Healthpeak Properties Inc (PEAK) 2018 Q4 法說會逐字稿

Good afternoon, good morning, and welcome to the HCP, Inc. Fourth Quarter Conference Call. (Operator Instructions) Please note, today's event is being recorded. At this time, I'd like to turn the conference over to Andrew Johns, Vice President of Finance and Investor Relations. Please go ahead.

Thank you, and welcome to HCP's fourth quarter and year-end financial results conference call. Today's conference call will contain certain forward-looking statements. Although we believe these expectations reflected in any forward-looking statements are based on reasonable assumptions, our forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from expectations. A discussion of risks and risk factors is included in our press release and detailed in our filings with the SEC. We do not undertake a duty to update any forward-looking statements.

Certain non-GAAP financial measures will be discussed on this call. In an exhibit on the 8-K we furnished at the SEC yesterday, we reconciled all non-GAAP financial measures to the most directly comparable GAAP measures in accordance with Reg G requirements. The exhibit is also available on our website.

I will now turn the call over to our President and Chief Executive Officer, Tom Herzog

Thanks, Andrew, and good morning, everyone. With me today are Pete Scott, our Chief Financial Officer; and Scott Brinker, our Chief Investment Officer. Also here and available for the Q&A portion of the call are Tom Klaritch, our Chief Operating Officer; and Troy McHenry, our General Counsel.

Through our efforts over the last few years, HCP is well positioned. We completed our portfolio restructuring and operator transitions, leaving us with a balanced portfolio and a clear and differentiated strategy. Additionally, our balance sheet is strong and positioned to support our growth strategy. The recent credit rating upgrades from S&P and Moody's confirmed the progress we've made on this front. Across our 3 core segments, we continue to see plenty of opportunities to capture embedded upside in our portfolio, and to create new value over time with development and redevelopment and complementary acquisition activities. Specifically, in medical office, tenant demand for on-campus properties remains strong. We're working to fill vacancies within the portfolio and seeing positive mark to markets on rents. We continue to mine our portfolio for redevelopment opportunities and we are also actively working with HCA to schedule additional on-campus developments in our partnership program. In life science, we’re focused on sourcing complementary acquisitions and creating value through our development pipeline. Late last year, we expanded this pipeline for a compelling opportunity to capture value at The Shore at Sierra Point. We added a combined $385 million for Phases 2 and 3, resulting in a $1.2 billion pipeline, which is higher than normal for us, but allows us to pursue the opportunities we have worked hard to create. Even including the just commenced Phase 2 and 3 of The Shore, our pipeline is almost 65% pre-leased and approximately $500 million is already funded. The remaining $700 million of the development costs will be spent over the next 2 to 3 years and is captured in our guidance.

In senior housing, Scott and his team are positioning our business for success. In 2019, you'll see us continue to work to make incremental moves, improve our portfolio and operator mix, while supporting our platform with enhanced asset management capabilities and data analytics. We've come a long way in the last 2 years, but there is still plenty of room for additional improvement and upside and we intend to pursue them aggressively.

Moving on to our outlook for 2019. As we reported last night, we are guiding to a solid total portfolio same-store growth in 2019. Over the last 9 months, we have communicated our expectations for choppy near-term Senior Housing fundamentals. As Scott will elaborate in a moment, we are feeling pressure on both occupancy and expenses, but we’re also navigating the headwinds that was a result of a number of intentional moves we made to improve our portfolio and position us for the long-term. Accordingly, we still anticipate noise in 2019 SHOP results, but fully expect our Senior Housing business will stabilize and be a strong growth engine over time. We have been very deliberate in our portfolio repositioning to build a company with diversification designed to maximize long-term growth, while reducing short-term volatility. We do recognize that each of our businesses operates within its own cycle and accordingly, segment-specific growth rates will inevitably vary. But our primary focus at HCP is and will continue to be on the overall blended growth our portfolio can deliver.

Turning now to the team. I'm very pleased with the way our senior leaders, and their teams, have come together. With all the major players now in place, we are now able to fine tune and are now formalizing certain responsibilities. First, I've asked Pete Scott to formally lead our life science platform in addition to his role as our Chief Financial Officer. While we're announcing this today, Pete has functioned as the life science lead for the last 6 to 9 months, and is instrumental in leading the operations and strategic transactions during that time, including the sale of the Shoreline campus. And he has quickly built relationships with key customers and partners. Pete leads a team of very experienced life science senior professionals that have an average tenure in the industry and at HCP of nearly a decade. Second, in addition to his role as Chief Operating Officer, Tom Klaritch has also assumed the role of Chief Development Officer. As we've increased our development and redevelopment activities, we determined that centralizing management under Tom allows us to scale our resources and ensure we are using consistent best practices across all 3 of our businesses. Third, we announced the Executive Vice President promotions for Shawn Johnston, our Chief Accounting Officer; and Glenn Preston, who leads our Medical Office business. Shawn and Glenn's promotions reflect the leadership and expanded responsibilities we have assumed within our organization. We're also pleased to announce that Jeff Miller recently joined HCP within our Senior Housing team. For those of you who don't know Jeff, he brings tremendous experience to HCP, having spent over a decade at Welltower, in roles including General Counsel and Chief Operating Officer. During his time at Welltower, Jeff worked very closely with Scott Brinker. At HCP, Jeff is responsible for day-to-day operations of our Senior Housing finance and asset management teams, and reports directly to Scott, who continues to lead our Senior Housing business. Jeff is an excellent addition and bringing him on is just another important step in strengthening our Senior Housing platform.

Before handing the call over to Pete, I'd like to provide a few board, governance and sustainability updates. During 2018, we welcomed Lydia Kennard, Kent Griffin and Kathy Sandstrom to our Board as new directors, and appointed Brian Cartwright as our independent Chairman. We also adopted a mandatory retirement age of 75 for directors, a policy in line with corporate governance best practices and one that ensures natural continued board refreshment. On the sustainability front, HCP has proven itself an industry leader and continues to build on the progress made, since committing to focus and environmental, social and governance initiatives over a decade ago. The recent efforts were again recognized by a prominent ESG reporting organizations, and for the seventh consecutive year, HCP achieved the Green Star designation from GRESB and was named a constituent in the FTSE 4 Good Index. Additionally, for the sixth consecutive year, we were named to the Dow Jones sustainability Index and CDP's leadership panel. Our cumulative efforts related to our ESG initiatives have resulted in an ISS environmental score of 1, social score of 2 and an overall governance quality score of 2. These results reflect the hard work and emphasis this team places on pursuing our ESG initiatives.

With that, I'll turn it over to Pete to discuss our financial performance for the quarter and 2019 guidance. Pete?

Thanks, Tom. I'll start today with a review of our results, provide an update on our recent capital markets activity, and end with a discussion of our 2019 guidance and related assumptions.

Starting with our fourth quarter results. We reported FFO as adjusted of $0.43 per share and blended same-store cash NOI growth of 1.5%. Full year 2018, we reported FFO as adjusted of $1.82 per share and blended same-store cash NOI growth of 1.4%, both of which were slightly above the midpoint of our guidance range. Let me provide more details around the full year results.

Medical Office, which represents 30% of our same-store pool, we reported cash NOI growth of 2.1%, which was in line with our guidance range. In 2018, we executed leases of over 2.6 million square feet of space, the highest volume of leasing activity in our history.

Turning to life science, which represents 23% of our same-store pool, we reported cash NOI growth of 1.5%. This was above the high end of our guidance range, and driven by better leasing and occupancy. On a normalized basis excluding the Rigel lease mark-to-market, cash NOI growth would have been 4.5%, which underscores the current strength of the life science segment.

For our other property segment, which is primarily our hospital portfolio and 9% of our same-store pool, we reported cash NOI growth of 3.2%, which was above the high end of our guidance range. The strong performance for the year was driven by the results at our Medical City Dallas campus.

Moving on to our Senior Housing segment. It is important to emphasize that approximately two thirds of our Senior Housing portfolio is currently structured in triple-net lease arrangements. Within this segment, which represents 28% of our same-store pool, we reported cash NOI growth of 2%, which was above the high end of our guidance range. This result was driven by better than expected add rents in our Sunrise portfolio. In our SHOP portfolio, which represents 9% of our same-store pool, we reported NOI growth of negative 3.8%, which was at the low end of our guidance range. As we have previously discussed, it is important to differentiate between the performance of our core portfolio and our transition portfolio. Growth in our core portfolio was solid at positive 1.7%, but those results were more than offset by our transition portfolio, which declined 17%. A quick note on the fourth quarter performance for our transition portfolio. NOI declined year-over-year from approximately $6 million to $4 million. This translated into a large percentage change, however, given the small size of the pool, the financial impact was only approximately $2 million. Additionally, we were encouraged by the 30 basis points of sequential growth in occupancy. This growth is driven primarily by 350 basis points of sequential growth in occupancy from the initial 7 assets we transitioned to Atria, and points to the upside potential as new operators stabilize performance.

Turning now to the balance sheet. We made tremendous progress reducing leverage and improving our credit profile. In the fourth quarter, we used the proceeds from the Shoreline and the Apollo transactions to repay $1.2 billion of debt. These actions resulted in credit upgrades to BBB+ from S&P and Baa1 from Moody's, along with a move to positive outlook from Fitch. At the end of the quarter, we reported net debt to adjusted EBITDA of 5.6x, and we had $1.9 billion of availability under our line of credit. During the quarter we were also active in the equity markets. We raised approximately $656 million, consisting of $156 million on our ATM and $500 million in a follow-on issuance, the majority of which was structured as a forward offering. This was our first follow-on equity deal in 6 years.

Turning now to our 2019 guidance. We expect full year 2019 FFO as adjusted to range between $1.70 to $1.76 per share. During 2018, we completed our major capital recycling transactions. This resulted in a diversified high-quality portfolio that we believe will generate superior risk adjusted growth over time and a more predictable earnings stream. However, as we previously disclosed, there is a significant carry-over impact in 2019 from these activities as well as from our balance sheet improvements, our ramp up in development and redevelopment activities and our Senior Housing operator transition. All of these positive actions will result in a stronger better positioned HCP, but in the near term, do result in some drag in earnings.

On Page 48 of our supplemental, we have included the detailed assumptions embedded within our 2019 guidance. I would like to take a moment to expand on 4 items: first, we have currently assumed a mid-year refinancing of our $800 million 2 and 5/8 notes due February 2020; second, we have assumed $600 million to $700 million of development and redevelopment spend. This amount is elevated relative to 2018 in order to capture significant value creation opportunities. Third, we have assumed $900 million of acquisition activity at an initial blended cash cap rate of 5% to 5.5%. And finally, we have assumed $500 million of asset sales at a 6.5% to 7.5% cash cap rate. We expect to fund our remaining capital needs through the drawdown of our $430 million equity forward and utilizing our excess debt capacity. Combined, these four key strategic decisions result in about $0.03 to $0.04 per share of headwind to FFO in 2019. However, as we have said consistently, our goal in 2019 is to create a strong base year with a high-quality portfolio that we expect to grow off of going forward.

Turning now to our SPP assumptions. We are guiding to blended cash NOI growth of 1.25% to 2.75%. We will update and reaffirm this range throughout the year based on performance. The components of our blended growth rate are as follows: Medical Office at 1.75% to 2.75%; life science at 4% to 5%; other at 2% to 3%; and Senior Housing at negative 1.5% to positive 1.5%.

Finishing now with some additional disclosure items. As part of our ongoing commitment to improve the reporting usefulness for our 3 core lines of business, we have made a few important changes. First, with regards to Senior Housing, we are now combining our triple-net and SHOP portfolios for purposes of guidance. However, we have disclosed that our guidance range was derived at the midpoint based on expected triple-net growth of positive 2% and SHOP growth of negative 5%. Second, we added a summary table for our blended Senior Housing SPP growth in the earnings release. For the full year 2018, our blended Senior Housing SPP would have been positive 50 basis points. This should provide some useful context as to how our 2018 performance compares to our 2019 guidance. Third, we expanded disclosure for our Senior Housing business. This quarter, we have provided additional quarterly detail pertaining to our core and transition SHOP portfolios.

See page 34 of our supplemental. Finally, effective Jan 1, 2019 we are reclassifying Medical City Dallas within our MOB segment. This property is a fully integrated medical campus, and we determined that surgically splitting the income into 2 separate reporting segments as we had done in the past, was not consistent with peer disclosure or how these assets would be valued in the private market.

With that, I would like to turn the call over to Scott.

Thank you, Pete. There's a lot to cover on the investment front, where we’re using our deep relationships to acquire and develop well-located real estate, where HCP and its partners have superior expertise. For example, in life science, we're expanding our footprint in Boston through our relationship with King Street. In January, we recapped their property at 87 CambridgePark Drive in West Cambridge. The asset has a superb location, just a 1 minute walk from the Alewife T-stop. The $71 million acquisition comes with a near-term mark-to-market opportunity and should produce a 6% stabilized cap rate. In a separate but related transaction, also being done with King Street, we acquired a big land parcel that is directly adjacent to the acquisition property in West Cambridge. Within the next few years, we intend to develop a second building, creating a Class A campus. We're also expanding in the 2 premier life science markets on the West Coast. In November, we acquired our JV partner’s minority interest in 4 buildings for $92 million. 2 of the assets are located in Torrey Pines, the leading submarket in San Diego. The other 2 buildings are located in South San Francisco and are nearing the end of a successful redevelopment. We've already leased the vast majority of the space, and expect to achieve a 6% stabilized cap rate on the 4 property JV buyout.

Also in November, we went under contract to acquire Sierra Point towers for $245 million, which is a 6% stabilized cap rate. The towers are highly strategic to us, given the campus is next door to our development at The Shore, a project that has tremendous momentum. The acquisition includes excess surface parking, so we can densify the campus over time. With the strategic and coordinated capital deployment, HCP is creating a Class A life science campus with more than 1 million square feet.

Moving to Medical Office, we're working on a number of potential on-campus development opportunities with HCA. We expect to announce new projects in 2019 and beyond driven by a 20-year history of working together successfully. The transformation underway in our Senior Housing business is equally compelling but harder to see, because we had to take 2 steps backward to take 3 steps forward. The HCP Senior Housing business that is being created will be unrecognizable from what existed previously. The entire business is being transformed - portfolio, operators, markets, deal structures, the team, and systems. In 2018, we took decisive actions that, while dilutive to earnings in the near term, were absolutely necessary to create a winning Senior Housing business over time. We sold $1.5 billion of non-core Senior Housing last year, and that's in addition to the $2 billion sold in 2017 - what remains is a higher quality real estate portfolio. We transitioned 38 properties to new operators, who are completely focused on capturing the embedded upside - we're now seeing a nice lift in occupancy from the first wave of transitions last March and expect continued improvement moving forward. We added 2 best-in-class operating partners: Discovery and LCS. Relationships like these would be incremental to our success in Senior Housing. We put 10 well-located but older assets into redevelopment - the enhancements will position these buildings to perform over the long term. We exited or went under contract to exit 5 very small operator relationships - this will help make our platform more efficient.

Finally, we built out systems and remade the org chart, including adding Jeff Miller to lead Senior Housing asset management. I know first hand that he's a great addition to the winning culture being built at HCP.

Moving to the fundamentals in our 3 core segments – the medical office outlook in 2019 remains solid, and life science fundamentals remain very strong, with demand exceeding the supply. We continue to be cautious about Senior Housing in 2019. I'll provide some additional color because there's a longer term story that's very relevant. We expect rents to grow in the 3% range in 2019, but wages are likely to grow at least 4%, due to low employment and high demand for well-trained staff. Importantly, Senior Housing is a very local business - and in many of our SHOP trade areas, the number of new deliveries in 2019 will exceed prior years, which will pressure occupancy.

Taking a step back, we're encouraged by 3 important trends: first, the penetration rate is growing, as the physical, cognitive and social benefits of Senior Housing are becoming better understood; second, new starts have declined to a level where supply and demand should be more balanced within the next 2 years; and finally, the growth rate for the 85-plus cohort, which hit a trough in 2018, is now at the very beginning of an upward slope that will gather momentum over the next 10 years and act as a tailwind for several decades. I'll now turn the call back to the operator for Q&A

(Operator Instructions) And our first question today comes from Nic Yulico from Scotiabank.

So the first question is just on development and redevelopment. You talked -- you have a $600 million to $700 million to spend in the guidance, and in the development page, you only have $750 million left to spend on everything that's listed there. So what are you assuming in terms of additional projects being started? How should we think about that?

Nic, this is Tom Klaritch. As we look at the HCA development program, we’ve kicked that off. Right now we have 1 project that is announced, we've got 3 or 4 that we’re in discussions with and there's a pipeline behind that that will be coming to the schedules later. Life science, as you know, we accelerated the start of Phases 2 and 3 of The Shore, because it's been such great leasing activity there. And there is anticipated several Senior Housing projects as we move forward. So we would look at 2019 being a fairly big year because of the acceleration of those projects at the $600 million to $700 million range, and then we have a solid pipeline of about $500 million a year for the next 2 to 3 years at a minimum.

Okay, so I guess, assuming that you started additional projects with HCA or some other projects, I mean, can you remind us how you think about the timing of -- for spending money in the next year, when would those projects come online from an NOI benefit standpoint?

Usually, you're looking at, in a medical office development, about 12 months to build the shell and core, it's about 6 months later to build out the tenant improvements on the initial lease. And then we look at the 2- to 3-year lease up to stabilization. Life science we've seen a lot better activity in leasing so many of these projects that we're starting have -- or are in process are 100% leased. We have very good leasing activity. So a little bit longer on the shell and core on those and design, it's probably 18 months to 2 years, and then lease-up, similar, you know, 6 to 9 months.

I wanted to say too, one more thing, if you look at our investor deck, there is a nice page that goes over all of our active developments, but there is also a shadow pipeline, that's not within our active pipeline. There are some projects, a lot of it's in life sciences as well, BML 3, we've got our Forbes site as well in South San Francisco, we've got some land in Torrey Pines as well as another site called Director's Place, which is near Torrey Pines as well. And then on the 101 CambridgePark Drive acquisition that we announced today, that is a piece of land that we'll also will put into our shadow pipeline. So we've got a nice robust active pipeline but also, we're backfilling the shadow pipeline.

Okay. Just last question is on the dividend. It hasn't been raised in a while. The guidance for the year assumes it's not raised again. You have talked about -- this is a transition year, you will eventually return to growth, I mean, how should we think about how the board's thinking about getting back to dividend growth? And just also wondering why it was assumed that, even at the end of this year, there wouldn't be any dividend growth -- dividend raise?

Nic, this is Tom Herzog here. Fair question. Where we stand right now is with the restructuring that we did, the dividend coverage is little higher than what we would consider ideal, and we will grow back into that dividend as income growth starts to recur in 2020. So I would say this year, even as we get into next year, we have to make another assessment as we go into 2020. But we'll probably capture some additional coverage before we increase the dividend is my guess, but that is a future board decision.

Our next question comes from Jordan Sadler with KeyBanc Capital Markets.

I wanted to just touch base on some of the acquisition and distribution activity baked into guidance for 2019. Curious around the acquisitions, how much of that is already baked? And then what types of assets would be already in their -- sorry, what types of assets are you looking at?

Hey, Jordan, it's Pete. Why don't I just quickly touch on the sources and uses, and then I'll talk about the acquisitions and dispositions, and Scott may jump in if he has some additional color to add. But from a uses perspective within our guidance, we've got acquisitions of -- we said $900 million; development and redevelopment at the midpoint of $650 million, and then the balance is a couple hundred million of capital spend. That all adds up to $1.750 billion. The funding of that is through non-core sales of $500 million, which was within our guidance. The drawdown of our equity forward of $430 million, and then the balance of that to get to $1.750 billion is some additional debt capacity we have, we ended the year in the mid-5s. We have capacity to go up into the high-5s. When you think about the acquisition of $900 million, some of that's already been announced. We announced the CambridgePark Drive acquisition today, 87 and 101 as well as Sierra Point towers, that's about $350 million combined. So the balance in that $900 million is stacked and we've got a nice pipeline of things that we're looking at right now. Nothing specific to disclose. On the disposition side, the $500 million -- $100 million of that is actually already closed. It was non-core Senior Housing stuff, and then we had land that closed in January already. And then within that is the U.K. final piece of about $100 million. So the balance of $300 million is just general pruning within the portfolio, but important to just think about those components.

And I would add, Jordan that most of that has been identified. We're not ready to provide the details, but we do have a game plan around that.

Okay. And then just as a follow-up for Scott. I sense a little more optimism or a little bit of a more positive tone on Seniors Housing. I wonder if you are in reading that correctly, what are you looking at that in the future? It seems like that way to me reading between the lines. Anything else you might offer that you're seeing at the property level as you have gone through this process of transitioning the portfolio and transitioning to new operators and just making your way through it to a greater extent?

Happy to answer that, Jordan. I would say that, there continues to be pretty wide disparity among markets and operators. We have a number are performing quite well even in the current environment. But overall, we still see 2019 as a challenging year for HCP, at least in part because of the carryover impact of the transitions, which are starting to show improvement, which is one of the reasons for optimism. There's a lot of upside there to be recaptured. I think we will start to see sequential improvement in that portfolio in 2019. I would just point out that the year-over-year growth rate will almost certainly be negative for at least the first half of that 2019, just to be clear on that. But we are seeing improvement sequentially, and I think by the end of the year, there's a good chance that you'll start to see year-over-year increase in the NOI growth, and hopefully into 2020 and 2021, rather than down 33 steps, you’ll see some materially positive percentage increases for growth. But again, it's a relatively small dollar amount, in absolute dollars, we're only talking about $4 million in that transition portfolio in 4Q. But the growth rate surely sticks out, and we're optimistic that in 2020, 2021, it will stick out as well, but with a positive number in front of it. So the optimism is we're looking into 2020 and 2021, Jordan. I think '19 is difficult in part because of the core portfolio, which, amazingly, I think it had a great 2018, we were up almost 2% in the core portfolio year-over-year. I think that would compare well to pretty much everyone in the sector, but we did see performance tail off into 4Q, which is one reason we're less optimistic about the growth rate in 2019 for that core portfolio. Maybe the final point I'd make is just, 2/3 of the portfolio, roughly, is still in triple-net, where we've got contractual rate increases. And we're projecting about 2% growth in 2019. So it's a good time to have a weighting towards triple-net, Tom, I think you wanted to add something?

What I would add, Jordan, is, as we look at our Senior Housing business. Certainly there's more work to do, clearly. And with that comes the potential for some strong upside. I think the optimism that you're hearing is that we have systematically taken that business apart and are rebuilding it literally in all aspects. We have rebuilt the team, we have put in place infrastructure and systems and have data and reporting. The portfolio today looks nothing like what it looks like a few years ago. The operator mix has been changed dramatically. We've more work to do and things that we’re working on that we're not ready to announce yet, but over time, we will. So it's been a systematic process, and we are definitely playing the long game on this one, because we believe we can create a very good business in a business that's quite inefficient, meaning that there are going to be some that do well and some that maybe not so well and we want to be part of the group that does well in this business, because we see long-term prospects being very good. That's probably the optimism that you're hearing within the comments.

Our next question comes from John Kim from BMO Capital Markets.

I have a question on the developments disclosure in Page 22. You provided a stabilized occupancy date for your development, and then there's a footnote saying, 6 months later, you’ll have economic stabilization. So should we be looking at this as the occupancy as the FFO contribution and the stabilization date, which is 3 to 6 months after as the AFFO contribution?

That's probably a good way to look at it. Really, the occupancy starts on these projects almost at 6 months after completion. The stabilized occupancy is when it gets -- for medical office, we normally consider that in 85-plus range, similar for life science. And that each segment could take a little bit longer to get to stabilization, if that answers the question?

For instance, for Ridgeview and The Cove, are those going to contribute to FFO this year?

There is some.

Yes, they will towards the latter half of the year. Now there is a free-rent component typically within the leases in life sciences. So it will contribute first to FFO, but then there's typically a 6-month lag-or-so before it contributes to FAD.

Okay. And then a follow-up on your guidance. Some of your peers do not include acquisition in their guidance, so I'm just wondering what this $900 million which Pete says some has already been announced, is this figure realistic or is it sort of a conservative number? And how much of this is driven by your cost of capital?

I would describe it this way. Typically, we wouldn't put future acquisitions in our guidance. But as you're well aware, when we took certain actions in 2018, that raised a lot of capital. We paid down debt below the level that we considered to be the optimal place to function, and we have forward equity issuance. We have had a number of different transactions in mind that we've been working on that would utilize those proceeds as part of a bigger plan, and therefore, in this particular case, because these funds are so obviously available, it would only make sense to you as you're trying to understand our numbers if we provide to you the acquisitions that we do see coming our direction in totality. Otherwise, typically, we would just -- if we didn't have the funds raised already and have access to them, we typically would exclude them.

Our next question comes from Drew Babin from Baird.

A quick question on the development pipeline. As you go through The Cove at Oyster Point and Sierra Point the remaining phases of those projects, can you talk about sequencing of yields as they deliver? I know some of those projects a lot of infrastructure was put on kind of the initial phases and then the yields kind of build over time, but little more specifically, what should we expect with those?

If you look at the various phases, normally, the last phase is with The Cove, there are no amenities or parking garage. So we're looking at a much higher yield on that, in the upper-9s. The same is true of Sierra Point. The overall return on the The Shore at Sierra Point is in the low-6s. If you look Phase 1, we have the amenity package, Phase 2, will have the parking garage, and again, the final phase, Phase 3 has none of that. So Phase 3 is more of a low-7 range, while the other 2 phases are in the low-6s.

Okay, that's helpful. And one question a triple-net portfolio. In the profile on Page 28 of the supplemental, it looks like there's 1 lease with about 0.75x coverage, that's about 2% of your overall revenues with no corporate guarantee. I'm just wondering if you could talk a little more specifically about what that is, when it expires and then what might be done to deal with that?

Scott here. I'll cover that. I think you're referring to one of the Sunrise leases. The lease matures in about 10 years. It's a complicated add rent structure that we inherited more than 10 years ago, and you've heard us talk on previous calls about the potential of the convert some of the Sunrise add rent leases into SHOP, I would put that in the category of potential conversion. But despite the payment coverage showing up as 0.75 on the schedule, that would not be dilutive to our earnings because of the way the complicated rents waterfall works. At the end of the day, the rent that HCP receives is quite consistent with the EBITDAR that's generated at the property.

And I guess, just one more follow-up on the topic of Sunrise. When you look at the 2020, the triple-net maturities, and obviously you've talked before about potentially converting some, if not all, of this to SHOP. I guess, how do CapEx cost play into this? Whether if the SHOP asset you're paying the management fee, you're taking on the CapEx burden. Could it potentially be more economical to stay triple-net with a lower rent payment or you kind of think about it as, with the troughing in the cycle, it might be better kind of, all things considered, to just go SHOP?

Yes, it depends. Not all situations are the same. Across-the-board, if you see us convert triple-net into SHOP, you can be assured that it would be higher quality real estate and operating partner that we have a lot of confidence in. And if we don't check those 2 boxes, I think it's highly unlikely that we would look to convert to SHOP. And then on Sunrise in particular, which is the most likely candidate for conversion, because of the complicated way the waterfall works, the CapEx is actually paid before the rent. So there would not be any leakage in the SHOP structure there.

I would add to that. When you think about the Sunrise conversion of those assets, again that's a structure that's dated and SHOP has taken its place. So when you think about our motivation to do it, it creates alignment with our operator. It's a lot less confusing to you, frankly, it's less confusing to us, because all these arrangements are different. It's a major headache. And from an earnings perspective, it's relatively a push, and that's how I would look at it.

Our next question comes from Michael Carroll from RBC Capital Markets.

Scott, I wanted to touch on the transition SHOP portfolio real quick. I know you made some remarks in your prepared comments. I just want to confirm, have those assets been stabilized already and have you seen declines, and I guess, Executive Director departures, employee turnover and things like that?

I would definitely not call them stabilized. We transitioned 38 in total in the first wave of transitions occurred in March, but nearly half of the transitions occurred in the second half of 2018. So there's still quite a divergence even within the transition portfolio and performance, and the ones that transitioned earlier have started to see a nice increase in occupancy and at least signs that expenses are getting closer to normal levels, whether they will return to normal levels. The assets that transition in the third and fourth quarter are still going through a period were occupancy is way down, it hasn't yet started to recover. And we just have some crazy increases in expenses, that just will not recur. I mean, just as an example, repair and maintenance is up 60% year-over-year, and insurance is up 80% and contract labor is 10x the normal level. I mean, it's just absurd numbers, that we could go through the exercise and normalizing all of these things, and it would be an enormous number. I mean, back at the envelope, it's about $1 million of expenses, that I think you can reasonably call transitory in nature, on the basis of $4 million of NOI. So I mean, we didn't normalize any of those things, but we keep trying to say this is such a small pool, such small dollars, with such unusual elevated expenses that the numbers this quarter are ugly, but we are going to recapture that, it's just a matter of time.

Okay. And I think in the prior calls, you highlighted that by stabilizing these assets you can generate about $25 million of incremental NOI, is that still a good estimate for stabilizing these assets and where that NOI number can go?

Yes. I think that's still a good estimate. The question is timing, and I think we're going to start to see improvement in 2019. At the same time, a number of the assets didn’t transitioned until late in the year, and those will take some time, and we've put 7 of the 38 assets into redevelopment and there’s massive upside on those, but it's actually dilutive in 2019 like any redevelopment, and then we can start to see some real benefit in 2021 and in '22.

And Scott, correct me if I'm wrong, we might have $4 million, $5 million of the $25 million built into our numbers, which could be higher, it could be lower, the timing is difficult to determine, but just for a basis for the analyst to use, probably $4 million to $5 million is spent on corporate. Correct?

Correct.

Okay, great. And then the redevelopment, is that in your development page, the 10 that the total budget of about $80 million to complete those?

That's right.

Our next question comes from Nic Joseph from Citi.

Just want to understand the thought process behind the refinancing of the 2020 debt given the low coupons? And then is there cost associated with the early repayment midyear?

Nic, it's Pete here. So what I would say about that is, there wouldn't be a cost just given the low coupon that that bond trades at. It actually trades at a discount to par. So if we take it up early, we still pay par. But nothing above and beyond, par. We have to pay par at maturity anyways too. As we think about refinancing that, we honestly would love to keep that low rate as low as possible but we have to pay that debt back anyways in early 2020. By incorporating it in our guidance, it gives us the flexibility if the bond markets are cooperating to do something earlier, if we so choose. We also have very little secured debt as well if we so choose to do something there, although our goal typically is to do the unsecured bond market from an issuance perspective. And from a rate perspective today, where would we issue somewhere between 4% and 5%, but it depends upon tenure. The longer the tenure, the higher the rate. I would say, in a 10-year basis, we're probably right in the middle of that. Maybe we can do a little bit better today, but again, we assume the midyear refinance of that.

And our next question comes from Vikram Malhotra of Morgan Stanley.

The life science segment continues to be very strong, the guidance surely suggests that. I'm wondering if you can give a little bit more color on the components of that same-store NOI between sort of occupancy rent spreads? And just given the expirations over the next 2 years sort, where do you think those are in the market?

Good question there, Vikram, and obviously, that market is performing well, and 2018 was really a banner year across the board for the industry. And so our occupancy is already quite high, the mid- to high-90s. So the vast majority of that same-store growth above and beyond what you expect normal escalators being around 3% is from the mark-to-market on the rent. Rents have gone up pretty dramatically over the last couple of years in all our markets, especially San Francisco. And so what I would say, from a mark-to-market perspective in the next couple years, the rents expiring in '19 and '20, as we look at it, are about 15% to 20% below market. So while we're having a nice year this year in life science as part of our guidance, we see this trend persisting for at least another year, perhaps and beyond, which gives us some comfort with regards to the development and other things we're doing within that segment.

And to clarify that, when do the new developments roll into same-store?

Typically, it's about a year after it hits its stabilization period. So for example, right now, none of The Cove projects Phases 2, at least, I don't think Phase I is actually in our same-store at this point in time. You really wait for a full year to wraparound for good year-over-year comparison.

We don't apply judgment on that. If you go back to our glossary in our supp, on the stabilization period, you can read it very specifically. Just so you don’t think judgment is not applied.

Okay, great. And then just a clarification on the expirations and the restructuring -- potentially restructuring, you referenced there, the triple-net expiration in 2020, is this mostly Sunrise and is that what you're referring to as a candidate of restructuring into RIDEA?

Vikram, this is Scott. The Sunrise lease that Drew mentioned is a 2030 maturity. It shows up 10-plus years from now. The near-term maturities, like 2020, be assured we are actively asset-managing each of those and have ongoing dialogues with the operators, but nothing to report at this point.

So that big $40 million, is that just a combination of a bunch of different operators?

Yes, that's correct. Not one operator.

Okay. And some could be RIDEA, there could be different outcomes for each like majority of that rolling at all, is it too early to tell right now?

I'd say the majority of that is very high-quality real estate, that would be a good candidate for conversion, and there are a handful that are more likely still candidates.

Our next question comes from Chad Vanacore from Stifel.

So I just wondering about a few comments on the Senior Housing operating platform. I think Scott, you gave us rate expectation of 3%, and that is its overall, not just in place, is that right?

Correct.

All right. And then was overall expense up 4%, or was that just wage and labor portion of expenses?

It's really both, but it's compensation expense that is driving most of it. And that insurance expense, it's going to be elevated a bit in 2019 as well. So labor and total operating expense should be in the say mid-4% for 2019.

All right. And then just given that, that leaves us the component of question of occupancy, because that would imply still a deeper occupancy drop. Is that -- are we thinking about that right? And kind of what level of occupancy drop would you be expecting?

Yes. I would separate the core portfolio from transitions, core, being about 3/4 of the pool, and Brookdale representing about 75% of that core portfolio. And I've mentioned the occupancy trailed off in the second half of 2018. So we actually see the core portfolio occupancy being down in the 150 to 200 basis points year-over-year, best guess, it's a small pool, that could change, but from where we sit today, that's our best guess. And we do have some new supply impacting our local markets. The transition portfolio is likely to be more flat year-over-year given the current trends.

What's the -- how should we think about the difference between same-store NOI between that core and transitional portfolio? Do you think that traditional portfolio is dragging down the overall performance?

Yes. We said 5% at the midpoint, and keep in mind that the core portfolio is roughly 70%-75% of that pool. And I would expect that the core portfolio would be a bit better in the 5%, and transitioned to a bit worse, but with very large differences from quarter-to-quarter, transitions would likely start out pretty negative on a year-over-year basis and then would get better through 2019, we hope it will show a nice positive number by the end of the year, whereas core is more likely to be just sort of mostly down throughout the year. But again, I'll keep saying it, that both of them are very small pools. There's just a lot of variability in it. If something changes, we'll let you know.

Got you. And just one final question on that. How should we think about that trend throughout the year? Your normal seasonality would be a dip in the first half and recover in the second half. Should we expect that following? Or should we expect kind of faster ramp up in the second half?

Yes. It is seasonal, and occupancy does kind of fall in the first quarter. At the same time, from an NOI standpoint, the first quarter is usually quite good for Senior Housing, because there are fewer days in the quarter, and you're paying most expenses on a daily or hourly basis, whereas rates are paid monthly. So usually -- we usually see the first quarter being quite strong NOI, even though it's weak on occupancy. So it's somewhat counterintuitive, but I just wanted to point that out, that we're not necessarily going to see the first quarter be a terrible quarter. If anything, it actually might be okay.

Our next question comes from Tayo Okusanya from Jefferies.

I want to focus on the SHOP portfolio. The transition piece that you talked about, this idea of moving from $4 million of cash NOI in 4Q '18, and again, correct me if I'm wrong but you said you could -- when this is all kind of said and done you could potentially be making $25 million in NOI in the quarter or is that an annualized number?

Let me clarify because there are different components. We transitioned 38 properties, and roughly 14 of those are in the same-store pool. So there are 24 roughly properties that are not in the same-store pool. So the annualized NOI today out of that pool is around $10 million, in the fourth quarter. So if it you annualize, it's close to $40 million, and we think there's up to $25 million of upside from there.

So the $10 million a quarter is both for the same-store plus non same-store?

Correct.

And that's $40 million a year, and then the upside gets you into the $65 million a year for the whole portfolio?

Correct. Rough numbers, correct.

Now can you just talk a little bit about what has to happen to move from $40 million to $65 million? Is this 500 basis points gain in occupancy? Is this reducing OpEx? Like what is that trigger?

It's mostly eliminating the transitory expenses, including the ones I mentioned earlier in the call, and recapturing the occupancy. That portfolio is down roughly 1,000 basis points from 2 years ago, and when we talk about the $25 million of NOI recapture, it's primarily from recapturing the lost occupancy and eliminating the transitory expenses.

And then on the HCA side of things, again it's good to kind of see the project starting off with them. Can you kind of remind us again about the relationship itself and kind of how big this could potentially become over time?

Sure. This is Tom Klaritch, again. Our relationship goes back many, many years. If you look back in the '90s, for example, HCP did a lot of development work for HCA and Health Trust. In 2000, we acquired MedCap properties, which was HCA's kind of spin-off medical office buildings portfolio. And personally, I've been both HCA CFO and then helped put together the MedCap properties. So I've been kind of affiliated with the company since the late '80s. So it's very good relationship we have there. If you look at the projects, what started out when we were first talked about it, it was about a $200 million potential pipeline, that's actually grown since then. We would anticipate, given the projects that we're working on right now and what's in the pipeline, probably to be $60 million to $100 million a year of spend in that program over the next 3 to 5 years.

(Operator Instructions) Our next question comes from Daniel Bernstein from Capital One.

I'm just trying to reconcile a little bit the -- you're giving your Seniors Housing guidance combined SHOP in triple-net, which implies you’re kind of indifferent to the structures versus the longer term positivity you're having around 2020, '21 fundamentals for Seniors Housing. Do you -- are you truly indifferent to one structure versus the other? And then if we went out 2 or 3 years, are we going to see the mix of sort of RIDEA versus triple-net very different for you guys versus where it is today? Do you want to be a little bit more like your peers, 30%, 40% RIDEA? Or would you rather stick to triple-net?

I'll start and I think, Tom has some comments as well. I wouldn't say that we’re indifferent. I would say that if we have a high-quality real estate property and an operator we have high confidence in, we're happy to use the RIDEA structure. I think it does typically align interest, more between the owner and the operator. And we think that can be a very successful investment structure over a long period of time versus we would be happy to put those same properties and operators into a triple-net structure as well, if that was an interest, it's usually not for the operator, but if it was, we would be happy to hold Senior Housing assets into triple-net. I think the real distinction for us in terms of ownership structure, it's on the more Class B properties, and older assets and maybe operators where we don’t have as much confidence and those would be more likely candidates for the triple-net. And I'll let Tom, would like to make a comment about the guidance combined.

Just on the guidance, I would tell you, again, how we think about that is, when we run the business from a management team perspective, it really is across the 3 lines of business: life science; MOBs; and senior Housing that we've been talking about for the last 2, 3 years, and we did want a recording to reflect how we look at the business, how we drive the business. In Senior Housing, we asset management, we look at it from a capital allocation perspective, et cetera, along those 3 lines of business. So we did want to have some reporting that reflected that. But at the same time we did not want to have you lose any information for your modeling purposes or your understanding of the components. So of course, we left that all in place in addition to adding some additional disclosure to give you quarterly information between the 3 buckets of core transition and, of course, you have triple-net, and we guided it the same way. So that is how we came to the conclusion that we thought that would be more useful for someone that would want to look at it a little higher vantage point, and look at it the way that we have a tendency to manage it around profitability of our company as we continue to grow and those that prefer to look at it in a little bit more detail. So all that information is in there.

Our next question comes from Todd Stender from Wells Fargo.

Just a quick one for me. What returns are you forecasting? When you look at the Torrey Pines and the South San Francisco assets that you just acquired, you took out the joint venture partner interest. Can you kind of compare what you were earning in your perspective on a yield basis? I imagine there were some management fees tucked in there versus what you're going forward yield is going to be?

I'm happy to take that one. That is we thought this was a great use of capital for HCP, we're happy to consolidate and own 100% of these four assets, the 2 in San Diego is largely stabilized. So there's really no change in returns. The 2 in San Francisco have been undergoing redevelopment for the past year-or-so, they are now 75% leased and 100% committed. So when we talked about the 6% stabilized cap rate, that should be fully in place by 2020.

Because you had some management fees, I imagine, tucked in that you lose, any real change there? It doesn't sound like there is?

Todd, no. That actually was a joint venture that was set up even before HCP bought about 20 years ago, and no, there are not really any asset management fees associated with that, no.

Your next question comes from Michael Mueller with JPMorgan.

Just a quick one. Just curious, did putting Med City Dallas in the MOB bucket for 2019 have any material impact on the 1.25% to 2.75% same-store guidance?

This is Tom Klaritch, Michael. No, it didn't have an impact on it at all, I think it was just around 10 basis points. So that was it.

Moving that is more around putting it within the -- we think appropriate segment from a cap rate perspective, in fact it might actually garner a better cap rate than Class A medical office buildings. But tucked away in our hospital segment, it typically was getting a cap rate that we didn't think is appropriate for that type of integrated facility. And we moved it over there, it didn't have anything to do with same-store growth and how that would impacted 2019.

It's a pretty unique and special structure. If it is not one that you're familiar with that a future investor conference, we should take a few minutes to talk about that one. It's kind of one -- it's one of the gems of our portfolio that's worth understanding.

To do because I think when you're talking about 2018, the rundown for other, that one is having a very good performance.

(Operator Instructions) Our next question comes from Lukas Hartwich from Green Street Advisers.

Just one for me. So the total SHOP portfolio, the 93 assets, how far below peak NOI is that portfolio?

I don't have that handy. I could tell you that the 46 assets in same-store are about 4% below '17. The balance of that 93, so about 47 assets, a lot of those are triple-net to SHOP conversions, and that portfolio performed generally consistent with the SHOP to SHOP conversions that are in the same-store pool. And there are number of redevelopments in the balance and of those would be very misleading to look at current NOI and then the balance of our assets are actually being marketed for sale. So that's the best I can do on the top of my head but we can follow-up with more specific.

And ladies and gentlemen at this time, showing no additional questions. I'd like to turn the conference back over to management for any closing remarks.

Thanks and thank you all for your today. Much appreciate your continued interest in the company and we look forward to talking to you all soon. Bye-bye.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending today's presentation. You may now disconnect your lines.