Diversified Healthcare Trust (DHC) has faced significant challenges in recent years, with the pandemic severely impacting its senior housing operations. Occupancy rates plummeted, debt levels rose, and the stock price took a hit. For a while, it seemed like DHC might be heading towards restructuring or worse.

However, the past year has witnessed a quiet but potentially significant turnaround at DHC. While much attention has been paid to the company's financial engineering, including the issuance of zero-coupon bonds to address immediate liquidity concerns, the real story lies in the operational improvements within its Senior Housing Operating Portfolio (SHOP).

What's particularly interesting is the potential scale of this SHOP turnaround. DHC's Q1 2024 earnings transcript, along with the previous Q4 2023 call, reveals a series of strategic moves that could unlock substantial value, potentially adding $1 billion or more to DHC's portfolio valuation over the next two years.

Key Drivers of the Turnaround

1. Occupancy Growth

DHC projects a substantial increase in SHOP occupancy, aiming for 300 to 500 basis points growth in 2024. This represents a significant jump from the 79.3% occupancy reported at the end of Q4 2023. Achieving this target would put DHC's occupancy back in line with pre-pandemic levels and potentially even surpass them in some markets.

2. RevPAR Growth

DHC forecasts RevPAR growth of 10% to 12% in SHOP for 2024. This implies a combination of occupancy gains and strong rent increases. AlerisLife, DHC's largest operator, has already implemented annual rental rate increases of 5% to 10% for 2024. This assertive pricing strategy, coupled with anticipated occupancy gains, sets the stage for robust revenue growth.

3. Turning Around Underperformers

DHC is actively addressing underperforming assets within SHOP. A prime example is the decision to transition 13 communities from a non-performing operator to Charter Senior Living, known for its turnaround expertise within DHC's portfolio. This move could significantly impact EBITDA, shifting from a negative $3.2 million in 2023 to potentially positive millions within the next two years.

4. Capital Deployment

DHC is committed to investing in its SHOP communities, allocating $190 million to $200 million in capital expenditures for 2024. This capital is being strategically deployed, focusing on renovations and upgrades to drive occupancy and rental rate growth.

5. Favorable Macroeconomic Backdrop

The senior housing industry is benefiting from favorable macroeconomic conditions. The 80-plus population is expanding rapidly, while new construction deliveries are slowing down. This supply-demand imbalance, coupled with moderating wage and labor costs, creates a favorable environment for organic growth and margin expansion in SHOP.

Potential Valuation Impact

Let's translate these operational improvements into potential valuation impacts. The hypothesis is that DHC's SHOP portfolio, currently valued at roughly $3 billion, could see its valuation increase by at least 33% over the next two years, potentially reaching $4 billion or more.

Projected SHOP NOI Growth

Conclusion

While DHC's recent financial maneuvers have provided some breathing room, the company's operational turnaround in SHOP is the real potential game-changer. If DHC successfully executes on its strategic initiatives, the company could unlock substantial value in its senior housing portfolio, potentially reaching a $4 billion valuation or higher within the next two years. This would represent a remarkable $1 billion increase, making it one of the most impactful, yet under-the-radar, turnarounds in REIT history.

"Fun Fact: DHC is a spin-off from what is now known as Office Properties Income Trust (OPI). The spin-off was completed in 2013."