Welltower Inc (WELL) 2005 Q1 法說會逐字稿

Welcome to the Health Care REIT incorporated first quarter 2005 earnings conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the call over to Georgeanne Pelfy (ph) of the Financial Relations Board.

Please go ahead.

Good morning.

And thanks everyone for joining us today for Health Care REIT's first quarter conference call.

You have received a copy of the press release late yesterday afternoon, but in the event you have not you may access it via the Company's website at www.HCREIT.com.

I would like to remind everyone that we are holding a live Webcast of today's call which may be accessed through the Company's website as well.

At this time, management would like me to inform you that certain statements made during this conference call which are nonhistorical may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Although Health Care REIT believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that its expectations will be attained.

Factors and risks that could cause actual results to differ materially from expectations are detailed in the press release and from time to time in the Company's filings with the SEC.

And having said all of that, I would now like to turn the call over to George Chapman, Chairman and CEO of Health Care REIT for his openings remarks.

Please go ahead, sir.

Thanks, Georgeann.

We had another solid quarter with strong FAD growth and continued improvement in our payment coverages.

Net investments were in line with our expectations.

And we also successfully accessed the debt markets recently.

Last week, we issued 250 million of 10-year notes with a coupon of five and seven eighths and an effective yield are of 591, we then called or tendered for approximately 230 million of our outstanding notes in '06, '07, and '08.

So that we have our only significant maturities now occur in 2012, '13, and '15.

We had excellent execution in pricing given the complexity of the overall transaction that involved both selling notes as well as redeeming and tendering for the outstanding notes.

As an update, we're in the process of renewing our lines of credit.

That process should be accomplished by June 30, of this year.

And is expected to reduce our rates and increase line capacity.

We also expect our swing line to be extended a year and move from 30 million to $40 million.

As an overview of the health care front, demand and supply components relating to long-term care are really quite attractive at this time.

In the assisted living arena, development has been at reasonable levels, with census in rents increasing.

In the skilled nursing arena, we have witnessed a decrease in the number of beds with the resultant increases in occupancy during the last several years.

Reimbursement in both Medicare and Medicaid programs is apt to be reduced somewhat or changed this year.

However, any such changes should be manageable for our operators, who are quite skilled at adapting to changes in this regulated industry.

The improved transparency and stability in the long-term care markets has created a very competitive investment landscape especially in the high end ALF arena.

Some believe the markets to be in a cyclical over-valuation phase.

Others believe a paradigm shift is under way that will drive out cap rates much closely to multi-family cap rates.

If that is the case when will there be a commensurate reduction in our cost of capital and those of our REIT colleagues that invest in long-term care, particularly assisted living?

To date, that change to capital costs apparently has not occurred, making current pricing somewhat speculative given the current disconnect between REIT's cost of capital and the pricing of investments.

Only time will tell, yet we are cautious about current long-term care pricing.

We tend to believe that there is some irrational exuberance entering our markets.

Some attribute that to the entry of financial buyers into the market without sufficient knowledge of the operating risks.

We have determined that we will maintain our historical commitment to sell at underwriting and conservative investing believing that a somewhat more favorable environment will be forthcoming.

As you know, by taking advantage of excellent investment environments as we did in the last three years, and being cautious during speculative ones like these, we have been able to close large volumes of attractive investments with excellent coverages and solid returns.

During the last three years, which was a very favorable environment, we concluded approximately 1.6 billion of new investments, with average initial cap rates of nearly 11%.

Coverages and cap rates for those assets have now moved to significantly higher levels.

Moreover, we drove our average portfolio life to approximately 12 years.

We also have had good success in the last 15 months in reducing our sub debt investments, at 12/31/03 we had outstanding sub debt of 45.3 million.

By the end of the first quarter of 2005, the sub debt balance stood at $23.3 million.

While we do expect to utilize the sub debt vehicle selectively in the future, we would like to see sub debt for companies repaid in a reasonable time period, allowing us to recycle funds to other companies interested in growing their portfolios.

We will continue to focus on improving portfolio quality and performance by allocating and reallocating investment dollars to the best performing assets and operators.

We will also continue to reduce FFO and FAD payout ratios and I should note that the straight line rent component in our financial results is being reduced ahead of schedule.

And finally, even in this competitive environment, we will capture at least our share of the good investment opportunities.

And with that, I will turn it over to Ray Braun who will bring you up to date on some financial and portfolio issues.

Ray?

Thanks, George.

Please note that our earnings release is posted on our website at www.HCREIT.com under the heading press releases.

The earnings release contains reconciliations of FAD, FFO, and EBITDA to net income.

I will first review the first quarter results and then management's guidance for 2005.

For the quarter, we recognize net income available to common stockholders of $0.33, FFO of $0.72 and FAD of $0.66 per diluted share.

Dividends paid in the first quarter were $0.60 per share and our FFO and FAD payout ratios were 83% and 91% respectively.

As previously announced the Board approved our 136th consecutive dividend to be paid May 20, 2005, in the amount of $0.62 per share.

Moving on to the operating results, our gross revenues including discontinued operations were 68.6 million for the quarter.

These revenues were 93% from real property and 53% from the assisted living sector.

I would like to note two other items with respect to our revenues.

First our loans on nonaccrual as of March 31, 2005, we have loans aggregating 35.9 million, with 7 different operators on nonaccrual with an average contractual yield of 12.5%.

The loans are approximately 57% ALF, similar to our portfolio balances.

Secondly, other income was up to 1.4 million.

The increase is primarily due to the payment of an assignment consent fee of $750,000 in connection with the assignment of a lease to a new tenant.

On the expense side, our quarterly depreciation including discontinued ops increased 20.4 million from 17.1 million in the prior year, as a result of the increase in real property owned.

We added $300,000 to the loan loss reserve in our allowance now stands at 5.6 million.

Additionally our quarterly interest expense including discontinued ops increased to 19.6 million from 18.6 million in the prior year, primarily as a result of the $50 million of senior unsecured notes issued in September of 2004, offset by savings generated from our swap agreements.

During the first quarter, G&A expenses totaled $4 million, representing a 27% increase over 3.2 million last year, but a decline of 2.2 million from the fourth quarter of 2004.

We continue to diligently monitor our G&A expense line item and remain comfortable with our overall guidance for calendar 2005 of 17.5 to $18.5 million.

Moving on to the balance sheet, we ended the quarter with net real estate investments of approximately 2.5 billion comprised of investments in 398 facilities in 35 states with 51 operators.

As previously reported our gross investment activity for the quarter totaled 63.5 million and we had payoffs totaling 28.8 million, generating 34.7 million of net new investments.

New acquisitions totaled 41.8 million and included 3 assisted living facilities with 256 units, for 39.6 million, and 1 skilled nursing facility with 78 beds for 2.2 billion.

These new lease investments have terms of 12 to 15 years, and average initial yields of approximately 9.1% and average expected yields of approximately 11.1%.

We had asset sales and loan payoffs during the quarter of 28.8 million, with an average yield of 11.6%, payoffs included 19.5 million of sub debt.

Our credit profile remains stable.

Leverage remains low at 38% debt to total market cap at the end of the quarter.

Our interest coverage for the year to date is solid at 3.26 times.

Our debt maturity schedule is in excellent shape.

We only have 2.4 million of mortgage repayments due in 2005.

We had no change in our credit ratings during the quarter and we will continue to manage the Company to maintain investment grade status.

On the capital raising front, during the quarter, we issued 291,500 shares under the DRIP generating $9.9 million.

We would expect issuing approximately 300,000 shares per quarter through our DRIP going forward.

As George alluded to, we did $250 million in senior unsecured notes, maturing in May 2015 with a coupon of 5.875.

We used proceeds from this offering to redeem all of our outstanding $50 million 8.17% notes due March 2006, to redeem 122.5 million of our 175 million, 7.5% notes due August, 2007, and to tender offer for our 100 million, 7.625% notes due March, 2008, of which 57.7 million were tendered.

In connection with the redemption of the tender offer we will take a charge in second quarter of '05 to reflect premiums paid to retire the debt in an estimated amount of 17.5 to $18 million.

The redemption in tender offer reduced our weighted average cost on unsecured notes to roughly 6.7%, a savings of approximately 50 basis points, and significantly lengthened our maturity schedules.

We have a $30 million unsecured line of credit that that expires May 31, of '05.

We have a commitment letter to extend the maturity another year and increase the commitment to 40 million.

We have also commenced discussions with our bank group for renewal and expansion of our $310 million revolving line of credit.

At this point, I will flip it to Scott Estes who is going to talk a little bit about the portfolio.

Scott?

Thanks, Ray.

With respect to the portfolio, please note that coverage statistics reflect the latest 12-month activity through 4Q '04, whereas balances, facilities, and bed counts reflect amounts as of March 31, 2005.

Our overall payment coverage is at approximately 1.84 times, an increase of 6 basis points from the prior quarter.

Our portfolio had 98% stable assets, 90% of our properties are owned, and 84% of our owned assets are in master leases.

At quarter end, our assisted living portfolio was comprised of 237 facilities, 15,936 units, and an investment balance of approximately 1.3 billion.

The stabilized portfolio was comprised of 232 facilities with 15,186 units an investment balance of 1.3 billion, and payment coverage of 1.47 times, an increase of 2 basis points from the prior quarter.

Our skilled nursing portfolio was comprised of 153 facilities with 20,926 beds, and an investment balance of 961 million.

Our payment coverage remains strong at 2.15 times, an increase of 4 basis points from the prior quarter.

Next I would like to provide an update on the reimbursement front.

As usual, budget and reimbursement discussions are on everyone's mind this time of year.

We will share with you what we perceive is our outlook for Medicare and Medicaid.

Based on our current information and strong payment coverages we do not anticipate a material change in payment risk in the nursing home portfolio as a result of proposed reimbursement changes.

First, regarding Medicare.

CMS is expected to issue a proposed RUG refinement within the next week.

After a public comment period, the proposal is intended to be implemented on October 1, 2005.

At that time, add-on payments worth 1.5 billion in fiscal 2006 and 10 billion over 5 years will likely be eliminated.

All else being equal, per diem Medicare rates would decrease by approximately $30 if the add-on payments are eliminated and coverage in our nursing home portfolio would decrease by approximately 28 basis points.

Our lobbying efforts opposing the cuts continue and may reduce the negative impact.

In addition nursing homes are expected to receive a market basket inflation update on October 1, 2005 of roughly 3%.

The net negative impacts of our coverage -- of the RUG refinement combined with an assumed 3% market basket increase would be roughly 20 basis points.

Next on the Medicaid side, Medicaid rates for fiscal 2006 will not be available until this summer.

A more immediate threat was the 2006 federal budget.

President Bush and the House proposed Medicaid cuts of several billion dollars over the next five years.

The House and Senate more recently passed a budget resolution that will delay Medicaid cuts until fiscal 2007.

The resolution also establishes a Medicaid commission that must recommend Medicaid savings of $10 billion over a four-year period which will likely include prescription drug reforms and asset test qualification changes.

The impact on our portfolio cannot be determined prior to the commission's recommendations.

Finally, with respect to provider taxes, the President's budget also proposed modifications in provider taxes that states use to increase the federal match on Medicaid for nursing homes. 14 of the 24 states in our nursing home portfolio have nursing home provider taxes.

The President's proposal is to reduce the maximum provider tax from 6% to 3% of nursing home revenues.

Which would phase in over three years at 1% per year.

All else being equal, the proposal would impact 12 of our 14 provider tax states and reduce portfolio coverage by roughly 8 basis points in year one, net of expense savings, and up to 11 basis points in year three.

In general, states that have a high federal matching percentage would be impacted most significantly.

Although the existing provider taxes are unlikely to be eliminated a more significant threat is that several states are now at the federal max of 6%, which limits the ability to use new provider tax funding to avoid future payment cuts.

I would now like to discuss management's expectations for 2005 and of course, these comments are management's expectations only and subject to the Safe Harbor statement read at the beginning of the call.

All expectations discussed regarding new investments, asset dispositions, and earnings are subject to the factors listed in the Safe Harbor statement, including market conditions.

As announced, we affirm our 2005 guidance and expect to report net income available to common stockholders in the range of $1.39 to $1.47 per diluted share and FFO in the range of $2.90 to $2.98 per diluted share.

The guidance assumes net new investments of 200 million with leases that will not require rents to be straight lined and we continue to anticipate that G&A expenses will total between 17.5 and 18.5 million for full-year 2005.

We now expect to record straight line rent of approximately 13 million for the full year, before any additional cash payments outside normal monthly rental payments and expect to report FAD in the range of $2.66 to 2.74 per diluted share.

That concludes our report and we will turn it back to you, George.

Thanks very much, Scott.

Just a few concluding remarks.

We now have a portfolio with a 12-year average life, improving FFO and FAD payout ratios, a debt maturity schedule without significant maturities until 2012 and a reduced level of straight line rent.

All point to more certainty in a stronger company.

We will also attempt to improve our portfolio this year by attempting to take advantage of the strong markets to sell certain assets to eliminate certain assets and operators.

Obvious targets are sub debt investments, loans that are on nonaccrual, and perhaps assets that might -- may be susceptible to underperformance based upon any kind of market shifts and reimbursement changes.

Those will be evaluated during the year.

But we believe that these kinds of sales would only strengthen our portfolio and reduce uncertainty, and that these are the type of transactions that can and should be concluded in an overheated transactional marketplace.

As I mentioned, our investments during the previous three years were concluded at an average initial cap rate of about 11%.

Generally, they are performing quite well on an average -- have now obtained an average cap rate of approximately 17% and a facility coverage after management fee of nearly 1.5 to 1, very strong performance and those cap rates and those coverages support our view that this three-year period was one of the best investment environments we have ever experienced.

We were pleased to be the leader in investment of volumes among the public health care REITs during those years.

In the current environment we will capture an appropriate level of investment volume as we further improve our existing portfolio.

We will not be overly aggressive simply to grow.

Our goal is to be positioned to compete even more effectively, efficiently, when the investment environment has improved in our sector.

And with that we'll open for questions.

[OPERATOR INSTRUCTIONS] Our first question comes from Robert Mains of Ryan Beck.

Yes, good morning.

How are you?

Very good.

How are you?

Appreciate the comments about the industry.

Scott, one kind of fine point on that, when you talk about Medicaid and means testing couldn't it arguably work in the favor of the nursing homes if there is extended look backs, that sort of thing?

This is Ray, Bob.

It could work in favor of the industry if it in fact increases the private pay percentages.

And my understanding is that's what the intent would be, right?

Right.

Because to get rid of the ability to transfer assets and qualify for Medicaid, and therefore you would have to come in as a private pay resident and pay those rates.

Okay.

And the second question, I know that you talked about this on the last call, but could you sort of refresh memory, in terms of the assets dispositions that you've announced to date, can you go over what the timing was of those?

Yes, we disposed -- well, we expected a couple of payoffs and one of them occurred in the quarter, and it was about 19.5 million of sub debt, and it occurred late in the quarter.

And the remainder, what you talked about last call, that is all in the current quarter?

We expected another payoff to occur.

It hasn't occurred yet.

And we're not sure if it will in fact occur.

But we just generally have a pool of assets that could be disposed of.

And we would anticipate we will dispose of at least that amount sometime in the next couple of quarters.

Okay.

Now, that one was a purchase option exercise, wasn't it, the one that you're waiting on?

Yes.

And is somebody getting cold feet or something?

No, it was a transaction to sell an asset, and the buyer decided that they didn't want to buy it.

So we may not see the option exercised.

Got you.

And then the last question, given the caution that you're talking about, going forward in the market, what kind of transactions are you seeing that still kind of pique your interest in terms of both asset quality and price?

I think the best opportunities today for us are turn-around assets, with operators that we know and are confident can turn around the asset, and they would be both in -- well, they would include independent living, skilled nursing, and assisted living.

And that's where we see the best values right now.

Large stabilized portfolios of assisted living are trading at unprecedented cap rate levels, and we don't view that as particularly attractive.

Okay.

Thanks a lot.

Our next question comes from Greg Andrews of Green Street Advisors.

Good morning.

Good morning, Greg.

The -- I just want to clarify on your guidance, you are taking this charge in the second quarter for the prepayment of all your debt, that was announced separately, but that is not included in your FFO guidance, correct?

That's correct.

But is the benefit that you're deriving from having lower rates in say the second half of the year in your guidance?

Yes.

Okay.

So there is a bit of mismatch there.

Then in terms of your straight line rent, it looks like the guidance went down from 14 to 13 million.

That's correct.

Sequentially.

What explains that, please?

Disposition of an asset that had straight line rents.

Okay.

Regarding the sub debt investment that was repaid, do you have any other financings with operator and what would those be?

Do we have other financings with that operator?

Yes.

Yes, we do.

They are operating leases.

And is your anticipation that those arrangements will remain in place and not be paid off?

Yes.

The way we look at sub debt, for some operators, Greg, is that it helps them grow appropriately, but we view the sort of permanent financing to be the operating leases that go out 10 to 15 years and the sub debt should be recycled and fairly early on, so this is, in our judgment, exactly how we planned to do it.

Okay.

And just on the Medicaid side, I understand that, without knowing exactly what the commission is going to decide with respect to the $10 billion in cuts, hard to say what the impact might be, but could you give us some sort of sense of what you think might result for the nursing home industry and what kind of impact that might have on coverage ratios?

It is very difficult question to answer, Greg.

I mean the 10 billion is for the entire Medicaid program.

Right.

Over four years.

Over a four-year period, and what percentage of that filters down to nursing homes, we don't know.

We've been nervous about Medicaid rates the last three years and we've seen on average rate increases of 2 to 5% in states in our portfolio, and only a few states have actually cut them.

As you know, it is well documented that Medicaid rates do not cover the cost of care, and I would think that very little of the cuts would filter down to the nursing home industry.

Bigger concern to us is if they go to block grants, because then states will have the opportunity to allocate how they see fit, and the number of states are more focused on home health rather than nursing care.

But even having said that, there is a core population that can be only be taken care of cost effectively in nursing homes, so I would not anticipate dramatic reductions in Medicaid to nursing homes.

Could you just give me a reminder, what are the total revenues for the nursing home industry these days?

I used to think of 70 billion, but it is probably higher now.

It is roughly $100 billion a year.

So just as a complete hypothetical, if all 10 billion hit the nursing home industry, which won't happen, over four years, it would be 2.5 billion a year or about a 2.5% hit?

That's the way we've looked at it.

Which we think is an unlikely scenario but a worst case scenario.

Okay.

Thank you.

Our next question comes from Jerry Doctrow of Legg Mason.

Good morning.

Hi, Jerry.

I just had a couple of things.

I think in some of our modeling when we head down for 200 million we have a common offering, sort of later in the year.

Is that something that you think you need at the levels you're running at or just with the debt levels and stuff?

It is a possibility, Jerry.

Depending upon where the investment volumes come in.

As George alluded to, in his opening remarks, or his concluding remarks, if we have opportunities to sell some assets this year, we may do that, and the proceeds from those asset sales could be available for reinvestment opportunities.

In which case you might not need the common.

Exactly.

We're still comfortable with 200 million net, but the source of that funding could either be common or it could be reinvestment.

Okay.

And my sense is you're a little bit more biased towards reinvestment just given where cap rates are.

Yes, we think we are going to have the opportunity to sell some assets this year and then reinvest the proceeds.

Ray, I didn't quite pick up on the yields on the new investments and also the payoffs and if you could break up the ALFs because everybody is trying to figure out what stuff is being done these days.

The ALF and the SNF.

Bear with me for a second, Jerry.

On the new investment, we had roughly 9.1% initial yields and our expected average yield over the life of the asset is 11.1.

Right.

But these aren't being straight lined, right?

And do you mind breaking it it up so the ALF and the SNF or just give me a range of where they were -- in terms of say initial cash yield?

Just a second.

ALFs are roughly nine and SNFs are 10.25 on initial yields.

That's really all I had, thanks.

Thank you, Jerry.

Thank you.

Our next question comes from Philip Martin of Stifel Nicolaus.

Good morning, everybody.

Good morning.

Just a couple of questions.

On the skilled nursing -- or the assisted living portfolio, that was 256 beds, you said?

The skilled nursing facility that we purchased was 78 beds.

And then the assisted living was 256?

Yes, assisted was 256.

Okay.

Perfect.

In terms of the cap rates on the specialty care hospitals, where did they shake out?

And if I could get coverage --?

We didn't buy any this quarter.

I thought I saw 8% in specialty care.

Or 14% of the investments.

Okay, maybe I just looked at that wrong.

So it was just assisted living and skilled nursing?

Those were construction add-ons.

Okay.

In terms of coverages, on your assisted living and skilled nursing in the quarter, can you give us some indication what that was or what they were?

Assisted living, we have coverages of 1.47 and skilled, 2.15.

And those were on the acquisitions in the quarter?

No, that's on the overall portfolio.

How about the the ones, how about the coverages just for the acquisitions in the quarter?

For the investments in the quarter?

For our stabilized assisted living, it was roughly 1.40 times.

And our SNF is a renovation.

Okay, that's a renovation.

And security deposits on the investments made in the first quarter were what?

Especially in assisted living, given the frothy sellers market there.

We're not sure.

None of us recall what we got for security deposits.

But you did get something?

One was added into a master lease that had a letter of credit on it.

And investments in the quarter, the 80% that were real property, those were all done under master leases or added into master leases?

Yes, generally, they were part of master lease transactions.

Okay.

The last question, too, what percentage of the buyers that you're running up -- or the sellers out there, or even buyers, or really the buyers would you estimate are the unsophisticated buyers going after and buying the assisted living, even skilled nursing, et cetera?

And how has that changed over the last couple of years?

I'm assuming it is higher.

I made a general comment, Philip.

I'm not going to pin down the unsophisticated buyers.

But it is certainly with the enhanced transparency and the stability, it is attract -- this whole sector is attracting more interest from nonhealth care buyers, okay?

And my own assessment is that often those buyers do not quite drill down on the operating risk, but I'm not going to -- I'm not going to go there.

Thanks.

But this could portend to some potential opportunities in a couple of years certainly, but okay, thank you.

Thanks.

Our next question comes from Robert Belzer of Prudential Equity Group.

Good morning.

Hey, Robert.

Just a few questions.

First, would you have in front of you the current percent of the portfolio that is incurring straight line versus alternative rent increases?

Hold on one second.

I think we can get that.

Just kind of curious if you are getting a little closer to possibly some organic portfolio growth.

55 to 60% of the portfolio has nonstraight line internal growth.

55 to 60% of the portfolio had some internal growth component.

The rest would be straight line.

Okay.

Great.

And then --.

Of the leases.

And then just on the investment activity you completed during the quarter, I think you mentioned that the dispositions happened late in the quarter, and how about the acquisitions, what were the timing of the acquisitions just in general?

I'm looking at a schedule here, Robert, and most of the acquisitions occurred late in the quarter, in March.

And then finally, you had 22 million of construction funding.

Was that funding that began generating revenues or was that money you put to work and is in the CIP?

Yes, I mean when we put the dollars out, they began earning a yield.

Okay, so that is already generating income.

Okay.

Great.

That's all my questions.

Our next question comes from Gary Taylor of Bank of America Securities.

Hi, good morning, guys.

How are you?

Good.

Just wanted to ask, I guess you've said a couple of times you're comfortable with the 200 million net investment for the year.

What are the chances that maybe divestitures could run earlier or heavier perhaps than you contemplate and you don't hit that number?

On a net basis?

Is that something we should be thinking about as the year goes by?

I will tell you, Gary, it is something we're certainly thinking about.

We're making our best guesstimate at any point in time, and as George indicated, some of the assets that we can sell and get repaid sub debt, if we had the opportunity, we would do it.

And it is very hard to ballpark the odds at this point.

Okay.

Did I hear you say your current SNF coverages were at 215?

Is that what you said?

Correct.

That is EBITDARM?

Yes.

And then two other quick questions.

I guess just in terms of Medicaid, we've been through this -- some form of this dance for years now, and it really hasn't yielded any major changes outside of a few states here and there.

I mean would you guys say you're more concerned than you have been historically, or is this just another round of really what you've had to keep an eye on over the last few years?

I would say that I was more concerned about Medicaid three years ago than I am today.

But with the caveat that with this new Medicaid commission, we could see a restructuring of how the Medicaid system is administered, and that poses some risk to the industry.

And then a final question, just housekeeping, I'm sure you've gone through this before and I've forgotten what it is, but on your reconciliation to FAD, you back out a piece of nonrecurring cash rental payments?

What is that related to? 852,000.

Prepaid rent and payoffs.

When we close a deal, and we get a -- an upfront transaction fee, we categorize it as prepaid rent, and when a transaction is disposed of, or paid off, we get repaid our straight line rent.

And those two things adjust the balance.

Okay.

Thank you.

Our next question comes from Scott O'Shea of Deutsche Bank.

Good morning, guys.

Good morning.

A question on the 16% of the sale lease back portfolio that is not covered under master leases, what is roughly the composition between ALF and SNF in that pool and then what kind of coverage ratios do you have there?

Is that commensurate with the broader portfolio?

The portion that is not covered in master lease is primarily SPEs where we assume debt, and we could not put them in a master lease because of restrictions in the debt covenants, and they are cross defaulted with master lease portfolios.

And they're mostly ALFs.

Scott, if anything, that number understates the security we have on those deals.

I mean two in particular are -- a number of the facilities that are in these SPE situations are cross defaulted to the master lease, with two of our best operators.

The other thing I would add, Scott, is we also have a a provision in those leases that when the debt is repaid, they become part of the master lease.

Okay.

Good.

That's helpful.

Appreciate it.

Our next question comes from Lou Taylor of Deutsche Bank.

Thanks, good morning.

You can talk a little bit about the rationale behind the recent debt financing, it looks pretty expensive, vis-a-vis the savings and the timing of the maturities.

Can you just expand on your rationale?

Well, it was an opportunity for us to basically put all of our debt maturities off to 2012.

We have minimal debt maturities until then.

And it matched up the duration of our assets with our debt maturities.

You don't think the price 18 million bucks was -- you said kind of was an appropriate price?

Yes, we thought it was appropriate, given the near term interest savings, as well as where we think interest rates may be moving.

Okay.

Thank you.

[OPERATOR INSTRUCTIONS] Our next question comes from Rick Murray of Raymond James.

Good morning, guys.

Nice quarter.

Hello, Rick.

Just a couple of questions on your comments, George, with regard to cap rates you're seeing in the market, where would you place the sort of lower bound of the range you're seeing in there?

And I guess as a second part of that question, what types of financing strategies are you seeing these buyers implement, if you have any read on that at all?

Well, I guess my -- I'm not going to characterize a particular cap rate level as inappropriate.

All I would say, reiterate is the fact that our costs of capital have not come down significantly, any of ours, during this time period of dramatic increases in asset pricing.

And for us, we do not see that as an appropriate return for making those types of investments.

Other people might evaluate their costs of capital differently than we do.

And I hope they're right.

Ray, did you want to add anything?

I just don't -- the problem with this is, we are saying what we do.

We had three great years, we made great investment, we have a 12-year average life, we have great revenue strength, and we just don't choose to play at certain pricing levels, but I really don't want that to be turned around on us to constitute a criticism of other people who are, so I want to be very careful on that.

Other people have different strategies, and different reasons to buy.

We just want to be very clear about how we look at the market.

Hey, George, we're not challenging that.

I think our question is --.

No, what I want to avoid Rick is having criticism -- this call being -- constituting criticism of our colleagues in the REIT industry, or elsewhere, in terms of what they're buying, okay?

I don't mean it that way.

A different approach.

George, this is Paul, we're not -- I think where we're headed with this is just really trying to understand sort of where you see the spreads currently, and the decision process.

It is really not -- I assume it is really not an IRR, it is a spread issue, is that accurate?

Sure, and you can -- we went over with our Board yesterday different ways that we could evaluate our cost of capital.

And at the very lowest level, assuming that one wants coverage of a asset level, we would not want to do a transaction at the 7% level.

It just does not give us the spread we need in direct response to your question, Paul.

There are a couple of things, Paul, one is we need to get an an initial shield that is accretive is our philosophy and that has to take into account our cost of capital, but as important as that, is that we have to get some level of coverage because we are committed to maintain an investment grade rated REIT, and in order to do that, we have to be able to go into the agencies, and show coverage over our rental on our portfolio.

And when you combine those two things, 7% caps don't work for us, and we're not going to do deals of one times coverage.

No, that's understandable.

I guess sort of along those lines, as you look at independent living, specialty facilities, any other options, sort of how do you think about that, and what sort of yields do you see there?

It has been very difficult for us to do independent living for the last even three or four years when the market was very good.

They have attracted buyers and investors that pay a lot more for the assets than we can, given the criteria that Ray just laid down for you.

On the specialty care side, we have made some good investments from medcap all the way through our current projects, but we have specifically limited ourselves to 5 to 10% of our portfolio for those type of projects as we wish to keep our focus on long-term care.

That's what people buy when they buy Health Care REIT.

So there are just limited opportunities based upon that portfolio management decision.

It is mostly SNFs, Paul, and as I indicated earlier, turn-around opportunities where we can assess the risk and work with an operator, we're comfortable with, to improve performance.

I probably -- probably the safest investments this year Paul are adding on -- adding beds to assisted living facilities that are already very successful with wait lists.

So we have about four or five of those going right now.

But again, that doesn't constitute that much money.

Thanks.

I mean don't take this as criticism of what you're doing or us trying to push you into the market, I think we were just trying to understand it.

No, I didn't take it as criticism.

Again, we just don't want to get into a war of words vis-a-vis people who make different decisions, okay?

Other REITs, for example, who make other decisions.

We tend to be very supportive of our colleagues.

Yes.

Very good.

One more thing.

The sub debt, how do you price that?

Well, there's historic pricing and then there's today's market.

Used to be around 14, 15%, just pick a number and it has really come down, Paul.

It seems to be more in the 10 to 12% range that we're hearing right, do you agree with that?

The high yield market, the spreads are at historic lows, and the sub debts generally available in the 10 to 12% range.

Very good.

Thanks.

Our next question comes from Chris Pike of UBS.

Good morning, everybody.

Hey, Chris.

Listen, I don't want to take too much more time here, I just wanted to very quickly on a qualitative sense, when you guys talk about acquisitions and I asked this of one of your peers the other day, how far are you going down the road in terms of bidding?

Are you getting through one round and two rounds and the third round you just throw your hands in the air?

I'm just trying to get a gauge of how ferocious the bids are coming in on the acquisition side relative to let's say a couple of years ago when perhaps people just gave you their packet and you only?

I will start.

The large packages that are auctioned, we've tended not to go very far with those because they always tend to be overpriced because there are too many bidders, financial bidders for that matter.

On the smaller deals, though, we tend to get to the second or third stage.

I would say probably we've just turned away from more deals this year than in the past three, because frankly, even in the smaller packages, they are tending to be overpriced as well, in light of the overheated market.

And is there a certain kind of investor that is running neck and neck with you, up to the third round?

Well, we have a very competitive group of Health Care REITs that are very active and they tend to be everywhere and then we have the specialty financiers that you know of, as well as increasing numbers of people from the outside who aren't perhaps specialized in health care financing.

And those are the people that I want to target.

I mean what type of folks are these?

I mean and I guess someone asked a question earlier about the type of investor, the less sophisticated investor, and forget about that, I'm just trying to get a gauge of , what types of institutions?

Are they individuals?

Well, we've seen, it has been publicly announced, the Kuwaiti money that came in last year.

We're seeing BC monies come in.

We're seeing other international funds.

Ray, do you want to add some color?

I think that's a good summary.

And I guess just on the disposition side, someone talked about perhaps the potential for increased volumes or increasing volumes, I mean should we also assume perhaps portfolio sales, or just maybe a significant number of one-offs?

No, there will be some -- some of the -- there could be some portfolio sales to take out some of the sub debt attendant to that, and especially if there is any kind of nonaccrual going on within that portfolio, that to me makes a great deal of sense to take care of that issue.

So yes, it could be.

Okay.

Great.

Thanks a lot, folks.

Our next question is a follow-up from Philip Martin of Stifel Nicolaus.

Thank you.

One follow-up question here.

With respect to your acquisitions that you made in the quarter, you've been pretty astute buyers historically, and I just wanted to know if you can go into a little more detail on the opportunities that you see with these investments?

Obviously on the skilled nursing side, it looks like you acquired at about $28,000 a bed.

You know that's -- .

Philip, let me interrupt you.

That's a bit misleading.

That's a project that we acquired and we're going to put a couple million dollars more in to renovate it but we're not getting it at 28 a bed ultimately.

So that is just -- okay, so that is more of an expansion value add sort of thing?

It is a shut down nursing home that is going to be renovated and reopened?

Okay.

So I don't want you to think that we're buying a nursing home at 28 a bed.

I was going to say that was really pretty good.

Thank you for clearing that up.

And secondly on the assisted living side, obviously, it looks like you ran at about 155 per unit there, and the market has obviously been frothy, but what specific opportunities did you see with that property?

What did you like about that property to go after it?

Those buildings are located in densely-populated hard to develop natural barrier to entry type markets.

And we think in the case of all the ALFs we purchased, that we're below replacement costs in those very good markets.

Are you able to tell us who the operator is and what the location is?

We historically don't talk about who we're doing business with, because we're working with private regional companies, but the markets are in Virginia, Massachusetts, and Pennsylvania.

Okay.

Perfect.

Thank you.

With no further questions, I would like to turn the call back over to you for any closing remarks.

We thank everybody for participating.

Ladies and gentlemen, this does conclude today's conference call.

You may now disconnect.

And have a great day.