Healthpeak Properties, Inc.
Q1 2011 Earnings Call Transcript

Published: 3 May 2011

[Operator:]

Good day, ladies and gentlemen, and welcome to the First Quarter 2011 HCP Earnings Conference Call. My name is Chanel, and I'll be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. Now I would like to turn the presentation over to your host for today's conference, Senior Vice President, John Lu. You may go ahead, sir.

[John Lu:]

Thank you, Chanel. Good afternoon, and good morning. Some of the statements made during today's conference call will contain forward-looking statements, including the statements about our guidance. These statements are made as of today's date and reflect the company's good faith, beliefs and best judgment based upon currently available information. The statements are subject to the risks, uncertainties and assumptions that are described from time to time in the company's press releases and SEC filings. Forward-looking statements are not guarantees of future performance. Some of these statements may include projections of financial measures that may not be updated until the next earnings announcement or at all. Events prior to the company's next earnings announcement could render the forward-looking statements untrue and the company expressly disclaims any obligation to update earlier statements as a result of new information. Additionally, certain non-GAAP financial measures will be discussed during the course of this call. We have provided reconciliations of these measures to the most comparable GAAP measures, as well as certain related disclosures in our supplemental information package and earnings release, each of which has been furnished to the SEC today and is available on our website at www.hcpi.com. I will now turn the call over to our Chairman and CEO, Jay Flaherty.

[James Flaherty:]

Thanks, John. Welcome to the 2011 First Quarter Conference Call for HCP. Joining me this morning on the call are Executive Vice President, Chief Financial Officer, Tom Herzog; and Executive Vice President, Chief Investment Officer, Paul Gallagher. Let's begin with a review of our first quarter results. And for that, I turn the call over to Tom.

[Thomas Herzog:]

Thank you, Jay. There are 3 topics I will cover today

[Paul Gallagher:]

Thank you, Tom. HCP's portfolio continued its excellent performance in first quarter across all 5 sectors, which is reflected in strong same-store growth. The portfolio experienced increased occupancy in senior housing, stable cash flow coverages in the hospital and post-acute sector and strong leasing activity and retention in the MOB and life science sectors. Now let me break down that 2011 first quarter performance in detail. Senior housing. Occupancy for the current quarter in our same property senior housing platform is 86.5%, a 30 basis point sequential increase over the prior quarter and a 100 basis point increase over the prior year. Facility rates and margins for our senior housing portfolio continued to improve and cash flow coverage is up slightly to 1.19x. Current quarter year-over-year same property cash NOI growth for our senior housing platform was 9.5%, driven primarily by the property's transition from Sunrise to new operators. Working with the Environmental Protection Agency and various senior housing associations, our capital asset management team assisted our operators in providing data, which was instrumental in developing a new category for ENERGY STAR related to senior housing properties. This new category was effective March 21, and we had 4 properties that earned this designation in the quarter. Hospitals. Same property cash flow coverage decreased 8 basis points to 4.65x. Year-over-year, same property cash NOI for the first quarter increased 16.8%. The growth continues to be driven by the Hoag lease at our Irvine Hospital. Post-acute, skilled nursing. Our owned post-acute skilled nursing portfolio year-over-year cash NOI for the first quarter in our Same Property portfolio increased 2.4%. Cash flow coverage is strong at 1.61x. Subsequent to quarter end, HCP received $330.4 million in proceeds from the payoff of its debt investment in Genesis HealthCare, which were acquired at a discount since September and October of last year for $290 million. The prepayment at par resulted in an annualized IRR to HCP of 40% on our investment. Also subsequent to quarter end, HCP converted at par its approximate $2.1 billion debt investment acquired at a $230 million discount at par into real estate in HCR ManorCare. HCP acquired 334 of HCR ManorCare's post-acute, skilled nursing and assisted living facilities subject to a long-term triple net lease for $6.1 billion. The lease is guaranteed by HCR ManorCare. Simultaneously, we exercise our option to purchase a 9.9% equity interest in HCR ManorCare for $95 million. Medical Office Buildings. Same property cash NOI for the first quarter was up 1.8%. The growth was due to normal rent steps and improvement in collections and continued success in our expense controlled initiatives, which translated into $127,000 of operating expense savings versus the first quarter 2010. Our MOB occupancy for the first quarter was stable at 91%, with strong leasing activity in California and Texas. During the quarter, tenants representing 573,000 square feet took occupancy, of which 462,000 square feet related to previously occupied space. Our year-to-date average retention was up 81.2%, up from 78.9% in the first quarter 2010. Renewals for the quarter occurred at 1% higher mark-to-market rents, with average term for new and renewal leases at 85 months. We have 1,295,000 square feet of scheduled expirations for the balance of 2011, including 213,000 square feet of month-to-month leases. Our leasing pipeline related to these expirations total 740,000 square feet, addressing 57% of our remaining 2011 rollover exposure. As we have highlighted in the past, our MOB sustainability initiatives continue to provide positive economic results. Utility costs on a same property basis are down $265,000 versus 2010. In addition, we received confirmation from the U.S. Green Building Council that our previously announced LEED Silver designated MOB in Seattle is the first existing medical office building to receive the Silver certification. As discussed on our last call, on February 10, we acquired 132,000-square-foot medical office building in San Antonio on our existing North Central Baptist Hospital campus for $31.2 million at a cap rate of 7 1/2%. The building is 100% leased. Life science. Same property cash NOI was up 5% for the quarter. This increase was largely driven by contractual rent increases, the burn-off of free rent that existed in the first quarter 2010 and increased recoveries on expenses. Occupancy for the entire Life Science portfolio dropped 130 basis points during the quarter to 89%. The drop in occupancy was due to 2 additions to the portfolio. The first addition was the completion and conversion of office space to lab space on a to-be-leased 88,000-square-foot building in Redwood City. Additionally, we acquired the 70% leased 200,000-square-foot Nexus portfolio in San Diego for $67 million at a stabilized cap rate of 8 1/2%. With the completion of our Redwood City redevelopment, our life science development pipeline is reduced to 3 redevelopment projects totaling 204,000 square feet, with the total redevelopment funding requirements projected at $29 million. For the quarter, we completed 232,000 square feet of leasing, with a retention rate of 57% on expiring space. And if you include leases executed with new tenants, over 90% of expiring space were re-leased without any downtime. In the first quarter, we addressed 119,000 or 41% of the 291,000 square feet left to expire in 2011. These remaining expirations represent less than 1% of HCP's annualized revenue. Jumping ahead to 2012, we have 218,000 square feet of expirations, which represent only 0.5% of HCP's annualized revenue. Subsequent to the end of the quarter, HCP acquired the Cove, a 20-acre parcel of land in south San Francisco adjacent to our existing 900,000-square-foot campus anchored by Amgen. The Cove, situated at the gateway to the largest life science submarket in the U.S., represents an opportunity to deliver new Class A lab space to the land-constrained peninsula market. The Peninsula has recently experienced a significant increase in absorption, driving direct vacancy in south San Francisco to less than 5% and total vacancy to near-single digits when including subleased space. Rental rates have increased as much as 25%, resulting from the ramp up of tenant demand from a cross section of industries, including those in tech, life science and medical device sectors. Additionally, with the sale of Mission Bay land to Salesforce.com, over 2 million square feet of life science developable land has been eliminated from the market, providing HCP with an attractive off-market acquisition. Upon full build out, the site can accommodate up to 800,000 square feet of new lab and office space at an estimated 8.5% return on cost. With that review of HCP's portfolio, I'd like to turn it back to Jay.

[James Flaherty:]

Thank you, Paul. We've had an especially active start to 2011. Most importantly, our portfolio is performing extremely well, allowing us to raise our 2011 Same Property Performance guidance by 50 basis points after just one quarter of results for the year. Our January debt and March equity offerings were completed on particularly attractive terms and noteworthy in many respects. The $2.4 billion in unsecured debt issuance had an average maturity of 10.3 years at a blended rate of 4.83% and included a healthcare REIT first, a 30-year maturity tranche. The $1.27 billion equity offering, which was increased 44% in size to meet investor demand, allowed us to execute our option to settle for cash and arbitrage the HCR ManorCare stock consideration taken by the Carlyle Group. Superb execution on both the debt and equity transactions further enhanced the accretive impact of our HCR ManorCare transaction. In fact, our current FAD per share guidance of $2.09 for 2011 results in a 10.5% increase this year versus 2010 and assumes no additional acquisition activity for the remainder of the year. Last Thursday, the Centers for Medicaid & Medicare Services (sic) [Centers for Medicare & Medicaid Services] offered 2 fiscal 2012 Medicare-proposed payout rules for skilled nursing facilities. One proposal was directed at reducing payment rates in response to the first quarter of data for the recently enacted RUGs-IV reimbursement. I would note that as of March 31, 2011, HCP's post-acute skilled nursing portfolio enjoyed a coverage ratio of 1.61x. Our HCR ManorCare underwriting excluded the benefit of any RUGs-IV reimbursement to arrive at our previously disclosed 1.5x coverage ratio. Both of these portfolio coverages are more than sufficient to withstand the most draconian of proposed reimbursement cuts. Please note that both these coverage ratios are computed after management fees. HCP's disciplined underwriting of post-acute skilled assets and our exclusion of any RUGs-IV benefit in these valuations drove

[Operator:]

[Operator Instructions] And your first question comes from the line of Adam Feinstein with Barclays Capital.

[Adam Feinstein:]

Good quarter here. Just wanted to just get some more details on to updated thoughts on ManorCare, Jay. Maybe just talk a little bit about this, the future development opportunities that you guys have talked about. So just curious as you're looking at additional deals in the future and having ManorCare manage those assets. And just what are your thoughts in terms of just those growth opportunities?

[James Flaherty:]

Yes, first of all, we believe that HCR ManorCare is the best-in-class operator in the post-acute skilled sector. We are obviously delighted with our current investment in the real estate. We are delighted with our investment in the operating business. We think that provides some very nice alignment. And as you know, when we enter into transactions that represent something other than a 100% ownership stake in real estate, it's very, very important to HCP that we have optionality in those non-100% owned real estate investments. You saw that very recently here with some of our debt investments, where we, after making them -- notwithstanding, they were very attractive in their own right. We had the ability and then in fact did monetize those for either cash, in the case of the Genesis and the HCA debt investments or conversion into property, in the case of HCR. You've also seen that in our joint venture -- some of our joint venture investing where we recently acquired the 65% stake in Ventures II at attractive terms. So optionality, when we get into non-100% owned real estate transactions, optionality is very, very important. As we sit here and look at our stake in the operating business of HCR ManorCare. And you kind of project out over the next couple of years, I think 3 obvious scenarios would be to either sell that stake for cash or it would include either selling that stake for cash, contributing that stake in support of HCR ManorCare, as part of a larger strategic transaction, or swapping the stake for additional real estate. So I think we've got -- we're very pleased with what we've got and we're very excited about what that particular investment might result in down the road. So that's, I guess, how I would respond to your question, Adam.

[Adam Feinstein:]

Sure, sure, definitely. And clearly, you guys about the gold standard there and just an absolutely great asset. As you just think about other opportunities, there's other assets for sale right now in the space. Clearly, ManorCare stands out as just having better quality than everyone else. But would you be looking at some of those other assets as well?

[James Flaherty:]

Sure. We look at everything just because I think that's a good way to stay current. I would suggest that the last Thursday's news would probably put a little bit of cold water, I would think, on some of the potential transactions, some of which were formally announced and some of which were kind of in process but not formally announced yet, in terms of the seller's intent to explore those alternatives. So we'll have to see. If anything, we'll probably benefit from this, from the standpoint of what it might result in, in terms of seller's expectations or ultimate valuation for transactions. But again, I think right now, with the option -- with the 2 options they've put forth, as opposed to one proposal and the fact that there's such a wide spread between those 2 options, up 1.5% in option one and down 11-plus percent in option 2. That spread is, I think, it's going to be challenging for buyers and sellers to agree here until there's probably some resolution. Not impossible but I think it's probably going to cool things off a little.

[Adam Feinstein:]

Sure, now definitely. And since it's the first quarter since ManorCare closed, I just want to say congrats on what is a great deal.

[Operator:]

Your next question comes from the line of Michael Bilerman of Citi.

[Quentin Velleley:]

It's Quentin Velleley here with Michael. Jay, you just commented in your prepared remarks about the $15 billion or thereabouts of potential transactions this year. I'm just wondering if you could comment on the tops of assets that you think that will comprise? And whether or not -- or sort of maybe a breakdown of where you think it's coming from, whether it's from private equity versus public company.

[James Flaherty:]

Quentin, it's going to be a mix across all the property, we were in 5 property sectors. We see activity in each of those 5 property sectors, and we see them involving both public and private opportunities. So I think for the most part, given the cost of capital advantage that the larger healthcare REITs have, I think private equity is probably more of a source of transaction flow at this point, as opposed to a competitor for transaction flow. So I think it's -- but again, it's broad-based both in terms of its property type as well as the public versus private. I will say, I think one thing that's different than, say, as recently as 6 months ago and thinking back into the throes of the recession, we see very little in the way of debt opportunities. I think that space -- with the improvement in liquidity in the capital markets and the alternatives that a lot of our operators or tenants have, I would not anticipate a lot of debt investment, at least from HCP's standpoint as being able to kind of clear the bar from a return standpoint at this point.

[Quentin Velleley:]

And maybe if you could just comment on what you think HCP's share could be of that transaction volume.

[James Flaherty:]

We really -- we kind of traditionally steer away from guidance relative to acquisition activity. We've obviously -- let me answer that question this way. We think there's a very, very attractive opportunity with respect to the private situations. If you think about a private company, whether it's owned by a private equity firm or some concentrated ownership, the alternative to those folks today to the potential sellers today of taking that portfolio or that company public, that's going to involve -- the buy side appropriately is going to want to have some discount to the NAB that if you look at the last 6, 12 months of IPO pricing, that's averaged somewhere between a discount of 5% to 7.5%. If you further load transaction costs on top of that, you get a valuation result, and if you compare that to what the larger publicly-traded healthcare REITs can do in terms of their cost of capital, you really almost have the mother lode of all of arbitrage there because that's a very, very wide window of value that I think the larger healthcare REITs can realize, hopefully. A good portion of that yet still provide a superior result to the sellers from a go-public transaction. So if you think about the transactions we've done in the last 5 years, it's really essentially 3 of them

[Michael Bilerman:]

Jay, it's Michael Bilerman speaking. Just a quick question. Just now having a 10% stake in HCR ManorCare on the operating side, both in terms of positives and negatives, should there be a draconian situation and should there be significant pressure on cash flows? At the operator side, I guess how do you recuse yourself being the landlord of the assets but also being an owner of the operator? Or at least in a minority position, how do you sort of deal with those potential conflicts?

[James Flaherty:]

Yes, I don't think we should want to be doing any recusing, Michael. In a situation where you had a more draconian reimbursement, again, I think that's going to set up as a very attractive investment opportunity for HCP and HCR. If you go back and -- remember, this is the management team, Paul Ormond, Steve Cavanaugh, Steve Guillard. They've been battle-tested for 2 decades. I mean, they've gone through all sorts of ups and downs with respect to reimbursement changes, both proposed and actual. They've morphed their platform over time in terms of acuity mix, and this Adam has just referenced. So this management team, we've almost -- I personally would prefer a more challenging sort of environment because I think that would allow for the HCR team to really extrapolate some additional value, and hopefully, with our existing investment in their real estate portfolio as well as our alignment through OpCo, we would benefit proportionately from that. So we're very, very comfortable and look forward to the coming 12- to 18-month period aligned with this management team.

[Operator:]

Your next question comes from the line of Suzanne Kim of Credit Suisse.

[Suzanne Kim:]

I was just wondering about your acquisition of the land at Oyster Point. I mean, you briefly talked about the opportunities there. But are you seeing some larger tenants or opportunities there that's sort of driven you to look at developing more on Oyster Point?

[James Flaherty:]

Well, let me say a couple of things. One, let's start out at 30,000 feet from our Life Science portfolio. What's standing between our existing occupancy and 100% is now down to about 750,000 square feet, and that's really 6 buildings. And we've got significant interest on at least half of those in terms of dialogue right now, so put a box around that. Now put a box around the fact that as Paul indicated, the actual vacancy now has dropped down in the Bay Area, in general, and the south San Francisco submarket to 5%. In addition, you've had a large development parcel, one standard deviation over -- in terms of the submarket, over in Mission Bay go away. And so that all those things combined with the fact that you've got this push up from the South with the tech business, you're starting to see in our most southern submarket, Mountain View. You've got Google in there. You've got LinkedIn there. You've got an awful lot of tenant demand push coming out from the tech sector from the South. So you put all that together with the fact that we're constantly looking at buy versus build opportunities. I suspect you'll see some deals in the not-too-distant future but buy opportunities or announced buy transactions that will be in the mid- to high-600 a square foot zone. So when you think about that, that provides a very, very nice pricing umbrella for us to be thinking about development. Now I would quickly add that I don't envision this sort of activity as being widespread across either our life science portfolio or our overall HCP portfolio. But what we've got in this south San Francisco submarket is a very significant market share with our Amgen and our Genentech campuses. And now with this parcel of land -- it's the last large parcel of land. It's 20 acres that's available, and it's right at the gateway to Oyster Point, sits right there off the 101 exit. We've got an opportunity here to -- and as a result, we're going to move very quickly on it to prepare that for what we expect will be an attractive supply-demand dynamic in south San Francisco but again, I'd encourage everyone to think about this as more of a pure play south San Francisco and maybe immediate adjacency sort of opportunity as opposed to some broader development play across the entire company portfolio.

[Suzanne Kim:]

Great. That's helpful.

[Operator:]

Your next question comes from the line of Jay Habermann of HBT (sic) [Goldman Sachs].

[Jonathan Habermann:]

It's actually Jay Habermann of Goldman Sachs. Just switching to life sciences, can you guys give us a little perspective on what you're seeing? I mean, you mentioned the occupancy, 89%. I know there's some planned vacancy as part of that. But can you give us a sense of maybe underlying trends and just activity right now?

[Thomas Herzog:]

Yes, we're actually seeing good proposal activities in the marketplaces as Jay has mentioned. Some of the vacancy that we're looking at in our portfolio, we've had very good activity. And in certain markets down in the Redwood City area, we've seen some very significant rent growth, and overall, we've seen anywhere from 15% to 20% rent growth in the marketplace. So we're seeing some good signs there.

[Jonathan Habermann:]

Okay. And Jay, this is probably the first time in a while we've seen the tenant diversification list look obviously, much, much better and clearly improving the risk profile. How do you think about this over time, whether it's growing through acquisitions or existing tenants today that perhaps continue to shrink? I mean, how do you see that complexion changing over the near term?

[James Flaherty:]

Now we're talking, your comment is specific to life science, Jay?

[Unknown Analyst -:]

Sorry, this is just a broad comment. If you look at Page 9 of the supplemental, operators and tenant diversification.

[James Flaherty:]

Yes, I think the answer is we've got our -- and I don't think there's a call in the last several years that I haven't referenced this, but we think there are 3 criteria -- let me rephrase that. We know there are 3 criteria that the folks that we want to have as partners in our portfolio have

[Jonathan Habermann:]

That's very helpful. And then as part of this $15 billion of transactions you talked about. I mean, I assume that continuing to pick up the right tenants is driving that. And how do you think about that sort of pipeline even as you extend beyond sort of the current year?

[James Flaherty:]

In terms of a dollar amount, Jay or...

[Jonathan Habermann:]

Yes. Just in terms of the total transfer of assets, whether it's from the private equity or private entities into obviously, the public REIT hand.

[Thomas Herzog:]

Well, I think recent transactions have created an investor preference for -- I'll use the term generically, kind of PropCo, OpCo sort of structures. They can come in various flavors and have various risk reward features to them, ranging from a bulletproof triple net lease structure through a RIDEA structure in some of these sectors through an actual operating ownership stake in others. So there's all sorts of flavors and things to think about. In terms of -- I know Jerry Doctrow put out a piece, I think it was last week. He looked at the potential pipeline. This was just in senior housing. He looked at a potential pipeline and quantified that at ,I think, he did $24 billion or $26 billion. That wasn't a prediction for 2011 activity. That was just a review of senior housing portfolios that are potentially out there and in play. And I think directionally, Jerry's correct. When and the pace of which those portfolios get monetized, I mean, that will be -- that remains to be seen but we have a consolidating industry, both at the landlord level and at the operator tenant level. It's driven by some external shocks right now. And notwithstanding, that it's still a very, very fragmented industry, with the amount of real estate in healthcare -- in healthcare real estate in the United States that sits on the balance sheet of the healthcare REITs is still quite small. So it ought to be a very attractive time here in the next, next couple of years, at least that's what we anticipate.

[Operator:]

Your next question comes from the line of James Milam with Sandler O'Neill.

[James Milam:]

I wondered if you could talk about the ManorCare operating investment? And just the accounting is obviously fairly complex, but if you could just talk about how you underwrote sort of the return expectations that we can compare that to what you get on your real estate investments, for example.

[James Flaherty:]

I think, first off, it's quite a small investment in the context of HCP overall, and we viewed it as very attractive and further aligning ourselves with the management team at HCR ManorCare. And I think this is absolutely kind of a step one to some future steps down the road. What those specific steps are as I'd alluded do, we think there's very nice optionality in that investment. But how that plays out over the next year or 2 remains to be seen. But we like any and all of those potential scenarios, so that's how I'd comment on that. With respect to the specific accounting, I don't know, Tom, if you want to...

[James Milam:]

I didn't mean to get into the accounting. It was just more a question if we should think about it as a strategic investment or if you looked at it as a 12% IRR versus 7.75% going in for the real estate.

[James Flaherty:]

We looked at it as a strategic investment that was economically attractive to us. That's how we looked at it.

[James Milam:]

Okay. My second question is just, Jay, can you give us a little color on your thoughts for the CFO search? I know the board appointed Scott to be the interim CFO. Is that something that's on a trial basis for him? Or are you interviewing other candidates and just sort of what the timing is for us to think about a permanent replacement coming onboard?

[James Flaherty:]

Well, Scott and I know something that -- I don't think the board appointed him as interim Chief Financial Officer. I think they named him interim Principal Officer. So the CFO search is well underway. At this point, I would say it involves a number of very highly qualified professionals, with experience in both public and private real estate roles, so very excited about that process and we will obviously update you as appropriate.

[James Milam:]

Okay. And I just -- my last one is just more of a modeling question. It looks like the GIs were a little bit lower in terms of sort of what we were expecting on a quarterly basis. Was that just a result of better retention in the first quarter? Or is that something that you think will ramp up as the year goes on?

[James Flaherty:]

Yes, that's just timing as far as the number for the first quarter. So the projection for the year hasn't changed.

[James Milam:]

So something more like $15 million a quarter still makes sense?

[James Flaherty:]

Yes, somewhere in that range.

[Operator:]

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

[Jerry Doctrow:]

One or two things here. I was curious a little bit more on just your view of sort of TRS REIT investments, and you have mentioned that as sort of your one alternative for doing kind of OpCo PropCo. But it seems to me that there are a few things in your portfolio that might reasonably convert like the HCP Ventures II portfolio, maybe your Sunrise, maybe there's some others. So I'm just curious whether that something you were thinking about.

[James Flaherty:]

Sure. When we look at these, we look at all the opportunities, and then we risk adjust them and determine which way we want to go. To date, as we've looked at these transitions, and we've done -- at this stage, we've done a lot of transition. We've transitioned some tenant hospitals. We've transitioned some previously managed Sunrise portfolios. So as we looked through this to date, when the dust settles on a risk adjusted basis, moving these to triple net structures at very, very, very attractive annual ramp bumps, either in the case of the Irvine hospital being taken over by Hoag or some of the Sunrise transitions we did last year. That's been the winner as we've kind of crunched the calculus. But every situation is different. The opportunities in these portfolios is sometimes different. Sometimes, it's more of a cost reduction, which can be easily quantified and agreed to between the 2 parties on either side of the transaction. Sometimes it's a revenue upside opportunity, which even if it is readily agreed to by the 2 parties, that the timing of one that might drop could differ, and so that might point you down or point you away from a triple net structure to maybe a RIDEA structure, things like that. But we absolutely have that under active consideration on some of the opportunities that you mentioned.

[Jerry Doctrow:]

And all else being equal, would you want to be investing more sort of outside skilled nursing or post-acute given that you've added a lot of that with ManorCare?

[James Flaherty:]

Yes, I think it's going to be where the risk adjusted returns shake out.

[Jerry Doctrow:]

And I just want to be clear. On ManorCare, you talked about the lease coverage. So your view is basically the lease coverage is based on pre-RUGs-IV numbers, so even if these CMS cuts are implemented, you're lease coverage base is unaffected?

[James Flaherty:]

Yes. Again, just to be clear on that, when we underwrote ManorCare -- HCR Manorcare -- sorry, Paul -- we specifically excluded the RUGs-IV benefit in determining that. And again, that got us to the 1.5 and again, versus -- I know there's a lot of -- there's some difference in terms of how these coverages are communicated. Ours is after an adjustment for management fee. If you were to pro forma -- how about this, Jerry? If you were to pro forma for the first quarter of 2011, the rent payment that would've come from HCR ManorCare to HCP, keeping in mind that, that transaction, Jerry, didn't close until April 6 or 7, that coverage for the first quarter would've been 1.6. So again, we've got ample coverage both with respect to our HCR ManorCare portfolio as well as the legacy HCP post-acute skilled portfolio. [indiscernible] So potentially more as an opportunity once there's some resolution to this issue.

[Operator:]

Your next question comes from the line of Jana Galan of Bank of America Merrill Lynch.

[Jana Galan:]

Just a quick question on the senior housing portfolio coverage. It looks like 2 of the operators fell below 1x on the EBITDA coverage, and I'm just wondering if that was just specific to this quarter or if this is something to be watching going forward.

[James Flaherty:]

Well, normally, that's going to occur with respect to when bumps of things of that nature, especially given what's going on with the market there. We monitor all of those various different operators, so we have a good handle as far as what's going on, both at the property level and at the manager level.

[Thomas Herzog:]

So the rent bumps are generally dropped in the first quarter?

[James Flaherty:]

It depends on when the lease was signed, typically.

[Operator:]

Your next question comes from the line of Rich Anderson, BMO Capital.

[Richard Anderson:]

Can you remind me, with Ventures II, the buyout of Ventures II, was that a situation where you -- the buyout was put to you or did you instigate that transaction?

[James Flaherty:]

Well, neither. Our partner had come to us. Our partner had come to us looking for liquidity. They had made other investments in the middle part of the last decade that had some specific issues there that might involve capital calls and things of that nature, and our portfolio had performed well, both on an absolute sense and a relative sense. So they came to us and indicated that they were interested in having a liquidity event and from a timing standpoint, if that could be agreed to prior to year-end, that would be helpful. So that was the backdrop, Rich, of what then involved the closing of the ultimate transaction.

[Richard Anderson:]

Okay, so in your mind, I mean, obviously, you priced it according to what you wouldn't have done had that conversation not have happened. But it does have a little bit of a challenged past. I mean, what is your view of that portfolio today, relative to some of the issues that were present over the past couple of years with Horizon Bay?

[James Flaherty:]

Well, I wouldn't entirely reject the notion that this has a challenged past. I mean, this was a portfolio that had $68 million of NOI in 2006 and in 2010, had $64 million, so it's down $4 million. It's largely independent living portfolio. It had an operating platform that did not provide for much, if any, in the way of ancillary revenues. And basically, it's a situation where the annual lease bumps ran away from the operations. They were very aggressive lease bumps in that portfolio. They were, what, 3.5 to 3.75.

[Thomas Herzog:]

3.75.

[James Flaherty:]

So you compound that for 4 years during the recessionary period, the lease payment ran away from the operator, but in terms of an opportunity, I would put this opportunity at the absolute top of the opportunities in terms of attractiveness of things that we're working on right now, Rich.

[Richard Anderson:]

So you having to stop straight-lining the rent, you don't think was a function of a portfolio that was a little bit questionable?

[James Flaherty:]

Absolutely not. I think it's a function of the fact that the annual lease escalators ran away from the cash flow of the operations. We think what we've been able to structure the 65% buyout on very attractive terms, and I think we're going to do extremely well on this portfolio in the years to come.

[Richard Anderson:]

Okay. And the second question is on Genesis and how you characterize that as a decision to exit that investment. I'm just curious, I mean, was it your decision? Or I mean, it seems to me, there was a bunch of parties involved, obviously, and ultimately, it turned out to be a fantastic return for you. But I mean, are you saying there was no interest in you being the buyer of that portfolio at any point in time?

[James Flaherty:]

At the right price, sure. But first, let me answer your first question. Both the investment to acquire the debt during the last week of September and the first week in October and the decision to exit the debt investment, those were absolutely our decisions. So that, I think, answers one of your questions, but again, we look at -- the beauty of our platform is that we can look across 5 property sectors and up and down 5 different types of investment vehicles, and we are constantly sourcing opportunities and then evaluating and ranking the risk-adjusted return opportunities and the pricing that the seller's expectations there, we are very pleased to have recorded the 40% return and added $330 million of cash to our balance sheet last month.

[Richard Anderson:]

Was there -- maybe I don't know this, was there an interim buyer between you selling that and HCN buying that debt or retiring that debt?

[James Flaherty:]

Our transaction closed as part of the sale last month.

[Richard Anderson:]

Okay. So I'm still not quite not sure how it was entirety your decision, because there was a...

[James Flaherty:]

We could've rolled that debt investment into a larger transaction as we did in HCR ManorCare or we could've taken the exit. That was our decision. We decided to take the exit.

[Operator:]

Your next question comes from the line of Dan Cooney, KBW.

[Daniel Cooney:]

On the 9.5% same-store NOI growth in the senior housing segment during the quarter, I was hoping that you'd be willing to kind of give us a breakdown between the portfolios that were transferred from Sunrise and maybe the rest of the segment?

[James Flaherty:]

Yes. Do we have the split of the -- you said, in other words, to get to that overall number, the split between the non-Sunrise and the Sunrise?

[Daniel Cooney:]

Yes, exactly.

[Thomas Herzog:]

Yes, we can do that. The number for the Sunrise came in at 7.9%. We had some strong performance in one of the portfolios that bumped it up beyond the normal expected growth. And for the non-Sunrise, which includes the 3 portfolios that had been transferred over the last couple of years, Deed [ph] and Tuoreas [ph] and Sunrise 27, that sums up to 10.1%. And so those 3 portfolios would have added a fair amount to the growth. And in addition to that, there was a working capital adjustment on the most recent Sunrise transition that bumped up the growth quite a bit as well, and those are the components.

[James Flaherty:]

And then the fourth portfolio that we transitioned, Tom, that won't show up in same-store until later this year, right? The PC 7 acquisition?

[Thomas Herzog:]

Right. It will spend in the population for a year.

[James Flaherty:]

Right. And that would've been -- that would depend on the annual escalator contribution. We'll have an annual escalator contribution of just under 6%, to give you some flavor as to where those different portfolios drop in.

[Daniel Cooney:]

Okay, great. And then on the Life Science side, I think last quarter, you guys are roughly flat NOI growth for the year. Is that really just a function of kind of the tough comp in the second quarter? Should we look for kind of comparable growth in the balance of the year relative to kind of what the first quarter was?

[Thomas Herzog:]

A lot of what that is, we had some free rent back in the first quarter 2010 with a tenant that has since burned off, and it's no longer in the same store number.

[James Flaherty:]

The tenant burned off?

[Thomas Herzog:]

The tenant free rent burned off.

[Daniel Cooney:]

Okay. And then finally, if we could just get an update on the Cirrus loan? I know it's placed on a non-accrual status and maybe just kind of a time frame on when you might think you get fully paid off on that loan.

[James Flaherty:]

Yes, I mean, it's basically in a kind of orderly liquidation. There's, I think, half a dozen or so individual portfolios rolling up to that and there are offers on several of them at this point. We're waiting to close on some of those, and I expect -- if things go according to plan, you'll start to see some significant repayment in the second half of 2011. That's the plan.

[Operator:]

Your next question comes from the line Rob Mains of Morgan Keegan.

[Robert Mains:]

Tom, just one thing, I think I have got this straight. But what I'm looking at your sort of normalized FFO, that does include the gain from the Genesis debt but not the ManorCare debt. Correct?

[Thomas Herzog:]

The normalized FFO is going to -- can you repeat that? I'm sorry.

[Robert Mains:]

Yes, you're saying that you're counting the gain on the ManorCare debt, you're folding that in the transaction cost that you're excluding or transaction gains that you're excluding?

[Thomas Herzog:]

That's right, we're backing that out.

[Robert Mains:]

Right. But the Genesis gain is included in the current quarter?

[Thomas Herzog:]

Right.

[Robert Mains:]

Okay, just wanted to make sure I had that straight. And then just follow-up on the question on the impact of...

[James Flaherty:]

I'm sorry, Rob, it's going to be included in Q2 based on the timing.

[Robert Mains:]

Yes, okay. Got that. And then to follow up on the question about the impact of Sunrise, you have -- Sunrise is having an impact on your SPP for senior housing as Hoag is in hospitals. If I were to exclude them, would both of those fall sort of within your general guidance range? I'm kind of looking for a normalized growth rate for those ones, the positive impact of those particular leases burn off.

[James Flaherty:]

Yes, you're saying the Hoag for hospitals, once that's burned off, would the SPP look more like normal rent bumps that you'd expect? In part, we've got 2 different leases on hospitals that are driving some of that outsized growth, and one of them is the Rockwell [ph] lease and the other one is Hoag. So if you excluded those 2, then you'd get something that looked more normal.

[Robert Mains:]

And then same question with senior housing, if I excluded everything in Sunrise, would that possibly be more around the 3% range?

[James Flaherty:]

Let me just look quickly. Yes, you'd be more in that same range.

[Operator:]

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

[Todd Stender:]

My question revolves around life science. As of today and incorporating the new life science facilities you acquired in San Diego, how do you feel about your critical mass in the San Diego market? And if you would also comment on your critical mass in the south San Francisco market and how your new development on the Cove parcel might impact that as well.

[James Flaherty:]

Well, I think if you take a look at our Life Science portfolio, it's -- in contrast to the other 2 portfolios that are out there, it's narrower and deeper. Okay? It's really, with the exception of -- it's really kind of a 2-market portfolio, Bay Area and San Diego, and it's quite a bit deeper. If you were to just look at those 2 markets, it is the largest amount of life science real estate owned by any of the healthcare REITs. So we like those 2 markets. We'd like to meaningfully get into critical mass. To answer your question, in the Boston Cambridge market, we have 8 property there that we're excited about but it's by no means represents how we would define critical mass. I think we have critical mass in both the Bay Area and San Diego and I think we, opportunistically, when attractive situations come up, we wanted to add to that the critical mass. The Nexus portfolio in San Diego and the Cove opportunity -- land opportunity in south San Francisco are very, very good examples of how we intend to kind of further penetrate what we already have in our portfolio.

[Todd Stender:]

And any numbers you could wrap around that market share, just to give us an indication of your presence?

[James Flaherty:]

Well again, if you take a look at just those 2 markets, we are, by a significant amount, the largest owner of life science real estate in the 2 California markets. We have, to date, not shared market share but we could evaluate that. I think we disclosed square feet by submarket so I think -- I don't know if that's in our supplemental or not, but my suggestion is take a look at what's in the supplemental, which I think is pretty good. And to the extent that we can attempt to enhance that, the discussion, we're certainly willing to evaluate that.

[Todd Stender:]

Okay. And this question's for Paul. I think you mentioned on the new portfolio, it's currently 70% occupied and has stabilized. Cap rate is the 8.1/2% range. What is the stabilized occupancy, do you think, for that portfolio?

[Paul Gallagher:]

I think it'll end up to about 90%, 95%.

[Todd Stender:]

Okay. And what are your expectations? How long do they think it will take to get there?

[Paul Gallagher:]

We think that we should probably be able to do something in 2012 there with occupancy.

[Operator:]

Your next question comes from the line of Tayo Okusanya of Jefferies & Company.

[Omotayo Okusanya:]

Jay, first of all, thanks for the details about the underwriting of ManorCare in light of the CMS. I think that's very helpful. We just have 2 more follow-up questions about that. I think the general idea of the adjustment is to basically create budget neutrality, such that payments are not any different from the old RUGs system. But I was just wondering when you specifically look at ManorCare and the RUGs code that they have the most exposure to, whether there's any negative impact that this cut may recently create, even though it was not meant to do that.

[James Flaherty:]

Well, first of all, let me say, again, remind you, it's HCR ManorCare. I think if you take a look at the proposal, you've got to look at the 2 options. There's a potential for that proposal to go even beyond budget neutrality. But what happens when it happens, I think there's a lot that's been written in the last couple of days. And again, we think at the margin, this sets up as an opportunity for HCP more than anything else.

[Omotayo Okusanya:]

So you don't see any risk that -- so when you look at all the different RUG categories and the cuts they're expecting to make to them, all the rehab and therapy categories seemed to have much higher cuts. There's no risk that ManorCare has meaningful exposure to those categories, and they end up with a large cut as a result of it, or a larger-than-expected 11% average cut?

[James Flaherty:]

I mean, look, there's risk at everything. But again, we've got a proposal out there that won't be resolved anytime soon. And more importantly, we've got a management team that for over 20 years through -- I think what you're asking is if you were to take the more draconian cut and apply it, all things being equal, would that be negative? I guess if that's the scenario we're in, I can assure you that Paul Ormond and his team will not have an "all the things status quo being equal" sort of response. So but they've done this for 20 years, and if you go back and look at the track record and the results of this company through very challenging periods of time in terms of reimbursement, that was the only company to maintain that investment grade credit rating back as you recall in the late 1990s. So again, when you've got a platform like this that's been battle-tested through several cycles, it's an opportunity to add to what is already a very, very attractive investment and that's why, in part, we've decided to exercise our option in OpCo.

[Omotayo Okusanya:]

Okay. If you're a betting man, what do you think ultimately happens when the final rules come out?

[James Flaherty:]

My guess is it'll be probably something in between. I guess it would be probably something in between and they'd push it out a year. That would be my guess but I don't -- that's how I'd respond to that question.

[Operator:]

Your next question comes from the line of Mike Mueller, JPMorgan.

[Michael Mueller:]

Most things have been answered, but real quick on the first quarter working capital adjustment that pushed up the same-store NOI comps for senior housing. How significant was that number?

[James Flaherty:]

It wasn't a very big number. Maybe a couple of million dollars.

[Operator:]

Ladies and gentlemen, that concludes the Q&A session. I'd now like to turn the call back over to your Chairman and CEO, Mr. Jay Flaherty.

[James Flaherty:]

Thanks, Chanel. Thank you, everyone. Have a good rest of spring, and we'll see most of you in New York City for maybe June. Take care, and thank you for your interest in HCP.

[Operator:]

Ladies and gentlemen, that concludes the presentation. Thank you for your participation. You may now disconnect. Have a great day.