Welltower Inc (WELL) 2010 Q2 法說會逐字稿

Good morning, ladies and gentlemen.

Welcome to the second quarter Health Care REIT earnings conference call.

I will be your Operator today.

At this time, all participants are in a listen-only mode.

We will be facilitating a question-and-answer session towards the end of this conference.

(Operator Instructions).

As a reminder, this conference is being recorded for replay purposes.

Now I would like to turn the call over to Mr.

Jeff Miller, Executive Vice President, Operations and General Counsel for Health Care REIT.

Please go ahead, sir.

Thanks, Operator.

Good morning, everyone, and thank you for joining us today for Health Care REIT's second quarter 2010 Conference Call.

If you did not receive a copy of the news releases distributed late yesterday afternoon, you may access them via the Company's website at www.hcreit.com.

A live webcast of today's call may be accessed through the Company's website.

Certain statements made during this conference call may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

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

Factors and risks that could cause actual results to differ materially from those in the forward-looking statements are detailed in the news releases and from time to time in the Company's filings with the SEC.

With that, I will turn the call over to George Chapman, our Chairman, CEO, and President.

George?

Thanks very much, Jeff.

Good morning.

Needless to say the Management team is quite pleased with our quarter.

We're on track to record the highest annual investment volume in our history.

We're also very pleased to announce the partnership with Merrill Gardens.

As you know in the last couple years, we managed the Company in a conservative fashion during the capital constrained downturns in the economy, yet even during that time, as we reported, we used this time to strengthen all of our capabilities and add key personnel.

We also maintained dialogue with excellent existing and new operators and health systems as we awaited economic improvement and reasonably priced capital.

And now we're here, and we're pleased that our investment platform is operating as planned.

We now expect to make investments in excess of $2 billion this year, with strong investment performance continuing in 2011 and beyond.

In turn these investments should drive and are driving significant earnings growth, as well, and we are quite pleased to raise our dividend and would expect continued increases going forward.

Not surprisingly, this morning our primary focus will be on our investment success as well as the reasons for this success and our confidence and the reasons for our confidence going forward.

In virtually every call, I have emphasized the critical importance of our full-spectrum investment platform.

This platform permits us to knowledgeably invest in facilities from early-stage senior housing to hospitals, and in doing so we can pick the best risk reward, the best projects, the best operators.

We are capable of doing so due to our team that has expertise across that entire spectrum.

We benefit as well from our development and property management capabilities that permit us to provide solutions to operators and systems.

In short we are much more than simply a capital source.

The key to our success continues to be our relationship approach to investing.

We looked back five years and found that 80% or more of our investments came from existing relationships, off-market opportunities.

We know the operators and systems and have confidence in their ability to deliver quality care in an efficient manner.

They know our commitment in turn to them and our flexibility.

Moreover, they have witnessed first-hand our ability to add value to their projects and programs, and you should note that we regularly add new operators to our relationship programs.

Due to this relationship approach, we generally do not need to pursue auction transactions to make our year.

We believe that too often these situations tend to price at high levels, and do not necessarily engender the relationships that produce future success.

Moreover these large transactions entail concentration risk, which we work hard to avoid.

Year after year, we have recurring business with our operator and health system base and that provides a predictable high level of investment support while maintaining our sector-best diversification.

Last night, we were very pleased to announce our expanded, deepened relationship with Merrill Gardens.

Our $817 million, 38-community venture with Merrill Gardens has all of the elements we believe are important for any RIDEA partnership; first-class operator, quality real estate in attractive markets, greater growth potential than our typical rental escalators and a very strong alignment of interest.

In this case, we have been doing business with Bill Pettit and his team for nearly 15 years.

They have operated in good and bad times and have the seasoning that comes from those experiences.

Their real estate is high quality and generally in high barrier-to-entry markets in Washington and California and we believe that this should provide strong pricing power as the economy continues to improve.

Moreover, with our 80/20 ownership structure, HCN's and Merrill Gardens' interests are very well aligned.

This venture we believe should provide excellent growth opportunities for both of us going forward.

I'm also confident that beyond the Merrill Gardens transaction, we will continue to develop or expand relationships with other high-quality operators and systems.

Some will be in the RIDEA structure, others won't; but in all cases, those relationships are important due to the quality of the operator and assets.

They also provide -- will provide future portfolio growth opportunities as well.

Our investment activity has only enhanced our portfolio performance.

Let me give you some data points.

At the end of the second quarter, approximately 75% of our portfolio committed balances were combination facilities in the senior housing space and modern customer-focused medical office buildings and acute care facilities.

This number should approach 80% by year-end.

On the other hand, freestanding skilled nursing and freestanding senior housing facilities are now down to 14.5% and 5.1% of our total assets respectively, and we expect the freestanding skilled nursing to be in the 12% range area by year-end.

Very importantly, after Merrill Gardens closing, our private pay percentage moves up to 73%.

We've also maintained our historical commitment to portfolio diversification with our top five and 10 operators comprising only 24% and 36%, respectively, of the portfolio.

And I should point out that after the Merrill Gardens investment, Merrill Gardens becomes our largest operator at 8.8% of the portfolio and our top five and 10 operators comprise only 28% and 40% respectively of the portfolio, and that is still the best in sector diversification.

Our facility coverages stood at 2.03 to 1, the highest coverage in our history.

Entrance fee momentum is picking up, with the expectation of rate increases beginning in 2011, and our medical office building occupancy remained at a sector high of 93%.

I want to put our program and performance in a historical perspective for everybody.

I look back at my comments from May of 2007.

In that call, I referred to our shadow pipeline of $2 billion, the vast majority of which were in the long-term care space.

I suggested then that as our medical facilities platform was strengthened, the pipeline would become even stronger and more certain.

And now after the couple years of tough economic times, we entered 2010 with optimism and an even better platform due to key personnel additions and a strong medical facilities team, and today the platform is working.

Today, our so-called shadow pipeline stands at approximately $6 billion.

Within that pipeline, approximately 60% are senior housing and 40% are medical facilities.

More than 80% are acquisitions.

While there is no certainty that we will close all, or even substantially all, of the transactions in such pipeline, our success with our relationship program does enhance the possibilities of substantial additional investments going forward.

Today, because of the focus on our strong investment strategy and our success, I'm going to first turn the call over to Chuck Herman, who is head of our Senior Housing Group, and then John Thomas, head of the Medical Facilities Group, to provide more in-depth information and color on their spaces, then the discussion will be turned over to Scott Estes who will review our financial results.

Chuck?

Thanks, George, and good morning everyone.

I'll provide an update on the senior housing and care investment environment, our deal pipeline and portfolio performance.

Health Care REIT is known for its strong investment platform.

Our senior housing team is top notch and very well networked.

We are in leadership positions in the industry trade associations and are viewed as a partner by many companies in the sector.

We currently have over 51 active senior housing and long-term care operators in our portfolio.

Because of our reputation as a partner, we are able to leverage those relationships into a very strong deal-sourcing network.

Historically over 80% of our transactions were off-market.

One of our very strong relationships is the one with Merrill Gardens.

George has already discussed the recent venture.

We have worked with Merrill Gardens since the late 1990s when they took over a portfolio of assets that were leased to another operator.

Since that time we've completed several other successful transactions and developed a very strong relationship.

We look forward to continuing that great relationship in the future with Merrill Gardens.

Currently, we have a very robust investment pipeline in senior living.

We are actively reviewing over $3.5 billion of new senior living and care transactions with close to 90% being acquisitions.

We are finding that many companies are looking for long-term financial partners with good reputations versus just chasing the lowest-priced capital.

Health Care REIT is very well-positioned to help companies recapitalize or provide growth capital for the future.

Since we are well-capitalized and are known as a good partner, we have added six new relationships in the last year or so with several more relationships in the works.

These new relationships, along with our existing ones, have allowed us to be on track to have our highest investment volume in the Company's history.

Currently there are two active sources of capital for the senior housing and care industries, REITs and GSEs.

We feel with the limited amount of capital in the marketplace that it is a good time for a knowledgeable investor to be active.

The fundamentals of the senior housing and care industry have held reasonably firm and there are strong demographic trends.

We believe the current environment -- with the current environment, it's an ideal time for us to invest.

In order to capture high-quality assisted living, independent living and combination assets, we are finding cap rates need to be in the mid-7% to mid-8% range, and skilled nursing home cap rates need to be in the low double-digits to mid-teens, depending upon the quality of the asset.

Turning to portfolio performance, at the end of the second quarter, our senior housing and care portfolio included 445 properties with an investment balance of $4.1 billion.

Our senior housing portfolio continues to perform well with payment coverage of 1.5 times and occupancy of 89%.

Same-store results were as expected with steady payment coverage and a 70-basis-point increase in occupancy versus last year.

Our skilled nursing home portfolio payment coverage increased to 2.3 times, which was the highest level in the Company's history.

On a same-store basis, coverage and occupancy increased 7 basis points and 40 basis points, respectively.

Regarding lease-up, we are starting to see an increase in monthly absorption rate at our communities.

To give you some perspective our average rate of fill-up has nearly doubled this year to 3.6 residents per month per community versus last year's average of 2.0 residents per month.

At the end of June our entrance fee portfolio included 13 communities with an investment balance of $651 million, representing 9% of the total portfolio.

With the new investment activity that is anticipated, we expect entrance fee communities to account for approximately only 8% of the total portfolio by year-end.

The current aggregate rental yield for the 13 open communities remains approximately 6%.

Most importantly, we expect to be able to receive higher yields commencing in 2011.

There is nice progress in the fill-up of these communities.

The entrance fee component increased 49%, up 3% quarter-over-quarter, while the same-store rental component increased 3% to 82% occupancy.

The aggregate entrance fee move-ins year-to-date through July 2 totaled 107 versus our budget of 98.

It should be noted that the reported rental occupancy of 79% in our supplement reflects the fact that we added 48 new rental units during the quarter.

With that, I'll turn it over to John Thomas to discuss the medical facilities.

John?

Chuck, thank you, and good morning.

Like the senior housing, medical facilities side of the house is seeing excellent activity and momentum, some of which is driven by healthcare reform legislation.

The impact of the legislation continues to evolve as providers in the market analyze the legislation and plan for the implications.

The pace of health systems beginning new development projects, both inpatient and outpatient, has accelerated, as evidenced by the number of health systems talking to us directly or indirectly through our development partners, and the number of RFPs for new projects hitting the market.

The pace of modernizations and efforts to raise capital have also increased by providers and developers alike.

Like senior housing, we are managing a very active pipeline of medical office buildings, hospitals and life science opportunities of nearly $2.5 billion, with at least two-thirds, or $1.8 billion, in potential acquisitions and one-third, or $700 million, in new development projects for leading healthcare systems.

The competition for high-quality, high-occupancy facilities increased, but we've been able to maintain appropriate pricing discipline and remain very competitive.

During the second quarter we completed the acquisition of two medical office buildings.

One, 85% occupied, on campus of a major healthcare system and another affiliated with and anchored by a leading healthcare system that is 100% occupied.

This brings our total 2010 MOB investments to $213 million and 19 properties, a total of 1.3 million square feet with an overall occupancy of 98% and initial average yield of approximately 9%.

Also during the second quarter, we began construction of an inpatient rehab hospital for a joint venture between Harris Methodist Hospital and Centerre on the Harris Methodist Hospital campus in Fort Worth, Texas.

We also began two freestanding emergency room ambulatory care centers for a leading healthcare system in the Pacific Northwest with one of our development partners.

Turning to a general update on our portfolio, payment coverage for our same-store hospitals saw a strong 45-basis-point increase in year-over-year payment coverage to 2.8 times before management fees.

This is largely driven by our largest LTAC and inpatient rehab hospital operators, which saw significant year-over-year and sequential increase in coverage.

Our medical office portfolio had another strong quarter with occupancy of 93% and a solid year-to-date retention of 83%.

Overall, NOI continues to increase up 9% quarter-over-quarter to $29.5 million for the quarter as a result of our acquisitions and very positive leasing activity, led by Mike Noto.

We continue to expect occupancy above 93% at year-end and a full-year retention rate of approximately 75% to 80%.

Same-store NOI increased 0.2% versus the second quarter last year and was up 2.2% sequentially.

This is a nice improvement and was a bit above internal forecast.

Also during the second quarter we invested $5 million in CapEx, bringing our year-to-date total to $8.8 million.

In life sciences, we closed on the seventh building through our joint venture with Forest City on June 30.

We now have more than $352 million invested through our joint venture with Forest City.

Our life science investment is performing in-line with Forest City's projections and our underwriting assumptions and we are seeing very positive data on the current market rents.

We remain very pleased with the performance of Forest City's life science property management and development team and the property management services to our joint venture's University Park at MIT campus.

And as mentioned, recent leasing has validated our expectation of rent growth in that market.

I'd like to take a minute to give you a little bit more background on the strategy behind our joint venture with Forest City.

As we've explained, this partnership has equal governance, but more importantly, the communication and collaboration of our Management teams has far exceeded expectations.

We are working through a pipeline of more than 1 billion in new acquisitions and development opportunities with Forest City, many off-market, and anticipate drawing our investments within that joint venture.

Capitalization of these opportunities will be determined on a case-by-case basis, but we anticipate no less than equal participation in the ownership and governance of these assets.

Life sciences, research and lab space is clearly a priority with our academic medical center clients, and we believe the partnership at Forest City provides us a strategic advantage to meet those needs and is a natural extension of our medical facilities business efforts.

With Forest City's 25-year history in life sciences and life science development and national footprint of mixed-use developments, we are very optimistic about the future of this partnership and adding to our medical facilities and life science platform, and perhaps generating additional senior housing opportunities, as well.

Finally, you may have seen our recent announcement about joining Energy Star.

Under George's leadership and the excellent work of Rick Avery on our team, we have initiated a number of programs to manage and lower the pass-through utility costs for our clients.

We have developed a more sophisticated energy procurement process and in-depth data and reporting capabilities that will assist Health Care REIT staff to identify energy savings opportunities and cost outliers.

The end result will be lower operating costs that will benefit our tenants and distinguish our properties in their local markets.

We believe it's very important to build and maintain our facilities in a sustainable, energy-conscious manner to lower the cost of occupancy for our clients.

We are in active discussions with a number of our clients about energy management tools and experience with alternative energy sources.

Thank you, I'll turn the call over to our Chief Financial Officer, Scott Estes, and we'll be happy to answer any questions you may have.

Scott?

Thanks, John, and good morning, everybody.

Before getting to the details, I would like to say that the investment success that George, Chuck, and John have discussed this morning have put us in an excellent financial position.

We've built a predictable future income stream at attractive returns.

I'd point out that the average initial yield on the acquisitions completed thus far in 2010 is in excess of 8%.

We're in a strong capital position to support our significant investment pipeline, which should in turn position the Company to generate more significant earnings and dividend growth over the next several years.

Turning now to the details, we completed just under $300 million of new investments during the second quarter and have announced over $650 million of investments subsequent to quarter-end.

This brings total investments announced year-to-date to $1.5 billion.

I'll review the positive impact of these investments on our guidance in a moment, but we believe that our ability to source investments is a direct result of our relationship approach and a testament to the quality and depth of our origination team.

Transactions closed during the quarter included the previously announced Capital Senior Living portfolios, two rental senior housing communities, two health-system-affiliated medical office buildings and the seventh life sciences property with Forest City Enterprises through our joint venture.

I would also announce two significant transactions anticipated to close subsequent to quarter-end.

First we expect to close our recently announced partnership with Merrill Gardens in September.

The partnership will consist of 13 communities currently owned by Health Care REIT valued at $307 million and an additional 25 communities currently owned by Merrill Gardens valued at $510 million.

Our 80% interest in the $510 million of additional communities will be paid through a combination of $209 million in cash and the prorata assumption of $249 million of total secured debt on the communities, which have an average interest rate of 5.0%.

NOI after management fees for the total portfolio in 2011 is projected in a range of $60 million to $63 million and occupancy is currently a solid 92%.

As George mentioned, we anticipate the portfolio will generate average annual NOI growth after management fees of approximately 5%.

I'd like to take a minute to explain how the rent we were receiving on the 13 existing Health Care REIT communities being contributed to the partnership compares to the NOI we will receive post-transaction.

Our annualized rent on these 13 existing HCN communities is approximately $20 million.

This compares to our estimated prorata share of 2011 NOI on these communities of approximately $19 million.

We arrive at approximately $19 million of prorata NOI by taking our 80% interest in the $23.5 million of 2011 NOI projected at these 13 communities.

So effectively we will trade approximately $20 million in annual rent for approximately $19 million of NOI, but most importantly, this NOI is expected to grow at a considerably faster rate, at an estimated 5% per year versus the typical 2.5% annual rent increaser received under a triple net lease structure.

Also today we announced the acquisition of $143 million portfolio with a new senior housing operator.

The portfolio includes six combination senior housing communities located in Indiana, New York, and Connecticut.

This transaction will occur in phases.

We'll acquire the first two communities in August for $47 million, three more communities in September for $70 million and the final community is expected to close in the first quarter of next year for $26 million.

We will assume $14 million of secured debt as a part of the September closing with an interest rate of 6.8%.

This master lease has a 15-year initial term and an initial yield of 8%.

Moving now to development, we delivered $217 million of development projects this quarter, and started six new projects with a total commitment amount of $221 million.

Three of these new projects are medical office buildings, which on average are 76% pre-leased, average 150,000 square feet in size and are projected to have a blended stabilized yield of 8.5%.

We also started two combination rental senior housing projects with an expected average initial yield of 8.8%, and one hospital for a new leading healthcare system with an expected initial yield of 9.9%.

Including these new projects, we currently have only $309 million of unfunded development commitments.

We believe our current development pipeline is comprised of high-quality assets, assets which carry relatively little risk.

More specifically, our current development pipeline is primarily comprised of six medical office buildings, which are 81% pre-leased, two medical facilities backed by investment-grade health systems and three rental senior housing projects that will roll directly into multi-asset master leases secured by personal and corporate guarantees.

Now before moving to financial results, I would like to touch on our same-store performance.

As John mentioned, our same-store MOB NOI increased 0.2% in the quarter versus last year.

Our same-store revenue growth for the senior housing, skilled nursing and hospital segments increased a blended 0.1% in the second quarter.

This will be the last quarter that this number is impacted by a few of the rent deferrals and concessions provided last July.

I think, most importantly, excluding the impact from these operators, we had a strong quarter with same-store revenue increasing 2.6% for senior housing, 3.4% for skilled nursing, 2% for hospitals and it was up 2.9% for these groups combined.

These results were above our expectations and I'd point out they were generally driven by some catch-up in rents we received due to positive CPI increases through the first half of this year.

Turning now to financial results, we saw strong sequential growth this quarter with normalized FFO per share increasing $0.05 sequentially to $0.80 and normalized FAD per share increasing $0.03 to $0.73.

Earnings on a year-over-year basis were flat to slightly down as we continue to see the impact of our capital raising and deleveraging efforts over the last 12 months.

And I think most importantly, as I mentioned, as we move toward 2011, we believe our strong investment prospects put us in an excellent position to generate more significant earnings growth next year.

I will just briefly provide a few details on some of the normalizing and unusual items this quarter.

First we recorded a net gain of $3.3 million on second quarter asset sales, which included three skilled nursing facilities, one medical office building and one senior housing community.

These sales generated gross proceeds of $17 million for the quarter.

We did incur a $7 million debt extinguishment charge as the result of our $139 million convertible senior note repurchase.

We recorded $752,000 of transaction costs associated with the $293 million of completed investments, and we incurred $150,000 of property operating expenses associated with the hospital held for sale that we expect to sell by year-end.

Finally, we recognized $1 million of other income as a fee paid to us related to an expected disposition that ultimately did not occur.

Now regarding our dividend, as previously announced the Board of Directors did approve an increase to the cash dividend for the quarter ended June 30 of $0.69 per share, which is a 1.5% increase versus the prior rate.

This will be our 157th consecutive quarterly dividend payment.

In terms of our capital activity, we successfully issued an additional $152 million of 3% convertible notes during the quarter, which allowed us to repurchase more of our existing 4.75% convertible notes which were puttable in 2011 and 2012.

This transaction, along with our first-quarter convertible repurchase, has enabled us to extend a total of $441 million of near-term convertible debt maturities through at least 2014.

These convertible debt exchanges also reduce current cash interest expense and free up capital to make additional investments over the next few years.

Also in June we reopened our April unsecured senior note offering, adding $150 million of notes priced to yield 6%.

And finally, at the end of June, we completed our previously discussed HUD transaction generating $82 million of proceeds at an attractive rate of 5.1%.

As a result of all of this activity, we have extended our average debt maturity from 4.4 years at the end of last year to 6.2 years today.

In terms of equity, we received over $19 million from our dividend reinvestment program this quarter through the issuance of 469,000 shares at an average gross price of about $42, and no shares were issued under equity shelf program this quarter.

With cash and line availability now of over $1 billion at quarter-end, we are in excellent position to meet our near-term maturities and fund our remaining 2010 investment projections net of assumed debt.

Our credit profile remains strong.

Currently, debt to undepreciated book capitalization is 41% and interest and fixed-charge coverage are 3.7 times and 3.0 times, respectively.

Secured debt remains low at only 11.5% of total assets at the end of June.

I'll take just a brief minute now to discuss the accounting and reporting of our $817 million partnership with Merrill Gardens, which we plan to consolidate on our financial statements.

Merrill Gardens' 20% interest will be treated as non-controlling interest on the balance sheet and income statement.

The additional 25 communities valued at $510 million that we'll be adding to the portfolio will be added to real estate investments on the balance sheet, and we do anticipate providing a separate page in the supplement detailing the necessary components to arrive at NOI after management fees for everyone.

Last today, I will just briefly review our 2010 guidance and assumptions.

In light of the investments announced subsequent to quarter-end and the attractive opportunities we continue to pursue, we're increasing our 2010 acquisition guidance by $800 million.

This increase brings our gross investment guidance to a range of $1.8 billion to $2.2 billion for the full year.

This includes $1.5 billion to $1.8 billion of acquisition and joint venture investments, and $300 million to $ 400 million of funded development.

We continue to forecast $300 million of dispositions resulting in a new net investment forecast of $1.5 billion to $1.9 billion.

As a result of our investment momentum and capital activity to date, we are increasing the midpoint of our normalized FFO and FAD guidance and now expect to report normalized FFO in a range of $3.13 to $3.20 per diluted share, and normalized FAD in a range of $2.89 to $2.96 per diluted share.

Our expectation for net income available to common stockholders has been updated to a range of $1.33 to $1.40 per diluted share as detailed in our press release.

With that, that concludes my prepared remarks, and Operator, I think we would like to open the call up for questions now.

(Operator Instructions).

Your first question comes from the line of Jorel Guilloty with Morgan Stanley.

Hi, gentleman.

I wanted to get a better sense of the performance of your senior housing portfolio.

Specifically, I wanted to see what the occupancy trends have been for independent living versus assisted living.

Hi, Jorel, it's Scott Estes.

You're breaking up a little bit.

I think your question was general performance in the senior housing sector and independent living in particular.

We report senior housing on a combined basis since the majority of the facilities are combination independent living-assisted living, etc.

The answer is the performance has been fairly stable.

I think during the economic downturn you saw a little bit of impact on occupancy, but overall coverages have been very tight actually over the last two years.

So I think the senior housing portfolio has proven to be fairly resilient even through the downturn.

We're optimistic about the growth potential as the economy hopefully continues to recover, and I think you can see the metrics in our supplement.

The question also involved assisted living, so is assisted living trending better or is it about the same as independent?

I guess I'd say assisted living is probably marginally better but, again, so many of our facilities are combinations and operators have combinations of independent and assisted living.

There's not too much of a distinction.

Got it.

And the other question I had was I was wondering if you can comment on the lease spreads you're currently seeing for the MOB space?

I didn't understand your question.

Say it again.

This is John.

Give me the question again.

Yes, I'm trying to get a sense of where releasing spreads are trending for the medical office building space?

Yes, they've been better-than-expected this year, actually much better from budget and what we were seeing last year and early in the market, but still a lot of pressure in the economy.

And my last question is, so you had -- you bought two MOBs this quarter for an initial cash yield of 8.6%, and in the first quarter you bought a portfolio of MOBs for 9.1%, so I was wondering is this a reflection of where yields for MOBs are generally trending to, or is this more having to do with the quality location of the assets?

These are high-quality assets and, again, they were -- I think all -- well, not think, these are all off-market deals and built through relationships.

There is a lot of competition out there for the auction transactions and the cap rates are running kind of 7.5% to 8% -- 7.5% to 8.5% cap rates on the on-market transactions.

But again, these are a reflection of high-quality systems, long-term leasing in place and really just the efforts of our origination team.

I guess what I'm more going for is have you seen more of a cap rate compression as the year has gone by?

Yes, absolutely.

There's a lot of capital out there chasing medical office.

Got it.

Well that's it for me.

Thank you very much.

Your next question comes from the line of Dustin Pizzo with UBS.

Good morning, guys, Ross is on with me as well.

Scott, just looking at the Merrill Gardens deal, can you provide additional color on the terms of the management contract and perhaps what the fee is based off of, how much it is, and then just also some of the assumptions behind the 5% projected NOI growth you guys talked about?

Sure, Dustin, Ross, how are you guys doing?

I think the pertinent items in terms of the management arrangement are that the fee is essentially 5% of revenues and the initial term is seven years.

And trying to think, the -- what was your other question?

The assumptions to get to the 5% projected NOI growth.

Right, sorry.

I think your basic assumptions, you know the portfolio has been a strong portfolio over time.

We believe that the current occupancy is running a little bit below where it can trend over the next few years, so we think that there's an opportunity for some occupancy and margin expansion, and we arrive at 5% NOI growth long-term through what we believe is our moderate assumption case.

Dustin, I'd also add, Chapman here, that there is some pretty good pricing power in general in these high-end markets that go along with occupancy improvements, so we're pretty bullish on it.

Okay, so there's no specific run rate for the assumptions that are behind that (inaudible -- technical difficulties).

There is.

It's incorporated in all of our detailed models on a facility-by-facility basis, and I think the main point is we're comfortable saying we think the facilities will generate 5% NOI growth over time.

Okay, and then it looks like Merrill Gardens in total owns or operates or manages about 56 properties, so there's 38 in the JV.

What's going on with the 18 others?

Are they owned by another REIT or are those potential acquisition opportunities down the road that you talked about in the press release?

Well, we hope that they, some are in development.

Some are new, relatively new, and occupancy is increasing.

We hope all of them -- virtually all of them will end up being in our venture.

And I know, Dustin, there are nine communities currently under development and we do have exclusive rights to look at those, and I believe their projected completions are over the next one to three years.

If I had to put the aggregate value, I think it's about $300 million to $350 million of community value.

Okay, perfect, and I believe Ross has a follow-up.

Yes, hi guys.

Have you locked in the pricing contractually on that potential pipeline?

No, we have ranges.

On a yield perspective?

We've talked in ranges, Ross, we'll have to look at each asset, but we really are pretty confident that we're going to be Bill's partner, Merrill Gardens' partner on virtually all of the future development deals.

And on the management fee, I know you said 5% of revenues, how are they incentivized to keep their eye on expenses then?

Is there any bump tied to NOI?

We think that the 80/20 partnership, both at the real estate and at the tenant level, provides more than sufficient alignment.

We think it's some of the best alignment that we've seen actually for RIDEA or quasi-RIDEA structures.

And then Scott, on a different topic, this is the same question I had asked you last quarter.

I want to see if I can get some clarity.

On the balance sheet you have a real estate loan receivable of $471 million.

I know $78 million of that is on non-accrual.

I guess we're really trying to get our arms around whether or not at the end of the day there's an impairment that's coming on that number and if you can give us any clarity around -- I know you'd talked last quarter about I think half of it or maybe a little more than half of it, you said you weren't worried about, it was with three operators.

What can you tell us about -- given the $78 million is non-accrual, there's no disclosure there, so what can we assume as to what's going to happen with that when receivables -- maybe when are those loans coming due and what happens when they come due?

Well, sure, Ross.

Let me give you some additional color.

I would generally categorize the current outlook for the loans in our non-accrual bucket is encouraging, we do, as always, feel we've been fairly conservative by not recognizing interest here, but I would say we're making some good progress.

When you look at the loans in that bucket, they are basically six different operator relationships, and essentially driven by either better performance, in one case a potential transition to a new operator that we're working on where they would assume the full loan and begin paying its current interest and potential pay-offs, I feel like at least $30 million to $40 million of that $78 million number could move out of the bucket over the next few quarters.

And really, again, the biggest risk at this point is probably $20 million to $30 million of loans where we've chosen not yet to move forward on development projects, and really as we evaluate our options with a few of those projects, those are the -- really to quantify the risk, until we determine that, that's probably the best number for you to think about.

And again, I would be remiss if I didn't say still an extremely small part of the aggregate Company portfolio.

And the ultimate game plan with those loans, as I recall was to hopefully convert them into a long-term lease, is that the ultimate game plan?

At this point, that's obviously on the table, yes, yes.

Again these are some projects that have yet to commence, so we're looking at our options.

So since we haven't made the determination, I would put those $20 million to $30 million in a limbo stage as we figure out the best option for those handful of loans.

Right but on the full $471 million, was the game plan on all of that to convert it into long-term leases?

Ross, George here.

Some of those, as you'll recall, are very good loans to a Florida nursing home operator, Emeritus, One Lantern, and we find most of our loans to be very good and they help to accommodate a very good series of relationships with high-quality operators.

Yes, Ross, those numbers with the three operators that are in our top 10 that George referenced represent about $256 million of that $472 million total, it's about 55% of the total loan bucket.

Those mature when?

I think a few of them if you look at the loan interest maturity schedule, it's 2011 and 2013 for some of those larger ones.

Your next question comes from the line of Karin Ford with KeyBanc.

Hi, good morning.

Good morning.

Just a few more questions on Merrill Gardens.

Scott, do you have an estimate as to how accretive you expect the transaction to be to your FFO in 2011?

I think the short answer is, I think that it would be flat to slightly accretive.

You think about the total transaction value of $817 million, there's $381 million of debt on the properties at 5.4%, and obviously we'll use our line initially, which makes it incrementally very accretive until you use your theoretical cost of capital, but using an equity cost of something like 8%, I think you can blend and assume it's slightly accretive next year.

Great.

Do you anticipate needing to issue equity later this year if the investment pace continues as you expect in your guidance?

The current situation is we have $1 billion dollars available, and based on our current guidance net of the assumed debt we basically need between $350 million to $750 million of capital.

So we have current availability more than enough to meet our current pipeline, but as always, we'll be watching the debt and the equity markets.

Okay, helpful.

Final question, just on the management contract with Merrill Gardens.

You said it had a seven-year term.

Do you guys -- what circumstances could you guys terminate the management contract sooner than that?

Are there any performance requirements?

Yes, this is Jeff Miller.

What I would characterize as typical kinds of performance requirements under the management agreement.

Okay, thanks very much.

Your next question comes from Rich Anderson with BMO Capital Markets.

Thanks, good morning everyone.

Hi, Rich.

If I could just play a little devil's advocate here.

You mentioned first-class operator, I'm sure they are, but you're also mentioning the opportunity for margin expansion and occupancy increases.

Can you just sort of tell me why they're a first-class operator but also there's money on the table?

Rich, Chapman.

We've dealt with Bill and his team for almost 15 years now, we've seen them turnaround underperforming assets, we've seen them take over troubled assets.

We've witnessed their efforts during tough economic times and we think that the only reason there's money being left on the table relates to the economy, and we've seen virtually everybody's occupancies move down into the high 80s on senior housing IL/AL, and Bill and his team's portfolio have been affected that way, as well, but they're moving back up and I think they are doing very, very well and they are performing very effectively, and every asset class gets affected in some way by the economy.

Was there some corporate level reason why they wanted to do this or is it pure love for HCN?

Well, I'm sure a lot of it was pure love for us, but I think that there were a few corporate goals, as well, to rationalize their particular capital structure, and other issues that relate to the Merrill family and their planning.

But I think that is as much as I would say right now.

Okay, are there any promoted interest opportunities for either party?

Yes, there is, after a very high return to the venture, there is some opportunity for a promote for Merrill Gardens based on performance.

Bigger picture, this is your first foray into RIDEA.

You've mentioned maybe as much as 25% of your portfolio having some type of RIDEA structure to it.

Is this perceived as a bit of a litmus test to see how it goes or are you going full-forward to look for other opportunities, maybe within your portfolio with current operators?

What is your game plan in the near-term as it relates to RIDEA?

Frankly, we have commented on RIDEA structures, and the way we tend to think about RIDEA is as follows.

We view relationships -- good relationships as the way we build our portfolio.

RIDEA is just one of the ways that we can form a good mutually beneficial relationship.

At this point in time, there may be more good opportunities to do RIDEA structures in the IL/AL space as occupancies had come down, and we view the next two or three years as a period of very high growth.

So yes we are looking at it for that reason.

Some of the operators and their portfolios are going to be perhaps candidates for that.

Others would not be and we would be better off just sticking with a typical operating lease with fixed increasers.

Okay, and last question.

Do you feel like at $2 billion-plus in terms of investment activity this year, you're kind of tapped out in terms of annual action or how much bigger can it get on an annual basis in terms of investment activity?

Well, you'll recall, when Scott and I have talked to you and talked to the street about this, we told you and all of the other analysts that we have built a program that could do $1.5 billion per year.

I think possibly we can go higher than that annually, but again, it depends on the opportunities.

We've added some great people, we have great capabilities and we could clearly go beyond $2 billion a year.

Okay.

Thank you.

Your next question comes from the line of Jerry Doctrow with Stifel Nicolaus.

Thanks.

Thanks for adding some excitement here to the earnings season.

We're glad to help.

I want to just clarify a couple details.

First, so when we think about the $60 million to $63 million of NOI, that's sort of your projected 2011 number or that's a current run rate and we add 5% to that?

Just want to make sure I'm understanding what's in place and what's assumed.

That is the projection for 2011 NOI after management fees, Jerry.

Okay, so with the ups built in.

Okay.

And I guess in terms of the triple net rents, wanted to just clarify, get a sense of how much of yours has floors, how much of it is really affected by just very low CPI escalators, because I think you'd made a comment that you're actually catching up some rents for CPI.

I mean, does that 2%, 2.5% go lower because CPI has been so low, what's your expectation as we go forward?

The short of it is about 80% or so of our senior housing portfolio has at least a component of the annual rent increaser that's influenced by CPI.

And if you remember last year, really through most of last year, that number was negative so we kept rents flat, and what we've actually found through the first and second quarter, the year-over-year monthly CPI increase, which is what is used for calculating increasers, is ranged between roughly 3.5% at the high end to I think maybe 2% or so at the lower end.

So we've actually received full increasers and even some catching up of previous years flat rent impact, so that is in part driving the higher same-store performance this quarter.

Okay, so at least you'd be comfortable with 2.5% on the triple net stuff easily?

Yes.

Okay, thanks.

And then just kind of coming back to the entrance fee and the stuff in lease-up, I was just wondering if we can get a little bit more color.

You provided some, but there were like four properties in your fill table that went from like 0 to 50, or 50 to 70, I was curious if any of that was entrance fee, maybe a little more color just on what's going on incentives or what's moving the entrance fees a bit higher, I think you said they moved 46-49.

And then the Stratford, you switched operators again, just trying to get a little more color there.

Jerry, it's me again, Scott.

On your unstable progress question, yes, I think that is important and we did have four properties move up in occupancy, as you referenced in our supplement, and two of those four were actually entrance fee communities in Florida.

The other was a combination rental-senior housing property and the other was a freestanding dementia building.

We are seeing nice momentum.

Our largest operator and two operators in the entrance fee world are doing very well.

As we mentioned part of our optimism is really based on that sequential improvement.

As Chuck mentioned, we're ahead of budget in terms of entrance fee move-ins.

Both entrance fee and rental components increased occupancy 3% this quarter, and the important metric for everyone to think about is as we looked at when we think the majority of those entrance fee communities can stabilize, we currently project between about 1.5 to two years and the vast majority of the entrance fee portfolio we think will meet our stabilization criteria of a blended 80% occupancy.

So we're actually very encouraged and we'll look at the end of the year based on where we're at but, again, as we mentioned, we think rents are moving up in direction.

Okay.

And then just on Stratford, I think -- who is the new operator and just what was going on there?

Jerry's referencing a community in Kenwood, Ohio that is one of the -- we think the premier piece of real estate in its market.

It's a project that's just come out of construction and in July, we transitioned this property to Senior Star who is a high-quality senior housing operator that's already in our portfolio.

They will be running that community as a rental model under what we think is an attractive long-term lease featuring an incremental gross revenue component, which could enhance future returns.

So we're happy, the team did a good job, I think, putting the -- resolving that situation and I think probably from a metrics perspective, the number that we would share is obviously return-wise not a home run, but we think based on conservative cap rate consumptions we can still get an IRR of 7% to 8% on that asset.

And was it an entrance fee that moved to rental?

That's correct.

It's was an entrance fee that we moved to a rental model.

Okay.

I think I'm good for now, thanks.

Your next question comes from the line of Tayo Okusanya.

Yes, good morning.

Just back to Merrill Gardens, it's already so well run, occupancy at 92%.

One, could you give us a sense of what the operating margins are right now; and then two, when you just look back at the economic boom five or six years ago, could you give us a sense of what peak occupancies and peak margins were back then?

John Getchey, go ahead and answer the question.

Yes, the occupancies have always been -- what was the year you were looking for?

They were low 90s -- 91% in 2009, 93% in 2008 and currently running at 92% today.

And as far as your operating margin question, it's probably around 35% or so.

So 35% today?

Yes.

And what about in the peak years?

We've kept -- it's always historically been around 35%.

So what does the upside come from then, if occupancy is at peak occupancies right now and margins are like peak margins, where does the 5% NOI growth come from?

I think John's giving general numbers, Tayo.

The 91%, 92% range of occupancy in our opinion can grow to 95% for this portfolio, and he said the current EBITDA is in the 30% to 35% range, it's somewhere in the middle there, there's definitely a few percentage points of EBITDA margin expansion from where the numbers are now and these guys have always been very good operators over time.

So we're comfortable with, as the economy improves, clearly assets like these will have some of the best pricing power in their markets.

Do you have any concern, at least near-term about so much of the portfolio, one, being independent living in California that has a weak housing back drop?

We certainly look at that and we know that the economy is probably been having the greatest impact on independent living, but we think cyclically that we have room to move up at this point.

Okay.

Appreciate that, and then just going back to the development, the one CCRC that you guys have not determined a development yield on yet, any reason why?

That was the Kenwood facility, Tayo, that I detailed through Jerry's response.

Okay, and then the deferred rents on the other recently opened CCRCs, it sounds like you're expecting to get some of that back in 2011?

Yes, we are.

Do you have a sense of how much you're expecting back and how soon that could start to happen?

We do think we are going to increase rents on the CCRC portfolio and we're going to look at the remainder of the year before making that determination.

Okay, that's helpful.

One more question, life sciences joint venture.

Anything changed in regards to that?

You guys still seeing the 20% leasing spreads you were expecting that will generate the 5% NOI growth?

Yes, Tayo, this is John.

What we're seeing in the market and some of the re-leasing there is really above our expectations, so the numbers you quoted we're very comfortable with.

Okay.

Well, one big transformational transaction in the first quarter, a second one in second quarter, what should we be expecting in the third quarter?

We get bored easily.

I hear you.

Thanks a lot guys.

Thanks, Tayo.

Your next question comes from the line of Todd Stender with Wells Fargo Securities.

Thanks guys.

I apologize if you already answered these questions.

The other transaction you announced, the $143 million, who was the seller on that?

Was that an existing tenant?

It was an existing -- it was an operator selling a portfolio to us.

It was a straight sale lease-back transaction.

They were not in our portfolio but we had had a long-term relationship and had worked with them back in the early 1990s, and their portfolio had matured and they were looking for growth partner so we were able to acquire that portfolio from them.

Okay, so the operator is going to stay the same?

You aren't changing out the operator?

Correct.

Part two of that, what factors contribute to the closing dates, at least on one of the properties, getting stretched in the first quarter of next year?

Some of it is tax considerations and some of it is related to debt assumptions.

Okay.

That's it for me, thank you.

Thanks.

(Operator Instructions).

Your next question comes from the line of Ron Maine with Morgan Keegan.

Thanks, good morning.

Most of what I had has been answered, so I've just got a little odd-and-end question left, and that is, skilled nursing portfolio, there have been -- we've had kind of a flurry of reimbursement issues that have come up FMAP and Medicare rates for next year and proposed therapy cuts and all that stuff.

Am I correct in assuming that when you look at this netted out, you don't see any significant impact on either your coverages or your appetite for that asset class?

I think that's correct.

We think it's a net neutral basically right now.

Okay, that's all I had.

Thanks.

Thank you.

You have a follow-up question from the line of Tayo Okusanya with Jefferies & Co.

Yes, just two quick questions.

One, although you expect it to generally be neutral in regards to Medicaid, are there any particular states where the outcome was somewhat worse than you expected?

I don't think so, Tayo.

Honestly so many of the state budgets are still in flux at this point.

You hear some encouraging news out of the potential for increasing FMAP through the next first couple quarters of next year and looks like that's going to move to the house in a vote later this week, as I understand it.

But again, the bottom line is our skilled nursing facility coverage is 1.72 times among the highest in the industry and based on all of the changes, we don't see a lot of -- or any operators with significant issues in light of the Medicare/Medicaid pricing changes that are on the table.

I appreciate that, and then just one more question.

I appreciate your patience.

I know you had discussed this just a few minutes ago, but the CPI related triple net leases, you say there was a certain catch-up you are getting right now which is why the increases were between 2% to 2.5%.

Could you just talk about that again real quick please?

Sure, Tayo.

You can see most of our leases would have the typical 2.5% approximate annual increaser, and as you can see, I even think in some of our independent and assisted combination operators we saw as much as 5% to 6% year-over-year increases when their leases came up during the first half of this year, because effectively what was happening was last year rents were held flat while CPI was negative, and then as CPIs come back positively, we've been able to not only get the normal annual increase but catch-up some of the rent that should have been increased in the prior year.

Okay, so that's how it works.

Okay, sounds good.

Thank you.

Your next question comes from the line of Karin Ford with KeyBanc.

Hi.

Just a follow-up on the two post-quarter acquisitions.

Are the two senior housing portfolios in the Merrill Gardens deal and the other $143 million deal similar, so that if we compare the cap rates -- the cap rate and the lease rate basically between those two deals, would that be a good measure of what you might consider to be a premium you'd need to pay to do a RIDEA deal versus a triple net deal?

How would you characterize the relative assets, Chuck?

Is there a significant difference?

As far as quality, I think they are of similar quality and similar mix, so I think they are reasonably the same.

As far as the differential for doing a RIDEA deal versus doing a straight acquisition, I think it potentially is one proxy.

I think there could be larger spreads depending on the growth in the RIDEA portfolios that may be out there.

Even IRRs, too.

Some of our potential IRRs on a typical triple net lease deal in senior housing may be more in the 9.5% to 10% range and we think we can get in excess of that based on some pretty reasonable -- what we think reasonable assumptions in terms of growth in the Merrill Gardens portfolio, as well as terminal cap rate, actually using a cap rate that's higher than the go-in cap rate, we still think we can get at least a 10% to 11% potentially, and that's kind of another way we think about the value-added proposition.

That's helpful.

And then just finally, do you anticipate within the current structuring of the deal that there will be any tax leakage or do you think it will be sort of tax efficient the way you've got it structured?

This is Jeff Miller.

There's inevitably some level of tax leakage because you're working through a TRS; however the way we have structured it, I think we have done a pretty good job of minimizing that.

Okay, thanks very much.

There are no further questions at this time.

Mr.

Chapman, do you have any closing remarks?

I have no closing remarks.

I just want to, on behalf of the Management team, thank people for participating in the call and to advise you that Scott will be available for any follow-up questions.

Thanks very much.

This concludes today's conference call.

You may now disconnect.