Description

SHORT Global Medical REIT (“GMRE” or the “Company”), a $1bn market cap healthcare REIT with a questionable management team, jumbled strategy and middling off-campus assets in secondary and tertiary markets. GMRE has been a beneficiary of a frothy medical office market and faces multiple headwinds over the next two years, none of which are reflected in the share price (5.7% implied cap rate, $400/PSF). 

Overview

Enterprise Value: $1.7bn (as of 3/14/22)

Gross Investment in Real Estate: $1.3bn 

Buildings: 167 

SF: 4,343,467

Occupancy: 97.5% 

Weighted Average Lease Term (“WALT”): 7.1 years 

Annualized Base Rent (“ABR”): $103.1mm

Annualized AFFO Run-Rate: $0.96

Consensus 2022 AFFO: $1.04

Annualized Dividend: $0.84

Net Debt/Cash EBITDA: 7.6x (7.1x Adj. EBITDA per GMRE) 

Short interest: 1.6% of the float 

Note: All portfolio stats as of 12/31/21.

GMRE’s portfolio is a hodge podge of different assets. Roughly half the portfolio is MOB and the other half is Hospital/ASC/IRF/LTACH. They have no exposure to senior housing (NNN or SHOP), RIDEA or similar investments. The properties are fairly spread out by geography in smaller markets. The Company tended to acquire single tenant off-campus MOB properties which carry greater re-tenanting risk. Tenant credits run the gamut from investment grade to junk and local to national. The odd mix of assets means that it is less likely a buyer would want to take down the whole portfolio. GMRE is much more similar to a net lease REIT than the big three healthcare REITs. 

Breakdown:

GMRE trades well above the intrinsic value of its properties (Implied Cap Rate of 5.7%, $400 PSF, 1.3x EV to Gross Real Estate Cost). At 15x ‘22 AFFO, GRME appears reasonably priced relative to a group average, but these averages are skewed by the big three healthcare REITs (VTR, PEAK, WELL) as well as HTA takeout (discussed below). The consensus 2022 AFFO estimate of $1.04 compares to a 4Q21 run-rate of $0.96 with potential headwinds from a large property sale (though likely to be redeployed) and further drag from vacancies. Moreover, if GMRE were to right-size its leverage and term out the existing debt, AFFO would take a hit. I think AFFO is more likely to disappoint, especially looking out to 2023 estimates. 

It is important to distinguish the assets GMRE focuses on relative to the more typical “on-campus” MOB in primary markets where scale and location can provide stickiness and allow the landlord to extract more value. GMRE does not buy this type of asset. 

GMRE’s value-add from growth via acquisition is probably net negative. The Company has little/no “off-market” deal flow and its underwriting leaves much to be desired. While guidance this year calls for $200mm of acquisitions, it seems like a tall order to get there, especially given the small bite sizes we are talking about. And management has already sacrificed quality to meet growth expectations, particularly in the move to multi-tenant assets with vacancies and shorter lease term. Throughout its history, GMRE has displayed a willingness to look past potential problems like tenant credit quality. This sets a cap on forward AFFO (NOI is largely fixed) over the near-intermediate term. To boot, price discovery from the recent HTA auction should also serve as a ceiling.   

The subdued upside potential is what makes this short so attractive in my opinion. The long-term, fixed nature of GMRE’s leases leave little for the imagination. And inflation cuts deep. 

On the other hand, while the downside to nominal NOI is mitigated by the very same long-term leases, if cap rates return to more normalized levels, or even gap out, the stock could fall by a third. Should further vacancies or tenant credit issues pop up (which is what I am betting on), GMRE could trade considerably worse. While GMRE is levered at ~7.6x Net Debt/EBITDA, I don’t see things getting dire because they have done a good job diversifying the tenant rolls (largest tenant is less than 10%).   

Considering the potential scenarios for how things play out, I think it is reasonable to frame the Base Case for the short at $11 a share, ~30% downside. At $11, GMRE would sport a 7.6% dividend yield, ~7% implied cap rate and a multiple on 2022 AFFO of ~11x. Even if medical office cap rates remain resilient and no tenant credit or vacancies surface, I think you are unlikely to lose more than 15% in the Bull Case.  

GMRE was written up as a long on VIC in March 2019. While the stock fell below $10 in 2020 post-COVID, it has done pretty well since then. I won’t rehash very much of the background here but one significant change was the management internalization completed in July of 2020 for $18mm. 

Why Now?

I believe this is timely as cracks started showing up in 4Q21 earnings. Think it is an interesting signal when companies remove disclosure. There could be valid reasoning, but usually they want to hide something. GMRE recently removed the detailed list of assets (including details like tenant, SF and base rent) which had been in financial supplement for years. This coincided with vacancies increasing from 1.1% to 2.5%. Vacant SF increased from 45,087 to 106,579. 

At the same time, with interest rates on the march and credit markets showing signs of fatigue, GMRE will be swimming against the tide. 

Lastly, with the 4Q21 CC, think it would be impossible for someone to miss the move towards lower quality assets. 

Problem Assets

Several assets within GMRE’s portfolio stick out to me as likely defaults. I don’t think it will be easy to re-tenant these properties because they were cast-offs to begin with when GMRE acquired them. The fact that GMRE underwrote these deals to begin with calls into question the quality of their portfolio. GMRE is one of the few REITs with exposure to Steward and Prospect. 

-East Orange Regional Hospital MOB: Recently sold by Prospect Medical to a local management team with no capital. Prospect had acquired this hospital out of bankruptcy around 2016 and it has been a miserable failure. The hospital was on the sale block for years with no buyers and continues to hemorrhage money. Current ABR of $1.1mm represents 1.1% of GMRE’s total portfolio. The 60k SF property was acquired in 2016 for $12mm under a 10 year lease to Prospect.  

-Marina Towers: This asset has been a problem for years. Tenant is in bankruptcy. Management made positive comments about releasing some of the space with First Choice taking some of the space. Not currently generating any rent. At acquisition, ABR was ~$1.1mm. The 76k SF property was acquired in 2016 for $15.5mm under a 10 year lease to First Choice Healthcare Solutions (“FCHS”). FCHS is a penny stock. The CEO was arrested in 2018 on securities fraud charges. Steward Health was a large investor in FCHS and two of its executives held seats on the BOD. 

-Steward/Medical Center of Southeast Texas: Current ABR of $2.7mm represents 2.6% of GMRE’s total portfolio. The 85k SF property was acquired in 2019 for $33.7mm (~$400/SF) under a lease with 10 years remaining to Steward. Unsure how GMRE gained comfort underwriting this credit, especially in 2019 as the financial statements show substantial risk of near term default.    

-City Hospital at White Rock: Another cast off. Was acquired by Pipeline Health from Tenet after a checkered history. Current ABR of $2.4mm represents 2.3% of GMRE’s total portfolio. The 236k SF hospital was acquired in 2018 for $23mm under a new 20 year lease to Pipeline East Dallas. Unsure how GMRE gained comfort underwriting this credit.   

-Prospect ECHN MOB/Dialysis: Yet another failed tenant that was acquired by Prospect. Current ABR of $0.8mm represents 0.8% of GMRE’s total portfolio. The two buildings totaling 59k SF were acquired in 2019 for $11mm under 15 year and 12 year lease to Prospect. Unsure how GMRE gained comfort underwriting this credit.   

-Oklahoma Center for Orthopedic and Multi-Specialty Surgery (“OCOM”): Current ABR of $3.7mm represents 3.6% of GMRE’s total portfolio. Three properties with 97k total SF. Acquired in 2017 for $49.5mm (~$500/SF) under leases with OCOM (which include USPI/Tenet and INTEGRIS providing partial guarantees at 25% each of OCOM South). In July 2020, OCOM settled a large False Claims Act case with DOJ. The former owners of the buildings (who sold them to GMRE) paid more than $6mm while USPI paid $66mm. Some of the allegations involve the real estate GMRE bought. 

https://www.justice.gov/opa/pr/oklahoma-city-hospital-management-company-and-physician-group-pay-723-million-settle-federal

In 4Q2021, it appears GMRE acquired a multi-tenant building w/ a 6.5 year lease term under a master lease with an affiliated tenant (Southwest Orthopedic Specialists) for $8.9mm. 

Other potential problems include: Star Medical Center/Legent Hospital for Special Surgery (change in operators, ABR of $1.4mm), Las Cruces MOB (vacant), Carrus Specialty Hospital (IRF/LTACH with $2.8mm ABR and no tenant credit protection), Hialeah MOB (a multi-tenant building w/ ABR of $0.9mm and 2 years of remaining term, Steward likely to be a primary occupier of space after it acquired Hialeah Hospital from Tenet in 2021) and Rock Surgery Center (vacant). 

While there are certainly solid credits in the portfolio, many of these assets carry lease terms under 5 years which eliminates most of the premium from tenant credit. Generally speaking, the assets with the longest remaining lease term also carry the worst credit so not many truly high quality properties which would be attractive to single-tenant net lease buyers paying the premium cap rates. These buyers can pay a hefty premium for term AND credit, not one of the above.   

Lease Roll

With ~7 years of remaining term, many properties within the portfolio are eroding value quickly. Retention has been good so far. That may change, especially since we know the management team didn’t underwrite these assets well. GMRE management has expressed that they expect to renew 80%-90% of 2022 maturities. It is likely they will have to provide concessions to get that done, whether through rent cut or funding tenant improvements (“TI”). Historically, GMRE has only funded a modest amount of TI, but the portfolio is not seasoned so can’t put too much faith in that number. 

Through 2024, 24% of ABR rolls. Through 2026, this number reaches 41%. Even if you are renewing at 80%, the leakage is meaningful and the capex required to re-tenant should be factored into the valuation.  

What is not being modeled by analysts currently is that when a tenant vacates, the landlord has to pay property expenses, which can be significant, until it finds a new tenant. This risk is even worse with multi-tenant buildings where some of the leases keep opex risk with the landlord. 

GMRE has recently seen a spike in vacancy. Current vacancy at 2.5% up from 1.1% at 9/30/21. Vacant SF increased from 45,087 to 106,579. The Marina Towers asset has been a known issue for some time. While management said they expect to get it leased up soon, these things often drag out longer than you would expect and require capex investment to bring in new tenants. I don’t see any of this being modeled by the Street in forward projections.  

Medical Office Outlook

As mentioned above, medical office assets benefited from robust private market activity over the past few years. I’m not a buyer of medical office in general and believe it was simply a beneficiary of low interest rates, substantial government funding for both health systems (CARES Act) and smaller practices (PPP) and appealed to high net worth/1031 buyers due to defensive nature of tenant base. It is hard to paint the whole sector with the same brush. Some of the larger REITs have dense/clustered on-campus MOB portfolios in primary markets which have different characteristics than generic medical office space. On the single-tenant side, medical office properties under long-term leases to investment grade credits can represent a compelling risk-return profile as a substitute for bonds. My comments re: MOBs focus on the more generic properties within this sector which represent the bulk of GMRE’s assets. 

Stepping back, it is a bit odd that medical office is viewed so favorably while the office sector is left for dead. This was also the case pre-Covid due to capex requirements and stagnating rents in the larger gateway markets. The narrative that Covid has proven the resilience of MOB strikes me as wrong. There are exceptions (noted above), but medical office is typically just more specialized office space with a more expensive buildout. Obviously, the big contrast is that demand for medical office space isn’t perceived as pro-cyclical and you don’t have quite the same “work from home” risk although telehealth is a wild card. But if demand for office space as a whole will be as weak as feared over the next few years, there is going to be a flood of supply from repurposed general office space into medical office, especially in the better markets. The exuberance in private markets seen during 2021 doesn’t appear lasting.   

HTA Sale

I think HTA’s recent underwhelming, highly public, sale process took some wind out of the medical office space. The Street was relying too much on frothy private market pricing which appears to be cooling. 

The implied cap rate on HTA is quoted as 4.8% in the headline, but it is almost all stock and both HR and HTA have traded down significantly from announcement. The lack of strategic logic behind the deal hasn’t helped either. Prior to announcement, HR traded with a mid-5% implied cap rate. The lack of a financial buyer is likely what was most disappointing to HTA investors because these were the buyers that could have paid the best price by using much higher leverage than REITs typically utilize. 

Valuation

There are several different ways to look at valuation here. Since GMRE is most similar to a net lease REIT, I prefer to use Implied Cap Rate and AFFO multiple. As noted above, AFFO should be reflective of capex required to re-tenant buildings as leases roll off or tenants vacate. For conservatism, I am not building any of this into my AFFO number and am instead using the MRQ run-rate. GMRE has a property under contract for sale and also a number of acquisitions under contract which roughly shake out to about the same amount. 

Consensus pegs 2022 and 2023 FFO/AFFO at $1.04/$1.04 and $1.19/$1.16, respectively.

On current run-rate AFFO (Company-defined), GMRE is trading at 16x. 

On Consensus 2022 AFFO, GMRE is trading at 15x.

Peers trade at multiples ranging from 9x to above 20x (though distorted by SHOP/RIDEA). HR/HTA are at 19x/20x while DOC trades at 16x. MPW trades at 14x.  

At its current Enterprise Value, the implied cap rate on GMRE is 5.7%. EV per square foot is $401 and the multiple on gross real estate cost is 1.3x. 

While GMRE’s ~7 years of remaining lease term looks attractive relative to some other MOB REITs, most of the peers with less term focus on primary markets and on-campus locations vs. secondary and tertiary markets with off-campus locations. 

In short, this is a sleepy, non-controversial name in a space (medical office) that is viewed as a safe haven due to solid performance through COVID and significant private demand bolstering cap rates.  

Dividend

GMRE just bumped their quarterly dividend to $0.21 from $0.205, which foots to a 5.4% yield at current prices. While the dividend is covered now at a ~88% payout ratio (using management adjustments), the Company did not fully cover its dividend in years past. A potential dividend cut is not part of my short thesis here as the Base Case assumes the current rate is maintained. The Company’s lack of tenant and property concentration helps in this regard. 

Given 7.6x leverage, current payout ratio and duration of financing, I don’t think it would take very much to put pressure on the dividend. 

Capital Structure

GMRE finances itself in a relatively simple manner. $580mm in total debt with $350mm from term facility, $173mm from revolver and $58mm in notes tied to individual properties. 

The debt carries a weighted average interest rate of 2.87% and a Weighted Average Maturity of 4.28 years. The $173mm on the revolver is floating rate, so exposed to some rate risk there.  

One knock on GMRE’s financing is that it does not match the underlying assets, so potential to get hammered refinancing the debt.  

Unused capacity of the revolver of $223mm as of 12/31/21 so enough dry powder to take down entire 2022 acquisition guidance. 

GMRE has an asset under contract that was expected to close in March but has been pushed back. Management’s commentary around viability of financing wasn’t inspiring but I don’t think it is a big issue if this sale closes or not. 

In addition to the debt financing, GMRE has $75mm of preferred stock outstanding which they are able to redeem in the back half of 2022. 

Coverage Ratio

GMRE’s disclosure on tenant coverage ratios provides false comfort to investors. In my opinion, the coverage ratio isn’t very useful for medical office properties to begin with. Unfortunately, there are a number of holes in the disclosure for the majority of assets where an actual coverage ratio would provide valuable information. However, I don’t think the situation here is as bad/misleading as the fake coverage ratios MPW provides. 

First, only 57% of tenants are calculated for coverage. GMRE says Large/Credit Tenants represent 30% and are not calculated (they don’t break down which entities are in this bucket). This is concerning because many of the assets are running up to the end of their primary lease term and if not profitable, odds of renewal drop considerably. Regardless of whether they are a credit entity or not. 

Since only the weighted averages are provided for coverage, investors have no ability to determine how many facilities may be in trouble and if one highly profitable facility is skewing the number. 

Another 12% of tenants are considered “not available”. For the ones that are calculated, physician comp is added back, along with other adjustments, making these completely useless. 

Management

Recent commentary on 4Q21 CC represents another red flag. Said move from single-tenant to multi-tenant driven by inability to source single-tenant assets at attractive cap rates. So they are making assumptions on expenses, lease-up (rents, lease term, capex-TI/LC) that are probably optimistic to get to the 7% yield. 

Management is trying to offer lease-up risk as a selling point but it shouldn’t be. GMRE is completely sub-scale to be able to efficiently manage multi-tenant assets, esp. considering all the different markets and the small size of each building. G&A as % of GAV of 1.15%. With 26 employees, GMRE is not capable of truly managing a multi-tenant portfolio. 

Other comments were also concerning. Management implied that single-tenant and multi-tenant are the same risk level. No mention of risk on expenses from inflation, but said they could better protect from inflation via more frequent lease roll. 

The latest wasn’t a one-off conference call either. Putting it all together, I view management as a key part of the short thesis.    

I think it is helpful for those interested to watch the presentation linked below: 

https://d1io3yog0oux5.cloudfront.net/globalmedicalreit/files/videos/GMRE+NAREIT+Video.mp4

Management’s “strategic rationale” for a lot of acquisitions and dispositions is actually bullsht. They are solving for a rationale after-the-fact.   

History

GMRE was formed in 2011 under a prior corporate entity and IPO’d as an externally managed REIT until internalizing in 2020 for a cash payment of $18.1mm. There has been substantial turnover in C Suite since the IPO. 

A Chinese group, Zensun Enterprises Limited, owns more than 6% of GMRE. Zhang Huiqi sits on BOD. She is the daughter of Zhang Jingguo. The remaining officers and directors own ~1.5%. 

Most of the execs date back to the external manager, Inter-American Management.  

The latest change in strategy to acquire multi-tenant properties with vacancy risk should not be surprising given GMRE’s history. 

Risks

There are a number of risks shorting a REIT of this size. Passive accounts for a large portion of the shareholder base for most REITs. As a result, non-fundamental events like index inclusion and fund flows can impact performance. 

Takeout risk is also significant. Many players in the real estate market are more concerned with aggregating assets to generate fees, so lower quality assets can trade hands at irrational prices. In my view, GMRE’s valuation and portfolio quality lessen the risk. I don’t think GMRE’s portfolio is viewed by acquisitive peers as an attractive acquisition candidate. The assets are spread geographically such that few efficiencies can be gained. The portfolio represents a mix of assets so scattered by property type that few REITs would have interest in the entire thing. This extends to their leases, which include triple net (more common in single-tenant) as well as gross (more common in multi-tenant). 

Similarly, investors tend to award high multiples to smaller REITs that have the ability to grow their asset base significantly in an accretive manner. If smaller acquisitions can move the needle, potential for a virtuous cycle. But this depends on accommodative capital markets and continued execution by the company. I don’t see GMRE as likely to achieve the acquisition guidance while still maintaining discipline on asset quality. Moreover, I expect more problems to surface within the existing book.

Catalyst

-Disappointing earnings

-Tenant defaults/credit issues

-Vacancies (either via tenant defaults or lease expiration) 

-Higher interest rates