Healthpeak Properties Inc (PEAK) 2018 Q1 法說會逐字稿

Good morning, and welcome to the HCP, Inc. First Quarter 2018 Financial Results Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Andrew Johns, Vice President of Finance and Investor Relations. Please go ahead.

Thank you, operator. Welcome to HCP's first quarter financial results conference call. Today's conference call will contain certain forward-looking statements. Although we believe the expectations reflected in any forward-looking statements are based on reasonable assumptions, our forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our expectations. A discussion of risk and risk factors is included in our press release and detailed in our filings with the SEC. We do not undertake any duty to update any forward-looking statements. Certain non-GAAP financial measures will be discussed on today's call. In an exhibit of the 8-K we furnished with the SEC today, we have reconciled all non-GAAP financial measures to the most directly comparable GAAP measures in accordance with Reg G requirements. The exhibit is also available on our website at www.hcpi.com.

I will now turn the call over to our President and Chief Executive Officer, Tom Herzog.

Thanks, Andrew, and good morning, everyone. With me today are Pete Scott, our CFO; and Scott Brinker, our CIO. Also here and available for the Q&A portion of the call are Tom Klaritch, our COO; Kendall Young, SMD of Senior Housing; and Troy McHenry, our General Counsel.

Our quarterly operating results were in line with our expectations. And this morning, we reaffirmed both our full year FFO as adjusted and same-property cash NOI growth guidance ranges. Leasing in our specialty office platform is off to a good start with both our MOB and life science lease pacing ahead of plan. Our SHOP SPP included the anticipated temporary disruption from the Brookdale transition and sale assets within our relatively small pool of same-store communities. Importantly, we had already baked this noise into our SPP guidance ranges we've provided in February. We will provide more details on our performance by segment in a moment.

Since our last earnings call in mid-February, we've made significant progress toward completing the $2 billion of strategic transactions announced in November of 2017. We've sold and transitioned certain of our announced Brookdale assets, exited the high-yield mezzanine debt business and today announced the clear path to exit our international holdings. Our operator transitions are well underway and expect we'll have more progress to update you on, soon. Our management team is fully in place and our board refreshment plans were communicated yesterday. In short, we're on track with all the elements of our previously communicated strategic plan.

With the completion of our remaining announced transactions, we will have a fully differentiated and diversified private pay portfolio. Over half of our business will consist of the specialty office segments of medical office and life science. Our medical office portfolio is over 80% on campus, and our life science business is well positioned in the top 3 life science markets.

Additionally, our senior housing concentration will be reduced to around 40%, we'll have a stronger demographic profile and lower exposure to new supply. Our portfolio will benefit from the powerful demographic trends underway, it will provide stability through this different cycles and attractive investing alternatives when allocating future capital, while largely eliminating exposure to stroke of the pen risk.

As Scott Brinker joining us in March, we have rounded out a deep leadership team with complementary real estate, senior housing, health care, transaction and finance experience, supported by a talented bench of highly qualified and motivated colleagues. We remain 100% focused on executing our strategy and positioning HCP as a top-tier health care real estate company by meeting the real estate demand for private pay health care companies and seniors.

With that, I'll turn it to Pete. Pete?

Thanks, Tom. Let's start with first quarter results. We reported FFO as adjusted of $0.48 per share. Our earnings in the first quarter benefited from higher yielding assets, targeted for disposition throughout the balance of the year. We expect FFO as adjusted to decline modestly in the coming quarters as we complete our planned transactional activity.

Let me provide more details around our major segment. For medical office, same-store cash NOI grew 1.6% over the prior year, which was ahead of our expectations for this quarter. In the first quarter of 2017, we reported above average same-store cash NOI growth of 4.4%, so we naturally anticipated the first quarter of 2018 to be lower. We expect to improve our quarterly same-store metrics as the year progresses. On a year-over-year basis, our same-store growth is driven by our 2.7% in-place lease escalators and a 3.9% mark-to-market on renewals, but partially offset by a 40 basis point decline in occupancy due to some known move outs. Our leasing pipeline for the balance of the year is strong.

Turning to life science. First quarter same-store cash NOI grew 0.4% over the prior year, which was ahead of our expectation. As we announced on our last quarterly earnings calls, the growth was impacted by the mark-to-market of the Rigel lease. On a normalized basis, same-store cash NOI in life science would have been 2.4%. While occupancy has ticked down from the near all-time high in 2017, year-to-date leasing is well ahead of where we expect it to be. To date, we have executed leases for LOIs for approximately 80% of our 1 million square feet of leasing slated for 2018.

At our recently acquired Hayden Research Campus in Boston, we have executed leases totaling 123,000 square feet since closing the acquisition in December, bringing the campus to 97% leased. At phase 3 of The Cove, which consist of 336,000 square feet of Class A specialty office, I am pleased to report today that we have leasing commitment for 100% of the state, well ahead of expectations. This milestone is another example of the strength of the South San Francisco life science market, combined with the unsurpassed quality of this best-in-class campus.

Lastly, in April, we signed 2 new leases totaling 150,000 square feet with General Atomic, at our Ridgeview development located in San Diego suburb of Poway. The $62 million development is now 100% leased to General Atomics. For our senior housing triple-net portfolio, same-store cash NOI grew 0.5% in the first quarter. This was in line with our expectation and takes into account our previously announced rent adjustment. On a normalized basis, same-store cash NOI in senior housing triple-net would have been 2.3%.

For our SHOP portfolio, same-store cash NOI for the quarter was negative 6.4%, which was in line with our expectation. Given the occupancy declines we experienced in the second and third quarters of 2017, we were not at all surprised by these results. Importantly, too, we do not exclude or normalize for performance in a transition assets or assets we are marketing for sale. While we experienced an overall decline in occupancy of 200 basis points, the performance in our core long-term portfolio and our transition and sale assets were dramatically different. Transition and sale assets typically underperform due to expected higher turnover in key operational positions, which can lead to significant temporary impacts on property performance. Page 32 of our supplemental provides a breakdown of this bifurcated performance.

For our core portfolio, we experienced a decline in cash NOI of 0.6%, which was the result of 70 basis points lower occupancy, 2.1% REVPOR growth and 2.2% expense growth. For our transition and sale assets, we experienced a decline in cash NOI of 12.3%, which was the result of 310 basis points lower occupancy, 1.4% REVPOR growth and 3.1% expense growth.

As a reminder, our SHOP SPP portfolio consists of only 69 assets, which will be reduced further as sales are completed, and is approximately 10% of our overall NOI. The small nature of the pool results in increased volatility and performance as well. We remain committed to reducing our Brookdale exposure to 16% or lower of our overall portfolio income. We look forward to getting these assets transitioned to operators, who we believe will improve performance.

We are well underway to achieving this having completed 13 transitions to Atria, with the remaining scheduled through early summer. Additionally, we transitioned one community to another existing operator, Sonata Senior Living. We are also nearing agreement with a select group of operators to take on the balance of the transition asset. On our third-party sales, we are in the midst of our marketing process.

Let me briefly touch upon some accounting items related to the U.K. transaction, which we announced concurrent with today's earnings. In March 2018, we consolidated 7 U.K. care homes that would be underlying security for our GBP 105 million bridge loan to Maria Mallaband. If you recall, this loan includes a provision that allows us to convert the loan to real estate, provided certain conditions are met. We received feedback from potential buyers that they would prefer to acquire the real estate directly, rather than through the debt investment.

Consequently, in March, we began the process to exercise the option to convert the loan to real estate. And upon satisfying the required condition, we consolidated the real estate at fair value in accordance with accounting rules, resulting in a loss on consolidation of GBP 29 million. The current fair value of the real estate was adversely affected by a temporary decline in occupancy and embargoes. I would also like to point out that upon closing the joint venture transaction, which Scott will cover in more detail, we expect to recognize a gain of approximately GBP 20 million upon marketing our other 61 assets to market in accordance with accounting rules.

Moving on to the balance sheet. We ended the quarter with a revolver balance of $1.1 billion. Subsequent to quarter end, we closed on the sale of $270 million of assets. Using the sales proceeds, we paid down our revolver, bringing the balance to approximately $800 million as of May 2. Pro forma for this pay down, our first quarter annualized 2018 net debt-to-adjusted EBITDA would be 6.5x.

Turning to the dividend. As previously announced, the company's Board of Directors declared a quarterly cash dividend of $0.37 per share to be paid on May 22. As a result of our high-quality portfolio, we are very comfortable with our current dividend payout ratio in the low 90% range for 2018. This payout ratio will vary by quarter, but we expect to remain fully covered on a quarterly basis through the balance of the year.

As we look beyond 2018, our payout ratio will benefit from approximately 3% contractual escalators on the vast majority of our portfolio, to significant near-term positive mark-to-market lease opportunities in life science and the substantial earning from key development project, including The Cove.

Finishing with our full year guidance. We are reaffirming our FFO as adjusted per share range of $1.77 to $1.83, and total cash NOI SPP of 0.25% to 1.75%. Additional details of our guidance can be found on Page 46 of our supplemental.

One last item before turning the call over to Scott. As we discussed on our last quarterly call, in order to create greater comparability to our peers, we have excluded unconsolidated joint ventures from same-property results. Starting this quarter, we have collapsed all of our unconsolidated joint venture disclosures in the supplemental for one section on Pages 43 to 45. Additionally, please refer to the SPP reconciliation table on Page 15 of the supplemental to see the adjustments to our SPP pools as a result of this methodology change. As a reminder, given the small amount of unconsolidated joint ventures, this reporting change has minimal impact on our overall SPP results.

Now I would like to turn the call over to Scott.

Okay. Thank you, Pete. I want to kick off with an update on transactions. The story here is execution. In March, we completed the share of our Tandem mezzanine loan for $112 million. We're very happy to be out of this freestanding, skilled nursing and mezzanine loan businesses. We closed the sale of 6 properties back to Brookdale for $275 million, with most of that occurring in April. We're also on track to close the sale of our JV interest in 48 Brookdale properties to Columbia Pacific this summer, which will generate $332 million in proceeds to HCP.

There's also good progress in the U.K. Earlier this week, we signed a purchase agreement with an institutional investor to sell a 51% interest in our U.K. holdings. The price is based on an enterprise value of GBP 394 million. We expect to close the JV this summer and we have a clear path to a full exit from the U.K. by no later than 2020. The proceeds from the asset sales will be used to pay down debt and to help fund our highly desirable life science development pipeline. Last quarter, we funded $72 million into that pipeline, which will provide growth in earnings and NAV when the projects come online.

Now 8 weeks in, I wanted to share a few things about HCP that stand out to me. One is that the team is united and highly energized to start talking about the future. Another is that we're emerging from this transformation uniquely balanced in life science, medical office and senior housing. All 3 segments benefit from undeniable and long-term trends in health care demographics. We have critical mass and expertise in all 3 segments.

I also see great upside in changing the public narrative about HCP away from the noise of the repositioning and towards a valuable and unique real estate that remains. After seeing some of that real estate first hand, one thing that stands out to me is the density of many of our campuses. You can park your car once and walk to 5 or more HCP buildings. Each tenant plays off the success of the other, creating a virtuous cycle of demand for space.

An example is Medical City Dallas, a 2.1 million square foot HCA-sponsored campus with 7 buildings, all of them owned by HCP. Each one of the leading medical campuses in the entire country, and would be impossible to replicate today given the location and scale. Another example is Centennial, our 600,000 square foot cluster of 7 fully occupied MOBs on the campus of HCA's flagship hospital in Nashville.

Our life science campuses were equally impressive to see in person. Their scale and density give us flexibility. This is super important because space requirements can change dramatically over time based on drug approvals and new funding and partnerships. A good example is at The Cove, a 1 million square foot campus of 7 buildings developed by HCP in South San Francisco.

This week, we signed a lease for 150,000 square feet with an existing HCP tenant. After a successful IPO and signing multiple new partnerships, that tenant was looking to expand its footprint by 400%. Our local scale enabled us to meet their needs. The expanded lease will commence next April when our newest developing project is completed.

And directly adjacent to The Cove is Oyster Point, our 9-building campus, with just under 1 million square feet. The most unique property I saw was in Mountain View, where a cluster of 12 fully occupied buildings fit like a jigsaw puzzle within Google's corporate campus. The scale of these 5 campuses is truly unique within health care real estate and they generate an incredible $200 million in annual NOI to HCP.

I also want to share some initial thoughts on capital allocation. First and foremost, we'll be focused on owning high-quality real estate that allows us to grow the dividend over time. We won't see earnings growth that's achieved through financial products and engineering which, in our view, have a track record of starting accretively but ending destructively.

We're going to be more mindful of concentration by segment, by tenant and by geography which, at their best, consistently grow their dividend. But we know that sector fundamentals change, operators change and markets change. Diversification will help us mitigate the big swings up and down. Our underwriting will be thorough and objective, and our investment decisions will focus on risk-adjusted cash flows over time.

Our portfolio mix will shift to a more equal balance between life science, medical office and senior housing. That means near-term capital allocation will be toward life science and medical office, and primarily through development and redevelopment where we currently see the best risk-adjusted returns. We like the mix of the low volatility medical office business, with the potential for higher growth in life science and senior housing.

The cyclical drivers of these 3 segments are very different, so the diversification is meaningful. Over time, we may see a step away from our small hospital exposure other than Medical City. But we're in no hurry to do so because we never lose sleep over the assets, given very strong rent cover and corporate guarantees.

Finally, I've been asked to share my thoughts on senior housing. (inaudible) aren't new to the sector. Today, the environment is difficult, and it likely will remain so for the next few years. New construction has started to decline but off a very high days, so the absolute number is still elevated. There needs to be a more significant and sustained slowdown in new starts before we would feel confident about the sector returning to strong growth in earnings. We're confident though that, over time, capital inflows will correct, allowing demand to catch up with supply.

Therefore, senior housing is an important part of our long-term strategy. We like the fact that demand for the park is growing, becoming harder and harder to find a family who hasn't been impacted by senior housing. And that phenomenon will only increase because the senior population will double in size over the next few decades and the penetration rate is rising.

We also like that senior housing is an inefficient market. And by that, I mean, there's imperfect information. That opens the door to outperformance through expertise and relationships. We expect to become one of the outperformers to 5 major initiatives. One, by selling select assets and transitioning others to new operating partners, most of which has already been announced. Two, by converting select high-quality triple-net portfolios with a strong growth potential into SHOP. Three, by redeveloping select older physical plans that are located in tremendous locations. Four, through smart acquisitions, new development and operator relationships. And five, by establishing a superior asset management platform led by data, analytics and relationships.

Before I turn it back to Tom, I just want to say I feel very fortunate to have joined HCP at this point in its life cycle, poised to once again generate significant value for shareholders. And now back to Tom.

Thanks, Scott. Before I open up the call to questions, I'd like to address a number of important changes to our Board of Directors. Yesterday, we announced that Brian Cartwright was appointed Chairman of the Board. Dave Henry, who has served on HCP's board since 2004 and recently as interim Chairman, will provide his extensive investment and transaction experience to chair the investment and finance committee of our board.

Brian has been on the HCP board since 2013. His background and experience are unusually extensive. Brian served our country in a top leadership role as General Counsel to the Securities and Exchange Commission from 2006 through 2009, a period of time which you'll recall included the incredible challenges of the global financial crisis. Prior to the SEC, Brian was a member of the senior executive team at Latham & Watkins from a local Los Angeles firm, which is one of the top law firms in the world. And before Latham, he started his career with a PhD in Physics, postdoctorate in Astrophysics and finally, a law degree. During his spare time, he was the President of the Harvard Law Review and served as a law clerk for Sandra Day O'Connor during her first term on the Supreme Court. As I'm sure you can ascertain, Brian has been an incredible talent and resource in our boardroom.

We also announced the appointment of 2 new highly qualified and accomplished directors to our board, Lydia Kennard, and Kent Griffin. Lydia's professional experience spans corporate law, real estate development and urban planning. She served as Executive Director of Los Angeles World Airports from 1999 through 2003, and again from 2005 to early 2007. In this role, she oversaw and managed the country's second-largest airport system, which included 4 airports, a staff of more than 3,000 and an annual budget of nearly $1 billion. Lydia's currently President and CEO of KDG Construction Consulting, a program in construction management and consulting firm.

Kent is a seasoned REIT executive having served in the role of President and Chief Operating Officer of the life science REIT, BioMed, from 2008 until 2015. Prior to BioMed, Kent spent 8 years as an investment banker and Raymond James and JPMorgan, following his time as a CPA and auditor at Arthur Andersen. On behalf of HCP, I'd like to welcome Lydia and Kent.

Finally, our board recently adopted a mandatory retirement age of 75, subject to limited exceptions to ensure an orderly transition of new members. This policy is in line with corporate governance best practices, and one that ensures continued board refreshment over time. It's worth noting that with the addition of Lydia and Kent, half of our directors have joined the board within the last 5 years.

With what I believe is an excellent management team and board and a strategically positioned portfolio, our sights are squarely set on delivering long-term, stable growth and strong total shareholder return. It is an exciting time for HCP.

With that, operator, please open up the line for questions.

(Operator Instructions) The first question comes from Jonathan Hughes with Raymond James.

Pete, earlier you talked about departures at the transition sales, SHOP portfolio, that was part of the driver of the decline in NOI there in the quarter. But I thought part of the strategic review of those assets late last year was to add managers and specialists to help stabilize operations. So I know some will be sold, but could you just talk about maybe what happened there in the quarter if the strategy on those assets changed at all?

Yes. I think one of the things to point out on the transitions in dispositions is, when you look at the year-over-year comparison, a lot of the occupancy decline actually happened last year. So we had anticipated those assets underperforming. We started the transition process. We've got, at this point in time, 13 transition to Atria, although that happened very recently, one to Sonata. It will take some time to see performance turn around at those assets. So I think the point is, the decline we've got baked in already and the upside will come as these operators have more time to actually operate these assets.

Okay. That's helpful. And then the SHOP portfolio is currently 13% of NOI and I thought the target exposure there was 20% back in -- at least back in November. What's the target there considering you still have -- you have several hundred million left to sell, this should be more like 10%?

Yes. I don't know that we necessarily have an exact target as we look at our portfolio right now, and the SPP pool is a little bit different than the overall exposure. If we look at senior housing, as well as MOBs, as well as life sciences, over time, we're trending more towards specialty office right now. I think we'll look to have a more even blend amongst all the segments as well and more of a medium- and long-term goal that we'll have, trying to have more of a 1/3, 1/3, 1/3 split. And I think it's hard to just say how much SHOP will be, some of that will also depend upon over time. And Scott talked about in his prepared remarks, in triple-net assets converting into SHOP. So I think, as we look at it, that's basically how we see our portfolio trending over the long term.

I think, Jonathan, the other thing within that number that could get confused is the CCRCs and their exclusion from SHOP. As you'll recall, we moved those into a separate bucket, and we're guiding to those separately in our guidance page at this point. That might be the difference that you're seeing there.

Okay. And then just one more, if I may, on life science. The appointment of Kent Griffin to the board, who has a deep background in the sector, was it done to try and specifically break into the Boston life science market in a more meaningful way? If so, can we expect that to be more development or acquisition focused?

Yes. This, again, is Tom. With Kent joining the board, he brings a very -- a specific expertise in the executive background around life science. He was, as I said, the President and COO of BioMed, prior to that he was the CFO of Biomed. As to -- specifically Boston, yes, I think that Kent's knowledge and contribution in all 3 of the major markets that we're participating in is going to be helpful to our management team and in the board room. So that was one of the very attractive elements of expertise that Kent brings to the board.

And the next question comes from Juan Sanabria with Bank of America.

Just on the Brookdale sales to third parties, can you give us an update on how that's progressing, the depth of the buyer pool, if initial colors that you're going to achieve your targeted proceeds and cap rates? And if you can just give -- and if those are a portfolio or kind of one-off sales that will aggregate up to your target?

Juan, Scott Brinker here. It's to be determined. We're talking to a number of parties about the assets. Our preference is to do something in scale, but we're open-minded to alternatives. There are a number of parties that are interested in the portfolio and they would have the ability to bring in their own operating partner here, so these assets would be acquired, unencumbered by the Brookdale contracts. And I don't want to say too much more than that, Juan, because we're in the middle of our process and we would hope to have more significant updates for you in the coming months.

Okay. Great. And then, Scott, maybe if I could stick with you just on -- if I think about asset management and areas of improvement, like what would you highlight as something that you think you can improve given your past experiences? And are the operators receptive to that, particularly Brookdale in those discussions in benchmarking best practices?

Yes. I'm happy to answer that, Juan. I think there's a great opportunity here. HCP was historically more of an asset triple-net landlord. And Tom and team have really made tremendous stride in the last 18 months to change that into what will become a best-in-class real estate operating company. But there's still some ways to go, and we're confident we're going to get there. It's happening rapidly, but it's a combination of people and technology and relationships with operators. There's also the issue of the size of our pool. So it bounces around a little bit in partly because it's so small. And that's something that, in senior housing, is difficult to manage even if you have A-plus team across the board. It's just a small pool and you're naturally going to have some movement given the dynamics of the sector with short lease terms and relatively low margins, and it's very unpredictable from month-to-month. So you're going to see that number jump around a little bit even after we improve our team, which we will do. But important to note, that it is a relatively small percentage of our portfolio and we think that's the right place for senior housing within a broad diversified portfolio.

Juan, this is Herzog again. I'll just expand just a couple of items. And this may come as a reminder, the comments we've made in the past that we've just spent the last quarter working on it, still, we have dramatically enhanced the team, that includes the asset management team. We have continued to build a dedicated finance team in senior housing. We then rapidly building out a system that is functional, at this point, that is going to be a great help in our analysis of senior housing and our reporting and tracking. And the senior leadership that we brought in has continued to have some time in the role. And as you know, from an operator perspective, we have been very active in taking actions on that front. So everything that Scott said or the things that he's focused on now, along with Kendall and the team, but there has been a lot of activity in the last quarter.

And one last one for Scott. And welcome back, by the way. You made the comment that supply may be elevated for a few years. So do you have any sense or color and share any thoughts on what you think the medium-term same-store NOI growth for the sector as a whole could be, just given supply will probably be higher for longer?

Yes. Well, I'm happy to comment on that. And individual companies will be above or below the national average if it's along the lines of my comment earlier, it is an inefficient marketing. You'll see quite a bit of variation in performance. But as an industry, I guess, I look at supply that's been growing around 3% per year a little bit more actively, and it's starting to come down but not meaningfully. Meanwhile, demand has been growing around 2% per year for a decade. Over time, we think that growth rate will increase pretty materially from the 2%, but not next year, and is probably a 5-plus year period of time before there's truly significant increase in that demand growth rate. That's our best guess at the national level. And that's why we look at the supply-demand picture nationally, and maybe aren't quite as optimistic as others that the industry, at large, is going to have a material turnaround in performance in 2019. Now all that being said, at HCP, I think we've got significant opportunity with the operator transitions. And as those assets recapture their occupancy and ultimately we think will move even beyond what they've achieved historically with better operations, not to mention all the improvements in asset management that Tom and I described earlier that -- look, we think we have a real chance to outperform this sector for a period of time here. But at the national level, Juan, I guess we're just a little bit more cautious about how quickly things can turn around.

The next question comes from Smedes Rose with Citi.

It's Michael Bilerman here with Smedes. Just a question on the U.K. deal. What was the structuring to not try to exit 100% upfront? And then can you talk about the next couple of years in terms of how the sale of your remaining 49% interest will be triggered, and how that will be priced?

I'm happy to take that one, Michael. It's Scott Brinker here. We did run a sale process for this portfolio. Like any seller, we looked at a number of factors that were relevant to us like price and certainly, of execution and timing. And ultimately, we chose a buyer that we thought offered the best combination of those things. So our view is that this is really a full exit. It's just going to happen in stages. So we like the fact that we got what we think is a fair price for these assets, about 6.5 after-tax yield to HCP. We think that's very fair. The initial closing should be this summer, which met our timing needs. And we were able to have a negotiation with the buyer and meet an important consideration for them, which was to lock up the deal, but have the time needed to do a full take out, which is their expectation against our expectation. It could happen as soon as this year-end. At the latest, it should happen by 2020.

And what is that, is that a put -- you have a put right by 2020 at the current price?

Yes. so the way the mechanics work, Michael is, first, this is an institutional investor that's well known at HCP and to me. And it will, in practice, be more consensual, and we'll have a discussion, but we do have contractual rights that would allow us to force an exit of our 49% interest. And the way the pricing works is, because this is a triple-net lease, the rent continues to escalate, so their purchase price continues to escalate. And if the performance was to decline quite materially, there would be an adjustment in the purchase price, but we do have a pretty significant cushion in terms of how much the NOI can fall before there would be a downward adjustment in price.

And then just turning to the triple-net master lease portfolio, Pages 26 and 27 of the supp. The percentages that are below that one line are growing in terms of exposure. But if you look at Page 27, outside of solving the Brookdale coverage issues, all the other ones are quite low. So I guess, how should the market be thinking about further rent reductions as senior housing and operating fundamentals not seem to be getting any bit better anytime soon, and so how should we think about the security of that rental stream?

Yes, Michael, it's Scott Brinker. I'll take that one as well. We view those as really having a number of options. The 2 most significant, one of them is only slightly below 1.0 coverage, and that's after management fee. So even if we were to renew the lease, I don't think it would be a material change in rents. And like a lot of these pool of master leases, there are oftentimes 1 or 2 properties that are really causing a problem in the balance of the portfolio's actually performing quite well, and that's certainly the case in a number of these. So we always have the option of just selling 1 or 2 underperformers and keeping the rest. We can transition operators, we can transition to SHOP. So none of these have immediate expirations. We've got 2-or-more years to figure these out. I can assure you it's a high priority for us, but we're also not feeling any urgency to do something, because a number of these new have strong guarantees. And the 2 on the list that don't, I think this graph is a little bit misleading or misrepresentational about the underlying cash flows because the 2 that you see on Page 26 without the guarantees, the actual rent that we're collecting is materially lower than what's reflected here. This historical or legacy triple-net add rent lease that we [acquired] from CNL, at the end of the day, the cash rent is what we're booking, and that means in the coverage is right around 1.0. So those 2 are I think a little bit misleading in terms of the payment coverage.

And then just last question, the down 12 on the SHOP portfolio that's being transitioned or sale -- or sold. Can you break out that down 12 between the assets that are anticipated to be sold versus the assets that are being transitioned, just to know how those different pools performed in the first quarter, because it seems a much steeper decline than one would've expected?

Michael, it's Peter here. I would say, broadly, the transformation and disposition, there's 34 assets that's probably at 50-50 split when you think about transitions versus disposition. I don't think there was a material difference in performance. It was sort of pretty consistent within both of those groups.

Pretty consistently poor?

Yes.

And any idea if that's going to keep trending at that sort of rate until these things are sold or transitioned?

Well, I think, on the transition, we would see some benefits, especially on the earlier ones that we have we completed already towards the end of the year. On the dispositions, I think, what I would say is, those assets, as we are looking to sell them right now, I guess it's somewhat irrelevant how they're going to trend going forward for the buyer. I mean, the buyers we're talking to at this point are all underwriting it based on a new operator taking over those assets. So they're not necessarily looking at what Brookdale could do with those assets. It's what the new operator could do with those. So I think you really need to take differences between the way that Brookdale's operating those and what the expectations would be for a new operator.

All right, well, if you can break that stuff for us forward for us in terms of sales versus transition, because I definitely think there's a lot of uncertainty when a new operator comes in. It takes a while for those benefits to see fruit, typically it goes the other way to a more significant extent early on as a new manager comes in. So having the details between those 2 pools would be helpful.

Yes, Michael, we would've done that, if not for the fact that were in the middle of the sale process on a handful of assets. So obviously, providing that details is something that we didn't want to do. The other thing that I would mention, I know that you kind of -- in the first time, you said, but in that -- those results that you just spoke to, in the prior year, most of that was baked in due to the comp for Q2 and Q3 occupancy had decline in the prior years. So that's what drove the whole piece of it, which is a great part of the reason why we have selected those assets for sale and transition.

The next question comes Jordan Sadler with KeyBanc.

I wanted to just follow-up, I guess, another one for you, Scott on the portfolio overall and then some asset management commentary regarding the senior housing portfolio. Your fundamental description sounds not exactly dire, but not exactly bullish for the next 5 years. And given sort of the company's ongoing process of trimming assets and paring the portfolio, is there consideration or thought of scaling down senior housing side of the business to a much more significant extent in the short-term? Is that on the table?

Well, there are a number of asset sales underway we're in, so we're not questioning our goal as a company is to create a more even balance between senior housing, medical office and life science. We're well on our way towards that path. And as I mentioned earlier, there will be pockets of outperformance, which is why we chose to sell the properties that we're selling and we transition some other properties that we think will have a potential for outperformance going forward. So we'll continue to look at what's left, match that up with relationships with operators and we'll constantly be looking at this portfolio to better position it, to outperform, and the asset management is an important part of that, but so is the real estate that we own and the operating companies that we partner with. So I don't think you should expect anything dramatic, but you should expect continued work to position this portfolio more effectively.

And Jordan, this is Herzog again. I would add that, as we complete the transactions, it will bring our senior housing down to 40% of our portfolio or just under that. And that -- as we look at what's dialed in, just to the -- what our expectations are as we continue to work our plan, it will be naturally reduced without doing anything dramatic, as we further expand in life science and MOBs. And I think you'll see that percentage decline, in the senior housing ownership percentage decline over time, some. But we still like the business. We still believe in it over the long term. We think it is an important private pay segment within a balanced portfolio that we want to own long-term. So it's probably, over time, more of a 1/3, 1/3, 1/3 between life science, MOBs, and senior housing over time without a specific target date. And some of that just occurs as we continue to recycle capital into life science, into MOBs, some of it through development to life science, et cetera, it will naturally move that direction, and there'll be certain actions that we take carefully over time that I think probably move us into that balance that we've been speaking to for a while.

Okay. And Tom, I do have another one for you. Just on -- you've now got much of the management team in place, it seems, that you were aiming for and the board has now been recast somewhat. I'm curious, number one, vis-à-vis earlier comments about making the company more of a real estate operating company, do you have similar -- is there a similar desire to add the personnel on the operating side on the -- either on the medical office or on the life science side or are you all set there? And any update on Doug Pasquale's consulting role?

As far as adding operational talent, that's something we've been doing for the last year. And I would see us continue to lean in that direction over the next couple of years, if it would continue to enhance our platform and infrastructure around operational talent, as you put it, that we really view ourselves as a real estate company in the health care business and having great operations is going to be critical to our plan. So the answer to that is, yes, we do intend to do that. There will be a lot of focus on, not just the team, but the rest of the platform and infrastructure, including systems, processes, et cetera. So that will be a focus. And I think it's going to be a very important element of what drives a success in our sector going forward. As for Doug Pasquale, he is an excellent talent in senior housing. As you know, he's run one of the major REITs in health care and was an operator in senior housing. So Doug continues to be part of the team that we're working with, and there's nothing that's changed on that front.

The next question comes from Rich Anderson with Mizuho Securities.

So I want to see if I can get into your senior housing head for a second here. On the transition of net lease to SHOP initiative, how much of that is, well, we're close to 1.0 coverage, and I don't want to cut rent, so let's move to SHOP? Or how much of that is a true belief in SHOP over triple-net? I'm curious if you're at 1.3 coverage, would this be as much of an initiative that you planned it to be today?

Rich, it's Scott here. I wouldn't call it initiative, I would call it an option. It's one that could makes sense...

Well, it's a major top 5, so you know...

One that might make sense for senior portfolios. And one of the things I notice about the portfolio and this may be a little bit different than what I would've thought about it 5 or 10 years ago is that HCP has some very high-quality real estate inside a triple-net portfolio and very high-quality operating partners, like Sunrise and Aegis and Oakmont. And those could well be opportunities for SHOP. Doesn't mean that we will do that, but it's an opportunity that I think -- these are assets that have performed over time. They've continued to outperform during the recent down cycles. That if we're going to have SHOP, one of our goals will be to have higher quality real estate and higher quality operating partners, and it may well be that we can accomplish that by transitioning some of our triple-net portfolio over to SHOP. But it's definitely not an initiative. It's just something that we would do if it made sense from a valuation and performance standpoint.

But the [one-off], if it's something that's close to parity in terms of coverage, that plays a role, I mean, like balancing, cutting rent and moving to SHOP. It certainly is a motivating factor, I would assume?

It's more of the lease maturity date that would be a motivating factor. Certainly, the cash flows are something that would factor into the conversation with the operator, because we don't have the right to unilaterally switch to SHOP, we would have to -- -- that would be with discussion and conversation. And if the cash flows are around 1.0 rent coverage, it's an easier conversation to have.

Okay. Okay, good enough. And then, another question on the Brookdale strategy, you mentioned, I think it was Peter, or probably all of you, getting to 16% lower. What do you think of the criticism that that's not enough, that you're still a proxy for Brookdale even at 16%? What's the over/under of getting much lower than the 16% when it's all said and done?

Rich, I'm going to compliment you for your listening skills, because that was a very quick comment but perceptive on your part. Yes, we said 16% or lower. We do intend to get to the 15% from what we've already dialed into the transactions that we've announced, and there may be some opportunities to reduce that over time. It's not that we're in a rush to do so. We're positioned well right now, but I do think over time, that we will be assessing it, we'll be working with Cindy Baier and her team, and there are opportunities to reduce that concentration in a few different ways. So those will be things that we'll be discussing.

I noticed when Ventas did their deal, they're kind of stepping down their rent concessions over the course of 8 years. And I was wondering if that strategy resonated with you at all as a mechanism to kind of pursue something below 16%, at least on the triple-net side or maybe it didn't at all? Just curious?

No, it's a good question. It doesn't at all for us. Our coverage on the triple-net is in the 1.20s. When we re-cut that deal with Brookdale, Kendall and the Brookdale team had taken actions to boost our coverage quite strongly, and so as far as -- in our fact pattern, utilizing the same approach wouldn't be relevant to us.

Our next question comes from Michael Mueller with JPMorgan.

Just curious how you're thinking about acquisitions at this point relative to your equity pricing once you withdrew the portfolio of the proceeds from the sales? So just thinking about that heading on down the road?

Michael, Scott Brinker here. We're not really thinking very seriously about raising external capital. Right now, we think there's a lot of value we captured, with improved performance and execution before we think about growing with new capital. We are in the process, of course, of raising a lot of capital through asset sales and the primary use of proceeds right now is to pay down debt and to fund a very attractive development pipeline and redevelopment opportunity in the medical office and life science segments. So we're looking at the market. We intend to be buyers at one point in the future, but I wouldn't expect to see us to be extremely active buyers in the acquisition market today really, in any of the 3 sectors. All that being said, there could be unique opportunities within medical office and life science and these are 2 markets that we're already in or in markets that we'd like to be in. That could be interesting but again, with recycled capital rather than with new capital.

Got it. And just one clarification on U.K. transaction. I know it's a transaction -- the second tranche can come down by 2020. Is that by January 1 or 12/31/2020?

So Mike, Scott Brinker again. The expectation in the contract would say by year-end 2019, we have the right to force an exit. We're hopeful and at optimistic it will actually happen before that, and so is the buyer. But it is year-end 2019, not year-end 2020.

Our next question comes from Vikram Malhotra with Morgan Stanley.

So Scott, maybe just sticking on senior housing, 'you've kind of referenced supply/demand in the outlook. Is it your view that we reached a low point in senior housing that it's going to take a little bit longer to see upside? Or do you think we're going to see incremental deceleration or declines in the NOI from here? And maybe at an industry level and especially to '18?

Vikram, it's not so much that we expect it get substantially worse. In fact we expect at least for HCP for things to get better, and hopefully significantly better. But at the industry level, it's more that the trough might last more than the market is expecting, is our general view, just looking at occupation growth and supply, it's leveling off, but not in any significant or material way. And the other thing that I noticed is that the traditional higher barriers entry markets are starting to get a fair amount of supply as well, like New York, or New Jersey or Seattle or Washington, D.C., in particular that, for years, have very little new supply and now even those markets are getting a fair amount. So I think that's worth monitoring as well.

Okay. And then, one of your peers obviously restructured their lease with Brookdale. I'm just wondering, taking a step back, given what we've seen happen to RIDEA growth, but also just the triple-net segment, despite the last maybe 5 or 6 years, EBITDAR has rarely grown above maybe 2% despite the strong housing market. So as these maybe leases come up in maybe a while, maybe 3 years or 5 years, do you think the economics of these transactions or lease agreements need to be changed substantially where the rent bumps are a lot lower, you have covenants in for the type of CapEx that you need? And maybe some other changes that we don't end up in the same situation if you see supplier being elevated for a longer time?

Yes, I'm happy to answer that, Vikram. Most of the triple-net lease that you see are really legacy arrangements. It's very rare that you see a landlord and a tenant enter into a brand-new lease agreement. They might recut an existing lease but that, at least in our view is a financing arrangement that made sense with senior housing a decade ago. We just don't see many triple-net leases being entered into today. If you did, I'm sure they would be setting rents at much lower levels with a bigger cushion and adequate cash flow to invest back into the properties and to create a reasonable alignment of interest and incentives between the landlord and tenant. Our portfolio is -- at least once the Brookdale restructuring is done, we'll be above market. But I was to start from scratch. I think we preferred to be substantially higher than that, right? At 1.13x after our management fee, that looks pretty good versus the industry, but it's still relatively tight. You also haven't seen us do triple-net lease in probably 10 years, and I don't think it's likely to see one of those going forward.

Okay, and then just one more, maybe this is just the broader team, Tom, you as well. Scott, if you were sort of in your former role or you had the opportunity where the deal that Welltower did recently on the SNF side were presented to you, what factors would you really consider as to what you'd like about sort of a similar transaction, what would you say no, this makes me sort of stay away from?

I have to verify, you said the, Vikram, you're talking about the Welltower transaction, is that what I heard you say?

That's right.

Yes, I'd tell you, I -- I'd hate to -- I'd probably kick that question over to the Welltower folks to answer that. I will tell you that from where we sit, as we think about our QCP spin, we are very pleased that we did get it spun off. It was a good result for us. We put it in the hands of Mark Ordan and his team where they had more flexibility in what they could do with the portfolio. You probably noted, as -- if you were following the transaction, that prior to the announcement with Welltower, that they were going to put the PropCo and Opco back together again, which would -- that's not something a REIT can do. So they had other alternatives, which was part of our mindset when we did the original spin that create value. And we were just really pleased to see that they did end up with a good outcome on behalf of our shareholders that stayed with QCP. We think it certainly could provide us a nice bump in the most recent news. So that's probably all I would say on that transaction.

So the scale probably is not part of the equation for HCP going forward?

Yes. We are really going to stay for very focused on the 3 private-pay segments. We like that strategy. It keeps us clearly in the real estate game, serving the health care industry. We don't -- we're not believers in the bumpy ride of government reimbursement, that doesn't mean that is not a good strategy for another company. It's just not the one that we've selected here at HCP.

The next question comes from the line of Sheila McGrath with Evercore.

On the transition assets in SHOP, is it your expectation that first quarter was a low point? And what are the new operators doing differently to help ramp NOI? Is it -- required additional CapEx, rebranding, what are they doing to reposition those?

Sheila, it's Scott Brinker. 1Q '18 should be the low point, in part because of what's been described earlier, where we really had a decline in performance throughout 2017. So whatever you're looking at, at growth rate, you need to understand the beginning and the end, and at least for 1Q, we had a very difficult comparable. So simply because of the difficulty of the comp in 1Q, that should be the worst quarter. But in terms of what will change, one is just in attention to the property. I think there was some distraction at a number of these assets over the past 3 years. When we've looked at performance in the markets versus performance of our property in particular, there's a pretty wide gap. Now there are some properties that we considered to have great real estate locations but maybe older physical plants, and it could be redevelopment opportunity and we're actively looking at a number of those right now. And those could come sooner rather than later. And the other thing I would mention is, for the most part, we weren't satisfied with the management teams at the local communities. So the expectation is that there will be a fair amount of transition at the key leadership positions. And unfortunately, that creates underperformance in the near-term, which for a public company isn't ideal, but we made a decision that these were good properties. And over time, we're confident with the right local teams and the right operating company up top that we will recapture anything that's lost in that zone.

And one follow-up on the balance sheet. You've targeted moving leverage lower. Pete, can you just remind us of your targets and the time frame and how you got there?

Yes. Sheila, it's Pete. So we -- in our pro forma basis, we're at 6.5x, variable to pay downs over the line, post the quarter end. We would like to be in the low 6s by the year-end. We're on track for that based on our projections for these sales. We'll probably be able to get there depending on the timing of the sales in the third quarter would be the assumption. But again, that depends upon the closing of some of these transactions, which, in senior housing, can sometimes take some time. But definitely by the end of the year.

The next question comes from Chad Vanacore with Stifel.

Welcome aboard Scott. So given the amount of dispositions expected at midyear, consensus seems to forecast FFO progression should be down in the second quarter, another dip in the third quarter and flat in the fourth quarter, as some of those proceeds may be reinvested. So does that agree with your internal models? And then what factors should we be considering in terms of disposition, timing in these proceeds?

Chad, why don't we start with the first part of that question. As I said in my prepared remarks, the first quarter benefited from some higher yielding assets. We've now sold most of those in post-quarter end. So as we look at our progression though the year, we see our first quarter being the highest, the second quarter probably being slightly higher as well as we work our way through some of these transactions. And then based on the timing, if you look at our guidance page that we have in the supp, we see the third and fourth quarter numbers probably being a good run rate going forward. But then you have to factor in 2019, which would -- we're obviously not coming out with guidance yet but we have some of the benefits from lease escalators, benefits coming online with life sciences as we released, we see some positive leasing spreads pretty significant as well. So that's how we look at '19 at a high-level, but the rest of '18, sort of the lines out as I just described.

Pete, so maybe last quarter, we probably talked about $0.07 to $0.10 per share net dilution. Is it still a good range or should we be thinking about something else?

Yes, I think the net dilution, as we think about the benefits we're getting this year in our numbers, it's probably around $0.05 a share, of the benefit we have been '18 that will have some dilution as we head into '19. But offsetting that with some of the benefits that I just described.

Got it, okay. And then just one more on SHOP performance. What's the worst performance within the portfolio held for sale? And then Tom, in your comments, you actually alluded to see some pressures in these communities in terms of management. Maybe give us some details of the changes at the facility level, and how it might stabilized under new operators?

Chad, if you could maybe repeat the question just to clarify exactly what you were asking. I got a little bit confused, please?

Okay. So the SHOP performance or the SHOP portfolio that's either held for sale or going to be transitioned on the transitional asset, how might they be improved from where they are now?

I see, thank you. Well, important to note that these were historically strong performers, with occupancies in the low 90s. But today, we're in the mid-to-low 80s and these are markets that are otherwise performing reasonably well. So we think, with the right leadership teams at the local communities, there's an opportunity to recapture what's been lost, Chad. That doesn't happen overnight. And we've identified 30-plus transition communities in 14. We successively finished the transition, but that's fairly recent within the last 30 days. We think the balance of the transition should be done in the next 2 months-or-so. So by year-end, we think we'll be completely through the transition process and the new operators will be up and running with their own teams and the systems, but it doesn't happen overnight.

Scott, maybe -- where might be some of the low-hanging fruit? Is it on G&A or is more operationally focused in [use] labor?

Chad, it's more of having the right team at the local community. When we think about what drives performance, there's the real estate aspect. And again, we like the real estate of these properties, but then there's the local culture within the property, and we spent a lot of time touring all these communities to get a sense for what was it we think is driving the under performance and we came away with comfort that, over time, this is real estate that should perform, but we have local teams that are not executing. And that will be the emphasis of the new operator, is, of course, putting in their own systems and technology. But putting in the right leadership teams in place to drive performance.

The next question comes from Tayo Okusanya from Jefferies.

Most of my questions have been answered, but just another one for the team. Going back to Vikram's question, not specifically around the Welltower transaction. But again, when you do look out on the horizon, opportunities to kind of do deals, where your restructuring problem assets where you think the upside on a going forward basis because you expect fundamentals to improve in 2 to 3 to 4 years, what's kind of like the appetite for the management teams to kind of do deals like that? And on what kind of structures when you consider to putting in place if you were to consider doing something like that?

I'll start and I'll -- this is Herzog -- I'll turn it to Scott. But I can tell you that, as we look at with our portfolio, we do identify different opportunities as we go forward, where there could be restructuring that takes place that provides better outcome over time. And there are a variety of different alternatives that we do discuss that we're assessing. Nothing we'd be ready to announce at this point, of course, but as to our appetite or desire to -- and ability to take these on, the answer to all those is that, yes, those are things that we'd be interested in doing in. Scott, is there anything you would add to your perspective?

Tayo, I would say that our biggest opportunity right now is the value creation in the existing senior housing portfolio. So that's been occupying a lot of our time and that's a pretty big project. And I think when we're done, we'll create some value for shareholders, it's creating some short-term noise in our operating results. But I think people, over time, are going to like the outcome. There is more work to be done but it will be around the edges as opposed to very material news that's been announced over the past year. In our other 2 segments, our life science and medical office, frankly there's not much distress in those segments, if there was, it would be all over it, given the strength of our teams.

Our next question comes from Drew Babin with Baird.

A quick question on the for-sale portion of the SHOP portfolio. Do you believe there's any risk of, kind of culturally or otherwise fundamentals, I guess, how confident are you that the fundamentals can hang on those properties long enough to realize the potential sale pricing that's been talked about before? Do you think there's any risk that things might deteriorate to the point that a buyer may begin to consider things they may need do to get operations going again?

Drew, it's Scott here. What we said is there's significant interest in the assets. And everyone that we've spoken to is bringing in their own operating partner and underwriting their own business plan. The performance at those properties is already pretty weak, and I don't think a small decline over the next 2 months is going to materially change the valuation. Now is it a positive? No, of course not. But I don't think it's materially changing the dynamics, it just puts us in a position that we like to get something done sooner or later, and we're making good progress. So we'd hope to have more significant and specific news in the coming months.

This is Tom Herzog again. The other thing I'd add is, in talking to buyers, there is a view that there is upside potential in these assets as this transitions as well. And so that factors into the thinking and underwriting. So the fact that these assets have had -- have stumbled from a same-store performance perspective, causes buyers to believe there could be some upside as well.

That helps. And just a question on life science, do you think currently into your occupancy levels, 94.3%, do you think that represents a bit of a bottoming? Or do you think the downtime required to sustain the robust leasing spreads on new activity, do you think that downtime's going to kind of keep that occupancy level kind of roughly where it is through next year?

No, Drew, it's a good question. Actually the occupancy dropped. We've actually back-filled all those leases already. They just haven't started this quarter. It will start, some in the second, I think maybe one towards the third quarter. But we're getting good leasing spreads, and we're back all that. So we see occupancy ramping up as the year progresses there.

This concludes the question-and-answer session. I would like to turn the conference back over to Tom Herzog for any closing remarks.

Okay. Thank you, operator, and thank everybody for your time today and your continued interest in HCP. We look forward to talking to you soon and we'll see some of you at NAREIT. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.