Healthpeak Properties Inc (PEAK) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2010 HCP earnings conference call. My name is Shanelle, and I will be your coordinator today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. Now, I would like to turn the presentation over to your host for today's conference call, Ms. Beejal Northrup, HCP's Director of Investor Relations. You may go ahead, madam.

Thank you, Shanelle. Good afternoon and good morning.

Some of the statements made during today's conference call will contain forward-looking statements. These statements are made as of today's date and reflect the Company's good faith belief and best judgment based upon currently available information. The statements are subject to the 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 disclaims 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 on our website at www.HCPI.com. I'll now turn the call over to our Chairman and CEO, Jay Flaherty.

Thanks, Beejal. Welcome to HCP's third quarter 2010 earnings conference call. Joining me this morning are Executive Vice President and Chief Financial Officer, Tom Herzog, and Executive Vice President and Chief Investment Officer, Paul Gallagher. Let's start with a report on HCP's most recent results, and for that, I will turn the call over to Tom.

Thank you, Jay. There are several topics I will cover today. First, our third quarter results; second, our investment and disposition transactions; third, our financing activities; and finally, our full year 2010 guidance.

Let me start with our third quarter results. For the third quarter, we reported FFO of $0.54 per share before giving effect to an impairment charge of $0.23 per share, compared to $0.52 per share before impairments and litigation provision for the third quarter of 2009. There are several items I would like to point out. First, our same property portfolio continued to perform well, producing a strong 4.8% year-over-year quarterly cash NOI growth. Paul will review our performance by segment in a few minutes.

Our third quarter results included the impact of two offsetting items that were not contemplated in our guidance. $0.02 per share related to gain on sales of HCA bonds and charge of $0.02 per share related to acquisition pursuit costs. During the third quarter we reported a non-cash impairment charge of $72 million, related to our 35% interest in HCP Ventures II, an unconsolidated joint venture that owns 25 senior housing properties leased by Horizon Bay.

Turning now to our investment and disposition transactions. First, on August 31st, we entered into agreements with Sunrise that allowed us to terminate management contracts on 27 of 75 senior housing communities. We transitioned these 27 communities to Emeritus, effective yesterday. In exchange, we paid Sunrise $50 million, which after certain closing and working capital adjustments resulted in $41 million, that was capitalized and will be amortized as deferred leasing costs in accordance with GAAP. As part of this arrangement, HCP and Sunrise agreed to dismiss all litigation proceedings between them. Paul will describe the terms of the new Emeritus leases shortly.

Second, during September and October, we purchased $278 million participation in Genesis HealthCare's senior loan at a discount for $250 million, and a $50 million participation in the mezzanine note at a discount for $40 million. Third, during the quarter, we made real estate acquisitions of $63 million, and capital investments of $36 million for construction and other capital projects. Year-to-date, this brings us to $640 million in real estate and debt investments.

Turning to dispositions. In September, we sold $73 million of debt investments, including $65 million of HCA bonds and recognized gains of $6 million. We also sold three skilled nursing facilities for $10 million, and recognized a gain of $4 million. Subsequent to quarter end, we sold our remaining bond investments in HCA and one other issuer for $102 million, resulting in fourth quarter gains of $8 million. We also sold nine senior housing facilities for $27 million and recognized a gain of $15 million.

Next, our financing activities. In September, we prepaid without penalty $68 million of 6% mortgage debt, which was scheduled to mature in February 2011. Also, we repaid $200 million of senior unsecured notes at 4.875% that matured in September. We ended the quarter with $320 million drawn on our revolver and had $1.2 billion of immediate liquidity from our revolver, cash and marketable securities.

Finally, full year 2010 guidance. Based on stronger than forecasted performance to date, primarily in our senior housing and life science segments, we are raising our full year cash same property performance guidance to a range of 4% to 5%, up from 3% to 4% previously. In addition, we are increasing our 2010 FFO guidance to a range of $2.18 to $2.24 per share before impairments and recoveries, which is $0.08 higher than our previous range of $2.10 to $2.16.

This increase was driven by several items. $0.02 from the increase in same property performance, $0.02 from the accretive debt investments in Genesis, $0.03 from gains realized upon monetizing our HCA bond investments, net of lost interest income. And $0.04 from a prepayment penalty related to the early payoff of a $34.5 million debt investment in our hospital segment that Paul will provide more color on shortly.

These increases were partially offset by reduced earnings from HCP Ventures II, acquisition pursuit costs that were not previously forecasted, and several other small items. I will now turn the call over to Paul. Paul?

Thanks, Tom. Let me break down the 2010 third quarter performance of our portfolio.

Senior housing. Occupancy for the current quarter in our same store senior housing platform is 85.6%, representing a 30 basis point sequential increase over the prior quarter, and a 60 basis point decline over the prior year. Facility margins across the entire senior housing portfolio are improving, with cash flow coverage remaining at 1.16 times. Current quarter year-over-year same property cash NOI for the entire senior housing platform was 9.8%, driven by rent steps and improved performance for 25 Sunrise assets transitioned to new operators in prior years.

During the quarter, HCP acquired another senior housing facility, formerly managed by Sunrise for $14.75 million. HCP entered into a 10-year lease with Emeritus with two 10-year renewal options at an initial lease yield of 8.3%, with 3.5% annual escalators over the initial term. In addition, subsequent to quarter end, HCP entered into two master leases with Emeritus for 27 newly terminated Sunrise facilities. The leases have an initial term of 15 years, with two 10-year extension options.

First year rent on the portfolio is $30.3 million, representing a $1.5 million increase from current rents. Fixed rent steps over the first five years result in a compounded annual growth rate of 13.9%. After year five, rent escalates at the greater of CPI or 3%. The unlevered IRR on the transaction, including the $50 million termination fee paid to Sunrise and $9.5 million in CapEx HCP has committed to fund, is 42%. Also, subsequent to quarter end, HCP sold a portfolio of nine senior housing facilities to the tenant, Assisted Living Concepts, for $27.5 million, for a gain of $15 million. The sale represents a 7% cap rate.

Hospitals. Same property cash flow coverage decreased 23 basis points to 4.7 times driven by expenses related to the opening of Medical City Dallas' new Children's Tower last quarter. HCA began paying base rent on their new tower in June and will pay add rent on incremental revenue. Year-over-year same property cash NOI for the third quarter increased 16.9%, and was driven by our new Hoag lease which began paying full rent in June.

During the quarter and subsequent to quarter end, HCP divested of its remaining $140.8 million holdings of HCA, 9.625% toggle notes at a price of 109% of par. HCP recognized a gain of $12.7 million, which provided a 13% return over the four-year hold. Yesterday, HCA's St. David's Hospital acquired MedCath's Austin Heart Hospital. HCP received a payoff of the $34.5 million mortgage loan on the MedCath hospital and received an $11.3 million prepayment premium.

Skilled nursing. Our owned skilled nursing portfolio year-over-year cash NOI for the third quarter in our same store portfolio decreased 1.3%, as a result of a lump sum payment received with a lease extension in the third quarter of 2009. Cash flow coverage remains strong at 1.48 times.

HCR ManorCare reported improved second quarter trailing 12 month debt service coverage for the entire debt stack of 4.63 times, an increase of 13 basis points over the prior quarter. During the quarter, HCP sold three skilled nursing facilities to the tenant for $10 million and recognized a gain of $4 million. HCP provided short-term 85% seller financing to the buyer at an interest rate of 11.5%, as a bridge to a HUD debt execution.

HCP purchased participations in both the senior term loan and mezzanine debt of Genesis HealthCare, one of the largest skilled nursing providers in the US. Genesis operates 137 owned, 43 leased, and 42 managed facilities in the US. HCP purchased a $277.6 million participation in the $1.3 billion senior term loan at a 10% discount, and a $50 million participation in the $375 million mezzanine loan at a 20% discount. The senior loan is priced at LIBOR plus 4.75 with a LIBOR floor of 1.5%, stepping up to LIBOR plus 5.75 with a floor of 2.5% in 2012. The mezzanine loan is priced at LIBOR plus 7.5, with no floor and contains an exit fee. Both debt facilities mature in September 2014.

Inclusive of the discounts, the senior loans scheduled interest rate steps and the exit fee on the mezzanine debt, HCP projects the unlevered IRR to the state of maturities for the senior debt will be 10.5%, and 18% on the mezz debt. For the trailing 12 months ended June 2010, Genesis generated cash flow for a year-to-date debt service coverage of 2.66 times on the senior debt tranche, and 2.02 times on the entire debt stack.

Medical office buildings. Same property cash NOI for the third quarter was up 1.4% over the same period 2009. The growth was due to normal rent steps and improvement in parking revenue on our Seattle and Houston campuses, and a reduction in recoverable operating expenses. Quarterly same store operating expenses were down $179,000, or 0.6% when compared to 2009. We were able to achieve these savings despite a spike in utility expense.

Our MOB occupancy for the third quarter remained stable at 90.8%. During the third quarter, tenants representing 803,000 square feet took occupancy, of which 665,000 square feet related to previously occupied space. Our year-to-date retention rate was 85.3%; the highest average retention in over four years.

Renewals for the quarter occurred at 2.9% higher mark-to-market rents and included five major leases totaling 282,000 square feet, at an average term of over five years. Average term for new and renewal leases executed year-to-date is 55 months, an increase in term of 12 months over the same period in 2009. Our pipeline includes 329,000 square feet of executed leases that have yet to commence, and 669,000 square feet in active negotiations, well in excess of the 736,000 remaining rollover for 2010.

We continue to advance our green initiatives. In October we received confirmation that our 1101 Madison building in Seattle on our Swedish campus was awarded LEED silver certification. This brings our total LEED certifications to four throughout the portfolio. This property was also recertified as an Energy Star building. In addition, we received a new Energy Star award for MOB in Littleton, Colorado, bringing the total Energy Star labeled properties to 15, five of which have received the award in multiple years.

As previously discussed, two MOBs were acquired on July 26th in an off-market Down REIT transaction. The properties are located in San Antonio, Texas and Bountiful, Utah and were purchased for $19 million at a cap rate of 8.8%.

Life Science, the third quarter same store cash NOI for Life Science was down 1.5% over the same period in 2009, but remains positive at 2.4% year-to-date. The decrease in same store performance for the quarter was primarily driven by an increase in vacancy, rent reductions experienced as a result of lease renewals in our Bay Area portfolio. Occupancy for the entire Life Science portfolio increased slightly to 88.9% at the end of the third quarter.

For the quarter, we completed 180,000 square feet of leasing and year-to-date we've completed 436,000 square feet of leasing that has resulted in a retention rate of 68%. In addition, we've completed an additional 62,000 square feet of leasing that will commence in subsequent quarters. Our Life Science exposure for the fourth quarter of 2010 is only 48,000 square feet.

Looking to 2011, we have 408,000 square feet of expirations with nearly 60% in active negotiations. HCP's Life Science development pipeline continues to consist of just three redevelopment projects, and was reduced during the quarter from 252,000 to 227,000 square feet, as approximately half of our Soledad redevelopment project in San Diego was completed and is now 100% occupied. As a result of the completion of this project, our overall projected redevelopment funding requirements total $27 million. As we mentioned on our last earnings call, we completed a $29 million acquisition in the third quarter of a building that was 100% leased and located within our University of Utah Life Science cluster at a cap rate of 8.5%.

Finally, the biotech industry financing environment remains strong with over $19 billion in capital activity in the third quarter, bringing year-to-date total to $42 billion. The capital flowing into the sector continues to be led by the $25 billion in partnership deals as big pharma continues its interest in the sector.

HCP's tenants continue to attract capital including Exelixis, which raised $60 million in upfront payments from Bristol-Myers Squibb and $500 million in potential milestone payments in connection with two collaborations, and Portola Pharmaceuticals announced collaboration with Merck on their drug candidate for stroke prevention, that included a $50 million upfront payment and up to $420 million in milestone payments.

In addition, the liquidity profile of our tenants remains strong with the Life Science companies in our portfolio with less than 12 months of cash representing under 0.5% of HCP's annualized revenue. With that review, I'd like to turn the call back over to Jay.

Thanks, Paul. We enjoyed a strong quarter across the entire Company. Our real estate portfolio continues to exceed expectations, allowing us to raise our same property performance guidance for this year for the second time in the last three quarters. The formidable rally in the high yield market, driven by a reach for yield, provided an attractive exit opportunity for HCP's entire marketable securities portfolio, most notably our HCA toggle note investment.

HCP's HCR ManorCare debt investment continues to benefit from strong cash flow generation at this leading post acute provider. Yesterday, we completed the transition of 27 senior housing communities, formerly managed by Sunrise, to Emeritus. The economics of the new master leases with Emeritus validate HCP's long-held view of the incremental value potential of this portfolio.

In addition to an immediate bump in year one rents of $1.5 million, the compound annual growth rate in rents for the first five years will be 13.9%. HCP's unlevered IRR on this transition is expected to be in excess of 40%. These events have contributed to HCP raising the low and high end of its full year FFO guidance by $0.08 per share, to $2.18 to $2.24 per share.

I want to comment on our investment activity, starting with our HCA toggle note investment, and more broadly, HCP's sector leading debt investment platform. HCP initially funded a $300 million commitment as part of the HCA LBO, exactly four years ago this month. We subsequently added to our position in the post-Lehman downdraft of late 2008 at discounted prices. We have now completely disposed of this position at a 5.5% yield to call valuation, realizing an unlevered return of 13% for the four-year hold period.

What is particularly interesting about the performance of this investment is that this was a pre-crash mezzanine investment versus our investment in HCR ManorCare. While we are confident there will be a time in the future to celebrate the successful fruition of our HCR ManorCare investment, the 13% realized performance on our HCA bonds, achieved through the teeth of the Great Recession, is especially rewarding for HCP's shareholders.

Let me turn to our most recent investments in Genesis HealthCare. We became quite familiar with the post acute sector by virtue of our successful investment in HCR ManorCare. Similarly, Genesis has performed nicely since its LBO in 2007. HCP's ability to underwrite the Genesis opportunity and close promptly to affect a quarter-end execution, has distinguished HCP as an investor for this type of paper. With expected IRRs of 10.5% on the senior secured position, and 18% on the mezzanine tranche, we will achieve equity-like returns with fixed income risk exposure.

The Genesis buy highlights an additional element of HCP's investment philosophy. Recall at our May Investor Day in New York City, I characterized HCP's five by five business model as a means to an end, not an end in and of itself. I went on to say that a key feature of our five by five model was that it created optionality for HCP to achieve our ultimate end, outright ownership of healthcare real estate. HCP's previous conversions of mezzanine debt positions and buyouts of joint venture partnership interests into 100% fee-simple ownership of real estate are examples of this optionality being successfully realized.

In this circumstance, Genesis is presently organized as a C-Corp, with the potential to elect a PropCo/OpCo separation. If and when this process plays itself out, HCP may be in the fortunate position of enhancing its already attractive return expectations on our Genesis investment.

Finally, we are pleased to have Kendall Young join HCP as Executive Vice President, focusing on new growth initiatives for the Company in the senior housing sector. Kendall has broad experience in creating value for significant real estate platforms. Kendall is currently evaluating the merits of converting our independent living joint venture portfolio from a lease arrangement to a RIDEA structure. Our preliminary view, speaking of optionality, is that the senior housing portfolio unlike the four Sunrise portfolios we have previously transitioned as leases may be especially well-suited for a RIDEA structure.

With that, we will open the call to your questions. Shanelle?

Thank you. (Operator Instructions). Your first question comes from the line of Jay Habermann of Goldman Sachs.

Hey, Jay, good morning. Just starting with Genesis, can you give us some perspective I guess how this -- the genesis of obviously this investment and are you viewing this as essentially something you plan to hold to maturity and then you spoke about sort of the potential split out between PropCo, OpCo, is this also an investment that you would look to own the real estate longer term and potentially even bring into the RIDEA structure that you mentioned before you're considering?

Well, let me say that we like heads we win, tails we win, investments and this certainly has all the hallmarks of that. We obviously got ourselves quite familiar with the economic fundamentals of the post acute space.

We had been knowledgeable of the management team there and very similar to the way the two investments we made in the HCR ManorCare debt went down, there was some motivation on the part of the major commercial banks, be it for Basel III purposes or other purposes to effect a monetization of those investments and they had a rather short time frame. We were up-to-speed on the space. We knew the management team and we were able to get our arms around an entry point from a valuation standpoint that made sense to us and makes sense to us on a hold to maturity basis. So let me just stop there.

Now, with respect to a PropCo/OpCo separation, it may well be if that's what ends up happening that we're positioned to as part of that process realize an even greater return by stepping into different -- modifying that investment, either becoming -- morphing into a different form of a debt investment and/or outright ownership of the real estate. I would stop short, however, of contemplating that this would go to a RIDEA structure. That's generally in the skilled nursing post acute space, that's generally a space that we would probably not have as a priority for our RIDEA structure. We would probably have that prioritized more over in the private pay senior housing space.

Okay. And I guess as well, as you look at your ManorCare investment, are you seeing any sort of further resolution in terms of an outcome, whether it's the improving equity markets or other sort of strategies that they're considering for an exit?

Well, I mean, you would have to talk to the shareholder. From our standpoint, it's a wonderful -- I mean, the outcome is just fantastic. The cash flow coverage keeps going up and the regular coupon payments on what at a face value amount now is $1.720 billion, are increasingly well-provided for. So from that standpoint, we couldn't be more pleased with that investment.

Okay. And I guess just going back to operations, at the start of the year I think you guys were talking about NOI growth more in the mid-2% range and now you're talking about 4% and 5% year-over-year. Clearly the repositioning of Sunrise, the Hoag hospitals, I guess if you strip those out of the numbers, the 4% to 5%, are you still sort of in that original 2% to 3% range? I guess what's driving most of that increase year-over-year?

We had increased it previously as a result of that deferred rent payment that came in from one of our Life Science tenants and that had caused the most recent bump or the bump from a couple of quarters ago. The increase that we had of 100 basis points is going to be really three different things. One is, we had the increase from the Sunrise 27 transaction that we talked about where there's some bump from that.

In our Life Science division, we had higher recoveries and lower bad debt. That would have been a piece. And then when we looked at our guidance when we put it together at the beginning of the year, we had incorporated something in for bad debt due to tenants or operators that would fall out and that just didn't materialize. Our portfolio held together very well, and as a result of that, we were able to pick up the additional SPP growth in our projection.

Jay, I'd step back though. I think -- and we've taken this group through this calculus before. But if you drill into our senior housing sector, which is the largest of our five sectors, it's about 37%, 38% of the NOI, and you take a look at the impact of having now transitioned 58 separate communities from Sunrise to replacement operators, they took place in four separate transitions. Three of those four transitions resulted in compound annual growth rate in rents for each of the first five years in the low double-digit percentage magnitude, the fourth transition which was the one we stepped into the ownership in June of this year, that's going to be if you recall about a 5.7% compound annual growth rate in rents for the first five years.

So the economics that has been validated with these transitions is not just kind of a 2010-2011 dynamic, that's going to continue to drive what I suspect will be outsized and senior housing sector leading industry growth metrics for the next several years. I mean, you just start compounding at 11%, 12% and in this case on this transition, 13.9%, those numbers get quite substantial.

I guess the perspective is looking at 2011, would you expect that pace to continue or more in line with the year-to-date, the target you had mentioned the start of the year?

In the next call we'll obviously with a fair amount of detail take you through all the assumptions, but I guess what I'm suggesting is that the effect of the transitions that Paul and his team have put in place this year are going to benefit HCP's shareholders for multiple years in the future. Those are not kind of one year phenomenon sorts of results.

I can add to that just a little bit, Jay. If we took 2010 in isolation and just looked at the transition to assets, the Sunrise 27, the Eden II and the Aureus, we're picking up a little bit in excess of 1.5% total SPP growth cumulative up against the 4.5% in the guidance. If we look forward to '11, '12, '13, we're going to see 1% growth as well on an overall HCP level. So there's going to be a lot of growth coming out of that.

Incremental.

Incremental 1% to our SPP growth. So it's a substantial amount of growth coming out of those transactions.

It's contractual by nature because these we put in place with the leases, the master leases. Those are contractual relationships that flow to the benefit of HCP's shareholders.

Great. Thank you very much.

Your next question comes from the line of Quentin Velleley of Citi.

Good morning there. It's Michael Bilerman with Quentin. Jay, just going back to Genesis. Who else -- I guess you're now 20% of the debt stack. Who holds the remaining 80% and what sort of conversations did you have with JER and Formation prior to purchasing?

I would say the ownership composition, Michael, of that debt is remarkably similar to the ownership concentration of the PropCo debt in HCR ManorCare so that group sees a lot of one another. And with respect to the conversations we had with the two private equity firms there that you mentioned, Formation and JER, there was certainly conversations that took place in advance of us moving forward on those acquisitions and they were quite supportive of us moving into those positions.

Did they not have the opportunity to buy it back and delever themselves?

I don't think -- I think you ought to talk to them about that. But that was not something that at the present time they, from my understanding, had the wherewithal to execute on.

So the other 80% is primarily held by the same partners that you have or partners -- I call them partners -- the same investors that are in the ManorCare debt?

I would call them partners. It's not dollar for dollar but there's an awful -- a lot of the folks in the PropCo ManorCare debt are in the debt in the C-Corp that is today Genesis HealthCare.

Okay. Just a question for Tom. I think just thinking sequentially for a moment, so $0.54 excluding the impairments in the third quarter, it would look like fourth quarter is about $0.60 to $0.66. I take it about $0.07 is just the debt gains and the prepayment on the mortgage loan and then maybe pick up another $0.01 on the debt investment that you've made, which sort of takes you to $0.61 or $0.62. I guess what makes the range still wider in terms of the fourth quarter? Is there any other things that are occurring? And is there anything else that we're missing in terms of that sequential move from 3Q to 4Q?

Yes. You're right in that when you do the math you're at $0.62 for Q4 and here's how you run it back down to a more normalized number. MedCath, that prepayment at a premium that we spoke to in my call, where we picked up $0.04, that's one of the items that occurs in Q4. The HCA gains net of the lost interest income from selling those 9.625% coupon notes pick up $0.025. The Genesis is $0.02 of that number.

And then the JV II, not so much the impairment but the lack of straight line rents going forward because as you might have seen in our footnote disclosure, we discontinued straight lining rents effective July 1st. That was a $0.01, so that goes the opposite direction. So if you take all those pieces into account, it would take you from the $0.62 down to a more normalized $0.55.

Right, but then the range for the fourth quarter is $0.06 wide. I didn't know if there were certain assumptions or certain things that you were projecting on occurring. It looked like a lot of these things that you mentioned are known events so why would there still be such a wide range for 4Q?

I just left the range as it was. It seemed that $0.03 on either side of the midpoint was not unreasonable.

And then just lastly on the acquisition pursuit costs, and I guess tying into hiring Kendall, was that effectively -- was Kendall hired pre-Atria or post, and the $6 million, was that related to that transaction?

Yes, the $6 million was not all Kendall, if that's your question.

No, I guess was he hired prior to pursuing the Atria transaction or post?

We've been in discussions with Kendall for the better part of two years. I think his actual start date was September 15th, but we've been recruiting one another for the better part of two years.

And the $6 million, where's that in the P&L and is that all -- can you break that up between transactions for us?

Well, I think relative to that, I mean, we continually evaluate many transactional investment opportunities both on the buy side and the sell side. We do not comment, Michael, I think you know that, on transactions that we are presently considering or those that we decide not to pursue. The only transactions we comment on are those that we choose to close because they're the ones that we believe will enhance shareholder value.

As to the geography of it, the $6 million, we have a little over $5 million of it in Q3, $0.8 million in Q1 and Q2 and it resides in G&A.

All in G&A. And that's multiple -- that all in the second, third quarter, that was deals that you abandoned rather than deals that you closed, just want to make sure I -- ?

Let me just repeat what I just said, Michael. We don't comment on transactions we are presently considering or those we decide not to pursue. The only ones we comment on are those we choose to close because they are the ones that we believe will enhance shareholder value.

But just to the second part of your question, the new accounting in the new world is that you expense transaction costs for both deals that you complete and deals that you ultimately abandon.

Okay. Thank you.

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

Yes, hi. A question, Tom, about the accounting for I guess the Sunrise Emeritus leases on the 27. If your rent's starting at about $30 million, the CAGR over a five-year period is about 13%, 14%. I think that takes you up to about $50 million at that point in time, and then you have CPI escalators going forward. How do you treat this from a P&L perspective? Is part of it straight lined? Is it all straight lined? Are we going to see the bumps from year to year in FFO because it's not straight lined?

No, the lease would of course be straight lined, so there's going to be a GAAP FFO impact from that, and a little bit in 2010 and a bigger number in 2011.

Okay. So if your first year rent is $30 million what's the GAAP rent that you're going to be booking?

That's total GAAP rent of $53.5 million, a year.

Okay.

And so from that you can -- I'll just save you from having to do the math, that's going to pick up $0.02 of FFO growth in 2010, and $0.06 in 2011. I think the second part of your question might have been how are we treating the $50 million. The $50 million minus the $11 million of working capital adjustments and other expenses, which is what GAAP would have us do, that $39 million -- actually it's $41 million inclusive of a couple million dollars of other items in Q4, that amount gets amortized for GAAP purposes over the life of the lease. But per the white paper explicitly states, that amortization is added back for FFO purposes so that will be the accounting on that.

Okay, and on the prior lease that you transitioned out of where the rent was $28 million, was that comparable to what the GAAP rent was on that lease?

Keep in mind that the -- there was no straight-lining on that lease.

Okay.

Yes.

Okay, so it's a 28 to 53 delta. Okay. And then on the --

That's the reason for the FFO pickup that I described in 2010 and 2011.

Got it. Got it. And then last question. Do you have the GAAP rates that you're using on the debt investments with Genesis as well? Are they about 10% and 12% or 13%?

Could you repeat that, please?

The interest rates that you're going to be recording under GAAP on the Genesis investments, I know you have the debt amortization.

Yes.

Is it about say 10% on the senior and 12% or 13% on the mezz.

Well, if you take the discount, the discounts into account, it's going to be about 10.5% on the senior and about 18% on the mezz piece. So when you take all the components into account on the mezz piece, the amount of the discount, the escalating LIBOR that prepayment -- I won't call it prepayment penalty. That other penalty.

Sure.

The exit penalty.

Termination, yes, exit.

You take all those into account and when you do that math if we hold it to maturity, that's going to be about 18%.

Okay. That's the IRR. Is that going to be the effective interest rate that you're going to book it at?

That's correct.

Okay. Thank you.

Same treatment as what we've applied for ManorCare.

Okay. Thanks.

Your next question comes from the line of Bryan Sekino of Barclays Capital.

Good morning. Just a question on the facilities you transitioned to Emeritus, I guess the 27. As you have really strong rent bumps for the next five years and as I think about your initiative to kind of look at the RIDEA structure, was that ever considered for this group of assets with I guess expectation that performance is really going to improve there?

Well, we obviously look at everything. I think you've got to go back to the original thesis that we had at the time we first noted the Sunrise portfolio and as part of the CNL transaction. And if you took a look at where we felt there was value and we've been able to validate this not once, not twice, not three times, but now four times, the value that we perceived in those Sunrise portfolios was really more one of potential cost reduction.

I think we've said very consistently for the four years that we've owned this portfolio that Sunrise does a pretty good job on the top line. Where they've struggled operationally with respect to our portfolio, which is all we can really speak to, our higher acuity sorts of communities and then with cost structures, particularly in the non-mansion portfolio.

So if you go back and look at what we've transitioned, which at this point in the aggregate now between what we originally bought from CNL and five properties we've added, a total of 58 properties, we've been able to realize what we think, what we believe are market-based cost structures and those were relatively straightforward for not only Paul and his team to underwrite, but also to convey to prospective replacement operators. There wasn't a lot of -- you didn't have to make a big leap of faith as to what was going to happen with occupancy or what the incremental ancillary revenue benefit was going to be. It was largely cost reduction.

So as we got into that and we started transitioning these portfolios, we determined that since it was a pretty straightforward mathematical exercise, both from our standpoint, from the replacement operator's standpoint, that really lent itself to more of a contractual lease obligation and that in fact is what we've now put in place with all these transitions and I would distinguish what we've done there, with respect to in my formal comments what might be in the offing with respect to our joint venture independent living platform, because there the cost side is -- they're in reasonably good shape on the cost side there.

That is really more of a potential revenue play and that in our view lends itself much more to a more of a RIDEA structure as opposed to a contractual lease structure. I'm hopeful that's some additional perspective for you.

Would you say, I guess just a follow-up on that, the 35 that are remaining under Sunrise management that are going to the RIDEA structure, you can see -- you expect occupancy increases there, that's why those facilities are under that structure?

I'm a little confused by your question. First off, there's 48, not 35. And we have said nothing about pursuing a RIDEA structure for those. I'm not sure I understand your question.

I thought Sunrise had put out a press release saying that the 35 facilities were going to be in the RIDEA structure.

You would have to talk to Sunrise about that.

Okay. Thanks for taking the questions.

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

Thanks. Good morning to everyone out there. Is there another side to the rationale behind not pursuing the RIDEA structure with Emeritus, that being Emeritus doesn't want to go that direction?

Again, you would have to talk to Emeritus about that. I'm not sure I can add a whole lot more to the thought process that we went through. We've been -- I think this is the third transition we've made with Emeritus of formerly managed Sunrise properties, but, you ought to pursue that line of inquiry with Emeritus directly.

Okay. On the Sunrise transitions that you've accomplished, I recall that the -- at least the first one resulted in the first year rent being down versus what it was but then a pretty substantial catch-up quickly thereafter. This latest one starts off right off the bat with a higher -- a little bit of a rent bump in year one. What is the difference between these transactions? Is the market just changing or is it something specific about the collection of assets that you transitioned?

Well, I think that first -- the first transition was the first one we had all gone through and that was done back in November of 2008. So we are two years on. I think the economy is at the margin. I won't say it's better but I think it stopped going down. And I think quite frankly, Emeritus has had the benefit of having six quarters now of actual experience with respect to that first portfolio.

Paul and Kendall and I were up with Granger last week and you've got real hard data now to look at and you can see notwithstanding from the start of that transition to today, portfolio occupancies are off, I want to say they're 30 or 40 basis points off, not much, but just off a touch. The margins have expanded 600 basis points and almost all of that is on the cost side.

So again, this is -- we're benefiting now from some actual experience and I think Emeritus is benefiting from that in terms of what they've been able to achieve and their confidence in achieving results like that going forward and we've benefited as well. That's what you're seeing reflected in the most recent set of terms for this new master lease, Rich.

I would add one thing to that. There was an accounting item, Rich, back in 2008 where there was some deferred rent that was received on those Aureus assets and that caused a bump. So when you looked at the comparison from '08 to '09, there was a $1.2 million item in there that would have caused some noise so that just adds to what Jay is describing but there was some accounting that causes the optics to look different.

Okay. Thank you. To the Genesis transaction, just quickly. You speak a lot about the growth and the strength of the HCR ManorCare portfolio. Do you have the same level of anticipation and excitement for the Genesis portfolio, the underlying assets under the debt?

I think the underlying -- I would make the following comparisons. The underlying portfolio is not as large in terms of number of assets. I would say it is less diversified than HCR ManorCare. Genesis is largely more kind of in the northeast. I would say the quality mix of that Genesis portfolio is markedly higher, markedly higher than the norms for the other for profit and private skilled nursing operators but is not at the level, quality mix wise, that the HCR ManorCare portfolio is. So those are just some kind of compare and contrast sort of comments or observations I'd make.

Last question. What do you think the -- in your mind, for HCP an optimal kind of level of RIDEA exposure is for your overall portfolio?

Again, we've never run the Company based on strict formulas, be it formulas for diversification across our five property types or concentrations within our five product rows. We tend to be very opportunistic and in fact somewhat contrarian. So I think our view would be we take each situation as it develops.

Clearly, if you're in a scenario where you're perceived that you're at or near a trough in a particular space, and you've got an operator that you've got real passion and belief in, and you've got alignment with that operator, and the entry point from a valuation standpoint is attractive, those would all come together to suggest a RIDEA structure could be quite attractive.

Alternatively, depending on where you are in the market or depending on your view of the operator or depending on what the opportunity is to create value in a particular portfolio, and I just referenced some of the cost opportunities in these Sunrise portfolios, that might lead you down a different path. So it's really, it's -- you can't -- there's not one criteria that you jump to. It's really a combination of a whole host of things.

But I mean if there was enough stuff out there that met your criteria to be involved in a RIDEA structure, would you allow the Company to get as high as, say, 40% or 50% RIDEA or do you think that would be out of range?

Again, we're going to be more opportunity-driven, Rich, as opposed to hard and fast rules and what have you.

Okay. Thanks.

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

Thanks. Hello. A lot of this has been covered, Jay, but I wanted to ask a different way. So on Genesis, I guess, I was just wondering sort of strategically your thinking about skilled nursing. Obviously you've made the investments in the debt, it sounds like on both ManorCare and Genesis if I'm hearing you correctly you would be willing to own the assets.

Over the last several years you've been working down sort of skilled nursing to kind of reduce reimbursement risk. So what's kind of your outlook on skilled nursing and again you just said you didn't want to have targets but kind of is there a level of comfort in terms of how much skilled you would be willing to do?

All skilled is -- I think the headline here is all skilled is not created equal. You used the word skilled. With respect to HCR ManorCare and Genesis, we would use the moniker of post acute.

Okay.

But to cut to the chase, we really drill into Medicaid exposure and if you take a look at the substantial dispositions we've made in the skilled space, and just as a quick reference point, if you take a look at the equity exposure that sits today in HCP's portfolio in the skilled space, it's 2% of the entire portfolio is represented by equity exposure in skilled nursing so it's been a conscious decision to move away from state-based Medicaid exposures.

And if you were to go back and look at the metrics of each of those portfolios that we divested ourselves, you would see a heavy, heavy preponderance of state-based Medicaid and then a very, very low quality mix. So that contrasts sharply with those very same metrics for HCR ManorCare, and Genesis. So that's probably the most important answer to your question.

On top of that, we also look at the opportunity to make money for our shareholders and when we can -- as we've seen with the other $640 million of investments that we've made this year, when we've got the opportunity to take down off-market acquisition opportunities that result in equity-like returns with fixed income risk exposure, we just think that's a wonderful result for our shareholders.

I think it goes directly to the franchise value that's been created within this company over the past 25 years, that we benefit from with each passing day. So again, you've got a couple different things going on there but that's how I would respond to your question.

Okay. And I guess two follow-ups, if I could. Implicitly, then, sort of you're relatively comfortable with the Medicare exposure that these guys have and sort of secondly should we be reading anything into the likelihood that you do a ManorCare deal based on the fact that you're now investing in Genesis and kind of expanding your opportunities?

Well, you have become the national acquirer of the healthcare real estate space so I'll leave reading into things to you.

Okay.

But from our standpoint, again, it's really more about the entry point and the pricing and the returns that we can achieve. So unlevered returns in the low to mid-teens with contractual risk exposure is -- particularly in the current environment -- stacks up quite nicely and so that was really the thought process behind our determination there.

Okay. Thanks.

Your next question comes from the line of Tayo Okusanya of Jefferies & Company.

Yes, good afternoon, Jay. Just a couple of very quick questions. The Genesis deal, just wanted to make sure the LIBOR rate being referred to is one month LIBOR not three month LIBOR.

We use the forward LIBOR curve and it's one month LIBOR.

So it's one month, okay. That's one quick question. And then the senior loan and the numerous step-ups involved in it, in regards to LIBOR floors and as well as the spread, could you give us a sense of just how that works up until the 2014 maturity?

Yes. The LIBOR floor starts out at 1.5% from the point that we've made the acquisition. And it bumps -- September of 2011, through September of 2012, well I guess it stays at 1.5%. It bumps in September of 2012 to September of 2014 at 2.5%. The spreads also bump from September of 2010 to September of 2011 they're at 4.75. The spreads go from September of 2011 to September of 2012 to 5.5 and then from September of 2012 --

Are they just kind of like equal annual bumps both on the LIBOR floor and the spread?

These are different bumps.

Yes, but are they like 25 basis point bumps over the next three years to get you from 4.75% to 5.75%?

No. Here's what they are. You're 4.75 spread from September of 2010 to September of 2011. 5.50 spread from September 2011 to September 2012. And a 5.75 spread from September 2012 to September 2014.

And then the LIBOR floor?

Yes, the LIBOR floors are 1.5% through September of 2012. From September of 2012 to September of 2014 they're at 2.5%.

Got it. Okay. That's helpful.

Yes.

And then next question, next quick question. The MOB portfolio, could you just remind us again how much of that, of your investment is triple net leases versus multi-tenant leases?

I want to say through some transitions which have occurred obviously only when the leases roll, I want to say the triple net component of MOB is somewhere between a third and 40% today.

Okay. That's helpful. And then the Sunrise transition, the 27 new assets, understand the logic behind that. Very strong growth of 13.8%. When you did the last deal you were kind enough to kind of give us a very specific breakout of how the rent bumps are going to happen over the next five years. Could you do that with these 27 assets? Rather than just us having a five year CAGR?

Do we have that handy?

Yes. In dollar amounts.

That would be great.

Okay. So year one, and I'm talking lease years, rather than calendar years, which is effective November 1st, the restructured lease is going to be at $30.3 million.

That's year one?

Year one. That 12 month period starting November 1st of 2010. In year two it goes to $33.8 million. Year three it goes to $41 million. Year four, it goes do $46 million. Year five it goes to $51 million.

Okay. That's helpful. And then the -- what was that question? Okay. I think that's it's from me. Thank you very much, Jay.

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

Good morning. Couple of numbers questions. On the income statement the other income of $6.7 million, that's the gain on the HCA bonds?

Yes, that's the biggest part of it.

Okay. And then if I look at where you've broken out some of the other stuff that might be able to do a FAS calculation, there's $55.6 million of TIs, LCs and CapEx. If I want to get to a run rate do I subtract 39 or 41? I wasn't really clear from the footnotes. It's on page three of the supplemental.

39.

Okay. And same page, given what you're saying, could you tell us what straight lines will approximate in the fourth quarter?

Well, I tell you what I can do is I can give it to you for the year and you could back into the quarter. Straight line, the last time I gave you guidance on the straight line on a consolidated basis was at $45 million and that's going to go to $47 million for the year. That's all the Sunrise 27 that's driving that.

Yes.

And then as it pertains to in the JVs, there's going to be a little bit of a tick down that you'll notice and that's due to the joint venture to impairment and discontinuance of recognizing straight line rent in JV two. So when you see the difference flowing through you'll note that's what that is.

Okay. And then actually the last question I had was about JV two. On one hand we're seeing the impairment that we're taking here. And Jay suggested that's kind of a top line related impairment rather than expense line related impairment. But also talking about possibly taking that in as a RIDEA structure. Can I surmise from that, that if I were to look back from the vantage point of a view years ago that those leases might not have been the right leases for where we were in the cycle but in terms of the facility operations in Horizon Bay you still feel pretty good about the operator?

Let me give you some facts. The year that we acquired that portfolio it was about four years ago today, that portfolio did $66 million, Rob, in NOI for 2006. Okay. As we sit here today with two months of the year to go there's a pretty high degree of certainty, that number for this year is going to be $64 million. Okay?

So -- now, remember, this is much more independent living. I think this is about 70% independent living. So not the -- not populated with the needs-based assisted living resident profile and a good chunk of it, I want to say as much as 40% of it's in coastal Florida. If you think about a portfolio, that potentially got exposed to some rough stuff if you will, independent living as opposed to assisted living or skilled and then a lot in Florida, our view is that the portfolio four years later at 64 versus 66 actually held in there reasonably well. The lease bumps in that lease that were put in place at the end of 2006, I want to say they averaged about 3.5 --

3 and a third.

3.33%. So there's the math for you. I think what's much more interesting is going forward, given that if you drill into the P&L on that portfolio, the costs are for the most part in line is the opportunity for there to be some substantial top line growth over the next couple years and that's really what we're interested in making sure that we are positioned to capture that. There will be some execution involved with that, for example, some additional CapEx will be required and there will be some other things that we have to do but that to us versus the four that we transitioned from Sunrise suggests to us a very nice opportunity for RIDEA structure.

Right. That would also -- one could surmise that you've got a JV partner who might not be interested in pursuing that.

Well, again, everybody likes to read stuff into it. I just deal in the world of reality. We are working very closely with our joint venture partner and again, we are passionate about our belief that there's upside in this portfolio. It's going to take a couple years to get that portfolio positioned to realize that growth in top line and again, I think that's largely going to be a CapEx spend. But that's where we are with that portfolio as of right today.

Okay. Fair enough. Thanks.

Your next question comes from the line of Dustin Pizzo of UBS.

Hi, guys, it's Ross Nussbaum here with Dustin. Couple of follow-ups here. On the Sunrise assets that transitioned over to Emeritus, I'm just trying to get my arms around what is the EBITDAR of those assets today such that they can tolerate that level of rent increase?

I think it's $33.5 million.

Call it a --

Let me verify that, it's just from memory.

Obviously it's substantial rent payments but how are the assets going to be generating that much EBITDA growth over the next five years?

Let me do a couple things that will help you. If you go back and pull the -- I can't remember if it was August. I think it was August 31st press release, Ross. We profiled the metrics for the portfolio that was being transitioned versus the portfolio that was remaining and a couple of key things that you ought to know. The NOI margin, let's start with your question right on the nose here. The NOI margin for the remaining portfolio Sunrise assets we had is about 29%. The NOI margin for the portfolio that's in question here, the 27 properties, is 18.7%. The occupancy of that portfolio is 81%. Okay?

That's 700 basis points lower than the occupancy for the remaining portfolio. So before we get into acuity and things like that, if you just look at the margin and the occupancy, this portfolio is an outlier to the remaining Sunrise assets we have. Then when you go to the profile of the previous portfolios we've transitioned and take a look at where the metrics were at the time we transitioned, the opportunity here kind of jumps out at you, both from a standpoint of the landlord, us, as well as the various replacement operators that we spoke with in terms of their interest level in taking this on.

So it's a very, very attractive opportunity and I think the results from our standpoint demonstrate that and I suspect the results from Emeritus' standpoint over the next couple years, if they do as well or better than they've done on the portfolios that have already transitioned and I suspect they will also bear that out, Ross.

Ross, correction, $31.6 million.

Got it.

Was the EBITDAR.

Thanks. On Genesis, as a follow-up, I thought earlier you had talked about the debt service coverage being two times. Was that on the last dollar exposure?

2.02 on the last dollar.

I'm sorry.

2.02 on the last dollar.

And can you comment on what you think the LTV is on your mezz?

On the mezz we think that we're right around 80% loan to value.

And then just switching over to the Life Science portfolio. In terms of lease expirations for next year, is there anything that you know of where you've already been advised that there's not going to be a renewal? I guess another way of saying where do you think occupancy is next year in Life Science?

Well, to answer your first question, the answer is no, we've not been advised of that. I think as Paul said in his script, we've got just under 400,000 square feet of expirations in Life Science for 2011 and we're in active negotiations relating to about 60% of that 400,000.

Thanks, guys.

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

Thanks, Shanelle. Thanks, everyone. We'll see you the week after next in NAREIT and don't forget to vote. Take care.

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