Healthpeak Properties Inc (PEAK) 2018 Q3 法說會逐字稿

Good morning, and welcome to the HCP, Inc. third quarter 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, Finance and Investor Relations. Please go ahead.

Thank you, and welcome to HCP's third 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 risks and risk factors is included in our press release and detailed in our filings with the SEC. We do not take a 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 today with the SEC, 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 Chief Financial Officer; and Scott Brinker, our Chief Investment Officer. Also here and available for the Q&A portion of the call are

Tom Klaritch, our Chief Operating Officer; and Troy McHenry, our General Counsel.

Let me start by saying, the last 2 years have been a whirlwind of activity, during which we have fully restructured the company and set forth a clear strategy. The HCP of today is barely recognizable from the

HCP of just a couple of years ago. Including the announcement of the Shoreline transaction today, we sold, spun or transitioned over $12 billion of noncore assets. We repaid $5.7 billion of debt. We reduced our Brookdale concentration from 35% to 17% of NOI. We expanded our development and redevelopment pipelines. We recruited and installed an entirely new C-Suite. And we refreshed our board. These actions have resulted in a vastly improved portfolio and balance sheet, with a cohesive and energized team.

So let me describe how I see the current state of play. Starting with the challenges. First, senior housing new supply has been a headwind for HCP and the entire sector. However, we are confident senior housing will be a strong business over time within HCP's balanced and diversified portfolio of private pay healthcare real estate. Second, the transitions from Brookdale to new operators have been painful and performance declined significantly prior to the replacement operators assuming control. The reduced occupancy impact will carryforward to at least the first half of 2019. Fortunately, the vast majority of the transitions are complete, and we are finally seeing stabilization. We remain confident that in the hands of new and engaged operators, we will recapture significant upside to this group of communities over time. Finally, this year's capital recycling and redevelopment activities will lean on our 2019 earnings growth as we earn in the dilution from completed sales and experience temporary downtime at properties undergoing redevelopment.

Next, what's going well. First, our 82% on-campus medical office portfolio remains consistent and stable. We're also benefiting from our decades long relationship with HCA, through the development program we announced today. Second, our life science business is performing exceptionally well, and we continue to see significant demand from growing tenants. Third, our current $800 million development pipeline is on-time, on-budget, fully funded and already 83% pre-leased. With the strong momentum and strength in the market, we're evaluating the acceleration of certain projects, such as the additional phases of The Shore at Sierra Point. In addition to the cash flow and earnings these projects will produce beginning in 2019 and accelerating in 2020 and 2021, we expect to realize significant NAV creation for our shareholders. We expect to deliver stabilized returns in the 7% to 8% range, which compares to the corresponding market cap rates of about 5%. Finally, we took advantage of robust pricing in the market and unlocked what we believe to be significant value for shareholders by monetizing our Shoreline Technology Center in Mountain View. This transaction will dramatically reduce leverage and position us with BBB+ credit metrics, support our value-creating development pipeline and provide us funding to support approximately $400 million of accretive acquisitions, which we believe will represent $0.02 to $0.03 per share of FFO and FAD accretion once fully invested. As you can tell, we have positive momentum, and this is a very exciting time for HCP.

With that, I'll turn it over to Pete to discuss our financial performance for the quarter and outlook for the remainder of the year. Pete?

Thanks, Tom. Today, I will start with a review of our results for the quarter and update on the balance sheet as a result of the Shoreline Technology transaction, and finally, provide an update to our guidance for the remainder of the year. Starting with our third quarter results. We reported FFO as adjusted of $0.44 per share and our portfolio delivered 1.7% year-over-year same-store cash NOI growth, which was in line with our expectation. Let me provide more details around our major sectors.

For medical office, same-store cash NOI grew 2.3% over the prior year, driven primarily by in-place lease escalators. We continue to see strong tenant demand for medical office buildings. Our retention rate for the year is over 78%, and we had a positive rent mark-to-market on our renewals of 4%. Same-store cash NOI in our other property segment, which is primarily our small hospital portfolio, grew 6.5% over the prior year period. This result was driven by strong performance at our Medical City Dallas campus, where our lease structure allows HCP to share in the expansion and success of the hospital, which is performing at a high level. As a reminder, Medical City Dallas is one of the leading medical campuses in the entire country. The fully integrated, 2 million square foot campus, includes an 800-bed hospital operated by HCA and over 750,000 square feet of on-campus medical office space. This is truly a trophy campus within our medical office and hospital portfolio.

For life science, third quarter same-store cash NOI grew 2.6% over the prior year driven by contractual rent escalators and positive mark-to-market on rents. Excluding the impact of the mark-to-market of the Rigel lease, which we have discussed on prior calls, life science same-store cash NOI growth would have been approximately 5.5%.

From a development leasing perspective within life sciences, we continue to make incredible progress and have significantly derisked our active development pipeline. During the quarter, we signed a lease with Global Blood Therapeutics for the entire 164,000 square feet of Phase 4 at The Cove. GBT is a rapidly growing publicly traded biotech company focused on developing treatment for blood-based disorders. We're now 100% pre-leased across the entire 488,000 square feet of remaining in-process development at The Cove. At the The Shore at Sierra Point, our other major South San Francisco development project, we are pleased to announce that we have executed leases with MyoKardia and a high-quality pharma company, and now have the entire 222,000 square feet of Phase 1 pre-leased. Our leasing progress at The Shore is well ahead of expectations, and we are benefiting from the strength and momentum we see in the South San Francisco life science market.

For our senior housing triple-net portfolio, year-over-year same-store cash NOI grew 1.6% in the third quarter. This was in line with our expectations and takes into account the previously announced rent adjustment with Brookdale. On a normalized basis, same-store cash NOI growth in senior housing triple-net would have been approximately 3.5%. And finally, our SHOP portfolio. Same-store cash NOI for the quarter was negative 6.3%. As we discussed last quarter, there continues to be a significant disparity in the performance between our core portfolio, which grew a positive 4.1% during the quarter, and the assets we plan to transition ourselves, which declined 25%. Scott will provide an update on our operator transitions and additional color on the performance of our senior housing portfolio momentarily.

Turning now to the balance sheet. We have significantly improved our balance sheet and credit profile as a result of the $1 billion Shoreline transaction. Initially, we plan to use the net proceeds from the sale to repay $450 million of bonds and $224 million of term loan debt. The balance of the net proceeds, or approximately $315 million, will be used to reduce our line of credit. The blended rate across the debt we intend to repay is at an average interest rate of 3.5%. With the repayment of debt, our net debt-to-adjusted EBITDA will be reduced down to the mid-5x range, or nearly a full turn, from the 6.5x we reported at the end of the third quarter. As Tom stated, it is our expectation that during 2019, we will redeploy a portion of this balance sheet capacity into select strategic acquisitions and to fund our accretive development and redevelopment pipeline. Importantly, we expect our net debt-to-adjusted EBITDA to settle in the high-5x range on a run rate basis after incorporating the reinvestment of this capital. Of note, the sale will utilize the remaining tax loss carryforward we crystallize as part of the QCP spinoff in late 2016.

Turning to the dividend. On October 25, our Board of Directors declared a quarterly cash dividend of $0.37 per share. We expect our dividend to remain fully covered in the mid-90% range in the near term. Over time, we expect the payout ratio to decline with the significant earning benefit from our development pipeline, our in-place lease escalators, which average approximately 2.75%, the positive mark-to-market opportunity in our life science segment and the future upside opportunity from our senior housing transition portfolio.

Finishing now with our full year guidance. We are maintaining our FFO as adjusted guidance in the range of $1.79 to $1.83 per share, and also reaffirming our aggregate SPP guidance range of 0.25% to 1.75%.

By segment, life science and other are trending towards the high end of our range. Medical office and triple-net are trending towards the middle, and SHOP is currently trending towards the low end of the range. Additional details of our guidance, along with timing and pricing related to our capital recycling, can be found on Page 46 of our supplemental.

With that, I would like to turn the call over to Scott.

All right, thanks, Pete. I would like to expand on the capital allocation theme. There has been significant activity, most recently the announced sale of the Shoreline campus for $1 billion. In August, we closed the $600 million medical office joint venture with Morgan Stanley. That trade diversified our markets, improved our on-campus percentage and added an A-rated tenant with whom we'll grow. We also captured a 200 basis point spreading yield, so the outcome was accretive both strategically and financially. Also in August, we sold a dated off-campus MOB for $20 million at a cap rate in the high 3s. This site will be redeveloped for multifamily, so we capitalized on an aggressive buyer to exit a noncore property at a highly attractive price. Those proceeds can now be redeployed into a $26 million on-campus development that we recently started in Myrtle Beach. The 90,000 square foot MOB will be anchored by

HCA, a best-in-class health system. Stabilized yield is in the low-7s, and we have a unique opportunity to do additional on-campus development with this long-standing partner.

Moving to life science. In addition to exceeding expectations on our highly profitable $800 million development pipeline, we're active on a few potential acquisitions in our core markets. These are strategic projects and include stabilized cash flow, value add and densification opportunities, allowing us to use our platform and expertise to create value. Each acquisition would be an accretive use of proceeds from the sale of the Shoreline campus. We continue to make rapid progress in remaking our senior housing portfolio and platform. In the last 2 years, we've improved our diversification and asset quality by selling or transitioning more than 200 Brookdale properties, totaling $3.5 billion of asset value. This massive undertaking with Brookdale is now very, very close to the finish line. We may seek to further reduce the concentration over time, but we're now in a position to do so opportunistically. We also began the redevelopment of 8 senior housing properties this year, with total spend of $70 million. The majority are transition assets, where substantial upside exists, with a revised physical plan and a more focused operator. Redevelopment is an important part of our initiative to modernize the portfolio. We expect low double-digit returns on cost, but the financial benefit takes up to 2 years, given the redevelopment time line, followed by lease-up.

Moving to senior housing operating performance. Results in the core portfolio have been strong at positive 3.3% NOI growth year-to-date. Occupancy and margin are essentially flat from the prior year, and rates are up 4%. We're very pleased with that performance given the environment. The 39 operator transitions are now 90% complete, and the final 4 should be done in the next month or 2. 19 of those transitioned properties were formerly triple-net, so they're not included in the same-store results, but their performance has been poor and underlying NOI is now below the rent payment that we have been receiving. This will likely result in a loss of $0.01 to $0.02 per share next year. We expect to eventually recapture this lost income through improved operations.

I'm pleased to report that occupancy in the transition portfolio increased in the past 2 months, particularly in the first wave of properties that transitioned back in March and April. This highlights the upside waiting to be recaptured and confirms that the turnaround doesn't happen overnight. So we continue to expect negative year-over-year NOI results in that transition portfolio likely until late 2019, when we do a full lap around the trough on occupancy. Importantly, from where the transition assets sit today, there's up to $25 million of NOI upside, simply from recapturing lost occupancy and eliminating the transitory expenses we incurred in 2018. There's additional upside from driving rate, which is certainly possible, given the higher service levels now in place.

I'll now turn the call back to the operator for Q&A.

(Operator Instructions) Our first question today will come from Smedes Rose of Citi.

It's Michael Bilerman here with Smedes. Just sticking, Scott, with the SHOP portfolio and the transitioning assets. I was wondering if you look at the sup Page 31 and 33, especially given your commentary around the negative impact this year and the eventual potential of upwards of $25 million of additional NOI, can you start breaking out all of the assets between transitioned and the remaining same-store pool, so that we can clearly sort of understand what's happening in the core assets versus the transition assets? Is that something you think you'd be able to provide?

Michael, it's Scott. Certainly happy to look into it. We did break out the amount of NOI from each of those 2 categories as well as the growth rate. In NOI, are you looking for like occupancy or revenue?

Yes. What I would say is the table above on Page 33, it states you having the history so that we can actually see the trend where it was, where it went to and where it may go in the future. I'm just trying to get a little bit more granular other than just a one quarter look at just the NOI number, because clearly, this is a big revenue issue, and you are also spending more money, so understanding those 2 things on how they relate to each other, given me the impact that it's having and the potential upside, would be helpful. I don't know if that's more of a comment than a question, but...

Yes, that's good. So let us look into that, Michael. For now, I'll actually -- I'll just give you the results for this quarter on occupancy. The core portfolio was modestly higher year-over-year, and that transition portfolio was down 400 basis points year-over-year. And there's a huge difference in margin as well. The core portfolio is in the low-30s, which is still, I think, low versus where it could get in a more normal environment, but the transition portfolio is in the mid-20s from a margin standpoint. So it probably would make sense to provide even more detail on those 2 portfolios, given how differently they're performing. Tom, you want to add anything here?

Michael, its Herzog. Yes, I think we can add that next quarter. That's a good point.

Okay. And then you mentioned the assets that were triple-net that went to SHOP, and I think you said those are -- the NOI that's coming out is below what the net rent was. Where does that show up in terms of differential? And what was that differential in the quarter?

Michael, it's Pete here. As Scott mentioned, we transitioned these assets over the course of the year, there's actually 19 assets that are transitioning from triple-net into SHOP. They are not in the SPP pool, which is why we wanted to point out that there's a roll down, we have transitioned these assets throughout the course of the year. We received rent for a part of the year. The roll down is somewhere between $0.01 to $0.02, as Scott mentioned. Now the good news is that, different than traditional capital recycling, we think that we will recoup this lost earnings, it just will take time. So that's why we included the $0.01 to $0.02 in the remarks today.

And as you're saying, the $0.01 to $0.02, is a annual '19, annual '18, I'm just trying to put that into context, and where we can actually grab that type of impact out of the sup?

It's not in the sup, which is why we wanted to talk about it, Michael. It's not a huge dollar amount, there's only $10 million to $12 million of NOI from those properties, but the rents that we have been paying was

$5 million to $7 million higher than that. So that's why when they convert into SHOP, there is a roll down, which will impact us more in 2019. And the performance has really fallen off quite precipitously, which is why we wanted to raise it.

Our next question will come from Juan Sanabria of Bank of America.

Just wanted to follow-up quickly, I guess, on Michael's question on the $0.01 to $0.02 drag from -- that conversion from triple-net to RIDEA. Is that net hit in the third quarter numbers? Or that would be incremental from a go-forward perspective from the third quarter into the fourth quarter?

Yes, most of it occurred this quarter, because we transitioned the vast majority of these assets in the second quarter, although some of it did happen over the third quarter. There will be a slight roll down into the fourth quarter. But the big chunk occurred in the second quarter already, Juan.

Okay, great. And then just bigger picture. I mean, it sounds like you guys are talking about a bit of a drag incrementally from triple-net to RIDEA as well as from temporarily getting some proceeds before you can put it to work. Should we think of earnings growth or normalized FFO growth in '19 on a year-over-year basis? Or do you think there's a risk that numbers will come down? I know you're not wanting to give guidance as of yet, but basically just giving the dividend, is -- should earnings grow next year and will the dividend coverage improve or not necessarily?

Yes, it's a good question, Juan. Let me tell you how I look at it. Pete here. If you think about the implied fourth quarter FFO as adjusted, when you look at what we've reported and then compare it to the midpoint of our guidance, if you annualize that, you'll get to a reasonable starting point as you look at 2019 versus 2018. And you would also have to factor in the natural growth that we see within our portfolio from an SPP perspective plus development and redevelopment earn-in will start to see some benefits next year as some of the projects that we've been working on, specifically The Cove, work their way into our earnings. And then we'll see actually a bigger ramp up in '20 and '21 from some of the other projects we've talked about today. And then obviously, the Shoreline accretion as well is something else that, we talked about $0.02 to $0.03 of accretion from that transaction, which is run rate accretion. So the amount that we can get in 2019 will depend upon how quickly we can put some of that dry powder to work. And then lastly, Scott did mention the upside opportunity in the transition portfolio that we've spent some time talking about today. So that's the way we look at 2018 headed into 2019. We'll obviously provide much more detail on it in our fourth quarter earnings call.

Okay, if you'd allow me, just one more question. On the HCA new relationship, is there any potential size of the opportunity you can quantify out in terms of new developments you could give on campus MOBs? Is that 7% yield kind of a good benchmark to think about that opportunity set?

Yes, this is Tom Klaritch, Juan. Yes, the low-7 -- low- to mid-7% returns is what we're targeting in each of these projects. There are a number of projects we're looking at right now. I would guess, it'll probably be in kind of the $70 million to $100 million per year for the next couple of years with it.

But could go higher from that as well, probably.

We'll continue to find additional MOBs as the program is sold.

Our next question will come from Rich Anderson of Mizuho Securities.

You said the -- I guess, I missed this. The Shoreline is accretive, meaning that the cap rate is below the 3.5% average interest rate on the pay down, is that right?

Yes. So here's the way we think about it, Rich, and it's a good question. Initially, we will take the $1 billion of proceeds, which is a 3.5% cap rate. And we will repay approximately $1 billion of debt, and the blended interest rate on that debt is 3.5%. However, that would take our leverage into the mid-5s, which is where we expect to report at the end of the year. We are comfortable taking the leverage up into the high-5s, which is what we have been talking about to the Street. So we have about $400 million of dry powder for acquisitions, which we would expect to put to work accretively, and that's the $0.02 to $0.03 that [Scott talked about].

Got you. And...

And Rich, that's on a run-rate basis once it's invested, just to be clear.

Say it again, Tom?

That's on a run-rate basis, once it's invested, just to be clear.

Yes, of course. Yes. On the performance of the core portfolio, 4.1%, it was a 2 -- had a 2-handle positive on it last quarter. That 4% doesn't sound very repeatable to me. I'm glad it's doing better than the transition portfolio, of course, but is there something about the elevated nature of the performance in the core portfolio last quarter, and again, even more so this quarter, that we should sort of just be a little bit more sober on?

Rich, it's Scott. Yes, it's a small pool of -- it's very few properties. When we reported last quarter at plus 2.9%, I thought that would be the high point for the year. Then we report plus 4.1% this quarter. So that's now the high point for the year. I don't think that, that will repeat in 4Q '18. That being said, there's some real positives about that portfolio. There's a number of assets in Florida that we spoke to last quarter that Sonata took over from Brookdale, and that's been a big part of the improvement in year-over-year growth this year. And then there's a portfolio that we acquired a couple years ago, put in a new operator, invested some money into the physical plants, and that's really paid off with higher occupancy and higher rate. So there are some things happening in that core portfolio that were temporary, but nice boost to 2018 results, that I think 4.1% is a little bit unusual and anomalous for this market, but we're happy to have reported it.

Okay, got you. And just one quick one, Pete. Can you quantify new lease accounting for 2019? How meaningful it is to you at this point?

Yes, good question, Rich. Overall, we do not expect the lease accounting standard to have a significant impact for us. We're still finalizing our adoption, but it's probably around $0.005 hit to NAREIT FFO in

2019, with relatively little impact beyond that. We'll talk more about it next call when we put out our guidance, but that's how we're looking at it right now.

Our next question will come from Chad Vanacore of Stifel.

I want to attack the other side of this SHOP portfolio. From what you -- you gave us some core numbers, but SHOP NOI growth run rate seems to fall below your stated range, it's down 4%, it's flat in guidance. Are you expecting a bump in 4Q? And would that be from the transitional side of the portfolio?

[So I wouldn’t] say, we're expecting a bump in 4Q. Year-to-date, the SPP portfolio, Chad, we're at negative 3.3%. So it's right inside of the guidance range. We're not expecting 4Q to be better necessarily. We're still in the midst of the temporary impact from these transitions, so I wouldn't be surprised if that number is down quite a bit again in 4Q for that particular portfolio.

Okay. And then how should we think about that SHOP trend into 2019? It seems like it would lag a bit in the first half of the year and maybe get better second half of the year as comps get easier?

That's definitely the case for the transition portfolio, Chad. We talked about the upside in these assets and that -- that's from where we sit today, just absolute dollars of NOI. But when we report, it's a year-over-year growth rate, and that's a much different analysis just given where NOI was, where occupancy was 4 quarters ago. And the trough in occupancy was really in August. We've actually seen a nice balance in September and October, so that's a positive sign, but just given where the year ago occupancy was, it's going to be until really late next year before we have a realistic chance to start showing year-over-year

NOI growth, even though the sequential growth should start improving before that.

All right. Any early signs so far into the fourth quarter with stabilization in those transition assets? I know you mentioned Sonata.

Yes. Well, Sonata is one reason that our core portfolio has been so positive. Those are our assets that transferred over to them quite a while ago. But the transition portfolio is more Atria and Sunrise and Eclipse and Discovery. And it's really the group of properties that transferred earlier in the year that have had enough time to put in place the new team and systems and culture, and those are the ones that have started to improve. So that's an encouraging sign. But those early properties that transferred are now showing signs of life. Occupancy is moving higher, so we're hoping -- we're expecting that the balance will be the same.

All right. Maybe just one quick one. For the last quarter, you reported 22 properties slated to be sold to Apollo. This quarter, it looks like 19. What's the difference with the 3 properties and that $50 million of proceeds you expected?

Yes, there were 3 properties, Chad. It wasn't related to the performance. They're actually doing just fine. But there was a management company that Apollo is using for the portfolio, had a non-compete restriction that we all thought would get waived, it didn't get waived. So we ended up holding those 3 assets. Two, we've already found replacement operators, so we'll keep them. And the third property is actively being marketed for sale.

Our next question will come from Tayo Okusanya of Jefferies.

For the SHOP assets that are in transition right now, could you just talk a little bit about what some of the things you're seeing that are kind of creating this pretty heavy impact on same-store NOI growth? I mean, I get transitions are always rocky -- always shaky and things happen, but I'm just kind of curious, like what are you kind of seeing thematically that's kind of leaving this kind of really big drag initially?

Tayo, it's Scott. A couple of things to point out. The occupancy in those assets is down about 400 basis points year-over-year, and with a 25% operating margin, there's a pretty big multiplier effect on NOI. So that's a big part of it. Can we capture that? Over time. But for now, it creates a pretty depressed NOI. And then we also had a significant elevation in certain expenses that we think is more temporary. Contract labor, over time, vacant positions that needed to be filled, huge increase in repair and maintenance to get the properties back up to the right standard, and then some miscellaneous things to add up, like insurance expense to buy the tail insurance, bad debt, a lot of account [receivable] written-off at the transition. So a lot of things that are purely transitory that will go away, but we don't normalize for these things. I know some others do, but we just give you the number and then we can try to talk through the different components, but those are the major categories, Tayo. It's just the occupancy, driven in large part by turnover. 50% of the EDs have been turned over. So that puts additional pressure on occupancy and then just those expenses, it's a more onetime in nature.

That's very helpful. Would the triple-net portfolio, again, pull some pressure on rent coverages. I'm just curious, will you be thinking about '19 as a year where you may see even more transition to RIDEA in some of your clients like -- some of your tenants like Capital Senior Living or any other?

I mean, we -- Tayo, we talked about transitioning some of the Sunrise properties to SHOP. Those are in the triple-net lease category today. They're a complicated waterfall structure that I think it makes sense to just go ahead and clean those up. And that's a material part of the NOI that shows up as being below 1 point of times in the supplement. And it's important to note, there's really no earnings risk from converting those to SHOP because the payment coverage that we report, the rent in the denominator is not the rent that they're paying us. You can think of those really as 1.0x coverage leases. So I think those probably will be converted, but there's no earnings risk on that conversion, which is -- that's not the conclusion you would draw by looking at the supplement. So I think it's important to note that. The others with tighter coverage...

Can you just...

I'm sorry. Go ahead.

Could you just explain that, again, why, again, in the sup, it looks like it's less than 1 coverage. So it seems like there should be some earnings dilution from -- to converting and you are saying that there shouldn't be?

Yes, exactly. It's a complex structure that we inherited when we acquired CNL more than 10 years ago. But the contractual rent that's due is a number that is higher than the rent they are actually paying us. And when we report the coverage in the supplement, we're reporting based on the contractual rent.

Our next question will come from John Kim of BMO Capital Markets.

I'm going to try a 3-part first question on Shoreline. Did you originate the sale or did the buyer? Is it considered -- or was it considered noncore because it's essentially office? And can you describe who the buyer was as far as PE, pension fund or some other kind of buyer?

John, I'll try and answer a couple parts of the 3-parter. The Shoreline campus is one that we acquired with Slough in 2007. And Slough actually had bought it from EOP back in 2005. At the time that we purchased it, there was more life science tenants -- there were more life science tenants within the campus. Over time, Google had taken over more and more of the space. They now occupy about 92% of the space. So it became more of a noncore suburban office asset for us, that was a great piece of real estate to own, but to get the pricing that we got and to be able to recycle that capital into more of the core markets that we're in, made sense to us. And we're not disclosing the buyer. I know that was one of your questions, but hopefully I answered at least most of what you're looking for.

Well, maybe not the name of the buyer, but the kind of buyer they are?

Yes, we're not going to get into the specific details on the purchaser, John.

Okay. On Page 27, one of your leases has like a 0.3 coverage around that area. And the footnote basically says it's because of developments will not reach 80%, but on that coverage, it suggests it's well below 80%, and I'm wondering if you could just comment on that scenario.

Sure. It's Scott speaking again. This a small portfolio where it's got 3 properties, obviously, they're brand new, that we acquired in January of 2016. So about 3 years ago. We acquired it well before they opened. There was a lease in place that we assumed. So the rent is relatively small. It's less than $4 million per year, so these aren't material amounts. A couple of the -- one of the buildings is leased up, the other 2 have not, but they are trending in the right directions. So remember, we report on a trailing 12-month basis and 1 quarter in arrears. So the coverage isn't good, but the coverage today is much better than what we're reporting in the supplement, these are at least moving higher, and these are good assets and we think good markets that, over time, should improve. So this is not one that we're worried about. We're monitoring it, but we've got good credit behind it and a very long lease term.

Our next question will come from Vikram Malhotra of Morgan Stanley.

Just on the balance sheet, the mid-5 leverage that you talked about. If you just fast forward include all the EBITDA coming on from The Cove? As you sort of know deployment from a year on, kind of where does leverage settle down?

Vikram, it's Pete. It's a good question. As we talked about, we see leverage settling in the high 5x net debt to EBITDA probably at the end of next year, and that assumes we redeploy the funds from Shoreline into fully funding our current active development pipeline, which is about $450 million plus some dry powder, and then we'll get some benefit from some earlier Cove developments coming online, and we'll see ourselves settling out in the high 5s. Now will that get better? Assuming your assumptions you talked about in 2020 and 2021, if we didn't do any more development? For sure, it would because we've got a lot of developments for Phases III and IV of The Cove as well as Phase I of the Shore at Sierra Point, that come online in 2020 and 2021.

Okay. And then just redeploying, you talked about development. There are a bunch of different MOB portfolios out in the market, obviously, Landmark and CNL. Can you just talk about your develop -- your appetite here for bigger acquisitions -- bigger MOB acquisitions?

Yes, this is Tom Klaritch. We're always looking at the portfolios, and quite frankly, one-off MOBs that are out in the market. When you look at the ones that are out there right now, we look at the on- versus off-campus percentage, the tenant mix, the pricing expectations, markets, and we just didn't find any of them really that interesting that we were going to stretch for. So we're looking for more on-campus properties, high hospital tenancy, if they happen to have some off-campus in it, and hopefully, in our core markets. So at this point in time, there's really none of those out there but when they come around, we'll certainly take a look.

Yes, this is Tom Herzog. I would add that as we look to 2019 and where we'd like to grow, it really remains in the current 3 core segments that we have. But if we're looking at a large portfolio with a very low yield attached to it, that probably isn't going to scream for us something that we would likely acquire. So specifically to your question, a couple of the portfolios that have come up, we've looked at and we've passed.

Okay. The HCA partnership that you outlined, that's interesting, but I also know HCA has been making a bunch of off-campus investments and really, the credit of these off-campus buildings have been improving as they take -- as hospitals take more space in them. Wondering sort of why they focus only on-campus and why not partner with HCA as they move more off-campus as well?

Yes. I don't think we're saying that we're not at all interested in off-campus. When we do look at off-campus though, we would look at the kind of buildings you just mentioned. Sponsorship by a strong hospital, certainly HCA, we would work with on most. In fact, in this development program we announced, there is one large off-campus development that's going to have a significant amount of hospital outpatient departments in it, and that's certainly one we want to do. So we do look at off-campus, but it has to have the kind of metrics that interests us in the asset class.

Okay. And if you could just clarify one comment, I think, Scott, you made. Just on the ramp back up -- the potential ramp up, you've said of couple times, it's going to take time. So just to be clear, we should not expect in '19 this 400 basis points you lost this year, and overall, maybe it's much, much higher over the last couple of years in these transition assets, we shouldn't expect any material ramp back up next year, but will you view it like a 2- to 3-year time frame?

So let me try to clarify the comment. There are 2 different ways to look at it: one is just the absolute dollars for occupancy, and I do think that we'll start to see a bounce back sooner than later. We don't have to wait 2 to 3 years for that, we're already seeing the occupancy start to improve in the transitions that happened a couple of quarters ago, but the second way to look at it, which is how we report, is on year-over-year growth rate basis and that number will likely take a full year to show a positive sign, because we have to do a full lap around the trough in occupancy just given how much it's fallen.

I'll just add, Vikram, to your question. The recovery that Scott has spoken to, just to be clear, is to bring those assets back to where they were performing prior to the transition. And that's the $25 million. As we think about new and engaged operators, we do think that there obviously is potential that they could perform better than that, too, over time. So I didn't want to limit it just to the recovery from where they were performing prior to the transition period.

And our next question will come from Jordan Sadler with KeyBanc.

A couple questions on Shoreline, Pete, Tom. So first, I'm curious, how do you shelter that gain, that $700 million?

Yes. It's a good question, Jordan. So if you remember, when we completed the spinoff in 2016, it was a NOL or a tax loss carryforward that was crystallized, that was about $1.6 billion. We have utilized, over the last few years, probably about half of that, maybe a little bit more. But with this sale, we will utilize the remaining NOLs, and we also have, with utilizing these NOLs, some natural gain capacity that occurs every year, which you can't use if you have these NOLs, so we're able to tap into that as well, so we can fully shelter the gain from the sale.

Okay, well done. So is there additional -- are there additional opportunities like this to exit noncore assets or locations? I know you guys have some life science at Hayward, Redwood City, Salt Lake City, Durham, Poway.

No, I get it. This is Herzog again. Yes, Jordan, obviously, we've got a member of trophies in the portfolio. In fact, in our investor presentation, we have a page that presents a number of them. Most of those are going to be core to the portfolio we want to hold going forward. And maybe, literally, the majority of the balance of them will be core to what we're going to hold going forward. So we certainly could choose to harvest something, but I think we'll find it less likely. In the case of Shoreline, it was a different fact pattern. It was not core to a life science business, and therefore, it's a really good match, and -- but the rest of these assets, I think, our assets we're going to want to hold onto long term.

Yes. And one other thing I would add Jordan, as we thought about it, Shoreline, clearly, we have the ability to shelter the gain. But importantly, we've talked about this for a while, we really wanted to get back to BBB+ credit rating metrics, and we we're very pleased that S&P upgraded us today -- this morning, in fact, and we actually put out a separate press release before the open, confirming that. So that was also another part of our thinking, with this transaction was not only could we shelter the gains and with a great price but we also felt confident that we'd be able to get a credit upgrade, which was important.

And I'll just add one more thing to it. Because once we utilize the remainder of the NOL, now we're in a position to need to manage with an annual gain capacity going forward like the rest of -- most of the REIT world. So as far as harvesting significant trophy proceeds, which, again, I don't think we will, that will come with tax implications. And we'd have to consider 1031s and the like. So just another factor.

Okay. And then, I'm curious where -- maybe for Scott, where's the best place to put the money right now? I know you've been more cautious on the general recovery in SHOP at this stage of the cycle, but it seems like you've seen some improvement, not only in the -- in your core portfolio and the prospects, I realize, don't really brighten so much with the transition portfolio to later in the year, but it looks like it gets better. Is now a good time to put money to work in SHOP?

Yes. Here is how we’re thinking about capital allocation. We've got a big and very profitable development pipeline already in life science, there may be ways to add to that, and to talk about accelerating Phase II and III of Sierra Point, now that it was fully pre-leased, almost 2 years before the buildings even opened on Phase I. We just announced some exciting development program in medical office. As Tom mentioned, it could be $100 million a year, 7% to 7.5% return, that's a pretty accretive way to grow in today's market. And in acquisitions for life science and medical office, there may well be more value add and unique opportunities that we would look at. I don't think you'll see us do big portfolio trades at very low cap rates. At least not today. That could change, but from where we sit today, we're very focused on more unique opportunities. It would allow us to put a platform to use and create some yield. And then on senior housing, the landscape's changing quite dramatically, and will continue to because of the operating environment and other factors and at some point, there will be a tremendous opportunity to grow that business. We've been quite focused on capturing value, positioning ourselves to capture value from the assets we already own. But we are starting to think about perhaps external growth at the right time. I don't think that's tomorrow, but I do think you'll see us be very active in that space as well over time.

Our next question will come from Jonathan Hughes of Raymond James.

A question for Scott. I was wondering if you could maybe quantify what percentage of the 23% or so of the company that's currently senior housing triple-net now. How much of that would you like to flip to SHOP or be open to flipping to SHOP over the next few years to maybe capture more upside once senior housing supply and demand imbalance works itself out?

Yes, it's a good question. Of the senior housing portfolio, about 2/3 of it today is triple-net, and that's been a good thing for HCP the past 3 years, because it has insulated us quite a bit. Everybody's paid the rent. So we've been able to show attractive year-over-year growth in that portfolio despite underlying EBITDA declining. So it's then nice to have that 2/3 mix in triple-net. I would also point out that the asset quality in that portfolio is actually quite good, and that's been validated by a number of objective third-party research analyst, and we agree with them. The markets are strong, stronger than SHOP, frankly. A number of the operating partners are very high-quality, and those are the 2 things that you look for primarily to try to establish a SHOP relationship. So we're totally open-minded about doing that, and you're right that looking forward for the next couple of years, it may be an interesting time to convert some of these, having recognized the steady stream of rental income and then convert to SHOP when the business starts to take off again, which, obviously, it will, it's just a matter of time on that topic. Deliveries in 2019 are still going to be quite elevated for our portfolio and really for the sector at large. But it has now been 3 straight quarters of new starts declining, in some cases, pretty materially. So you start to look out beyond these current wave of deliveries that the demand and supply dynamics start to look a lot more attractive, especially given the demographic. Growth rate is going to accelerate quite a bit over the next 5 or 10 years. It's really in 2018, that it hits a trough, so we'll start to see some pretty steady growth in this portfolio.

And then sticking with that, I mean, I think 15% or so of that senior housing triple-net portfolio matures in 2020. I mean, would you look to maybe with that next year, ahead of the assumed acceleration in demand? I mean, it makes sense to maybe do it at the trough as opposed to after things are already on the upswing.

We'll see. I'd say we have the ability to be flexible and opportunistic. The 3 leases that mature in 2020, there are some very good quality operators there and some very high-quality real estate. So I think it may, in fact, be an opportunity to convert. And we have active dialogue with every one of our triple-net operators. There's nothing imminent, but it may well make sense, and if so, we'll do it.

And what's the coverage on those 3 leases -- or 3 operators?

One is comfortably above 1.0; one is right around 1.0; and one is very slightly below 1.0.

Okay, all right. Just one more for me, and switching to life science. Almost 10% of those leases mature next year, and I saw that renewals this quarter were down at about 11% cash spread versus expiring? Is that 11% spread something we can expect next year? Are you seeing a sense of urgency from tenants looking to renew early to avoid losing out on their space and beat future market rent growths? Just any color there would be great.

Yes. Jonathan, it's Pete. I would say a little bit of what you just said, which is certainly, there's urgency in the tenants' perspective to renew leases, because there's just not a lot of vacancy. If we think about next year, we look at it right now and we're probably about 50% sort of in discussion and/or we have LOIs signed at this point in time. From a mark-to-market perspective, we actually think we could do a little bit better the next couple of years than 11%. We think that it could be 15% to 20% of a positive mark-to-market on the leases that are expiring. So while we do have, I think, it's about 9% of revenues expiring next year, we see some real opportunity within that. And yet a lot of these are, they're spoken for, in discussions, or under LOI.

Okay. That's great. And there are no onetime items, like the Rigel lease or the purchase option in there, so maybe now we can see that segment return to the mid-single digits on NOI growth basis, kind of like what it did this quarter ex the Rigel lease?

Yes. And one of the reasons why we do like to talk about things ex-Rigel is that probably is more appropriate for what we see the next couple of years. I'm not going to give an exact number, but it's in the range of what you just described.

Hey, just a note, we've hit the 1-hour mark and we still have a number of people in the queue. If you could, we'd probably better stay with one question and one related, so we don't have a 2-hour call. So let's continue, but if we could on that basis, please?

Our next question will come from Drew Babin of Baird.

I'll keep this quick. Focusing on medical office, most of what you own, obviously, is gross lease, decent amount of expenses and sometimes, CapEx obviously fluctuates. But with shorter lease duration, TIs, leasing commitments can sometimes work against AFFO. I'm just curious, going forward, these exploring opportunities with HCA as well as within the Morgan Stanley JV, are you considering more of an emphasis on longer duration triple-net type MOB leases? Or should we expect more of the same going forward?

Yes, actually, when you look at our lease profile, we have -- the vast majority of our leases are base year, or fixed years, fixed stop leases. So we do benefit from expense increases on those. I mean, the only time you really get hurt on a lease like that is if you're in a period of expense reductions. And most of our expense reductions in the portfolio, we've kind of done in the 2008 to 2011 timeframe. We've been pretty successful at holding expenses kind of in the 1.5% to 2.5% range increases over the past 5 or 6 years. So we kind of like the base year format. I don't -- unless it's specific to the market, we don't intend to switch to a lot of triple-net. When you look at pure gross leases, where we get no expense recoveries, we only have about 15% to 20% of those in the portfolio. Most of the 15%, and almost all of those are at our Medical City Dallas campus. We do a standard lease across the portfolio there. So...

Okay, so just a quick follow-up, it sounds like growth activity going forward with HCA and Morgan Stanley, likely look like more of the same?

Yes. I would say with HCA, that does create a program. So certainly more of the same there. Morgan Stanley is an excellent partner for us, so we'll see what plays out there as well. As far as other structures that could be similar that create value, we would certainly entertain those. Scott and his team are working on those all the time.

Our next question will come from Michael Carroll of RBC Capital Markets.

Scott or Tom, I kind of wanted to talk a little bit about your life science platform. I know you had a pretty good base in Southern San Francisco on your expanding with mainstream Cambridge. I mean, do you have any desire to get in some of the other of these top cluster markets, similar to like Seattle, for example? I mean, how do you guys think about that?

Pete, why don't you take that?

Sure. Mike, our life sciences platform right now is San Francisco, San Diego and Boston, and we believe we have a dominant foothold in San Francisco, especially South San Francisco. We have a nice market share in San Diego, and we just reentered Boston. As of -- to answer your question about going into new market, I think we have plenty to do right now within our core markets. We certainly see a lot of opportunities in Seattle, Philadelphia, New York has come up more now. For us to enter into those markets, we'd have to be getting an appropriate yield to compensate for what we think is a riskier play versus the core market. But for us right now, there's plenty in our pipeline to do in our core markets. And frankly, if there was a market within the 3 that we'd like to try and expand, it certainly would be Boston, where we have a toehold right now. As we like to get bigger, we've said that. We like the campus we have there with Hayden. It will be 600,000 square feet when it's done, so it's kind of its own mini little cluster. But we certainly like to expand to do more in that market if opportunities present themselves.

And just one last question related to that, how do you think about growing that platform I guess -- within those existing markets? Are you looking to find new land sites to develop on? Are you really focused on the sites you currently have and try to maximize those first before you try to find new sites?

Yes. It's probably more value add. I talked about Hayden as a good example, where, within that campus, we bought a core asset, we bought a value-add asset, where there was some lease-up risk. The blended yield across the 2 of those was around 5.9% or 6%. That makes sense to us. And then we also got land that we had an option to purchase, which we've since purchased and we think yield there in the low 7s on that development. So we'll look at opportunities like that because of our current cost of capital as opposed to just buying core low cap rate assets, which frankly, doesn't look as exciting to us as some of the other opportunities.

And Michael, Herzog here again. I'll just remind you in addition to our already sizable pipeline, we do have a shadow pipeline that constitutes a future $800 million as well. So it's not that when we complete the current pipeline -- active pipeline that we're out of opportunities. I just wanted to make that clear.

Our next question will come from Daniel Bernstein of Capital One.

I have 2 unrelated questions, but I promise to keep it to 2. One, I think, I mean, everybody's focused on occupancy in the senior housing space. But when you look at the Department of Labor, print this morning, on wages, it's accelerating. But by question really revolves around labor and in particular, the transitioned assets. Have you seen any changes in employee turnover, contract labor or something that might signal that the margins on that portfolio could improve from here on the next 12 months?

Hey, Daniel, it's one reason that the year-over-year growth rate and NOI has been so negative. We talked about occupancy being down, but we also had elevated expenses that should be temporary, and that was driven in part by labor-related expenses, like over time in contract labor in filling vacant positions. So that is one of the reasons that we see a lot of upside in these particular properties. There was also a significant amount of turnover of the leadership teams in each of those communities. So that was also driving the NOI growth that we've reported this year.

But that's stabilized though?

Well, some of the assets were only transitioned recently. So that's why I say that the occupancy improvement that we've seen is primarily from the assets that trend from 6 and 7 months ago because it does take some time to put the new team, culture and systems in place.

Okay. Some of the other REITs, not necessarily health care REITs, have talked about delays in deliveries of construction, particularly labor shortages, another labor topic, in the construction area. And have you seen any of that? Does it change how you pencil development going forward?

This is Tom Klaritch. We haven't seen any delays in construction. If you look at the projects we have in place right now, The Cove, it's on-time, on budget. The Shore at Sierra Point, the same thing. We're moving ahead with that, actually a little ahead of budget. So we haven't seen really any delays.

Our next question will come from Lukas Hartwich of Green Street Advisors.

Can you provide some more color on the Shoreline cap rate? Are those rents at below market? Or is there redevelopment opportunity with that asset?

Yes, good question, Lukas. So the leases are below market there. Probably about 25% to 30%. What I would say though is that weighted average lease term is 4 years, so there's nothing you can do about that for another 4 years. If we think about a market cap rate, probably in the low 4s, if you factor in a mark-to-market on the rent, but then you've also got to factor in a pretty good increase in property taxes that any purchaser has to underwrite, because the tax basis is so low in that asset right now. So 3.5 today, probably low 4s on a market basis, but you have 4 more years of lease term, which is important to factor into that.

Our next question will come from Michael Mueller of JPMorgan.

This is Sarah on for Michael. You mentioned that you can participate with your Medical City investments, could you elaborate on how unique it is in your portfolio?

I'm sorry, I couldn't capture that. Could you please restate it or just say it louder?

Sure. You guys mentioned earlier in the call that you can rather participate with your Medical City investment. So could you guys talk a little bit more about that, and how unique it is in your portfolio?

Yes, so Medical City Dallas? Yes, Tom.

This is Tom Klaritch. The Medical City lease is, its structure is a fairly low base rent to it, but we do share in the revenue of the hospitals. So that's where the growth comes from when the hospital bodes real well like Medical City always has. We get a piece of that upside.

Our next question will come from Todd Stender of Wells Fargo.

Just with the volume of taxable gains you've generated this year, I know you've got those offsetting losses you mentioned. Is there a chance of a special dividend? I asked that because your rent will naturally decline into next year from these asset sales, which just brings into question your dividend level, FAD coverage, that kind of stuff. So any comments you have on maybe a special dividend and then a regular run rate?

Hey, Todd. I'll take this one, it's Herzog. No, there's no intention of doing a special dividend. Our dividend coverage, as Pete, I think, mentioned in the remarks, will land in the mid-90s. We're comfortable with that based on our balance sheet, our portfolio and we'll certainly grow into a stronger coverage position and there would be no reason for us to do a special.

This will conclude our question-and-answer session. At this time, I'd like to turn the conference back over to Tom Herzog for any closing remarks.

Well, thank you, operator. And thanks for everyone for joining us today, and we'll talk to you soon. I guess we'll be seeing a bunch of you guys in San Francisco next week, so we look forward to that. Thanks so much.

The conference is now concluded. We thank you for attending today's presentation. You may now disconnect your lines.