Healthpeak Properties Inc (PEAK) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter HCP earnings conference call. My name is Letasha and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will facilitate a question and answer session towards the end of this conference. [OPERATOR INSTRUCTIONS] I would now like to turn the presentation over to today's host, Mr. Ed Henning, HCP's Senior Vice President and General Counsel. Please proceed, sir.

Thank you. Good morning and good afternoon. Some of the statements made during this conference call will contain forward-looking statements subject to risks and uncertainties which are described from time to time in press releases and SEC reports filed by the Company. Forward-looking statements reflect the Company's good faith belief and best judgment based upon current information, but they are not guarantees of future performance. Projections of earnings and FFO may not be updated until the next announcement of earnings and events prior to the next announcement could render the expectations stale.

Additionally, certain non-GAAP financial measures will be discussed during the course of this call. We have provided reconciliations of these measures to the most comparable GAAP measures as well as certain related disclosures in our third quarter supplemental information package or our earnings release, each of which has been furnished to the SEC and is available on our website at www.hcpi.com.

I will now turn the call over to Jay Flaherty, our Chief Executive Officer.

Thanks, Ed, and welcome to HCP's third quarter earnings call. Joining me today are HCP's Chief Financial Officer, Mark Wallace, and Chief Investment Officer, Paul Gallagher. Let us begin with the review of the Company's third quarter numbers, and for that I will turn the call over to Mark.

Thanks, Jay, and good morning. The level of activity continued to accelerate at HCP during the third quarter. Since our last conference call, we completed our acquisition of CNL Retirement Properties, closed on $3.4 billion of related bank financing, priced $1 billion of senior unsecured notes, and this morning we announced a follow-on equity offering of 22 million common shares. At the same time, we have continued our strong pace of investment and repositioning activity and posted solid third quarter operating results. For the quarter, we reported FFO per diluted share of $0.50 and net income of $0.52 per common share. FFO for the quarter excluded realized gains aggregating 36 million from two transactions we discussed on our last call, the sale of the Sierra Health property and the swap of assisted living facilities with Atria. Consolidated GAAP basis same property NOI growth was 1.5% for the third quarter while adjusted same property NOI growth was 2%.

I will provide earnings and FFO guidance for 2006 and 2007 in a moment, but let me first cover our recent investment activity. During the third quarter, we purchased interest in $99 million of properties at average initial yields of 7.8%. As previously announced on July 28th, we acquired two institutional quality assisted living facilities from Atria in exchange for three assisted living facilities valued at approximately $20 million plus $37 million in cash. The initial lease rate is 7% with escalators based on the property's revenue growth. The overall transaction resulted in a net gain. However, the appropriate accounting required a $2 million second quarter impairment charge on the two sold assets while a $3 million gain on the third asset is included this quarter.

The Sierra health property was sold on July 25th for 73 million and resulted in a third quarter gain of 32 million. Neither of these gains is included in FFO.

On October 2nd, we acquired five assisted living and independent living facilities for 31 million through a sale leaseback transaction. The facilities have an initial lease term of 15 years with two 10-year renewal options. The initial annual lease rate is approximately 8.5% with annual escalators of 3%. The properties are 93% occupied and will be included in our existing master lease with Summerville that will have 31 properties and a cash flow coverage of 1.2 times.

On October 24th, we agreed to acquire GE's interest in our medical office building joint venture for $141 million. Closing is expected to occur in November after which HCP will be the sole owner of the venture's remaining 59 medical office buildings. The JV has been very successful for HCP. Our IRR will be nearly 50%, which includes a $28 million promoted interest that resulted in a reduction of the purchase price. We expect to execute the purchase through a taxable REIT subsidiary to provide the flexibility to transfer that interest to a joint venture partner in the future.

In September, we priced $1 billion of senior unsecured notes in three tranches, $300 million of two-year floating rates notes at LIBOR plus 45, 300 million of five-year notes at 5.95 and $400 million of ten-year notes at 6.3%.

In connection with the CNL acquisition, we arranged new bank facilities that included the following: a $1 billion three-year revolving credit facility, a $1.7 billion two-year term loan and a $705 million one-year bridge loan. Pricing of each facility is based on a ratings grid. The revolving credit facility is priced at LIBOR plus 70 basis points with a 15-basis point facility fee while the term and bridge loans are priced at LIBOR plus 85 basis points. The bridge and term loan each contain covenants requiring certain prepayments with the proceeds from capital market transactions, asset sales, and proceeds from joint venture asset contributions. Our previous line of credit was terminated and we expect our fourth quarter results to include a charge of 1.2 million related to the write-off of deferred financing cost.

The CNL acquisition closed on October 5th. The total consideration of 5.3 billion was comprised of 2.9 billion in cash, 1.7 billion of assumed or refinanced debt, and the issuance of 27.3 million common shares valued at approximately $700 million. Of the 1.7 billion of CNL Retirement debt, CNL Retirement Properties repaid just under 400 million prior to our acquisition and we assumed the $1.3 million balance. The assumed debt is 72% fixed rate, has an average maturity of 5 years and an average interest rate of 6.1%.

We also redeemed $120 million of HCP's outstanding 7.5% bonds in connection with the CNL acquisition. These bonds were assumed as part of our 1999 $1.2 billion acquisition of American Health Properties, and were scheduled to mature in January 2007. Restricted cash on our quarter end balance sheet represents escrowed funds related to this redemption.

In closing, our balance sheet included $6.8 million of consolidated debt. I want to emphasize what we have said previously about our balance sheet. Our intention is to return our leverage ratios to traditional levels within one year. We have developed a deleveraging plan that allows us to accomplish this through a combination of events that includes capital market transactions, asset dispositions, the contribution of assets to joint ventures, and the strategic deployment of additional equity.

Jay will discuss our deleveraging plan more in a moment, but let me finish my remarks with our guidance for 2006 and 2007. Regarding our outlook for 2006, our forecast is for gross investments during the fourth quarter to range between 250 and $500 million. Assuming that level is achieved, our consolidated growth investments for the full year, excluding the CNL acquisition, would be between 700 million and $950 million. Our on-balance sheet disposition during the fourth quarter are expected to range between 500 million and 630 million resulting in full year disposition between 620 and 750 million. Our fourth quarter disposition includes an expected sale of 78 skilled nursing facilities. Our net income guidance includes gains on dispositions of about 350 million for the full year. We expect to transfer about $700 million in assets into two newly formed joint ventures near the end of this year. And last, we expect to pay down the $705 million bridge loan with the proceeds of our equity offering announced this morning.

I do want to caution that predicting future activity for any particular quarter is an imprecise science at best and accordingly, some expected volume could shift into 2007 or not close at all. Given those comments, we expect net income for common share for the full year to range between $3.26 and $3.32 and FFO per diluted share to range between $1.80 and $1.86. As a result of the CNL Retirement acquisition, we expect to incur $21 million of related costs or approximately $0.14 per diluted common share in the fourth quarter. These merger related costs include the amortization of fees associated with our acquisition financing, the write-off of unamortized deferred financing fees related to our previous line of credit, severance and retention related compensation as well as integration costs. Excluding these merger related costs and second quarter impairment charges of $0.03 per diluted common share, we expect FFO per diluted common share to range between $1.97 and $2.03 for 2006.

Regarding our outlook for 2007, we are still in the process of completing our annual planning cycle for the combined companies and expect to provide further detail and update our guidance on our next call. However, we are able to provide preliminary guidance for 2007 at this time. Let me start with a few key assumptions that underlie that guidance. First, gross investments are expected to be about 1.5 billion. 20 to 25% of our gross investment volume will be targeted for joint ventures. Dispositions our expected to be between 100 million and 200 million. The dispositions should generate gains reported for GAAP earnings of approximately 50 million. However, such gains are not expected to be included in FFO. Roughly $1 billion in existing assets, principally acquired from CNL Retirement, are expected to be transferred to joint ventures generating cash proceeds between 500 million and 700 million. We expect cost savings associated with the merger between 10 million and 15 million in 2007. And last, we anticipate additional capital market transactions as well as the strategic deployment of equity capital. Given those comments, we expect net income per diluted common share for the full-year 2007 to range between $1.63 and $1.73, and FFO per share to range between $2.09 and $2.19. We expect to incur $12 million of merger related costs, or $0.06 per diluted common share in 2007, similar to the costs I previously described. Excluding these costs, we expect FFO per diluted common share to range between $2.15 and $2.25 for 2007.

I would now like to turn the call back over to Jay.

Thanks, Mark. With respect to the third quarter numbers announced this morning, prior to impairments, this is the seventh consecutive quarter that HCP's actual results have exceeded Street expectations. This feat is particularly noteworthy this quarter in light of the extraordinary efforts on the part of HCP and CNL employees in closing and integrating the CNL acquisition.

I would now like to update you as to the status of the acquisition and the progress we have made on our delevering plan. Paul Gallagher will then review the significant amount of portfolio restructuring activity that we have achieved since the announcement of the CNL acquisition on May 1st. I will then finish with a perspective of how HCP is positioned strategically and share some thoughts on our go-forward business model.

As Mark mentioned, we closed the CNL transaction earlier this month. I am pleased that one member of CNL senior management, Sharon Yester, has agreed to join HCP as Senior Vice President, Asset Management. Sharon is a consummate professional with 30-plus years of experience, both as an operator and owner of senior living properties.

Since our May 1st announcement, the vast majority of HCP's senior management's time and effort have been devoted to one, restructuring the CNL portfolio and two, delevering the HCP balance sheet. Notwithstanding the fact that we have only owned the CNL portfolio for 25 days, substantial progress has been made on both fronts. Paul will speak to the restructuring activities in a moment.

Let me now update you on our delevering actions. We took down the 5.3 billion CNL acquisition with a mix of 80% debt and 20% equity. Our discussion with the rating agencies in July identified four components or buckets for the delevering plan: asset dispositions, formation of institutional joint ventures, capital market transactions, and placing equity strategically.

One, asset dispositions. We targeted existing HCP properties for disposition and expect minimal CNL properties to be sold. The largest component of our disposition activity will be a portfolio of existing HCP skilled nursing facilities. We are under a signed purchase and sale agreement for the transaction with a single buyer and expect to close the deal by mid-December. It is important to understand our rationale for electing to dispose of this particular portfolio. As we have accelerated the magnitude of lease restructuring activity in recent years, we have come to the conclusion that we are better suited to own chunky portfolios, that is, concentrations of multiple properties with single operators. Borrowing from the retail industry's concept of SKUs, HCP's competitive advantages enhance when our real estate portfolio looks a lot more like the merchandise for sale in a Costco rather than the merchandise for sale in a traditional grocery store, less choice of competing brands and more units per package. This particular portfolio of SNFs is comprised of 78 properties with 27 different operators. Following the sale, our SNF portfolio will represent 4% of overall HCP assets and our SNF operators will have been reduced from 42 to 16. The transaction is expected to result in a significant gain and as a result, has been structured as a 10-31 exchange.

Two, institutional joint ventures. We have made substantial progress with our investment management platform. We closed on two new joint ventures, are in discussions on a third, and as Mark just related, expect to dissolve a fourth, our MOB joint venture with GE. Of the two newly signed joint ventures, one is focused on MOBs and the other on senior housing. The MOB venture has a Fortune 25 corporate pension fund as our partner, which last week closed on the Johnson MOB portfolio that HCP acquired earlier in 2006. The venture's initial equity is 35 million and they have indicated an interest in increasing their equity investment up to $150 million for MOB assets. The CNL MOB assets have been identified as the next portfolio for review by this venture and we anticipate that this venture could grow to a total of $700 million of MOB assets in early 2007.

The senior housing venture was initially closed with an equity commitment of $130 million from an offshore investor group and they have recently received commitment committee approval to increase their equity investment level up to $300 million. The Horizon Bay independent and assisted living portfolios that Paul Gallagher and his team have recently restructured, have been targeted for inclusion in this vehicle, which we expect to be sized at approximately $1 billion once due diligence is complete in early 2007.

This morning's announcement of GE's exit from our current MOB joint venture gives us the opportunity with a portfolio of attractive properties to create a third joint venture and we have recently initiated conversations in this regard. At the present time, we would anticipate a total of 1.6 to $2 billion of assets under management during Q1, 2007.

Three, capital market transactions. We have accelerated the timing of our debt and equity offerings from our original plan in light of the bond market rally, the progress we have made on our delevering plan and the recent material increase in our acquisition pipeline. In September, we priced $1 billion of unsecured debt, traunched across three maturities, with an average interest rate of 6.1%. This transaction was moved up from its original year-end time frame and increased in size from 500 million to $1 billion. This reduced the amount of borrowings under the acquisition bridge facility funded at closing of the acquisition from 1.7 billion to 705 million. We anticipate the remaining bridge facility will be largely repaid from the proceeds of the equity offering announced this morning. These two transactions will have the effect of turning our one-year bridge loan into a one-month bridge loan.

The SNF disposition and joint venture transfer proceeds will be applied against our two-year term loan, allowing repayment to occur one year earlier than our original plan.

As to the proposed equity transaction, I would like to digress for a moment and provide a little historical perspective. We have become quite stingy when it comes to parting with our crown jewels, HCP equity. In my three-plus year tenure as CEO, the only equity offering completed was a $40 million overnight secondary priced in July, 2003. The proceeds of that offering funded our 33% interest in the joint venture with GE, which has now realized a 50% IRR over a three-year investment period. Prior to this, the only other equity issuance in this decade for HCP was a $100 million offering in February, 2001. The relative absence on the part of HCP from the equity capital markets reflects, one our increased activity as a recycler of capital; two, our ability to put out directly strategic equity via our down REIT program and entity level deals; and three, our extreme sensitivity to shareholder dilution. Recall that my own compensation is structured in an unusual fashion in that aside from my base salary, I receive no other cash compensation. Furthermore, as the periodic vestings of restricted share grants occur, personal funds have been used to pay the related taxes so as to allow for a 100% hold of divesting shares.

Fourth, placing equity strategically. The final component of our delevering plan involves the continuation of directly placing HCP equity via additional down REIT transactions and entity level deals such as the 700 million that was part of the recently completed CNL acquisition.

What is the bottom line of all this? On our May 1st call, I stated that we expected to return to our pre-CNL leverage ratios within 12 months of closing the transaction. Our success to date now allows us to accelerate that timing by an additional three months so that we intend to be leverage neutral by June 30, 2007. On that same May 1st call, I indicated that were we to have maintained the levered deal structure we used to close the acquisition on a go forward basis, we would achieve an FFO result that was 10% accretive or $2.20 per share for 2007. However, I quickly added that it was HCP's management and board of directors' intent to move quickly to delever the balance sheet and as a result, to expect a significant moderation in the $2.20 metric for 2007.

Fast forward to this morning. With a 2007 midpoint of $2.20 per share of FFO, after giving effect to our delevering plan, you can now see that we've been able to have our cake and eat it too. A very accretive acquisition using our traditional financing structure. However, that is only half the story. I'll take you through the other half of the story in a few minutes, but first let me have Paul Gallagher summarize the heavy lifting that has occurred over the course of the summer with our portfolio restructurings. Paul?

Thank you, Jay. I'd like to provide an update on several of our tenants and the restructurings that have taken place within both the HCP and CNL portfolios. First, let me start with the HCP portfolio. In July, we swapped three assets that were not covering their rent back to the operator, Atria, for $20 million, and bought two new assets for $57.5 million at a lease rate of 7%. The leases were structured with participations and incremental revenue growth. Additionally, we put our entire portfolio of six properties into a master lease guaranteed by Atria, improving the overall coverage from just under 1.0 times to a stabilized 1.16 times.

Also this July, Formation Capital announced the sale of a $1.4 billion portfolio of SNF assets to GE. Of this portfolio, nine assets were owned by HCP and leased to Formation. Our leases contained sole and absolute discretion consent and transfer consideration language in the event of a change in control. Formation also announced the acquisition of Tandem, an operator of nine assets in our portfolio. Our restructuring changes served to increase the rent on the Tandem assets by $300,000 per year, extend our lease term, push out purchase options by five years to 2014, and obtain a security deposit of three months rent where there previously had been none.

On the assets acquired by GE, we were able to extend the lease term by ten years and trade a formation guarantee for a guarantee from a GE entity with a $4 billion net worth on all nine of the assets acquired by GE.

In August, we entered into a purchase and sale agreement with Kindred to swap 11 SNFs for $77 million in exchange for three LTCs valued at $54 million plus cash of $36 million. As a part of this transaction, we will extend the lease term ten years to 2016. We anticipate a December close. The transaction significantly improves HCP's portfolio with Kindred, increasing the cash flow coverage from 0.8 times to 2.1 times.

Some key before-after metrics for our SNF portfolio, taking into account both the Kindred transaction and the pending SNF disposition. SNF exposure is reduced from 17% of the portfolio to 4%. Occupancy increases from 81% to 86%. Property age decreases from 27 years to 21 years. The number of operators are reduced from 42 to 16, and our portfolio cash flow coverage increases from 1.3 times to 1.6 times.

In July, HCP sold an office building in Las Vegas leased to a major HMO. As we have mentioned in the past, we regularly call our portfolio, assessing both the bottom as well as the top of the portfolio. This asset fell into the top category, was purchased four years ago at a 10.2% cap rate and had an initial lease term of 15 years. The rent increased at only 1% per year and this fact, combined with strong demand for net leased office investments, HCP decided to market the asset. We were able to sell the asset for $358 per square foot and achieved a cap rate of 6.6%. This allowed HCP to recycle capital into higher yielding assets with superior growth potential.

Last week, we agreed to buy out our MOB JV partners two-thirds interest for $141 million. The buyout will produce a property level IRR of 30%. With HCP's returns, including our promoted interest, acquisition fees, disposition fees, and asset management fees, equate to a 50% IRR. HCP's promoted interest equates to $28 million. While we initially intend to bring the assets on books, we have structured the transaction where we can contribute the GE portion to a new institutional venture. Were that to happen and given the effect of the promote, HCP's original one-third interest would increase to 44% of the ownership with no incremental investment.

Now, I would like to turn to restructurings within the CNL portfolio. As Jay has mentioned previously, the CNL portfolio can be characterized as superior quality real estate. What we have tried to do over the past few months is to take advantage of the opportunities to restructure and improve the quality of the lease structures. Our first opportunity occurred in May when Brookdale announced the acquisition of ARC. Both the HCP and CNL portfolios contained ARC assets. HCP's assets were master leased with apparent guarantee while CNL's were not. The CNL assets also contained [ROFERS] and purchase options. The consent language in the CNL leases called for reasonableness, while the HCP leases contained sole and absolute discretion and transfer consideration upon a change of control. As a result of our lease structure, HCP was able to negotiate the Brookdale guarantee on both the HCP and CNL assets as well as a master lease on the CNL assets. With respect to the ROFERS and purchase options, we required the payment of $2.2 million if they were not eliminated and we expect to receive this by year end.

The CNL portfolio has three separate portfolio investments with Horizon Bay. One portfolio was purchased by CNL while still in lease and had a $15 million security deposit that had been depleted down to $2 million. The transaction required that the deposit needed to be replenished once the portfolio cash flowed. Another portfolio consisted of high quality stabilized assets with good cash flow coverages. In addition, these leases contained ROFERS. The portfolios were leveraged 33% with three different lenders. We were able to restructure the Horizon Bay relationship by combining all three investments into one master lease with a Horizon Bay guarantee. The combined portfolio is projected to have a 2007 cash flow coverage of 1.03 times. Horizon Bay has also agreed to eliminate the ROFERs. The result is a single portfolio that is joint venture friendly where we can relever the portfolio from 33% to 65% and lower the debt costs to provide enhanced returns to both HCP and our potential JV partner.

Harbor Retirement is a tenant on several of Sunrise-managed portfolios, an operator on -- an operator and tenant on nine assets, and they lease on a month to month basis a large newly developed CCRC still in lease-up. The principals have extensive operational experience including previous tenure at Sunrise. HRA has been unable to reach an agreement to enter into a long-term arrangement with CNL on their CCRC, their flagship asset. HCP was able to structure a long-term solution for HRA's CCRC, convert the nine assets to a master lease, and restructure the rent payments.

These three restructurings have significantly reduced the risk within the CNL portfolio and improved its quality as the security and structure of the leases were vastly improved. Prior to the restructuring, CNL's non-Sunrise senior housing portfolio had no master leases. As a result of these restructurings, this portfolio will be 73% master leased.

Now, I would like to turn the call back to Jay.

Thanks, Paul. Given the effect of the delevering plan, let me now take you through the dramatic shift that has occurred in the composition of HCP's real estate portfolio over the past four years. Skilled nursing declined from 23% to 4% of the portfolio. Senior housing increased from 21% to 60% of the portfolio. Private pay component increased from 51% to 87% of the portfolio. The average age has been reduced 5 years to an average age of 12 years. Our top three operators have gone from being Tenet, ARC and HealthSouth to Sunrise, Horizon Bay, and Brookdale. Our enterprise value has more than tripled from 4 billion to 12.5 billion while the payout ratio has been reduced from 96% to 85%. Perhaps most importantly, the combination of these strategic decisions has increased HCP's annual FFO growth rate from 2 to 4% to an expected 8 to 12% annual rate.

How will this be achieved? New FFO growth drivers are now in place that supplement same store property increases and acquisition volume as HCP's traditional two drivers of earnings growth. These are, one, active capital recycling and lease restructuring such as our recently announced swaps with Atria and Kindred. Two, an investment management platform which we expect to exceed $2 billion in asset value in early 2007. Three, development, largely off our newly acquired Cirrus platform where we have an attractive development acquisition pipeline in excess of $250 million. And four, entity level consolidation. We have now successfully acquired and integrated $7.1 billion of health care REITs in the last seven years. We will remain opportunistic as the pace of consolidation increases among owners of health care real estate.

In summary, HCP's operating platform will generate 8 to 12% FFO growth in 2007 and 2008. And in the context of the strategic shifts we have achieved to reduce risk in our real estate portfolio, materially increase the quality of earnings and potential for dividend growth for HCP in the period ahead.

At this time, we'd be delighted to take your questions. Operator?

Thank you. [OPERATOR INSTRUCTIONS] Your first question comes from the line of David [Santos] with Merrill Lynch. Please proceed.

Thank you. Good morning. Obviously you went through that lot there. Let me focus on, is there an optimal mix of rental revenue versus the fees you earn with your JV structure?

I don't know if there's an optimal level. We think -- we like a lot of the return on equity components of the fee stream. I think what we've kind of gotten comfortable with is the notion of migrating our total real estate portfolio from one that three years ago was 100% owned on balance sheet with no real estate owned in joint ventures to something that probably looks a little bit more like maybe two-thirds of our real estate owned on balance sheet and maybe one-third of our real estate portfolio owned in partnership with joint venture investors. I think that's kind of a -- that's a rough guideline that we hold out there. Giving effect to the closed and anticipated transactions I just took you through, we're not quite at that two-third, one-third mix. I think we're probably in the 20, 25% zone. So I think Mark indicated that with respect to our '07 acquisition volume, we're kind of targeting that 20 to 25% range that would go to institutional joint ventures. So that's kind of our current thought process on that.

That's great. On the development front, you're obviously focused on the MOB space. Are there other areas where you would consider development?

Yes, I think the answer is yes. Cooking through the spaces, I think it's hard to make the math work right now with the reimbursement situation to do newly developed skilled facilities. I think in hospitals, the -- the cost of -- the cost of construction and the current amount of stress that's filtering through both the for-profit and non-profit spaces with this bad debt expense which for those of you who've seen the last couple of days of some of the for-profit hospital companies, that continues to be a sore spot for them. I think that makes that challenging.

Senior housing, we would love to do some development there. I think there's been very, very modest, and we watch this very, very carefully. They've been very modest amount of new development, almost counter -- to the point of being counterintuitive in light of the increased occupancy in that space and the ability for the operators to realize some very nice rate increases. One would think you would have more of a pipeline developing, but that, at least as of right now, has not been the case.

In medical office, in particular, the Cirrus platform that came to us as part of the CNL transaction, is very attractive. They tend to focus more on off-campus medical office building, ambulatory surgical center and specialty hospital development, and we like that a lot. Recall that our roots in terms of the MBO space are in that core on campus, on the campus of the number one, number two market share hospital systems in growing metropolitan areas, and we've got a lot of that, most notably, the Medcap portfolio. But again, land continues to get scarce and the ability to kind of develop more of that right now is limited. And the Cirrus team are fantastic. And we've got a very nice attractive pipeline that's growing there and we look forward to -- from a development standpoint, probably seeing the preponderance of our development activity come off that platform for the next year or two.

Great, thank you very much.

And your next question comes from the line of Rob Mains with Ryan Beck & Company. Please proceed.

Good morning, or afternoon depending on the coast, I guess. Couple income statement questions. The interest in other income, anything in there that you view as kind of non-recurring?

Not in the interest and other income lines, not this quarter, no.

Okay. And then couple other things. Operating expense up a little bit as a percentage of revenue as your G&A continues to go down both absolutely and as a percentage of revenue. Anything we should be looking at modeling that forward, ex-CNL of course?

Yes. Ex-CNL, I would say that G&A would probably be close to this quarter of run rate or in the range of last quarter and this quarter on average. It's kind of interesting on G&A, this quarter, actually the G&A line item actually includes about $400,000 of sort of integration related costs. It's actually up a little more than what it would have been ex-CNL. On the operating expense side, now there's really nothing specific to sort of point to there. In absolute terms, the operating expense is a reflection of the MOB acquisition activity that we've had and could be maybe up a little bit just because of property taxes and insurance costs.

Okay. The Summerville transaction you did. That's a better, excuse me, initial yield than we've seen on a lot of assisted living transactions lately. Is that largely due to the fact that it's kind of a tuck-in with an existing master lease?

Yes, that would be accurate.

Okay. I've got a couple more, but I'll jump out.

Okay.

Your next question comes from the line of Jonathan Litt with Citigroup. Please proceed.

Hi, it's Craig Melcher here with John. Can you discuss the fee structure and your ownership structure in some of the JVs that you've created and also what you're planning?

Yes, sure. The GE venture that we're exiting that we were one-third owner of, GE was two-thirds. We got acquisition fees, ongoing asset management fees and disposition fees. As Paul indicated, one of the nice features of the way we structured that transaction is that going forward, we're effectively, our ownership will accrete up from 33% to 44% with no incremental investment which builds in a recurring increase in our FFO going forward. And simply stated, whereas before in '07, we would have been recognizing a third of the NOI, this is a scenario where we migrate the remaining 56% of that venture to a new institutional partner. Instead of recognizing just one-third of that NOI, in '07 we'll recognize 44% with no incremental investment. So that works out quite nicely in terms of building in a recurring FFO stream.

With respect to the two new joint ventures that have been closed, I think you'll -- and by the way, when -- if and when we move the 56% ownership stake in the existing GE joint venture to someone else, we'll probably leave that ownership for that new venture. In other words, you're likely to see that venture be 44% owned by HCP, 56% by a new venture, so that's kind of the exit and potentially the entry in terms of ownership levels for that venture.

With respect to the two ventures that we've closed to date, one there is likely to be 70/30. That would be the one focused on the MOB platform. And the one that's focused on the senior housing portfolio is likely to mimic the original ownership stake we had with the GE venture. That will be kind of a two-thirds, one-third.

So to summarize, GE was one-third, HCP two-thirds venture partner. That will likely morph to 44%, 56%, given the recognition of our promote. The newly entered into MOB venture is likely to be 30% HCP, 70% our capital partner there. And then the venture that's targeted at senior housing, likely to be 33% HCP, two-thirds that investor group. In general, I think you should expect to see a continuation of acquisition fees and asset management fees. Everything's a little bit different. There's no kind of set pattern. In general, we've been seeing acquisition fees kind of centering around a 50 basis point metric. And then asset management fees, we tend to try to focus and structure as a percent as the cash flow. They can range from anywhere from 3.5% or more of NOI and oftentimes will get a, also a percent of the net asset value. That's how I would kind of characterize the fee structures coming off that platform.

Okay, and then second question is just, can you discuss where you are on your debt covenants now?

Sure. Mark?

Sure. The, in terms of the bank covenants, the bank covenants were sort of structured sort of considering the leverage that we would have post-the CNL acquisition, and they're designed to sort of step down over time as we execute against the deleveraging plan. At closing, we were at a leverage ratio of about just under 70% and then we were at a unsecured leverage ratio, currently sort of in excess of 100% but it's under the bank covenants, it's currently untested. The secured leverage ratio as of closing, we were at 20%. The bank covenants allow for a maximum of 30%. And as of closing, we were at a fixed charge, trailing 12-month fixed charge coverage ratio of 2.46. The minimum is 1.5 times. Now, as I've said, the covenant sort of stepped down over time as we executed against the deleveraging plan, as Jay said earlier, with the expectation that we would sort of be leverage neutral by the second quarter of 2007.

Thank you.

Your next question comes from the line of Jerry Doctrow with Stifel, Nicolaus. Please proceed.

Hi, thanks. I wanted to actually just go back and sort of walk through the transactions for modeling purposes and if this gets too laborious, we can maybe pick it up offline. You touched on pieces of these, but if I could just sort of walk back. The couple on the quarter, there was a sale of the building for 73 million. I think you touched on it and it's a medical office and I think you talked about the 6.6% sale price. What kind of rent were you giving up on the property? You said that, I think, it was initially like 10 something.

I like your suggestion of stepping through these offline.

Okay. I can come back to you. Maybe one or two specifics. Is there any sort of sense of just the schedule on the development? You talked about a 250 million pipeline, Jay.

Yes, that's both a development and acquisition pipeline. There is in that -- there's about a third of that, well, at least a third of that, you should anticipate coming online by mid-year '07.

Okay.

That's really only our kind of a 12 to 15 month out, kind of through the end of '07 sort of pipeline. There's -- they've got a shadow pipeline that's quite a bit more significant, but in terms of what we might realistically see drop into service, that's -- we're looking at it more over the next 12 to 15 months.

And this is specifically just for Cirrus on the medical office?

There's a little bit, -- Cirrus is the best, I would say Cirrus is about 3/4 of that number.

Okay. Okay. And then the one other thing, we just track your expense ratio relative to the revenue and just your managed assets, and is that a number that you happen to have or I could get that offline, as well?

Yeah, why don't we do that offline. We don't have that handy right now.

Okay. Fine. I'll, let me come back to you offline for the details. Thanks.

Your next question comes from the line of Greg Andrews with Green Street Advisors. Please proceed.

Good morning. I'm here with Jim Sullivan.

Congratulations.

Thank you.

When do you start?

In a few weeks.

So this is your swan song?

They still have me working here.

All right.

With respect to the JV deals, it's interesting, it seems sort of like a soft announcement for something that's really new to the health care sector and I'm surprised you haven't done it in a splashier way. But one question I have is in terms of these joint ventures, what is the length of commitment of the partners here? Are these partners looking for kind of a 5 or 7 year horizon or longer than that?

Well, first off, we've got $700 million of equity commitments that have been closed on. So I guess we tend not to be splashy but we think it's a pretty significant development. And both these partners are looking out a decade or more in terms of the commitments.

Okay. And I assume on the MOB joint venture there's, in addition to the fees you mentioned, there's fees related to the leasing and property management of those properties? Is that correct?

Well, recall that that function we outsource. We use third party, third party property managers in our MOB platform. So --

So each party will just pay its pro rata share of that?

Exactly, Greg.

Okay and in terms of setting these up, to me it feels like it's been a long wait since you announced the CNL deal back at the beginning of May. And I'm just curious, is -- was your experience one where you had lots of interest and had to sort of winnow through it to pick the partners you felt best aligned with? Or was it more a process of having to educate potential investors about the sector and really show them the benefits because they needed to understand it better?

I think it was probably more the latter. We had the wind at our back with the results we've had off our initial joint venture. But you seem to be drilling into the timing here. The timing couldn't have gone any faster for one simple reason. In order for these portfolios to be what Paul's term was in his comments joint venture friendly, there's a fair amount of leg work that has to occur in terms of restructuring the portfolio. In the case of the senior housing portfolio, eliminating purchase options and ROFERs, master leasing it, and then get the debt right sized and in this case we've got some nice debt refinancing things. You literally can't do that until you take ownership of the real estate. So that's why in terms of the specific transactions, informed observers of our Company will note that we've made the most headway on two portfolios that were owned by HCP, specifically the skilled nursing facilities and then the Johnson portfolio, which we owned and we acquired back in January which we dropped into this first MOB platform. Now that we've actually taken ownership and can actually be the principal on the other side of negotiating with the lenders and negotiating with the operators and things like that, now the other pieces will fall very quickly into place. So from our standpoint, the timetable here has been significantly exceeded from the original plan that we share with our board and the rating agencies in July.

Okay. And with respect to increasing the size of the two joint ventures that you have signed up, you mentioned how much additional equity your partners might be willing to kick in. I'm trying to get a sense of how tangible that is. Do you think that they would kick that extra capital in for things that are in your portfolio today that you might contribute to those joint ventures or is that more predicated on future acquisitions you would need to identify and get their approval for?

Well, no, Greg. As I said, the venture that's set up for the MOBs, we -- that's been -- that's closed on the Johnson portfolio and then we will now look to roll in the MOB portfolio of the newly acquired, i.e., 25 days ago, CNL assets that were in the MOB space. The senior housing portfolio, now that Paul has successfully restructured that portfolio, we haven't quite finished right-sizing the debt but that's in process now. Once that occurs, those are the assets that will be dropped into the senior housing venture. Taken together, those are that 1.6 to $2 billion amount of assets. That's just assets coming off the CNL portfolio, both MOB and senior housing, plus the previously acquired Johnson portfolio. Going forward, I think Mark indicated that with respect to our 1.5 billion acquisition volume that's included in our '07 guidance that gets to the mid point of $2.20 a share in FFO, we are targeting 20 to 25% of that incremental volume to work its way into joint ventures, and I think you could very well see some additional ventures come to fruition to be focused on that buy-in.

Okay, that clarification's very helpful. The 1.6 to 2 billion then, you expect by the end of the first quarter '07, you feel highly confident that that will be completed within that timeframe? Is that fair to say?

Yes. Again, the ventures have been legally closed on and now with what's going on is now that we've taken title and ownership as of October 5th of this month, we can now finish the debt that has to go on those two portfolios and finish off the, kind of the legal and title due diligence on the part of our venture partners to go about the process of dropping those transactions and buttoning those down.

Okay, great. And with respect to the 10-31 exchange related to the SNF portfolio that you're selling, is that going to be accomplished through, again, new properties that you have to identify or did some of the CNL assets get tagged as potential 10-31 acquisitions?

It's all buttoned up, Greg. That was all part of the component of the portfolio that we acquired from CNL. So it's all done.

Okay and then just last point. On CNL, when you announced the transaction back in May, you cited a coverage ratio for the whole portfolio that was, I think, 0.98 times and I'm curious if you have a figure that kind of updates us through, say, the end of the third quarter or, I guess, would really be probably lagging a quarter but through mid year?

Yes. We're right now, we're cresting just, we're about to go over 1.0 so just a skosh under 1.0 right now. The portfolio has performed nicely.

Great. Thank you.

Your next question comes from the line of Ross Nussbaum with Banc of America, please proceed.

Good morning to you out there. Couple questions. First, on the JVs, can you add some color on what is the return threshold above which you're going to get a promoted interest?

On the two new ventures that we've signed?

Correct.

Yes, I think what we would like to do is button those down and we'd come back to you on the next call with that information.

Okay. Second related question is on the earnings guidance. Of the 1.5 billion of acquisitions you lay out for next year, I think Mark your comment was 20, 25% of that in JVs. Am I reading correctly that you're going to on your own balance sheet have 1.2 billion, 1.3 billion, will be 100% owned? And then you're going to have a small position in another 300-ish plus million? Is that -- ?

Yes, yes, that's correct.

So I'm guessing that in order to keep leverage at current levels, and I think you mentioned this, there is additional balance sheet plans in the works to help finance that?

Mark indicated that the additional capital market transactions, depending on the pace and timing of that 1.5 billion of anticipated volume in '07.

In terms of the FFO guidance, do you have a specific forecast on what straightline rent and FAS 141 is? How much of an impact is that having on your guidance?

Regarding a straightline rent, we have traditionally run about sort of in the range of 7 to $10 million a year. The forecast currently includes a combined number of about $17 million in straightline rent for 2007. Okay. So I know that is sort of significantly less than what CNL has.

So 17 million for the combined portfolios. And is there any FAS 141? Do you have to mark any of the revenues to market, and if so, how is that pulling in?

The 141 adjustments really aren't very significant either on real estate intangibles or on debt intangibles mark to market.

Okay.

So no significant effect.

Okay. Next question. With regard to the sale of the, I think it was the 78 SNFs that you mentioned. Is that getting sold to a private buyer or public buyer?

Excellent question and I anticipate being able to give you an excellent answer on our next earnings call.

Okay, I'll try to read into that one. I think that does it, except for, Jay, we did notice that you went to both Notre Dame and UCLA so I'm trying to figure out the meaning of the intro to your conference call.

Good question. Operator, are there any more questions?

Yes. And your next question comes from the line of Jonathan [Hemmerband] with Goldman Sachs. Please proceed.

Hello?

Please unmute your line. I'll go on to the next question. Your next question comes from the line of Rich Anderson with BMO Capital Markets.

Thanks. Good morning, folks. Jay, with the 2007 number being equivalent to the number that you said you could have achieved if you did nothing from a deleveraging standpoint, what are the factors that were able to get you to identical number, post deleveraging plan? Is it mainly the fees that you'll be earning on the joint ventures that you're arranging?

Well, actually, I think now, no, no, absolutely not. The take away now, now that we've got the benefit of five months of looking at the portfolio and seeing the performance come in above our expectation, the reality is that if you go back to that May 1 and kept the levered deal structure in place, we would have been between 2.30 and 2.40 a share of FFO prior to the dilution relative to the equity raise that we announced this morning and the SNF disposition. Both those are dilutive. So the reality is that we'd be at 2.30 to 2.40 today. Ex those two components of the delever plan, that gets us to 2.20, so a materially better set of facts quite frankly. The portfolios performed great. We've had -- I think we've gotten a little lucky here on the bond market in terms of where we put the debt, the billion dollars of debt on the books versus where we had it planned. So there's a variety of factors, but the take away here is that ex the delevering plan, the FFO per share for the Company would have been materially higher than the mid-point of 2.20 that we announced this morning.

Got it. Thanks for that color. And staying on the topic of leverage neutral, how will your balance sheet look, not so much with absolute levels of debt, but from an unsecured versus secured basis and a fixed versus floating basis once you finish your process?

I think when we're finished, you'll see the fixed versus floating return to kind of our normal 20, 22% floating, 80,78% fixed, Rich. With respect to the secured unsecured, I think you will see that go up, recognizing that the main avenue for CNL to put on debt with the secured debt market given that they weren't public and didn't have an unsecured credit rating like ourselves. I think our current plan calls us from kind of directionally going from historically at HCP a very modest amount of secured debt of say perhaps about 12%, up to about 20%. That's what our current plan calls for. That could potentially go up or go down given the incremental amount of joint venture activity we have in terms of our '07 and '08 acquisition finds. In other words, to the extent that we go above that 20 to 25% amount of our deal volume in '07 and '08 in joint ventures, you would expect to see more, a higher percentage of secured debt because the secured debt is largely all a function of the joint venture strategy.

Okay. With regard to the CNL portfolio, you have 1 billion targeted for a joint venture of MOBs. Beyond that, is there anything else in the CNL portfolio that you think you might sell outright for whatever reason?

No, I think in terms of selling outright, I think there's one or two properties that are part of, some of Paul's restructuring activity that will come out of that. But I don't think you'll see us really sell any of the CNL portfolio. You will see the remainder either joint ventured or owned on balance sheet. And just to recoup the the bidding there, the $1 billion you mentioned, that's targeted for senior -- those are CNL assets that are targeted for the senior housing venture whereas the 700 million were CNL assets that were targeted for MOB venture.

Okay. So 1 billion for senior housing from CNL, and then another 700 million for MOBs?

Well, it's 700 in total of which the Johnson portfolio was 175, so the net there is about 525 of CNL MOB assets.

Okay, good stuff there. As far as it goes with regard to the GE buyout, who initiated that sale, that transaction?

That was very much a negotiated process. The venture's now been in place since early October '03, and they've done that rather consistently. They tend to, from time to time, look to take exits and so that was very much a negotiated transaction.

Okay. And just a minor thing. You list in the supplemental 55 properties in the joint venture, but you mentioned 59 in the release. Why is there four -- what are the four missing properties?

Four, four of those properties were in the joint venture so we owned a third, GE owned two-thirds, and they were located down in New Orleans and didn't fare so well in Katrina. However, we've had a more than satisfactory result relative to our insurance coverage so we actually did pretty well there. But I'm pretty sure that's the difference between the 59 and I guess maybe I'm speculating we discontinued the four, is that what the difference is? Yes,that's the difference of the four.

And I'm sorry, one final quick question. The 25% of investments in '07 targeted for JVs, those will be new third party properties? Those won't come from within like you're creating in these -- ?

Good question, absolutely the case. Absolutely the case.

Okay. Thank you.

Your next question comes from the line of Rob Mains with Ryan Beck & Company. Please proceed.

Yes, just a couple follow-ups. First of all, when you look at the JVs going forward, do you anticipate that they'll all be structured as you have a minority stake and they would be unconsolidated with your interest coming in on equity income line?

Yes.

Okay. And then also the Sierra property just from a bucket perspective, is that in the MOB or in the other bucket?

That was in the MOB bucket, Rob.

That is, okay. And then since you seem to have a pretty active acquisition pipeline, hearing that possibly we're seeing some stability, I don't know if you would say prices are necessarily going down, but some stability in the senior housing, assisted living independent living space. Just sort of where you see cap rates going in the market for the types of transactions that you're looking at?

I think we've seen cap rates kind of stabilize. Yes, pretty much across the board. I think there was a couple of transactions in the skilled sector in early '06 that created some new precedent. But I think by and large the last six months, I think we've seen stabilization across all of our asset classes in terms of cap rates. What has taken us by surprise, quite frankly, and is the impetus for which we have accelerated the debt in the equity offerings is what's happened to our acquisition pipeline, which has absolutely exploded. Right now, we are tracking that $12 billion of volume in our pipeline which just to give you some historical perspective, that's twice the all time previous high of $6 billion. So it's -- it's amazing what's occurred here just in the last couple of months.

Is that a function of more sellers or fewer buyers?

No, I think it's what you're seeing. Again, if you go back to the comments I shared with this group for the last several quarters, you've got two very significant disruptive forces that are rolling through the traditional health care REIT model. One is the institutionalization of health care real estate with more and more very high quality institutional investors with long successful track records of investing in the four core commercial real estate groups rotating for the first time into health care. That's one of the disruptive forces. The other disruptive force is the extent to which a lot of the operators, particularly on the senior housing side, have gotten quite healthy. And in terms of the balance sheets that got them right sized, they've got the ability to push rates nicely with the residents. So those two things are -- have really had a little bit of the shock to the system with respect to the traditional health care real estate model. The bottom line of all of that is you're starting to see, you're in your early stages of starting to see the public ownership by health care REITs of the health care real estate stock go from what it's been historically kind of a 2% metric, starting to see that increase. Now as we've talked before, if you take a look at the publicly traded REITs in the multi-family, office, industrial, and retail sectors, on average they own about 12% of the real estate stock in their respective sectors. So where you go from 2 to 12, which by the way I don't think is going to happen any time soon, that's an incremental $75 billion of transaction volume of health care real estate. One thing we track is acquisition volume of health care REITs. In '05, that number was 1.2 billion. '06 year-to-date, it's 9 billion. And I'm reasonably confident you'll see that 9 billion exceeded certainly by mid-year in 2007 in terms of what's happening. You're starting to see a lot of this real estate as more, as increasing acceptance on the part of investors. You're starting to see that morph into different hands.

Okay. But I guess there's some sort of impetus happening to get more sellers to the table, as well right?

Yes, I think everything's different. In the case of the CNL, clearly you had a liquidity issue there. They had in terms of the money they raised, they needed to have a liquidity event for their investors by no later than I think it was early '08. I think there was a transaction, a couple transactions earlier this year that both involved SNF assets. I think the -- I don't think there's any one specific trigger that's behind this, but when you've got institutional debt and equity participants that are, for the first time ever, interested in having exposure to health care real estate, that's facilitating a lot of these transactions, Rob.

Okay. That's very helpful, thanks.

Your next question comes from the line of Jonathan Hennerband with Goldman Sachs.

Hi, guys, sorry about that. It's [Mark Biffert] with [Jay Haberman.] First question relates to the GE exit, I guess. What's the background on that? Did GE come to you with that coming out of that transaction or did you go to them with that transaction?

No, they -- again their plan had always been, looking at a 3 to 5 year time frame, so we started having discussions kind of around about the June of this year. And then they accelerated and we've got the announcement this morning, which we anticipate to close on or before actually November 30th.

Okay. And of the dispositions that you're planning to make over the next year to delever your balance sheet, how much do you expect to come from the skilled nursing or each of the areas where you're invested?

Well, I think after the disposition we talked about, I think we're pretty much done divesting of assets. I mean to be quite honest, the balance sheet will be delevered at that point. So I think -- I think Mark's got a number of what was it, 100 to maybe $200 million of potential disposition?

Right, for 2007.

For 2007. So I think you'll see the disposition activity track down very quickly. I mean, to be honest, with the disposition we're talking about and the equity offering and the institutional joint ventures, at that point we've actually delevered the balance sheet. So now it's back to business as usual.

Okay. And last question. I guess given the -- what would you say 15 billion in potential acquisitions are coming into this space over the next year? Where do you guys see HCP as a potential consolidator in each of the areas where you guys focus?

Yes, there's, I mentioned two numbers, just to be clear. The amount of transaction volume that would come about from health care REITs owning the same percentage of health care real estate stock in the United States that publicly traded multi-family, office, industrial, retail REITS own of their respective spaces, that potentially is an incremental $75 billion. I don't think it's realistic to expect that 2% public ownership is going to 12 any time soon. I then said that our current pipeline is approximately $12 billion. And I think is your question more in terms of which sectors is represented in the pipeline?

Yes, that and where does HCP see themselves. What's your max? You've built up this operating platform or this joint venture over the last year. What's the maximum capacity that you see HCP acquiring on a year basis either through joint ventures or through your standard portfolio?

Yes, and we just don't think that way. We -- the portfolio -- the pipeline we've got right now is very attractive real estate. The way we -- we want to be in situation where we're kind of neutral to whatever the environment is. So for example, the market environment we're in right now, our enormous and unique competitive advantage is a situation where we can use HCP equity. We will win all the ties when we get in a situation where there's some structuring or tax issues or things like that because of the unique properties of our HCP equity in terms of the diversification and the age of the portfolio. Now that we've made the portfolio shifts and the lack of, the relative lack of the government reimbursement risk and things like that. So whenever we get a situation when we can use our equity, we're going to have a leg up. If we're in more of an all-cash deal, if we can structure a transaction that has appropriate returns for our joint venture partners as well as ourselves, then we'll go down that path. If neither of those two paths work, we'll look to development and or potentially recycle some capital in the form of selling some real estate. So we want to be kind of, we want to be able to make them, make money for our shareholders across all product types and across any environment we get to. And I think now with the way we've built out the platform and kind of moved away from just what's our acquisition going to be next year and what's the same store sales growth for the core portfolio going to be, and that's your FFO growth, we really wanted to move away from that and create these additional platforms and we feel that's what we've achieved at this point.

Okay, and related to the senior housing joint venture, you're using Horizon Bays assets, was that because the investor that you're working with wanted those specific assets, or did you feel that you would be better suited to have that specific portfolio stay together in that venture?

No, it certainly wasn't that at the beginning. They were actually in three separate portfolios. It's very important when you're in the phase of where we are now in terms of building out this investment management business, it's got to work, it's got to be successful. If you recall two quarters ago, we talked about the strategy on taking a partial disposition from the GE venture to -- because we had -- we had done everything at that point that we had to do except we hadn't realized an exit, an attractive result. That's why we did that transaction early in January. With respect to this portfolio, once Paul and Steve and their respective teams got the portfolio master leased and once we can put a more attractive debt on it, that will produce some very, very nice returns and that will work. What we're building is a platform here. And you've got to kind of take it one step at a time and every step's got to work along the way or else you're going to go backwards. So we're looking for assets in general that are going to perform well, that we can build in some downside protection, and we can put some attractively priced debt with long-term holds on it and just let it go.

Okay. Great, thanks.

Ladies and gentlemen, this concludes the Q&A session. I would now like to turn the call over to Jay Flaherty for closing remarks.

Again, thanks, everyone. I imagine we'll be seeing a number of you this week on the road show and if not, next week at NAREIT. So thank you for your time today and we look forward to following up in the near future. Thank you, Operator.

You're welcome. This concludes the presentation. You may all now disconnect. Good day.