Welltower Inc (WELL) 2005 Q4 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Health Care REIT Incorporated fourth quarter 2005 earnings conference call. [OPERATOR INSTRUCTIONS] At this time, I'd like to turn the conference over to Georganne Palffy of the Financial Relations Board. Please go ahead.

Thank you. Good morning and thanks to everyone for joining us today for Health Care REIT's fourth quarter conference call. You may have received a copy of the press release late yesterday afternoon. But any event that 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 not historical, 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 that, I would now like to turn the call over to George Chapman, Chairman and CEO of Health Care REIT, for his opening remarks. Please go ahead, sir.

Thank you, Georganne. We can now report that, at least in our judgment, that 2005 was one of Health Care REIT's most successful years. We had a record level of investment, $642 million. These were largely back-ended as a result of a very successful joint National Investment Conference American Senior Housing Conference in the fall.

Our 2005 adjusted FAD per share grew 19% over 2004. In our portfolio, our coverage has moved to 1.92-to-1, up from 1.53-to-1 two years ago. In our program that we announced early in the year to take advantage of the overheated property markets to sell non-core assets was very successful. We sold 147 million of such assets, reducing loans to 6% of the portfolio and virtually eliminated sub-debt loans.

As a result, we captured 4.5 million of previously unrecognized interest. And let me just add some comments about dispositions. We are very, very happy about our solid record, investment performance, but we're also very pleased with our disposition policy because we're totally committed to strong portfolio management.

And in our judgment, good portfolio management requires us to regularly [toll] through the portfolio, disposing of properties and operators that are underperforming. This allows us to redeploy funds to the best operators and properties. Now on the capital front, we increased our lines credit from $340 million to $540 million and we also raised over 700 million of debt and equity capital at very attractive pricing.

In the next couple of weeks, we will pay our 139th consecutive dividend. I don't know how many companies can make that kind of comment. And on top of that, we also announced that commencing with our May dividend the dividend will increase from $0.62 to $0.64 per share, going forward. So we think this was a tremendous year for Health Care REIT.

And with those brief introductory remarks, I'll turn the call over to Ray Braun, our President and CFO, and Scott Estes, our Vice President of Finance, who will take you through a more detailed review of the portfolio and financial matters. Ray?

Yes. Thanks, George. We've posted our earnings release on our website, at www.hcreit.com, under the heading "Press Releases," for those of you who haven't seen it yet. And I'm not going to read through the release, but I'd like to review a few of the key drivers of our quarterly and annual results.

As George mentioned, we had another great year of divestment activity with gross investments of 642.5 million. During the fourth quarter, we had gross investments of $374.6 million, including acquisitions of $366 million that had average initial cash yields of 8.3%. In connection with those acquisitions, we had above average annual increases in those deals of roughly 29 basis points per year, and we expect to realize average yields of roughly 10.6% on those investments.

I will note that we did acquire 11 independent living and CCRC units with 1,763 units at $230 million. As a result of this large independent living CCRC acquisition, we've separately broken out in our portfolio of classifications the independent living CCRC classes. What we chose to do was adopt the NIC facility definitions, and we went through our portfolio and re-classed some of our existing buildings that have combinations of independent living and assisted living and will now be reporting that separate classification in our quarterly results.

As an example of a typical transaction of what we're purchasing, we bought a portfolio of six buildings in the San Francisco Bay Area with an existing operator that had 970 independent living units, or roughly $127 million. And generally, our fourth quarter acquisitions were a combination of mid to large sized deals with existing operator, and we did pick up a new skilled nursing operator in Ohio and a new CCRC operator in North Carolina. And George will touch upon a little bit of the change in our investment strategy to orient ourselves more towards this early-stage state senior housing.

As George mentioned, we also continued to prune the portfolio during the quarter. Our dispositions for the quarter are set forth in our investment release. Loan payoffs for the year included 19.1 million of nonaccrual loans, which reduced our nonaccrual loans by over 15% down to 16.8 million, 21.4 million of mortgages, and 37.5 million of sub debt, which virtually eliminated our sub debt classifications. And you can see on the balance sheet, we have eliminated that because we're out of that investment category.

We received $4.5 million of traditional interest relating to those non-accrual and sub debt loans, and we collected at the contractual rate on those. The average yield on the 147 million of dispositions is 9.8%. We also repaid five mortgage loans totaling 66.2 million, with an average interest rate of 7.55% in the fourth quarter. In connection with repaying those, we recognized a charge of $3 million and collected $822,000 of fees in connection with those extinguishments. So for the full year, we ended up with 21.4 million of extinguishment charges offset by the $822,000 of fees.

Dividends. We again paid 52% per share for our last quarter dividend with FFO and FAD payout ratios of 75% and 57%, respectively. The Board approved our 139th consecutive dividend for February 21st in the amount of 62% per share. And they also approved a dividend policy for '06 of increasing the dividend $0.02 per quarter to $0.64, which is an annualized increase of 3%.

Moving over to the portfolio, we continue to have great results at the portfolio level, with payment coverage of 1.92 times. We own 93% of our property and 87% of our owned properties are in [inaudible]. At year-end, our independent living CCRC portfolio was 31 facilities with 4,400 units, an investment balance of 426 million, payment coverage of 1.43 times. Assisted living, we had 195 facilities with 11,746 units, roughly $1 billion. Payment coverage of 1.52 times. And then on the skilled side, we have 203 facilities, 27,748 beds, 1.3 billion of investment balance, and a very strong 2.18 times payment coverage.

A couple of other items I'd like to talk about are Kindred/Commonwealth, update on LTAC reimbursement, and a reference to consolidation. Kindred/Commonwealth-- we issued a release several months ago outlining what we expected to happen. Kindred has requested that we consider leasing the LTACs to them rather than selling. And we are amenable to that request and we're in the process of negotiating lease terms. At this point, we would expect that we'll lease those four buildings to them rather than sell them.

Reimbursement. CMS issued a proposed rule on LTAC reimbursement for fiscal year 2007, which begins on July 1, '06. And in connection with that rule, they have proposed eliminating the market basket increase and changing the payment rates for outliers. They think that the rule will reduce aggregate LTAC payments by roughly 11% in fiscal 2007. And that rule is not subject to a 60 day comment period.

In terms of assessing its impact on our portfolio, we currently have nine LTACs with an investment balance of 124.7 million. Those LTACs account for roughly 4.34% of our revenues. The payment coverage on those LTACs today is 3.39 times before management fees and 2.95 times after. And we expect, even if the rule were adopted, we would not realize a material increases in payment risk as a result of the implementation.

The other item I'd like to touch upon is the consolidation trend that we observed in 2005. The net result for us is several of our tenants have been consolidated or in the process of being consolidated into public companies or tenants with a much stronger balance sheet. That would include [One Lantern] an affiliate of [Regarda] acquiring Senior Living, Brookdale acquired Alterra, and in the process acquiring Southern Assisted Living, and Kindred is in the process of acquiring Commonwealth. So as a result of this consolidation, we expect about 30% of our portfolio to be with public operators and another 45% with large private operators with a strong balance sheet.

And with that I'll turn it over to Scott. He'll provide a little color on our earnings and the guidance for '06.

Thanks, Ray. Good morning, everyone. Today I'll be commenting on our 2005 earnings, followed by a discussion of management's expectations for 2006. I'd first like to reiterate that a major goal in 2005 was to improve the overall quality of both our portfolio and earnings, thereby enhancing the risk adjusted returns from our portfolio through selectively disposing non-core assets.

I'll spend a couple of minutes now highlighting what we believe is an improved quality of earnings. First, in 2006 straight-line rent is anticipated to be only $7 million or $0.11 per diluted share, which represents only 4% of the 292 midpoint of our 2006 FFO per diluted share guidance. This is a huge improvement from only three years ago, when in 2003 straight-line rent represented 16% of our FFO. In addition, I'd point out that in 2008 we anticipate hitting the crossover point, whereby straight-line rent will decline to the point where we'll begin to receive cash in excess of reported revenues.

Second, we will begin realizing more internal growth as a result of our commitment back in July of 2004 to modify our lease structure by adding contingency-based rental increases, which has served to minimize straight-line rent. Currently, approximately 76% of our lease portfolio contains an internal growth component, which we believe should begin to add roughly 1% to 2% of internal earnings growth per year going forward within the next several years.

Third, we virtually eliminated $44 million of high risk sub debt investments. Fourth, we collected loans on non-accrual of 19.1 million and received previously unrecognized interest of 4.5 million. Fifth, we reduced the overall loan portfolio to only 194 million or 6.8% of our net real estate investments. And sixth, we've seen facility payment coverage before management fees increase by 39 basis point over the last years to the current 1.93 times.

So putting this all together, we believe that active portfolio management, including selected dispositions, will continue to generate outstanding earnings growth for the Company. To further elaborate on this point, our adjusted FAD back in fiscal 2004 was $2.40 per diluted share, excluding any one-time cash payments. In 2006, also excluding any potential one-time cash payments, the mid-point of our FAD guidance is $2.81 per diluted share.

Over this two-year period, from '04 to 2006 expected, this represents a compounded annual FAD growth rate of 8.2%. Over the same two-year period, our FAD payout ratio based on the same numbers will have declined significantly from 100% back in 2004 to a projected 91% in 2006 while increasing our dividend in excess of 3% per year over the last two years.

Now turning to 2006 guidance. For any of you who haven't had a chance to look at our release yet, we have released our initial 2006 earnings guidance. The company expects to report net income available to common stockholders in the range of $1.28 to $1.36 per diluted share, FFO in the range of $2.88 to $2.96 per diluted share, and FAD in the range of $2.77 to $2.85 per diluted share. Our assumptions are discussed in detail on the earnings release.

However, guidance for 2006 FFO is below 2005 FFO, primarily as a result of the 4.5 million of non-recurring 2005 interest income, a 3.8 to 4.8 million increase in G&A expenses, which does include 1.3 million related to accelerated vesting of restricted stock and options for certain officers and directors. And lastly is an approximate 4.5 million reduction in rent and interest as a result of the Kindred/Commonwealth transaction, all of which combined to represent an impact of about $0.21 to $0.22 per diluted share to our 2006 numbers. So as always, the company's guidance excludes any impairment, unanticipated additions to the loan loss reserve or other additional one-time items.

With that -- that completes my report, and I'll turn it back to you, George.

Thank you, Scott. I'll summarize, make some general comments and then open for questions.

In many respects, I want you to look at our last four years as a seminal period in the evolution of Health Care REIT, during that period we doubled revenues and assets. And we now approach 3 billion in asset size. As we look back to 2004, we eliminated straight-line rent going forward. Today, as Scott indicated, approximately 76% of our leases have an organic growth component and that percentage should increase every year as straight-line rent is minimized.

As we have discussed, we entered 2005 seeking to take advantage of the strong property markets to significantly reduce non-core assets. And we accomplished that by selling approximately 147 million of such assets, and expect to dispose of additional assets in 2006.

In addition, in the first half of 2006, we anticipate the acquisition of Southern Assisted Living by Brookdale and Commonwealth by Kindred, and once accomplished with all the other consolidation that Ray mentioned in his report, our top 10 operators will include three public companies -- Ameritas, Brookdale and Kindred -- as well as three key private companies, including the fourth largest [DRIP] operator in the United States, and the sixth and seventh largest assisted living operators in the United States as well. And all of the [foregoing], elimination of straight-line, disposition of non-core assets, and pay down of loans, and the improvement to our top operator profiles, contribute to an improved quality of earnings, as Scott just discussed.

But let me add a few comments about healthcare and change, especially as it relates to our portfolio and our investment focus. Clearly, there are a wide array of trends within healthcare. Probably the most important trend has been the primacy of the customer. Even a doctor has to look at a patient and consider a patient a customer, a rather radical change in healthcare. But we've often talked about the movement towards less institutional and more cost effective settings.

In the long-term care arena, there is a demand for facilities that provide a much more holistic approach, that addresses a variety of social, wellness and healthcare issues. We certainly have all seen the effect of new technologies and pharma developments and breakthroughs that are making non-invasive and minimally invasive procedures more of a norm in healthcare procedures. And certainly, all of these changes will pale in comparison to those demanded by the baby boomers when they hit early stage senior housing.

That means that healthcare investors cannot take a business as usual approach to investing. We need to embrace operators and provide state-of-the-art healthcare in non-institutional settings. Health Care REIT will be in the forefront of such changes, just as we were when we became the leader in assisted living investing several years ago. And we believe, as Ray indicated, that our acquisition of a number of independent living facilities and CCRCs in the fourth quarter demonstrates our commitment to adjusting our investment focus as the market continues to evolve.

And with that summation and those general comments, I'll open for questions.

Thank you. [OPERATOR INSTRUCTIONS] We'll go to Ross Nussbaum of Banc of America Securities.

Hi, guys. Good morning.

Good morning.

A couple of questions. First, in your press release you talked about one of the factors behind the guidance as being your DRIP program and secondary equity offerings. Can you expand on that in terms of how much equity will get issued through the DRIP by your estimation in '06? And what's the potential size and timing of the secondary equity offerings?

Hey, Ross. It's Scott Estes. We've been running about 300,000 shares in our DRIP per quarter. So about 1.2 million shares per year, I would estimate. And I think on the equity side, we really don't know. It would be based on the markets. We do have an intention to reduce our leverage generally. So if we felt the time was right, you could see us do a secondary offering some time in '06.

So I guess you're saying at this point, the leverage level that the company is operating at is a level that you're not comfortable with longer term?

I think what we'd say -- this is Ray Braun, Ross -- I think what we'd say is it's at the high end of the range we'd like to see it run in. And typically, we move our leverage up as our line expands, as we do acquisitions, and then we move it towards a normalized range. And -- so we're at the high end of where we'd like it see it, and we're going to need to normalize it during the course of this year, assuming we do the acquisitions we anticipate.

Okay. And then on the income statement, with respect to the straight-line rents going from, I think you said $7 million in '06 down to -- it sounds like zero by 2008. Is that expected to occur ratably or is there going to be any lumpiness to it?

There's always lumpiness to us because of collections. I mean, if you look at this last quarter, we collected a large amount of straight-line rent receivables. So we would anticipate large collections going forward.

I guess -- let me add a couple of things, Ray. One, we have never not collected our straight-line rent. So what a number of analysts seem to view as an issue has never been an issue. We just removed the noise from straight-line rent by moving to organic growth. And two, just to be clear, Ross, when we get to the crossover point at 2008 whatever remaining straight-line receivables we have at that point will be gradually eliminated over the next, say, seven years. So it doesn't fall off completely.

What happens is if you - if one looks at a 15-year lease, the straight-line receivable builds very quickly, and then comes to the middle of 7.5 years, and then slowly is reduced over the back end of the lease. So we will have very little of it but it will take the full 15 years, if you will -- seven years or so from 2008 to eliminate it altogether. But it will be very, very small.

Right. Just to make sure I understand. You're saying so the receivable on the balance sheet doesn't go away, but you'll have enough leases that are in the back half of their life that will be causing you to actually have zero or even potentially a slightly positive straight-line rent adjustment in getting down to the AFFO calculation?

We'll have -- we'll have the FAD or AFFO exceeding -- FFO at some point.

Right. Thank you.

And we'll go next to Robert Mains of Ryan Beck.

Good morning.

Good morning, Rob.

Hi, Rob.

How are you doing? I've got three questions, and then I'll get out of the queue. The first one, do I surmise, then, that the [inaudible] tax that you were going to sell for 80 million, are you not including those in the guidance anymore? This is on the Commonwealth transaction.

Rob, it's Scott. We're basically assuming that those are now leased, so that the assumption of leasing those facilities is incorporated in our guidance.

Okay. So the dispositions you talk about are exclusive of anything from Commonwealth other than the loan repayment?

Correct.

Okay. And can you tell us anything about what type of lease rates you would expect or is that still in negotiation with them?

We're still negotiating now but we agreed -- we have a formula to lease the other buildings still on that's probably going to end up being roughly between 8.75 and 9%. And we would assume that we'll end up in a similar range on the LTAC.

Okay. Fair enough. On the income statement the one line I wanted to ask about was transaction fees and other income. That was up. Was there anything non-recurring in there?

Yes. The $822,000 reimbursement that we received for debt extinguishment was incorporated in that line.

Okay. Nothing else though, right?

No.

And -- well, you answered my question about commerce. I'll ask the other one. I just missed the beginning -- I had a hard time hearing Ray. Could you go over the details on the acquisitions you talked about yields and escalated -- and I didn't catch all of it?

Yes. What I indicated, Rob, was that we -- in the fourth quarter we did 366 million of acquisitions, and our average initial cash yield on those assets was 8.3%. And we anticipate that we're going to have, for the year, above average increases in our portfolio of 29 basis points. So that we're expecting to get average yields for the investments we did over the year of roughly 10.6%.

Okay. Very good. Thanks.

Thank you.

We'll go to Michael Dimler of UBS.

Good morning, guys.

Good morning.

I just want to ask the previous question in a different way. Is there kind of a leveraged target that you're planning for the end of the year or are you going to just kind of play it by ear?

I think we think -- in terms of debt-to-undepreciated book value or 45% below is generally our target that we stated in the past.

That kind of mid range, 45 would be the mid range of your -- the range you talked about?

40% to 45% that would be higher range of our, so that ranging under those terms.

Okay. And as a follow-up could you talk about the net impact on the entire portfolio, the tenant rent coverage, of all changes in Medicare, Medicaid, for '06? So it's going to be more likely higher or lower by the end of the year?

Yes. We can comment on that. We've actually looked at that. We had a bump up in Medicare rates in the fourth quarter and we're expecting that to be cut back beginning in the first quarter of this year. We had an average net increase in our Medicaid rate and a slight increase in private pay rates in the nursing home portfolio. And I think on average we would expect in the course of 2006 for Medicaid rates to go down.

Medicare, I would say, is flat to maybe down 0.5%. Medicaid would be probably and this is in the skilled nursing portfolio, up probably 3% to 4%.

But that overall roughly is about, what, a 20 basis points impact on the portfolio?

Yes. And you blend all the pricing things and privates pay is the other component on the revenue side is probably, up somewhere between 6% to 8% over the last couple years. So your blended price increases when you look at revenue mix is probably something on the order of 3% and depending upon what happens with costs - costs historically have gone to 4 to 5%, so you could see some slight coverage pressure as a result of that -- assuming the operators don't do anything to - combat those changes.

So flat -- slightly lower then?

Yes.

Yes.

Okay. Thank you.

We will go next to James Sullivan of Prudential Equity Group.

Thank you and good morning.

Good morning.

I was hoping you guys could provide some more detail on the Kindred/Commonwealth transaction. I think we assumed that you guys would sell it and now it's leased. Just what happened and what does this tell us about the market?

I think what happened is the CMS issued a proposed regulation relating to LTAC reimbursement, and Kindred decided that they'd like to lease the assets for a while, until they figured out exactly where that was going, and asked us to consider a lease, which we were agreeable with.

So does that suggest that they may actually -- you may sell in the future?

Yes. We could very well, sell that portfolio in the next couple years to Kindred. But I think they wanted some more time to, let the dust settle around the propose reg and figure out what they wanted to do with the assets.

Okay. And then in terms of the reduction in NOI, I mean, what was the negotiation that created such a big decrease?

Pretty simple. Kindred bring to the table a much stronger balance sheet than we have with Commonwealth. And we felt that on a risk adjusted basis, that they should get a lower lease rate then a private operator.

Okay. And then does this continued consolidation in the sector then suggest that in general, as more of these companies lease space that NOI should decline?

I would think that when we look at things on a risk adjusted basis that as stronger credits comes to the table, we're going have to sharpen our pencils on pricing, but our core business has to do more with regional operators and realize the benefits of their growth and consolidation in the public company, which is what we've historically done.

Okay.

So the answer is yes and no.

And then if you look at your portfolio, how much is left that may be subject to consolidated tenant?

25% to 50% I think is going to remain with smaller, regional operators that could potentially be consolidated. Roughly 75% of the portfolio is what we consider key private operators, which are larger regional operators or with public companies.

I think there is a dynamic, though, that has to be mentioned. We have seen consolidation in the past, in skilled nursing in particular. Less so in assisted living. And what we experienced is the following. With health care being such a local enterprise, looking to local people for referrals, that we expect that even with consolidation of former EVPs, of finance operations from some of these companies that have been consolidated, will go out and start their own companies.

And with our 35 years in the business, they're very likely to come to us. So there will be a new group of regional companies that will emerge even from the consolidation and give us ample opportunities to do business with them as well as a very strong consolidating companies that we've been discussing right here.

Okay. Well, I guess what I'm trying to get at is, if you look at the portfolio today, how much is subject to a similar reduction in NOI based on stronger person on the other side -- a stronger company on the other side of your lease?

It's very minimal.

Minimal?

Commonwealth is a unique scenario, that they turned around some underperforming assets from about five or six years ago. And considering the change in tenants, we were willing to accept a little bit of a rent reduction as a part of that transition.

We could in this case, we could have easily let Kindred take the assets and not release them to Kindred and gone out to find regional operators probably at higher rates. We -- as Ray indicated we like the risk adjusted return here. We like Kindred and what they're doing. And we think it was a strong operator. This was an opportunity for us to accomplish that. In most cases, if there is consolidation, we keep the assets and the consolidator takes over our lease rates the way it is. And that's probably 95% of the time.

Yes.

What you're doing is you're trying--and this is unfortunate, I think, and maybe we haven't made it clear-- but we are trying to sort of go from a specific and a very unique situation where we made a hard call in favor of Kindred, keeping them in our portfolio, getting them in our portfolio. And you are trying to generalize that and it's not the case. This is a unique, isolated situation.

I think when you look at the transactions that I mentioned earlier on, like when [Lazard] acquired [Newton], [Brookdale] acquiring [Alterra] and Southern assisted living, there's no changes in the rent structure there. So that supports what George indicated - Kindred's kind of a unique situation.

Okay. So it's kind of safe to assume that going forward, it could happen again?

It's doubtful it would happen again because we're going to hold any consolidator to the existing lease terms. In this case, we had a unique situation, as Scott indicated and Ray indicated, where Commonwealth had come in and turned around some underperforming assets taking them over from an earlier operator. And we had agreed to accommodate Commonwealth in some fashion. And that's what Kindred could take advantage of either by paying off those assets or we could decide to re-lease them to Kindred at a lower rate given their strength.

Okay. Well that answers time - I'll move on. What's your outlook for acquisition yields going forward? And what does kind of '07 look like versus '06?

'07?

If you were to just characterize the environment how is it, is it getting weaker, is it getting better?

It's still -- yields are somewhat compressed. We have found in every year during the last four years when we entered the marketplace somewhat skeptically, at first, that we've always even outperformed our assessments. So we've come in with a somewhat more aggressive forecast. We think we have the best marketing team in the sector. Our 35 years in the sector and strong partnerships with operators means that we're going to do just fine this year and probably fine next year. We probably preferred 2002 and 2003 because we were getting yields that were more like 10, 10.5% going in. And they've been dropping every year. We suspected at some point they'll move back up for some reasons. But we're going to do fine. We're going to be in the ranges that we believe that we've been experiencing the last four years.

Okay. Thank you very much.

We'll go next to Jerry Doctrow of Stifel Nicolaus.

Hi.

Good morning.

Just a couple of things that haven't been covered. I want to shift a little bit just to the forecast on this development items. I think you talked about capitalizing 150 to 250 million with the investment balance maybe coming later. Just if you can give me a little color there and is that something we should then expect to come on sort of '07? And maybe a little color on what kind of development yields are like versus the acquisition?

Under GAAP, Jerry, when we owned the land and our tenant is developing the building on our behalf and going to lease it, we are required to capitalize the interest at roughly our average cost of debt, during that development process. So that's what's happening from an accounting standpoint. What's happening from a business standpoint is that we are finding companies that are in our portfolio who have selected opportunities to expand and develop and that we're sorting and doing that. And we are also as George alluded to looking at doing some development of assets that are geared towards the changing dynamics in the marketplace, i.e., combination independent living, assisted living buildings. And other types of real-estate that we think is going to better accommodate the aging baby boomers. So those are really the two classes of development I would see going on right now.

Okay. But again if we think about just the course of '06 and then sort of '07, course of '06 is your cash interest charge higher then you're capitalized, so there will be a cash adjustment -- or not and then following that?

You're saying is the stated rate higher than the 6.6?

Yes.

Yes, it's usually a couple of hundred basis points or so greater.

Okay. And then you're not -- you're doing this minimal offset because you're capitalizing at the rate of the interest. But as those properties are completed they become income producing assets. So as I start thinking I know you don't want to give me '07 guidance but say that 150, 250 million, I'm assuming then that's completed in 2007 maybe some of it's completed in 2006. And so I need to assume that that's out there. What's kind of the timeframe for getting that -- some of that stuff completed, and what are kind of the initial cash yields once it's finished?

I would think for your modeling, Jerry that to assume 12 to 18 months cycle on building those things and initial yields, and roughly the 9% range would be appropriate.

Okay.

The reason there was such a variation, Jerry is that we are trying to add campuses. And once one builds out some sort of combination facilities or actually CCRC's continuing care retirement communities that can be a 18 month buildup.

Okay.

That's why there's a variation. And we'll probably be able to give more color in subsequent quarterly calls once we actually see the dirt being moved and can perhaps give you a better idea of the average construction period.

Okay. Is -- would it be reasonable for me to think about '07 that this is sort of additive to say some sort of normalized level of acquisitions whatever that may be?

Yes.

Okay. And then maybe just -- actually I think everything else has been covered. So thanks.

Thanks Jerry.

We'll go to Kristin Brown of Deutsche Bank.

Good morning.

Good morning.

Can you just talk about the new leases you're signing and what they include in terms of rent increases?

Generally, we're still -- leases are around 8.5, maybe 9% beginning yield and 25 basis points is still about the correct level of increases.

Okay. And do they typically include purchase options?

They all do. And generally, we have adhered to our historical practice of splitting the upside with the customer. That is to say at the end of 15 years or whatever the lease term is, that the appreciation of the original release amount is split 50% for Health Care REIT and 50% for the operator. And the reason for that since people have commented on that, in the health-care field where we're reliant upon operators because Health Care REITs are not allowed to operate health-care properties which is totally different from other types of REITs. And somewhat more similar I guess to the hotels but there's a special provision under the REIT laws for hospitality.

We cannot operate. So we're very dependent upon the operator both during the term of the lease to do a good job for us. We monitor regularly, as you know, but also to keep the project up and to not allow deferred maintenance to occur to keep capital improvements going with respect to those projects. And frankly, we think that splitting the upside is one of those incentives to the operator that will keep our buildings in very good shape during the course of the lease. So we think it is absolutely the appropriate policy for Health Care REITs to do as we do.

Okay. That's it. Thanks.

Okay.

We'll go next to Greg Andrews of Green Street Advisors.

Good morning.

Hey, Greg.

Hey, Greg.

Yes. On the acquisitions made in the fourth quarter, I think you said that on average the initial yield was around 83, which looks like it's kind of at the lower end of the range that you gave for '06 -- what you expect to do? And I'm just wondering, if there was anything, kind of, unusual in the fourth quarter that pulled that number down or why we should take comfort that you could do at least that or better in '06.

Yes. The answer is yes. We had one fairly large block of facilities that we purchased, that are turnarounds, so that's the beginning rate is lower. And the increases are much greater at some point to catch up to our average yield rate.

So therefore the initial yield was less for those facilities took down our initial yields in general. And because the higher increasers over the term of that lease, we have greater than normal increasers as Scott and Ray indicated the 29 to 30 basis points. So and you should take comfort from that.

Okay. And what type of facilities are those? Are those independent, gentlemen?

Those are ILF/ALF.

ILF/ALF, geographically located in an area where it's going to be difficult for anyone to come and compete with them and with an operator that's going to do an excellent job of repositioning the assets.

Okay. And then -- I'm sorry -- I joined the call a little late. I don't know if you talked about this, but did you provide coverage ratios for different types of properties you bought in the fourth quarter?

No we didn't.

Can you do that?

[off mic] Just a second, Greg. Our underwriting suggests that we were buying at 1.6 times before management fees and 1.3 times after.

Okay. And was that different for that [SNITs] versus ILF or ALF?

Yes. The SNITs were slightly higher than that and the independent revenue CCRCs were lowering. So this is independent living CCRCs were at roughly a 138 and 124 before and after. And the SNITs were at 196 and 144.

Thank you. And then in terms of the dispositions that you've outlined for '06, do have a sense of the timing? Is that stuff that would mostly happen in, say, the first half or would it be spread throughout the year?

I think it's probably weighted toward the first half.

But pretty spread out [inaudible - cross talk]

For modeling if you're looking at, I don't think there is any need to weight it any differently by quarter.

Guys, thank you.

We'll go to Chris Pike of UBS.

H. Good morning, everybody.

Good morning.

Yes. Hi, Chris.

Almost all my questions are answered. I just had a couple of follow-ups here. On the disposition question, I guess I'm assuming there's some new additional non- or partial non-accruals baked into the '06 numbers? In other words, when you sell them there'snot going to be any add backs that we saw this quarter?

Non-recurring cash, collection --

Yes. Cash -- any additional cash payments or recovery of additional interest is not included in guidance.

Okay. Are any of those assets linked to like a non-accrual? I mean, should we expect any one-timers again in '06 given that the stuff that you're looking or you're earmarking to sell at this point?

We still have a small group of assets in non-accrual.

Okay.

We'd love to collect it.

Okay. Fair enough.

We're not going to predict it right now.

It sounds like it's a very interesting -- you had a interesting inflection point there at HCN and -- in terms of looking into the future. I guess my question, George, how long conservatively-- or choose not to comment -- how long do you think it would take to transform HCN into what you guys see as the future of senior health care? And how much capital do you think it would require?

I mean, we hear about some apartments REITS who've basically transformed their portfolios over several years and they're in a much better position now. And it's worked from a strategic perspective. How long do you think it would take to transform what you see to be as the future, and how much capital are we really talking about?

That's an interesting question, Chris. One, I'd say that the baby boomers aren't here yet -- six years out before they probably hit early stage senior housing, and then go through the pipeline just creating chaos wherever they go. So we have some time to change our portfolio.

The other thing I should say, is that while we really want to be and will be a leader in this change, we feel very comfortable with many of the standalone facilities we have, such as skilled nursing and assisted living because we don't think those types of facilities are going to be -- become obsolete. They're simply going to have to be underwritten more increasingly based upon non-private pay and more of a Medicaid model.

Because as you well know, with 35 million uninsured people in the United States, which again is a travesty for the country, you're going to have quite a difference in terms of real estate buying power between different groups of people. So we're very comfortable with where we are.

We're just going to reposition over probably an 8-to-10 year period. And as you well know, our access to capital is just excellent within our space. And we're making even some progress I think with the rating agencies in terms of debt. So I don't think we have any problem whatsoever in terms of transforming the REIT fairly quickly to capture some of this very good real estate and state-of-the-art facilities that people are going to demand. It's just virtually impossible to tell you how much in any one year, as we begin this transformation.

And it's an evolution, Chris, not a revolution.

So it sounds to me that it's a growth story, it's not a recycling -- it's not a recycling story, what you're going to be selling out of certain markets and certain asset types and then just replenishing the capital pool with a different type of provider?

No. I think it's just going to be -- it's going to be gradual. And you're going to continuously see us culling through our portfolio if somebody in skilled nursing -- or for that matter a CCRC operator-- isn't performing we're going to eliminate underperforming assets and operators regardless of the particular asset class to bring in better operators and put our money into better properties.

Now, over time, what I see as eventually evolving away from standalone facilities, whether it'd be snip or else. I suppose over time you might see some gradual trend that way. But as Ray quite clearly points out this is an evolution, not a revolution.

So near-term it wouldn't be inappropriate to assume that maybe based upon your comments George that maybe we start blending in some -- and we'll take care or some outpatient, maybe just baking into some of that type of asset class that ultimately will be required of these larger campus-type setting in the future?

Yes. There is no question about it. I'm chairman of a local teaching hospital here. And even with a state or non-state institution or a non-profit institution, they are radically changing how they deliver care. Even in a 24/7 general hospital, Chris, let alone, perhaps, a more nimble non-profit systems, let alone the very fast-moving for-profit chains.

I mean that clearly, it is going to happen. Clearly, we have to be there at some point. Just as clearly, though, the main driver of the AFCs and the specialty care hospital growth and changes to the even the general hospitals are going to be driven most dramatically by the baby boomers, who are probably still 8 to 10 years away from that. Okay.

So I think that we're going to gradually move in that direction and we're going to clearly follow the baby boomers through the health care delivery system. And you get some sense I think of timing.

Would be surprised to see a $300 million, not the development stuff, that's obviously going to be part and parcel of your existing, of course, properties set. But of the new 300 million, that's expect to come inline in '06, should we expect to see maybe some of these types of asset classes being added to the portfolio?

I think -- that since we have been gradually moving in that direction, we have a standalone --

Right

-- orthopedic hospital, we have neurosurgical hospital as well, and we did the early [Medcap] fields for [pocket]. That's we've been getting our feet wet there and we clearly see the need to delve more deeply into it. Okay. But getting our marketing efforts working, takes some time and we hope to add some projects in that area and hope that it becomes a larger percentage of our portfolio over time.

I guess in your comments today, in terms of SG&A guidance you talked about modestly higher guidance or modestly higher G&A, is that just adding more bodies or perhaps folks with different skill sets i.e. development, or may be looking at folks with expertise in different types of financial structures like joint ventures or something along those lines?

Let me first make it clear that there is one non -- one component of the SG&A that is non-cash and it relates to the need to take charges for, if you will vested stock options relating generally to old people like me who because of age and years of service in theory it has to be accelerated. That's a non-cash charge.

Okay.

But with respect to the rest of those charges, yes. We are clearly positioning the company for growth. We're positioning the company for growth in other areas. And yes, we are already hiring some people and we're also looking at some very interesting affiliations with people who have expertise in areas that we have not done a high percentage of our investing within. So, yes, I think that is clearly the sign when we are increasing our SG&A guidance.

Okay. And just one last question, George. All that being equal, I guess, I would assume that the Kindred folks -- you would rather the Kindred folks buy the assets, and maybe that's the wrong assumption out of the gate. But how concerned are you folks with Kindred's change in posture in terms of now wanting to lease versus buying? Do you think this is a systemic concern across [LTACs] folks, or do you think maybe it's specific just to the Kindred operator?

I think we're very pleased to have Kindred in as an operator. We would have welcomed Paul Diaz and his team as less [inaudible] of ours throughout the whole Commonwealth portfolio. We have timed it on our theory risk adjusted returns in a very unique situation for Kindred.

If you look at the LTAC pronouncements by CMS, clearly that has shaken up that sector somewhat and people are going to have to make adjustments in terms of how much they spend on development and developing LTAC and how much they spend to acquire LTAC, clearly the reimbursement has changed or probably will change subject to the comment period. So I don't - I want to - I guess on one hand say we're very pleased with Paul Diaz and his team becoming tenants. On the other hand I think it is important for everybody to look hard at their underwriting, in their investing in LTACs's given the impending change.

Great. Thanks a lot, gentlemen. I appreciate your time.

We'll go next to Robert Mains of Ryan Beck.

Yes. Hi. Just a clarification follow-up. If the guidance suggests that you'll be doing 300 in acquisitions and in answer to Jerry's question, you said that the development investments, we probably wouldn't see those produce revenues until next year, then that means that net kind of revenue producing investments for the year, you're talking about 150 to 200? Just doing the math.

Well, you're saying net of the dispositions, I suppose that would be where our guidance would take us. You're assuming 100 million of dispositions and 300 million of acquisitions.

Right.

Yes, that's what the math suggests.

Okay. Fair enough. That's all I had. Thanks.

And we have a follow-up from Jerry Doctrow of Stifel Nicolaus.

Just real quick, I was wondering if you can give us a sense of what the EBITDAR or EBITDA coverage might be on these Kindred leases, trailing 12?

I would suspect that on the LTAC it's going to be over two times. And on the nursing homes - I think we have that --

I would - at that rate it's a high --

One-and-a-half to two times, Jerry.

And we're talking EBITDA or EBITDAR, I'm sorry, before management fee there?

EBITDAR

EBITDAR would be --

After management fees. It's a very strong portfolio and with a lease rate that we're going to lease to a lot of [variable] companies.

And so over to EBITDAR trailing 12 on the LTAC -- I'm sorry, what did you say, again, on the skilled?

One and half two times.

And again, EBITDA coverage.

Yes.

Okay. All right. Thanks.

We'll go to Sam Miran of Gem Realty Capital

Hi, folks. Congratulations on a good quarter and a strong year. Actually, most of my questions have been answered -- been here on the tail end of these questions. But just wanted to comment, that I think Kindred is a strong operator, they will adjust to these new conditions just fine. One clarification though on these Kindred leases what are your expectations as far as revenue reductions generally speaking regarding the CMS rules?

Well, we have it on our earnings release, Sam -- I'm sorry.

He's talking about Kindred.

Yes. These LTACs from Kindred, I know they can go up to 11% reduction, but wondering what you assume in your estimates.

Not all the LTAC are coverage's and I think we wouldn't comment until the proposal is final on their revenue impact.

Got you. But you have some adjustment in that just for a margin of safety purposes, right?

Yes. Assuming what's going on there, yes, we look at obviously the proposal.

Got you. Okay. Thanks.

And at this time, there are no other question in the queue. Mr. Chapman, I'll turn the conference back to you for any additional remarks.

No closing comments. We just would like to thank everybody for participating in our earnings call.

And that does conclude today's conference call. We thank you for your participation. You may disconnect at this time.