Healthpeak Properties Inc (PEAK) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2007 HCP earnings conference call. My name is Melanie, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session toward the end of today's conference. (OPERATOR INSTRUCTIONS) Now, I would like to turn the presentation over to your host for today's conference call, Mr. Ed Henning, HCP's Executive Vice President and General Counsel. You may go ahead, sir.

Thank you. Good afternoon and good morning. 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're 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 second 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 our Chairman and CEO, Jay Flaherty.

Thank you, Ed. Hello, everyone. Welcome to HCP's 2007 second quarter earnings conference call. I would like to now turn the call over to Executive Vice President Chief Financial Officer Mark Wallace to discuss our most recent results. Mark?

Thanks, Jay. This morning, we reported FFO per diluted share for the second quarter of $0.58. Our results include $1.7 million of CNL merger related cost and $6 million of FFO income as a result of our change in estimate related to the collectability of straight line rent from the Meredith Corporation following their recent offering of common stock. Consolidated GAAP basis same property NOI growth for the first half of 2007 was 3.2% while same property adjusted NOI growth was 2.6%. Skilled nursing facilities, medical office buildings and senior housing reported adjusted NOI growth of 4.9, 4.6 and 4.1% respectively. The growth was principally driven by lease renewals and contractual escalators. Adjusted NOI growth of 1.8% for our hospitals reflected the first quarter catch up recognition of HealthSouth additional rents offset by lower participation rents at our [tenant] healthcare hospitals. As we discussed on our first quarter call, our other sector was impacted by a tenant that reduced their space by 160,000 square feet at our Lusk campus in San Diego. We have signed a lease for half of the vacant space, with an expected rent commencement date in January of 2008. We're currently in discussions to lease an additional 50,000 square feet to an institutional quality tenant.

During the second quarter, we acquired interest in $72 million of properties that average initial yields of 8.2%. Property acquisitions in the second quarter included two inpatient rehab facilities located in Plano, Texas and Baton Rouge, Louisiana that we purchased for $39 million through a sale leaseback transaction. The facilities are master leased, with an initial lease term of 15 years and two ten-year renewal options. The initial lease rate is 8.2% with annual CPI based escalators. Year one cash flow coverage at the facilities is 1.66. During the second quarter, we sold 20 properties for proceeds of $187 million, which included the sale of a 17 property senior housing portfolio for $186 million at a cap rate of 5.6%. Subsequent to quarter end on July 12th, we received $44 million upon the early repayment of an 8.75% loan receivable due May 2010 that was secured by a hospital in Texas. We received a $4 million prepayment premium and expect to recognize that gain in FFO during the third quarter.

In April 2007, we sold $45 million par value HCA senior secured toggle notes that we acquired in November of 2006 and received proceeds of $49 million. The $4 million gain is included in FFO and reflected in interest and other income. At the end of April, we formed a new medical office building joint venture thing that included 55 properties valued at $585 million. Prior to closing, we placed $122 million of secure debt on 14 previously unencumbered properties, increasing the portfolio's overall leverage to $344 million or 59%. The portfolio secured debt had a voided average rate of 5.47% at an average maturity of just under nine years. Upon formation, we received $196 million in proceeds, including a one-time acquisition fee of $3 million. We contributed the properties to the joint venture at our initial purchase cost and recognized a gain of $10 million principally resorting from depreciation since our acquisition. The gain is not included in FFO. We retained a 20% interest in the venture, will act as a managing member and will receive ongoing asset management fees.

On May 31st, the venture acquired two medical office buildings from Cirrus, valued at $23 million, and concurrently placed $15 million of secured debt. Our investment management platform now includes three institutional joint ventures with assets approaching $2 billion. Our balance sheet at quarter end includes consolidated debt of $5 billion, about 11% of which is at floating rates. We have no borrowings under our bank line and have unrestricted cash of about $330 million as of the close of business yesterday.

In connection with the Slough acquisition, we've arranged two new bank credit facilities. A $3 billion, 364 day unsecured bridge loan and $1.5 billion four year revolving credit facility that replaces our existing $1 billion revolver. Pricing of each facility is based on a ratings grid. At our current rating, the bridge is priced at LIBOR plus 70 basis points, while the revolver is priced at LIBOR plus 55 basis points plus a 15 basis point facility fee. Similar to our CNL related financing, we've negotiated financial covenants that accommodate the higher leverage at close and then step down or adjust over time as we execute our deleveraging plan. The LIBOR spread on the new revolver is 15 basis points less than the pricing on our existing line and a new agreement provides enhanced flexibility as we continue to grow our various business platforms. We presently intend to draw $2.75 billion on the bridge with a balance of the Slough purchase price funded by existing cash. At closing, our leverage ratio will increase from 50% at quarter end to 62%. Given that the Slough properties are virtually all unencumbered, our secured debt ratio is expected to improve from 16% to 13%. We continue to be committed to being leverage neutral within 12 months.

Turning now to guidance, we have updated our 2007 forecast for the expected impact of our acquisition of Slough, our deleveraging plan and other events and assumptions. We now expect 2007 FFO to range between $2.20 and $2.30 per diluted share excluding merger-related items. The key assumptions that underlie our current guidance are as follows. Gross investments are forecast to be $4.5 billion including Slough. We expect transfers of assets into joint ventures this year to range between $1.7 billion and $2.2 billion, including the senior housing joint venture we formed in January and the medical office building joint venture we formed in April. Our investment management platform should generate between $10 million and $15 million in fee income. Real estate dispositions are expected to be between $900 million and $1 billion. Gains reported from a GAAP earnings on these dispositions should be between $500 million and $600 million. Adjusted same property performance is expected to be between 2% and 3%. Reported G&A should range between $75 million and $80 million. We expect to recognize approximately $9 million of currently reserved straight line rents associated with our Summerville properties when the acquisition of Summerville by Emeritus closes. At that time, an Emeritus guarantee will go into effect and provide credit enhancement for our existing Summerville leases.

CNL merger related costs for the full year continue to be estimated at $11 million. Slough merger related costs for 2007 are also expected to be $11 million and include the following: a charge of interest -- a charge to interest expense of $6 million related to the write-off of unamortized deferred financing costs associated with the early termination of our existing $1 billion revolver. Bridge loan fees are expected to be amortized to interest expense and integration and other related costs. Our guidance does not currently contemplate any new capital market transactions and our guidance assumes weighted average diluted shares of about $216 million for the full year. With that, I'll turn the call back over to Jay.

Thank you, Mark. We're pleased with our year-to-date results driven by a reshaped real estate portfolio generating 4% plus same property NOI growth in our two largest property sectors, and the scaling of recently introduced operating platforms. Let me provide a little more color to Mark's comments by touching upon five separate topics.

One, investment activity. For the quarter ended June 30th, we observed cap rate compression across each of our property sectors. Through the seven months ending today, including our announced portfolio disposition to Emeritus scheduled to close in mid August, we have been net sellers of investments to the tune of $375 million. These dispositions have been particularly focused in the senior housing space where we are net sellers of $707 million year-to-date and in our mezzanine debt portfolio where we're net sellers of $29 million for the year. These activities will generate $400 million of gains, increasing the equity component of the company's balance sheet. I would anticipate that the remaining five months of the year will generate a significant outflow of investment dollars with the closing of our previously announced acquisition of Slough estates and our substantial deal pipeline, which looks all the more interesting in light of opportunities created by recent dislocations in the credit markets.

Two, Slough Estates. Last Thursday, the shareholders of Slough's parent company, UK based SEGRO, approved HCP's $2.9 billion acquisition of this best in class life science real estate company. We anticipate closing this strategic milestone later this week. Since our June 4th announcement, we have been focused on completing all of the activities necessary to close and effect a successful integration. We are looking forward to welcoming Slough's management team to HCP and the resulting growth initiatives that will be forthcoming in the period ahead.

Three, delevering plan. HCP's targeted 50% debt, 50% equity capital structure would require $1.5 billion of debt and equity fundings for the Slough acquisition. Our recent disposition activities will result in approximately $750 million or 25% of the Slough bridge facility not being drawn or being repaid within days of takedown. This accelerated funding represents 50% of the targeted equity component of the acquisition. We anticipate additional property dispositions and joint venture contributions later this year. In connection with the Slough acquisition, we will replace HCP's existing $1 billion revolving credit facility with a new $1.5 billion facility. Both the $3 billion bridge and $1.5 billion revolving credit facility were oversubscribed with investor interest. At the present time, we have no outstandings on our revolver, allowing for the complete availability of the $1.5 billion in potential investment activity.

Four, executive management addition. Effective tomorrow, Don McNutt will join HCP as Executive Vice President of Operations. Don has enjoyed a 31-year career at the Irvine Company, leading a number of different initiatives including leasing activities for the Irvine Company's 24 million square foot office portfolio, oversight of their industrial and business property operations and the development of resort properties. The Irvine company's market leading positions in the multifamily and office sectors are directly analogous to HCP's market-leading presence in the private paid senior housing and healthcare office sectors. Initially, Don will be partnering with Marshall Lees and our Slough colleagues to position HCP to scale its life sciences platform.

Five, brand recognition. After 22 years of superlative performance for the investing public, the Health Care Property Investors name will be retired next month in favor of HCP. The name change is largely symbolic. In fact, it was none other than our founder and Chairman Emeritus Ken Roath that made the motion at last week's Board of Directors meeting to propose the new name. However, the new name recognizes the evolution of the company's real estate portfolio in operating platforms since its IPO. In May 1985, Ken took Health Care Property Investors public with an initial portfolio of two national medical enterprise acute care hospitals and 22 Hill Haven nursing homes. A single tenant, MME, predecessor to [Tenet] Healthcare, represented 100% of revenues for the newly-created REIT, all of which were sourced from Medicaid and Medicare reimbursements. HCP enjoys industry-leading real estate ownership in life science campuses, medical office buildings and private pay senior housing. Together, these three sectors represent 90% of the company's investments and include relationships with such best in class names as Amgen, Genentech, Sunrise Senior Living, Brookdale, Horizon Bay, AEGIS, HCA, and the Ascension, Norton and Swedish medical nonprofit hospital systems. As the institutional partner of choice for healthcare real estate, HCP's development pipeline and investment management platform will each exceed $2 billion. The company's conservative balance sheet provides substantial liquidity and HCP's taxable REIT subsidiary has $2 billion of equity capacity.

HCP's array of product offerings -- from sale leaseback to joint ventures to development to downREITs to mezzanine debt -- across multiple property sectors provide the company with the unique capability to create shareholder value in an increasingly challenging environment. Simply put, the company has never been in as strong a financial and strategic position as it is today. HCP's talented employee base, while proud of the accomplishments in their company's first 22 years of existence, are intently focused on exceeding this track record in the period ahead. At this time, we would be delighted to take your questions. Operator?

(OPERATOR INSTRUCTIONS) Our first question comes from the line of Jim Sullivan with Green Street Advisors. Go ahead.

Thank you. Jay, your largest tenant, Sunrise Senior Living, is apparently trying to sell itself. Is that good for you, bad for you? What do you make of it?

Well, there is not much at this time I can add to what's already in the public domain. We're focused on what we've got right now and our Sunrise portfolio year over year -- which is through the five months ended May 31, Jim -- on a property level NOI is up 6.2% and on a year-over-year rent collected basis, is up 3.4%. So, we're focused on the performance of our portfolio. We're just about halfway done. And we like what we're getting there and we're obviously watching that situation.

Jay, you have plenty going on as you described in the prepared remarks. But with the stock off more than 30% from the peak, where does share repurchases fit in terms of your capital allocation menu?

Everything is on the table. I think right now, it is a question of priorities. We come from the school of -- it is a lot easier to get a new loan if you've done a good job repaying your past loans. That's why we're so focused on delivering the balance sheet after CNL. Priority right now is to delever from the Slough acquisition. As you can tell, we've already got or about to have 25% of that bridge loan repaid. One very important metric to watch in this regard, Jim, is our leverage ratio. Little background here -- right before CNL, that ratio was at 49%. At closing of CNL, it went to 70. Today, it is at 52%. Upon closing of Slough, as Mark just indicated, that 52% will go to 62. And pro forma for the Emeritus closing two weeks out, we're back to 58. So you can see we're very, very far along. We've committed to our credit constituencies, our creditors and the rating agencies that we will be leverage neutral within 12 months of closing the transaction. That's our first priority. But as you have alluded to, given the velocity of what we've got going on, we're tracking ahead of that timetable.

Jay, you talked about dislocation in the real estate and debt markets providing opportunity perhaps. But a lot of your delevering plan is dependent on asset sales. Are you concerned at all that your ability to sell assets and get the values that you hope to get might be disrupted by what's going on?

Right now, what we're seeing are very attractive valuations. I would note, as you saw in the transactions that we've sold to date, a lot of those are going to the operators which have interesting opportunity to not only take over ownership and switch out rent expense or interest expense, but also pick up a little bit of a multiple enhancement that I think the equity markets properly accord operators that own their real estate, as opposed to lease their real estate. So, we are seeing, as I mentioned, we have seen -- we've observed cap rate compression in the second quarter -- almost to the extent of what we saw in Q4 of last year. It has been a very significant -- across all of our property sector cap rate compression here.

And as you complete your sales, your acquisitions, et cetera, we're keenly focused on how much value you're creating through that process and in that context, your real estate sales during the second quarter is $187 million of senior housing, and I think you said 5.6 cap rate. The gain was just $2 million. I assume that was against depreciated book which would suggest the gain is minimal or negative against undepreciated book. Was there something about that portfolio that led you to not get the kind of results that we might see?

That portfolio just came in. That was one of the few assets we decided to sell out of CNL. So, that's -- I think it is more instructive to look at the projected gain on the Emeritus portfolio, which will be almost $300 million, Jim. The Encore portfolio had just come on and with purchase price adjustments and things like that, that's by design, Jim.

Got it. Thank you.

Our next question comes from the line of Mark Biffert with Goldman Sachs. Please go ahead.

Hi, guys. Jay, regarding your comments on what you plan on moving more items into your joint venture structures, which property type would you be moving in? Would it be the MOB portfolio with GE?

That's next on the docket, Mark.

Okay. And when you look at the -- the investment opportunities across healthcare spectrum, which ones are the most attractive to you? Are you still finding attractive mez opportunities given you just sold the toggle notes?

We didn't just sell those. We sold those back in April. We made that investment -- we landed that investment in November at par. Those bonds got as high as 110. We took 15% of our position off the table between 108.5 and 109, so that was a good three months ago. We're in a different world today. And it is -- it is all the more interesting in light of what's happened and that's -- our pipeline right now is quite interesting.

Okay. But no specific property type you're looking at?

We have -- in our pipeline today, we've got each of our five property sectors represented.

Okay. And Mark, I noticed that you switched the way that you recognize the JV income and how you're bringing it into your income statement. Was there any reason for that?

Actually, we didn't switch anything that I'm aware of. The one difference here was really the gain recognition that we have in the contribution that was really just a function of the fact that these properties had already been depreciated as opposed to the senior housing joint venture where they had not. I'm not sure exactly what you're referring to. But we haven't changed anything else.

Maybe I can follow up with that on the call. Then also related to the straight line rents for the $9 million you mentioned for the -- in the third quarter of the year --

Yes.

That entire $9 million is related to the Emeritus deal, is that correct?

It is Summerville which is being acquired by Emeritus, Mark.

So, you have to wait for Emeritus to take that over before you can recognize it?

Yes, our view is that we should look for independent third party arms length transactions that close before any adjustments are made. That's arguably a very conservative approach, but that's the one that we employ.

Okay, great. Thanks.

Our next question comes from the line of Tayo Okusanya with UBS. Go ahead.

Good morning.

Good morning.

Jay, your comments in the second quarter about cap rate compression, could you provide a little bit more detail in regards generally to what you have seen across types?

Sure.

Could you also provide any details on what your current leasing with all the dislocation in the credit markets at this point?

Sure. In terms of cap rate compression, again, the cap rate compression was significant and spread across each of our property types. In skilled, I think the Humana Care transaction has gotten a lot of attention in terms of the valuation there. In senior housing, I think the 5.6 cap rate that we achieved on the disposition of the Encore portfolio was relevant. In MOBs, we're aware of a significant size quality MOB portfolio on campus, mostly nonprofit, that is likely to trade here in the low 6 or actually right marginally through the 6 cap rate. In life sciences, there is a transaction that we expect to be announced of good size. That will come at a 6 cap rate that -- that portfolio, it is also interesting, relevant, relative to our Slough portfolio. Recall that our Slough portfolio is heavily weighted toward the San Francisco Bay Area, where the market is quite tight. In fact, south San Francisco alone right now has life science vacancies below 2%. This portfolio is heavily weighted toward San Diego, which is a softer market and the price per square foot will be significantly above our Slough transaction. So between skilled MOBs, life science and senior housing, that's a little flavor of what we see just in Q2.

With respect to the dislocation in the credit markets, I think the key takeaway there is -- I take you back to our last call. Not the Slough call but the last earnings call, the May earnings call. And in that -- I'll quote from my transcript there, I was talking about the significance presence of private equity in the senior housing space. I mentioned Fortress's success with Brookdale and most recently Holiday. I mentioned Blackstone's closing of a joint venture with Emeritus. I mentioned Apollo exchanging its ownership stake in Summerville for a position in Emeritus. I mentioned Lazard -- been an active buyer -- [Adrian Investment] and I mentioned Chartwell ING which has added to its Horizon Bay exposure with an investment in Merrill Gardens. I also noted that it was particularly significant from our perspective that none of these firms were taking any money off the table at the present time.

Let me bring that forward to today. Two comments. One, we've taken a different approach here in the last couple of months. We've taken a significant amount of money off the table in senior housing. $707 million on a net basis year-to-date. But I think to your question, Tayo, I think on a relative basis here -- the private equity firms are disadvantaged relative to HCP, given what's going on in the credit markets and our ability to access, whether it is through our revolver or through some of our other capital sources, our institutional joint venture partners or additional asset sales. So, we really like our position right now and we're very focused on a large number of situations.

But doesn't the dislocation can ultimately cause cap rates to start to appreciate again rather than compress?

It certainly could. Again, we're as good as through July 31st and I've just shared with you what we've seen going on in our various property types for the past couple of months. We're watching this very, very carefully.

Great. Thank you.

Yes.

Our next question comes from the line of Rob Mains with Morgan Keegan. Go ahead.

Good morning, good afternoon. Mark, a couple of questions. Numbers things. The shares out guidance that you gave -- that's the shares out calculation for FFO, not EPS, right?

That's correct.

Okay. And then do you have -- I know this will be in the queue but just -- do you have the managed properties revenues in front of you in thousands if you've got it?

I can get it. Give me just one second. Revenues for medical office buildings is $85 million, 342.

Then the $6 million you got through the recognition of the Emeritus straight line, that falls into triple net revenue line?

Yes.

So, if I wanted to take that out, that would be a nonevent as far as [FAD]. Because that would be taken out.

Just to be clear on the back on the $6 million -- the $6 million it does fall into triple net. It also falls into discontinued because we're planning to sell those assets.

Okay.

So, it is in that -- it goes into that sector, but it is not in the revenue line that's presented on the income sheet.

Okay. That's helpful. Acquisition pace in the quarter was not quite what you have been in previous quarters. I'm assuming that's a combination of working on Slough, and timing consideration -- shouldn't read anything more into it?

I would agree with that assessment, Rob.

Okay. And then as far as JVs going forward, you said kind of resuscitate the old GE one. Are you also anticipating making more contributions into the existing institutional JVs?

Any future contributions would come from -- yet to be closed additional portfolios.

Fair enough. So, nothing in the current asset base.

Exactly.

Okay. And then a modeling question. I know that you're not talking about 2008 but just -- is it safe to assume that some of the integration cost for Slough will leak into 2008 as well?

Certainly, because part of it is related to bridge loan fees that will be amortized so yes, some will be into '08.

I think that's all I've got for now. Thank you very much.

Our next question comes from the line of Rich Anderson with BMO Capital Markets. Go ahead.

Thanks. Good afternoon, morning. Just on the straight line question, quickly, the $9 million is unrelated to the $6 million, correct?

Yes.

Okay. And the $9 million is roughly $0.04 a share. That pretty much explains how you're able to basically raise your guidance by $0.05 from last guidance provided in the first quarter, is that correct? Or is there anything else that I'm missing?

It is one item, but I think relative to guidance, I think probably sort of saying that that one item was it and solely it is probably --

A big chunk of it though.

It does encompass all of the other facts. Sort of go through the -- underlying assumptions that we had in the guidance this time relative to what the underlying assumptions I gave in the guidance at the first quarter call. There are a number of differences there.

Understood. Just wanted to make sure. And then the $9 million, will that come in all at once or will that come in ratably over the course of the second half?

The $9 million would come in when the transaction closes, and then those properties would continue to have a going forward effect of about $1 million to $1.5 million this year.

Okay. In terms of SEGRO, the acquisition -- that's contemplated in your current guidance, is that correct?

Yes.

The $2.9 billion. Now, I know you've seen me write on this and I'm not getting it. I mean the 6.3 is one part of the transaction, the 6.3 cap rate that you assume, but you also bought a lot of land. We come up with a number that's closer to 5 type cap rate, unless you do something like maybe JV the development side of the business with SEGRO. So, when you think about your guidance for 2007 and maybe further out in 2008, are you contemplating some sort of capital transaction within the SEGRO portfolio?

We have no capital transactions contemplated for the rest of the year in our guidance, period.

Meaning like a joint venture, I'm saying it wrong. Like a joint venture, development joint venture with development assets of SEGRO.

No, there is nothing contemplated in our guidance for the rest of the year of that nature.

And so how do you respond then to the dilutive nature of the land that you're buying in the SEGRO portfolio? You say 6.3 is a cap rate. For the core --

We said 6.3 on the 80%.

Right.

We said 6.8 on the stabilized portion, which is 86% of the 80. The remaining 14, blend that to 6.3. We said we bought the land which we don't -- we have no development starts anticipated for the rest of this year.

Right. But you bought the land. The land would be dilutive at least initially until you put it to work.

All of that is included and incorporated into Mark's guidance.

Okay. You mentioned GE MOB being next on your list from a joint venture perspective. The Sunrise assets in the CNL portfolio I know at least were also at least on your radar screen. Has what's gone on with Sunrise home office impacted your ability to pursue a joint venture with them?

Oh, no. We've just by mutual agreement, both parties -- Sunrise and ourselves -- have agreed to kind of put the restructuring which is very well advanced on hold, pending resolution of the process at Sunrise going through now.

Okay. Fair enough. Last question, G&A guidance is $5 million higher this quarter versus last. Is that Slough impacting the numbers?

It is. There is roughly -- there's $2 million that's in the -- of the incremental $5 million that you mentioned, there's $2 million related to the Slough integration cost then another $3 million ongoing G&A for Slough.

Okay, great. Thank you very much.

Our next question comes from the line of Karen Ford with KeyBanc Capital Markets. Go ahead.

Good morning. It is Jordan Sadler here with Karen. Just a couple of quick ones. First, Jay -- you talked about selling off some of the senior housing exposure and the PE guys adding exposure at this time. What should we infer from I guess your view? And what you're doing that -- do you think growth is going to slow or is that a function of asset quality?

Sorry, Jordan, I'm not sure I understand -- you're connecting growth in our portfolios.

No, no, no, no. I think you said some people are adding exposure to senior housing at this time. You guys are reducing. And I'm curious as to what the takeaway is.

I think the take away from our perspective is we're constantly looking -- at the opportunity to recycle a lot of older, lower growth assets that trade into newer higher growth, higher quality assets. So, year-to-date activity through today, July 31st which is seven of the 12 months are in the bag. That would be my one and only takeaway.

That would be because of the relative quality or location of some of the assets you've sold?

A lot of things go into the calculus. Age of the properties, barriers to entry. There are a number of factors that go into that calculus.

Would the Encore portfolio be dilutive to the overall quality to what you held on to? In terms of senior housing -- meaning would that 5.6 cap rate be above or below or appropriate?

As we stratify our senior housing portfolio investments, by a number of factors that get into an overall rating, the Encore portfolio would have been in our fourth quartile of senior housing portfolios.

Okay. And then -- I don't know if I'm reading more into your wording, but in your opening commentary and in response to a question, you characterized the pipeline of acquisitions is, I think, all the more interesting. Given, I guess, the dislocation. And the debt markets. And you said that the same property types are represented. Is there anything different about the prospective acquisitions? Is it an entity level deal that we might see or is it sort of still consistent with what you own in your existing portfolio today?

It is absolutely consistent with the portfolio. We're not venturing outside of healthcare. We've got five components of healthcare represented in our portfolio. The pipeline is very different if I were to take you back just nine months ago, when I took you through the pipeline which at that time was $12 billion. That was effectively -- a slight exaggeration, but -- it was effectively three deals, all entity deals. The [Halliday] deal, the Sunrise REIT deal and the Slough deal. If you look at that pipeline -- and historically, as we communicated to the Street, our batting average in terms of what we end up taking from the pipeline and putting into the end zone is typically about 20%. So, if you take a look at the $12 billion Slough deal plus or minus $3 billion, that's about 25%. We batted a little higher there than our historical average. If you look at our pipeline today, it is about half of what it was nine months ago. So $6 billion versus $12, but the transaction -- you probably got about 15 different transactions in there. So the average size is quite a bit smaller and for the most part, those are all portfolio opportunities as opposed to entity level deals. In that respect, it has changed quite a bit in the nine months.

Okay. And then just lastly, sort of follow up to Jim's question on Sunrise. Any thoughts on who a likely buyer for that type of company would be? Do you think a private equity player would likely step up there given sort of their appetite of late?

As I indicated, I have nothing intelligent to add than what's already in the public domain in that situation at the present time.

Okay, thanks.

Our next question comes from the line of Jonathan Litt with Citigroup. Go ahead.

It is [Pat Meltzer] here with John. I'm -- on the Slough accounting, is there any noncash income in the FFO that we should be aware of?

There is -- I mean Slough does generate straight line rent so I guess that's probably the biggest item you ought to be aware of. And for 2007, we have about $13 million in straight line rent related to Slough incorporated into the forecast.

Then that assumes that that's for five months? Of the year?

Yes. That's correct.

Okay. And on the development pipeline, is there going to be any capitalized interest related to that?

There will be capitalized interest to the extent that we have -- to the extent that we have development pipeline that we had incurred expenditures on. So yes, we would capitalize it at roughly 6%. Roughly 6% rate.

What's the total -- the cost on which that interest will be capitalized initially on?

Yes, it would be capitalized on the amount of the development which would be about $250 million.

Hi, Jay, on the operator of a senior housing facilities, do you guys have any interest in -- now doing your scale, you can stick it in TRS in having an operator in a TRS and owning an operator?

Mr. Witt (sic), you're coming up to speed on the fundamentals of senior housing, aren't you? In the right situation, we would have a high level of interest in that.

Thank you.

Our next question comes from the line of Jerry Doctrow with Stifel Nicolaus. Go ahead.

Thanks. I want to come back to some basics. I think this is for Mark to start. Just trying to get a good sense of sort of normalized FFO. There were two or three things that you touched on in the quarter that I just wanted to kind of go over. One was Emeritus. I'm not sure if that's discontinued or really in your FFO number. There is also this gain on sale on the -- I guess it is the toggle notes which I guess I would think of as a one-time item which I believe is in FFO. Could you go through that and whether there's any other kind of one-time nature things that are in there?

Well, as I said earlier, on the Emeritus $6 million, both continuing and discontinuing are included in FFO. In Emeritus, it is discontinued, but it's by definition included in FFO. You're right, on the securities transaction as I indicated on my prepared remarks, the sell of the HCA toggle notes, the gain, the $4 million was included. And I guess the other thing that I highlighted for the quarter was the acquisition fee that we earned on the medical office building joint venture as well.

Right. I think we've been giving you credit for the acquisition fees on the joint venture because that's a regular part of the business. But the straight line is kind of a -- you're going to have one next quarter as well. I assume the sale of the securities, I guess I'd also -- they're more than [HRBS] asset sales, which are generally excluded. Do you have thoughts on normalizing them out?

Not really. I think what we tried to do on the quarter, if you look at the supplemental -- we provide all of the discreet items that people normally need to adjust FFO and to adjust to an AFFO or a FAD number. So I think what we try to do rather than coming up with a normalized FFO is to provide people with the different elements and people can make their own adjustments.

The only last one I had because a lot of things have been covered already, and I guess I want to follow up on Jonathan's question, which sounds like SRZ -- you're a potential buyer for them in a period that you would buy an operating company. And then I also want to just ask about operating performance on hospitals and other -- they were down a little bit in the quarter. I just want to ask on an ongoing basis whether you would expect a continued deterioration there or what the growth projector would look like?

In a hospital space, that's probably the sector that's bringing up the rear at this point. And I think it is pretty well-known what's going on out there. You saw the most recent quarterly results from some of the -- there are not too many public operators left. The ones that are public, they're continuing to experience volume declines and increases in bad debt expense and things like that. So that, if you recall, Jerry -- that's why we shifted our investment in this space very significantly into kind of mez debt investments or hybrid investments like our our HCA note deal and like our Medical City Dallas deal.

I was trying to be a little more specific. You have the participating rent on the tenant stuff. Trimmed it down a little bit this quarter, if I understand what was going on. You see that's continued trend down or flat or up or in any sense of where it goes from here as we go out a quarter or two?

Right. I don't. We're watching it very carefully right now. As I said, the good news is we reshaped the portfolio and it has gone big into office, whether it is life science or medical office or senior housing.

So it makes less difference --

In each of those, there is 4% plus per quarter. Hospitals right now, it is 1.8%. And of our hospital portfolio HealthSouth is doing a little bit better than that metric, and Tenet is doing worse than that metric.

Okay. On the SRZ thing, I don't want to beat this to death but -- SRZ, legally you could buy them even though they're mostly a management company. They would still fit well within the TRS structure, whether you're interested or not, but they would fit as an acquisition.

As I mentioned, I have nothing intelligent to add to the discussion that's already in the public domain on Sunrise.

All right, thanks.

(OPERATOR INSTRUCTIONS) Our next question comes from the line of Brian Legg with Millennium Partners. Go ahead.

Maybe I can ask Jerry's question another way. What's the maximum capacity you have to -- in your TRS from an enterprise value standpoint to purchase an operator?

Well, again, our TRS isn't -- set aside to buy operator. It is set aside to do a variety of things. We don't look at it from a capacity for the transaction value. We look at it from a standpoint of an equity investment which is a direct function, a formula of calculation of a basket which goes to the scale of the remainder of the company. Right now, that calculation would suggest that we have capacity in our TRS of approximately $2 billion of equity. (inaudible)

Okay. That's very helpful. And just going back to Tayo's questions on cap rates. Can you just talk about what would be the range of cap rates for assisted and independent living portfolios from high quality assets like the Sunrise in your portfolio to more rural properties?

Well, I think those precedents are well-known. I think the holiday deal which is mostly independent, albeit more of a rural nature, was kind of in a mid 5 cap rate metric. I think the cap rate if I recall correctly was about a 5.7. We've sold the Encore portfolio this quarter at a 5.6. If you start to get -- outside of high barrier to entry markets with older assets, you can see that trend up probably -- well, predislocation of the credit markets probably see some precedence as high as 8, depending on the amount of the acuity in the community.

But if it is all private pay, would you be hard-pressed to find any portfolio of assets above a 7% for independent or assisted living?

No. No, as I said, you look at location. You look at age of the asset. You look at the operator. You look at amount of supply coming into a particular market. And it is a multifaceted equation. But there is certainly precedent. In fact, I think we bought some in the second quarter, if I recall correctly, some senior housing assets at an 8.2.

Can you talk about where interest rates would be for -- to borrow against a assisted living or independent living property, where they are today given the dislocation of where maybe they were six months ago?

Well, again, it is a rather -- appreciate the fact it is rather fluid situation. I think a lot of the senior housing assets avail themselves to Fannie and Freddie debt, which is treasury spread based. So actually, with the flight to quality that's going on, you've seen the ten-year treasury for example come in from I guess 5.32, broke through 5.8 I think last week, it was low [4.8] today. So, you've seen almost 50 basis points of a pickup there. I think the spreads have also widened out, but I don't think they've widened out as much as the treasury has come in. So, to the extent that you can access the -- near the agency debt, you actually may have picked up a little bit in terms of your interest burden here in just the last month or two.

Just in general, what would be spreads to treasury?

Well, again, if you take a look at the large piece of debt that we put on our Horizon Bay joint venture back in January, I believe the spread to treasury there was about 100 basis points. I think realistically today, it is probably widened out by maybe 25 to 35 basis points would be my guess.

Okay. Great. And last question on that type -- on debt for senior housing, what type of LTD can you go up to?

Typically, the agencies will go to say 65% loan to cost.

Okay. And can you get second mortgages and how expensive would they be?

Well, you can. That type of thing that folks such as ourselves would be particularly interested. We've done some of that in the past if you recall in our American Retirement Corp. investments. We put in $0.25 billion. That was obviously in a different interest rate environment and a different point in the senior housing cycle. That can get interesting.

All right. And any sense of how much you can go on LTV on a second mortgage? Up to 80% or so?

Sure. I mean I think you can go -- in fact, if I'm not mistaken, I think Emeritus in their joint venture with Blackstone has gone as high as 80% on a first mortgage. Obviously you're going to tradeoff rate for proceeds there. But we tend to not look at -- we tend to not try to go the turbocharged to leverage. We tend to like the 60%, 65% in our joint ventures to have a more modest level of leverage.

Okay, great. Thank you.

Our next question is a follow-up from the line of Rob Mains with Morgan Keegan. Go ahead.

Mark, I may be doing something wrong here. If I look at your interest and other income line and you said had you the $4 million gain in the quarter -- if I take that out, it is a sequential decline from the first quarter despite a higher balance of loans out. Was there another similar item in the first quarter I'm forgetting about?

It is probably going to be down because one, we had the -- because of the -- we sold some of the (inaudible) bonds early in the quarter. So you had less interest income during the quarter.

Right. (inaudible) Okay. That does it. Thank you.

Our next question comes from the line of Jim Sullivan with Green Street Advisors. Go ahead.

Mark, you may have just answered this, but the accounting for the toggle notes, you only put the gains and losses when you sell the notes? Or do you mark the market quarterly and run it through income?

Yes and yes. You mark to market. You run it each quarter. You run it through what's known as other comprehensive income which is in the equity section of the balance sheet. So, you do mark to market on the balance sheet. You don't run it through income on the income statement or in FFO until you actually sell the security.

Okay. And then with respect to cap rates for MOBs. You cited a portfolio deal that will price around 6. How reflective of that is that cap rate for high quality deals? And if you were looking at one-off deals, do you think it is possible in the current environment to buy cap rates in the 7.5 to 8.5 range?

No is the answer to your second question. That's an asset class that -- it is remarkable to watch what's happened in the almost four years since we acquired the midcap portfolio at a 9.25 cap rate. A lot of money has come into this space and quite frankly, a lot of it is committed but not even expended yet. So, that's -- you talk about a wall of capital. That would represent a mini wall of capital. I don't see -- that's obviously going to access secured CMBS market in particular. You can give a little ground there. But there seems to be a very strong bid in the market for MOB opportunities. So, I don't anticipate that change and I would think your 7.5 to 8, if I recall your question correctly -- I don't think that's realistic in the environment we're in, notwithstanding the credit market dislocation.

Thank you.

Ladies and gentlemen, there are no further questions at this time. I would like to turn the call back over to HCP CEO Jay Flaherty for closing remarks. Please proceed, sir.

Okay, everyone. Thank you very much for your interest in HCP. And enjoy the rest of the summer and we'll talk to you after our third quarter results. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. That does conclude the presentation. You may now disconnect. Have a good day.