Welltower Inc (WELL) 2015 Q2 法說會逐字稿

Good morning ladies and gentlemen and welcome to the second-quarter 2015 Health Care REIT earnings conference call.

(Operator Instructions)

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

Now I'd like to turn the call over to 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 second-quarter 2015 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 Tom DeRosa, CEO of HCN.

Tom?

Thanks, Jeff.

Good morning.

One of the things that gets me and the team here excited to come to work every day is that HCN is part of a solution to a big problem.

Today, healthcare delivery is faced with a mandate to drive down costs and deliver better outcomes.

Sounds like a great idea, right?

As they say, easier said than done.

This mandate cannot be met unless we can drive patients from acute care hospitals into lower acuity settings.

You may have seen Mount Sinai Hospital's ad in last week's New York Times that stated, "If our beds are filled, it means we've failed".

What does that mean?

It means that one of the top hospital systems in the world recognizes that their old business model is not sustainable.

If they, like many hospitals, continue to house low acuity, uninsured and cognitively impaired elderly patients, their historic business model simply won't work.

Better real estate solutions are needed.

In many of the top metro markets in the US, the UK and Canada where our Company is concentrated, we simply do not have adequate post-acute and outpatient care for the broader population and senior care communities to keep our aging population well and avoid unnecessary hospital stays.

HCN has established itself as the preeminent capital partner to drive the most effective healthcare real estate solutions.

And, I'm proud to announce to you this morning that one of the largest and certainly most respected real estate investors in the world has chosen HCN as its partner to establish its initial investment position in healthcare real estate.

The Canadian Pension Plan Investment Board, commonly known as CPP, has entered into a joint venture partnership with HCN to acquire a superb portfolio of medical office buildings largely located in the famous Golden Triangle of Beverly Hills, California, one of the most prized locations in the world to own any category of real estate.

Like nearly all of our new investment volume, this outstanding opportunity was sourced, not from a broker-led auction, but from an existing relationship that was looking for liquidity and saw the benefits of taking HCN shares.

CPP's decision to co-invest in this portfolio underscores the high institutional investment grade quality of the real estate and further validates the unique investment proposition that HCN offers to our shareholders.

We are excited to welcome CPP to the HCN family.

Scott Brinker and Scott Estes will take you through more of the details of our Q2 asset and financial performance but I'm pleased to say that our results have exceeded your expectations.

Given the hangover of issues posed by weather and flu from Q1, 5.2% same-store NOI growth from our US seniors housing portfolio and 3.2% same-store cash NOI growth from the entire portfolio is noteworthy.

I am also pleased to report FFO per share of $1.09 for the quarter versus $1.06 for the same quarter last year.

Keep in mind that we have pre-funded our capital needs for the nearly $3 billion in new investments made in the first half of this year as well as continuing to drive down leverage.

These efforts awarded us positive outlooks by Moody's and S&P this past quarter.

Hence, while providing you with outstanding growth and new investment opportunities, we have not taken you out on the risk spectrum and will not compromise capital structure, asset quality, market or asset class in order to chase yield or manufacture short-term earnings growth.

This is a core value of HCN and a clear differentiator.

We stick to our partnership model and work hard every day to maintain the value proposition that the top senior care and post-acute operators and health systems derive from HCN.

It's what you, our shareholders and partners, can count on.

Now Scott Brinker will provide you with a closer look at our operating performance and new investments made during the quarter.

Scott?

Thank you, Tom.

I'm pleased to report accelerating internal growth with same-store earnings up 3.2%.

The operating portfolio in the US led the way with outstanding 5.2% same-store growth for the second consecutive quarter.

Our footprint is paying off.

For years, we've targeted large metros that have superior growth in population, jobs and housing values.

Today, we have 8% market share in the top 10 MSAs.

That compares to less than 4% share in all other markets; clear evidence of our concentration in large markets.

The big metros are more transparent, more liquid and deliver better results.

Our same-store growth in large markets continues to be substantially higher than our smaller markets.

Modern physical plants and premier operating partners further differentiates us.

Shifting to the operating portfolio in the UK, until this year it's been a tremendous growth engine with double-digit same-store growth.

The severe flu season this year caused a big spike in move-outs and a decline in earnings.

Census is moving back up and we expect strong results in the UK to resume within a few quarters.

Same-store earnings in the overall operating portfolio grew 3.3%.

Rental rates were up 3.2% and occupancy increased 10 basis points.

Move-ins continued to be strong and move-outs have normalized, setting the stage for census to move higher.

To that point, occupancy is up 60 basis points since our early May earnings call.

Triple-net senior living continued its excellent performance.

Same-store earnings were up 3.4%.

The superior growth was driven by active asset management.

In particular, the former Merrill Gardens properties that we converted to a lease with large escalators and the CCRCs that we converted from entry fee to rental.

Moving to development, we've opened 22 properties in the past two years.

They are 700 basis points ahead of underwriting on occupancy and $7 million ahead on NOI.

Meanwhile, new supply in our local markets measured as a percentage of existing inventory is less than half the number provided by NIC.

We're also seeing and hearing about 10%-plus increases in development cost since the beginning of the year.

This should help put a governor on new supply.

Turning to post-acute and long-term care, our rental income is growing consistently.

Same-store earnings were up 3.1%, payment coverage was flat and remains at secure levels.

Next up is outpatient medical where again the takeaway is steady, predictable growth.

Same-store earnings increased 2.6%.

We're seeing minimal new supply and growing demand for outpatient services.

Digging deeper, our assets benchmark favorably on key indicators like occupancy, age, hospital affiliation, lease rollover and NOI per foot.

These assets are poised to deliver steady earnings growth for years to come.

Turning to transactions, we continue to pass on or be outbid on nearly every auction.

The vast majority of our $600 million-plus of investments was privately negotiated follow-on activity with our existing partners.

That list included Brandywine, Avery, Senior Star, Legend, Cascade, Mainstreet and Genesis.

The blended initial yield is 6.7%, which is a healthy spread to our cost of capital.

And we funded much of it through the sale of our life science portfolio at a 5% yield on sale.

Our stable of operating partners is a massive competitive advantage and that gap is growing.

The leading operators want to be part of our team.

In the first quarter we added Aspen and Oakmont and in the second quarter we added EPOCH, who develops and operates Class A senior living properties in New England.

We acquired three of their new development projects all located in high barrier to entry submarkets in Boston, one of our core markets.

We also agreed to acquire a publicly traded senior living company called Regal.

The properties are heavily concentrated in our core Canadian markets: Toronto, Montreal, Ottawa, Vancouver.

Revera, an existing JV partner, will co-invest 25%.

HCN will receive a 6.1% unlevered preferred return that grows by 4% each year until year six.

This is another signature HCN investment: existing partner, strong alignment, major metro locations, and an accretive return.

The headline investment last quarter was an outpatient medical portfolio that we acquired from an existing relationship.

The assets are concentrated in the Golden Triangle in Beverly Hills, one of the world's most coveted real estate markets.

Beverly Hills has a moratorium on medical space, which creates a major supply shortage.

Rental rates in these buildings have increased by 6% per year over the past decade.

As the owner of half the medical space in the city, we stand to benefit for years to come.

We issued DownREIT units to the seller at $78 per share for much of the consideration.

That's a double-digit premium to our current share price.

The key strategic element here is that we established a partnership with CPP.

They joined PSP on our team of pension fund partners.

Their capital inflows are large and steady through all market cycles.

When the capital markets are choppy, these partnerships will be a huge differentiator.

Our CFO Scott Estes will now discuss our financial results.

Thanks, Scott, and good morning everyone.

You just heard Tom and Scott talk about our recent investment success in an environment where there is greater uncertainty about our cost of capital due to recent pressure on our stock price and the future direction of interest rates.

So, from a financial perspective, how do we think about balancing your desire for us to be more prudent in the current environment with the hope that we can continue to invest accretively to grow our portfolio in future earnings?

And the answer is that you should expect us to do the following: to emphasize investing with our existing partners in off-market transactions, to maintain the strength of our balance sheet and to maximize our financial flexibility by pre-funding investments and leveraging additional sources of capital such as JV partnerships and dispositions when appropriate.

We've successfully adhered to these principles, so I'd like to leave you with three specific takeaways this quarter.

First, we preemptively raised the capital needed to fund the investments completed year to date.

Second, we've done so while further strengthening our balance sheet and credit metrics, resulting in nice momentum with the rating agencies.

And third, we moderated our pace of investments and retained significant liquidity, which will allow us to selectively capitalize on acquisition opportunities moving into the second half of the year.

I'll begin my detailed remarks with some perspective on our second-quarter financial performance and enhancements to our disclosure.

Normalized FFO came in at $1.09 per share and normalized FAD was $0.95 for the second quarter, representing sequential increases of $0.05 and $0.03 respectively.

These were solid sequential improvements in light of raising $3.1 billion of capital year to date through a combination of equity, debt and disposition proceeds, which were used to fund the $2.9 billion in gross investments completed during the first half of the year.

I think our most important financial message this quarter ties directly to something Tom talked about in his earlier remarks.

That is, we will not sacrifice the balance sheet in an effort to drive short-term earnings growth.

More specifically our net debt to book capitalization has now declined nearly 5 full percentage points over the last five quarters to the current 38%.

In terms of dividends, we will pay our 177th consecutive quarterly cash dividend on August 20 of $0.825 per share, an annual rate of $3.30.

This represents a 3.8% increase over the dividends paid last year and the current dividend yield of 4.7%.

In terms of our supplemental package, we made a few notable enhancements this quarter in response to investor and analyst feedback.

First, on page 13, we've added back disclosure in our unstable portfolio around the timing of projected future development fundings and gross investment balances.

On page 14 you can see that we provided a pro rata share of beds, units and square footage data to allow you to more accurately calculate those numbers on an NOI basis.

And last on pages 22 and 24, we've added our Canadian portfolio performance to both our RevPAR and NOI reconciliations.

Turning now to our liquidity picture and balance sheet the significant highlight of our second-quarter capital markets activity was the largest single tranche US debt offering in the Company's history.

In late May we completed the sale of $750 million of 10-year senior unsecured notes priced to yield just over 4%.

In addition, we issued 1 million common shares under our dividend reinvestment program generating $70 million in proceeds.

We generated $596 million of proceeds through the sale of our life science portfolio interest and loan payoffs, which included $190 million of gains and represented a blended yield on total proceeds of 5.3%.

We completed several debt payoffs during the quarter, the most significant of which was the discharge of our $300 million of 6.2% senior unsecured notes which were scheduled to mature in June of 2016.

And finally we repaid approximately $99 million of secured debt at a blended rate of 4.5% and assumed a refinance $166 million of secured debt at a blended 2.4% rate.

As a result of these activities there were two important outcomes for HCN.

First, the blended cost of debt on our senior notes declined to 4.3% while our average senior note maturity was extended to 9.3 years.

And even more importantly, we ended the quarter with over $2.6 billion of liquidity, including $2.15 billion available on our line of credit, an additional $218 million in cash and the anticipated cash proceeds of approximately $216 million from dispositions forecasted throughout the remainder of the year.

Our balance sheet and financial metrics at quarter-end remain in great shape.

As of June 30 our net debt to underappreciated book capitalization was 38.1% which as I mentioned previously has declined 5% over the last five quarters alone.

Our net debt to adjusted EBITDA declined slightly to 5.46 times, while our adjusted interest in fixed charge coverage for the quarter improved nicely to 4.15 times and 3.27 times respectively.

Our secured debt level declined 10 basis points to only 11.2% of total assets at quarter-end.

It's important to us that the continuously improving strength of our balance sheet was recognized by the rating agencies during the quarter as well as both Moody's and S&P recently improved our ratings outlook to positive from stable.

I'll conclude my comments today with a brief update on guidance and our key assumptions.

In terms of same-store cash NOI growth, we continue to forecast blended same-store growth of 3% to 3.5% for the total portfolio in 2015.

Our forecasts are generally unchanged for the respective portfolio of components but As Scott mentioned we are forecasting more moderate pace of growth out of the seniors housing operating portfolio until the performance accelerates in the UK.

In terms of our investment expectations, in addition to investments completed through the second quarter, our guidance includes the Regal Lifestyle Communities and Genesis investments detailed in our earnings release expected to close late in the year plus approximately $160 million of investments through our Mainstreet partnership and $170 million of development fundings.

Our 2015 guidance also include $63 million of development conversions at a blended projected yield of 9% and we continue to expect to receive disposition proceeds of approximately $1 billion for the full year and an expected yield on total proceeds of approximately 7%.

Our capital expenditure forecast is now approximately $50 million for 2015 comprised of $30 million associated with the seniors housing operating portfolio with the remaining $20 million coming from our medical facilities portfolio.

These amounts continue to represent only 6% to 7% of anticipated NOI in both asset categories.

Our G&A forecast is now approximately $147 million for 2015, which is generally in line with our previous estimate.

And finally in terms of earnings guidance, we are in a position to maintain our 2015 estimates today despite raising $750 million of new capital in the quarter and accelerating the disposition of our life science portfolio interest considerably earlier than previously planned.

So as a result, we continue to forecast normalized FFO in a range of $4.25 to $4.35 per diluted share, representing 3% to 5% growth while our normalized 2015 FAD expectation remains in a range of $3.83 to $3.93 per diluted share representing a solid increase of 5% to 7%.

In conclusion, we're pleased to have preemptively funded the investments completed year to date, to have significantly strengthened our balance sheet and maximized our financial flexibility by retaining a significant liquidity position entering the second half of the year.

So, that concludes my remarks.

I think, operator, at this point we'd like to open the call up for questions please.

Thanks.

(Operator Instructions) Paul Morgan, Canaccord.

Hi, good morning.

Just in terms of the same-store guidance you held the guidance steady and if I read right it sounded like the UK operating portfolio isn't set to accelerate sharply in the second half of the year if I read your comments correctly.

So where are you seeing offsetting upside in the portfolio that's keeping you in the range?

Yes, it's Scott Brinker.

I'll start.

The US continues to be really strong.

So 5%-plus growth in the first two quarters and that's roughly three-quarters of the operating portfolio.

So that's by far the most significant driver.

And I would say the UK actually is improving.

Census is definitely moving back up it's just we need to climb out of a pretty big hole because of the flu from the first quarter that extended into April.

So, we're going in the right direction.

Each quarter moving forward is going to improve.

It already is.

It just will take a while for that growth rate to turn positive but I would say 2016 at the latest based on current trends.

And I'd say Paul our US same-store growth is quite encouraging and I think, again, speaks to some of the concerns about supply coming into the markets.

We maintain that in the markets where our portfolio is concentrated there is not a supply issue.

And I think that now that 5%-plus same-store sales growth in the US portfolio which obviously is the overwhelming majority of our asset portfolio I think should help address some of those concerns.

Yes, the same is true in the UK where two-thirds of our operating income comes from greater London which is I think the most favorable supply/demand market of any city in our entire portfolio.

And we own very modern assets so there's no question that you will be happy we own these assets over time.

They just had a really bad flu season.

Okay, great, and my follow-up just on Regal maybe can you offer any color in terms of how you see the growth upside in that portfolio relative to the rest of your Canadian assets?

Yes, it's Scott Brinker.

I'll take that.

First, we're doing it with an existing partner in Revera who is the second-biggest senior living provider in Canada, so there should be some economies of scale on the expense side.

Regal is a relatively small company with plus or minus 25 homes.

So, we are expecting some upside there.

And the way we structured the deal is that while we will maintain our pro rata share of all the upside we will have a fixed 4% increase in NOI through this preferred return for the first five years and that starts at a 6.1% yield.

So it's a very attractive initial yield plus growth at a minimum and then we do capture the upside as well.

I also think that Regal portfolio is in the top markets in Canada.

Again we are creating critical mass in the major metro areas in the Canadian market.

I think that's something that we feel very good about, the long-term growth prospects for this portfolio based on those markets.

Great, thanks.

Rich Anderson, Mizuho Securities.

Good morning.

So on the MOB deal with CPP how would you characterize those assets being in Beverly Hills?

Are they kind of like cosmetic-type surgery or I'm just thinking of the demographic there in Beverly Hills.

Well, good question, Rich.

As you might imagine lots of plastic surgeons and dermatologists to the stars.

Okay.

And to the CEOs of companies?

Well, you know we can all use a little refreshment sometimes.

But the bigger question is do you think that having CPP, not to speak for them, having this be their first investment in healthcare, do think this is kind of a first salvo for them in terms of medical office?

Do you see them being a partner and having this relationship grow specifically in medical office or outside of medical office in other healthcare areas?

Rich, the way I'd answer that question is I would say we first met them over a year ago.

And it was I believe July of last year, early July and I would say they've spent maybe more time underwriting HCN than they actually spent underwriting this investment opportunity.

This is not a one-time find a joint venture partner to finance a deal.

This is all about HCN being CPP's partner to enter a new class of real estate investment for which they prior to last year when we first met them said they never really could get their hands around.

So a lot of diligence went into this process both with respect to HCN as well as the assets.

I can tell you this is an asset portfolio that anyone would invest in.

It is the locations are outstanding and we actually see some upside even in some of the retail, first-floor retail that's associated with these assets that can over time be upgraded and be more in character with the luxury retailers that are one block away or on the corner.

So, this is very significant, this announcement is very significant because I think it also says that the most sophisticated real estate investor in the world is now looking to healthcare real estate.

I think it validates what we do.

Yes, but do you see more in the way of transaction activity in medical office specifically vis-a-vis this relationship?

Or just generally is this a signal that we should be expecting more to come?

So one of the things that we've talked about, Rich, is that I think I made in my comments I think the outpatient medical infrastructure in the major metro areas in this country is inadequate to meet the needs of driving patient population out of the hospital.

So, when you think about the scale of capital that will be needed to address that issue, having a partner like CPP is very important for us.

And I will also tell you that they are -- they would consider other investments other than medical office in healthcare I think you will see play out over time.

But their decision was more of a broad decision to enter the space with us.

Okay.

And then last question, maybe just a comment on the Canadian economy.

I know we're talking about the UK performance but just in terms of natural resources down and maybe an oversupply of housing in some areas, just wondering what your read is on the Canadian economy being that you positioned yourself pretty substantially up there in the senior housing space.

Yes, this is Scott Brinker speaking.

We don't have a ton in those areas, like the middle part of the country that are heavily dependent on natural resources.

Certainly Toronto, Montreal, Ottawa, Vancouver, those cities are not as impacted by natural resources.

That being said the Canadian economy is very much tied to what happens in the US.

And I would say it's more stable than the US just given how they finance things and the way their banks work.

But as a general comment we like the Canadian market because we own very, very low acuity, I'd almost say senior apartments in Canada.

This is a very independent living portfolio.

It's a nice complement to what we do elsewhere and it is very stable.

So, long lengths of stay, very high occupancies, very high margins but it's not going to grow 5%, 6% per year.

It's more in the 3% to 4%, very steady, stable, and we view significant opportunity over time to then add services, particularly assisted living and memory care.

Because just think about the fact that there are really two businesses or two sectors in Canada.

There is independent living where we have a major play and there's a long-term care that's funded by the government and there's this huge area in between that's unmet today, the same thing that existed in the US 20 years ago.

Now over time that's going to change and we think with Chartwell and Revera, by far the two biggest players in that market, we'll be well positioned to capitalize.

And I think a reminder, Rich, just from a financial perspective we very much hedge the currency risk.

Obviously the Canadian dollar has been weak of late against the US dollar but as a reminder really for everybody 90% of our balance sheet risk is hedged and about 75% of our earnings is hedged.

So we're not really in the business of taking any currency risk.

Got you.

Thanks, Scott.

Thank you.

John Kim, BMO Capital Markets.

Good morning, Tom.

I had a follow-up question on the CPPIB joint venture.

Can you discuss what the fees paid to you by them are either for asset management leasing or transaction-related fees?

We've agreed not to disclose fees with our partner.

I would say we're taking advantage of our platform and it improves the return profile for us but is still a very attractive way for CPP to enter the space because it takes a lot of expertise to do what we do.

But they will be paying some kind of fees to you?

For your expertise?

They will, yes.

And then as far as sourcing new MOB acquisitions, do they have any right of first offers?

They do in Southern California.

So it's limited by time or investment amount.

But I would say separate from what's in the legal contracts we have every intention to substantially grow our partnership with CPP.

But at the same time, John, we'll be also looking to grow with PSP as well.

So there are two major joint venture partners now and both those institutions have a good relationship and we will be looking for ways to grow with both of them.

Yes, PSP is a good precedent.

It took us a year of working with them before they chose us as their partner on the Revera portfolio which is a company that they wholly owned.

That was three years ago and in the interim three years we've now closed on three separate projects with them.

We've brought them into the Sunrise Management Company, we've brought them in to the Gracewell portfolio in the UK and they brought us into the SRG portfolio on the West Coast.

So I think it's evidence that even when it comes to capital partners we never just do one portfolio.

It's always establishing a partner and then doing things together.

Okay.

And then moving on to developments I appreciate your additional disclosure on page 13, but I have to ask you a question, why are the RIDEA developments projecting a much higher yield than the triple-net lease senior housing?

I just wanted to make sure this was an apples-to-apples deal comparison.

Yes, the difference is that when we do a triple-net senior housing there is some residual cash flow that benefits the operator.

So, on a triple-net lease the tenant pays a lease rent amount and keeps all the upside.

So if you look at the RIDEA properties, the unlevered return on cost is around 10% plus or minus and our return on cost for the triple-net assets are more like 8%.

And the difference is the payment coverage which means that we're underwriting triple-net leases to 1.25%, 1.3% plus or minus payment coverage.

That's the difference.

And then outside of RIDEA are these 100% preleased development?

The triple-net leases are preleased from our standpoint.

For purposes or from the tenant's standpoint they have to lease the properties but on day one of the triple-net leases we receive the full contractual lease payment.

Okay.

And the MOB as well?

Yes, MOB we generally don't break ground unless we're at least 75% preleased.

And you can see in the supplement the average preleasing for the current projects under construction is currently at 91% preleased.

Great, thank you.

Michael Knott, Green Street.

Hi guys, good morning it's Kevin Tyler here with Michael.

I wanted to ask you, it was asked earlier and I didn't hear it or I may have missed it, but did you provide the exact annual figure for the senior housing operating same-store NOI growth you're targeting?

No, we didn't provide guidance for the operating portfolio for the second half of the year.

Michael and Kevin, we just provided reaffirmed the expectation for the whole portfolio in the 3% to 3.5% range.

Okay.

And then I guess going back to the MOB deal, given the large size and the premier location we might have expected an even lower cap rate.

I think you said it was somewhere in the high 5%s but was that exceptionally high cap rate a result potentially of floor or was there a floor on the cap rate as a result of the high price per foot?

No, it's more the benefit of the fees that helped the return from our standpoint, Kevin.

Okay.

And then I guess --

And again Kevin you have to remember this was not broadly -- this was not a marketed deal.

This is a relationship we have, we knew these assets before they were considered for sale and the sellers saw great value in taking HCN shares.

Hey guys, it's Michael.

Was this above replacement cost and was that also part of the reason the cap rate was not lower?

I don't know, it's hard to say what replacement cost is in Beverly Hills.

I don't think anything has been built in decades from a medical office standpoint.

Remember you can't build in Beverly Hills, you can't even repurpose existing assets.

So replacement cost is really irrelevant in this case but we're around I think $1,000 a foot.

I doubt you could build for that.

I mean this is one of the top five locations, probably, in the world to own real estate.

And any kind of real estate could sit on the dirt that these medical office buildings are positioned on and I think that to Scott's point it's really hard to say what replacement costs would be.

But suffice it to say, it's one, it's a five-star prime location.

Thanks for that color.

The last one I had just the Avery acquisition in the UK I saw that you did add some capital there on the real estate side, but I recall seeing an article that talked about potentially upping a stake that you guys have in the operator itself.

Is there any validity to that?

Yes, occasionally we take an equity stake in key operating partners.

Avery is one that we had targeted on day one of entering the UK three years ago as a premier provider.

And they have lived up to that expectation.

We did a big sale leaseback with them to start the relationship and then we've done a number of follow-ons, both acquisition and development.

And we thought it made sense to actually take a stake in the operating company itself.

A small stake, I think it's 9%, it cost us a few million pounds but it aligns us with a really important partner in the UK.

Hey guys, it's Michael.

I just have one more.

Obviously your senior housing operating portfolio is very high quality but I'm just still trying to understand how the increasingly discouraging NIC data and then also Brookdale's struggles here don't have any effect on your portfolio and your ability to operate and garner the types of growth that you're talking about?

I'll start that off and I think we'll all probably have a comment to add.

I think that we are in the right markets where there is not oversupply.

There are oversupply in many markets in the United States and those are places we do not choose to own real estate.

So I think that's number one where I think we differ from the NIC data.

So, Scott?

I think also as the business continues to evolve and mature you're starting to see differentiation.

So, 10 years ago from the standpoint of the outside world everybody owned the same assets.

And an asset in the middle of Oklahoma that was 20 years old was viewed the same way as a building in Manhattan or Beverly Hills.

And as in other real estate classes as they mature I think people start to understand and see the performance over time and asset quality does matter.

It does matter where you're located, is the modern physical plant has it been reinvested.

And importantly in healthcare do you have the best operating partner?

And that's the piece that I don't think again people fully understand but they're starting to.

So now that we're entering this period where maybe operations are a bit more challenged, it's a bit choppy, I think the quality of our real estate will increasingly stand out and differentiate itself.

And what we're saying is well understood in other sectors of real estate.

It's early days I think in that view being embraced by people underwriting healthcare real estate.

The fact is medical office buildings sitting in the Golden Triangle of Beverly Hills have better prospects than medical office buildings in Lubbock, Texas.

It's just the way real estate works.

It's why you like Kalman and Simon Malls and you don't like other mall companies that don't have those same irreplaceable locations.

Let me tell you these medical office buildings in Beverly Hills or our senior housing assets on Connecticut Avenue in Washington, DC or on Wilshire Boulevard in Westwood are irreplaceable locations.

Right.

Thanks, guys.

Vikram Malhotra, Morgan Stanley.

Thank you.

Just a question first to start off on the medical office side.

It seems from some of your peers that there's probably more confidence from tenants maybe of some longer lease terms being signed, there's also more interest from this new investor that you've highlighted.

I'm just wondering can you give a sense of where you think cap rates could go over the next call it six months as more people might get interested in the MOB space?

Yes, for high quality medical office portfolios to date it's probably in the mid-5s plus or minus.

I would say that at least in senior housing and post-acute the REITs are still the dominant funding source for M&A.

So, our cost of capital has increased a bit in the last few months and I think that will over time be reflected in cap rates so maybe they will start to move up with it.

That's certainly the way we're positioning ourselves in discussions with sellers.

I don't know that we have as much pricing power in medical office because that has already attracted pretty substantial interest from the investment community at large.

So REITs do not constitute the majority of the buyers in that marketplace.

So I think we just have less ability to influence pricing but importantly that we approach that space the same way we approach senior housing and post-acute which is doing things off market.

And that does lead to better pricing.

I think you'll see perhaps some other institutions entering the space.

But I also think we may see some of the marginal players, I think we're already starting to see marginal players that were circling this sector 12 months ago have fallen away a bit.

So I think maybe those two factors are at play here in terms of cap rate.

I think, look, there's a recognition that this is a good sector to invest in.

Okay, thanks.

And then just on the acquisition front you talked about potentially being a bit more selective focusing with your existing partners.

So assuming kind of stocks the prices remain where they are today in terms of stocks what sort of -- what are you looking at in terms of specific sectors and would you consider given where the balance sheet is maybe changing the way you fund these?

And I know you're not looking for near-term benefit but just given what you've done with a balance sheet, is there a way could maybe change the funding of additional acquisitions?

Well, we're not going to compromise our capital structure in terms of making new investments.

I think one of the benefits of bringing a CPP in along with PSP is we have now a huge pool of capital to access for the right types of investments.

Understand that they are very aligned with how HCN invests and manages real estate assets across the spectrum of what we own which starts in independent living and goes up to the front door at least in the US of the acute care hospital but doesn't go inside those doors.

We are in the outpatient, we want to do outpatient with the best health systems and we want to bring state-of-the-art post-acute care as well as build the infrastructure of senior communities in the markets that need to have it.

And they're aligned with that.

And we are going to continue to grow this business and we're going to continue to strengthen the balance sheet which I think takes a lot of risk out of this whole equation for shareholders.

And then just last to clarify on the RIDEA side I guess you talked about 5% at the start of the year and maybe a bit lower now given the ongoing issues in the UK and the near-term improvement.

But would it be safe to say that in the US you're still expecting that 5% plus growth for the year?

Yes, it should be in that ballpark.

And by the end of the year I think we'll get back there for the whole portfolio as the UK bounces back.

Just it will take a little time.

Okay, thank you.

Juan Sanabria, Bank of America.

Good afternoon or good morning guys.

Just a quick question with regards to the US RIDEA portfolio.

Could you just give us a snapshot of where the portfolio is from an occupancy perspective and how you think about that evolving going forward, upside or if it's more sort of steady-state from here and all about rate growth?

Well, there should be rate growth given our locations but occupancy today for the RIDEA portfolio is around 90%.

So again that's up 60 basis points from when we last talked in early May.

So it's moving in the right direction but by no means would we consider 90% a fully stabilized number.

We expect that to increase at least through August, September, October which are really strong months.

And then probably starts to flatten out again in November and December.

And longer term where do you see the portfolio stabilize to?

Probably low 90s, 92%, 93% I think is a reasonable number.

Now that can be higher for certain sub portfolios.

A number of our independent living portfolios like a Merrill Gardens, SRG, or Revera would have higher occupancy just because the turnover is so much lower.

But for the higher acuity portfolios say like a Silverado, it's hard to maintain 95% occupancy across a portfolio.

Great, thanks I'm just following up on Vik's question; kind of noted that you'd expected to slow down given somewhat I guess dislocations in the capital markets, do you see that continuing into the Fall as people are expecting the Fed to eventually hike rates or is this a second-quarter phenomenon and you're back to the races?

Yes, I see that the whole interest rate talk creates an overhang over a sector and particularly over the healthcare REITs.

And I think that we need to -- I think we need some clarity there in order to lift the lid that has seemed to have appeared over our stock prices.

So that's my thought.

Scott you got any --

I think when we really get maybe more introspective making sure we really if you're going to circle the wagons up you always emphasize the investments with the existing partners.

I mean you can see almost 80% of this quarter's $627 million is with existing partners.

So we'll always have I think a similar baseline level of investments, off- market transactions.

And we want to make sure we have the financial flexibility no matter what happens in the capital markets to finance those and support our partners' growth.

So I would just add I really I believe we have many avenues for financing that growth.

So we essentially have our full line available.

We have an ATM that's in place.

We get about $280 million a year through our dividend reinvestment program.

Obviously joint venture partners, we actually added a potential call it $100 million medical office portfolio to our held for sale assets this quarter.

That will probably happen early next year.

So we're looking at all the different avenues to make sure we can continue to grow with our partners first and foremost.

Great.

Just a last quick one for me; I'm not sure if you guys looked that the Omega senior housing development they put together in Manhattan but any thoughts or color around that would be appreciated.

Sure.

We think that Manhattan needs senior housing assets.

It's a market that we circle in terms of what we own with our operators but we're not in Manhattan and I think that this is something that is needed in Manhattan.

I don't know a lot of the details of what they bought.

It struck me that this is a fairly, like all Manhattan real estate deals, very complicated.

So it's something we'll probably take a closer look at so we understand what was underwritten here.

Good.

Thanks, guys.

Smedes Rose, Citi.

I wanted to ask you to mention, in your press release, that you have a new relationship with EPOCH.

I was just wondering how maybe that came about and what sort of future investing could you do with them?

And then you mentioned that you bought senior housing in the Boston market in the high 5s.

Is that kind of what you're seeing for senior housing in kind of good core markets, in general, at this point?

Yes, I think high 5s for senior housing is in the right zip code, if not a little bit lower.

EPOCH is a regional provider.

They are concentrated entirely in the New England market, primarily Boston

They mostly develop and operate.

And we bought three of their newly developed properties in towns like Wellesley.

So we're happy to have a new partner as they continue to grow through new development and hope we'll be a big part of that growth.

You don't have any sort of agreements with them or right of first refusal as they bring properties to market for sale?

We don't.

Of our 30-plus operator relationships, there's a handful of it do not have contractual rights.

There are a handful that have exclusivity.

But in any even we have historically found a way to grow pretty substantially with everyone on the list.

And I would expect EPOCH to be part of that team.

And remember they have co-invested in this portfolio, so it's not they're just a passive third-party manager, they are a joint venture partner with money at stake.

Whether we have a contractual obligation or not, if you asked our partners they would say they see a much broader value proposition in terms of working with us than just money.

And that's what drives that new investment flow to us versus other sources of capital.

Okay, thank you.

And then you mentioned on your last call that same-store NOI in the UK portfolio I think was down 4%.

Did you provide it for the second quarter, or could you?

It was down I believe it was 3.7% at the end of the first quarter and then this second quarter it was down 5.7%.

Okay, thank you.

Jordan Sadler, KeyBanc.

Just coming back to the joint venture with CPP, can you offer a little bit more color maybe in terms of what this might look like over time?

Is this going to be focused I think you said it would be beyond outpatient, but how broad ranging could it be and is there an initial sizing?

It's all based on investments that we will source that fit CPP and PSP's broader investment parameter.

So there's no specific size or numerical mandate.

I think they believe we will continue, they believe in our business platform and how that business platform will source very high institutional grade investment opportunities.

So, it remains to be seen what that will generate over time.

But we're very optimistic as they are that given the number of things that we have in process that there will be interesting investment opportunities for them to co-invest.

And just to clarify there was it your $125 million pro rata share or investment that was done in DownREIT units?

That was the cash portion.

The accounting gets really confusing.

So if you have very technical questions we should follow up.

But the DownREIT units are actually not included in the $124 million because technically that isn't owned real estate yet for us.

Clearly the DownREIT units are convertible into cash or stock at which point it will be owned real estate from our standpoint but the $124 million that you see is really the cash portion of the purchase.

Okay, I guess I could follow up after.

I was just trying to get to the number of units.

And then I just noticed and had a question on dispositions.

Obviously you had success with a life science portfolio sale and I noticed that the held for sale bumped up sequentially despite that sale closing in the quarter.

Can you maybe speak to the prospects for this disposition as you see them and what sort of the outlook might look like?

I'll take a crack at it.

This is Scott Estes.

I think we, big picture, are always looking at calling the portfolio and have been proactive in thinking about dispositions.

This quarter's sequential change, the life science portfolio was a minority investment so that number was not on that line.

And as I just mentioned we did add about $117 million medical office portfolio this quarter to the held for sale bucket.

So, I would think even though I think the majority is strategic dispositions in terms of the assets that are less desirable have been culled out of the portfolio really over the last three to five years, we'll still look to be opportunistic and probably have a few hundred million of asset sales per year going forward.

Okay, thank you.

Nick Yulico, UBS.

Good morning, guys.

Just going back to this California medical office portfolio, was this purchased from G&L Realty?

Yes.

Okay.

Then did you guys have to assume any debt on this and if so what was the terms on that?

We did assume a small amount of debt, Nick.

Three-year term at pretty low interest rates.

I think it was in the 2.5% range.

So attractive assumed debt and not much of it.

Okay.

And then what are like the net rents today for the medical office component of those buildings and are there typical lease escalators?

Yes, the net rents for the medical office sections of the buildings are in the high 50s.

And the retail portion of the portfolio is closer to $100 a foot.

And they do have escalators 3% to 4% per year.

But we've been able, well, the historical seller G&L has been able to get much higher escalators upon renewal.

As I mentioned rental rate growth over the last decade in this portfolio has been 6% per year on average.

Okay, that's helpful.

Then just one question on the UK.

You gave, I guess, some numbers on where the growth was down in the second quarter versus the first quarter.

How much is that portfolio NOI right now sort of off its peak after going through a couple of quarters of the tough flu season?

Well, the peak was last year and it's down 5.7%.

So we're working with a very tough comp from 2014.

Right.

I'm trying to -- I'm just thinking about how to think about over time if you have the situation where I know it was I guess an unusually cold winter and you have a flu season how you faced periods of time I guess you're going to face these issues where is this going to be you think the worst where you're down almost 6% when that situation happens?

Nick, we hope it is but this is something completely outside of our control.

So I think on the last call we talked about lessons learned when and it's why having a very deep bench on the ground in the UK will help mitigate some of the issues that result when you have these very much unexpected events that can occur in our business.

So I hope it's the worst but over time we'll just never know.

Nick, the other thing is in the three years we owned the assets the NOI growth has been double digits to date.

So there's been huge appreciation, it's been a huge tailwind for our whole Portfolio.

The last two quarters weren't as good but also remember that the UK operating portfolio is like 4% off our total portfolio.

We are very well diversified.

This has a very small impact on our aggregate results and that's why you see us grow 3.2% same-store last quarter despite being down almost 6% in the UK.

Yes, you can see the NOI in the back of the supplement.

The effective this quarter is down only $1.3 million so what's that about a quarter of a penny?

Third of a penny.

Okay.

Got it.

That's couple.

Thanks guys.

Michael Carroll, RBC Capital Markets.

Thanks.

Hey Scott with regard to your construction activity comments, how competitive are AL developments against your IL communities that you have?

I don't know, Michael.

It depends.

I would say the line is oftentimes a bit blurry but from a licensure standpoint independent living facilities cannot provide a number of services that most assisted living facilities provide.

So the average age is very similar but the residents look a lot different.

So I would not consider them direct competitors.

They are more often complementary to one another but on occasion they may compete a bit.

Okay that helps.

Then in your stats when you said that construction activity in your markets is half of that of the NIC data, and are you looking at the total senior housing I guess construction activity or are you breaking it out only comparing the AL developments versus your AL communities and the same thing with the IL?

Yes, we're just looking at all the supply in our local markets.

There is no distinction.

Okay and then my last question is a little bit about the flu season in the UK.

Was it more severe in the UK, I guess why is the flu season being impacting your UK portfolio more than it appears that it's impacting the US portfolio in this most recent quarter?

Well it was bad in both locations but it was particularly bad in the UK.

So our death related move-outs in the first quarter were 130% above seasonal norms.

I mean that's an enormous number so that's what has driven the occupancy decline.

Move-in activity is right in line with our budgets and with history.

We continue to have pricing power.

It's not a demand issue, it is just that people got sick and unfortunately passed away and the stats bear that out.

So that's why we're confident that things will bounce back.

We're already seeing that happen.

Great, thank you.

Daniel Bernstein, Stifel.

Good morning.

So I also I want to follow up on construction cost comments up 10%.

If we want to take this off-line later we can but does that really change the equation for operators if capital is expanding for them or covenants are loosening up?

When you say put a governor on construction is that something you're getting from your operators or is that your management opinion?

We're seeing it directly.

Either projects that we're funding on balance sheet or that we're involved with.

For example, all the Mainstreet properties.

But we probably have exposure at one level or another to 100 projects at various levels of constructions in the US and the UK.

So we have view into what's happening in the development marketplace.

And costs are up.

Demand is up, paper is up, materials are up.

That doesn't mean that no one is going to build, that's not what we're trying to say.

But if it costs 10% more today than it did six months ago that probably does impact the number of new projects that are put under construction.

That's good color.

Also a follow-up on that, does it impact all senior housing equally?

Or say does it impact urban asset, urban development projects versus suburban secondary markets, does it impact assisted living more than independent living?

I'm just trying to understand is it across the board impacts or is there going to be more specific impacts that we can think about.

The most acute increase we've seen is in the bigger metros where senior housing and healthcare developers are competing with multifamily and other real estate developers for land, for labor and for materials.

Okay.

And then on the capital structure side of the business you did this joint venture for medical office.

Should we be expecting to see some more joint ventures from you are, or are you using that as a structure to reduce your capital needs given the backup in capital costs until the market corrects itself in terms of cap rates or capital costs go back down?

Is this a one-off transaction for you in terms of structure?

Or are you thinking you might use the JB structure a little bit more given where --

No, clearly it is another oar in the capital water for us.

And we think that this is an arrangement that was not readily available to a healthcare REIT historically.

And we've worked hard to bring in two of the most sophisticated investors to help educate them about investing in this sector.

So you should expect that it's one of the ways we will finance the growth of our business in the future.

And remember, Dan, that the Regal transaction which we announced it's CAD770 million, Revera will co-invest 25%.

They're owned by PSP and they brought us into that deal.

So it's not just CPP.

This PSP relationship has been really a game changer for us in the last three years and continues to be as they bring us opportunities as well.

Do you think there are opportunities like that with US investors or is this something just not isolated to Canada I would assume, it's something that you could use investors around whether it's Europe or the US you may be seeing some more joint venture opportunities with those partners?

Well, yes.

I would say that the institutional investment world and real estate looks to the Canadians I think.

And I think that CPP and PSP I think go a long way in validating the asset class and certainly go a long way in validating HCN in the industry.

We have many discussions with other potential large pension fund types of investors that are getting interested and looking to be educated in investing in this sector.

But I think we feel good about that we've aligned ourselves with the gold standards in that community.

And I wouldn't be surprised if you saw some others of similar quality and caliber get on the HCN team.

I'll hop off.

It's getting to be a long call.

Thank you for taking my questions.

(Operator Instructions) Tayo Okusanya, Jeffries.

Yes, good morning.

Thanks for taking my questions.

Just a quick one for Scott and Scott on the financing side.

If you were to try to do your bond deal, the $50 million bond deal today one, what type of rate do you think you would get on that same deal and is that having any real impact on how you're underwriting acquisitions?

I'll answer the capital part.

Today we're probably in the 4.3% range so call it about an increase of about 30 basis points.

And I think Scott can address the fact that we're thinking about our cost of capital every day on the investment side.

Scott, do you want to address how we think about pricing deals in the current environment?

Yes we're definitely trying to push pricing a bit.

It's easier in private negotiations than it is in auctions but that is definitely our thought process right now.

But that whole kind of -- it sounds like what's happening is very consistent across all the public names and that really hasn't impacted cap rates yet.

Cap rates haven't started backing up yet.

Well, it takes a while.

So our cost of capital has really increased in the past few months.

And I don't think anyone was certain how long it would last, would it get worse or better.

I think it's been long enough now that we're starting to think that cap rates need to move up a bit for us to continue to be as aggressive as we have been.

Okay, that's helpful.

Thank you.

At this time there are no further questions.

We'd like to thank you for your participation on today's conference call.

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