Healthpeak Properties Inc (PEAK) 2012 Q3 法說會逐字稿

Good day ladies and gentlemen and welcome to the third-quarter 2012 HCP earnings conference call. My name is Suzette and I will be your coordinator today. At this time, all participants are in a listen-only mode. After the speakers' remarks, there will be a question and answer session.

(Operator Instructions)

Thank you. Now I would like to turn the presentation over to your host for today's conference call, John Lu, Senior Vice President. You may go ahead, sir.

Thank you Suzette. Good afternoon and good morning. Some of the statements made during today's conference call will contain forward-looking statements, including the statements about our guidance. These statements are made as of today's date and reflect the Company's good faith beliefs 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 up 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 will now turn the call over to our Chairman and CEO, Jay Flaherty.

Thanks, John. Welcome to HCP's third-quarter earnings conference call. Joining us today are Executive Vice President, Chief Investment Officer, Paul Gallagher, and Executive Vice President, Chief Financial Officer, Tim Schoen.

Let me start by expressing our concern for all those impacted by Hurricane Sandy, especially those seniors residing in our communities. We have had our emergency team in place since last Wednesday, coordinating response and assistance with our operators and tenants. At this point, we have a multitude of communities experiencing leaks and minor flooding and several properties operating on backup generator power. Hardest hit, were two Sunrise communities in Brooklyn, one of which was evacuated yesterday, and the other where the residents have been moved to the second floor, due to flooding. All of the residents are okay. With that, we have much to update you on, so let's start by turning the call over to Tim.

Thank you, Jay. Today, I will cover four topics -- third quarter results, investment transactions, financing activities and balance sheet, and finally, our updated 2012 guidance. Let me start with our third quarter results. Our same-property portfolio, again, produced solid results, generating a 3.6% cash NOI growth compared to the third quarter last year. The results were driven by contractual rent increases from our triple net leases and occupancy gains in our life science and medical office portfolios. Our quarterly same-property results now include the triple-net, master-leased HCR ManorCare portfolio consisting of 334 properties. Paul will discuss our results by segment, in a few minutes.

For the third quarter, we reported FFO of $0.67 per share, which included a non-cash impairment of $8 million, or $0.02 per share, resulting from the sale of a land parcel in Poway, California. This sale was part of a larger transaction with our tenant General Atomics, which meaningfully expanded our relationship to 396,000 square feet, under long-term leases through 2024. The transaction monetized and placed into development a total of 26 acres of land, allowing us to stabilize additional non-income producing assets. Excluding the $0.02 impairment, FFO is adjusted for the quarter with $0.69 per share and FAD with $0.55 per share.

Switching to investment transactions. During the third quarter, and through October, we executed on $2.3 billion of investments. First, we announced an accretive $1.78 billion senior housing portfolio acquisition, that included 133 properties master leased to Emeritus on a long-term triple net basis, valued at $1.73 billion and a four-year loan of $52 million secured by nine properties, concurrently being purchased by Emeritus. We expect to close on substantially all of the real estate assets as early as tomorrow, depending on the impact of the storm. This timing is approximately one month sooner than previously anticipated. Second, we closed the acquisitions previously announced in July, totaling $486 million, including 1.2 million square feet of on-campus MOBs and the mezzanine loan facility with Tandem Health Care. We made additional funding of development and capital projects totaling $63 million during the quarter.

Turning now to financing activities and balance sheet. On the capital markets front, during the last four months, we raised total proceeds of $1.5 billion in the equity and credit markets. On October 19, we issued 22 million shares of common stock generating proceeds of $979 million. During the third quarter, we raised $515 million of debt capital consisting of $300 million of 10-year, senior, unsecured notes at a coupon of 3.15% and GBP137 million, or $215 million, 4-year term loan at a fixed rate of 1.81%. Proceeds from these transactions were used to fund the cash consideration for our recently completed acquisitions, including using the term loan to currency hedge our UK debt investments in Four Seasons Health Care. The remaining proceeds totaling $1.1 billion, represent 60% equity component of the $1.78 billion purchase price for our senior housing acquisition. In doing so, we've achieved the equity component of our 60% equity and 40% debt, long-term financing plan, just minutes after announcing the acquisition.

Turning to our credit metrics. At quarter end, our financial leverage was stable at 40%, and secured debt ratio improved to 9.1%. Fixed-charge coverage for the nine-month period through September increased to 3.5 times. Year-to-date, we have achieved a significant reduction in our cost of capital, allowing us to opportunistically capture over 300 basis points in lower borrowing cost upon the refinancing of debt and preferred stock totaling $546 million. This, combined with the accretive acquisition of a large, unencumbered senior housing portfolio, financed with attractive long-term capital, further strengthens our credit profile.

Upon closing, our secured debt ratio will drop below 8.5% and the trailing 12-month fixed rate charge coverage will trend to 3.7 times. We have no scheduled debt maturities for the remainder of 2012 and looking into 2013 our debt maturities total $873 million at an average rate of 5.9%, of which, $150 million is due in the first quarter of 2013. Finally, our updated 2012 guidance. As a reminder, we provided full-year guidance two weeks ago, including raising our cash, same-property performance, FFO as adjusted, and FAD per share metrics and lowering NAREIT FFO per share due to acquisition-related items in the fourth quarter, and the impairment charge mentioned earlier.

Let me take a moment to update our projections from two weeks ago. First, our new guidance assumes the closing of the Blackstone JV acquisition to occur one month sooner than previously anticipated. As a result, we are raising our earnings projections to reflect the additional accretion and reduced negative carry in the fourth quarter. We are increasing our FFO guidance by $0.03 per share, to a range of $2.68 to $2.74 per share. Our FFO guidance includes the impact of acquisition-related items, deferred stock redemption charge and impairments totaling $0.07 per share. Excluding these items, we expect 2012 FFO as adjusted to range from $2.75 to $2.81 per share, which is $0.01 higher than our October 16 guidance. We are also raising our FAD guidance by $0.01, to range from $2.20 to $2.26 per share. In addition, we are tightening projected cash same-property growth to a range of 4% to 4.5%. With that, I will now turn the call over to Paul. Paul?

Thank you, Tim. Before I review HCP's third quarter portfolio performance, I would note HCR ManorCare is now included in our quarterly same-property performance results, bringing HCP's same-store portfolio to 94% of all investments. Senior housing. Occupancy in our same-property senior housing platform, was 85.3%, a 20 basis point sequential decrease over the prior quarter, and a 40 basis point improvement versus the prior-year. Excluding HCR's, 66 assisted-living memory care facilities now in the senior housing same-store portfolio, occupancy for the senior housing portfolio was 85.7%, a 20 basis point sequential decrease over the prior quarter and a 30 basis point improvement versus the prior-year.

Same-store cash flow coverage for the portfolio declined one basis point to 1.12 times, driven by out-sized fixed rent bumps on our transitioned assets and higher property expenses in our Brookdale portfolio. Current quarter, year-over-year, same property cash NOI was up 2.1%. Growth was driven by rent steps, including higher rents for assets transitioned to new operators, offset by the collection of additional rents in 2011 for one Sunrise portfolio. Net of this nonrecurring item, NOI increased 3.2%. Occupancy for our RIDEA JV for the 12-month period ended June 30, 2012, is 86.1%, a 40 basis point decrease from the prior quarter. On a sequential basis, average third quarter occupancy increased 90 basis points over second quarter average occupancy.

Post-acute/skilled nursing. Coverage metrics in our post-acute/skilled nursing portfolio now reflect three quarters of lower reimbursement rates under RUGs-IV. For the trailing 12-month period ended June 30, 2012, HCR's fixed-charge coverage ratio was 1.29 times, a 15 basis point decrease. Rolling forward, for the trailing 12-months ended September 30, 2012, the fixed-charge coverage was 1.21 times, which included an increase of $39 million in the reserves for insurance claims for the years 2006 through 2010. Excluding this $39 million charge, the fixed-charge coverage would be 1.29 times.

Digging a little deeper into September's trailing 12-month results, HCR's operations generated over $130 million of cashflow after rent. For the same period, HCR invested $101 million or over $2,400 per bed in its facilities, which is almost twice the amount required under our master lease. This significant reinvestment by HCR in our assets reflects the confidence HCR has in its business model. Cashflow coverage in our non-HCR [Smith] portfolio was 1.49 times, a 9 basis point decrease versus the prior quarter and a 29 basis point decrease versus the prior-year. Year-over-year same-property cash NOI was up 3.6%, primarily driven by HCR's annual rent steps.

Hospitals. Same property cash flow coverage increased 10 basis points to 4.83 times, driven by strong performance at our Medical City Dallas and tenant hospitals. Year-over-year same-property cash NOI for the quarter increased 4.7%. Subsequent to quarter end, [Seris] Health sold its interest in one of the surgical hospitals in HCP's loan collateral pool for $10 million. In addition, Seris has entered into a definitive agreement to sell a second surgical hospital with closing subject to regulatory approval. This sale is structured as an asset purchase and proceeds are expected to be approximately $30 million. Together, the $40 million in net sales proceeds will reduce the carrying value on our Seris loan to $30 million.

Medical office buildings. Same-property cash NOI for the third quarter was up 2.8%. The growth was the result of normal rent steps coupled with increased occupancy, versus the third quarter 2011. Our MOB occupancy for the third quarter increased 10 basis points to 91.5%. Excluding the impact of new acquisitions, occupancy would have been 91.9%. During the quarter, tenants representing 615,000 square feet took occupancy, of which 418,000 related to previously occupied space. Our year-to-date average retention rate is 78.3%. Renewals for the quarter occurred at 0.7% higher mark-to-market rents with the average term for new and renewal leases at 69 months. Our leasing pipeline remains strong with new and renewal prospects totaling over 1 million square feet, 45% of our remaining 2012 rollover exposure.

Life science. Occupancy for our life science portfolio increased 40 basis points to 90%, driven by new leasing in the Bay Area and San Diego. Same-property cash NOI was up 7% in the third quarter driven by normal rent steps, the previously announced linked in expansion on our Mountain View campus, and a decrease in nonrecoverable expenses. For the quarter, we completed 405,000 square feet of leasing, bringing the year-to-date total to 807,000 square feet, with a retention rate of 90.2%. The life science development pipeline consists of three redevelopment projects totaling 166,000 square feet, and two development projects totaling 185,000 square feet, with the total remaining funding requirements projected at $51 million.

A significant contribution to the third quarter's life science leasing total was a transaction with HCP's tenant, General Atomics, in Poway, California. The deal has three components. First, HCP agreed to sell 19 acres in Poway for $18.6 million. General Atomics will construct a corporate amenities facility on the site which is adjacent to the buildings leased with HCP. Closing is expected by January, 2013 and HCP recorded an $8 million impairment this quarter on the sale of the land.

Second, a blend-and-extend for two existing leases for 281,000 square feet, which lowered rents by approximately 16% in exchange for extending lease expirations on average, 7.5 years to June, 2024, with two, five-year renewal options. Importantly, we negotiated the elimination of the tenants in the money-purchase option. HCP provided no landlord-tenant improvements and the new leases escalate at a fixed 3.25% annual rate. Third, HCP will construct a new $23 million, 115,000 square foot building, 100% pre-leased to General Atomics with a projected delivery in July, 2014. The new lease will also expire in June, 2024, and will contain the same renewal options and also provide for 3.25% fixed annual rent steps. The projected initial return on cost, on HCP's basis is 6%. This transaction reduces HCP's land exposure in Poway, creates a high-quality, growing, long-term income stream and expands HCP's relationship with General Atomics, the largest tenant in the Poway market by 30% from 281,000 square feet to 400,000 square feet by 2014.

Acquisitions. On October 16, HCP announced the $1.73 billion acquisition of 133 senior housing communities from a joint venture between Emeritus and Blackstone. Emeritus will enter into a new triple-net master lease and will continue to operate the communities. Emeritus is obligated to spend $30 million for capital improvements during the first two years of the lease. This is in addition to $42 million already spent on the properties by the seller, over the past two years. The lease yield in year one is 6.1%.

We will have a primary term of 15 years and will have annual fixed rent increases that average 3.7%, for the first five years. At the beginning of year six, the rent on 34 lease of assets will increase by the greater of 3% of the previous year's rent or fair market cap at 130%, to capture potential upside from these non-stabilized assets. Finally, as a part of this transaction, HCP will provide debt financing of $52 million to Emeritus for their acquisition of nine remaining properties. On July 31, 2012, HCP closed a $205 million mezzanine loan facility to an affiliate of Formation Capital as part of the recapitalization of its tandem skilled nursing portfolio. The 68-property portfolio is 100% master leased to LaVie Care Centers, the operators of 208 skilled nursing facilities in the US.

The loan is subordinate to $400 million in senior mortgage debt and $137 million in senior mezz debt and well be funded in two tranches -- $100 million funded two months ago at a 12% fixed rate, and $105 million second funding, at a 14% fixed rate. The second tranche will be funded no later than August 31, 2013, and the proceeds will be used to pay down the senior mezz loan. The loan has a blended yield to maturity of 13%. The facility which closed on July 31 has an initial term of five years. The 68-property portfolio located across six states has an occupancy of 93%, a quality mix of 52%, an NOI margin of 17%, and in-place rent coverage of 1.3 times. This debt transaction provides HCP with an attractive, risk-adjusted exposure at a 10.5% rent yield to last dollar investment.

Sustainability. HCP was named Sector Leader in the healthcare hospitality sector for the 2012 Global Real Estate Sustainability Benchmark Survey. We were also designated as a Green Star, the highest designation in the survey. Separately, the FTSE Group, the global leader in providing index and analytical solutions, added HCP to their socially responsible investment index series, which includes the Global Benchmark, US Benchmark, and US 100 Index Series. These indices measure the performance of companies that meet globally recognized corporate responsibility standards.

Our response to the Carbon Disclosure Project's 2012 investor questionnaire generated a very favorable result for a first-time respondent. During the quarter, we received an additional two Energy Star labels in our medical office portfolio bringing HCP's total Energy Star labels to 77. HCP's best practices implementation and investment in energy-saving technology resulted in continued positive economic results. On a same-property basis, utility expenses were down $578,000 versus the third quarter of 2011 and $1.2 million on a year-to-date basis. With that, I'd like to turn it back to Jay.

Thanks, Paul. Too frequently, the quarterly earnings call process narrowly focuses on the past quarter, rather than providing perspective across multiple quarters. As background for my remarks today, I want to highlight comments from our four prior quarterly calls. A year ago, on our Q3 2011 call, I detailed HCP's philosophy of utilizing RIDEA structures for senior housing investments. To compensate, for the additional risks of cash flow uncertainty and CapEx liability, with RIDEA structures, we expect a premium over the return achievable through a triple net structure. Said differently, we prefer negotiated, accretive, triple net acquisitions of unencumbered real estate with credit-worthy counterparties.

On our Q4 call of last year, I anticipated substantial M&A operator consolidation across each of our property types in the coming years, as real healthcare reform began to take shape in the marketplace. On our first quarter call of this year, with significant activity sourced by our proprietary Five by Five business model, I noted the steps we had taken to prepare our balance sheet for increased transaction volumes and meaningfully reduce our cost of capital by repricing our $1.5 billion line of credit and reducing our leverage ratio to historically low levels. On the very same call, in response to an analyst question regarding our then-relatively low level of acquisition activity, I referenced Ted Williams' famous advice of, needing to wait for the right pitch. I also placed a priority on monetizing our non- stabilized investment portfolio.

On our second quarter call, three months ago, I noted the increasingly attractive outlook for making accretive acquisitions and predicted that HCP's quarterly deal volumes would ramp sequentially during 2012. Let me now tie these perspectives together with our recent accomplishments. One. We finally got the pitch we were waiting for and it was a fastball right down the middle of the plate. HCP's $1.73 billion acquisition of the Blackstone Emeritus JV was a negotiated transaction of 133 senior housing communities with significant upside, leased to Emeritus in a triple net structure. This portfolio will be acquired on an unencumbered basis, provides attractive annual escalators, and our fair market value rent reset in five years on the 34 lease-up communities.

The transaction allows Emeritus to secure the long-term management of these properties, generates proceeds to Emeritus of $140 million, which significantly increases their credit profile, and provides funding for an incremental $30 million CapEx investment by Emeritus for this portfolio. By pre-funding the equity component of the purchase price two weeks ago, HCP locked in substantial earnings accretion for 2013, which will grow overtime. I want to express my appreciation for the extraordinary, diligent, and cooperative efforts of the Blackstone, Emeritus, Chicago Title, and HCP business and legal teams, which results in our ability to close a transaction of this size just two weeks after it was announced.

Two. We are pleased to have made progress monetizing, what we refer to as, our non-stabilized bucket of investments. Agreements to generate $40 million of proceeds against our $69 million Seris loan were entered into this month. We expect being able to report additional paydowns in the future. In addition, this quarter's General Atomics transaction extends existing lease terms, eliminates purchase options, and monetizes a portion of our San Diego County land holdings. We anticipate additional monetization of our land inventory in 2013.

Three. Our Five by Five model continues to be especially active, with dialogue across each of our investable targets. Year-to-date announced acquisitions are $2.5 billion and have grown sequentially, by quarter, throughout the year. This $2.5 billion in transaction volume represents a 13% increase in assets under management since year-end 2011. Four. Among a number of sustainability accomplishments, we are thrilled to have been named Sector Leader for the 2012 Global Real Estate Sustainability Benchmark Survey. This recognition represents the successful effort and ongoing commitment of a number of HCP colleagues to our various sustainability initiatives.

Finally, with regard to our HCP colleagues. Like every organization, HCP takes great pride in the accomplishments and value-add of our talented team members. Two weeks ago, Merrill Lynch's global research team noted that our market cap per employee was the highest in the REIT sector, an astonishing $175 million of market cap per employee. One would expect nothing less from a bunch of dividend aristocrats and sustainability sector leaders. With that, we are delighted to take your questions. Suzette?

(Operator Instructions)

Michael Carroll.

In the acquisition market, today, how many of these large portfolio deals are still available?

Time will tell, Michael.

Okay. And then, related to the Emeritus/Blackstone deal, I think the press release indicated that would close in phases. Can you give us more color on how large each phase will be?

Well, again, in my comments just a minute or two ago I noted the rather extraordinary efforts that have been put forth by the business and legal teams at Blackstone, Emeritus, Chicago Title, and HCP. It now looks, as we sit here today, that we have a very good chance of closing the entire transaction tomorrow, which when you think about a transaction that was just signed and announced two weeks ago, and it's $1.73 billion in transaction value, representing 133 separate properties, is an absolutely extraordinary accomplishment.

That would be pretty quick. Than, related to, Jay, your comments that would monetize more land in 2013. Do you mean you would start more developments? Or is this more outright land sales?

It could take either path.

So, it's a combination that you'r thinking, right now?

I said it could take either past.

Okay. Great. Then, related to the General Atomics transaction, did you buy another land parcel to do that development?

No. No. That was part of our initial landholding when we acquired Slough back in August of 2007. And we have, overtime, grown our relationship with General Atomics, which obviously is experiencing a very, very favorable demand for its products. So, we have grown that over time, rather consistently. Now we are up to 400,000 square feet, if you include the build-to-suit building that we will be bringing online.

Okay. And then, what am I missing -- from the previous supplement it said that you had land held for development of 182 acres. Now it says you have 174 acres. In the press release you indicated that you sold 19 acres to General Atomics.

Yes. It's Tim Schoen. There's another -- that sale will actually be effectuated in the fourth quarter. That will come off our land holdings by the end of the year.

Okay. Great. That's what I'm missing. Thanks guys.

Philip Martin.

You noted in your remarks that their investment level going forward is going to be significantly larger than what's mandated under the terms. Number one, is that a surprise to you? And can you give us a bit more detail? I mean, the investment sounds more than just cosmetic or maintenance. Is the investment more representative of a repositioning play with respect to certain assets that may improve the risk and reward profile underlying valuations? Just want a bit more detail on those comments.

Yes. Your first part of your question cut out. I'm assuming, Philip, you are referring to HCR?

Yes. HCR, yes.

Well, they have gone into playing offense mode. They've got great conviction about their business model, and they are obviously generating a significant amount of cash. They've got a significant amount of cash at quarter-end; at September 30, they are sitting on just about $130 million.

But, as Paul noted in his comments, they have reinvested in their business model, in terms of our facilities, approximately two times the amount that is required, the minimum by the lease. What you are really seeing, I mean, you are seeing the early stages of what we call HCR version 3.0. This was the leader in the '90s with respect to the Institutional Skilled Nursing business. After the ManorCare investment acquisition in 1999, they morphed their business model to a higher acuity, more complex, shorter stay business model.

Now, what you are seeing, is real healthcare reform start to play out in the post-acute setting, which involves payers, providers, very large acute care hospital operators. You will see cost shift here, you will see capitation. You may see some bundling going on. You've got a management team, here, that is consistently taking advantage of changes in the marketplace. That's what they're going through, right now. They have moved into, very much with conviction, what I would call playing offense in their business model. I suspect that you are going to see some very, very good results in the next year or two to come.

So, it sounds pretty comprehensive, in terms of service levels being improved, probably technology, just within the integrated help system, and, I'm sure some cosmetic, as well. So, it's -- as you said, if they are going on offense, it's pretty comprehensive, here. Is there a meaningful change in service that's happening from current levels with this investment?

That's part of it. Let me just underscore one of your points. This is far more than cosmetics that are going on, here. HCR is in discussions with dozens of potential partners all focused in their cluster markets. As they retool, here, for what will really be true healthcare reform, not something that comes out of legislation from Washington DC, with the likely involvement or inclusion of block grants to the states.

They are really getting very their well-positioned here, for the next couple year period. Frankly, I find it fascinating to watch how this management team continues to evolve and be very dynamic in their response to what is going to be a very, very good opportunity. Of course, everything at the end of the day is a function of the fact that in the healthcare continuum, they represent the lowest-cost setting. So, they are sitting there and with that enormous business advantage and now retooling their business model, investing aggressively there own capital into our properties, to position themselves to take advantage of this.

Again, I appreciate the color. From an outcome standpoint, in your discussions with them, have you seen an improvement in healthcare outcomes from the services they provide? Has that -- is that --

Their outcomes have always been superior. We are, year-over-year, you do see meaningful increase in census. So, if you do a spot October 2011 versus October 2012 spot occupancy, that is up meaningfully. I think -- so, I'd make that observation.

Okay. So trends sound positive both from a cost efficiency standpoint and a health care outcome standpoint. Okay.

Yes, Philip.

Thank you very much.

Yes.

Jeff Theiler.

Couple questions about the Sunwest portfolio that you purchased. The initial coverage is a little bit skinny, less than 1.1, but, you have some lease-up potential there. Can you talk about, specifically, what Emeritus is doing to drive the lease-up there, and maybe how much of their CapEx commitment is going directly to those lease-up communities?

Yes. Let me give you the silver bullet, here. They have managed this portfolio for two years. In those two years, there has been $42 million invested by the venture. As we sit here, today, that has gone into transitioning 52% of the communities, so that those are now branded Emeritus.

The flip side of that, is that 48% of this portfolio, today, 48%, Jeff, is not branded with Emeritus operating discipline. So, what you will see -- this $30 million that has now been funded as a part of this transaction to Emeritus -- you will see them finish off the job, if you will, in the next 12 months. You will see them invest that $30 million to convert the remaining 48% of this portfolio into branded Emeritus communities.

This is why it was so important, when Paul and Kendall and their team were structuring the transaction, that we had an indirect participation in this cash flow. Because, you can see in the first two years, for where they had invested the capital, they had an occupancy spike of 800 basis points.

Yes.

So, by structuring the transaction so that we have indirect participation, not one, but two ways. Number one, we have got these outsized escalators in the first couple of years starting at over 4%, averaging 3.7% annually for the first five years. And, then specifically on the lease-up portfolio, which is going to get the majority of this $30 million CapEx, we have the right after five years to move that rent to market, subject to a cap of 30% of the prior-year, which would be the year five cash flow.

Right. And, do you have a sense for what the overall occupancy is an those and those lease-up markets? What do you consider to be stabilized occupancy? I know those markets aren't necessarily top markets, they are more secondary type markets, is my understanding.

Well, the occupancy -- I think that was all in the press release, Jeff. The occupancy in the lease-up component of the 133 properties was 74%, 75%.

What do you anticipate stabilize -- once Emeritus go goes through that transformation and brands all the communities and all that, where do you see that going and over what timeframe?

I think you could see that, certainly moving up to 80% and then overtime 85%. Again, I would go directly to where we set that fair market value reset at the end of year five. We think it will take a few years to move that component up. This is one of many reasons why we are so excited about this transaction.

Okay. And then, one last follow-up on the coverages. So, initially, again, it's a little low. Can you just talk about what you project out over the next, kind of at the end of year two and three. How fast that coverage moves up?

I think it's instructive for you to look at the pace of the annual escalators in the first couple of years. I think that direction will give you a sense as to how fast those coverages are going to move up.

Okay. Great. Thanks very much.

Rich Anderson.

Jay, just to that last question, there. You said look at the escalators to figure out how the coverages are going up. I don't quite understand that. If your rent escalators are going up, their profitability has to go up by a commensurate amount to maintain coverage above one. Am I misunderstanding something? Can you explain that last comment you made?

Well, if you wanted to maintain one, but we are not interested in maintaining one. You will see their cash flow go up, not commensurately, you'll see the cash flow go up at a faster rate, Rich.

And that's because of the deployment of the CapEx, but what's the long-term prognosis for this -- in part because of that -- what's the long-term prognosis from a CapEx perspective? I mean, I get the $30 million isn't really deferred maintenance, it's more of a rebranding initiative --

It's part rebranding, part some repositioning, some expansion. Again, we are very fortunate. We have perfect information, because, we have seen the Blackstone JV invest $42 million and get phenomenal returns on that investment. Then, we, ourselves, have seen what has happened when we have transitioned properties to Granger Cobb and his team with respect to not one, not two, but three portfolio transitions we moved from Sunrise that included initial CapEx spend that we funded and we've been able to monitor the very strong results that Granger and his team have affected.

We have got a proven commodity, here. We've got a racehorse in Granger and the Emeritus team that has demonstrated on multiple occasions with multiple portfolios the ability to transitioned properties, rebrand them with Emeritus and grow cash flow. We have seen that in this portfolio, with respect to the stabilized component of that. Now, with the benefit of the incremental $30 million that Emeritus will fund into our triple net lease structure, you will see the lease-up component come up, as well.

Okay. So, if your rent escalators are averaging 3.7 in the first five years, you are saying that they are going to grow rental revenue at the property level by something more than 4% over that same time frame? It's going to be even greater than that, is that what you are telling us?

Exactly.

Does the coverage include the kind of recurring CapEx that will happen after the $30 million? And what is that number? Is it $1500 a unit; is it $1000 a unit? What would you say the number is?

Well, our triple net coverage is because, again, this goes into our orientation towards, when you look at triple net structures, you have that CapEx responsibility is a responsibility of the tenant. So, our coverages wouldn't pick that up. If we were in a RIDEA structure, it's much more relevant to look at economic cap rates. Because, there, the CapEx is a liability of the landlord, the REIT.

In this case, the CapEx is a liability of the tenant so it's more instructive to look at nominal coverage ratios. But, once the $30 million is invested, in the next 12 months to transition and rebrand the remaining 48% of this portfolio, I think you're probably looking at the next couple of years as being plus or minus $500 a unit and then that will grow overtime.

That low, okay? For a class B, C portfolio. Is that the right way to think of it, class B, C, maybe?

It depends what the B and C refer to. If the B and C refer to not top MSA-31 market, I think that's fair. These are A-quality properties. They are in secondary markets. For example, I give you two points of comment, there. If you look into Emeritus's strategic plan as disclosed in their annual report and their most recent Q, they specifically target this middle market, the market segment that they feel is most attractive to them, which is smaller cities and suburbs with populations of 50,000 to 150,000 people.

So, when we've transitioned the portfolios that we've transitioned, we have seen them extract and get those portfolios performing by an order of magnitude better than had been previously the case. So, I would be careful with B and C. If B and C are referring to not a top size MSA-31 market, that's fair. But these are very, very high-quality properties.

Paul and I visited one in the Preston Hollow section of Dallas, which is literally located next-door to the Carrell Clinic. Preston Hollow is one of the more affluent parts of Dallas. The Carrell Clinic would be Dallas' version of the Mayo Clinic. You've got some very high-quality real estate, here. But, they are located in size markets that are the next tier down than the top MSA 31 markets.

Fair enough. Just so I understand -- call it 1.1, or 1.08 or whatever the number was, the coverage coming out of the gate. If you were to include CapEx in that analysis you would be below 1. I'm not suggesting we should do that -- but at least for the time being, it's going to be a below 1 cash flow coverage at the property level including CapEx.

Yes. I think that would be relevant, Rich, if we were acquiring this subject to a RIDEA structure. You've got to change your orientation, here. There's RIDEA and there's triple net. They have different economic responsibilities between the landlord and the operator tenant.

Paul, did you want to add something.

Yes. I think, Rich, when you look at what will have been spent over a 4-year period, they are going to spend $7000 a unit. We did underwrite into our rent steps and into our rent reset in the fifth year, over $1000 a unit in CapEx that the landlord would be spending and took that into consideration when we negotiated what those rent bumps will be.

Okay. Thank you very much for that. Just a last question on HCR ManorCare. When you have a situation like property level rent coverage is at 1.04 times and the fixed-charge OpCo coverage is 1.29 times, why would HCR ManorCare I mean just kind of -- rhetorical question -- but that's weighing down their profitability, right? The 1.04 versus the 1.29. Is the CapEx that they are going to spend -- is that recognition of this and they want to get that 1.04 up to something that's more in line with what you are seeing at the fixed charge level? Is that a fair way to think about it?

Remember, HCR's business model is quite complex. They create multiple cash flows out of our properties that they manage. So, they've got a variety of the ancillary businesses that produce very substantial capital. You heard Paul's comments -- for the period of time ended September 30, 2012, which was the 12-month period most impacted by the changes from August 2011. They still generated, after rent obligations to HCP, $130 million of cash flow. So, this is a very, very significant business. It is our properties that allow them, in large part, to create the value for their shareholders.

But, not debating that at all, about the quality of the company, but 1.04 versus 1.29, they don't want a lower profitable business if they can avoid it, right? So that's the reason for the CapEx? To close that gap? Is that what's going on?

I think I made -- in response to a question earlier. What you have seen here, is a significant change in this Business, the post-acute, just in the last 12 months. Everybody took a look at the 11.2% cut, which we never underwrote any of that in our underwriting. What, only now, with the benefit of perfect hindsight that people can now see for the industry, is the cut, the net effect of the cut was far greater than 11.2%. You had very significant changes, increases, in the cost structure that related to the group in concurrent therapy.

So, you are now experiencing trough coverages. If you use the 12 months ended September 30, 2012 -- now, recall, we only have the 12 months ended June 30 in our supplemental, so, we are kind of giving you a heads-up on what we will report the next quarter. If you look at these coverages for the 12 months ended 9/30/12, this represents a troughed coverage. In the fourth quarter calendar quarter you will see the coverages start to come back up.

Notwithstanding that, with the changes to this Business, this Company has aggressively, A, generated cash flow, B, invested much more cash flow than they were required to under the lease, and C, are now in a position -- and this is why I reference the HCR version 3.0 of this business model, to really play offense in 2013 and '14 with what will likely be, as part of the grand bargain with whoever is the new President, and whoever is sitting in Congress, the beginning of some serious health care reform.

Very good. Thank you very much, Jay, you are one fighting Irishman.

(Operator Instructions).

Durell Galati.

It's actually Paul Morgan here with Durell. Just going back to the Emeritus, maybe I could ask it slightly differently. So you've got 12% to 13% rent growth in the escalations before it stabilizes -- what are you underwriting for your coverage at the end of that period. How are they going to get the growth in excess of the -- where is that going to come from? I know you talked about the $30 million investment. Are there any incremental units? Is it growth in occupancy? Occupancy seems pretty high for the stabilized portfolio. Is it just rent upside from the facelifts of the assets? Any color about that?

Yes. Paul, in terms of the underwriting assumptions, it's really very mild growth, about 3% upside in rent growth and about 100 basis points in occupancy pick up.

Then, where would that leave you in terms of coverage at the end of year four?

My guess is that you are probably bouncing between 110 and 115, notwithstanding the out-sized annual bumps in rent.

Okay. Great. All my other questions were taken care of. I just want to make sure -- you said what you'll put next quarter in terms of the HCR ManorCare coverage should be the trough and then we should go from their based on the same type of reporting that we're seeing?

Yes. We already told you what it was. In Paul's remarks, he's already gone fast forwarded to September 30 numbers. Recall that we report these numbers on a three-month lag. But, again, we've got those numbers and have communicated those to you on this call, this morning and have also noted the rather aggressive actions HCR has taken with respect to reinvesting in it's business model and the very strong level of liquidity that they have can currently.

Great. Thanks.

Ross Nussbaum.

I'm here with Derek Bauer. Two questions on the Sunwest portfolio. First, Jay, where do you peg your acquisition cost relative to replacement cost?

I think, overall, Ross, I think we are -- I don't have the number in front of me -- I think we're about $157,000 a unit. I think that number was a little higher on the stabilized portfolio and a little lower on the lease-up.

To be honest, I think that's probably right around replacement cost, Ross.

Okay. I appreciate that. If I look out five years and I think about the benefit you're going to get from not just the contractual rent bumps but the potential rent reset on the lease-up facilities, based on your underwriting, where do you see the yield on this portfolio in year five?

Well, we negotiated very hard for a higher cap than 130% of year-five rent and Emeritus, to their credit, negotiated -- would've preferred something lower. We settled at 1.3. If you just assume that it goes to the cap, I think the five-year compounded annual growth rate in NOI grows to 4.7%.

So, if I take 4.7% compounded for five years, you are suggesting that will get me to the right answer?

That would be the number -- remember, with the sharing, HCP is sharing with Emeritus. So, obviously anything north in the scenario where we hit the max on the cap in year six rent for the lease-up of the year five cash flow, we would be cap maxed out at 130% of that number. That would calculate out to, over that five years, a 4.7% compound annual growth rate, which obviously, in the context of a triple net structure, where the CapEx liability is the responsibility of the tenant, from a risk-adjusted return standpoint, is very, very attractive return for HCP shareholders.

Okay. If I switch over to HCR ManorCare, I was looking back at the coverage ratios a year ago, at least, as you reported them at 12/31/11. And at the OpCo, the coverage was 166, at the facility level, it was 137. So, we are talking, give or take, call it 35 basis points of erosion in those metrics. I guess, the question I would have is, there was a lot of talk over the last year about how HCR ManorCare was going to mitigate the reimbursement change. I'm not seeing a lot of mitigation in the numbers that you are reporting. Based on some of your comments, you are suggesting that, perhaps, some of that mitigation will start showing up going forward. I guess my question is, why is it going to start showing up going forward? Why hasn't it already shown up?

Again, I don't know if you heard the answer to the previous question. They did a great of mitigating the 11.2%. The problem was, and it wasn't just a problem unique to HCR, it was endemic in the industry, the real economics of the August 2011 CMS reductions were far greater than the RUGs-IV benefit going away. They included a substantial increase in the cost structure because of the group and concurrent therapy cost increases. So, now that you've seen the benefit of the full 12-month affect, you've basically seen a 1.5 underwritten coverage decline to 1.3, if you eliminate the prior-year 2006 to 2010 insurances, you're at 130.

Basically, that increase, you can now quantify with the full year of the impact of this new business model as 20 basis points of the incremental cost associated with the August 2011 CMS announcement. Fast-forward to where we are today. We are now in the fourth quarter. They're going to get an increase -- they have already gotten the increase of 1.8%. We will see what happens with sequestration in the new year. But, that's why I have indicated you ought to think about these coverage ratios as of September 30, 2012, as trough level coverages.

Notwithstanding all that, they have aggressively moved to reinvest in the business, because the business model is going to be different in the next couple of years. You are going to see whether you get block grants to the state or not. You are going to see cost sharing; you are going to see some capitation, probably some bundling. This is a business model that, within the cluster markets that HCR operates in, is going to have very much of the Affordable Care Act, some of the dimensions in terms of accountable care organizations and things like that.

You are really seeing a very dynamic change in this market. I would say, if you look across our five sectors, right now, you've probably got more going on in this post-acute setting, right now, as people position for what could come out of a grand bargain scenario next year than in any of our other four sectors.

And, just one final question. What is your contractual rent increase in 2013, those HCR ManorCare assets?

It's 3.5% each year for the first five years.

Okay. Thank you.

Rob Mains.

Just a couple of quick ones. First of all, Emeritus -- the lease does that have any purchase options embedded?

No, it doesn't, Rob.

Okay. And then, just as follow-up, yet again on ManorCare. Given what you are seeing as the opportunities there, would you be interested in, is there some CapEx spending that you did in the quarter. How interested is HCP in doing more on that front with ManorCare? Would they prefer to fund it themselves?

I'm sorry, we didn't do any CapEx spending, Rob. That was all funded by HCR.

I realize -- but, HCP has done CapEx spending generically. Would you be interested in doing more with ManorCare? Or do they want to just do it themselves?

I'm a little confused. These are triple net lease structures. The CapEx responsibility is the responsibility of the tenant, much like the Blackstone JV transaction we just announced where Emeritus is our partner in a triple net structure. When we do CapEx spending, we will do that in our medical office, where we will do TIs or potentially in a life science space. Under triple net structures, the CapEx is the responsibility of the tenant.

Right. I think we are defining CapEx differently. If ManorCare wants to expand a facility or build a big new gym, and it's going to be $2 million or whatever, $5 million, whatever, to do it -- that would be an opportunity for you to invest additional funds in the facility and then get, I assume, the same return on that investment that you are getting on the current lease. Is that something that HCP is interested in?

Well, first of all, it's HCR, not ManorCare. Secondly, sure we be interested. But, HCR has substantial liquidity. My guess is, that they've got higher and better uses for liquidity than to be adding to the rent obligation to HCP. But, certainly were they to come to us to have that discussion, which they have not -- they are generating substantial amounts of cash flow in excess of their rent obligation to us, and they are sitting on substantial amounts of cash liquidity. So, that's not a discussion that has taken place.

Okay. Fair enough. Last question. Given your comments about what you see as the opportunities in that sector, has your view of new investments in skilled nursing changed?

No. I think anytime you get an external shock to a system, that is a catalyst for M&A activity. The August '11 CMS announcement was a major shock to the system. I think, for the first couple of quarters, people limited the impact of that to merely the RUGs-IV benefit that existed for fiscal year 2011 as going away in fiscal year 2012. The reality is, given the increased cost structures with that CMS announcement, the impact was far greater.

As HCR and other leading players have retooled their business model, I continue to believe you will see significant consolidation in this space. By the way, I think you're going to see, as I've said in my prior comp calls, you will see significant M&A consolidation in some of the other spaces, as well. That will be for different catalyst reasons. In this case, it all starts with the August '11 CMS announcement.

Fair enough. Thank you.

John Roberts.

You mentioned the impact of the storm. I know it's early in the evaluation process, but are you liable to see any charges on that or it's covered by insurance? Or are the tenants going to be the ones that cover any potential damage?

Gee, we haven't even -- the two Sunrise communities that I pointed out -- I have been back-and-forth with their CEO, Mark Ordan, several times this morning. In fact, his mom is a resident in the community that got evacuated yesterday. So, all we are focused on right now is the safety and protection of the residents.

Sure. I understand that. But, basically, what I'm looking for, is there liable to be any charges based on potential damage? I mean, you've got those two but there's a lot of others you have on the East Coast. (multiple speakers).

For the most part, you know, in a triple net structure, first of all, we have significant insurance coverage.

Okay.

Secondly, most if not all of those properties -- there are some and MOBs, by the way, that have some minor flooding. Most of those are triple net structured. Again, we are not even thinking about that. We're making sure that the residents -- the very dear residents in these senior housing communities are safe and protected, and to the extent we've had to evacuate them, making sure that they are in an equally safe and protected and caring community.

Obviously, that's the first worry. Okay. Thanks, Jay.

Thank you. I will now turn the call back to Mr. Flaherty, CEO. Please go ahead, sir.

Thanks, Suzette. Thank you, everyone. Again, especially for those of you that are impacted by the storm. I would leave you with three thoughts. One, please, please, please be safe. Two, please go out and vote next Tuesday. Three, go Irish. Thank you.

Thank you. This concludes today's conference call. You may now disconnect.