Healthpeak Properties Inc (PEAK) 2009 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the third quarter 2009 HCP earnings conference call. I'll be your coordinator today. At this time all participants are in a listen-only mode. We will be coordinating a Q&A at the end of the call. Now I'll 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 contain forward-looking statements. These statements are made as of today's date, reflect the Company's good faith beliefs and best judgment based upon currently available information and are subject to risks, uncertainties and assumptions that are described from time to time in the Company's press releases and SEC filings. Forward-looking statements are not guarantees of future performance. Some of these statements may include projections of financial measures that may not be updated until the next earnings announcement or at all. Events prior to the Company's next earnings announcement could render the forward-looking statements untrue and the Company expressly disclaimed any obligation to update earlier statements as a result of new information. 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 supplemental information package and earnings release, each of which has been furnished to the SEC today and is available at our website at www.hcpi.com.

I'll now turn the call over to our Chairman and CEO, Jay Flaherty.

Thank you, Ed, and welcome to HCPs third quarter earnings call. Joining me on the call today are Executive Vice President, Chief Financial Officer, Tom Herzog and Executive Vice President, Chief Investment Officer, Paul Gallagher. Let's start with a review of our third quarter results. Tom.

Thank you, Jay. There are several key items that I'll cover today. First, in Q3 reported FFO of $0.52 per share excluding impairments and litigation provision and strong year-over-year quarterly same-property performance of 3.3%. Second we recognize impairments in litigation provision which total $0.41 per share. Third, we issued $441 million of equity and further strengthened our balance sheet, ending the quarter with $144 million of cash and a $0 balance on our $1.5 billion revolver. Finally our FFO guidance for the full year 2009 remained unchanged at $2.10, to $2.16 per share before impairments and litigation provision.

Let me start with our third quarter results. For the third quarter we reported FFO of $0.52 per share excluding impairments and litigation provision. Inclusive of impairments and litigation provision a $0.05 and $0.36 per share respectively our FFO as defined by NAREIT for the quarter was $0.11 per share. Our same-property portfolio continued to perform well, producing a positive 3.3% year-over-year quarterly cash NOI growth during the third quarter versus the third quarter of 2008. Paul will review our performance by segment in a few minutes. The third quarter results were impacted by several items not contemplated in our guidance, including the following. First, in connection with our 2006 C&L purchase, we acquired five land assets subject to direct finance leases from Erickson Retirement Communities. Two of these DFL's were subsequently monetized and three remain in our portfolio today.

During the third quarter we reported impairments of $15 million or $0.05 per share related to two of the three remaining DFL's. These impairments were recorded in connection with Erickson's October 2009 bankruptcy filing and reducing the carrying value of these DFLs to $19 million. A third Erickson DFL relates to a performing stabilized community and the lease payments are current. Second we accrued a litigation provision of $102 million, or $0.36 per share in connection with a jury verdict reached in the Ventas litigation. We intend to appeal this judgment. Third, during the quarter we incurred $6 million of Ventas related litigation expense which exceeded our previous estimate by $3 million or $0.01 per share. 2009 Ventas related litigation expense totaled $13 million through the end of the third quarter. Lastly, we realized gains of $6 million or $0.02 per share related to sales of a portion of our HCA debt investment representing $111 million of face value.

Turning now to our balance sheet. In August we completed a $441 million equity offering by issuing 17.8 million shares of common stock at $24.75 per share. Net proceeds from this offering totaled $423 million, of which $165 million was used to fund our Manor Care debt investment and $100 million to prepay a 2010 mortgage maturity. Remaining proceeds were used to repay the outstanding balance of our revolver and for general corporate purposes. We ended the quarter with our financial leverage of 43% and third quarter fixed charge coverage at 2.6 times. We're comfortably within all covenants of our credit agreements. We continue to manage the Company's net floating rate exposure.

During the third quarter we entered into two interest rate swap agreements representing an aggregate notional amount of $500 million that mature in 2011. These swaps offset the increase in net floating rate asset exposure that resulted from our Q3 HCR Manor Care investment and repayments of floating rate debt. The remainder of 2009 our debt matures including only $23 million of mortgage obligations, our 2010 debt maturities totaled $321 million which consist of $206 million of senior unsecured notes and $115 million of mortgage debt. This amount decreased $183 million from the 2010 maturities reported at the end of the second quarter due to the $100 million prepayment discussed earlier and the extension of certain mortgage debt. At the end of the third quarter we had unrestricted cash of $144 million and our $1.5 billion revolver which matures in August 2011 was completely undrawn.

Before reviewing our full year guidance I would like to speak briefly to our $85 million secured loan investment with an affiliate of Cirrus Group. As disclosed in our second quarter 10-Q, the borrower became delinquent during the second quarter. However the value of the collateral and guarantees supporting the loan are currently believed to be sufficient to reasonably assume full recovery of the carrying value. We'll continue to assess the status of this investment during the coming months. Switching to full year 2009 guidance. We continue to expect full year 2009 FFO of 2.10 to $2.16 per share before impairments and litigation provision. Additionally our projected full year same-property performance remains at 2.5% to 3%. I'll now turn the call over to Paul. Paul.

Thank you, Tom. As we conclude the eighth quarter since the beginning of the economic downturn, HCP's overall portfolio metrics continue to perform well. In addition our senior housing operators are reporting increases in occupancy and revenue. Now let me go to the details of the performance of the portfolio.

Senior housing, occupancy for the current quarter in our same-store senior housing platform is 85.7%, representing a 90 basis point sequential decline over the prior quarter and a 250 basis point decline over the prior year. However, our most recent data indicates occupancies in our nonSunrise portfolio have stabilized. All of our nonSunrise operators are reporting margin improvement resulting from both modest rate increases and ongoing expense controls. As a result, we saw sequential same-property cash flow coverage increase from 1.13 times to 1.16 times. Current quarter same-property performance for the entire senior housing platform declined 4.2% with a drag being our Sunrise portfolio. Our nonSunrise portfolio had an improvement of 2.5%, driven by normal rent steps. Our Sunrise portfolio had a decline of 18.4%, driven by 2008 insurance credits, downward LIBOR trends and current quarter costs associated with the Eden Care transfer.

In June we announced the termination of Sunrise's management contracts on our 15 Eden Care communities. On October 1, we sold one asset and leased the remaining 14 communities to three operators in our existing portfolio. The new lease terms were for 15 years and were structured with average rent increases of 9% on an annualized basis for the initial four years with more standard fixed or CPI increases for the remainder of the term. This transition reduced our revenue concentration from Sunrise from 14% to 12%. End of the Eden Care leases were transferred to Horizon Bay. In conjunction with the transfer, HCP and Horizon Bay have agreed to terms to modify the leases on 25 properties in our Ventures 2 joint venture where HCP owns 35% of the equity. HCP will provide short-term modest rent deferral in return for a new, stronger guarantor. Horizon Bay remains one of our better performing operators with occupancy of 91.8% and margins in excess of 40%.

Hospitals. Same-property cash flow coverage was up slightly to 4.46 times. Year-over-year same-property cash NOI for the third quarter remained down 11.6%, driven by the short-term rent relief at our Hoag Irvine Hospital. Hoag began to pay partial rent in August and is scheduled to pay full rent beginning in June 2010.

Skilled nursing. Our skilled nursing portfolio continues to perform well. Year-over-year cash NOI for the third quarter in our same-store portfolio increased 3.7% driven by contractual rent increases with stable cash flow coverage of 1.59 times. HCR Manor Care reported improved second quarter trailing 12 month debt service coverage for the entire debt stack of 3.03 times, an increase of 49 basis points over the prior quarter. Their performance continues to benefit from stable occupancy, year-over-year rate increases and a favorable interest rate environment.

Medical office buildings. For the current quarter, same-property adjusted NOI was up 8.4% over third quarter 2008, which excludes a $164,000 lease termination fee at a facility in Texas. This growth was driven by continued success in our expense control initiatives and the ongoing impact of previously discussed operating support revenues. Our revenue reduction initiatives resulted in a decrease in quarterly controllable operating expenses of $1.2 million, when compared to the prior year.

In addition, we've seen significant improvement in collections of rent with our outstanding AR being reduced by 33% or almost $2 million since the first of the year. MOB occupancy for the third quarter was 90.7% unchanged from the end of the second quarter. During the third quarter, tenants representing 353,000 square feet took occupancy of which 227,000 square feet related to previously occupied space. Our year-to-date renewal activities have resulted in a retention rate of 79%. These renewals occurred at a 1.3% higher mark-to-market rents and included two sizable renewals on leases that were previously above market. Absent the renewals on the above market leases, the mark-to-market rent increase was 2.4%.

As of the end of the third quarter, we have 690,000 square feet of scheduled expirations remaining for the balance of 2009, including 220,000 square feet of month to month leases. Our pipeline remains strong with 500,000 of square feet executed leases that have yet to commence and 510,000 square feet in active negotiations. During the quarter we sold two properties in West Virginia for $5.8 million resulting in a gain of $2.3 million.

Life science. The 2009 life science third quarter same-store adjusted NOI was up 18.3% over Q3 2008 levels. These gains have been principally driven by normal rent increases, mark-to-market rent increases, achieved in prior quarters, increased occupancy in the portfolio, and the recognition of revenue due to completion of tenant improvements on several buildings. Occupancy for the entire life sciences portfolio remains stable at 91.1% at the end of the third quarter.

For the quarter we completed 126,000 square feet of leasing of which 89,000 square feet related to previously occupied space that was renewed at an average rent increase of approximately 2%. Including leases from new tenants, we were able to address 91% of the expirations that occurred during the quarter with year-to-date retention of 88%. Our focus on retaining tenants has allowed us to preserve cash flow with no down time and minimal TI investment as our average tenant improvement cost on renewals is just $1.25 a square feet year-to-date. Our life science portfolio has limited lease expiration profile over the next two years. Lease expirations for the remainder of 2009 total 127,000 square feet and represent only 0.4% of HCPs annualized revenue. Looking to 2010 we have 280,000 square feet of expirations which represent only 0.8% of HCPs annualized revenue.

HCP continues to pursue a pipeline of leasing prospects in excess of 500,000 square feet for existing space. We continue to monitor institutional clients who have begun to seek space to accommodate expansion needs or relocate functions. Our redevelopment and development remains unchanged with four projects, 44% preleased totaling 568,000 square feet. As we have discussed in past calls, we continue to monitor the underlying credit and liquidity profile of our tenant base. The performance of our larger tenants is truly impressive with strong product pipelines producing double digit earnings growth for companies like Roche/GenenTech, Amgen, Takeda, Myriad Genetics, and NuVasive. In addition, tenants like Exilexis, Portola and Lygam continue to advance lead compounds via partnership agreements with companies like Sanofi Avantis, Merck, Novartis, and GSK.

Finally, we've seen the public capital markets open up as tenants like Rigel complete follow on equity offerings to meet funding needs relating to their arthritis drug, and M&A activity picked up as evidenced by the acquisition of our tenant (Protoloox) by Onyx Pharmaceuticals. From a liquidity standpoint the profile of our life science tenants continue to improve with tenants of less than 12 months of cash representing only 1% of HCPs total rent. Our venture back companies raised $900 million in financing year-to-date with additional milestone payments of $2.9 billion from multiple sources including partnerships, public equity and venture capital.

With that review of the HCP portfolio, I'd like to turn it back to Jay.

Thanks, Paul. I will focus my comments on the performance of HCP's portfolio and the unprecedented level of operator tenant activity within HCP's portfolio. With the great recession seemingly at an end after eight quarters, HCP's uniquely diversified investment portfolio has continued to generate outperformance. To be clear, we believe our portfolio is truly one of a kind. And it is uniquely diversified in that A, we are invested in five separate subsectors of healthcare. Acute care hospitals, skilled nursing, medical office buildings, life science, and private patient senior housing. B, these subsector investments are substantial in their own right. To underscore this point, if we waved a magic wand and broke HCP's portfolio up into five stand-alone publicly rated REITs, four of the five entities would immediately be the market leaders in their subsectors and the fifth, life science, would be the second or third largest, depending on the valuation metric used. Finally, C, HCP's portfolio is unique in the concentrated positions it enjoys with best in class operator tenants in each of its five subsectors.

A discussion in last week's UBS research note entitled, "The bite may be worse than the bark", caught my attention. The author stated, quote, While the market appears to be expecting tough property level results, we can't help but wonder whether seeing 3 to 10% year-over-year same-property NOI declines will serve as a harsh reminder that we're in for a reasonably tough 2010. With this back drop, HCP's portfolio produced a positive 3.6% same-property performance cash NOI result for the nine months ended September 30, 2009.

In addition, and significantly, our first look rollup of 2010 budgets is quite encouraging. HCP's consistently positive same-property performance results for the past several years support the recession resistant characterization of healthcare real estate and stand in stark contrast to the results from the four traditional food groups of commercial real estate during this economic downturn.

In yesterday's heard on the beach commentary, Mike Kirby challenged REIT executives by asking the question, "Wouldn't it be refreshing to hear a call devoted to thoughtful commentary about what the coming decade might have in store?" Well, HCP's FFO model does not go out a decade but the demand driver for our five property types certainly does. America's aging baby boomer.

In light of the relative outperformance of healthcare real estate during the great recession, I would challenge Mike and his peers some of whom are on the call with us today, to compare the fundamental underlying demand and supply drivers for US healthcare real estate over the next decade with what is apt to play out in the retail, office, multifamily and industrial sectors. As I've stated before, I would not trade our healthcare space or HCP's platform within that healthcare space for any other real estate entity in the world.

Turning to operator tenant activity within HCP's portfolio, the reopening of the capital markets coupled with the expected near term passage of healthcare reform has set in motion an unprecedented volume of strategic and capital market activity that will likely result in healthcare deal volumes for the first six months of 2010, exceeding their aggregate levels for the 36 months ending December 31, 2009. The favorable impact of this activity on HCP cuts across our entire portfolio and is likely to redefine our Company in the period ahead. These opportunities will manifest themselves in several ways as market valuations of HCP owned investments increase in value. As an example, our HCA Toggle Goat investment had moved from a price of $0.78 at December 31, 2008, to a price of $1.07 in recent weeks. A 37% increase.

As our operator tenants seek to recapitalize their balance sheets, HCP consent rights and other deal protections will be monetized in the form of additional fee income, and/or the improved structuring of our existing investments. In addition, it may be possible to recast current debt investments to more attractive components of the capital stack, depending upon the risk-reward tradeoff for HCP shareholders. Our HCR ManorCare investment may become a case in point.

A Stifel Nicolaus research piece of a little over a month ago handicapped potential end game scenarios for our HCR ManorCare position. That analysis concluded with a concern that, and I'm quoting directly from the research report, "Under current REIT rules, we do not believe HCP could take a controlling stake in the operating Company." Now, what brother Doctrow did not know and could not have known at the time he authored his report, was that HCR ManorCare had embarked upon a process that could involve a Company reorganization through which the holding Company, her ManorCare, bifurcates itself and creates a real estate investment trust. Subject to market conditions, a public offering of the new REIT would be completed by the end of the first quarter 2010. The IPO proceeds are expected to be used to reduce leverage. The comprehensive plan was posted on the state of West Virginia healthcare website just last week.

For those of you that have participated in HCP's earnings calls over the last two years, you have consistently heard me speak in glowing terms of the operating results achieved by HCR ManorCare's enduring business model. Their 30% plus growth in EBITDA speaks for itself and $562 million of trailing 12 months EBITDA is even better. This extraordinary cash flow generation reduced $700 million of term debt at Opco to a net debt position of $65 million in less than two years. On top of this success, HCR Manor Care will now delever its PropCO balance sheet and have improved access to the capital markets. Obviously this enhanced liquidity indirectly accrues to the benefit of HCP.

To educate the Street in its analysis of privately held HCR ManorCare, we have included additional disclosure on pages 21 and 22 of our third quarter supplemental schedules. On the eve of its 25th anniversary as a publicly traded Company, HCP sits in the strongest absolute and relative competitive position in its history. Our portfolio is performing well. Our near term lease expirations are negligible and our liquidity position is strong. With $1.5 billion in line of credit availability at a cost of LIBOR plus 70 through August 2011. $300 million of cash balances and liquid marketable securities, minimal 2010 debt maturities, and substantial access to the capital markets. HCP's Management team is focused on a number of significant near-term opportunities and we look forward to sharing with this group the outcome of our decisions in the period ahead. We would be pleased to entertain questions at this time.

(Operator Instructions) Your first question comes from the line of Dustin Rizzo of UBS.

Good morning. It is actually Ross Nussbaum here with Dustin. A couple of questions. First, it looks like 17% of your MOB leases expire next year. Jay, where do you see the mark-to-market on this space?

Paul, why don't you take that.

We've consistently seen over the past couple of years mark-to-market increases anywhere from 2 to 5% and the 17% is pretty typical of the rollover that we have in that space. We typically have 4 to 5 year leases on average and typically anywhere from 15 to 20% of the portfolio rolls each year.

Do you think it will still be positive next year?

Positive so far. We haven't seen any pushback yet on rental rates. So we do not anticipate it going down at this point in time.

It looks like on the interest income line it looks like $13 million of interest income on maturing loans receivable next year, are you going to be extending those loans or are those getting repaid?

$13 million of interest income maturing?

Yes. On page -- it's on the supplemental page on page 11, if I'm reading this right you've got $132 million of hospital and sniff interest tied to loans maturing.

Hold on just a second, Ross. Oh, that's the Deltas Cyrrus loan. So that does have a 2010 maturity. So that's accurate.

Do you expect those to get paid off?

We do. We look at the collateral there and it's quite substantially in excess of the debt position we have, the debt balance we have right now.

Okay. And then finally, appreciate the extra disclosure on Manor Care, I just got a couple of clarifiers here. The $562 million of EBITDA, is that EBITDA or EBITDAR.

EBITDA. But it's only facility based EBITDA. There is still the Opco piece which you do not have disclosure on in the supplemental this morning.

Thank you.

A lot of donuts.

Your next question comes from the mine of Mark Biffert with Oppenheimer and Company.

Good morning, Jay, I was wondering if you could maybe extend a little bit more on Manor Care in terms of some of the scenarios that you think now they're coming out as a real estate Company. Would you look to convert some of that debt to equity? What is your first take? Or would you prefer to get your debt paid off?

Well, let me say a couple of things. First of all, before we do anything, we want to wait and see the ink dry on the healthcare reform legislation. Which we expect to have happen sometime between Thanksgiving and Christmas. And it's obviously fluid, but the bid asked is that narrowing we continue to expect it -- the Baccus bill working its way through the finance committee in the senate is the best thing to be looking at in terms of what the ultimate legislation looks like.

Now, so that's healthcare reform. But stepping back to the investment itself, we've always, always maintain that our worst case scenario on our Manor Care investment was a par payoff at maturity. The inverse of that view is that we've always maintained that we were quite comfortable with taking ownership of the underlying real estate.

Now to quantify that scenario for you, if you were to simply take the current rent from the Propco master lease and roll forward the contractual escalators to the January 2013 maturity date, and assume a maturity default at that time, HCP would own the real estate at a 9.5% lease yield, which would be a terrific result for HCP shareholders. As I've said in the past, I think that scenario is highly unlikely and it gets more unlikely with last month's announcements by HCR Manor Care.

With the public filing as to their intent to bifurcate the Company and make the reelection, I would simply say the optionality of our investment alternatives has increased exponentially and then I would kind of probably conclude with saying that its impossible to connect the dots right now as to the ultimate exit of our HCR Manor Care debt investment, but I can say that when you've got a combination of -- this Company's exceptional business model, combined with the best in class management team of this year's Ormond and Giliard and Cavanagh and blue chip equity sponsor Carlyle who very very significantly here is not focused on a quick exit but instead interested in growing and adding value to this fundamental investment over the intermediate term, our expectation is that only good things will be happening going forward.

So I mean is it Carlyle's intent to do acquisitions and expand the Manor Care portfolio with opportunities in the market? And that's part of the reason why they're doing an equity raise as well?

I think Carlyle understands that it's got a world-class management team and a world-class operating model and as healthcare reform gets finalized, that management team and that business will thrive and looking at growing the value of their investment over the -- not the short-term, but the intermediate to longer term really sets up a number of very interesting strategic moves that Carlyle can be positioned to take advantage of here. And I think this -- my view is this just kind of starts to set the table to allow them to create a significant amount of incremental value for their investors.

Okay. And then quickly, when you look at the hospital med piece that you sold, I'm just wondering what drove your decision to sell that. Are you seeing higher yielding opportunities where you can put that money?

Well I think a couple of things. One, there's been a big move and there is obviously a lot of HCA, IPO speculations that kind of filtered into the market and I thinks that probably impacted the valuation of those bonds. But just from a pure real estate investment perspective, when we saw the yields on those bonds, the market yields go into the mid to high 7s, our ability to monetize those and reinvest them just within the quarter in a piece of debt like what we call Manor Care II, our second Manor Care investment at unlevered yields of 13%, I mean that's a wonderful pickup of spread investing for the benefit of the HCP shareholders. So as we've historically looked at all of the alternatives available to us, both in terms of raising capital and investing capital, that particular opportunity was unusually attractive for our shareholders.

And then when you look at the unsecured debt markets we've seen spreads come in quite a bit and you have a little over $200 million coming due in 2010 I'm just wondering what your thoughts are in issuing right now and just holding that cash on balance sheet in case you have opportunities to do other acquisitions versus waiting until next year given the uncertainty that spreads might go back out or expand out again?

Well, we always separate the investment decision process from the fund raising process. If the $200 million was coming due today, which it's not, we're sitting on $200 million of cash and marketable securities. So I think we'll probably just take it out of petty cash and pay it off that way. We in fact during the quarter prepaid a $100 million mortgage that was due if the first half of 2010. That's why you've seen such a dramatic decline in the amount of debt maturities that we now have for 2010. So we've affectively done what you've suggested. Quite frankly, Mark, we're awash in liquidity right now. So the last thing we're concerned about is liquidity. It's continues to try to optimize our existing portfolio and try to identify and close additional investment opportunities like the one we closed in the quarter with the second investment of Manor Care.

So, I mean, are you seeing other opportunities out there? Or is it pretty dry right now and that you expect more opportunities in 2010?

I would use the quote of that gifted real estate investor Maverick to describe the current situation, which I think his quote was, it's a target rich environment right now.

Okay. Any specific sector you want to talk about?

I'll talk about any sector you want to talk about. What do you want to talk about?

Independent living, assisted living, skilled nursing, where are you seeing the opportunity? What are the cap rates, what are the size of the deals, are they more portfolios versus individual assets?

Well, we typically would not look at a lot of individual assets. If I were to rank them by sector in terms of where we're apt to be most active to least active, I would probably group senior housing, skilled and life science at one end of the continuum and I would put hospitals at the other end of the continue and that would be -- sorry, less likely to invest in hospitals, more likely to invest in senior housing, skilled and life science I would probably put MOB somewhere in the middle. So that would be how I would handicap that.

Okay. Thank you.

I'm sorry, with respect to cap rates, there is really -- the only data points since we've last gotten together, there have been two in senior housing and one in MOBs so I would prefer not to speculate on cap rates but I'll just -- I can give you those data points because they're announced yields. They haven't closed. In senior housing there was two AL portfolios and the cap rates there were for the most part in the mid 8s mark. And then there was one MOB portfolio and that was at an 8% cap rate. So those are -- rather than kind of speculate, I would rather just stick to the facts and those are the three transactions that occurred in the quarter.

Okay. And just one last one. On the Horizon Bay assets -- on the Horizon Bay assets that you -- or the Sunrise assets that you gave to Horizon Bay, when is -- or how much is the short-term rent deferral going to impact your numbers in 4Q and when do you see the escalators of the 9%, is it a year out that it bumps up 9% and then a year after they're at 9% like what happened with Emeritus?

I think you might be confusing two things here. One is the Eden Care II properties that we transitioned to from Sunrise to Horizon Bay and then separate was the tweaking of our existing investment with Horizon Bay which, as you will recall, is through a joint venture where we own 35% of the equity net venture and an institutional party owned 65%. I believe Paul's comments on the restructuring deferral related solely to the joint venture but let me have Paul take you through the math on both.

That's true. With respect to the transfer of the Eden Care assets, the rent is effectively flat for the first year and then on average of the remaining four years it bumps on average of 9% then it goes to either a fixed or a CPI type increase. That's on the transition of the assets from Eden Care. With respect to the rent deferral, our portion of the rent deferral will be over a two-year period and will be up to about $4.9 million of deferral portfolio.

Okay, thanks a lot.

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

Dr. Doctrow.

A lot of this stuff has been covered here. I just want to circle back on a couple of things, Jay. One, you had mentioned in passing HCP's rights and I guess I was trying to figure out if that was specifically referenced to Manor Care or there was some other investments you have where you thought the -- the level of transaction activity in healthcare might give you some opportunities?

Oh, no, I think what I said was the deal activity where I said -- I expect the deal activity in the first six months of 2010 to exceed the 36 months through the end of this year. That was specific to names that are in HCP's portfolio. Let me go one step further. If we were to carve out the office side of the equation here, so the life science and the medical office, those two pieces, you're at about 60 to 65% of the Company with the remaining sectors, skill, hospital and senior housing.

Okay.

Let me just describe it this way. I can't, off the top of my head, in the 60 to 65% piece of our portfolio, think of one name that is not presently involved in either a strategic discussion, or a go-public discussion. So it's that pervasive. But that comment of activity level, that was not a broad-based healthcare comment, that related specifically to names in HCP's portfolio.

And the issue would be even on a basic lease, if they want -- if somebody wants to buy somebody else, the lease essentially has to get reopened and you have got rights to potentially pick up additional--?

It's a variety of different things, Jerry. There is a lot of that. If someone wants to go public and maybe there is -- there is some existing debt that has to be dealt with and the IPO proceeds, while it will be a successful IPO, maybe you're not sufficient enough to deal with all of the debt and we can kind of slide up or down the capital stack and fill in a hole that way. There is -- we've gotten warrant positions, probably more so in the life science base. But with all of this life science activity with the big pharmas and medium sized pharmas moving in and acquiring the biotechs, it's just -- it really, like I said, it kind of cuts across our entire portfolio.

That's helpful. And then just back to Manor Care and specifically what you are talking about and I haven't read the West Virginia website, I confess. One of the options would be obviously from your remarks would be for HCP to acquire all of Propco rather than be paid off or take -- convert even just what you have into leases. Is that sort of the right inference in what you're saying?

I think the right inference is the fact with their election to bifurcate the Company and create a REIT, the options that we now have available to us are -- like I said, have expanded exponentially. How that shakes out, what happens out of healthcare reform, what is the timing of the IPO, whether there is a blend and extend discussion with the existing debt, it just -- it's just a complete gamut of things. But at the end of the day, if you've got top quality equity sponsor like Carlyle that has the ownership stake in a top quality business model like HCR Manor Care that has led with a top quality management team, it's really kind of -- what is going to be the winning scenario here for HCP, because it's almost -- you have nothing but good things happen from this point going forward.

Okay. All right, thanks.

Your next question comes from the line of [Michelle Cole] of Banc of America, Merrill Lynch.

Hi, I was wondering if you could give us more details on the nonSunrise occupancy piece you had talked about that it had stabilized somewhat. I was just wondering if you could give us more color around that and what you're seeing so far into October?

Well, I think -- let me give you just a 30,000-foot view. Last night or this morning we had three significant operators in our portfolio Brookdale, Kindred, Tenant all report better than expected results as it relates, I think your question is more focused on senior housing, Brookdale had an unexpectedly positive result so that's kind of what you see going on big pictures but in terms of the details in our portfolio, Paul?

Yes, I think if you look at the reports that have reported so far, they're reporting occupancy increases, our numbers that we reported out were trailing 12 months as of the second quarter. So the comment about beginning to stabilize, that's based on discussions of commentary with the various different operators based on what they will be releasing for the third quarter.

Okay. And then I was wondering if you could tell me, if you were to tap the unsecured debt market, what rate do you think you could obtain for financing.

What maturity would you like us to talk to you about this morning?

Five and ten year.

The indications we've gotten recently have been in the mid to high 5s for the five-year and probably slightly above that for the ten year, adjusting for the underlying treasury reference.

Okay. Great. Thank you.

Your next question comes from the line of Michael Mueller of JPMorgan.

Hi, good morning. Most things have been answered but a couple of things. First of all in the senior housing portfolio, I'm not sure if it's maybe a question for Tom, can you walk through the sequential revenue and NOI changes going from Q2 -- Q1 -- or 2 to 3. Excuse me. Sorry about that.

Q2 to Q3?

Yes.

Yes, we've got, and what you're referring is the cash, same-property performance of a negative 6%; is that right?

Yes. I'm looking at the GAAP NOI going from $78 million to $68 million and the cash going from $65 to $61.

Okay.

On page 13.

In looking at the sequential change, you've got a few different things. First of all the Eden II transition resulted in some projected working capital shortfalls and in the Sunrise portfolio, that would have had a negative 8% impact just on the Sunrise portfolio itself. But across all of senior housing that would have been a negative 2.7%. Another item would have been again on a sequential basis, the MA1 and MA3 portfolios had some cash that had been held back in Q1 for working capital purposes that was released in Q2 and of course that didn't occur again in Q3 and that would have had a negative 12% impact on Sunrise and across senior housing a negative 4%. So those are the two big drivers that you would see in arriving at the negative 6% for senior housing.

So if we're looking at that Q3 number that has been impacted by the changes you mentioned and thinking about a cleaner number, thinking Q4 and going forward, what happens to the $68 million number or $61 million number?

Well, there it depends. We have got a number of items that -- like for instance, if we look to the year-to-date numbers which smooths out some of that, year to date, year over year, you would find the senior housing to be at -- at a minus 2% all in, but a minus 10% of that is due to Sunrise for the same reasons.

Okay.

So absent the Sunrise, we would have had just under a 2% same-property performance result year-to-date, year-over-year results.

Okay. Okay. Switching gears for a second. Life science, just want to clarify, the 18, 19% same-store NOI growth, is that being impacted by the development lease-up at all?

I mentioned a couple of different things. One is the normal rent steps that we have within the leases. And it also takes into account the fact that we've leased up the portfolio dramatically. We've gone from 80% to 91% and then we've had some of the TI's completed on some of the development buildings where we're now recognizing that revenue.

Okay. On a go-forward basis if we're looking at projects that are on your development page, that's not in there, those are segregated, correct?

Correct.

Or do you lump it all together.

No, they're segregated.

They're segregated. Great. And I think that will be it. Oh, Tom, last question, did you mention the rate on the swaps?

Yes. I didn't, but let me give those to you. We've got the $250 million swap that has a pay rate, and that's the one that is due in 2011, has a pay rate of LIBOR plus 421 and a receive rate at a fixed of 595. And then we entered into the two subsequent swaps this past quarter and it has a pay rate of LIBOR plus a received late of 0.87. That's for the swaps that are due in February of 2011 or the swap that's due in February of 2011 at 250 million. The additional $250 million which is due in August of 2011 is a pay rate at LIBOR and a received rate at 1.24%.

Hey, Mike, before we let you go, Tom, you might for the audience just take a step back and look at big picture in terms of what our net floating rate exposure was, what happened after we did the equity deal and with the swaps put back on what our exposure is right now.

If you took our total rate assets and you'll have all of the Manor Care assets that are all floating rate and against our current floating rate deposition and despite that, the impact of the swaps, we would be at a net floating rate asset exposure of just over $300 million. And so if we had for instance a 1% upward change in LIBOR that would be equivalent to $3 million or $0.01.

Positive.

Positive. And on the down side, with LIBOR at 25 basis points, there is not a lot of room to drop. So we have match-funded our portfolio in the way that we like, but there is a little bit of upside in the way that we have it structured. And then the same thing applies on the Sunrise ramps where we have got some LIBOR based rents. There is some upside potential there. I think every 1% change in LIBOR increases NOI by about $800,000.

Okay. Great. Thank you.

Your next question comes from the line of David Toti of Citi.

Hey, guys. Michael is here with me as well. Jay, can you talk a little bit about your thoughts around capital recycling in today's environment given relatively stable asset prices, why do you continue to go to the debt and equity markets rather than recycle some of your mature assets? I understand there are dilutive consequences, just your thoughts on strategy about that would be helpful.

We're talking about HCP, right?

Yes.

Okay. Because we did just the opposite of what you said in the quarter. We didn't go to the debt markets, we recycled our -- a portion of our existing HCA bonds at a yield -- current yield in the high 7s and took -- effectively look that forum, if you look at it on a quarter basis, which we do not, that basically was the equity component that we used to invest in what the required equity investment was in Manor Care II that 13% and by doing so we picked up a little over 500 basis points which I thought -- which we think was a real good maneuver. So.

Absolutely, but you haven't done it in scale yet. So I'm thinking does it just not make sense relative to your platform to recycle capital in any sort of size?

Well, I think we sold almost $3 billion of real estate David. I don't know if you're talking about HCP, if you're talking about healthcare REITs. If you're talking about HCP rates specific, I think we recycled over $3 billion of real estate in the last two and a half years which I believe exceeds the asset sales of the remaining entire healthcare REIT industry. So if you would like to kind of -- we would like to educate you off offline but we are in a significant proponent of capital recycling. So.

Okay. Thanks. And then if you could just update us on any discussions that you're having within senior housing with ages and capital. Their coverage ratios are looking low. I'm wondering if there is any issue around performance thresholds there?

No. I think we have the benefit of master leases and the big picture is you've seen of our five sectors, senior housing has probably been most impacted by the great recession. So Paul had mentioned that you've seen overall coverage ratios increase in the last quarter but that's less to do with occupancy and revenue growth and more to do with expense -- expense controls. I think I've said in a previous call that that's been wonderful and we applaud our operating management teams, but we're going to continue to see occupancy declines at some point, you reach a point where you can't continue to cost cut your way to profitability. With respect to those two portfolios, we were watching them like we're watching everybody else but we're pretty relaxed largely because of the benefit of the master lease as to where we are with those two situations.

Great. Thank you.

Your next question comes from the line of Jay Habermann of Goldman Sachs.

Good morning, everyone.

Hello.

Jay, you mentioned in the first half of 2010 and clearly you guys are very busy, you're looking at lots of potential opportunities, can you just give us a sense of your interest level I guess of acting now versus waiting throughout the cycle? I mean would you anticipate given healthcare reform that you'll see an elevated level of deal activity beyond the first half of 2010?

Okay so acting now if you go back and look at the eight quarters of the great recession, Q4 '07 through Q3 '09, if we want to call the recession over, which I guess by definition it is, but as you've heard me talk previously, I'm not as upbeat with where we're heading here. But if you do look at those eight quarters, we've been very active, we put out a $1.5 billion of our shareholders capital that was largely with the completion of the development fundings up in the bay area on our life science portfolio, that was largely in the debt stack of Manor Care. I think coming out of this, we're positioned given the opportunistic investment activity that we're very proud of having achieved in the last eight quarters, we're nicely positioned to benefit as those investments are restructured.

I think largely at this point, certainly healthcare opportunistic investing is more or less in the rear view mirror. Unless you have got something that is unique within your portfolio where you may have some leverage of some -- I'm not talking about financial leverage, I'm talking about more contractual leverage, I think the opportunity as the markets have begun to normalize here is going to be less opportunistic and more of what I would say market level deals.

Now the one exception so that, again this is all in the concept of healthcare, is that there is a dam getting ready to burst here with healthcare reform, expecting to be finalized. There has been just a lot of folks that, notwithstanding the capital markets being closed, have kind of been on the sidelines, understandably so, until the final rules get written. So I think you're going to have a one-time explosion here which I've suggested will occur in the first six months of 2010 of deal activity and we're obviously privy to a lot of it given a lot of it is going to impact or involve the folks that are in our portfolio.

So I think you're going to have a one-time kind of pop here in the first half of the year, Jay, and then after that, healthcare reform is going to -- it will certainly starve the losers and reward the winners. And as I've said previously, winning here in post healthcare reform environment, you're going to have to be efficient and I think the best gauge as to whether you're an efficient operator is your margin. And you're going to have critical mass and you should read that to mean market share, not necessarily nationally but within a regional geographic area and you're going to have to have quality outcomes and you can go into this with each of the sectors of healthcare and the deck chairs are going to get further reordered here and what the -- the winning economic models like an HCR Manor Care and I do not mean to be fixated on HCR Manor Care, certainly HCA and others will be in that discussion, they'll benefit disproportionately. Because what will happen is to what extent they get their margins squeezed a little bit they're going to more than make up with top line volume increases, because they are A, efficient, B, have critical mass, and C, have quality outcomes and those are the folks we want to partner with going forward here.

Right. In terms of NOI and the outlook for 2010 it sounds like leasing activity remains pretty strong. Are you really anticipating something similar to 2009? Any major hike up with variables.

I think you have a couple of things that are going to be working our way that are ripe because you have the whole lease coming on for -- and then you have got the Orius and you have a couple of things that we're going to have the wind to our back in 2010 versus 2009, but absent those, MOBs, which I think I've said previously is our most defensive sector looks to be steady as a rock. They just keep knocking out the results. We couldn't be more pleased with the national group. Life science, that is proving to be a wonderful strategic move two years almost to the month after we've made it with the Slough acquisition. And then most of the rest of the stuff is triple net with the exception of the Sunrise portfolio, everything else is triple nets that's got next to nothing in the way of lease expirations for the next several years but has contractual escalators built in. So the amount of variability in the model increasingly is -- it's just isolated to just a handful of items.

And then lastly, on Ventas, can you give us some sense of the legal costs going forward? Should we assume the quarterly rate will drop off substantially and any updated sense of timing for the appeal?

Yes. I think Tom quantified for you the expenses for the 9 months year-to-date in 2009 relating to that matter, which I think was $13 million, is that what you said?

Yes.

Yes, going forward, that's -- the appeal process is not expected to be material. And depending on how this plays out in the courts, it could be anywhere from a late 2010 to an early 2011 resolution, Jay.

Okay. Great. Thank you.

Your next question comes from the line of Rich Anderson of BMO Capital Markets.

Thanks, good morning to you guys.

Good morning.

A question for Tom first. The amortization on the HCR investment is it till running at a 35 million, $36 million annual rate. Is that the way we should be thinking about it?

Yes, Rich, what you do is you take the $130 million discount on Manor Care II and you take the what was $100 million discount on Manor Care 1 and put them in an amortization schedule and amortize those using the effective interest method so it is going to vary as to where you're at in the time line, so I would just recommend setting up an amortization schedule and crunch those in that way.

All right. So for this quarter, should we assume if you have interest income of 39 million or almost $40 million, maybe $8.5 million or so of amortization? Is that close.

Well, somebody put a calculator to it real quick.

We can do it off online too. I thought maybe knowing you, you would have it right in front of you.

I have the big numbers in front of me in the amortization schedule, but it's -- hold on a sec. Yes, it's about $60 million.

$60 million?

Per year.

Per year. Okay. Okay.

Yes.

Just to make sure that I know this, the $6 million gain on the debt sale, that's an interest income, is that correct?

That's correct.

And the 6.2 legal costs is in G&A?

Correct.

Okay, I just wanted to clarify. Jay on the HCR deal, is this -- first of all, and pardon me for not knowing exactly how these things play themselves out, but were you a part of the process for this Propco Opco move? Would you as a bondholder have to sign off on it?

Well, nothing has happened yet. They started -- you might want to -- I mean--.

I mean are you in the process, I guess I'm saying?

Well, we've been having on going discussions with the shareholder.

Could you stop it?

Could I stop it? I'm not sure why I would want to do that. I would want the Company to do extremely well. I guess it's hard to do extremely better than it's already done since it's done extremely well. But we're their biggest champions and to the extent that we can facilitate their continued success and have some of the trinkets of gold fall our way, I think that's a great result for HCP shareholders, so we're huge supporters of the Company's business model, the Company's management team and the Company's shareholder.

Okay. Is it -- is your optimal outcome, I think this was kind of asked but I didn't get the full answer, your optimal outcome to be an owner of the entire portfolio or would you be -- is it a viable option to be some sort of mix of debt and equity at the end of the day with HCR?

We do not really have an optimal outcome at this point. The one outcome I would just as soon not deal with is a 100% par payoff on January 2013. The scenario that I would love to have is that we own the entire real estate portfolio at that 9.5 lease yield calculation I took you through. My sense is that neither of those two scenarios will occur and so therein lies some opportunities for us to partner with Carlyle and the management team and optimize something that works well for everybody.

Okay. And in your view, HCR is the tip of the iceberg?

I'm sorry, what do you mean the tip of the iceberg?

In terms of transactions of this ilk to find their way into -- on to your table to take a look at.

Well, there is a number of either strategic discussions that are in the works and/or IPO transactions that are in the works that at this point are reasonably fully developed, but everyone understandably so is waiting for the ink to dry on the healthcare reform legislation. So that's going to be the -- that will be the--?

Okay. Just catching up a little bit. And then last question. What do you think are the losing asset classes if any in the healthcare real estate environment vis-a-vis healthcare reform?

We're going to limit this discussion to healthcare real estate?

Well, you could go -- as you've been saying other people, go where ever you want to go with it.

I think the HMOs are going to get whacked maybe a little bit unfairly but they seem to be the whipping boy in congress right now. So I think that's probably a little unfortunate and probably a little overdone. I think--.

But what about just the -- what about just your portfolio, your world of healthcare real estate? Do you see any specific property sector that could bear the brunt on the negative side or do you think everybody benefits?

Well, I think everybody -- I wouldn't say everybody is going to benefit. In fact, I would say it would be the exception of somebody benefiting, Rich. Everybody is going to contribute at the alter here a little bit to the cost, including by the way, everybody on this call in terms of higher taxes. But certainly in terms of the healthcare providers, everybody is going to contribute to the collection here to fund the greater access of the uninsured population in this country over the next couple of years.

But it--?

But what I'm saying is that the folks that are in the best in class operators will win because when they give up in margin they'll more than recapture in terms of volume gains so those are the folks you want to be in line with. I guess the answer to your question is not so much a take on which particular healthcare real estate sector benefits from healthcare reform, because I don't think -- I guess the way you asked the question is what is the loser. I don't think there is a healthcare real estate sector that goes away because of healthcare reform. I do think there are going to be operators in each of the sectors that go away and there will be operators in each of the sectors that get disproportionately benefited from healthcare reform. I turn your question around and answer it that way.

Okay. That's fair. Thank you very much.

Your next question comes from the line of Rob Mains of Morgan Keegan.

Hi. Good morning. I'm watching about that higher tax here in Upstate New York where we're all about that wealth transfers.

Unfortunately that's -- you ought to come out to California. Today we've been greeted with the news that we've all now had the opportunity to effectively provide the state of California with an interest free loan in the form of an additional 10% withholding out of your paycheck which they assure us we'll receive back next year. But I fear that as goes California, there goes the country the next couple of years which underlies, as you personally know, having been on the losing end of some wagers with me, my rather down beat view of where things are going here in the next couple of years.

Fair enough. I won't go any further. Just a couple of quick ones. Paul, you gave a breakdown of the NOI growth in the senior housing with and without Sunrise. Do you have that for hospitals, ex Hoag.

Without Hoag, we would have been down just about 1%.

And that's on triple net, why would that be down?

We had one hospital in Texas that we repositioned to a new operator and there were some effect concessions with respect to that lease.

And don't you have the participation? They don't kick in until the fourth quarter.

Yes. Not as much of an impact.

Okay. Fair enough. And then--?

And the good news is that the hospital is it's now covering at 4.5 times. The bad news is that it increasingly looks like a participating bond from an ACP shareholder perspective.

Right. And then the Eden Care, there were 15, one got sold, eight transferred to Horizon Bay and the other six you've undisclosed which operators went to the them in the portfolio or isn't it material?

It's not material. There were three folks that were part of the semi capitalized tenants that we had with Sunrise. One was a group called HR and the other one was Solomon out of Atlanta.

So, Rob, as part of the restructuring, remember we cleaned up all of those entities between ourselves and Sunrise with the new deal, just like we did with Orius and Eritus and as part of that they ended up getting a couple of the properties themselves.

So they were originally the operator of the property just now they do not have the middle man.

The operator, the manager was always Sunrise, they were between Sunrise and us and if you remember all of those convoluted structures we inherited when we acquired C&L and as part of this process we are, as we move these portfolios like Orius, like Eden Care, we're cleaning that up so it's much more transparent to our shareholders in the form of more traditional triple net lease structures.

Okay. That's all I had. I got all of my Manor Care questions answered.

Your next question comes from the line of Mark Biffert of Oppenheimer and Company.

Yes, just a quick follow-up. On the Erickson, the remaining Erickson, is there any kind of straight line rent adjustment that could be recorded in a future period for that at all?

Mark, what happens with the Erickson on the two that we ended up taking impairments on, is we project out the cash flows on those two assets, based on on the terms of the potential bankruptcy -- restructuring of the bankruptcy court and then we discount those back at the -- at the implicit rate in those contracts, the original implicit rate, it brings it down then to a carrying amount based on the discounted cash flows and then what you do -- now this gets a bit complicated, and then what you do is you then recognize income based on the reduced book value with the original implicit rate in those leases. So it's not a straight line concept, it's simply a reduction in the book value and then we then have income generated off of the original interest rate in the contract times the new book value and it accretes forward to the anticipated amount of cash flow that we'll receive.

Okay. Thanks.

Your final question comes from the line of [Karen Fort] of KeyBanc Capital Markets.

Hi, good morning. Can you tell us what HCP's current IR return requirements are on new investments?

Which sector -- which geography? Which real estate type, where in the capital stack in terms of the component would you like us to respond to that question with.

I guess if you could parse it between debt investments and equity investments first and/or talk about your preferred subsectors, like I guess senior housing, skilled nursing and life science?

Well, I think in the skilled space, we've obviously put out a boat-load of our shareholders' capital and that's been increasingly senior in the capital stack where you've got coverage ratios that are quite frankly unheard of in terms of the cushion there. And notwithstanding debt investments, which in general ought to carry lower IRR returns and given the substantial coverage ratios, you've seen those IRR's range from 9 to 13 and that's assuming those -- those investments are A, held to maturity, and B, don't find their way recast into more of an equity play. So that's how we'd -- that's kind of how we played skilled. With respect to hospitals, we've really -- we've really kind of backed away from hospitals. That's been a disproportionate amount of our disposition activity. We now have a portfolio -- an owned real estate portfolio that as I mentioned a short minute ago is covering at 4.5 times. We're not likely to deploy a lot more capital into equity ownership of acute care hospitals. It's just a kind of a view we have.

We would play as a Mez debt investor and have played in the HCA position where we've made a lot of money for our shareholders, albeit not just holding that debt investment, but also trading that investment over the last 2 or 3 years so we think we have a pretty good fix on what fair value of that debt security and when it gets above that level, then we monetize some of it and when it gets below that level, as we did post Lehman Brothers last fall we doubled down, if you will.

In senior housing, like I said, the market, there is only two transactions this quarter and they were kind of in the mid 8s and then the MOB deal was kind of 8%. So as you can tell, you really just cannot generalize care and you have got to be very situation specific and looking at where you are in the capital stack, what the sector is, what the geography is, what are some of the structural considerations that we could bank into an investment would be which include things like master lease and letters of credit and potentially some sort of equity call on the Company.

Okay. Thanks. Last question. Do you have an update or can you give us some sense of timing on the litigation with Sunrise on the 64 assets?

Sure. Those lawsuits were filed both in the Delaware and Virginia courts. The discovery process has begun. And we expect to have the cases ready for trial in early 2010. So early next year. The specific trial dates haven't been set, but the Virginia court has set a schedule that requires the parties to be ready to try the case by mid-February. So that's about three months out. And the Delaware courts have set a schedule that requires the parties to be ready for trial by October 2010. With respect to Virginia proceedings, Sunrise has already been to the Virginia court to ask that the schedule be pushed back.

ACP resisted the delay that Sunrise was seeking and the Virginia court has declined Sunrise's request for further delay. So we anticipate continuing on a track that will get the Virginia case ready to go for trial by -- in three months, in February, and we would also expect Sunrise to continue to try to avoid going to trial by seeking further extensions. Thank you.

Ladies and gentlemen, that concludes the Q&A session. I would now like to turn the call back over to your CEO, Jay Flaherty.

Thanks, thanks everybody. We'll see you soon. Take care.

Ladies and gentlemen, that now concludes the presentation. Thank you for your participation. You may now disconnect. Have a great day and enjoy your week.