Welltower Inc (WELL) 2014 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the third-quarter 2014 Health Care REIT earnings conference call.

My name is Holly and I will be your operator today.

(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 and Chief Operating Officer.

Please go ahead, sir.

Thank you, Holly.

Good morning, everyone, and thank you for joining us today for HCN's third-quarter 2014 conference call.

If you did not receive a copy of the news release distributed this morning you may access it via the Company's website at hcreit.com.

We are holding a live webcast of today's call, which may be accessed through the Company's website.

Before we begin let me remind you that 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 HCN 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 release and from time to time in the Company's filings with the SEC.

I will now turn the call over to our CEO, Tom DeRosa.

Thanks, Jeff.

The strong third-quarter financial results we announced this morning are a tribute to HCN's people, partners and industry-leading business model.

A model that has been built not over years but decades.

Our unique model provides strong and predictable cash flow growth, new investment growth, dividend and debt coverage and access to capital that is delivering for our shareholders on all fronts.

Here are a few highlights of the quarter.

Same-store NOI for the entire portfolio grew 4.3% and our seniors housing operating portfolio posted an outstanding 7.6% growth.

I'll let Scott Brinker provide you with more detail about how we achieve these industry-leading results.

But as I have said in the past, it is about partnering with the top operators and health systems who own the best healthcare real estate in the best markets.

We were happy to welcome HealthLease and Gracewell to the HCN family during the quarter.

With HealthLease, we will acquire an excellent portfolio of seniors housing and Class A post-acute assets for a blended cap rate of approximately 7%.

This acquisition also gives us a development pipeline with Zeke Turner's Mainstreet development business to acquire $1.4 billion of their state-of-the-art NextGen post-acute facilities.

Our Gracewell acquisition in the UK provides us with another senior housing brand and development pipeline in the more affluent London and Southern England markets.

I would also note that Sunrise UK will manage the Gracewell assets for us, which is a value add that we were able to deliver to our largest operating partner, Sunrise Assisted Living.

Also in the quarter we were pleased with the announcement that Genesis HealthCare agreed to combined with Skilled Healthcare.

This gives HCN's second-largest operator access to public capital further improving the credit quality of our portfolio.

We are also happy to see our friend George Hager back in the public markets.

And we are excited about what this means for the future of our relationship with Genesis.

We generated $757 million of accretive investments in the quarter of which $558 million was generated from our existing team of operators.

We have been speaking to this every quarter as it is another example of the predictability and unique transparency of the external growth component of the HCN model.

Our financial results also reflect our history of financial and strategic discipline.

Whether it is the discipline to dispose of over $2 billion of non-core assets over the past four years, or the discipline to have raised over $2 billion in equity in the last six months to further enhance the strength of our balance sheet, we believe that these prudent actions are what enables us to deliver strong earnings growth over the long term.

As Scott Estes will speak to later, despite the enormous growth in our business our balance sheet and financial metrics have never been better.

With that, I am now going to turn the mic over to Scott Brinker our Chief Investment Officer.

Thanks, Tom.

I have a lot of good news to share today.

The HCN team delivered another outstanding quarter.

Our investment activity and proactive asset management are driving best-in-class internal growth.

We have averaged 4% same-store growth over the past four years.

I'm going to start with outpatient medical office.

This portfolio has been completely transformed in the eight years since we entered the business.

Today on every important metric our outpatient medical office portfolio is at or near the top of the peer group.

We have added a slide to our corporate presentation showing how we stack up to our peers.

Operating results in this portfolio are very steady.

Same-store NOI grew 3.3% over the comparable quarter.

Looking forward we see strong demand for space.

The shift to outpatient care is a fundamental change in healthcare delivery that greatly benefits our portfolio.

Let's turn to seniors housing.

Same-store NOI in the operating portfolio grew 7.6% extending our history of superior results.

Performance continues to be exceptional in the UK, strong in the US and steady in Canada.

This portfolio has averaged 8% NOI growth since inception four years ago, substantially above all benchmarks.

The outperformance is driven by the quality of our real estate and operating partners.

We were highly selective in picking both our partners and our acquisition targets.

The consistency is driven by purposeful diversification, by operator, geography and service type.

Our well diversified triple net senior housing business continues to generate steady growth.

Same-store NOI increased 2.7% continuing a nice history of inflation plus growth.

Moving to post-acute, our rental income is well secured and growing consistently.

Same-store NOI increased 3% over the comparable quarter.

The big news last quarter was Genesis agreeing to combine with Skilled Healthcare.

This is a big win for HCN.

Genesis will become a public company with improved liquidity and higher payment coverage.

You might remember that we received warrants in Genesis as part of the sale leaseback in 2011.

We will convert those warrants into common stock at closing giving us ownership in the public company that is worth about $40 million.

With a cost basis of zero, we will make a nice return on that investment.

A small note on life science, which represents just 1% of our income.

This Class A portfolio sits in an irreplaceable location at the doorstep to MIT.

NOI declined last quarter due to a large anticipated lease expiration.

We will soon recapture the lost income.

More than half the space has already been released with a 2Q 2015 commencement date.

Term sheets are outstanding for much of the remaining vacant space on the campus.

Turning to investments, our partners helped us generate more than $750 million of new investments last quarter.

Consistent with our longtime strategy, the lion's share of the activity was with existing partners.

For example, we expanded our relationship with Sunrise through a $250 million acquisition in the UK that also comes with a large pipeline of to-be-developed communities.

Looking forward, we secured partnerships with the leading private pay operators in the UK and Canada.

These partners will help us deliver significant internal and external growth.

This is the same blueprint we've used so successfully here in the US.

In sports terms, if you held a draft and gave me the first 20 picks, there are only a handful of operators I would pick that aren't already in our portfolio.

That's a competitive advantage that cannot be replicated.

These are the operators who are best positioned to consolidate what remains a fragmented market.

The $950 million HealthLease acquisition is on target to close this quarter.

The assets are primarily seniors housing in Class A post-acute with a blended cap rate of 7%.

We like to get more than just a collection of assets when we do a big deal.

HealthLease is a good example.

We received a $1.4 billion pipeline of brand new assets being developed by Mainstreet.

The cap rate on the pipeline is nearly 7.7%, highly attractive given the Class A building quality and 100% Q-Mix.

The pipeline beyond HealthLease is exceptionally strong and dominated by off-market deals with existing partners.

We get lots of questions about selling assets.

The transaction market is strong, so why not take advantage?

It's a good question, and it's exactly what we have been doing.

We've raised more than $2 billion over the past four years by selling non-core assets.

We got rid of our bottom 5%.

This allows us to feel even more confident about the future.

In summary, our portfolio, people and relationships position HCN for continued outperformance.

I will now turn the call to Scott Estes to discuss our financial results.

Thanks, Scott, and good morning everyone.

From a financial perspective we sit in a good position entering the final three months of the year.

My remarks today will focus on our financial results, balance sheet and guidance.

First, our continued success on the acquisition front and strong portfolio performance drove another quarter of meaningful earnings growth.

Second, we have strategically positioned the balance sheet to produce the strongest financial metrics that I can remember, which includes sitting on $1 billion in cash as of September 30, effectively pre-funding all acquisitions announced to date.

And third, the strength of our results have allowed us to maintain the midpoint of our 2014 guidance despite increasing our annual disposition forecast by $175 million and raising over $1 billion of additional equity in the quarter.

So I will begin my more detailed comments by taking a look at our third-quarter financial performance.

Our platform continues to generate consistently strong earnings growth.

Normalized FFO increased to $1.04 per share for the third quarter while normalized FAD came in at $0.91 per share representing solid 7% and 6% year-over-year increases respectively.

Results were primarily driven by the same-store cash NOI increase and the $2.3 billion of investments completed over the prior 12 months.

In terms of operating expenses, our G&A for the third quarter came in at $31 million in line with expectations.

Regarding our dividends, as we move into 2015 our confidence in our portfolio's internal and external growth has allowed us to announce a 4% increase in our 2015 dividend payment rate.

Our Board of Directors has approved a 2015 quarterly dividend payment rate of $0.825 per share, or $3.30 annually beginning with the February 2015 dividend.

And in terms of our disclosure, I would note we added pictures of our MOB portfolio to the website today, which I believe is a nice addition.

Turning now to our liquidity picture and balance sheet, in terms of third-quarter capital markets activity, the highlight was our secondary equity offering which settled in mid-September.

We completed the sale of 17.825 million shares of common equity at $63.75 per share generating $1.1 billion in gross proceeds.

We have now completed the two largest overnight offerings by any New York stock exchange company in 2014 based on total gross proceeds.

In addition, we issued 982,000 common shares under our dividend reinvestment program generating $62 million in proceeds and generated $376 million of proceeds through the sale of nonstrategic assets and loan payoffs.

We also repaid approximately $54 million of secured debt at a blended rate of 5.4% and assumed $51 million of secured debt associated with acquisitions at a 2.9% rate.

As a result of our third-quarter capital activity and new line of credit, we are in an outstanding liquidity position at quarter end and have raised the capital to finance all acquisitions announced to date.

More specifically, as of September 30 we have our full $2.5 billion line of credit available and $1 billion in cash, an additional $152 million of pending dispositions throughout the remainder of 2014 and are generating an additional $60 million of equity per quarter through our dividend reinvestment program.

We have limited near-term debt maturities with only $51 million of debt maturing through yearend 2014.

Our balance sheet and financial metrics at quarter end improved to the strongest levels in recent memory as a result of our improving portfolio performance and capital markets activities.

As of September 30, our net debt to undepreciated book capitalization was 36% and net debt to enterprise value was 30%.

Our net debt to adjusted EBITDA declined to just below 5 times while our adjusted interest and fixed charge coverage improved to 3.9 times and 3.1 times respectively.

Our secured debt as a percentage of total assets declined 30 basis points to 11.8%.

All of the preceding credit metrics are now comfortably inside our targeted levels.

I will conclude my comments today with an update on 2014 guidance and our supporting assumptions.

I will begin with our same-store cash NOI growth outlook.

Given our strong third-quarter results we are increasing our 2014 forecast from the previous range of 3.5% to 4% to approximately 4%.

The increase is largely based on the strength of the seniors housing operating portfolio as our same-store cash NOI forecast for the remaining components of our portfolio remain unchanged.

In terms of our investment expectations, there are no acquisitions included in our guidance beyond what we have announced through the third quarter.

We do continue to expect an additional $1.05 billion of previously announced acquisitions to close in the fourth quarter, which are included in our guidance.

Our forecast now includes $625 million of dispositions at a blended yield on sale of 9.5% representing an increase from the previous expectation of $450 million.

Finally, we have narrowed our normalized FFO and FAD per share guidance ranges for the full year around the midpoint of previous guidance.

I believe this is a positive result given the additional $1.1 billion of equity raised in the third quarter to significantly strengthen our balance sheet and the incremental $175 million increase in our disposition expectations for the year.

As a result, we are narrowing our normalized 2014 FFO guidance to a range of $4.07 to $4.13 per diluted share representing a 7% to 8% annual increase and our FAD guidance to $3.59 to $3.65 per diluted share representing a strong 7% to 9% increase.

That concludes my prepared remarks.

But I will conclude by saying we are very well-positioned to execute on our growth pipeline given the strength of our balance sheet and cash available to close all investments announced year to date.

So at this point, Tom, I will turn it back to you for some closing comments.

Thanks, Scott.

So as you have heard, our third-quarter results underscore the power of the HCN model.

We continue to deliver strong predictable growth and financial performance through our unique, diversified global operating partner network as well as embracing a disciplined and conservative approach to managing our capital position.

Our external growth is equally disciplined and conservative.

The fact that I can tell you that $1.2 billion of our total year-to-date new investment growth of $1.8 billion has come from our existing operating partners truly demonstrates the transparency and predictability of our external growth model.

I am proud to say that HCN is now the fourth largest publicly traded real estate company and is truly a global business.

We know that investing outside the US requires dedicated knowledge, skill and feet on the street in order to properly manage the opportunities and risks in these markets.

I am delighted to tell you that last month HCN moved into its new London offices on Cornhill in the city of London, just a few paces away from where John Goodey, our SVP International, and I worked together in the 1990s.

I invite all of you to visit John and the team when your travels take you to London.

During the quarter we welcomed Serge Rivera, President of the Americas for Starwood Hotels and Resorts, to our Board, which adds additional bench strength and lodging and hospitality industry knowledge to an already outstanding group of Directors.

Finally, I want to acknowledge the recent passing of a great friend of HCN, Mary Wolfe, wife of our founder, Fritz Wolfe.

For over 40 years Mary was a strong supporter of our Company.

She was a passionate patron of the arts here in Toledo and in Palm Beach, Florida.

Mary's intellect, kindness and humor were an inspiration to all of us.

We will miss you, Mary.

Now, Holly, please open up the line for questions.

Yes, sir.

(Operator Instructions) Michael Knott, Green Street Advisors.

Good morning.

Question for you, Tom or Scott, on your thoughts on the cost of capital environment and Scott talked about the forward pipeline being strong, just curious if you want to add any more color to those comments, what we might expect to see you guys do over the next 6, 9, 12 months?

Why don't you just kick it off on the investment pipeline and we will talk about cost of capital.

I can talk about the investment pipeline.

It is consistent with our history.

So you're going to see us be active in the US, UK and Canada.

High quality assets, major metro markets, mostly private pay and importantly, the lion's share of it will be with existing partners.

And this is referring to the pipeline beyond HealthLease.

So some of it will close in the fourth quarter, the rest might spill over to the first but it is definitely an active time for us.

And from a cost of capital perspective we obviously are sitting on a nice bit of cash today.

But given the solid stock price performance and debt markets performing pretty well, I think we can absolutely continue to invest accretively.

I would support that.

And because of our cost of capital and access to capital really be opportunistic when we think about the business going forward.

Okay, thanks.

And then a question on the operating portfolio in senior housing.

It sounds like you are increasing your guidance.

I think before it was 6% to 6.5% and it seems like you guys could hit 7% for the year if you can finish at maybe 4% or 5%, or better in 4Q.

Curious if you want to comment on the operating guidance?

Yes, Michael, the fourth quarter is usually a little bit lower.

So it is hard to say for sure but I'm not sure that we will get to the high 7%s, low 8%s like we have over the past few quarters.

We won't know for sure for a couple of more months but our best guess is it will be a bit below that.

Okay, so just to clarify what then is the new bogey for the full year?

We would hope that it would range 6.5% to 7%, if not toward the higher end of that range pending Scott's comments on the fourth-quarter performance.

Okay, and then last question for me, Tom or Scott, when you look at life science and you see kind of an ugly NOI print like you had this quarter and then also you maybe think it maybe it doesn't quite fit your passion for improving healthcare delivery like your other business lines, do you sort of say to yourself I've got some really valuable Cambridge properties like you noted on the call and maybe think about maybe time to recycle that and focus on your other business lines?

Is that a thought that you guys have?

You know Michael, that's an asset that we are quite proud of and I think the decision to invest in that asset a number of years ago has really proved to be a very good one.

As you look at the life sciences market, we think that is probably in the United States among the very best locations you could find.

So we think owning the best-in-class asset in the best market kind of fits our strategy.

And we don't worry about that asset at all.

As Scott mentioned, already we will see very good lease-up of that available space.

And that being said, you know that we always actively manage our portfolio and we look -- we know that's a very valuable asset.

We know it's an asset that where we have a very large gain in.

And there may be an opportunity at some point in the future where we would consider doing something with that asset.

But today we are very happy to own it and we feel very good about how it is being managed and we like seeing it in the portfolio.

Okay.

Thanks, everyone.

Joshua Raskin, Barclays.

Hi, this is Rachana Fellinger on behalf of Josh.

Thanks for taking my questions.

Just a couple of quick ones.

Do you have any plans to ramp up development in England in the RIDEA portfolio in the near future?

We do.

We have been actively developing in that market for over three years now.

It is interesting if you go do some site visits the quality of the stock in the UK is quite low on average.

So we feel like there is a real opportunity as that market transitions away from government pay and towards private pay to build high quality assets that people will actually want to be in and want to pay for.

And that's what we own.

So we've got 60 or so communities in the UK right now and these are all very new purpose built private pay assets.

And that is not typical in the UK.

So we've been very purposeful about what we have bought but frankly there's not a whole lot left to acquire.

There certainly are portfolios we are looking at but there is really a development opportunity.

So we're actively developing Signature, Sunrise and Avery, all three of our partners so you could easily see us do 10-plus projects a year going forward.

And they've been extremely successful to date with yields on cost in the high single digits or low double digits.

Okay, great.

Just one other question.

Are you seeing anything particular in terms of demographics with individuals that are moving in and out of your RIDEA portfolio?

Are they younger, living longer, utilizing more ancillary services?

No, we haven't seen a material change there.

They continue to be in the mid-80s.

They are still staying two to three years, on average, so these aren't -- I wouldn't say that the demographic profile of our communities has changed materially over the past few years.

It is just that demographic trends are going to mean there are going to be more people attracted to these assets in the future.

So we just see more demand coming and I think we see that across the US, we see it in Canada and we see it in the UK.

And just to add to Scott's comment on the UK, you are seeing a real change in the UK, a societal change there.

Eldercare has been in existence there for a long time and offered by the National Health Service.

You are seeing a change in the UK in that people are now willing to pay for their elderly care.

There is a more affluent market and so the product that is being developed is really being developed to meet the demands of that market.

Okay, great.

Thank you.

Emmanuel Korchman, Citigroup.

This is (inaudible) for Manny.

In early September there was a press release regarding the acquisition pipeline being around $1.7 billion for the second half of 2014, including $535 million of expected future acquisitions.

So we were hoping that you could give us maybe some color on the composition of those remaining deals.

The press release in August included the HealthLease portfolio, which was the lion's share of the $1.7 billion.

That accounts for about $1 billion of it.

And then most of the balance is what we just announced for this quarter.

So it is the Sunrise deal, there is a big private pay senior housing acquisition in the UK with Avery Healthcare, an existing client and then we did some MOB acquisition.

So the third quarter activity plus HealthLease should total the $1.7 billion.

Okay, great.

Thanks.

And in terms of the international pipeline, could you give us a sense of the acquisition or investment pipeline that you are seeing today?

You just made some recent comments about UK being a little difficult in terms of acquisitions and there's going to be more development focus.

Are you looking at any other additional markets, so maybe some color that might be helpful?

I would say we continue to see good opportunities in the UK.

As Scott did mention, a lot of it is development oriented but there may be some additional acquisition opportunity there as well.

So I will tell you, as I have said in the past, we see tremendous opportunities in the US, number one.

And then we are also seeing good opportunities in Canada and the UK.

I would say our plate is quite full today with those markets.

So we are not spending a tremendous time looking outside of those markets but I can assure you that we're on top of where there may be opportunities in the future outside of those markets.

I think having a strong team on the ground in Europe helps us understand those opportunities and gives us a competitive advantage at seizing whatever opportunities may come out of the existing markets we are in, the existing market we are in in Europe and other markets that we may choose to go into in the future.

Okay, great.

Thank you very much.

That was helpful.

Rich Anderson, Mizuho.

Tom, I have heard that you might be more upbeat or sanguine on life science than your predecessor and maybe even willing to increase your exposure in that business over time.

Is that a fair characterization?

Rich, when I have talked about life sciences in the past it has been life sciences that are related to academic medical centers.

And we still believe at some point in the future there are tremendous real estate investments for us that may come out of those large academic medical centers that lead many of the life science efforts in this country.

So to the extent that there are life science assets that may provide a connection to one of those or a few of those institutions, that's where I am interested.

We don't see it as a leading business for us going forward, but it may be a bridge into the type of business that -- or the type of assets that you like to see us invest in.

Okay.

Good stuff.

In the UK, first a big picture question.

A lot of talk of deflationary pressures in Europe; and UK being kind of close proximity, do you worry at all about that in terms of expanding your platform there, or are you just going to plow through at this point?

Rich, so much of our portfolio is concentrated in the greater London MSA and Southern England.

So I think that there are issues in England as you go throughout the country.

We are very deliberate about where we own and develop assets, and I cannot underscore that enough because we know the UK market quite well.

Our assets, again, are largely around London.

We see London as perhaps the most resilient market in the world.

The amount of wealth that continues to consolidate into London is extraordinary.

So we feel that being there is very important.

And when you look at across any property type owning assets in the UK, I think investors should want to see a focus on the greater London market, Southern England and the other market, which is attractive because it is the second largest market in England, is around Birmingham, England, which is the middle level of the country.

As you get above Birmingham we pause because we worry about some of the demographic issues from the mid- to Northern England markets.

So I think like a lot of markets, Rich, if you are with the best operators who own the best real estate, generally you create a bit of a strong competitive advantage.

I can say that about certain markets in the United States, too, that where people will say might be overbuilt but if you are in the best submarkets in those larger markets with the best operators we think we are in a great position to capture growth in the future.

Okay.

And specifically the Gracewell deal, if that company is winning awards for managing their assets, why replace them with Sunrise, or did they want that?

I wouldn't call it a replacement.

It's more like an addition to Sunrise's already strong team.

So Tim and Danny, the two principals at Gracewell, really have a development expertise.

They are real estate guys and they are going to continue in that function going forward.

They're going to deliver this pipeline of assets in London and Southern England and then the best of the operating team from Gracewell is joining Sunrise.

So to me we are just combining two good platforms.

Okay, fair enough.

Scott, maybe a question for you, the 7.6% same-store NOI growth this quarter for RIDEA, when you think about sustainability of that number, Ventas is producing a number lower than that.

Do you think the number is more like in the 5% to 6% range when you get through some of the occupancy lift, or do you think a long-term number is close to 7% for now?

Rich, I hope it is 7%.

We have said when we started doing RIDEA four years ago that 4% to 5% long term in a static environment was probably realistic.

I don't think our view has changed.

We are confident that because of the assets and the operators we will outperform the industry.

But in terms of continuing at our current pace of 8% per year, that would be very difficult.

It's just the comparable quarter has become so difficult to exceed.

Rich, you have heard us talk about the operating initiatives that we lead for our operating partners.

That's real stuff.

That's not made up.

And so we would like to think that because of our relationship and the skill set that we bring to the operator that we have a direct role in driving that same-store sales growth.

And I think that's a unique aspect of our business model.

Okay.

And then I don't know if anyone has asked you about this but with the problems that Ventas had with their Sunrise in Canada, do you have any comment about why that might have happened since you are a part owner of the management company?

We are a minority investor.

We have zero input on what Sunrise does operationally and there is a strict Chinese wall, so I couldn't even begin to comment on it if I wanted to.

We have nothing to do with their portfolio.

Okay.

All right, thanks.

Daniel Bernstein, Stifel.

Good morning.

I actually wanted to start on the entrance fee property.

Some of your peers have been making investments in that space.

And I don't feel like you have done a whole lot since development a few years ago.

If you can talk a little bit about how your entrance fee portfolio is performing and maybe how you feel about increasing investments again in entrance fee CCRCs?

Dan, I can comment on the existing portfolio performance.

It is obviously very small.

We have only eight properties at about $390 million investment balance but they actually continue to fill pretty well.

Right now the overall occupancy is in the mid-80%s, is about 86%.

And the entrance fee community component of those properties are filling up, they are over 80% and the rental part is in the low 90%s, so I think they are doing fine.

We have chosen not to make additional investments in that portfolio.

Yes Dan, it's less than 2% of our income today and we've been in that business for over a decade and we have just found that the cash flows are too volatile.

Not saying that we would sell this portfolio that we have.

It is performing well.

But that is not an industry that we are looking to expand in.

Just we like the consistency of our results and it is very difficult in that business to generate any level of predictability.

Okay.

And speaking about your dividend growth was a little bit -- was coming in a little below your FAD growth.

If you could talk a little bit about goals for the FAD payout ratio, or however you are thinking about the payout ratio for the dividend going forward?

Yes, we would like to be in a position where we can increase the dividend meaningfully but still push the payout ratios down pending earnings growth.

So where we are at today I think we can get our FFO payout ratio down into the mid-70%s or below and FAD in the mid-80%s or below over the next several years pending our rate of earnings growth.

Okay.

And then in terms of -- I've been trying to think about a lot of investors I think have been concerned in the healthcare REIT space about investment spreads over cost of capital.

You addressed a little bit about the strengths in your capital availability earlier in the call, but can you talk a little bit about how you are thinking about investment spreads today versus where you have seen them in the last couple of years?

Just want to hear how you are thinking about your ability to invest accretively.

Yes Dan, we have spent a lot of time looking at that.

The spreads haven't changed that much.

It is important that we are doing the vast majority of our investments off-market with existing clients and the yields are pretty good if you compare that to what people are paying in auction.

So if we were generating all of our volume through large public auctions it would be difficult to maintain a positive spread.

We feel like we have continued to do that and it is still in the 50 to 150 basis points given our current cost of capital, which for us is plenty of cushion to make a profit.

I think what you are seeing, though, is just the Company is getting bigger.

So it is more difficult to on a percentage basis grow the Company through external growth.

But we knew that was coming and that's why we are so focused on the performance of the existing portfolio and have these systems in place to improve NOI growth.

Dan, on the external growth I think again our operators who we say we are aligned with the best national operators and the best regional operators, these operators are seeing tremendous demand and need to grow their businesses.

And we are at the table with them and working with them to deliver the capital to realize their business plans.

And I think that is where largely you have heard us say that over the last few quarters and we said it strongly today, that's where our external growth is coming from.

So again we think -- and as Scott said these are not opportunities that are being put out to auction.

They are opportunities that are coming directly to us and we think that we are still able, as you have heard today, generating plenty of accretive investment opportunities for our shareholders here.

Given what you said about market transactions, does this also suggest that you are going to pick up more development as we go forward in the next couple of years?

It looked like your development picked up a little bit.

I think you are running CIP to gross book below 1%, do you see that increasing significantly over the next few years given where cap rates are, or marketed transactions?

Dan, you heard us today for instance talk about the $1.4 billion development pipeline with HealthLease.

Here is a situation where we are developing with them the next generation of post-acute care.

These assets need to be brought to the market in order to have a healthcare delivery system that will lower costs and improve outcomes.

So there is development that needs to be done in healthcare in the US today because the product just doesn't exist.

You don't see us investing a lot in old -- what we would say are old model SNFs, because we think that business will be challenged in the future.

But we are very bullish on what we call post-acute and the next-generation post-acute, things that you have seen in our portfolio with the Genesis PowerBack facilities and what you will see more of through Mainstreet and its NextGen post-acute facilities.

Dan, the other thing I would mention is that a lot of the development that we are involved with right now is really not our capital.

I think we have been, we have tried to be smarter about this round of development so that we are not taking as much risk if two or three years from now when these projects open, the market is not conducive to new supply.

So Mainstreet is an example.

We have an option to buy those assets once they are built, so we are not putting out the $1.4 billion of capital.

They build it and then we have the option to buy it when it is complete.

And that is the case with a pretty large number of our development projects right now.

So the dollars you see on our balance sheet and in our supplement are actually a lot lower than what the potential pipeline could be.

That's good color.

Appreciate that.

I will hop off.

Thank you.

(Operator Instructions) Juan Sanabria, Bank of America.

Hi, good morning guys.

I was hoping you could give specific numbers on the RIDEA portfolio's growth by geography?

The UK led the pack at about 11%.

The US was right in line with the overall portfolio, about 8%, and then Canada was right around 4%.

Okay, great.

And then on the previous question on the developments, with Gracewell are those options to acquire those assets upon completion, or are those -- do you have to take those out upon stabilization?

The Gracewell assets are set up as more guaranteed takeout at a slight premium to their billed costs.

So we underwrite the project alongside Sunrise, they take all the predevelopment risk being the developer, so we're not involved there.

They find the land, they get it approved.

Sunrise and HCN agree to the project and then they build it.

And 12 months later we buy it at a fixed price.

Okay, great.

And just in terms of quantifying that potential pipeline of opportunities that we don't necessarily see, is there a way for you to quantify kind of what you are funding maybe off-balance-sheet to preferred or mezz lending that maybe it is not as apparent?

Just some of your disclosure would help us get a sense of that.

Yes, if you include the Mainstreet pipeline, Juan, the potential pipeline of new development projects is in the range of $1 billion a year.

But again most of those are set up where we have the option to buy, not an obligation.

Okay.

Thank you very much.

Michael Knott, Green Street Advisors.

Just wanted to clarify on the operating expenses for the senior housing operating portfolio.

I think they were about 6% higher this quarter and I think they were about 3% higher year-over-year last quarter.

And just wanted to see if you could give some color on why that ticked up so much.

And then also just can you talk about to the extent that most of your operating costs there are variable to some extent, with I think is the case, just maybe chat about if the top-line growth were to slow a little bit you would be able to rein in that operating expense increase is my understanding?

Thanks.

It is tough with just three months of data to draw any conclusions.

So operating expenses were a bit higher this quarter but there was nothing dramatically out of line and nothing that we view as a long-term issue to be concerned about.

Occupancy was up substantially year-over-year.

180 basis points so that certainly impacted expenses a bit.

But again hopefully there is room for improvement if at some point in the future revenue growth is a little bit slower.

In terms of your last question, it is an important one.

The vast majority of the expenses at these communities is variable so when occupancy declines at some point in the future we do think that there is a real opportunity to reduce cost and maintain NOI growth.

And we saw that happen during the recession and that is really a difference in seniors housing versus some of the other real estate asset classes.

People talk about our operating margins being in the mid-30%s rather than 70% like multi-family and that is true but it is also true that most of our expenses are variable.

So when you have issues with revenue or occupancy you can adjust and maintain NOI.

So we've seen that happen in the past and we think it could happen in the future if revenue growth ever slows.

Okay, and then can you just talk about the pricing power in your top-line revenue growth that you reported this quarter and what you are seeing looking forward?

It seemed like it was mostly occupancy and maybe on the rate or services revenue side it was maybe in the mid-3% type range.

Can you just talk about any change or maybe no change that you see on the pricing power side?

Yes, the pricing power is huge, Michael, that has been the main driver of our performance over the past few years.

The same-store rate growth this quarter was 4.6%.

That's a little different than the supplement because I'm giving you a same-store number, the supplement is the whole portfolio.

So that is roughly 2 times what the industry is achieving and we have tracked that over a number of years and we have been about 2 times the national average consistently.

That is driving most of the substantial NOI growth that you see.

And then last question is on the UK.

You mentioned the NOI growth there and that portfolio was double digits.

Can you remind us where that has been in the last few quarters and then kind of what is driving that substantial rate of growth?

Is it occupancy pickup, or is it pricing power?

Yes, it has been double digits for a year now.

And it is a combination of occupancy and rate growth.

So all the numbers that I just gave you, which is our entire same-store portfolio, the UK is even better.

Okay.

Thanks a lot.

And that will conclude today's conference call.

We do appreciate your participation.

You may now disconnect.

Thank you.