Sabra Health Care REIT Inc (SBRA) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Sabra Healthcare REIT Inc. announces second-quarter 2013 earnings conference call. This call is being recorded. I would now like to turn the call over to Talya Nevo, Chief Investment Officer. Please go ahead, Ms. Nevo.

Thank you very much. Before we begin, I want to remind you that we will be making forward-looking statements in our comments and in response to your questions concerning our business strategies, our expectations regarding our acquisition and investment plans, and our expectations regarding our future results of operations.

These forward-looking statements are based on management's current expectations and are subject to risks and uncertainties that could cause actual results to differ materially, including the risks listed in our Form 10-K for the ended December 31, 2012, that is on file with the SEC, as well as an earnings press release included as exhibit 99.1 to the Form 8-K we furnished to the SEC yesterday. We undertake no obligation to update our forward-looking statements to reflect subsequent events or circumstances, and you should not assume later in the quarter that the comments we make today are still valid. In addition, references will be made during this call to non-GAAP financial results.

Investors are encouraged to review these non-GAAP financial measures, as well as the explanation and reconciliation of these measures, to the comparable GAAP results included at the end of our earnings press release and the supplemental information materials included as exhibits 99.1 and 99.2, respectively, to the Form 8-K we furnished to the SEC yesterday. These materials can also be accessed in the Investor Relations section of our website at www.sabrahealth.com. And with that, let me turn the call over to Rick Matros, Chairman and CEO of Sabra Health Care REIT.

Thanks, Talya, and thanks, everybody, for joining us this morning. We appreciate it. I will be discussing where we are strategically, then move onto operational metrics, and then I will kick it over to Harold to go through the numbers in detail, and then we will move onto Q&A.

To start with let's talk about our capital market strategy. Because as many of you know we've taken advantage and are very active in the capital markets the first six months of the year, but certainly second quarter of this year having access to preferred equity markets early in the year, the high-yield market in the middle of the second quarter, and then as of Friday, closed our new revolver. And this is really positioned us extremely well. We now have, when you add up everything we've done and include the ATM which we haven't had the need to activate yet because of all the over capital we have raised, we are in excess of $550 million in available capital, which if you look at the current rate of growth that we've had over the past couple years, will easily take us over the next couple years.

And the point here, I think, is we've been opportunistic taking advantage of a market that's been extremely frothy, to say the least. For us to have done a high-yield walk in at $200 million at 5.375% was an amazing opportunity for us. Now we will have the opportunity to grow the Company, and if you look at us doing a $500 million or so of acquisitions at the current rate over the next two years, will be much more diversified, much larger. We'll have ratings bumps and we won't be dependent upon a frothy market to access good rates. So, we fell like we've really positioned ourselves well. How? We will get into more detail on the numbers, but we have very little exposure to interest rate fluctuation with all the moves that we've made. And probably the next thing that we will look to do, barring bigger deal that may provide other opportunities, is taking out the remainder of our original high-yield, will have the opportunity in the middle of the fourth quarter of 2014. And that will help us bring down our cost to capital that much more dramatically at that point in time.

In terms of growth, we announced a new pipeline agreement yesterday. We have a third pipeline agreement that is getting close to done and we have a fourth pipeline agreement that we are working on. These are critical for a number of reasons. I think as some of you have heard from us before, the assisted living market has changed dramatically in terms of the product, in terms of the nature of the resident, and memory care as well being a relatively new business, and so we're really focused on bringing new assets, purpose built assets in, and all four of these pipelines will be primarily assisted living and memory care. There might be a little bit of skilled nursing in there.

And each of these pipelines will be approximately 10 facilities. Total value per pipeline upon stabilization will be $100 million to $150 million. So, if you project that on a go-forward basis, and assuming that we do no additional pipeline, and is our intent to do the additional pipelines, but just with the ones that I've just discussed, that's 40 new assets coming in to the Company over the next four to five years. And given the size of our Company, we will have the highest percentage of new assets and certainly purpose filled assets, the senior housing market in the sector. And while I realize that may be a little bit unfair to say because of our size, on the other hand it reflects how we view things strategically, what our focus is, and that focus we think will reward shareholders greatly.

In addition to that, we're starting to see more repeat business with our existing tenants, so that bodes well for us as well. And so, if you look at the combination of what we've done with the capital markets, what we are doing with the development projects, and now that we are building on repeat business, we've really created a hedge for ourselves over the next couple of years. Both in terms of the capital markets and then from an acquisition pipeline perspective, to the extent the pipeline continues to stay healthy, those new assets that come into the portfolio, as they stabilize will just be accretive to our growth. To the extent that there are ever slowdowns in our pipeline activity, then we can count on a nice chunk of new assets coming in every year.

In addition to those new assets, we have the Chai deal that we announced in the second quarter, the $50 million of that will come in somewhere around the next 18 months. So again, we feel like we've positioned ourselves very well on the go-forward basis. Pipeline as it stands today has gotten a lot healthier. As you all know, when you look at the healthcare REIT sector across the board it is been a slow year, although I would point out that we had $33 million, a $32 million deal we did in the fourth quarter that for tax purposes would have been done in the first quarter normally. And if that was the case, we actually would have been ahead of where we were last year. But that said, it has been slow. Pipeline today has picked up nicely. We have about $300 million of deals that we are looking at in the pipeline. About 65% of those deals are senior housing and the remainder are primarily skilled nursing. So, we look forward to working on that and still feel very comfortable that will hit the range that we identified at the beginning of the year for 2013.

In terms of the environment beyond just what we are seeing with our pipeline, make a couple of notes. There's been a reaction, obviously, and a lot of questions raised about interest rate pull back and how does that affect things and have we seen any effect in terms of both acquisition activity and cap rates? And the answer is no. And to expand on it, here's a couple of things. The operators that we work with, the size of the deals we focus on, so call it $20 million to $50 million, these operators do not pay attention to what's happening in the interest rate environment. They never have and I doubt they ever will. They look at how their business is doing.

They look at what their Medicaid rates look like, their Medicare rates look like, what their private rates look like, the ability to do increases, and how the business is doing. And then they look at their personal situations. What's going on, [a bit in their life], is it time to monetize? So, I've never in all the years I've been in the business, I've never seen any alignment between the interest rate environment, good or bad, and what's happened on the acquisition side.

In terms of cap rates, I make a similar comment there. And obviously, there's a lot more history on the skilled nursing side than the senior housing side, but cap rates haven't moved with the interest environment, historically. Even if we would like to think that there will be some relief on cap rates if interest rates move up slightly. But at this point, we expect there to be a stable cap rate environment, that's what we are seeing, that's what we are hearing from potential sellers out there and also with the developers that we are working with. So, really a pretty benign environment relative to what's going on in the financial market. It just doesn't seem to be much of a relationship there. Maybe if we were doing $300 million to $400 million deals then they'd be more of an impact, but that's not the case with us.

From a reimbursement perspective, I'd say it's stable to positive. For our skilled nursing facilities on the Medicaid side, we are looking at a consolidated Medicaid rate increase of 1.44%. And most those rates come in July 1 and August 1. Six of our top eight states have increases, only a few of our states are down and they are barely down. So overall, very positive on the Medicaid side. And pretty much in line, I think, what we would expect here, though, we have a few states that have much larger increases than we were anticipating. New Hampshire, which is our largest state, has almost a 5% increase. New Mexico, 13% increase. Idaho, 7% increase. There are some big ones in there. The ones that are down are down less than 1% except for two, North Carolina and Delaware, and they are down under 2%. So, I can give more detail on that if you guys would like during Q&A. So, Medicaid looks good. Medicare, CMS announced a final rule last night, so 1.3% net market basket increase, which is pretty much in the range that we were expecting. It is different from facility to facility, so it might be slightly different than that but not very much. So all in all, pretty benign, subdued environment on the reimbursement side.

I think the only thing to keep an eye out for on the reimbursement side as a pertains to Medicare specifically, and that's if they do a permanent doc fix. And there's some optimism that they will do permanent doc fix, because the 10-year CVO score for doing one is almost a third of what it used to be because of costs coming down which makes it very doable, and to the extent that all the various health care sectors would have to be paid for as enact, the 10-year number isn't that big a number and I think everybody would view that as a positive in terms of being a pay forward for that. You get it out of the way, fix it, and not have to deal with that every year. So, that's the one thing I think that's out there to keep an eye on so we will see what happens with that.

Moving onto Genesis. Things are going very well with Genesis and a couple of things specifically. One, I think we talked about on the last call that's got $65 million in synergies, that's right on target. Which is terrific, but most unexpected is that Genesis is going to be able to mitigate sequestration completely. That's a huge number because our working assumption up to this point was that sequestration would essentially offset the October 2012 market basket. In Genesis's case, that market basket accretive. Still offsets sequestration with another market basket coming in October 2013. So, all that obviously improves coverage and gives them a lot of cush going forward. So, that's something we are obviously very happy about. We do affirm our previously issued guidance overall.

Moving onto operating statistics, our skilled nursing EBITDAR to EBITDARM coverage improved sequentially from 1.26 to 1.28, and 1.73 to 1.75, respectively. Coverage already also improved year-over-year for the quarter from 1.21 to 1.28, and 1.70 to 1.75, respectively. These results are slightly stronger than that on a same store basis. This is the first quarter since mitigation was completed that we saw increases in rent coverage for sequential end year-over-year periods.

Normalized EBITDAR and EBITDARM for our senior housing portfolio was slightly down but still comfortable for the 3- and 12-month period at 1.11, 1.35, 1.17, and 1.41, respectively. On a same store basis, normalized coverage for the senior housing portfolio for both EBITDAR and EBITDARM improved from 1.22 and 1.52, to 1.35 and 1.64, respectively, for the second quarter 2013 compared to second quarter 2012, so very strong coverage there. And for the 12-month period the results almost identical.

Occupancy for our skilled portfolio was 88.5% for the quarter, down 80 basis points. Senior housing was up 320 basis points to 85%, primarily driven by one particular facility that we bought in turnaround mode that's improved pretty dramatically. Skilled mix is down 50 basis points to 38.3%. That's the best, actually, year-over-year comparison that we've seen in a couple years. The better news really is that sequentially skilled mix was up 180 basis points. A very good sign along with the year-over-year comparison, so we believe we've seen the worst of what's been a week two years and that weakness over the last two years, accommodation in both the senior managed rate pullback in 2011 and the strategies and observation days [in the part] of acute hospital sector. So, but the skilled mix sequential growth is maybe the most important stat that we've discussed this morning. Because it's all about strategy, it's all about changing the model, and the skilled nursing facility -- the skilled nursing industry needs to continue to move up the acuity scale, so that's really a particularly good sign. We do expect to see skilled mix lighten up as we head to the end of the second quarter and third quarter, that's very typical. It is always seasonally light as we end the second quarter and go through the third quarter, so that's just normal stuff.

So overall from our perspective, we are by far in a strong position than we've ever been with the current pipeline that looks good. Activity coming down the road that looks very good from a development perspective. And again, with what we've done on the capital markets. And with that, I will turn it over to Harold.

Thanks a lot Rick. Before I get into the details of our numbers for the quarter, I want to piggyback off of some of Rick's comments and spend a couple minutes highlighted the recent activities in the capital markets and some of the other steps we've taken to increase our liquidity and improve our cost of capital. Both of which should enhance our long-term prospects for AFFO growth.

At December 31, 2012, we had capacity to fund acquisitions of about $155 million from available cash and capacity on the revolving line of credit. We begin 2013 expecting to finance our growth into the foreseeable future by utilizing this capacity and by putting into place $100 million ATM program. As 2013 has unfolded, we've put the ATM program in place, but also saw it took advantage of two significant opportunities to access long-term capital and unprecedented pricing. First, we issued 5.8 million shares of 7.125% perpetual preferred equity, netting proceeds of $138.4 million. This permanent capital was priced within 21 basis points of the yield to maturity on the bulk on bond offering we completed in 2012 which is due in 2018.

Then in May, we took advantage of extremely attractive bond market opportunity by issuing $200 million aggregate principal amount of 5.375% senior unsecured bonds due in 10 years. This pricing was 154 basis points inside the yield maturity for the 2011 bond offering I just referenced. In addition, the perpetual preferred equity offering created the opportunity to call back 35% of our $325 million aggregate principal amount of outstanding bonds that were issued in 2010 and 2012, having a 7.75% effective interest cost. This claw back was completed in June of 2013. The $333.3 million of total net proceeds from these two transactions were utilized to number one, repay the full $92.5 million outstanding on our revolving line of credit, and number two, execute the 35% claw back of $113.8 million of the senior unsecured bonds due in 2018, plus fund the $9.3 million early redemption fee associated with that claw back. This left us with an excess of $117.7 million. A portion of this excess cash has been utilized for recent investment activity to pay off of 9.43% mortgage note and other Corporate purposes, leaving us with cash of $92.8 million as of June 30, 2013.

Finally, the latest step we took to improve our capital position occurred on July 29 when we closed on an amendment to our revolving line of credit, which increased the commitment to $375 million, and included both pricing and structural enhancements over the prior $230 million line. The new line has an accordion feature which allows up to $225 million of additional availability. We currently have $286.5 million available for borrowing which we will expand to the full $375 million as we determine appropriate over time. The pricing from this new revolver is 50 basis points higher than the prior revolver across a four level pricing grid, ranging from LIBOR plus 250 LIBOR plus 350. Furthermore, the revolver is no longer secured by mortgages, but by the pledge of equity of subsidiaries that own certain of the Company's real estate assets. This gives us significant higher flexibility and ease of increasing the borrowing capacity under the revolver. Furthermore, it represents a significant step for the Company toward a fully unsecured revolver, a goal that we have for the future.

To bring all this into focus on the strategic benefits of these opportunistic capital structure moves we have made in 2013, let me highlight a couple of things. First, now we have the ability to finance over $450 million of investments with cash on hand and the revolver, and that's before considering the accordion feature. Plus another $100 million of investment through utilizing the ATM program. By way of reference, we have invested approximately $448 million since the inception of Sabra in November of 2010. And through these acquisitions, have diversified our portfolio from 100% concentration in Genesis to just under 61% at June 30, 2013. Having over $550 million of capital to deploy puts us in a position where we will not require another capital raise before we have significantly increased the size of the Company, and improved our tenant and asset class diversification dramatically. However, we will continue to be opportunistic in accessing the capital markets if necessary, including the potential redemptions of the remaining $211 million of bonds due in 2018. As Rick pointed out, this opportunity is likely to be in the fourth quarter of 2014. Increasing our size and diversifying are the primary requirements of obtaining higher ratings from the rating agencies. Having significant capital in place to execute on our growth and diversification strategy will allow us to achieve higher ratings and improved pricing before we need to tap those markets again.

And second, these capital structure move have lowered our cost of debt and significantly extended our maturities. Our weighted average effective rate on our long-term debt declined from 6.77% at the end of 2012 to just over 6% as of June 30, 2013. A 73 basis point improvement. In addition to lower cost on the revolver, we'll enhance the accretion of our acquisitions in the short-term.

Finally, after these steps, 43% of our long-term debt matures after 2022. That's up from 8.4% at the end of 2012. We believe these moves have puts us in an excellent position to execute our growth strategy while enhancing our earnings potential, and has put us in a great position for continued progress toward higher credit ratings and, therefore, a continuing lowering of our cost to capital. And now, I'll spend a couple minutes with the numbers.

For the three- and six-month period ended June 30, 2013, we recorded revenues of $32.3 million and $64.3 million, respectively, compared to $25.1 million and $48.8 million for the same periods in 2012. Increases of 28.5% and 31.6%, respectively. As of June 30, 60.8% of our revenue was derived from our leases to subsidiaries of Genesis, which is down from 69.7% a year ago. FFO for the three- and six-month period ended June 30, 2013, was $5 million and $22.5, respectively. FFO for the same period was $5.6 million and $22.2 million, respectively.

During the three- and six-month period ending June 30, 2013, we incurred a loss on extinguishing of debt totaling $9.8 million, and a one-month interest overlap of about $800,000 associated with the issuance of the new bonds and the redemption of the $113.8 million of outstanding bonds. Excluding these nonrecurring items, normalized FFO was $15.6 million and $33.1 million for the three- and six-month periods ended June 30, 2013, respectively. Or $0.41 and $0.87 per diluted common share, compared to $13.7 million and $25.4 million, or $0.37 and $0.69 for the same period in 2012.

Excluding the nonrecurring items, normalized AFFO was $15.7 million and $32.2 million for the three- and six-month period ended June 30, 2013, respectively. Or $0.41 and $0.84 per diluted common share, compared to $15.7 million and $29.7 million, or $0.42 and $0.79 per diluted common share for the same period 2012. Normalized AFFO for the quarter was flat year-over-year due to the timing and extent of the capital raise activities that began with $100 million high-yield bolt-on that we completed in Q3 of 2012, and includes the 2013 capital markets activity described above.

For the second quarter of 2013, we incurred a net loss attributable to common stockholders of $3.2 million, or $0.09 per diluted common share, compared to $5.9 million net income for the second quarter of 2012, or $0.16 per diluted common share. Our net income attributable to common stockholders was $6.1 million or $0.16 per diluted common share for the six-month period ended June 30, 2013, compared to $10.3 million or $0.28 for the same period in 2012.

G&A costs for the quarter totaled $3.4 million and includes stock-based compensation expense of $1.5 million, and acquisition pursuit costs of $200,000. Excluding these non-cash transactions related costs, G&A costs were 5.4% of total revenues for the quarter, compared to 5.8% in the same period of 2012. Interest expense for the three- and six-month periods ended June 30, 2013, totaled $10.1 million and $20.1 million, respectively, compared to $7.9 million and $15.6 million for the same periods in 2012. These increases are the result of the capital markets activity discussed previously, including the $800,000 impact of overlapping interest from the recent bond offering.

During the quarter ended June 30, 2013, we recorded an adjustment to an asset purchase earnout liability resulting in other expenses of $1.4 million. For further clarification on this item, this is one of those accounting rules that requires us to estimate our earnout at the time of closing the acquisition, and any adjustments to the ultimate payout runs through the P&L. So actually, this expense is a very positive sign for the performance of that asset, which will ultimately be put into our TRS with Stoney River. So in this case, more expenses is actually a good thing for us economically.

The estimated liability of $2.2 million is expected to be paid out in the third quarter, and will result in additional rental revenues based on an 8% first-year cash yield on the additional investment. Our investment activities for the quarter considered of acquisitions of one senior housing asset of $6.1 million and a mezzanine loan of $12.4 million, increasing our total gross real estate investment and loans in other investments on our balance sheet to $962.9 million and $43.1 million, respectively. The weighted average of one-year yield on all of our investments during the first six months of 2013 is 10.9%. Cash flows from operations totaled $22.9 million for the six months ended June 30, and $32.2 million excluding the $9.3 million one-time payment related to the early extinguishment of debt. This compares to $24.1 million during the same period of 2012.

We're in compliance with all of our debt covenants under the senior notes indentures and our secured revolving line of credit agreement as of June 30, 2013. Those metrics include the following based on defined terms in the credit agreements. Consolidated leverage ratio of 4.45 times, consolidated fixed charge coverage ratio of 2.51 times, minimum interest coverage ratio of 3.4 times, total debt to asset value of 43%, and secured debt to asset value of 11%. Unencumbered asset value to unsecured debt of 152%.

Finally, a quick comment on our HUD refinancing. We continue to work on refinancing our $87.7 GE mortgage debt through HUD. We currently have approximately $57.3 million in process with HUD underwriters, and expect to lock in a rate in the coming several weeks. Rates have backed up a little bit in the past two months, but we still expect to see solid investment savings as well as the benefit of pushing the maturities out from 2015 to well beyond 2033. Closing of the $57.3 million portion currently with HUD underwriters will likely be completed in the fourth quarter, while the remaining $30.4 million is likely to be a 2014 closing. Once we have completed the GE debt refinancing, we will have all of our mortgage debt termed out over 20 plus years, and all of our borrowings will be at fixed rate excluding the future utilization of the revolver. This sets us up nicely in an environment were interest rates are expected to increase in the future. And with that, I will turn it back to Rick.

Thanks, Harold. Why don't we go to Q&A now?

(Operator Instructions)

Our first question from Omotayo Okusanya with Jefferies.

Yes, good afternoon, everyone. Thanks for the thorough commentary.

Harold, the HUD financing, just how much in regards to rates are you expecting to save? What's current rate on it, and where do you think you may end up?

So, early on a couple of months ago rates were still hovering around 3%, and when Bernanke made his comments and investors got concerned about a rising interest rate environment, rates backed up to as high as the mid- to high-4%s. But in talking with our lender earlier this week, they have locked some deals this week in the high 3%s, so below 4%.

So, our current GE debt all in is a little higher than 5%. So if we can get something locked in around 4%, a little bit lower, than we are looking at maybe a 1% benefit. And it if things continue to settle in and improve, maybe it will be a little bit better than, that but that's the range we are looking at.

And Tayo, if you think about all of our mortgage debt, because as you know we refinanced a bunch last year, all of our mortgage debt all in will have a blended rate of maybe 3.75%, and you are talking 30-year money.

Right.

Yes. That's helpful. And then second thing, again congratulations on the pipeline deal. It sounds like you have two other big ones coming in line. So, you have this very nice acquisition pipeline in front of you.

The question is how quickly do you actually expect some of this stuff to close? And the reason I ask that is, if I'm just tracking the first one you announced, First Phoenix, it was announced about a year ago. You expected to do about 10 of these things, and I think if I'm correct you've really done one or two so far a year later?

Because they all -- when we announced the pipeline, it's really, except for one or two, they are all just beginning to break ground. So, by the time you build them and stabilize, and you're looking at a about a two-year period. So, we are close to, they're getting closer to stabilization on one particular facility now. They are filling up at a relatively nice clip, so it will save for being that in later in the year.

But I think you will see a few next year It's really the year after that they are going to be coming in on a regular basis. Because by then, they will have had enough time, given the size units or the size facilities that are being built, because these are 50- to 70- unit facilities for the most part. Assume 12 months to get it open and another 12 months to get it to 90% or so occupancy.

That's very helpful. Thank you so much.

Thanks.

We will take our next question from Emmanuel Korchman with Citi.

Hi Emmanuel.

So, Rick, as you go into more of these relationships, especially with different partners, can you just talk about how you expect terms and timelines and volumes and all that stuff to change as it becomes more of a core part of your Business rather than something new?

Well, the terms were really all negotiated up front. There were formulas for take out, for set stabilization. Those formulas really look very much like what would happen if we just bought a leased stabilized asset on a sale leaseback basis. So, it is trailing performance with a bit of appropriate coverage that we are going to underwrite based on, so [1.2], and north of that on senior housing and [1.5] on Smith's, 8% cap-ish range for the senior housing stuff, and something north of 9% for any skilled stuff, and let me remind of that, there won't be a lot of that.

And because it is a few years out with some of these projects, in some cases there's also a spread to Treasury with a cap on that that we will look at as well, not knowing exactly where interest rates are going to be. So we get some protection there. There is a put in place in almost all cases, and there's also an end date, because as we know, we've seen projects out there that are prestabilized for 25 years. So, generally speaking, there's a two-year drop-dead date where some event is going to happen. I don't know if that answers --

No, that does. Do you see your -- the preferred returns you're getting on just the preferred equity piece, do you see that changing with the changes in interest rate market? Are you more of a needed financing provider, I guess, is the right way to look at it?

Yes, I think there are more of a needed finance provider. And remember we are just a piece of the cap stack. So, we actually have very little development capital at risk, so these guys are getting traditional construction loans, we make it easier for them to get it because we are providing preferred equity and the banks know that we're going to be there to take it out, so they can see the light at the end of the tunnel.

But it's a quote, say at a $10 million to $15 million project, we are in at about $3 million. So even though our return is relatively high, its high on not a whole of dollars, sort of net perspective, but they need it anyway. So, the construction loan will take them, say, 65% to 75% of the cap stack, our preferred equity strip will take it to 90%. We may go a little bit higher, and then they kick in the rest.

So, and our view on the interest rate environment is, yes, they're go up, but it's not going to just up 300 basis points for the year over the next few years. It is going to be a gradual rise, and we expect the returns that we are currently getting, which are, call them, the10% to 15% range to stay in that range.

And then do you have any interest in moving, however you want to look at it, up or down in capital stack and providing the actual construction financing? Or are you happy just to be the preferred partner, and then let the banks deal with the rest?

Well, it is a good question. I think earlier on we didn't want to do the entire capital stack because what is still most important for us is to diversify away from Genesis as quickly as possible by doing stabilized deals. We've got so much capital available right now. In certain circumstances, I wouldn't preclude us from doing that, particularly with guys we already have a history with in these pipelines. And we may step up and do some different things.

So, for example, on the New Dawn Sun City West Memory Care Facility that we announced a few months ago, that facility just opened, so it wasn't stabilized yet. Our operating partner had some very expensive money in there. He asked if we could take everybody out even though the facility wasn't stabilized, so we said yes. We put a mortgage in place, that mortgage is a means to the end. It's not a long-term instrument. We have an option to purchase the facility upon stabilization.

So, we got the option secured, he got cheaper money in place than he had, and so the answer is, we will look at doing some of those things in certain circumstances. But there has to be a relationship that's already grounded and has some history to it that we feel good about in order to do that.

And certainly as our cost of capital continues to improve and its interest rates go up, the spread between what they can get at a construction loan and what we can do for them obviously narrows. Particularly if you don't just look at the rate on the loan, but you look at the associated fees dealing with a bank. And then just the general hassles of dealing with one entity for this piece of the construction and then they deal with another. And we've already had guys say to us it would be nice at some point just to deal with you from start to finish and not have to deal with anybody else. So, that's a long answer to your question. So the answer is yes in certain circumstances.

And then maybe my last one, which should be quick. And maybe I missed it. In the $300 million pipeline that you are talking about, how much of that's going to be stabilized product versus these take some time to stabilize type product?

Yes, that's almost entirely stabilized.

Okay, thanks, I'll see you --

When we talk about the pipeline, we are not talking about any of our development stuff. So, we have our stabilized assets.

Perfect. Thanks.

Yes, thanks, Manny.

Our next question from Rob Mains with Stifel.

Hello, Rob.

Good morning. Just a couple questions. First, Rick, you talked about how cap rates really haven't moved. For you, at least the cost of equity capital has gone up a little bit. What does that say about investment spreads? I know we're talking about issuing equity not this year in all likelihood.

Yes, I'll -- about the pullback, obviously, and perhaps you don't completely understand it. But it doesn't really -- it doesn't affect us right now because we cannot look at the stuff on a day-to-day basis. One, it has gotten more expensive, but it still a lot more reasonable than it was a year ago. So, we're still in relatively good shape there, and we just believe that as we continue to execute as we've been doing, and particularly because we've hedged ourselves against rates for quite some time. And I don't know if we've pointed this out earlier, but with the exception of the revolver, once the rest of the GE debt gets refinanced to HUD, all of our debt will be fixed. So, we are really not that concerned about it.

If we roll the clock forward, because we have the ATM to activate, see where we need that, and we look at when we might need to do an equity offering. So, when we want to take out the high yield in the fourth quarter 2014, is that going to be an option?

We are going to be quite a bit larger at that point. We're going to have Genesis well below 50% at that point, all of which should be reflected in how we are trading. So, it should make equity a lot more reasonable, and the only circumstance, really, that I can think of that would cause us to think about a follow-on sooner than later, was if there was a big enough deal to justify it, and it would have to be pretty big deal, because [there's not that much capital] available to do a big deal anyway.

And what the reality is it is probably not all that realistic, because we're not going to do a big scale deal because we don't want to go in that direction. And if we see a big senior housing deal, if it is too big then the three bigs are going to be in there and they are just going to be outbidding each other. So, we are probably not going to be competitive there.

So, it is unlikely. I think for us, if we think about a big senior housing deal it is probably in the $100 million range and we certainly have plenty of capital to do that, and everything else we're looking at without having to consider a follow-on at this point in time. Does that answer your question?

And then, I talk about competition for deals. One of the call this morning alluded to private REITs maybe being a little less disciplined, and are you seeing private equity anybody else other than competitors that you've talked about on prior calls for deals?

So, we are not seeing private equity yet. In terms of the private REITs being somewhat undisciplined, they're completely undisciplined, we see them once in awhile. We don't see them that much. Usually for us it is no different than what we've said in the past, on the senior housing stuff, we usually see LTC or NHI.

We actually haven't seen S&H, at least not that we are aware of. And then, on the skilled stuff, we'll see the same players, plus maybe Omega and Avee. So we don't see Griffin America as much as we used to because they've been doing a lot of MOB stuff. And we haven't seen some of the newer -- we haven't seen CNL really. We may see Newcastle at some point, but we haven't seen them yet.

But usually I would say, generally speaking, on any deal we look at there's usually a couple of other guys who are competing with us, not a big group.

And on the private equity, I would characterize the two names that we do see occasionally, which is AEW and PRU, we tend not to be looking at the same assets. Or when we look at the same assets, we're not in the same ballpark on pricing, so we are not really -- I would not characterize us as competing with them.

Okay. By not the same ballpark you are, I'm not going to give you a baseball analogy, they are doing a higher rent deals?

They are paying six caps on NOI. Doing manage back, so structurally and in terms of price point they are in a different place.

Got it. Okay and then, Harold, just one numbers question. I want to try and understand, the $1.4 million contingent liability. So, it is an earn out of $2.2 million, that gets capitalized, but you collect rent on it?

No, it doesn't get captilized. So, when we closed on the transaction we booked a $1.3 million estimated earnout. And, again, you just have to make estimates per GAAP. Any changes to this estimate flowed through the P&L statement.

So, if you look at our last quarter numbers, we actually had a $500,000 gain, because you look like performance was lagging from what we expected. This quarter performance picked up dramatically, resulting in a $1.4 million charge, so what will happen is, when we write that check for the earn out payments, the liability will obviously go away on our balance sheet. But we will also be recording rent of 8% on that additional investment, so we will be paying rent associated with that. So, on books we've got $1.3 million associated with that earnout, and anything different from that runs through the P&L and the actual cash out results in 8% return on our money.

Okay. That's great. And then just a clarification. When you talked, Rick, early about coverages and skill mix and everything, that's for the quarter ended June 30 in arrears?

Everything is a quarter in arrears.

It is in arrears. Okay, fine.

Everything is a quarter in arrears. And skilled mix looks like it is a little bit lighter as we move into the second quarter and get closer to the third quarter.

Right, but that's normal seasonality, right?

Yes. Occupancy actually is -- has been moving. For our consolidated portfolio, occupancy has been moving up since the end of the quarter, so April and May occupancy is up over the first quarter and actually pretty significantly.

Got it. All right, that's all I have, thank you.

We will take our next question from Michael Carroll, RBC Capital Markets.

Harold, so is $0.45 a good FFO run rate going into the third quarter adding back that earnout charge?

If you look at our supplemental out of the pro forma AFFO number. I'm just going to go back to it so I make sure I get the right number here. And that pro forma takes into account everything that has happened pushing it back to the beginning of year, so it is in about $0.42 on a pro forma AFFO.

But that includes the charge for the earnout, right? So, you should add that back to your run rate going into third quarter? No, that's pulled out of there, as well. That's pulled out. Okay. And then, I know we've been waiting for the second half of '13 for your investment activity to really start ramping up. Should we be expecting that to start -- hit pretty meaningfully in the third quarter, or is that going to be weighted more towards the fourth quarter?

It is probably, it's going to be weighted more in the fourth quarter. There will be some activity in the third quarter, but it is weighted more in the fourth quarter.

Okay. And then with the Meridian pipeline, can you give us a little bit more color on that? I think in the press release, it indicated that it could be one of three product types, senior housing, memory care, or skilled nursing facilities?

It is primarily assisted living. There will be some memory care, and they are looking at expanding already existing projects that they're working on, which will include memory care. The skilled nursing piece, you're not going to see that much of that.

There's one facility that is opening and filling up that has a rehab unit, because it's spitting distance to a hospital and the hospital specifically asked for short-term rehab unit. And Talya and I were in that building about a month ago, and the thing is gorgeous. And when you go from the assisted living section to the skilled rehab unit, you cannot tell the difference. It is arguably the most non-institutional skilled rehab unit that I've seen. But that was specifically at the request of the hospita,l because they were just going to fill it, and it is not that big unit, but I would not expect to see much of that on a go-forward basis in the First Phoenix pipeline, and that may wind up being the only one.

Okay. And then for each of these projects, how much preferred equity are you planning on putting in?

Seriously, going to be somewhere around $3 million, give or take.

The way we think about it is that we think about the cap stack as a whole, and we typically are willing to go -- if a conventional lender is willing to lend from somewhere between 65% and 75% of cost, we are willing to go up to, call it, 90% of cost. So, we are filling that gap with a third-party equity. So, that gives you a sense. But given the scale of the projects that we are looking at, the actual dollar amount is what Rick said. That's a good proxy.

Okay, then how many projects are picked out currently?

Well, on First Phoenix there's --

Six.

There are at least, yes, there are two that we talked about because we already are -- we are already invested in them into some form or fashion.

Then the other four

And then there are four beyond that, and that's in a program that had had 10, that is planned to have 10. So, they are already six are already identified. At a minimum the land is entitled and some of them are shovel ready. Waiting to close on conventional financing and move ahead.

A new deal on which we haven't announced the pipeline yet, but we've announced two deals but that will be a pipeline agreement, as well. They have four additional projects besides the two where they already, they got the land and they are in the process of working on when they're going to start breaking ground.

So, there's four there and those are all memory care, 48 units. And then from Meridian that we just announced, they have just recently identified three to four parts of the land for primarily assisted living development that they are pursuing right now.

Okay, great. Thanks, guys.

(Operator Instructions). We will take a follow-up Omotayo Okusanya from Jefferies.

My question has actually been answered. Thank you.

Thanks, Tayo.

I'm showing that we have no further questions at this time. I'd like to turn the call back over to Mr. Rick Matros for closing remarks.

Thanks again for your time today. As always, Harold, Tayla, and I are always available for any follow-up and again we are pleased with how things are going for us. And particularly pleased that we were as opportunistic as we were to set ourselves up on a go forward basis and be able to be more competitive than we've been able to be historically on acquisitions, particularly on the senior housing side.

And with that, have a great day and we look forward to talking to you and seeing you here. Take care.

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