Diversified Healthcare Trust (DHC) 2012 Q2 法說會逐字稿

Good day and welcome to the Senior Housing Properties Trust second-quarter 2012 financial results conference call. This call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Thank you and good afternoon, everyone. Joining me on today's call are David Hegarty, President and Chief Operating Officer; and Rick Doyle, Treasurer and Chief Financial Officer. Today's call includes a presentation by management followed by a question-and-answer session. I would also note that the recording and retransmission of today's conference call is strictly prohibited without the prior written consent of Senior Housing.

Before we begin, 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 other securities laws. These forward-looking statements are based on Senior Housing's present beliefs and expectations as of today, August 1, 2012. 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 regarding this reporting period.

In addition, this call may contain non-GAAP numbers, including normalized funds from operations, or normalized FFO. A reconciliation of normalized FFO to net income and the components to calculate AFFO, CAD or FAD are available in our supplemental operating and financial data package found on our website, at www.snhreit.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 on any forward-looking statements. And now, I would like to turn the call over to David Hegarty.

Thank you, Tim. Good afternoon, everyone. Thank you joining us today on our second-quarter earnings call. During the second quarter we continued to make progress on our business plan of acquiring and maintaining high quality, private pay properties leased to strong credit tenants in our taxable REIT subsidiary, while maintaining our historically solid financial profile. 94% of our NOI today is derived from private pay resources and we maintained the lowest exposure to government reimbursement programs out of all the publicly traded healthcare REITs.

For the second quarter we reported normalized funds from operations, or FFO, of $0.45 per share and our Board of Trustees declared a quarterly distribution of $0.38 per share, which represents a 6.7% yield based on yesterday's closing stock price and a payout ratio of 84% of our FFO. Since April 1, we have closed on $227 million of acquisitions.

And in July we successfully raised $650 million of gross proceeds from equity and debt offerings. Both offerings were upsized due to significant investor interest and allowed us to maintain a healthy balance sheet, while positioning us for future growth with no additional capital needs for the foreseeable future.

On our last several earnings calls, we discussed our pending acquisition activity and I am happy to report that during the last 60 days, most of this backlog has closed. Looking at our acquisition activity since April 1, we have completed $227 million of acquisitions, of which $45 million represents the completion of the Bell portfolio we announced last year. The weighted average yield on these $227 million of acquisitions was 8%. We assumed $64 million of mortgage debt along with this acquisitions at a weighted average interest rate of 5.6%.

In fact, yesterday we closed on the previously announced acquisition of a sale lease back of four private pay senior living communities with a new third-party private regional operator by the name of a Stellar Senior Living for $37 million. The lease was underwritten at 1.2 times rental coverage based on historical results and the initial yield will be 8%.

Today we have $142 million of pending activity, of which $99 million represents one remaining senior living community located in Yonkers, New York, from the Beat portfolio we announced last year. We expect all the pending acquisitions to close during the third quarter. In addition to these acquisitions, we're on pace to fund $30 million to $40 million of revenue producing capital improvements to our triple net lease tenants this year, which yields us 8% on amounts funded.

Not including our 2011 pending activity, so far in 2012 we've acquired or announced $225 million of new investment, which puts us on track to meet our expectations of acquiring $300 million to $400 million in 2012. Most of our investment opportunities continue to be small portfolios and one off private pay senior living communities and medical office properties.

In the Senior Housing space, most investment opportunities happen with private operators and investors looking to monetize their real estate or exit the operating business altogether. We've been successful in acquiring individual assets and small portfolios with high quality, private pay senior living communities and we expect to continue our growth in the same manner.

We also see positive signs for acquisition opportunities in the medical office pool. The Supreme Court's recent decision should positively impact acquisition opportunities of hospital systems by allowing them to accelerate their decision-making.

We continue to see an increase in demand for outpatient services. A recent survey by Modern Healthcare stated that there had been a surge in outpatient services in just the past year. For instance, they reported that there was a 41% increase in the number of healthcare systems operating freestanding chest pain clinics, a 35% rise in emergency services facilities, and a 32% increase in dialysis centers.

Furthermore, according to the Census Bureau, approximately 10,000 people a day are turning 65, adding to the demand for medical services. The aging demographics and potential impact of the Affordable Care Act will add millions more to the insured population. The increasing demand for medical office buildings is undeniable, which is why we continue to see it as an attractive area of growth for our Company.

Moving on to our financing activity, we were active in the capital markets during July and raised a gross $650 million, consisting of $300 million of common stock issued at a price of $21.75 a share and $350 million of thirty year senior unsecured notes at 5.625%. Our closing stock price yesterday was $22.75, almost 5% above our offering price. Total proceeds from these offerings were used to pay off the $360 million balance on our revolver and we intend to use the remaining proceeds to repay $200 million of our Fannie Mae secured debt currently at 6.4% on September 1, as well as fund pending acquisitions.

Turning to the performance of our portfolio, first I will review our senior living triple net REIT properties, with results reported on a rolling 12-month basis as of March 31, 2012. Occupancy increased across independent assisted-living, but skilled nursing occupancy declined. These results are in line with recent industry data. Recent National Investment Center, or NIC, data reported independent living has the greatest improvement occupancy with assisted-living and memory care also improving.

We've seen a continued shift in the skilled nursing sector towards higher acuity, shorter-stay patients, which has caused turnover to increase impacting occupancy. Since the recession, skilled nursing patients have opted to defer care and also chose other home community-based services, which has impacted occupancy as well.

Assisted-living and memory care facilities are also a caring for lighter acuity residents and private patients, and patients with private resources. Clearly, there have been strains on government reimbursement programs affecting skilled nursing operators, and we will continue to decrease our investment in skilled nursing, while focusing on private pay senior living and medical office buildings. Our current exposure to skilled nursing is only 4% of our NOI.

Starting with our largest tenant, Five Star leased properties have combined occupancy of 84.4%, which was down from 85% compared to last year. Essentially flat compared to last quarter. Five Star's occupancy trends have been increasing for independent living and assisted living, while skilled nursing has continued to decline. Rental coverage on an EBITDA basis ranged from between 1.17 to 1.4 times across our four leases and was 1.3 times in the aggregate.

Five Star's coverage was down overall primarily due to lower Medicare rates implemented last year, and negative trending skilled nursing occupancy. Five Star reported its results for the second quarter earlier today, and occupancies continue to trend slightly higher for independent assisted-living. Since Five Star is our largest tenant, it is important to mention the significant steps they made to enhance their valuation.

They continue to generate profits quarter after quarter, for the last 14 consecutive quarters. They recently obtained $150 million secured line of credit, in addition to their $35 million working capital line of credit. And, have agreed to sell their pharmacy business for a net $39.9 million, reflecting a gain on their investment of $24 million.

Our next largest senior living tenant is Sunrise Senior Living. Sunrise's leased properties are a slight uptick in occupancy compared to last quarter. But overall, coverage declined to 1.53 times. The decline is primarily related to the reduction in skilled nursing Medicare rates.

To remind you, Sunrise will continue to lease four communities from us until 2018 with a [Marriott] guarantee, but we came to a mutual agreement with Sunrise in May to terminate the remaining 10 leases with 10 communities which will be moving into our taxable REIT subsidiary. We expect to complete the majority of this transfer over the next 30 to 60 days. We continue to monitor the performance of the 10 properties as the transition progresses and we will evaluate their condition to determine what kind of capital is necessary to improve the operation and performance.

Next, Brookdale's lease properties saw a nice improvement in occupancy and rental coverage, and our other triple net lease properties continue to perform well with occupancy and rental coverage holding steady at 2 to 3 times.

Now, looking at our managed senior living portfolio, occupancy for the June quarter increased to 87.7% from 87.2% last quarter. We do not yet report same-store data on this private portfolio as it did not own these properties for the full second quarter of 2011. Many of the properties and units recently added to this portfolio have been independent living, which explains the slight decline in average daily rate this quarter. NOI declined by $327,000 due to higher expenses, primarily from higher utilities, insurance premiums and real estate taxes.

During the first one or two quarters as the new owner and operator on acquired properties, we typically experience a decline in occupancy coupled with an increase in operating expenses, particularly real estate taxes. Once our managed communities are rebranded and fully transitioned, the overall operations will stabilize and we expect NOI to grow from there. Overall, we feel good about the performance of these properties and are excited by the growth potential.

We spent $2.3 million in capital improvements in our managed senior living portfolio during the quarter. This was up significantly from last quarter and I want to point out that we are aggressively investing in this assets given the current low cost of construction and are working to transition these assets, rebrand them, and evaluate capital needs across the spectrum to put these properties in the best shape so we can reap the benefits over the long term.

We also expect the transition of the 10 Sunrise properties to our managed portfolio to increase our capital expenditure spending as well. As we transition this properties, we anticipate some initial cash flow volatility and once we are operating these properties, we will be able to determine our own capital expenditure budget.

Moving on to the medical office building component of our portfolio, in the second quarter our medical office building NOI increased 16% year-over-year as we are now up to 112 properties with over 8 million square feet. This growth has primarily come from new acquisitions, recent acquisitions have established new relationships with Straub Medical Clinic in Hawaii, Northside Hospital in Alpharetta, Georgia, and Washington, D.C., Children's Hospital, as well as expanding our relationship with Emory Clinic in Atlanta.

On a same-store basis, occupancy was down to 94.2% from 96.8% last year and the same-store NOI declined slightly as well. The decline in occupancy and NOI is mostly attributable to 124,000 square-foot vacant building located in a suburb of Philadelphia that we discussed last quarter, but we are still trying to reposition and re-lease or sell.

During the quarter we had 26,000 square feet of new leases and we renewed 185,000 square feet. Overall, we saw rental rates on renewals decline slightly this quarter, but we don't believe the decline in renewal rates is representative of a trend in our portfolio. But rather represents one large lease at a property located in New Mexico, which was renewed at a slightly lower rate but was offset by a longer lease term. Now, with that, I will turn over to our Chief Financial Officer, Rick Doyle, to review our financial results.

Thank you, Dave. Good afternoon, everyone. I will now review our year-over-year quarterly financial results. We reported normalized FFO for the second quarter of $73 million, or $0.45 per share, up 17% in the aggregate and 2.3% on a per-share basis from last year. Looking first at the income statement. Rental income increased to $111 million, mainly due to external growth from investments in medical office buildings in leased senior living communities we made over the past year.

Residence fees and services from our managed senior living portfolio grew to $36 million from the 24 communities with over 3,300 units we owned as of June 30, 2012, compared to $844,000 from the 10 communities with 824 units for the same period last year. Percentage rent from our senior living offerings increased 7% to approximately $3 million, driven from occupancy and rate increases at our triple net senior living communities.

Property operating expenses for the quarter increased to $41 million, compared to $11 million last year, which was in line with our expectations as we added a significant number of both managed senior living communities and medical office buildings to our portfolio. Of the $41 million of property operating expenses, $15 million were derived from our medical office buildings and $26 million were derived from our managed senior living assets. Excluding our pending acquisitions, we believe this is a good run rate.

General and administrative expenses increased to $8.1 million, compared to $6.8 million last year, which is in line with our expectations and we believe this is a good run rate. As a percentage of revenues, G&A decreased to 5.5%, compared to 6.7% last year.

Interest expense was up 20% to $28 million. Interest on our debt has increased since last year due to the $274 million of mortgage debt we have assumed with acquisitions. The [SUN] sold $300 million of unsecured senior notes in December 2011, net of the repayment of 19 mortgage loans for $48 million in 2012 and the repayment of $225 million of a 8.625% unsecured senior notes in January 2012.

We expect interest expense to increase by $2 million to $3 million in the third quarter due to our financing activity subsequent to quarter end, which includes the issuance of $350 million of senior notes with an interest rate of 5.625% issued in July, $66 million of mortgage debt at a weighted average interest rate of 6.1% we will assume with acquisitions, offset by the repayment of $200 million of the variable rate Fannie Mae mortgage loan at an interest rate of 6.4% on September 1. Because we cannot utilize the proceeds of our July debt offering to pay our Fannie Mae debt until September 1, our interest expense will be unusually high for the third quarter.

Moving to the balance sheet. We closed $125 million investments during the quarter comprised of one senior living community and four medical office buildings, and assumed $57 million of mortgage debt. We also invested $7.8 million into revenue-producing capital improvements at our triple net senior living communities for the second quarter. Subsequent to the quarter, we closed on $98 million of acquisitions of five senior living communities and two medical office buildings, and assumed $7 million of mortgage debt.

The weighted average capitalization rate for these acquisitions since April 1 was 8% based on estimated annual NOI. We still have $142 million of pending activity comprised of two senior living communities and two medical office buildings, and will assume $59 million of mortgage debt, the majority of which we expect to close during the third quarter.

At quarter-end we had $20.4 million of cash on hand, $360 million outstanding on our revolver, $750 million of unsecured senior notes and $863 million of secured debt and capital leases, making our total debt to capitalization ratio of 45%. Our targeted leverage using debt to total book capital is in the range of 40% to 45%. Our credit statistics remain extremely strong with EBITDA over interest expense of 3.6 times and debt over annualized EBITDA at 4.8 times.

Following quarter-end we sold 13.8 million common shares, raising gross proceeds of $300 million and issued $350 million of 5.625% unsecured senior notes due 2032. We used part of these proceeds to repay the entire outstanding balance on our revolver, and intend to use the remaining proceeds to repay $200 million of Fannie Mae secured debt on September 1 and to fund our pending acquisitions.

Following our equity offering, our weighted average shares outstanding for the third quarter will be approximately 175 million. We do not anticipate having any additional capital needs for the foreseeable future. Today we have nothing drawn on our revolver and approximately $250 million of excess cash available for our -- pending the closing of acquisitions and the refinancing of Fannie Mae debt. And taking into account our recent financing activities on a pro forma basis, our debt to book capitalization ratio would be under 40%.

Our recent finance activity has helped fuel our growth in acquiring high-quality properties that increase the size of our portfolio, allowing us to improve our overall cost of capital and the diversity of our property type and tenants. However, our FFO per share will be temporarily reduced by $0.03 to $0.04 in the third quarter versus the second quarter because we will be holding excess cash pending closing acquisitions and the refinancing of our Fannie Mae debt.

In closing, we believe the healthcare supply and demand fundamentals are positive and growing for the healthcare REIT sector. Our high-quality portfolio purchased at rational prices, along with our conservative financial approach, access to capital and covenant dividend yield of 6.7% makes us an attractive option for investors. With that, Dave and I are now happy to take your questions.

(Operator Instructions)

Phil DiFelice, Wells Fargo Securities.

Good afternoon. This is Phil DiFelice for Todd Stender.

Hi, Phil.

Hello. You mentioned the rate associated with the mortgage debt on the assets closed in Q2 was 6.1%. Is this similar to the $59 million you expect to assume in Q3? And what are your plans for these mortgages?

We expect average -- weighted average rate on the pending acquisitions about 6.1%.

You plan on holding them through to maturity?

We do. We always look in to see if we can pay those off during the acquisitions and see what the terms are. And on these, we will hold them until close to maturity so we will assume those.

Okay. Thank you. Regarding your asset purchase in Hawaii, which is one of the largest single asset purchases of the grouping, it looks like the property is very well leased at nearly 100% and has an average lease term of about four years. I was wondering if you could talk a little bit about the lease rollover schedule over the next couple of years and how you were thinking about rent rolls and retention for that asset?

Sure. That asset is a unique asset because it is physically located adjacent to the Straub Medical Clinic in Honolulu, and it has, in fact, much of the parking and garages that are in our building supports the hospital. So, the tenant rollover, as you said, it is pretty much full. It does have an anchored tenant, which is a highly rated insurance company that is almost half the building and they are in there for, I believe, another seven more years as a tenant and the rest of it is mostly the Straub Medical Clinic itself, plus a number of physician groups and so on.

So, I think there is pretty much a waiting list currently for the space. So, we believe that is going to constantly be occupied by healthcare related tenants and we're frankly not terribly concerned about the lease rollover risk as far as vacant -- increasing vacancy or anything. We think it should be a positive for us as leases roll over.

As far as lease rates go, you believe the current rates are below market?

We do. Yes.

Great.

Just like our Cedars-Sinai, that's probably the best type of healthcare asset, and we are hoping that this is a smaller version of that. At Cedars, we are clearly able to push north of $70 a foot, and again continue to have a huge waiting list, and we're constantly full there. So, I'm expecting, on a smaller scale, a similar dynamic.

That helpful. And occupancy in your TRS managed portfolio was up another 70 basis points sequentially, 500 basis points from Q2 of last year. How are you thinking about the potential for further improvements currently?

Nobody can predict, but I imagine our expectation's that that trend will continue to improve from here. Independent living was one of the segments that got hit the hardest with the recession, and has -- is now -- we are seeing the rebound, the greatest in a particular type of product type and so our properties are holding up very well and continuing to grow on the independent living side. So, I'm expecting definitely better results going forward from those properties.

Great. Thanks for taking my questions.

Thank you.

Jana Galan, Bank of America Merrill Lynch.

Thank you, good afternoon. You mentioned in your prepared remarks that hospitals were starting to accelerate their decision-making on the investment sales side of MOBs. I was curious if you are seeing similar trends in the leasing activity?

Yes. We are seeing that there has been a pick up in activity since the Supreme Court ruling. I think hospitals tend to move a little bit slow anyways in signing up stuff, but I think that now there is a sense of urgency with accountable care organizations being formed and I believe that activity has picked up from, what we can tell in our properties.

Maybe a more big picture question on MOBs, just trying to follow recent trends, do you feel the industry is moving towards shorter-term leases? Or, maybe is there a difference between the on-campus versus off-campus, in terms of lease term?

Right. I think people in the nature of the healthcare environment is such where people do not want to commit to long-term anyway. So I think people, physicians and hospitals, are reluctant to sign long-term commitments beyond what they feel they have to.

But, I think people all do realize that there is going to be increasing demand for the space. So, I think you will see development pick up. But I think that bodes well for existing space, too, that people want to take up as much outpatient space as possible, as soon as possible. But, there is still hesitation to execute long-term leases unless it is for the whole building or to be the primary anchor for the building, and those tenants want to sign long-term. But otherwise, the smaller physician groups are trying to stick to pretty much, more or less, five-year terms.

Thank you very much.

You're welcome.

Tayo Okusanya, Jefferies.

Good afternoon. Just a couple of questions. The Sunrise, the transition to the TRS managed by Five Star, could you talk a little bit about what the financial impact of the change would be in regards to the nice triple net leases before, now you are kind of moving towards the TRS structure. What that would mean for the bottom line?

Sure. Our expectation first is that we expect seven or eight of the properties to come online in the next 30 to 60 days. And, there is two properties that are, because of the states they are in, will take much longer for licensing, up to six months longer. And, from an operational perspective, they are more or less neutral to what we are currently getting in rent from the properties. So, it could be a little bit less, could be a little bit more, but not materially different from what we're currently getting.

And, our expectation is that we will be making some changes in the operations, we will be putting -- some of the properties we will be putting a fair amount of capital improvement money into making them more competitive today. But again that -- I don't anticipate a significant change in operating performance. And then we believe from there we should have upside potential. I do believe that the properties could be performing better with some capital spent on the physical plant.

Got it, that's helpful. The $126.7 million of deals still to close, the biggest piece of it is the New York piece, about $99 million. Can you give us an update when you expect that to close at this point?

It's really $142 million pending deals to close, Tayo. And you are right $99 million relates to the Yonkers, New York, the last REIT, and we do anticipate -- we're moving very close to trying to close that in the middle of the third quarter before even the third quarter finishes. That's our goal.

That's helpful. I may have missed this earlier on, because I got on the call a few minutes late but, the decline in occupancy for the MOB portfolio this quarter, as well as a reason for that again?

The main reason was we still have that property that is vacant in the Philadelphia market place that I think was in May it became vacant, I believe.

Right.

So that is still in our numbers. Otherwise, there is nothing of any significance with any other properties.

It is just a small decline.

Got it. And lastly, just acquisition outlook? You guys announced a bunch of other deals again during the quarter, which is great, and I understand the whole pre-funding situation and how that impacts Q3 earnings. We're beyond that, when I kind of start thinking about what could the back half of this year look like from an acquisition perspective and the potential impact in regards to 2013 earnings?

Okay. It is always challenging, we had a great quarter and what are we going to do next to top that? I envision that it is going to be more or less the same of these one offs of decent size senior living communities, as well as the $10 million to $25 million MOBs that are in the pipeline.

So I don't -- I would say at the moment there are a few portfolios out there that we're looking at that could be a couple hundred million dollars, but I don't -- I couldn't tell you today whether or not we will be the winning bidder on those. So, I caution you to envision more of the same $50 million a quarter, let's say, of acquisitions may be better.

Got it. So for the year you are going to be roughly at about $400 million or so?

I think we said $300 million to $400 million, and I expect to be in that range.

Okay. Got it. And year-to-date you have what in acquisitions?

Since the close, since April 1, $227 million, and we did 11. So about $238 million for the full-year.

Okay. Right. Thank you very much.

Thank you.

Jorel Guilloty, Morgan Stanley.

Good morning, gentlemen. I have a question in regard to debt investments. The Five Star bridge loan has already been paid down. I was just wondering if you are considering further investments in debt going forward? Or if you are seeing much right now?

Right. We have not seen a lot. We have not targeted debt to invest in as an asset class to invest in. There are some opportunities on a case-by-case basis that we are evaluating about possibly doing, but again I'd say it's not a targeted sector or type of investment.

Okay. So the Five Star leases, the rent covers ratios are continuing to decrease gradually, having to do with the Medicare rate cut. How much more do you expect the coverage ratios to decline? What is the target number for, when all is said and done, when mitigation goes through and everything is stabilized?

Overall for the four leases, I think we went from 1.32 to 1.3 times coverage. So it's conceivable, when you roll in two more quarters of the lower Medicare rates, that could come down another 20 basis points or so. But, as you can see from the charts in the supplemental, the one lease is trending down. Actually a couple of them are trending down, but the lease number four, which is the one people are originally concerned about, is crossing the 1.2 times coverage and trending upward.

So, I think net-net, it won't be that significant a change in current coverage ratios. As mentioned too, Medicare rates are going to increase October 1 by about 2% and then will have to see what happens in January with the sequestration decrease. Again, all the more reason why we try to focus on private pay.

Got it. And then both you and Five Star were talking about the fact that a lot of the residents, or patients rather, in skilled nursing are migrating more towards either post acute setting or an assisted-living setting. That being said, do you have a strategy of either divesting from SNF assets or going more into a post acute care model?

We will not be going into a post acute care model for investing and on a skilled nursing side, we have repeatedly said that we tend to gradually exit the skilled nursing business. I don't really envision a wholesale, out right sale of everything but it would tend to be more from regions of the country and individual assets. But again, it is now down to 4% and we continue to try to bring that down.

My last question is related to something else that Five Star said on their call. It was about how cap rates are at a four to five year low for assisted-living. Or senior housing in general, I just wanted to get a sense of where yields are trending in your transaction pipeline, or do you see them compressing? Do you see them flat for both the senior housing space and medical office buildings?

I do see them compressing. Again, probably for truly top-of-the-line Class A products, it is probably high sixes, low sevens at this point for initial returns. And I think that some of the other assets that have been running around say 9% or so, cap rates are coming down into the mid-eights. But still when you're looking at individual assets there's a limited universe pursuing it. And it all depends on what capital is available to help finance those transactions. And Fannie and Freddie are still readily available. I still don't see significant increases in bank financing or life insurance company financings in any significant way in our space.

Thank you very much.

You're welcome.

James Milam, Sandler O'Neill.

Just wanted to ask a question. As you think about some of this capital spending into the Senior Housing portfolio and even some of the MOBs, have you guys -- is there a way for you to quantify what is going to be maintenance capital expenditures versus maybe for the Sunrise portfolio capital spending, that's really designed to improve the property's performance and can be thought of more as a an ROI and investment type of capital spending?

Certainly on the Sunrise portfolio, we have not had the chance to do that yet until we start to really take over the properties, and get in there and have true engineering studies done. That's still to be determined. On existing assets, clearly we are trying to do as much as we can to revenue enhancing. You have one bucket of capital expenditures that have been to Five Star and some of our private operators, and those are predominantly to freshen the property, as well as expand the physical plant of the properties to add more units.

So, I would -- and we get a return of at least 8% on the amounts funded in those cases, so those are revenue enhancing, obviously, to us. But with the MOBs and the managed properties, again it is still very early, we are starting to put the capital in there and most of that is to refresh the property at this time. Less so to expand or add revenue enhancing type of capital improvements.

Okay so if it's mostly refresh type of spend, you expect that number -- you are accelerating some of that now, but that number should start to decline over time?

That is our expectation. We've taken these over, this is our chance to really make an impression and pump the money in, first of all, given the state of the economy. Construction cost and so on are probably at the lowest they're going to be for a while, so we should spend the money today.

And it calls transition anyway, so you may as well fix the issues today and show you are really committed to the property. So we are pushing people to identify in these areas and spend the money today so we don't have to down the road.

Okay, that makes us. And my last one, as you guys are out, and obviously, you look at, as you said, some of the smaller one-off deals, $10 million size acquisitions, do you guys see anybody that is maybe thinking about selling or that could potentially drive more transaction activity ahead of any potential changes at the end of the year with the tax code and the fiscal cliff, and all the good stuff we're looking forward to?

There is certainly a number of people who are thinking through that exercise, whether or not on capital gains is clearly more attractive this year, and, of course, the uncertainty of the future. And a number of transactions in the marketplace today have asked for special preference would be given to bidders who could close before year-end.

So, it's definitely a consideration. We do see a little bit of repeat business on deals that we've done in the past that they were very happy with the way the transition occurred and would like to try to do something before year-end. So, it is affecting people's decisions. I couldn't really quantify to you how much of the acquisition pipeline falls into that category, but it is definitely, I would say -- of what we are looking at is probably a few hundred million dollars of that type of decision factored opportunities out there.

That helps. Thank you.

Philip Martin, Morningstar.

Good afternoon. Dave, just a question with respect to -- when you look at your active acquisition pipeline, what percentage of the total would include the addition of a new third-party relationship, or the potential for?

Certainly on the MOB part, I would probably say two thirds of it is new relationships. I would say in a couple of cases that there very potentially could be some future transactions coming of that relationship. But I'd say we haven't made a wholesale new joint venture relationship with anyone. So I wouldn't say it would open a huge amount of opportunity, but I do envision a few repeat customers, or opportunities to expand with.

And would that also include on the triple net and TRS managed assets, as well?

Definitely.

Okay. And when you look -- with respect to the triple net leases renewing in 2013, I know on page 28 of your supplemental there is about $18 million worth of annualized revenue there up for renewal. What portion of that is triple net lease? I am assuming it is -- the greater portion is triple net lease. Can you give us some insight into lease rate and growth discussions on the triple net portion?

Actually, there is not a lot in the triple net portion, the MOBs. We have a number of short leases with Cedars-Sinai, so we constantly have quite a bit of space rolling over every year and we have seen nothing but rental increases at that property. We have a couple of -- we do have a couple tenants, but not a significant that we expect to renew. I expect the renewals to be more of the nature of a 5 year renewal, as opposed to a branded 15- ear term or 10-year, as was probably the initial term. I just think that people -- we're finding that people are less willing to commit to much long-term leases.

That is even on the senior housing side? Senior housing triple net side?

The next renewal on that is in 2013, about $18 million you see on page 20 of the supplemental, and that relates to the 10 leases right now with Sunrise.

Got you.

Once we transitioned those over to our taxable REIT subsidiary, that will be eliminated.

Okay, so really that number is more like $10 million when you exclude Sunrise?

No, that is all of Sunrise.

That is all of Sunrise?

That is all Sunrise.

Okay. That clears that up.

Just to be clear about that, it is 10 of the properties are Sunrise. The four other properties were moved down to 2008 since they already extended their lease from 2013 for four of the properties to 2018.

Okay. That clears it up, thank you very much.

(Operator Instructions)

Daniel Bernstein, Stifel Nicolaus.

Good afternoon. The first question I have is on the Stellar Senior Living acquisition, I assume that is a traditional sale lease back. Are there other opportunities or other assets that Stellar has that you might be interested in, or they would be interested in selling to you?

Not in their existing portfolio. We do expect to continue to grow with them and finance a number of their acquisitions. So there will be another avenue for us. You are right, it is standard triple net lease, long-term with 4% growth in revenues at the properties, so very similar to our existing triple net leases.

Okay, do they have a purchase option on that at some point?

No.

Okay. And, I just want to get to the TRS properties, I had a few questions on there. Obviously, it wasn't same-store numbers, the 23 properties in Q1 and 24 properties in Q2, can you provide just a little clarity as to what the same-store performance was sequentially? Obviously, it would've been more independent living in the second quarter, that additional property brought down the rate. But can you provide, for the 23 properties, sequential occupancy and rate?

The occupancy had moved up a bit and the rates are pretty much stayed the same just between Q1 and Q2. So it really hasn't been that much change in the rates. Revenues are up $700,000. So the expenses are pretty much about another $250,000 more, clearly, and so it is really on the expense side of things that there's been more volatility. And one of the things that does hurt us is, as we buy these properties, particularly in states that are looking for real estate tax revenue, that they are very quick to reassess and increase the real estate taxes, and you can't necessarily bill them back to the tenants until the next rate increase goes into effect. So, that is something we hope to stay ahead of the curve on and properties that are going to experience rate increase -- real estate tax increases.

So basically the margin compression there is more of real estate taxes and whatever additional kind of expenses you're putting into the facility to get them up to whatever standard that you think they should be?

Right.

So on that note, the timing of that, is it usually a one or two quarter transition of adding whatever personnel changes and putting in CapEx? Is it going to take a quarter or two before we start to see some stable -- some good comparison numbers for those portfolios or at least the same-store portfolio?

Yes. Because typically I would say more or less it's sometimes two quarters to work through the transitional costs and they could be -- you have all kinds of transitional matters like changing the signage of the property, changing the menus, just going through -- and some branding and some updating of carpets and wallpaper and stuff like that. So, I say it is more volatile in that first two quarters or so and it should level out. And then our experiences that we've seen with other properties is that once you've done that, you start to really reap the benefits.

So you transition that $99 million V property transition the other seven, eight Sunrise we are going to see some fluctuations in the TRS occupancy rate margins over the next couple quarters and be hard to read into what's really going on there? That's essentially what I am --

That's exactly correct. Most operators typically don't allow you to get in and get your hands on operations or even for that matter, even talk to the employees and the residence families until a couple weeks before the acquisition transfer takes place. You really can't do a thing until you get in there and start to run it yourself.

Okay. And on the 10 properties that you are going to transfer from the Sunrise lease to TRS, my understanding those are little but more SNF heavy or has a little bit more -- a few SNF units then some of your other assets on the TRS? How are you going to alter some of those -- what kind of CapEx are you putting in? Are you transitioning those SNF units to more higher acuity? Essentially what do you need to do to improve the operations of those 10 properties? I'm trying to get to that.

A couple things, it is still very early and probably it's another conference call or two before we can get into that in any meaningful way. But, just initially, you are right that every one of 10 properties has a skilled nursing unit in it, and their results for Q1 and Q2 of this year pretty much reflect the new Medicare rates. So, I think once we get in there, we still have yet to evaluate what can be transitioned to a member care unit, or if it's just a refresh and maybe privatize some more of the rooms to attract more Medicaid and higher acuity residents, that is still all to be determined and evaluated.

Okay. That's all for me. Thank you very much.

You're welcome.

I'll now turn it back to Mr. Dave Hegarty for closing remarks.

Thank you all for joining us today. We will be presenting at the Wells Fargo Midwest REIT forum in Chicago in the middle of August. And, the Bank of America Merrill Lynch global real estate conference in mid-September in New York. So, we look forward to updating you at those conferences and talking to you again in late October for our third quarter results. Have a good day.

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