芬塔 (VTR) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2009 Nationwide Health Properties earnings conference call. My name is Mary and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Mr. Ron Hubbard, Vice President of Capital Markets and Investor Relations. Please proceed.

Good morning. And thank you for joining our conference call and webcast presentation to discuss Nationwide Health Properties second quarter 2009 earnings. Certain statements made in this webcast are forward-looking in nature. These statements are based on reasonable expectations and information currently available. However, actual results could differ materially from those projected in or contemplated by the forward-looking statements due to risks and uncertainties described from time to time in the SEC reports filed by the company. As this webcast will be available on our website for some time, it is also important to note that it includes time sensitive information that may only be accurate as of August 6th, 2009.

The company believes that funds from operations and funds available for distribution are an important supplemental measure of operating performance. The company's definition of FFO and FAD have reasons for their importance, certain of their limitations and reconciliation to net income are included in our earnings release dated August 5th, 2009. As a reminder, NHP's complete second quarter 2009 earnings package was filed on August 5th, 2009, separate form 8Ks and available on our website at www.nhp-reit.com. I would now like to turn the call over to Mr. Doug Pasquale, Chairman and CEO of Nationwide Health Properties.

Thank you, Ron. Good morning, and thank you for your interest in Nationwide Health Properties. For today's webcast presentation, I am joined by NHP's senior management team. After reviewing our financial results, we will provide updates on NHP's liquidity position, summarize key terms of our restructured master lease, review our same property portfolio performance and conclude with our 2009 guidance update. Our financial results remain strong and compare favorably to last year's second quarter with revenue up 5%, FFO increasing 7% in tandem with the 9% reduction in interest expense, FFO per share up $0.01 and FAD per share of $0.02. Always looking to improve our balance sheet, particularly in this economic environment, we issued about $105 million of equity from the end of the first quarter through August 5th at an average price of $27.50 per share. We also retired $30 million of senior notes for $25 million, realizing a $5 million gain.

On the strength of our 1.3 times dividend coverage, our Board of Directors maintained our cash dividend. NHP's fixed charge coverage is 3.4 times with a low debt to EBITDA ratio of 4.4 times. These measures combined with our undeprepreciated book leverage of 39% put NHP's financial position among the very best in REIT sector. With debt maturities of only $163 million between now and July 2011, about $200 million of cash on hand through August 5th and the full capacity of our $700 million credit facility, we are well positioned to take advantage of opportunities as they arise.

Our 2009 investments have been limited to a $66 million commitment for revenue producing capital expenditures of which $18 million has been funded to date at a blended rate of 8.4%. In addition, we reached an agreement to acquire The Broe Group's interest in our two joint ventures. Established in January 2006 the Broe venture gave NHP an opportunity to begin advancing in the medical office building sector. Given our now significant investment in this asset class comprising 3.5 million square feet in 82 buildings and the limited long term growth potential for our partnership, we jointly believed that it was in our mutual best interest for NHP to acquire The Broe Group's minority interest. The Broe Group is a successful and widely diversified company and we hope our paths cross again. Looking ahead on a near term investment horizon, we are currently exploring a few interesting but relatively small opportunities.

We completed our restructured master lease agreement with Hearthstone which includes the following key terms. Base rent is unchanged and base rent escalators were converted from being primarily CPI based to a 3% fixed rate. Supplemental rent is deferred to September 30, 2011. Distribution restrictions were implemented until defined rent levels are maintained. Bankruptcy protections were added, and if certain major events of default occur, ownership of the operating entity would at our option be transferred to NHP. NHP is afforded enhanced oversight rights and we agreed to work together to identify, evaluate and effect the orderly transfer of underperforming facilities that would be in the best interest of both parties. We are pleased with our restructured agreement which materially preserves the potential economic benefit for which we originally bargained, improves our position in a downsize scenario and provides Hearthstone with substantial motivation to be successful.

Turning now to the performance of our portfolio, so far our same property senior housing tenants have been able to maintain slight increases in monthly rental rates with operating margins and rent coverage showing slight year-over-year improvement. In addition, a slowing in the velocity of occupancy declines hints of stabilization, but only time will tell if that momentum continues. With the second quarter, our year-over-year senior housing occupancy declined 80 basis points, an improvement from a 180 basis point first quarter decline. Despite this decline, EBITDARM coverage remains stable at 1.3 times. For the quarter, our same property skilled nursing portfolio has maintained relatively stable operating performance with 2.1 times EBITDARM coverage. Our same property MOB portfolio continues to perform with occupancy remaining stable at about 91% and year-over-year NOI growth of 4%.

Health care reform is now and will remain in the national spotlight for some time to come. But until there's further clarity, we will leave politics to the politicians and speculating to those who have the responsibility and energy to do so. This time last year a few of us could have imagined the severe downturn and subsequent revival that were lying in wait. and while the free fall that began last autumn seems to have ended and a few have even boldly declared the recession's end, predicting the future these days is a precarious and perhaps futile endeavor. But here's one prediction I'm willing to make. What happens with Sunrise matters and Sunrise fate will have interesting ramifications as to how senior housing evolves. Here is just one example. Sunrise has been considered an industry leader for at least as long as most of us have been associated with senior housing. They are the only company of substantial size and reputation that comes to mind for which fee for service management is a meaningful part of their business strategy.

RIDEA for which there has been much talk and speculation is to ever have real meaning to health care, the industry needs many strong reliable third-party managers. With few exceptions today's operators are primarily focused on their own portfolio with little to no attention allocated to fee for services management. So who would be the third party managers in the quarters and years to come and how will this aspect of the industry evolve? It seems inevitable until there are several quality national, regional and local operators committed to third party management that the realities of our idea to health care REITs will fall far short of its possibilities.

Having raised $105 million in equity since the end of the first quarter, we are decreasing the upper end of both our FFO and FAD guidance range by $0.01. A reconciliation of net income to FFO and FAD is provided in our press release as well as on page eight of our comprehensive analyst supplemental package. Our guidance range incorporates no results from acquisitions, except those completed or previously announced, nor does it incorporate the impact of any future capital transactions or impairments. We're now pleased to answer your questions. Mary, please open the lines.

(Operator Instructions) We'll wait a moment to compile questions. Your first question comes from the line of David Toti of Citigroup.

Good morning, guys. Michael Bilerman is here with me as well. Is it possible you could elaborate a little bit on some of the details of the Hearthstone adjustments specifically with regard to the property transfer clauses and the central bankruptcy provisions?

Yes. Good morning. This is Abdo Khoury. The -- what Hearthstone has agreed to is to pledge the stock of Hearthstone, of their operating company, to NHP, and in case of some event of default -- material event of default, NHP has the right to execute on that pledge.

Okay. And then moving over to your skilled nursing portfolio. Just quickly, and obviously the CMS ruling is well publicized. Do you believe there's any adverse impact or is that widely expected by the operators?

I think it was reasonably expected -- this is Brent Chappell by the way. I think it was expected by the operators. And really taking what was an effective net 1.1 decrease in the rate has really a marginal effect on coverage in their operations. I think for our portfolio specifically, it's about a four basis point potential deterioration without any mitigating effects of offsetting operating expenses.

Do you net-net given CMS given what's going on with the sort of administration's agenda on health care, do you still remain pretty positive on that space overall relative to your portfolio?

We do.

Okay. Then just lastly, relative to the most recent PMB option, can you characterize your discussions around that negotiation?

Sure. First of all, I would say that they're ongoing. We have frequent discussions with them. Second I would describe them as positive and we are moving toward a mutual understanding if nothing else of where we each believe the assets values are in today's environment. We've come a long distance in reconciling the perspectives on value, but we still have a ways to go and the dialogue will continue, and continue to be optimistic that if and when the assets are hold that NHP will be at the table and has -- will have an opportunity to acquire them if we decide that that's in our best interest.

How many assets are still sitting on their books that you passed on that maybe they haven't been able to sell?

Somebody help me with the numbers. About seven.

Seven that we passed on.

Seven that we passed on, and then there are a couple that we have -- that are not ready to be purchased yet pursuant to the agreement.

And so those seven, they didn't sell to third parties, they're just holding on to them?

They're holding on to them for now. They are exploring possibilities with other potential buyers, and we encourage that; and on the other hand, these are very well performing assets and given what their investment base, their development cost in the assets, they don't have to sell and we don't have to buy, and that makes it good for both parties and it also makes it a little more complicated in terms of getting to a number and set of terms that makes everybody happy.

Right. This is Michael Bilerman speaking, I had one final question. Doug, I think in your opening remarks you talked about looking at a number of interesting yet small opportunities. I guess given the size of the company today, it's $4.5 billion or so gross assets. Can you put some goal posts around the transactions and give a little bit more color as to what you're looking at?

I can very generally and ask Don to join this conversation as well, but we're not seeing as many things right now as we thought we might at this point in time in the recovery, particularly given that things have stabilized or there are signs that things are stabilizing. We thought that there would be a little more activity. So we haven't seen a lot. We were at least window shopping all along just to try and make sure that we didn't lose contact with the market, and so we're seeing things around $50 million -- $20 million to $50 million, I'd say, more in size and -- but there's -- we're not seeing an abundance of them.

We passed on a number of possibilities, but, frankly, the number that we've passed on dwarfs amounts that we've passed on in recent years. And so we just have to be patient and that's what we're doing and will continue to do. It's not much fun, and frankly it's a little difficult, but we know that that's a proper approach to things and I think we'll do it. I have every confidence that with Don's leadership and the five really excellent senior investment officers we have in the company stationed around from coast to coast, that as things become available for acquisition, we'll at least have the opportunity to have a good look at it. Don, is there anything you'd like to add to that?

I think you covered that quite well, Doug.

Thank you, Don.

Never disagree with the boss, right?

I'm a lot of things, but I'm not a fool.

Thank you.

He's also on a cruise ship and really happy, so --

Thank you. Your next question comes from the line of Jerry Doctrow, Stifel Nicolaus.

Thanks. I guess a little bit on some of the themes. Doug, I was sort of intrigued by some of your discussion with Sunrise and sort of the need of a third party manager and use of RIDEA, so I wanted to ask kind of about two or three maybe broader issues. One was just kind of where you see kind of the nature of kind of the investments going? It sounds like you are anticipating NHP being more of a -- making greater use of RIDEA your idea, having maybe a more intimate relationship with some operators, is one way this thing could go, and then I also wanted to ask about the balance sheet and capital markets.

Sure. On the idea front, really our attitude hasn't changed much about it, Jerry. We have said that we would use it in select cases for specific purposes, and really with Hearthstone as an example, that might have been a situation where you would have considered it more seriously than we did, and let me qualify that a bit. We did consider it as a possibility, but frankly, Hearthstone in the fact pattern that we had was not deemed to be an independent third party manager, so you couldn't use it. And so I really wanted to just elevate to the thinking of those of us that are interested in our industry that there's some challenges out there before our idea can really be fully utilized and it also points to some situations where if Sunrise has future changes ahead of it that would cause it to not be -- it's not now the company that it once was, but if it even changes further, I mean what's going to happen? Who's going to stand in and manage these assets?

It's not that easy to hit the qualifications that are prescribed in the tax laws as to what a third-party manager is and while I'm sure that there are operators out there that will say they manage them, it's not that easy to just change the culture and say, hey, all of a sudden we're a third-party manager. I've done it in the hotel industry and there's a different culture and a different mindset that's necessary for doing third party management, and I'm just not sure that we as an industry have really thought through this as thoroughly as maybe we should.

Okay. Okay. Thanks. That's helpful. And then kind of capital market side, I mean kind of from my view of the world and from what you have said to date, it sounds like there remains a strategic opportunity with PMB and it's just an issue on whether you guys can get together on price, and obviously the market has been helping your side of the price equation there. Other investments it doesn't sound like there's a lot right now coming, but as we start looking out as we're doing to model 2011 numbers and that sort of thing, you guys do have a very good balance sheet, good maturity schedules, but you do start as you look out further, start having some lower cost debt roll and that sort of thing. How are you thinking right now just about managing the balance sheet? Any need for equity given the prices have run, any thought about some maybe advanced refunding of some of those debt rolls?

Good question, Jerry. I don't see any dramatic changes in our capital structure strategy. Even without the immediate need for capital, you saw that we've raised $100 plus million in the past few months and since then there's been a run up in price. So now we'll just really have to balance things, taking into mind -- all the implications of raising additional equity. We do think that the theories on deleveraging are probably with us for at least the immediate future, and so we might raise more equity, but we have not made a decision to do that in any substantive way. We, as you know, like the continuous equity offering program. It allows us to make decisions in small increments and we find that helpful, particularly in the times where you really don't know what's going to happen next, so we don't mind having a bit more equity and I think we'll favor that. It's not that easy to prefund the debt on terms that are attractive, but we'll continue to look to doing that. And if there are ways to prepay some of our 2011 debt and even some of our 2013 debt, I think if the right terms presented themselves, we'd certainly be willing to do that.

Okay. And so your guidance assumes any continuous equity issuance or it really doesn't?

Does not.

Okay. And -- okay. And what --

That's consistent with what we've always done, Jerry. We include continuous equity in any capital raising activities.

Right. But just to make sure I understood you correctly, real world at least some continued use of that given stock prices might be a reasonable assumption for us to make independently?

That's certainly a reasonable assumption that you might choose to make.

Okay. All right. Thanks a lot.

Thank you. Your next question comes from the line of Rich Anderson, BMO Capital.

Thank you. And good morning, everybody.

Good morning.

And wherever you are, Don. Maybe it's nice there. Doug, your Sunrise comments, just to get back to them, not to use it in a bad -- I mean it kind of sounds like a eulogy to me, and I guess have you come to a conclusion that they are virtually -- they're likely to go away as the predominant manager of assisted living facilities, is that what you're doing, you're assume -- you're making that hypothetical and making a comment about the industry?

All I know is, Rich, and I didn't mean to sound like a eulogy. I'm going to have to take some up jelly beans or something here because I was gloomy Doug when I was saying when occupancy might fall the last several quarters, really my comment is Sunrise is a lightening rod for a lot of different things, I mean, you just cannot -- if you follow our space, you can't go a week or two without reading something about Sunrise, and we don't have a dog in the Sunrise arena. We've never done business with them, but I sit here as an interested former operator and as a CEO of a large health care REIT, and I'm saying, I really care what happens to these guys and I don't know what's going to happen to them because, again, we don't have a dog in the fight, so I'm not following it as closely as I'm sure many others are. But what I do know is that we talked a lot about RIDEA when it came out and there's just not any substantive operator out there that has as part of their business strategy that we could think of, and perhaps we overlooked somebody and if we did, we apologize for that, who has a business focus on managing assets for others on a fee for service basis. And if that doesn't exist and you're required to have a third-party independent manager, how are we ever going to get to RIDEA.

And furthermore, if there are subsequent changes to whatever happens to Sunrise and I hope they survive and I hope they thrive, but if that isn't the case, what's going to happen to the assets that are there? Are they going to move to operators who really haven't done a lot of third party management? Who's going to step in and do that? I'm just raising the question and I'm hoping and have encouraged privately operators for some time to consider this as a line of business for them, because I think it could be lucrative and I also think it's needed in the space.

Okay. That's fair, and thanks for clarifying that. On PMB, and I assume the answer to this is no, but maybe not. Do they have any -- I don't remember the legal or the legalities of the original agreement with them, but do they have the opportunity to put some of the assets to you if they wanted to?

Well, they did. It's -- we have to be careful about the -- let's not get tied up in the exact terminology, but effectively, they had the right to say these assets are now ready to be bought within the parameters of our agreement, and we, in turn, if all the parameters were met were required to buy the assets.

Okay.

In the cases where we elected not to buy the assets, not all the parameters were met, and there was kind of an in between zone where there would be some pricing adjustments for the assets. And so we said really under these conditions, we choose pursuant to the terms of our agreement not to acquire these assets at this point in time. And so they said, okay, we'll just continue to manage and operate these profitable assets and maybe somewhere down the road we'll buy them. There are a couple of assets for which they are still evolving and they're not ready to be presented to us having met all the criteria for which we may have an obligation to buy them, and those assets we've listed in our supplemental conditional obligations. And if all the terms are met and we're required to buy those assets, we either will or there's one more slight complication that we can pay a liquidated damages fee, and just say, you know what, we just really don't like the pricing of these assets, we understand the terms have been met, but here is a liquidated damages and you decide what you want to do next.

Okay.

So that's how it plays out, Rich, materially. And what PMB and we are trying to do is find a way that satisfies our individual and mutual objectives. Both PMB and NHP have motivation to try and find a way to do a transaction with each other. So as long as they want to sell, they have a motivation to sell it to NHP, and NHP has a motivation to buy the assets. We like the assets. We did back in January of 2008, we still like them, but we just don't have a complete agreement on pricing and some other factors that we're discussing, and we'll either come to an agreement or we won't. If we don't come to an agreement, lots of things could happen. They could just keep the assets and continue to own them and the partnerships that have them. They can sell them to some other party. We have rights of first offer on the ones we've passed on, so we'd have another look at them. And if they sell them to another third party, you know what, that's not bad for NHP in some respects. NHP will be a stronger company because they'll get the profits from the sale of the assets. We will have had a look at the assets and we, for whatever reasons, if this played out this way, we chose not to.

So there must have been a good business reason for doing so. And the real value of our relationship over time is the development agreement. We -- there were three parts of it, the management, we wanted to have a company that had good management, we've got that, that company is growing and evolving and improving. We bought good assets. We hope to buy more from them. But the real value creation for NHP all along was and remains being able to facilitate their development of new assets and us being able to buy them at a discount to what would otherwise be retail, which is why we've said in prior calls, we want to do everything we can to make sure that PMB is a vibrant, growing, developing company because that's where the real value comes. So at the end of the day, if it plays out like would be our preference, we'll find a meeting of the minds as to valuation and we'll close on the remaining assets and the development will occur as we planned. The second next best scenario is either PMB keeps the asset or sells them and makes a terrific profit on them and we continue with the development agreement.

Okay. The liquidated damages happens, you're obligated to pay them if they don't sell them to the third party.

If they bring them to us and say we've met all the criteria -- but only for two. The seven that we've terminated, we don't have that. There's only for two, an asset in Pasadena that's currently being leased and an asset in Burbank and if they meet all those criteria, one of the criteria that hasn't been met is that the triple B REIT index has to be 7.34% or lower. It's currently about 8.6%. So if the REIT index doesn't come down, then they would never meet that criteria, we would never -- our conditional obligation would never come to play, but if it did and we said, geez, you met all the terms, you're right, we have the chance to buy all of these assets at the price that was specified back in January of 2008 when we completed it, we look at it, say, are those market terms, and if they are, we'll buy it. If they're not market terms, we'll pay the liquidated damages and move on down the road, and again, that's what the parties agreed to when we did the transaction.

Okay. How big is that liquidated damage?

It's roughly based on pro formas, the anticipated value when we did the deal back in January 28, it would be $2 million or $3 million on one asset and $4 million or $5 million on the other asset.

Okay. And --

Think of it as a cancellation fee, Rich.

Okay. I understand. But for the other assets outside of those two, you have first right, but no obligation to buy them?

That is correct.

Okay. I just wanted to recall that. Last question is on the Broe buyout. Can you talk about the management of those assets on an ongoing basis?

Yes. It was -- even though we had the majority ownership interest in those assets, we didn't have complete control of the assets. And as I described in my remarks, Broe is really a good-sized, very successful company and since we weren't intending on growing that platform, it just made sense for us to acquire their minority interest and now it gives us full control of the assets, even though they had small percentage interest, they had really many decisions about the assets that we decided that we'd like to have. So we took the portfolio.

We took about a third of it and we're in the process of transitioning management which will go to PMB real estate services, and then we took the remaining of it and allocated it to two other parties for management. And so the next logical question is why didn't you give it to -- all of it to PMB, and the answer is really it was in NHP in our shareholder's best interest to give it to parties that were in one case closer to the assets, like right in their backyard in Illinois. And the other part was a good group that we have considered doing some business with and they're closer to the assets in the southeast part of the country. And we're also hopeful that maybe we can develop a relationship with them over time, after we get a chance to work with them on a party to party basis.

Throwing them a bone.

Throwing them a bone. But really not so much. I mean the primary thing is we just think they're the best manager for the assets. The frosting on the cake will be if they're as talented as we hope they are, and we'll say, okay, let's see if we can expand this relationship in the southeast part of the country.

Got it. Sounds good. Thank you.

Thank you.

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

Yes, hi. At the beginning of the call you talked a little bit about seeing some opportunities, a few of them, but they were interesting opportunities. Wondering if you could take that and maybe segway into the types of pricing on deals that you're seeing in the market today and just how it's different from nine months ago.

Don.

Sure. The opportunities really are -- I mean all three asset classes and I would say skilled nursing is the one that looks probably the most like it did nine months ago. The cap rates didn't really compress as much there. You could see cap rate -- or starting yield somewhere in the 10% area for the really high quality stuff that we've been buying recently to maybe 11% for stuff that's a bit older or maybe not as solid a Q mix in them or for other reasons. The senior housing side, again 9% to 10% depending on the quality of the assets is the starting yield you're going to see there and then in the medical office building sector, I think before the really high quality stuff you might see mid to upper 7%s, somewhere around there and I think overall you're seeing an average somewhere around 8.5%, 8.75% nationwide.

Okay. And the opportunities that you were looking at, is it in one particular sector at this point?

It's both skilled and senior housing.

Okay.

We're also looking at stuff in the medical office building, but I think the stuff that Doug was referring to was more the senior housing and long-term care sectors.

Okay. That's great. Thank you. I appreciate it.

Thank you. Your next question comes from the line of Brendan Maiorana, Wells Fargo.

This is Phil DeFelice for Brendan.

Good morning.

I have questions on the investment front as well. We were wondering if you could discuss the potential for further improvement financing at owned and JV properties going forward? Do you have any estimate of how large that investment potential could be? Do you have any comparisons to previous years?

Could you repeat that? It cut out and it over a key word. I couldn't hear what kind of investment. Did you say --

Improvement financing at your facilities.

Okay.

So could you repeat the question? You cut out and we didn't get the full -- could you please repeat it?

We're just trying to understand the potential that exists for improvement financing at owned and JV properties, your return expectations, how large that's been -- you expect it to be compared to previous years.

Well, we have announced that we have signed about $60 plus million of commitments and this will be funded over a couple of years, two or three years. And we -- if you look at our supplemental on page 28, it will give you the amounts that are expected for 2009, 2010 and 2011.

Okay. How about mortgage loans? Are you seeing any more opportunities there? Could you talk about your [rate] and yield expectations?

It's not a large pot for our business in terms of expectations. Don, do you want to talk about that? We don't do a lot of mortgage loans. We do them just to help some operators in certain states where the reimbursement is more favorable for loans rather than leases, but overall, we don't try to do a lot of mortgage business. And we have done some seller financing with some of the operators that had options.

Okay. So you --

And there's a good reason for that. We like to have the equity interest. We like to own the real estate, and should the bad word bankruptcy occur, you're much better off in a landlord/tenant relationship than you are in a lender/borrower relationship. So we really do use mortgage loans more as an accommodation than as a targeted asset class.

I understand. And when you do participate, are there restrictions on the use of those proceeds for the operator?

No. It's like we provide the financing, much like any kind of loan and I don't think we might have to maintain certain kind of working capital levels or there could be a default on the loan, but there's no restriction on the use of proceeds.

I see. Understand. Thanks, that's helpful. I appreciate it.

Thank you. (Operator Instructions) Your next question comes from the line of Jim Sullivan, Green Street Advisors.

Thank you. Good morning.

Good morning.

Doug, I thought your comments on third party management were really interesting. What are the reasons that in senior housing we don't have dozens of third party managers as you do, say, in the hotel business? Is the senior housing business -- the senior housing industry just too small or have those who might have the capacity to do third party fee management been making too much money on the operating side of their business on properties they either own or lease to devote resources to third-party fee management? What are your thoughts?

Jim, it's -- I thought about it and I don't really know the answer to it, but I have some ideas that I'll share. And I do think their hotel industry from which I come gives us maybe some clues as to why that is. And I think the history of senior housing where really many of the legacy of senior housing kind of spawns from some type of development enterprise first, which is very clearly tied to ownership of real estate. And so I think we have a few things going against the third party management fee for service concept just in the legacy of how the industry was born and got going. And I think that there's a general feeling that you make more money if you own the assets and if you can't own the assets or you view growth more valuable than having a bunch of assets and facilitating your growth, then you look to refinancing as an alternative and other forms. It's a very capital intensive business and people run out of capital, and they constantly -- we still see this in the space, the owners and developers of senior housing properties from an operating side always seem to underestimate the cost of their equity, and so you really have to convince them what their true cost of equity is.

Anyway, so there's kind of this history of thinking you're going to make more money in real estate and the cap rate compression we saw over the last couple of years did nothing but to reinforce that perspective. Now, I think it's unlikely that any time soon we're going to return to cap rates we saw a few years ago, and frankly I never completely embraced the cap rates that we were seeing for that period of time. I thought that they were -- might be short lived just like the cost of capital. But now maybe people need to rethink things a little bit and a few companies might -- the scale of the industry is definitely, I think, a problem and it's going to take some stimulus for people to focus on this. I don't know if that stimulus has been provided yet or not, but I don't see anybody running to the starting line to say I want to be that leader in this field. Somebody might, though, and I think if somebody chooses to, they could have a real competitive advantage because I -- it's just not people focusing on it.

That's very interesting. And then sticking with senior housing, I just think it's interesting given your background from the operating standpoint, the perspective you can provide in terms of what the right way to run a senior housing business might be in a downturn and the adjustments you can make to a business model to maintain profitability. I guess when we look at the operating results at senior housing for 2Q, the broad themes are not much good news on revenue other than it's stopped declining at the pace that it had been, but I would say a surprise at least in our eyes has been the ability to cut operating expenses and maintain profit margins, even enhance profit margins in some cases. From your standpoint given your operating background, what's the right place to cut and with respect to your operators, how active are you in working with them and prompting them to make operating expense cuts in certain areas and perhaps not cutting in areas where you don't think it's appropriate?

It's an excellent and difficult question Jim, so I'll try to answer it and ask Abdo to embellish it, because Abdo is really an excellent operator. It's hard to say, Jim. I'm impressed, really, and a bit surprised with the success that the operators have had. If Paul Harvey were here, I'm not sure that he would say he knows what the rest of the story is, and I kind of feel a little bit that way. There's a lot of things that are helping the operators, specifically the labor market. Once you get past the financing costs for the business, whether it's leases or interest, really your biggest cost is labor, and with the labor market being weak, the operators, I'm sure, and we've read about it and heard about it and talked about it, they're controlling labor costs, and they're doing that in ways that seem to be were prudent and appropriate.

Companies are doing away with 401k plans or matches and a variety of different things, benefits may be being cut and with the labor markets the way they are, they can do that because employees don't really have any choices. But other costs that are being cut, it's hard to say exactly, and even financial statements, just reading the face of the financial statements, it's hard to really tell what's happening. In some respects, we tell our operators, you need to do what you need to do, but please take the long view of things and -- because we do and there are real dangers that you can cut the wrong things or you can cut too much. And so we've tried to encourage our tenants to not forego needed capital improvements and we are willing to reinvest in our assets and their business at rates even that are discounted to what may be justified based on a cost to capital, because we really -- once you go down that path, it's hard to reverse it, and so we're encouraging them not to cut some costs, as well as we're encouraging them to manage their business as they deem appropriate. We can't get too involved with the operations of the business. That's just not what our relationship is, nor do we want the operational liability for getting too involved in their business, but I think Abdo primarily because he deals with them much more than I do, I think they have a certain, I hope, trust and respect of us that they can talk to us about some of their issues. The bigger operators are less inclined to do that than some of the smaller operators because they feel comfortable in their ability to manage things. But we can at least have conversations with them that are more frank and precise than maybe others may be able to do so. So I didn't, Jim, really probably provide you as satisfying an answer as you would have liked, but it's not because I'm trying to avoid it, it's just difficult to do so. Abdo, anything you'd like to add to that?

Jim, mainly, they all have done a great job managing their expenses and -- but as Doug said, they've been helped by the employment environment and also the cost of utilities as well as the cost of gas, of oil coming down. A year, a year and a half ago, most of the food companies had added a surcharge for delivery of food which has now gone down. A lot of our tenants that we talked to have tried to renegotiate some of their contracts of supplies, food and others, due to the economic conditions. So they've been hurt by the economy, but they also, they've been helped by being able to renegotiate a lot of their contracts.

That's very helpful. And, Doug, on the labor side, what are some of the things an operator can do other than cut hours for their workers to cut costs on the labor side?

Well, a lot of them you really do try to look for efficiencies and if you're in an assisted living facility, there are times where people are really busy and there are times where they're less busy, and so you try to maintain them being more evenly busy throughout the day by using -- people have pointed to different terms, but one you hear a lot is a universal worker where maybe you're food service part of the day and other parts of the day you do other things, and so you try to encourage that. The good operators most of the people at the assisted living facilities are -- have a caregiver tendency to them. That's why they do what they do for a living because it's not the highest paying profession and it's hard and -- but they really derive satisfaction from delivering good care.

And so you really encourage them as managers to explain the situation to them, you explain why sacrifices are needed and appropriate, and how they can make a contribution to the viability of their own company, why that's in their best interests and how it promotes better care and frequently and really these people deserve far greater accolades than they get, they'll step up and they'll stand up and try to help out. So you do those kinds of things. What you have to be really vigilant of, though, is just because people don't have better choices doesn't mean they're happy, and you've got to make sure you're really watching for unhappy people, because they can do a lot of harm in an organization by corrupting other employees or providing poor care, and so that's why the rest of the story hasn't been written. Again, I'm very impressed with the way operators have handled this, but if this downturn lingers for too long, I still don't think we're completely out of the woods, Jim. You just cannot continue to raise rates indefinitely.

I mean at some point in time there is a certain inelasticity to rates, and old people when you give them a rent increase, they just don't say let's go pack up the station wagon and get the hell out of here, we can save $50 someplace else, that's not how they think. But you do it over time and they reach a point that it's no more. And some of the families with loved ones in these facilities are doing estate management too, and they're kind of saying, the more we're spending here, the less we're going to have ultimately passing through the estate, and I must say, I don't know if it's a bad thing or a good thing, but it does happen. And I read somebody who -- I can't remember who it was, somebody I respect, and I disagree with the comment something to the effect people can't hold out forever. They're going to have to make a decision. That's true for some people. In other words, they're going to have to put them in a facility at some point in time. That's true in some respects and for some people, but the last I saw statistics for people that are age and income qualified, and I mean this as an opportunity, but it's a negative in this one regard, people that are age and income qualified, the penetration rate of people that are in the senior housing is-I think around 10% or less. That means 90% of people have figure out how to do something else.

So I don't really prescribe to the notion they have to go to a facility in mass. People have choices and they'll continue to exercise these. The second and third quarter tend to be better quarters for senior housing operators, so is that masking the results or not, I don't know. But I say continue to watch indicators like unemployment and some other things, before we can really signal the all clear sign and that we're out of the woods and everything is moving forward. Positively, though, there are low penetration rates. I think that bodes exceptionally well for senior housing with the passage of time and here we are already past the longest recession since the great depression and for the most part, we're doing remarkably. So I tend to look at it more positively than negatively, but I do try to point out to people, particularly when people ask me specific questions like you have, things that maybe they may not think about because they haven't had the same experiences that Abdo and I and others in our organization have.

We appreciate the candor. It's all very helpful. Just one final question for Don. Don, you were asked about cap rates before and you cited some figures. Can you clarify, were you citing property level cap rates, or were you citing yields to you on what you would get on an investment?

True yields to us, Jim.

Okay. And with respect to certain property ties, what kind of coverage ratios were baking into the figures that you provided?

We're looking more in the -- closer to the 1.3 times on a senior housing side on a DAR after CapEx basis, and I'd say close to 1.5 on skill.

And on senior housing has the market moved there? So many deals were done the last go round at 1.0. Has it moved to 1.3?

Well, there's not that many deals yet, so we're not sure. I'm just saying we're looking for now because we're not -- as Doug says, we're not sure we're out of the woods yet. So for both the operator and us, we want to make sure there's enough cushion there, and it just seems to us that we leave a little bit more on the table for both of us as we underwrite new investment opportunities. But again, can't say there's been an abundance of those. When the market does pick up, we may find that that's just not competitive and we may have to back off of that, but that's more or less what we're targeting for now.

Great. Thank you very much.

Thank you.

Thank you. There are no other questions at this time.

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