Dividends are paid quarterly on 1/15, 4/15, 7/15 and 10/15.
Comparing NHPAP to NHPBP
NHPBP (formerly traded as HTIBP) is a very similar par $25 cumulative preferred issue with a 7.125% coupon. NHPBP is even less actively traded with an average daily trading volume of only 13k shares. There is currently $91 million par value of NHPBP outstanding. See the prospectus for additional details. NHPAP and NHPBP are equal in seniority. Compare yields to find the best value when trading. Dividends are paid quarterly on 1/15, 4/15, 7/15 and 10/15.
Strong balance sheet liquidity
Sufficient balance sheet liquidity is always an important concern for high yield investors. As of Q3 2024, HLTC held unencumbered (not subject to loans) properties valued at $523 million (see page 21 of the 10Q filing). This is in addition to balance sheet cash of $33 million.
2.4X pro forma preferred stock dividend coverage
The quarterly preferred stock dividend obligation for NHPAP and NHPBP totals $3.45 million. Q3 2024 adjusted funds from operation was only $1.9 million, so the preferred dividends were not fully covered by AFFO. However, the management internalization that was completed in Q4 is expected to generate annual savings of $25.6 million (see page 3 of investor presentation). That puts pro forma preferred dividend coverage at (1.9 + 6.4) / 3.45 = 2.4X. Note that the actual preferred dividend coverage in 2025 may be even better as the SHOP sector rebound continues while the OMF sector delivers steady 2.2% rental increases.
46.1% balance sheet leverage
As noted on page 2 of the Q3 investor presentation, HLTC maintained net balance sheet leverage of 46.1%. However that leverage number may be somewhat misleading since it's based on the book value of SHOP and OMF properties. Even with the recent rebound in SHOP valuations, property values have not yet returned to their pre-covid values.
Adjusted interest coverage of 1.3X
Given the uncertainty about SHOP property book value, it makes more sense to look at leverage from a cash flow perspective. The company calculates pro forma annualized adjusted EBITDA of $110.9 million (see page 3 of the investor presentation). That puts quarterly (pro forma adjusted EBITDA) / (interest + preferred dividends) = $27.7 million / (18.0 + 3.5) = 1.3X
Is HLTC undervalued at 0.45X book value?
At a recent price of $8.02, HLTC has a market capitalization of $230 million. The Q3 balance sheet (see page 3 of the 10Q filing) shows total stockholder equity of $703 million. If we subtract the $99 million par value for NHPAP and the $91 million par value for NHPBP that leaves the book value of the HLTC common stock at $513 million. HLTC is trading at only 45% of book value.
To some extent the low valuation of HLTC may reflect a "pink sheet discount". Moving HLTC to a NASDAQ listing could help the valuation somewhat. However, there are also negative factors to consider. Even with the recent recovery, SHOP property values may still be lower than book values. I believe that an equity offering to increase liquidity will be done in conjunction with the planned move to NASDAQ. HLTC shareholders should expect some dilution.
NHPAP holders would benefit from a common stock offering
While dilution is a potential concern for HLTC holders it would be positive for preferred stock holders. Let's assume that about $100 million of new equity is raised as HLTC is moved to a national exchange. That would improve preferred stock dividend coverage and help to fund growth.
No near term debt maturities
Many high yielding preferred stocks are issued by companies with near term refinancing risk. Fortunately, this is not the case for NHPAP. The nearest debt maturity is November 2026 (see page 21 of the 10Q filing). Refinancing risk is not a major concern given that AFFO is trending higher, there is $523 million of unencumbered properties and there are no substantial debt maturities until November 2026.
Management is highly motivated to get HLTC listed
NHPAP would benefit greatly from a public listing for the common stock and it's apparent that management is focused on that goal. BMO Capital Markets Corp. was hired to facilitate that process. The management internalization was completed. The company rebranded. The Q3 earnings conference call (see page #2) stresses the focus on getting a public listed. Even reporting metrics were changed:
" Beginning this quarter, as we continue to progress towards an anticipated public listing of our common stock, we are adding certain new same store operational and non-GAAP financial metrics to our quarterly reporting that more closely align with other publicly-traded REITs."
Management employment contracts and performance bonuses are based on their success in getting the stock listed. For example, here's an excerpt from Chief Financial Officer Scott Lappetito's employment contract (see page 2) that was filed on 12/20/2024:
"For fiscal year 2025, Mr. Lappetito's long-term incentive awards shall have a target grant date fair value of no less than $800,000 and shall be made as soon as practicable following shareholder approval of a Company omnibus equity incentive plan (the "Plan") and the listing of the Company's common stock, par value $0.01 (the "Common Stock"), on a public stock exchange."
What are the major risks?
See page 13 - 42 of the annual report for a comprehensive discussion of risk factors. A few of the major risks are highlighted here. The preferred shares would benefit if the HLTC common stock moves off the pink sheets and becomes listed, but there is no guarantee that such a transaction will be completed. The SHOP and OMF sectors could be harmed by a new wave of Covid or other illnesses that disrupted normal operations. NHPAP is a somewhat illiquid issue. Positions should be sized accordingly. While cash flow at HLTC is improving, there is still significant balance sheet leverage. Pro forma adjusted EBITDA coverage of interest costs and the preferred stock dividend obligation are only 1.3X as noted in the article.
Conclusions
At a recent price of $15.25, NHPAP offers an attractive 12.1% dividend yield and trades at a 39% discount to par. Pro forma preferred stock dividend coverage is currently adequate and should improve due to an expected equity capital raise as well as continued positive trends in the SHOP and OMF sectors. The thinly traded HLTC common stock may be undervalued at 0.45X book value, but dilution is a major concern. NHPAP is likely to trade higher due to improving preferred dividend coverage and increased investor recognition as the common stock is listed on a national exchange.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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