Diversified Healthcare Trust (DHC) 2008 Q3 法說會逐字稿

Good day, and welcome to the Senior Housing Properties Trust third quarter 2008 financial results conference call. This call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call to the Director of Investor relations, Mr. Tim Bonang. Please go ahead, sir.

Thank you, Jill, and good afternoon, everyone. Joining me on today's call are David Hegarty, President and Chief Operating Office, and Rick Doyle, Chief Financial Officer. Today's call includes a presentation by management followed by a question and answer session. Before we begin today's call, I would like to state that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and Federal securities laws. These forward-looking statements are based on Senior Housing's present beliefs and expectations as of today, November 6, 2008.

The Company undertakes no obligation to revise or publicly release the results of any revisions of the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission, or SEC, regarding this reporting period. In addition, this call may contain non-GAAP numbers, including funds from operations. A reconciliation of FFO to net income can be found in our Q3 supplemental operating and financial data on our website at www.snhreit.com. You will also find there the components to calculate AFFO, CAD or FAD. Actual results may differ materially from those projected in forward-looking statements. Additional information concerning factors that could cause those differences is contained in our 2007 Form 10-K on file with the SEC and third quarter Form 10-Q to be filed with the SEC within the next day. Investors are cautioned not to place undue reliance upon any forward-looking statements. Now, I would like to turn the call over to Dave Hegarty.

Thank you, Tim, and good afternoon, everyone. Thank you for joining us during this very busy reporting season. We are pleased with the results of the quarter and the strong financial position we are in today. In fact, based on several research reports, SNH is considered one of the top REITs of the entire REIT industry for our liquidity and our strong balance sheet. Let's first focus on the results for the third quarter. For the quarter, we reported funds from operations of $0.41 per share. And if not for the significant amount of uninvested cash we had for the first half of the quarter, our FFO would have been higher. The results do not fully reflect the impact of the new investments made during the quarter, and we view this as a transitional quarter. During the quarter, SNH made new investments totaling $359 million and an average cash yield of 8.2% and a GAAP yield of 9.0%.

We acquired 23 medical office buildings and clinics totaling 672,000 square feet for $149 million, which were part of the HRPT acquisition. We acquired 10 private pay senior living communities with 563 units for $76 million; one 89,000 square-foot multi-tenanted medical office building not affiliated with HRPT for $18.6 million; four wellness centers developed and leased by Lifetime Fitness for $100 million; and funded $14.8 million of improvement financing on existing properties. We funded these acquisitions by using cash on hand, proceeds of $21 million from the sale of three properties to Five Star, the assumption of 18 mortgages totaling $61 million at a weighted average interest rate of 6.6%, and borrowings on the revolver. At quarter end, we had only $93 million outstanding on our $550 million revolver. Subsequent to the quarter end, we acquired a 79,000 square-foot diagnostic center in Austin, Texas, for $29.8 million, which was part of the HRPT transaction, and a 249 unit trophy retirement community in Bloomington, Indiana, for $29 million. Now I would like to have Rick review the quarterly results with you and the properties acquired, and then I will discuss the operating trends, the acquisition environment and the outlook for SNH.

Thank you, Dave. For the third quarter 2008, our FFO was $47 million compared to $34 million for the third quarter 2007, or a 38% increase. On a per share basis, FFO was $0.41 for the third quarter in both 2007 and 2008. FFO results for the third quarter 2008 were hindered, primarily because net proceeds of our June equity offering had not been fully redeployed until over halfway through the quarter. In addition, we received $21 million of additional cash on July 1 from the sale of three properties to Five Star. We have provided a number of reconciling items on page 14 of the supplemental package to allow you to calculate FAD, AFFO, CAD or a comparable other number, and under all calculations they are a penny higher than our FFO.

After we have acquired all of our medical office buildings from HRPT, we will begin providing complete office-type statistics. There were no capital expenditures or leasing commissions of any consequence during the period. Revenues for the third quarter 2008 were $59.7 million compared to $45.2 million for the third quarter 2007. This was a result of acquiring 68 properties since July 1, 2007, including 29 medical office buildings. Interest expense was modestly higher as a result of increased borrowings on the revolving credit facility in the 2008 period and the assumption of 18 mortgages totaling $61 million with an average weighted interest rate of 6.6% during the third quarter of 2008. General and administrative expenses increased by approximately $700,000. The increase primarily relates to the 68 properties we acquired since July 1, 2007, higher legal fees, and non-cash stock compensation. Percentage rent earned from our tenants was $2.3 million for the quarter, which is a $600,000 increase from the same quarter last year, or a 35% increase. These revenues dropped to the bottom line.

And as we acquire properties, future growth in percentage rent is built into the leases. On July 1, we sold three underperforming assisted living facilities formerly leased to New Seasons to Five Star for $21.4 million, and recorded a modest gain of approximately $266,000 on the sale of these three facilities. Subsequent to quarter end, our Board declared a dividend of $0.35 per share, which is a payout ratio of 85% of the quarter's FFO. The Board reviews the dividend on a quarterly basis. On our last call, I described each of the medical office clinic and laboratory buildings that we have acquired through August 8 from HRPT. To briefly recap, we have acquired five properties in June for a total of $84 million, primarily leased to the University of Pittsburgh Medical Center, HCA, Quest Diagnostics, Omni Care and Stem Cells. In July, we acquired three properties for a total of $39 million, primarily leased to Hematology Oncology, Associates of Central New York, Atlanta Center for Medicine and Affiliates of Emory Clinic and the primary and multi-specialty physicians practice in Anaheim, California. In August, we acquired 20 medical clinics for approximately $110 million.

18 of these clinics are leased to Fallon Community Health Plan in central Massachusetts, and one is leased to Health Insurance Plan of New York, which is actually subleased to Maimonides Medical Center in Brooklyn, New York, and one is leased to Children's Hospital of Philadelphia. By quarter end, we had closed on a total of $233 million of the $565 million of the medical properties to be acquired from HRPT Properties Trust. On October 31, we acquired a multi-tenant diagnostic center in Austin, Texas, for $29.8 million. We anticipate acquiring three biotech laboratory buildings located in La Jolla, California, and leased to the Scripps Research Institute late in the fourth quarter. The purchase price is $115 million. The remaining $187 million of properties we -- are expected to be acquired in the first quarter of 2009. These purchase prices are fixed pursuant to purchase and sale contracts. On August 25, we announced the acquisition of four health and wellness centers operated by Lifetime Fitness for $100 million. The four properties are located in Romeoville, Illinois, Omaha, Nebraska, Alpharetta, Georgia and Allen, Texas. These properties were all built in the last four years. They were leased to Lifetime for 20 years at an initial rental rate of 9.1%. Lifetime is a New York Stock Exchange listed company.

During the quarter, we also acquired ten private pay senior living facilities. Two were discussed extensively before. They are two assisted living facilities with a total of 112 units located in Birmingham, Alabama. They were acquired on August 1 for $14.1 million and were leased to Five Star. On September 1, we acquired eight independent living facilities in communities around Indiana containing 451 units for $62.1 million. In connection with this acquisition, we assumed $50.5 million of Fannie Mae debt with an interest rate of 6.5%. These properties were leased to Five Star by adding them to lease number three. The initial lease rate for these transactions was 8% on the amount funded. On September 30, we acquired a six-year-old multi-tenanted medical office building for $18.6 million located in Syracuse, New York, adjacent to two of the medical buildings we acquired from HRPT. The medical office building has 89,000 square feet and 12 tenants, the largest of which is Central New York Family Care, which leases 42% of the building to 2016. The initial cash cap rate is 8.5%.

At the end of the quarter on October 31, we also closed on the acquisition of a 249 unit retirement community in Bloomington, Indiana, for $29 million and leased it to Five Star. This acquisition is very unique, as the community was founded by alumni of Indiana University, which has the third largest alumni association in the country. It was selected the top retirement community this summer by AOL Money & Finance, and was cited in the Wall Street Journal on September 13 as an ideal retirement community. Finally, during the third quarter we also funded $14.8 million of capital improvements to Five Star for improvements in expansions at properties leased by them. At September 30, we had $457 million available on our $550 million revolving credit facility. The credit facility has an accordion feature to increase the capacity to $1.1 billion.

The retirement community and MOB acquisition closed on October 31 totaled approximately $59 million. And today, we have $416 million undrawn on our revolver. We continue to be lowly leveraged, with debt representing only 25% of our book capitalization and 17% of our market capitalization. We have no debt coming due until 2011. Now I will turn it back to Dave to discuss other activities on the quarter.

All right. Thanks, Rick. And I'd first like to point out our current business plan, and our plan is to first closely monitor the portfolio in these tough economic times, to look for opportunities that have risk adjusted returns in today's market, to prudently manage our liquidity and look for opportunities to grow cash flow in order to increase the dividend. Our underlying portfolio of properties continues to perform very well. Our tenant operating statistics are a quarter in arrears, but worthy of a brief discussion. On Tuesday, the NIC came out with its second quarter key financial indicators, and our properties compare favorably to the second quarter occupancies.

Our properties that are primarily independent living experienced a sequential decline in occupancy from the March quarter to the June quarter from 91% to 89% and year-over-year from 90% to 89%. The NIC data suggests stabilized independent living properties were 89% occupied for the second quarter, so our properties are trending with the industry. In contrast, our assisted living properties increased occupancy to 90% in the June quarter from 87% in the March quarter. The NIC data for assisted living average occupancy was 88% for the June 2008 quarter. Finally, the skilled nursing properties experienced a decline from 87% to 85% sequentially, and the NIC data indicates average occupancies at skilled nursing facilities in the second quarter was 84%. These occupancy levels appear to be holding steady for our portfolio for the third quarter. This occupancy data illustrates that the need-driven assisted living units continue to perform well, and the independent living is more susceptible to problems in the housing market and the overall economy.

Nursing home occupancies in our portfolio have declined primarily for several reasons. Some of the rural locations are experiencing a declining eligible population. A few of the private operators are making substantial renovations currently to be competitive. And last but not least, private pay patients are choosing assisted living facilities over nursing homes. Coverage of the rent due to us under our leases reflects the underlying trends better. Coverages continue to be very strong, but have been impacted by the economy. Our lease number one with Five Star has 100 properties in it and is 1.31 times coverage compared to 1.27 times coverage in the March quarter and 1.27 times coverage a year ago. These are mainly assisted living properties in nursing homes. The lease number two had a dip in coverage from 1.59 times to 1.47 times, but is essentially the same as the 2007 quarter. This lease contains 30 large retirement communities and two rehabilitation hospitals.

The different coverage is because most of these properties have a large independent living component which is feeling the impact of the weak economy, and as Five Star discussed last night in their earnings call, reimbursement at the rehab hospitals has declined. Lease number three represents 23 nursing homes and all acquisitions that have occurred since March 31, 2008. Since the new acquisitions are underwritten at about 1.2 times the rent, the new properties pull down the existing lease coverage. The lease still covers overall the rent at a strong 1.53 times coverage. And lease number four represents the seven former New Season assisted living facilities that are now leased to Five Star. Until Five Star took over in July 1, 2008, the coverage ratios had declined from 1.28 in the March quarter to 1.08 times in the June quarter. This reflects how quickly things were deteriorating at these properties once a sale had been announced. Five Star has since made many significant operational changes; and as expected, it will take a few quarters to see results dramatically improve. Five Star reported their third quarter earnings results yesterday, and they were very respectful in this current environment. They generated $2.6 million of EBITDA for the quarter and about $5 million of cash flow from operations. The 14 properties released to Sunrise still have strong lease coverage, but they have slipped from the previous quarter to 1.43 times.

Again, this is mostly attributable to the fact that these properties have a large component of independent living, and several are located in Florida and Arizona two of the worst housing markets in the country. As a reminder, though, these leases are guaranteed through 2013 by Marriott International, which is a BBB, BAA2 rated company. The lease with Brookdale is maintaining strong coverage at over two times. Each of our properties with Brookdale is assisted living or Alzheimer's care, and they have strong coverage which re-enforces that assisted living is not being fully impacted by the economy. The private operators had a different coverage this quarter, but most of that is attributable to two operators closing wings to remodel them to compete in the future, and it's viewed as a temporary dip. The performance of the wellness centers continues to be very strong, despite the weak economy. Coverage of the rent of the Lifetime Fitness locations and the Wellbridge locations have over two times coverage of the rent, and the trend has been improving.

Membership has been steady or growing at our centers. Where the economy has had an impact on that industry has been at the new locations where new memberships have been slower than budgeted, and the ancillary revenues from personal training services, to spas and food service have been softening. Our properties are stabilized properties. Lifetime reported earnings on October 23 and reported $0.55 per share of earnings, and over $61 million of EBITDA for the quarter. Occupancy at the medical office buildings has remained at 98%, and we've had a few new tenants at our multi-tenanted buildings coming in at higher rents than at in place rents. When we complete our acquisition of the whole HRPT portfolio, we will begin providing several office property statistics. All of this is to say that I'm very comfortable with the cash flows of our underlying portfolio to support our current rental revenue stream. As Rick discussed, we invested $359 million during the quarter at an average initial cash yield of 8.2%. This was funded using our cash on hand, the sale of three properties for $21 million, the assumption of $61 million of long-term debt which had a weighted average annual interest rate of 6.6%, and the balance was funded by borrowings on the revolver.

The senior living investments leased to Five Star, and the MOB acquisition with HRPT all had been committed to back in the spring, and the rates of return were locked in at that time. However, cap rates for senior living properties and medical office properties have increased, and I expect future transactions to be 25 to 50 basis points higher for senior living investments and 100 to 150 basis points higher for the medical office buildings. We have rejected many investment opportunities we would have considered before, as we are increasing our return hurdles; and with our capital position, we can be more selective. Generally, owners of real estate are not selling in this environment unless they have to. However, we still see a continuous flow of one-off properties in small portfolios. We expect there will be increased pressure on operators to sell in 2009, as more debt comes due or investment funds face redemptions. We will be conserving capital, as there will be attractive deals in the foreseeable future, and we will continue to evaluate possible secured financing options. Substantially, all of our assets are unencumbered, and most are worth more than our historical costs. We do not have any meaningful debt maturing until December, 2011 when our revolver matures; and you count the one-year extension at our option on the revolver, and as you can see on page 16 of our supplemental package, we are well within all of our debt covenants.

As I said before, we are among the top of all REITs for liquidity and strength of our balance sheet. As you know, the dividend provides a floor for all REIT stock prices, and so the security of the dividend is sacred. As Rick mentioned, our payout ratio is currently 85% of our funds from operations. This means we are generating $25 million to $30 million a year of excess cash flow to provide a cushion for the dividend, should any operator experience difficulties or any unforeseen needs. Now the surplus cash is currently being used to fund improvement financings, make new investments and to prepay debt. Before opening up the call for questions, Rick and I will be at the NAREIT Conference in San Diego in two weeks, and we'd be glad to meet with any of you. In addition, we are offering a property tour on Tuesday afternoon November 18 in connection with the conference. We will tour the three biotech buildings in La Jolla, California leased to the Scripps Research Institute for the next 11 years, an Alzheimer's facility, and (inaudible) that we acquired on March 31 to lease to Five Star, and a large rental CCRC we own in Rancho Cordova which is also leased to Five Star.

These are three very different representative properties, and if you have not signed up, please contact Katie Johnston in Investor Relations. In addition, in December, Rick and I will be at the UBS Health Care REIT & Operator Conference, and RBC's Health Care Conference, which are both being held in New York. And with that, I'll turn it over to the operator for questions.

(OPERATOR INSTRUCTIONS). Our first question is from Kevin Ellich from RBC Capital Markets.

Good afternoon. Thanks for taking my questions.

Hi, Kevin.

Good afternoon.

Just wondering, there has been a lot of activity going on, and I was just wondering, how does the pipeline look now? I mean, are you still seeing good opportunities? And Dave, I kind of missed one of the comments that you made right at the end there about cap rates. I was wondering if you could go over that again.

Sure. As far as opportunities we are seeing out there, the volume of opportunities we are seeing has slowed down. I think what people have decided to do is -- you know, there were people motivated to close on transactions before year end. So that window is quickly closing. We are not seeing many transactions right now rushing to close before year end. And then I think -- and those people I believe are going to wait until now January to market other properties. So I think it's a little bit quiet right now. We are still seeing several one-offs and a couple of small portfolios and so on. So there are still some opportunities to consider out there.

Cap rates have moved up. It's a little challenging to discuss the cap rates in a sense, because for the REIT we charge -- we have been charging historically about 8% for our initial rental rate. And I referred to the fact that I expect our initial rental rates required to go up another 25 to 50 basis points on future transactions in the senior living space. And -- but when people buy a property outright for ownership of the real estate and the operations, those cap rates are now more in the 9% to 10% range for independent assisted living, and obviously higher for skilled nursing. And we have not pursued skilled nursing at all. So -- and the medical office building is similar. We are seeing some transactions out there. I think the rush for year end transactions has slowed down and now people are waiting until the beginning of the year to put properties on the market again.

Okay, no, that's helpful. I appreciate that. And then Rick, I don't know if you could address this, this but I was wondering if any of your debt is callable? I see the fixed rate, secured notes -- or unsecured notes, sorry -- the interest rates are a little bit higher than the other debt. Any opportunities on that front?

We don't have any of our debts recallable and won't be recallable for another couple years. 2012.

2012. Okay, excellent. Thanks, guys.

Thank you.

And we will take our next question from Omotayo Okusanya with UBS.

Good afternoon, gentlemen. Just a couple of questions. In regards to your operating trends, could you give us a sense of what you are seeing versus the general downturn in 2Q?

The operating trends of the retirement communities?

Yes.

Yes. Well, they've -- I guess for the -- for I guess the spring and summer they had declined; but from what I have been able to tell, they seem to be holding pretty steady for the last several months. And so hopefully that's a floor. And like I say, the assisted living is holding up very well. In fact, I think Five Star commented that they are converting a number of units that are in independent living over to assisted living in Alzheimer's care, because that's where the demand for the foreseeable future will be. And, of course, independent living is hurting because of the housing market. And that's not necessarily being resolved any time soon. So I expect that to continue to be under pressure.

What occupancy did Five Star report in third quarter over the second quarter? Was it up? Down? Flat?

Well, their occupancy was down a little bit from the second quarter. Not a lot. I think it was about 88.2% from 88.4% or something quarter to quarter. But again, the difference is like the assisted living is actually up, but the independent and skilled is down. So -- and like I said, I think with time -- there is a lot of -- a lot more subtlety things going on. People are moving from -- I mean, occupancy only tells part of the story. There is quite a bit of discounting going on out in the industry. So the actual revenue per unit per month has been down. And that's probably going to continue to be under pressure, as everybody is competing to just fill units.

Got it.

But I think it is going to continue to be under pressure for at least another quarter or two.

In regards to some of your most recent contracts where you kind of have these rent bumps that have come online in 2010, is that -- should we kind of expect that's going to be your standard-type of contract going forward? Or does it have these sort of participating ones going forward?

Right. You know, every -- each operator we have different structures with depending what's negotiated and what they are sensitive to and what we are. And all of our leases with Five Star have this percentage rent formula. And almost every time you have -- the way it's worked historically has been that the year we acquire the property, it's really not been under Five Star's operation for a full period, so they have to make their adjustments and get in there to operate at the way they would. So we make it the first full year of operations under their watch becomes the base year, and the following year becomes when they start to pay us percentage rent based on the growth in revenues. So for the acquisitions that are occurring or have occurred in 2008, 2009 is the base year and 2010 we start to participate in that.

Now what is that percentage again?

It's 4% of the growth in revenues at those properties. And it's a very property-specific calculation. It's not an overall net lease calculation. So they can't offset the properties that decline in revenues, let's say.

Okay, and then could you remind us -- from one of your tenants, I'm not even sure if it's Five Star -- has an opportunity to do a rent reset sometime in 2010?

No. I think what you might have been referring to was when we originally did the rehab hospitals --

Yes, exactly. That's what it -- yes.

We had a -- sort of a contingent rent in there that we weren't sure if this was normal stabilized. But subsequent to that, that has recast and that provision was dropped out. So the current rent of $10.3 million was the base, plus it's gone up because of improvement financings. I think it's about 10-6 right now is their locked in rate.

Okay, so you don't have the -- okay, the rent or resets on that stuff any more?

Correct.

Okay.

I guess based -- if we had to do it today, the rent would probably go down or at least stay the same. I don't think there would be any upside at the moment.

Right. Okay. Thank you very much.

You're welcome.

Thank you.

And our next question comes from Jerry Doctrow with Stifel Nicolaus.

Thanks. I just had a couple things, David. Just you had talked about the initial yields and that sort of stuff. And again, I think you repeated it for senior housing. On the MOBs, I think you were saying it was going to be up 100 to 150 basis points conceivably. What's kind of the base number that you had in mind when you were saying that?

Well, I was referring to the HRPT acquisition. We were -- you know, that was a negotiated transaction back in the spring, and those prices are locked in. And the cash cap rate was 7.1%, and 7.9% was the GAAP yield. The recent transaction we did was a 8.5% cash yield. I think it was about 9.1 or so GAAP yield. So I expect to be more -- So I was referring to basically the differential between the deal back in the spring versus today's. So I think 8.5% to 9% or so.

So that would be true for HRPT or anyone else, something in that range?

For HRPT's acquisition?

Well, not the stuff you already got locked in. But isn't there some other stuff that you have the option of buying from them. Is that at a fixed rate or that would be negotiated in the future?

That's -- what that is -- is I think you are referring to the right of first refusal that we have.

Yes.

And those assets would have to be put on the market, and all we can do is match what other people are willing to pay for those if we are willing to do that.

Okay.

So the market is going to determine what the cap rate is going to be, and then we don't have to buy it or we do -- or we would buy it.

Right, okay. And right at the beginning you had talked about the acquisitions you made in the quarter, and it was a cash yield of like 8.2%. What was the GAAP yield on that again? I just didn't hear it.

9%.

9%. Okay. And then last thing. Just, I know you are going to put out these stats when you get everything bought. But since we have to deal with estimates today, any sense about sort of CapEx spending TI costs on the -- I guess particularly on the MOB stuff that you would've acquired? Because I don't have any good way to get a run rate on that stuff. Do you have a sense of what it might be?

Sure. For the quarter, like I mentioned, we had a couple tenants -- new tenants come in. I think the overall leasing commissions and everything else was under $20,000. So it really wasn't of any consequence this period.

Okay.

Next quarter, I don't anticipate there to be anything meaningful either, because I think -- at least the present knowledge is that we close on the La Jolla properties during the fourth quarter and there's no Cap Ex or leasing commissions or anything affiliated with that.

Okay.

So it would be a 2009 thing you would have to factor into your estimates. And we're working on the budgets for 2009 as we speak, and we will be in a better position give you an idea of that on our next quarterly conference call.

And how about just -- any sense on straight line as well for the quarter, given that everything -- ? I don't know that we've got it. I guess you gave us the GAAP and the cash yields and that basically points (multiple speakers).

Yes. Also on the supplemental on page 14, the straight line rent that was included in the September quarter was $523,000. Let's see -- I'm sorry, I'm sorry. No, the straight line rent in the fourth quarter was $82,000.

Okay.

The amortization deferred finance fees was 523,000.

Okay, okay. And in terms of just dealing with that for the quarter you have given us the cash yield and GAAP yield, so for the acquisitions we can just try and factor it in from that?

Correct.

Okay, all right. I think that's all for me. Thanks.

Okay, you're welcome.

(OPERATOR INSTRUCTIONS). And our next question is from Chris Pike with Merrill Lynch.

Hi, Chris?

Hey, sorry about that, Dave. I was on mute. Good morning. Just wondering what your thoughts are on campus, off campus -- refresh our memory in terms of what the HRP. I know David went through some of the acquisitions and talking about some of the portfolio with respect to being closer to on campus-type facilities. But I know a lot of that stuff also is medical office, whether it be down in D.C. or other markets. So how do you guys view positives, negatives, what percentage of the portfolio is on and off, and just your general thoughts there?

Sure. I mean, most of our portfolio is off campus. But I say off campus, but in several cases they are a block away. Or the one in Washington, D.C. is literally one block away from the George Washington University Hospital there; and I guess the greatest risk that we -- concerns we've had is that when you are on campus, the --- your chance -- almost always you are required to lease the land from the hospital. And that puts you sort of at a disadvantage in negotiations for rental increases and other things, or lease renewals and so on. So we have tended to -- and interesting enough, because of the proximity and the co-dependence between the hospital and the MOBs, those often go for the lowest cap rates. And so we have chosen not to aggressively pursue those. We would rather own the property outright and make our own decisions down the road. And as it turns out, that's also where we are able to get a little bit higher cap rate, because not everybody wants stand alone multi-tenanted medical office buildings a block away from a hospital, whereas we are very happy with that product.

I guess then implicant in that is to the extent some of your peers established relationships with faith-based, not for profits and things of that nature. So it's safe to assume that going forward with this structure and this strategy, you're really not going to be on campus?

That's not going to be the general rule. That's correct. We are not going to be on campus as a rule. We are going to be more in proximity, very often with major tenancy of doctors that are affiliated with those hospitals. But the hospital itself may not control our destiny.

Now, I know there's an ongoing trend of, I guess, doctors becoming employees of hospitals, okay? And I guess within the industry it's a trend that's going to continue to grow. If that goes through fruition, do you think that puts you at a disadvantage?

No. There's still many doctors' practices. I think people are very much concerned about a shortage of doctors and health care professionals in general in this country just because the demographics are going to increase the demand for it. So frankly, I'm not -- and people are trying to build medical office buildings to accommodate the demand. So I don't -- I don't foresee a real issue with that.

Thanks a lot.

Okay.

And we will go next to Philip Martin with Cantor Fitzgerald.

Good afternoon.

Hi, Phil.

I wanted to -- David, you spoke quite a bit about occupancies holding and doing reasonably well, even in this environment. But -- and again, you may have addressed this a bit earlier, too. But how about monthly resident rental rate at the community level? Is that holding right now? It's probably community to community and it's care-type by care-type, but -- what's going on with that rental rate and the margins?

You have hit on exactly the difficulty in trying to nail that down or to be general about it, because, A, at the end of the day this business is a local business. Almost everybody in a community -- the majority by far of the population of the residents there -- come from the nearby five to ten mile radius of the community. So you can look at a state or a county or whatever, and see several properties doing extremely well and other properties hurting. And it's more reputation, it's more what the services are exactly that they are offering. So it's very difficult to generalize. But there is quite a bit of discounting going on out there, and I don't think that that has shown up in everybody's numbers yet. It is starting to, but I don't think it's fully being felt yet. And we're just seeing the competition out there, and people are offering all kinds of incentives and lifelong contracts and so on to draw in residents. And so -- and people are moving from, say, that $4500 a month unit down to the $3000 a month smaller unit. And things like that are happening. So -- but for the facilities that are, say, 90% full, they are able to still push through the 4% or 5% or more rent increases each year. We have seen Five Star in general has raised their rates about 5% on a same store basis. And they are still expecting to get another 5% increase going forward.

Okay, so they are still -- so they are still -- I mean, being your largest operator, I mean, they are still able to have some pricing power and push rents a bit here?

Correct.

I mean -- and you may have just answered the next question. I mean, would you expect that? I mean, using your crystal ball -- and I mean, I know it's not -- we're living in uncertain times. Well, I guess we are always in uncertain times, but --

More so now.

That's right. More so now. But from a coverage standpoint, what do you think that coverage could drop to next year? I mean, certainly it sounds like independent living is a bit more exposed, for obvious reasons. But where do you think the coverage could go here?

Well, I mean, I think that it's a -- I would expect coverage to pretty much level off. From what I have been able to see from lots of different operators out there is that the occupancies seem to be holding at this level. And we know that there is no new supply coming online of any consequence. And the demand is continuing to tick. There is also a significant amount of pent-up demand out there that people have been deferring and deferring their decision. But typically, that means they are becoming less healthy and will need the services more than ever. So I -- I don't know. My prediction, for what it's worth, is just that we -- things have bottomed out and we are holding at this level, and I expect it to move up from there.

Okay. Then just more of a question in terms of the -- is there a number -- and this might be in the supplemental. But is there a number out there in terms of the value of the security deposits, letters of credits, corporate guarantees that you have against your rental stream?

No, I don't think specifically it is. We have some security deposits. But most of our largest credits are dependent on the guarantees of the parent company. So, like Five Star obviously guarantees everything. But Marriott guarantees the Sunrise lease. Brookdale guarantees the [El Terra]/Brookdale lease, and so on. We always get a corporate guarantee, and then the smaller operators we get cash security deposits. We have not been fans of letters of credit because, as we are seeing now that many of the banks that backed the letters of credit are not necessarily going to be around when it comes time to renew that letter of credit, and people have to go hunting for where they can get another party to give them a letter of credit, and that may not be available. And we don't want to trigger a default under our leases because somebody can't get a letter of credit.

Sure.

So -- but I'm sorry, no, it's not disclosed per say in any of the supplemental because it isn't really something you can't -- there's no monetary value to guarantee that we can put on it.

So from a -- in terms of security deposits, what's roughly the number -- the value of the security deposits you have? It sounds like it's mostly corporate guarantees.

That's right. We have a couple hundred thousand dollars of -- yes. Rick has pointed out that the medical office buildings have many security deposits -- usually one month or two month security deposits. And that's going to be several -- $4 million or so. On the private operators, it's more like a few hundred thousand dollars of security deposits, and that's anywhere from two to six months.

Okay, okay. Thank you.

You're welcome.

And we will go next to Steve Swett with KBW.

Hey, Dave.

Hi, Steve.

I imagine once the new year comes around and maybe the acquisition pace picks up again, you guys believe you have to pass these to continue to buy. Can you just kind of lay out your thoughts on your various potential sources of capital unsecured debt, secured debt, equity asset sales and how you would view those as likely sources for further acquisitions?

Sure. I mean, they are all on the table. We have capacity on the revolver, and there is an accordion feature to that, which that would have to be it tested. I don't know of all that would come to fruition. So that's one option that's not -- the revolver isn't due until 2011. We also periodically sell assets. Typically they're the less desirable assets rather than our trophy assets. So that's another source. We have -- on and off had discussions about secured financing with either the agencies or some insurance companies. And also, equity is another option that we have to see what is happening with the stock price, what opportunities are out to invest that would be accretive and so on. And it would all -- we make those decisions as we see opportunities out there and when we have a need for the money. As far as secured financing, that is something that we have been on and off exploring, like I said. And that's something that takes time to do, so we probably would take time to procure that.

In terms of your portfolio, I imagine you have an awful lot of unencumbered assets that you could use without starting to run up against your various covenants?

That's correct. We are only about 6 or 7% encumbered debt on our properties. So substantially all of our portfolio is available to encumber. And as you know, many of these properties we bought way back, like for instance the 30 properties at lease number two were bought back in 2002. And our investment per unit is around $90,000 per unit. And those are large CCICs, so those would probably be worth substantially more than what they are on our books for. The Marriott or Sunrise facilities are similar high-end quality assets that are unencumbered. And then pretty much everything else we bought at very low price per unit values and are worth 50 to 100% more than what they are on our books for.

And in terms of equity, I mean, I think it's been a long time since you sold stock in the mid-teens, so I imagine your comment on equity is an option would be at some higher price than where the shares are today?

Sure, yes.

Okay, thanks.

Okay, thank you.

And our next question is from Mark Biffert with Oppenheimer.

Good afternoon. Just wondering, you had talked about IL versus AL, and how IL is underperforming the AL group. And I'm wondering if there is any opportunity in any of your assets to do some type of conversion to an AL from an IL, and what that would entail?

Sure, Mark. I mean, that is -- first of all, I guess, as a landlord there isn't -- it's not our decision per se. We have to consent to it, but we are not the ones to initiate that change. But what is happening is Five Star has announced that they were going to convert something like about 150 or something units over to assisted living and Alzheimer's care. And I think that's the best way to capitalize on the environment the way it is now, because obviously it's not going to change, say, over the next probably the next year or two or more. So that would be the best way to switch -- the best use of those units. And I think I would expect that several of the Sunrise properties could also be converted to an AL or Alzheimer's use, and periodically they have done that. And so I think definitely the assisted living is the market to be in to capitalize on the environment we are in today.

So in terms of what you are looking at in terms of acquisitions right now, where do you see the best risk adjusted returns, and what type of coverage are those? Because I'm just -- when I look at the acquisition you guys made of the wellness centers, and just in terms of your focus of property types, to me wouldn't there be better opportunities in maybe the senior housing side?

Well, I guess a couple thoughts on that. I have noticed several of our competitors have been going to skilled nursing facilities to acquire and attaining higher cap rates on those type of properties. We have consciously decided not to pursue skilled nursing facilities, because we question some of them -- the long-term viability of them. And we just know that once new budgets get proposed and so on, there's going to be a lot of pressure on the various states and on the Medicare system to try to figure out ways to cut back funding. And so that's where the higher returns have been. On the private pay senior living facilities, there are very few opportunities that still would get us a higher return than that fitness center transaction that we just did. So I think we are still into the eight to nine range for initial yields for those types of -- for assisted and independent living and CCICs. And there may be other potential as far as like if we bought a distressed situation and turned it around, and maybe under a TRS structure or something like that realized a higher return in the long run. But that has not been our business plan to date, and that would be a case by case situation. I'm not going to say that we're going to do that in a meaningful way in the foreseeable future. And so think it's very hard for us to get above, say, a 9% initial return for any asset class that we are willing to go into right now.

Okay. And I'm just wondering, on the fitness centers and the research that you have done through past recession on those types of fitness centers and how they performed, I mean, did you feel comfortable with the margin you had to go forward with it, I take it?

Yes. I mean, obviously not all centers are alike, and we particularly were willing to do these transactions because, first of all, they are new facilities, they're very high end, and they're more of a -- sort of a comprehensive country club-type set up with the pools, the family events. They are large facilities that accommodate many different demographic groups. And they -- the membership at these facilities is typically between, say, 6000 and 10,000 or 11,000 members. And all of these have achieved those levels of memberships. And so at two times coverage of the rent, they would have to experience significant drops in membership or services to not be able to pay the rent to us. So you have to choose widely in making those investments. But these were ones that we felt comfortable with.

Okay, and just quickly, my last question on the HRPS that you have yet to acquire next year, how much debt on that -- or how much assumable debt are you taking from that?

None with those.

Yes, none with the remaining properties have any debt with them.

So you will be using your line to finance that?

Yes, we will be.

Okay. Thanks.

You're welcome.

And we will take our next question from Kevin Ellich from RBC Capital Market.

Hey, guys, just a couple follow-ups. I guess, Dave, we've had a lot of discussion about the senior living properties, and I was just wondering, big picture, what's your take how the economy is impacting your portfolio? And I guess the second part of that question is, under the new administration, are there any other types of properties that are more attractive to you now versus before the election?

Well, let's see. First, to your question about the economy -- and I think we went to quite a bit of detail about that. What it's really doing is it's affecting the confidence level of seniors who are typically private pay, and whether they are willing to make the decision to move into these retirement communities knowing that either they haven't sold their house, or that they are looking at their investment portfolio and seeing it decreasing in value and wondering if it is going to keep going that way. So it's shaking their confidence, and that has pretty much -- the brunt of that has been felt on the independent living side of things. And, like I say, assisted living seems to be holding up very well, and the skilled nursing, I think to some degree, is probably a flawed business model because it's becoming -- anybody who has private pay resources is not going to skilled nursing if they can avoid it. But -- and then -- so as far as the political landscape and effect that would have on our investment decisions, that's probably a bit positive for Medicare/Medicaid, because I think they will try to figure out more ways to keep those programs operating and viable for people. It's still not going to -- people with the best of intentions still have to balance the budgets. And as we found out with the prospective payment system back in the late '90s, that they can make mistakes and cut rates too far, and they don't react until everybody is in bankruptcy and has to regroup. So we've just been there before and are not willing to take that gamble again.

Right. And just going back to your comment about skilled nursing being kind of a flawed business model, is that only for those that are private pay, or I guess, why do you think it's flawed?

Sure. Well, fundamentally, I mean, there are some exceptions, like say many in the Medicare facilities or some others that are private pay and Medicare-based may have a better chance. But the typical nursing home is still 60 or 70% Medicaid funded. Another, say, 20% Medicare and the remaining 10% or so coming from private pay. Medicaid is going to try to hold rate increases to 0% or 2% or 3% at the most, while the cost of living for paying of nursing wages, benefits, utility costs, food costs and everything else are going up by more than 2% or 3%. So you can't run a facility under a Medicaid funded system. So they have to depend on Medicare to make up for the shortfalls of Medicaid. And Medicare has been -- they lobbying efforts have been very successful in getting the last several rate increases. But again, that system is going to come under more pressure. And just similar to the prescription drug plans, there's going to have to be some sort of a shifting of the landscape and the payment mechanisms there. And typically that's not good for the nursing homes.

No, that's helpful. That makes sense. And then my last question is, going back to the wellness or fitness centers, is there more opportunity on that front or in other types of health care related facilities like pharmacy -- we talked about that in the past? And then also, what type of metrics are the -- will Lifetime and the other wellness centers give you to kind of track how the performance is -- how they are performing relative to the economy?

Okay. First on the statistics, I mean, they are very close to the vest with a lot of the information, and probably give some indication of memberships and maybe even revenues. But we are going to have to work through that probably for the next supplemental at year end. And we will try to give as much as they will allow us to disclose. As far as other opportunities out there within the RMR organization, we see numerous investment opportunities from all different facets, periodically review them for whether or not they would be a fit for us. But there is nothing at the moment that we are planning on doing anything outside of this space. But we do look at it; and frankly, I don't know how much opportunity there is in the near term, and that's these areas of business. But we would still stick to triple net leased, something related to health and wellness and the health care field.

Excellent. Thanks.

You're welcome.

Thank you.

And due to time constraints, I will turn the call back to Mr. Hegarty.

Okay, I just want to thank you very much, and as I said, we are more than happy to meet with you at NAREIT, or please join us on the property tour. Thank you.

We thank you for your participation in today's call, and have a wonderful day.