Healthpeak Properties, Inc.
Q4 2014 Earnings Call Transcript

Published: 11 Feb 2015

[Operator:]

Good day, ladies and gentlemen. Welcome to the HCP, Inc. Fourth Quarter and Year-End 2014 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. [Operator Instructions] As a reminder, today's program is being recorded. I would now like to introduce your host for today's program, John Lu, Senior Vice President. Please go ahead.

[John Lu:]

Thank you, Jonathan. Today's conference call will contain certain forward-looking statements, including those about our guidance and the financial position and operations of our tenants. These statements are made as of today's date, and reflect the company's good faith beliefs and best judgment based on current information. These statements are subject to the risks, uncertainties and assumptions that are described in our press releases and SEC filings, including our Annual Report on Form 10-K for the year ended 2014. Forward-looking statements are not guarantees of future performance. Actual results and financial condition may differ materially from those indicated in these forward-looking statements. Future events 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 on this call. We have provided reconciliations of these measures to the comparable GAAP measures in our supplemental information package and earnings release, both of which have been furnished to the SEC today and are available on our website at www.hcpi.com. Also during the call, we will discuss certain operating metrics, including occupancy, cash flow coverage and same property performance. These metrics and other related items are defined in our supplemental information package. I will now turn the call over to our CEO, Lauralee Martin.

[Lauralee Martin:]

Thank you, John. Welcome to HCP's fourth quarter conference call. Joining me this morning are Paul Gallagher, Chief Investment Officer; Tim Schoen, Chief Financial Officer; and John Lu, Investor Relations. We are very proud of all we accomplished in 2014, and more importantly, how we have positioned the company for growth in 2015. I would like to start by summarizing the highlights of our accomplishments. We generated 3.3% same-store cash NOI growth consistently above 3% for the six consecutive years. We completed approximately $1.9 billion of accretive acquisitions and developments at a blended 7.8% cash yield and have an active transaction pipeline in all segments of our portfolio. We have added acquisition professionals at the P&L level to drive consistent investment activity and capture both, mid-sized assets and portfolio transactions. We are well positioned to bring our restructuring expertise and reliable execution to large transactions and respond with the total strength of HCP. We have proven, we can navigate a competitive domestic and international marketplace using transaction and capital structures to optimize investment returns. We have completed triple net sale leasebacks, RIDEA joint ventures, developments and debt transactions. We have maintained our investment discipline even as competition has bid asset prices above replacement cost. Paul will cover our recent investments and portfolio performance in a moment, including the add-on investment with HC-One we announced today, our U.K. investments now exceed $1 billion and our London office opened in January. We just announced a 3.7% increase in our annualized dividend in January, representing our 30th consecutive year of dividend growth. We continue as the only REIT in the S&P 500 Dividend Aristocrats index and we continue to excel as a global leader in sustainability. As we have put all this together, we entered 2015 from a position of strength. Let me turn the call over to Tim, to cover our 2014 financial results and expectations for this year.

[Tim Schoen:]

Thank you, Lauralee. Let me start with our fourth quarter results. Our same property portfolio generated strong year-over-year cash NOI growth of 3.5%, driven by contractual rent increases as well as higher occupancy in our Life Science portfolio. For the quarter, we reported NAREIT FFO of $0.07 per share, which reflected an $0.08 non-cash impairment announced in December, reduced the carrying value of our HCR OpCo equity investment to $39 million. Excluding the impairment and $0.01 per share of acquisition and pursuit costs, we reported FFO as adjusted of $0.79 per share and FAD of $0.66 per share the results benefited from the same property performance and accretive investments closed in 2014, representing strong per share growth rates of 3.9% and 8.2%, respectively, compared to the fourth quarter 2013. Turning to our full year 2014 results, cash same property performance increased to 3.3%, consistent with our forecast. Full year 2014 NAREIT FFO was $3 per share, which included an $0.08 per share impairment in Q4 offset by a positive $0.08 per share gain recognized in Q3, resulting from the Brookdale transaction. In addition, we incurred $0.04 per share of acquisition and pursuit cost for the year, year which are now broken out from G&A and reported as a separate line item on our income statement to provide better transparency. Excluding the impact of $0.04 per share for the year from impairments and transaction related items, 2014 FFO-as-adjusted was $3.04 per share and FAD was $2.57 per share above the mid-point of our last guidance for both metrics. On a year-over-year basis, the 1% per share growth rates for both metrics were moderated due to a number of favorable one-time items recognized in 2013, including gains from monetizing our U.K. Barchester debt investment Brookdale stock in Hyde Park senior housing development project. Absent these 2013 favorable one-time items on a recurring basis FFO-as-adjusted per share increased 3% and FAD increased 5% in 2014. Our 2014 cash dividends of $2.18 per share resulted in FFO-as-adjusted tail ratio of 72% and in FAD payout ratio of 85%, providing $160 million of retained free cash flow after maintenance CapEx to fund our 2014 investment activity. Moving onto investment and financial transactions, during the fourth quarter, we invested $813 million led by a £395 million or $630 million loan facility secured by a care home portfolio operated by HC-One. At closing, £363 million pounds were initially funded yielding 8.2% of which majority was match funded with a four-year £220 million term loans at 1.8% in January 2015, with the remainder funded in pounds-sterling on our revolver. Also, in January, we raised $600 million of 10-year senior unsecured notes at a 3.4% coupon proceeds were used to pay down the entire U.S. dollar portion outstanding under a revolver in prefund all of our 2015 debt maturities, which consists of $400 million of unsecured notes due in March and June at a blended rate of 6.5%, thereby realizing a favorable 300-basis point refinancing spread. Taking into account the $930 million of debt raise in January, we substantially increased our liquidity from $1.3 billion at year end to $2.2 billion currently. Our long-term commitment to a strong balance sheet has remained consistent. We began 2014 with financial leverage of 39.2%, slightly below our long-term target of 40%. We opportunistically took advantage of this balance sheet capacity to finance 2014 acquisitions primarily with debt proceeds, which was motivated in part by currency hedging benefits. As a result financial leverage increased to 41.5% year end 2014 and is forecasted return to a 40% level by the end of this year, principally driven by organic cash flow reinvested in our portfolio. Fixed charge coverage in stable at 4.1 times in 2014 secured debt ratio improved to 5% representing 880 basis point reduction as a result of our strategy to finance mortgage maturities with unsecured notes at a lower cost. Next, our full year 2015 guidance and dividend, our guidance it is not include the impact of any future acquisitions dispositions or early repayment of debt investments and reflects the following. 2015 NAREIT FFO is projected to range from $3.14 to $3.20 per share which reflects $0.01 per share of acquisition and pursuit cost for transactions executed year-to-date. Excluding the deal costs 2015 FFO-as-adjusted is projected to range from $3.15 to $3.21 per share, which at the mid-point is projected increase 4.6% year-over-year. 2015 FAD is projected to range from $2.73 to $2.79 per share which at the mid-point represents a strong 7.4% growth rate compared to 2014. The earnings increase from 2014 is driven by one, our cash same-store growth. Two, a full year benefit from accretive acquisitions completed during the last 12 months. Three refinancing benefit from 2015 debt maturities mentioned earlier, offset slightly by higher G&A as we expanded P&L business development teams including our international platform and the prefunding of our 2015 debt maturities in January. Cash same property performance is projected to increase between 2.75% and 3.75% this year was strong same-store with same-stores capturing 90% of our overall operating portfolio. Paul will discuss the outlook by segments in a few minutes. Note the 2015 earnings projection are describe in more detail on Page 12 of today's earnings release on a per share basis. Let me quickly run through a few assumptions. G&A is forecasted to be $90 million, including stock based compensation of $24 million, amortization are below market lease intangibles and deferred revenue of $4 million, amortization of deferred financing cost of $20 million, straight-line rents of $27 million, DFL accretion totaling $137 million of which $72 million is reported in income from direct financing leases with the remaining $64 million reflected in income from joint ventures. DFL and other depreciation of $27 million, lease restructure payments of $23 million related to the 2014 Brookdale transaction, our 49% share of FFO contribution from the CCRC joint venture to range from $24 million to $26 million and the FAD contribution to range from $46 million to $50 million inclusive of non-refundable entrance fees. Leasing cost in second generation tenant and capital expenditures of $86 million in addition total development redevelopment and first generation capital investment of $315 million including $80 million in 2015 for the Phase 1 Life Science development at the Cove in South San Francisco. Regarding our 2015 dividend, last month we increased our quarterly dividend from $0.545 to $0.565 per share, marking the 30th consecutive year of dividend increases in continuing HCPs representation as the only read in the S&P 500 Dividend Aristocrats index. The annualized dividend of $2.26 per share represents an increase of 3.7% or $0.08 per share for 2014. After taking into account the increase in the dividend and based on the mid-point of our guidance, our projected 2015 FFO-as-adjusted and FAD payout ratios remain low, improving to 71% and 82%, respectively. As a result, we expect to retain $230 million in cash flow after dividends and recurring capital expenditures to continue growing our portfolio. Let me end with a quick word on our expanded disclosure. As you may have noticed this quarter we made available on our website a downloadable list of property addresses for each of our 1,200 assets under management. Added disclosure in our supplemental providing metrics by major markets for a 68-property RIDEA portfolio. As I mentioned earlier, report acquisition and pursuit cost as a separate line item on the income statement for greater transparency. With that, I will now turn the call over to Paul. Paul?

[Paul Gallagher:]

Thank you, Tim. Let me start with an overview of our investments. 2014 represented an outstanding year of growth for HCP, and our progress led by the creation of our $1.2 billion strategic joint venture with Brookdale, the restructure of our legacy Emeritus triple net senior housing portfolio, and our expansion into the international markets. Together, we completed $1.9 billion worth of investments across four of our segments, with the blended cash yield of 7.8%, resulting in a 12% expansion in our total assets under management. During the year, we acquired over 1 million square feet, representing $260 million of medical office buildings. Acquisitions for the quarter included a 327,000 square foot portfolio of three medical office buildings located in Louisville, Kentucky, for $51 million at 7.5% cash yield, which complements our 386,000 square feet of existing MOBs on three hospital campuses in Louisville. Notably, since our last earnings call, we closed our £395 million debt investment in a care home portfolio operated by HC-One, with an 18.2% yield to maturity, bringing our total international investments to over $1 billion with a blended yield of 9%. Our 2015 investment activity, including several new developments is off to a strong start. As announced last week, we broke ground on the first phase of the Cove at Oyster Point, the premier life science development at the gateway to the South San Francisco market. The Cove will be lead silver project and is planned to feature a 5.5 acre outdoor green space, a state-of-the-art amenity center, retail and hotel entitlements. Upon build out, the project will comprise seven buildings, totaling 884,000 square feet, with a high 7% return on cost. The first phase encompasses two Class A buildings, totaling 253,000 square feet at a total cost of $177 million and is expected to be completed by the third quarter 2016. We also entered into a development agreement to construct a $37 million medical office building with the projected return on cost of 8.7%. The 165,000 square foot MOB, will be on the campus of Memorial Hermann's, Cyprus, Texas hospital in suburban Houston and is 25% pre-leased. This is our third ground up MOB development project in process and the second with Memorial Hermann. Our MOB development pipeline now consists of $164 million of projects. We exercised our purchase option right to acquire the newly developed assisted-living and memory care facility currently 98.8% leased in Houston Texas for $36 million. The facility is one of seven in our $141 million participating development loan program with Formation Capital that provides us with the opportunity to convert our debt investments into real estate ownership in and off market transactions. The acquisition is projected to close in the first quarter of 2015 at which time we will realize a 19% unlevered IRR on our development loan. Including the reinvestment of our participation interest of $5 million, our investment provides a yield of 6.6%. Upon closing, the assets will be contributed to our RIDEA joint venture with Brookdale. In addition, we entered into an 85-15 joint venture with Formation Capital to develop a 117-unit independent living facility adjacent to our new development I just mentioned in Houston, Texas. The $29 million development has a 10.9% return on cost and will also be contributed to our RIDEA joint venture with Brookdale. This is the second joint venture with Formation Capital and brings our total senior housing development pipeline to $77 million. In February, we further expanded our relationship with HC-One and facilitated their acquisition of Meridian Healthcare by adding a £108 million short-term bridge tranche to our existing $195 million debt investment. By the end of the first quarter 2015, we expect to convert £174 million of the debt investment into sale-leaseback of 36 care homes. All 36 sale-leaseback facilities will be long-term leased to HC-One at 7.3% initial yield at a 2015 EBITDA and coverage of 1.65 times. Now, let me review the highlights the portfolio's performance. Our life science segment reported an all-time high occupancy of 95.2%. The strong performance of our portfolio coupled with strong demand from life science tenants and low inventory in South San Francisco market were key factors in our decision to undertake the first ground up multi-tenant life science development in South San Francisco, in nearly a decade. The senior housing portfolio performed well in the fourth quarter. As you are all aware, Brookdale reported lower than expected results in the fourth quarter and lowered guidance for 2015, primarily due to a 40-basis point sequential occupancy decreased driven by legacy Emeritus assets. However, HCP 68 RIDEA facilities operated by Brookdale experienced a sequential occupancy increase of 70 basis points as a result of our efforts to identify and commence the capital investment plans for the legacy Emeritus RIDEA assets, immediately upon closing the merger. Our RIDEA portfolio reported an increase in occupancy from the prior quarter of 70 basis points to 86.7%, including a 50-basis point increase in the 40 assets transitioned from Emeritus. As Tim mentioned, we added a new page in the supplemental, Page 22, which provides metrics by major market for all 68 properties in our RIDEA portfolios. Looking at our senior housing triple net portfolio cash flow coverage and Brookdale triple net portfolio remained unchanged from previous quarters at 1.12 times and 1.11 times, respectively. We do expect the coverage to soften slightly in the first half of 2015 and rebound in the latter half of the year as Brookdale implements the integration of the former Emeritus assets and accelerate their CapEx spending to improve the underlying performance of this portfolio. As Tim mentioned, HCP's portfolio produced full year same property growth of 3.3%, representing the sixth consecutive year that we have generated organic growth above 3% and demonstrating the consistency of our real estate portfolio anchored by triple net leases with contractual rent increases. Looking to 2015, we have a positive outlook with same-store cash NOI expected to range from 2.75% to 3.75%. By segment, medical office is projected at 1.5% to 2.5% lower than the mid-point due to too large tenant vacancies. Senior housing and post-acute same-store growth 3% to 4% each, and hospital growth at 1.5% to 2.5%, all driven by contractual rent steps. Life science is projected to grow at 3.5% to 4.5%, driven by strong leasing activity. In summary, we continued to achieve solid growth across our entire portfolio in 2014, driven by strong same-store growth from all five segments, accretive investments in four of our five segments, including significant growth in our international platform and advancements in our development pipeline. With that, I would like to turn it over to Lauralee.

[Lauralee Martin:]

Thank you, Paul. Before I close out the call and open the lines for questions, I would like to discuss our largest operator and portfolio concentration HCR ManorCare. Several of you have noticed this morning an ongoing civil investigated demand involving HCR ManorCare mentioned in our 10-K today. This ongoing investigation began in 2013, and was previously disclosed in HCR ManorCare's 2013 audited financial statements, which we provided as part of our 2013 10-K last year. The investigation is ongoing and as such has been consistently described in the HCR ManorCare's audited financial statements the last two years. Our regulatory counsel has discussed The Department of Justice inquiry with HCR ManorCare's regulatory counsel and HCR believes that it is a material compliance with all applicable laws and regulations and that they are fully cooperating with the inquiry. Investigations such as described by HCR's financial statements are typical of the industry as can be seen in similar filings of Kindred Genesis scale. Turning to HCR's operating performance, in December following receipt of HCR's 2015 preliminary base financial forecast, along with their year-to-date operating performance, we impaired the carrying value of our equity investment in OpCo. HCR's preliminary base financial forecast indicates that HCR will continue to meet its contractual obligation under the master lease with HCP. Their fourth quarter results were consistent with expectations if we exclude one-time costs related to taking back food service capabilities, which they had previously outsourced. Trailing 12-month normalized fixed charge coverage was 1.08 times and normalized leased coverage of 1.81 times at the facility level. HCR end the year with $128 cash balance, after spending $95 million on capital expenditures in 2014. Their total year results for 2014, particularly the second half of the year were impacted by the continued shift in Medicare to Medicare Advantage, which unfavorably impacts reimbursements for both, length of stay and daily rate. Despite the changing reimbursement landscape, HCR did continue to increase its market share and admissions 2014. They also delivered very impressive 9.6% year-over-year EBITDA growth in their hospice and home health business. HCR's strategy focuses on higher acuity, post-acute services, where they continue to demonstrate positive quality and patient outcomes. Their test results with UnitedHealth, regarding clinical care are exceeding expectations. HCR is positioned to benefit with various proposals designed to deliver higher quality care at lower cost such as bundled payments, site-neutral or episodic payments are implemented. We continue to have discussions with HCR on how we can support the success of their business while also improving our lease coverage. As part of those discussions, we have jointly agreed to market for sale and identified who will adopt this 50 non-strategic properties. The proceeds of any sale are anticipated to be reinvested by HCP and then return provides HCR rent relief which will improve both, fixed charge coverage at the corporate level as well as improvement in facility level coverage. Because of the required time to market a transaction and to transfer licenses at the property level, the impact of any sale will likely be seen in the latter part of this year or early 2016. Switching gears, on May 11, we will be celebrating our 30th Anniversary with an Investor Day, held at the New York Stock Exchange in New York City. We hope you will join us, where you can get to know our P&L leaders. Kendall Young, Senior Housing; Darren Kowalske, Hospitals/Post-Acute; Tom Klaritch, Medical Officer; Jon Bergschneider, Life Science and John Stasinos, International, as well as others on our management team. Let me close by again saying how proud I am of the results delivered by HCP professionals in 2014. We have only begun to show you the potential growth and performance we can deliver. Operator, can you now open the lines for questions?

[Operator:]

Certainly. [Operator Instructions] Our first question comes from the line of Joshua Raskin from Barclays. Your question please?

[Joshua Raskin:]

Lauralee, I know you were just talking a little bit about ManorCare. I guess, my question is around the potential asset sales and what prompted that discussion and I guess when did these discussions start and what prompted that? Then related to it have you already identified the potential assets that will be sold and any sort of magnitude or size would be helpful. I don't know if there is a targeted coverage ratio when you are all done. Then I think you said none of this was in guidance, but just want to make sure that was the case, too.

[Lauralee Martin:]

Joshua, none of it is in guidance. If you will recall, we did sell one asset with them last year. We call it the Beckley [ph] asset and it did have benefit for both of us and we have had an ongoing dialogue of are there more assets as you know any portfolio probably has 10% to 15% assets that don't exactly fit the sweet spot and this would fit that profile. Together, we have identified those assets focusing on what are non-strategic. The portfolio it is going to be listed with an agent. It is really at this point in time to tell you what the magnitude of that is what I would say as you all know that this is a good market to go to in terms of selling assets and that would be the goal.

[Joshua Raskin:]

I mean, any sort of color around just sort of thinking about the reinvestment. I mean, in terms of the potential size of this? It sounds like you guys have come together and it sounds like this is different commentary than what you have said in the past. I understand you are constantly evaluating portfolios et cetera, but should we think about this as a material piece of your current relationship?

[Lauralee Martin:]

50 assets out of over 300 is not going to be material, particularly since these are the non-strategic, but directly to your question, what we have agreed with HCR is that we will work this very similar to what we did with Beckley, and that is we would give them rent credit at 7.75% of any proceeds with the idea that both of us are highly motivated to get the highest level of proceeds out of this transaction.

[Joshua Raskin:]

Okay. Then just more broadly on SNFs. Does this, the sort of events that have transpired in the last year or so and the write down, does this change the way you think about your exposure to skilled nursing. I guess, maybe commentary on current rates, you said this is a good environment to sell into, so should we think about HCP broadly speaking probably reducing exposure to SNFs. Is that fair to expect?

[Lauralee Martin:]

We continue to have other operators that we do business with, so we are not at all negative on the space. It has been a space that has been challenged, no question, by changes in regulations. That being said, it's a very important part of the healthcare landscape. It is a part that we plan to be part of.

[Joshua Raskin:]

Okay. Perfect. Thanks.

[Operator:]

Thank you. Our next question comes from the line of Vikram Malhotra from Morgan Stanley. Your question please?

[Vikram Malhotra:]

Lauralee, just following up on that, just in your initial budgeting, I guess, when you looked at those 50 assets and the metrics associated with them, can you give us any kind of broad idea or just color, help us think about what the coverage levels could look like when all that is completed?

[Lauralee Martin:]

It is premature. Again, we were just getting the package together to sell and what we don't know is do we sell all of them, part of them or whatever. It is going to be based on best proceeds and what makes sense for both of us. It is just early in that process. Generally speaking though, these are assets that were not contributing to the coverage of the portfolio, so there is benefits both in terms of proceeds and their impact on the overall coverage.

[Tim Schoen:]

One thing that I would say, when we originally underwrote the sale-leaseback, we had identified what the sub-performing assets had been. We on a regular basis sit down with ManorCare and go through and we view that. Sometimes it expands, sometimes it contracts and given where we see pricing today, it makes sense given the environment and the fact that a lot of the short-term noise with respect to reimbursement seems like it might be at this point in time that it was the right time to evaluate and pull the trigger and go to market and see what we can get for these assets.

[Vikram Malhotra:]

Then just on that, are any amendments required to kind of make those sales or is that all within the lease?

[Tim Schoen:]

No. We have the ability to sell the assets.

[Vikram Malhotra:]

To your point, you said based on the pricing you are seeing, can you kind of just give us a sense of what you are seeing for the quality of assets in the marketplace in terms of pricing?

[Paul Gallagher:]

I think we will let the market determine what the price is going to be.

[Vikram Malhotra:]

Okay. Then just sort of one last clarification on the puts and takes related to the ManorCare EBITDAR, can you just remind us? I think the rate increase went in, in the new fiscal year, but just kind of looking at the decline in the EBITDAR, I am just wondering based on your discussions with ManorCare, was there a big impact from either expenses and can you maybe just give us some color on the shift that occurred this last quarter to Medicare Advantage?

[Lauralee Martin:]

In the fourth quarter, the principal impact was what I had mentioned and that was they took back in-house food service capabilities, so there was a modest charge to do things like build inventories and so forth, so not an ongoing impact but it did impact the quarter.

[Vikram Malhotra:]

Okay. Thanks, guys.

[Operator:]

Thank you. Our next question comes from the line of Juan Sanabria from Bank of America. Your question please?

[Juan Sanabria:]

Hi. Good morning, guys. I was just hoping if you could speak to cash flow generation and liquidity position of ManorCare, and what you would expect the company to reinvest? Do you expect them to be able to put in that $90 million to $100 million in CapEx, and if you could just remind us what is required by your lease?

[Lauralee Martin:]

Right. Well, they ended with $128 million of cash. They also have planned asset sales outside of the 50s modest that are cash proceeds to them their requirement for CapEx on ours is just a little over $30 million. Again, as we get and look at their financial forecast, which they provided to us, they both cover our lease as well as their obligations, so we are very comfortable.

[Tim Schoen:]

I would expect them to be a little bit more cautious with their growth CapEx.

[Paul Gallagher:]

Yes. One thing to bear in mind, Juan, this was originally formed into an OpCo/PropCo. Carlyle spent quite a bit of money at the facility level. For the first couple of years of our lease, we had what we deemed kind of to be above market CapEx spend in the portfolio. Lion share of what they have been spending has been on new value creation and new opportunities. We have expected that the ongoing maintenance to come down to a more normalized run rate, which is the $30 million that Lauralee talked about.

[Juan Sanabria:]

What is that level now?

[Lauralee Martin:]

They were just a touch over 70 in 2014 for maintenance CapEx.

[Juan Sanabria:]

Okay. Thanks for that. Just switching gears to the senior housing portfolio, could you just comment if you are seeing any pressure on costs at all, particularly labor given the strong employment numbers we have seen. Then as a side note to that, if you could just comment on your Houston exposure and what you are seeing on the ground there with what is going on in oil as well as still elevated supplies there locally?

[Paul Gallagher:]

Yes. I can talk a little bit about that. We haven't seen much in the way of the employment other than the issues with respect to integration in our Brookdale portfolio. That said, with respect to Houston, in our portfolio between 2013 and 2014, we spent about $14 million in CapEx, which is a little over $8,000 per unit, so that they would remain competitive. We have seen year-over-year growth in that portfolio in Houston of 7.6% and over 320 basis points of occupancy and over 500 basis points in rate, so we are seeing good results as a result of kind of being proactive on the front end in repositioning those particular assets. With respect to Houston and what we are seeing on development, what have you there, absorption still exceeds the inventory growth by about 110 basis points, however construction is high, we had good success with the leasing of the property that we are buying. As a result of that, we had numerous in-bound inquiries about the independent side and since these this will be complimenting facilities, we think that this is the right investment to be doing at this point time in Houston.

[Juan Sanabria:]

Okay. Great, and just one last question from me. If could you just comment on what drove the sequential decline in occupancies, in the SNF portfolio, was that the continued shift to Medicare Advantage?

[Tim Schoen:]

Yes.

[Juan Sanabria:]

Great. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Michael Knott from Green Street Advisors. Your question please?

[Michael Knott:]

Hey, everyone. Question for you on ManorCare coverage, I think Page 26, you guys showed a 1.08 normalized coverage for 2014. As I recall, when you took the impairment charge, I think you gave a 1.07 number for 2015. Is that a fair assessment that you think that coverage is basically going to remain flat during the course of this year?

[Tim Schoen:]

That is right, based on their base financial forecast. That is right Michael.

[Michael Knott:]

Okay. When you think about the lion share of your HCR investment is in the form of the real estate, you have that sliver in the operator. As you think about future outcomes with your real estate, how would you think about the opportunity or possibility of shifting some of that real estate pocket into the operator pocket?

[Paul Gallagher:]

Well, if you are talking about trading real estate or rent for ownership interest in the OpCo, there are certain limitations that we have as a REIT. From our standpoint, we are going to do what is in the best interest of the HoldCo, which is both the property and the operation and we are closely with ManorCare to figure out what is the best way to maximize value of the entire structure.

[Michael Knott:]

Okay. Then just with respect to that disclosure that was in the ManorCare part of your 10-K last year, what prompted to you put it in the actual HCP portion this year as opposed to last year or why not have done that last year?

[Tim Schoen:]

We just wanted all the risk factors of HCR in one place, Michael. You noticed that every year we go back and reorder a risk factors by order of importance, so we start with tenant concentration and then we mention all the risks associated with HCR and then follow up with Brookdale, so it is really interesting ordering of the risk factors that is really what drove it, then to put everything associated with HCR in one location for the reader.

[Michael Knott:]

Okay. It is not a fair assessment to say that your view of the riskiness of that situation is higher than a year ago?

[Tim Schoen:]

No. I think it just continues to progress.

[Michael Knott:]

Okay. Thanks. That is it for me.

[Tim Schoen:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Smedes Rose from Citi. Your question please?

[Smedes Rose:]

…but I did want to ask you on the Cove development that you announced. You mentioned for another development you pre-leased 25% and you have begun to pre-lease on the Cove development as well?

[Paul Gallagher:]

No. Part of what is driving that is that the market has really changed in South San Francisco from the standpoint of kind of lead time. We have actually seen decision making shorten quite a bit, we were up with several of our tenants this last week right after the announcement, all very excited about the opportunity, all in need of expansion space, but we thought that given what is going on with occupancy and vacancy in the marketplace, what we have seen with rental rates, where we have seen rental rates increase as much as 65% in the marketplace in last 18 months it was the right time to come out of the ground for space. In our portfolio there, we have got 900,000 square feet that we developed adjacent to the Cove. It is basically full at this point in time, so it is just a matter of time that we will have people occupying the space and the reception was quite strong.

[Smedes Rose:]

Sorry. Go ahead.

[Tim Schoen:]

It is me, so we started on as the first phase. I know you are a New York guy, but if you take a 20-storey building and you cut it in phases, we have just started the first phase, which is about 253,000 feet and that is adjacent to our Oyster Point project, which is 100% leased today, so that gives you a little bit more color.

[Paul Gallagher:]

Yes. I think the other thing that is unique about this, we have done quite a bit of development. I mentioned the 900,000 square feet, we did a little over 800,000 square feet with Genentech. This is going to be the first in South San Francisco that is going to be fully contained where you are going to have large green space, you are going to have amenity space both, food and activities and exercise, you are going to have a full service boutique-type hotel on site and this is something that is going to be very unique in the marketplace. We got very good response back from the marketplace as a result of our announcement.

[Smedes Rose:]

Okay. Thanks. Then just in your opening remarks you mentioned you had hired acquisition professionals that would look at a range of acquisition sizes, including smaller ones. Are you seeing more attractive opportunities on smaller assets or larger portfolios harder to track down or is there any kind of additional detail there?

[Lauralee Martin:]

I said mid-sized transactions and you can see it in our activities, just our medical office that we invested in this quarter.

[Paul Gallagher:]

Yes. I think if you look across the spectrum, medical office and life science are going to be more of the one-off type buildings. Obviously, there are portfolios there, but a lot more one-off buildings where as the skilled nursing and the senior housing are much more portfolio-based.

[Smedes Rose:]

Great. Okay. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Daniel Bernstein from Stifel. Your question please?

[Daniel Bernstein:]

Good afternoon. Not to keep going on the HCP, the HCR leases, but is there a lease termination fee that you might be able to get on the sale of those assets that might contribute to your cash position?

[Tim Schoen:]

No.

[Daniel Bernstein:]

Okay.

[Tim Schoen:]

No. We would just redeploy the proceeds, Dan.

[Daniel Bernstein:]

Okay.

[Paul Gallagher:]

We would get the proceeds from the sales and then go ahead and redeploy those.

[Daniel Bernstein:]

Okay.

[Tim Schoen:]

I think about what we do with the Kindred assets last year.

[Daniel Bernstein:]

Okay. Then is there any obligation in your leases to fund CapEx? I think you are funding some CapEx for Brookdale, but do you have any obligations or lines that they could draw upon to fund their CapEx if they want it to?

[Tim Schoen:]

No. We do not have any obligations under the leases to fund the CapEx, but we would look at that and we have talked about that in the past that we would look at providing new growth capital if it is expansion of an existing facility or opportunity to increase their market penetration in certain markets?

[Paul Gallagher:]

We do that across the board in our portfolio.

[Daniel Bernstein:]

Okay. Then when I am looking at that your projection for 1.07 fixed charge coverage, how should I think about that going through the quarters? Is that going to dip down closer to one, and then pop back up the second half of the year or is it going to be just relatively steady? How should I think about the pattern policy this year?

[Tim Schoen:]

Yes. It is relatively steady Dan, but it will have some seasonality to it.

[Daniel Bernstein:]

Okay. Then just want to get off that real quick, the CCCR JVs, you are developing some property that would go in there, are those actually CCRCs that you are developing to put in a joint venture or is it some other combination assets?

[Paul Gallagher:]

We have got two scenarios. One is, we are buying a loan that was or a property that was in our development loan program and that is going into our RIDEA joint venture with Brookdale, and we are also doing a ground-up development joint venture with Formation. Upon completion, that particular project is also going to go into our Brookdale RIDEA joint venture.

[Daniel Bernstein:]

Okay.

[Lauralee Martin:]

Those are 90/10.

[Tim Schoen:]

The loan aspect is assisted living and memory care. The new development is going to be independent living.

[Daniel Bernstein:]

Okay, so they are not really CCRCs, but they are moving in, are still moving.

[Tim Schoen:]

These are properties that are adjacent to each other and based on the demand

[Daniel Bernstein:]

Okay.

[Tim Schoen:]

…that we got from the AL and memory care, it just made sense to go ahead and do the independent living component.

[Daniel Bernstein:]

Okay. Can you talk just broadly about the opportunities there to develop more CCRCs and acquire more CCRCs? How should I be thinking about how fast you can grow that joint venture with Brookdale?

[Paul Gallagher:]

I would probably look at it more from an acquisition standpoint as opposed to a development kind of play.

[Daniel Bernstein:]

Okay.

[Paul Gallagher:]

It is really going to be a function of the opportunities that are out there. We have actually seen a couple of portfolios here in the last six months. We continue to mine, there is a lot amount of profits out there that could potentially use some liquidity, so we are actively pursuing those opportunities.

[Daniel Bernstein:]

Okay. I have asked plenty of questions. I will hop off. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Nick Yulico from UBS. Your question please?

[Nick Yulico:]

Thanks. Going back to the talk of the possible asset sales at HCR ManorCare, when you are having those discussions with the majority owner of HCR ManorCare to explore a rent cut on the master lease as a way to sort of ease the financial burden of would looks like a pretty tough capital structure at ManorCare right now?

[Lauralee Martin:]

Well, just to reiterate, HCR's forecast show they can and will pay our rent as well as met the CapEx obligations of our lease so let me start with that. We have also said very consistently, if the rent restructure is to be considered, it would need to be beneficial to our shareholders. A good example is our transaction with Brookdale where we demonstrated that positive trades could be mutually made but without similar type benefits with HCR we are very happy to continue to collect the rent. I would say, though that we are very favorably positive about the recent joint decision to market up to 50 nonstrategic properties because that is a very constructive way for them to address parts of their portfolio that are not necessarily additive to their strategy.

[Nick Yulico:]

Okay. And so it sounds like we could infer that rent cut is probably not on the table right now and you said, you are going down the asset sale approach first to see if that maybe helps things?

[Lauralee Martin:]

Yes.

[Nick Yulico:]

Okay. And then we are going on term loan that HCR ManorCare has, how close are they to breaching the covenants in that term loan, and if they are breached in the next, whatever they might be breached, how does that what does that mean for your rent payments?

[Lauralee Martin:]

Well, they are in compliance.

[Tim Schoen:]

And they remain in compliance with their term loan, Nick, and they have room to remain in compliance there. Any default on any debt over $25 million is a default under our lease.

[Nick Yulico:]

Okay. Thanks. I think Rose add follow-up.

[Smedes Rose:]

Thanks. Going back to the talk of the possible asset sales at HCR ManorCare, when you are having those discussions with you also meet with the majority owners of HCR ManorCare to explore a rent cut on the master lease or the way they sort of ease the financial burden of what looks like a pretty tough capital structure at ManorCare right now?

[Lauralee Martin:]

Well, just to reiterate, HCR's forecast show they can and will pay our rent as well as met the CapEx obligations of our lease, so let me start with that. We have also said very consistently, if their rent restructure is to be considered it would need to be beneficial to our shareholders. A good example is our transaction with Brookdale, where we demonstrated that positive trades could be mutually made, but without similar type benefits with HCR, we are very happy to continue to collect the rent. I would say, though, that we are very favorably positive about the recent joint decision to market up to 50 non-strategic properties, because that is a very constructive way for them to address parts of their portfolio that are not necessarily additive to their strategy.

[Nick Yulico:]

Okay. It sounds like we could infer that. Rent cut is probably not on the table right now and you said, you are going down the asset sale approach first to see if that maybe helps things?

[Lauralee Martin:]

Yes.

[Nick Yulico:]

Okay. Then regarding the term loan that HCR ManorCare has, how close are they to breaching the covenants in that term loan. And if they are breached in the next, whatever they might be breached, what does that mean for your rent payments?

[Lauralee Martin:]

Well, they are in compliance.

[Tim Schoen:]

Yes. They remain in compliance with their term loan, Nick, and they have room to remain in compliance there. Any default on any debt over $25 million is a default under our lease.

[Nick Yulico:]

Okay. Thanks. I think Rose add a follow-up.

[Smedes Rose:]

Yes. Hey, guys. I just wanted to follow-up on the asset sale question. 50 properties is about 19% of the 267 SNFs that is you have with HCR. I am guessing this is not going to be the right math, but if you took 19% of your investment of $5.7 billion, you would be looking at $1.1 billion of asset value. Is it fair to say that we should not be expecting anywhere near $1.1 billion of proceeds given that these are the weaker assets in the portfolio?

[Lauralee Martin:]

I think that would be an accurate statement.

[Smedes Rose:]

The second part of it would be, in thinking about a cap rate, I know it does not serve you to discuss cap rates ahead of a sale, but just big picture here while a rent cut is not happening today, it would seem to me that these things are going to get sold at significantly higher cap rates on what the implied rent would have been versus where you are going to be able to redeploy those proceeds in today's lower cap rate environment. In essence, shareholders will be suffering some dilution as a result of these asset sales. Can you talk maybe to that dynamic a little bit?

[Lauralee Martin:]

Well, we have talked about a 7.75% rent credit on proceeds. If you will recall, we have been, you are right, I think it is a competitive marketplace, but we have been highly successful with the investments that we have had to be above that number or and believe we can be close to it. I think it is insignificant the impact.

[Paul Gallagher:]

We invested $1.9 billion in 2014 at 7.1%, so we will take that reinvestment risk.

[Smedes Rose:]

Just to make sure we all understand that rent credit, you are suggesting when we look at the master lease after these assets sales and we are thinking about what the remaining rent is on I guess what the, let's call it, 217 assets, you are suggesting we just take that 775 rent credit. I am trying to think about backing into.

[Lauralee Martin:]

It's again proceeds from a sale, so it is depends on what the asset sale for that dollar number times 7.75%. It is independent of the rent of the assets.

[Smedes Rose:]

Okay. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Michael Carroll from RBC. Your question please?

[Michael Carroll:]

Thanks. Can you break out the CapEx spend by HCR ManorCare? What was maintenance and what was guess new CapEx or gross CapEx in 2014?

[Tim Schoen:]

Yes. In terms of maintenance CapEx, it has been $40 million $50 million range, Mike. There were some renovations. Lauralee mentioned the $70 million number, so call it $20 million to $30 million of renovations and improvements to the facilities. Then the rest of it growth CapEx call it $25 million to $35 million. I am rounding, Mike, but it gets you directionally there.

[Michael Carroll:]

Okay. You think going into 2015, they will do the maintenance CapEx and be more thoughtful about the growth and the new CapEx?

[Tim Schoen:]

Yes. That is right.

[Michael Carroll:]

Okay. Then can you also talk about, what was the logic of agreeing to switch the U.K. debt investment into a lease? Are you planning on doing that on more of the HC-One portfolio over time?

[Tim Schoen:]

Well, I will let Paul answer.

[Paul Gallagher:]

Yes. We had the ability to get in and see the performance of some of the underlying assets and worked with the operator to lock in kind of long-term escalating-type income as opposed to debt that at some point in time that is pre-payable. The assets are good, high quality assets, we got a great operator there and we look forward to in the long-term relationship that we have with HC-One and [ph] .

[Tim Schoen:]

Mike, as we mentioned, we have about $1 billion portfolio of debt and we would like to convert that into long-term ownership or real estate over time. I think Paul has pointed out a couple of things. One is the sale-leaseback opportunity with HC-One and then the other one was the development loan that Paul had mentioned in the script, both of those are good examples of using debt to create long-term ownership of real estate and then having nice attractive growth in those assets over time, so converting net debt to an equity ownership in real estate.

[Michael Carroll:]

Okay. Great. Thanks.

[Operator:]

Thank you. Our next question comes from the line of Rich Anderson of Mizuho Securities. Your question please?

[Rich Anderson:]

Good morning. When I wrote my note this morning, I searched the 2013 10-K and there is no doubt that the disclosure of the issue with HCR ManorCare was way more obscure than it is in the 2014 disclosure and your 2014 10-K. If nothing has changed there in your mind and it is just kind of see how it goes, why did you escalate the disclosure? Further, why not just put it in your press release, particularly considering the sensitivity everyone has around this tenant, why not be an full open book and make sure everyone is aware of what is going on?

[Paul Gallagher:]

Did you put out a note this morning Rich? To answer your question, listen, we go through our risk factors every year, but we just want to put all of the risk factors associated with HCR in one place. They had been scattered, not scattered but they were throughout our 10-K document previously. As I said previously, when I answer the question, we ranked our risk factors. HCR is obviously our largest tenant concentration and we put all of the risk factors associated with HCR in one place. We did that, Rich, because obviously the coverage ratio has become tighter in the 2014.

[Lauralee Martin:]

Rich, the other thing I think it is important is these investigations are very, very typical of the Industry. You have similar filings with Kindred, you have similar filings with Genesis and HCR has a long history of high quality care and a long history of compliance with regulations, so they believe they are in compliance and we support that decision.

[Rich Anderson:]

A coordinated effort by the Department of Justice, the Department of Health and Human Services, the Office of Inspector General? All these, this is par for the course for any?

[Lauralee Martin:]

…the industry.

[Paul Gallagher:]

Yes. It is not unique to HCR, Rich. It is not new news. It has been out there since 2013.

[Rich Anderson:]

Okay. Then we have all been talking about this HCR coverage. Why not open your book and say, by the way, we have this out there. I cannot imagine everyone knew about this, so why not be an open book and say this is out there we just want to make sure everyone is aware as we are talking about rent coverage and what is going on. We also have this issue to make sure everyone is aware of and then it is out there and everyone has the full information. Just curious why not fully disclose the whole entire picture?

[Tim Schoen:]

Well, first of all I think we have fully disclosed. Second of all, we have been answering questions about these investigative demands since 2013, so I do not know what else to tell you.

[Rich Anderson:]

Okay. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Derek Bower from Evercore ISI. Your question please?

[Derek Bower:]

Great. Thanks. Could you talk about how you are thinking about this source of capital for future investments given your leverage targets are now above your 40% long-term target?

[Paul Gallagher:]

I am sorry can you repeat that?

[Derek Bower:]

Yes. Your current leverage is above your 40% long-term target, so I was just curious to know how you are thinking about funding needs for future investment activity.

[Tim Schoen:]

Yes. As I mentioned in my prepared remarks, we are little a bit about our target, because we have utilized debt for the benefit of our currency hedging. If you took our organic net cash flow from this year, we expect to return to that 40% leverage ratio. You should continue to think that as we look at acquisitions that we would finance that in 40 parts debts, 60 parts to equity basis, so no real change. It is just that we utilize the debt for hedging purposes, because we had done more transactions in the U.K. late in 2014.

[Derek Bower:]

Okay. Got it. Thanks. Then just lastly, do you have any updated thoughts on potentially diluting your ManorCare concentration through investing in other property segments? I know despite the competitiveness of the market, would you be more inclined to maybe purchasing larger senior housing or MOB portfolios just so ManorCare is less of a headwind or less of a noise for your overall story?

[Tim Schoen:]

Well, I will let our Chief Investment Officer answer that, but I think generally we look at investing on attractive risk adjusted basis and that is the better arc of our investment decisions.

[Paul Gallagher:]

Over time with the investments that we have made, we have actually whittled down the exposure to below 30% at this point in time, so we continue to work o that.

[Operator:]

Thank you. Our next question comes from the line of Tayo Okusanya from Jefferies. Your question please?

[Tayo Okusanya:]

Yes. Good afternoon. Most of my questions have been answered, but in regards to the line of questioning around the rent cuts, I understand what mindset, but in April when you get the additional 3.5% rent bumps it seems like that is built into the 2015 guidance. I just wanted to confirm whether that was already a foregone conclusion that was going to happen or whether it could still be part of the negotiation process?

[Lauralee Martin:]

That is built into the forecasted it is built into ManorCare.

[Tim Schoen:]

It is also built into the budgeted coverage of 107 times as well.

[Tayo Okusanya:]

Okay, so it is also built into the budgeted coverage at 107. Okay. That is helpful to know. Thank you.

[Tim Schoen:]

Yes. That is right, Tayo.

[Operator:]

Thank you. Our next question comes from the line of Todd Stender from Wells Fargo. Your question please?

[Todd Stender:]

Hi. Just a couple questions remain. Just looking at life science leases assigned in the quarter, what kind of return profiles are you looking at? You are repositioning at least three assets, I see, you are putting money into the South San Francisco building. Can you just talk about what that return profile looks like with new additional cash being put in?

[Paul Gallagher:]

I am sorry. I missed the first part of that question. Can you repeat that?

[Tim Schoen:]

The development.

[Todd Stender:]

Sure. Just the repositioned assets, I am just looking at the three repositioned life science facilities that you have got Sacramento, South San Francisco and San Diego. One of those return profiles look like, now that you are putting more money into the buildings?

[Tim Schoen:]

On an incremental basis, those are up around near the high teens or in one case almost 20% on additional invested capital. On an overall basis, they would be in the 7% to 7 5% range.

[Todd Stender:]

Okay. That is helpful. The seven-year lease on the biotech, the 30,000-square foot building, is that a vacant building right now?

[Tim Schoen:]

Yes.

[Todd Stender:]

Okay Thanks. Paul, I think when you were going over the medical office building forecast for 2015, it sounded like you are expecting to get a decline in medical office. Did I hear that right?

[Paul Gallagher:]

We have two tenants that we know are going to vacate. In the guidance shows them leaving the space or actively looking to backfill that and hopefully we can get tenants in there soon than expected.

[Tim Schoen:]

Todd, the same-store impact of that is, we expect about 2% same-store growth in the MOB segment. Absent those couple of buildings that Paul just mentioned, we would be closer to the 275 to 3% growth rate range for MOBs.

[Paul Gallagher:]

On the radar screen, our guys do a pretty good job of being proactive and getting those spaces filled, hopefully we can get the space released quicker.

[Todd Stender:]

Okay. That was my next question. Thanks Tim.

[Tim Schoen:]

Yes.

[Operator:]

Thank you. Our next question comes from the line of Michael Mueller from JPMorgan. Your question please?

[Michael Mueller:]

Thanks. Hi. If you do sell the 50 properties, can you give us a sense as to how significant the fixed charge coverage benefit could be? I think just a rough magnitude, are you thinking five basis points, 10 basis points, could it be more than that?

[Lauralee Martin:]

It is way too premature…

[Tim Schoen:]

We will let you know after we have some prices discoveries..

[Lauralee Martin:]

Yes.

[Michael Mueller:]

Okay. That was really it. Thanks.

[Tim Schoen:]

Thanks, Mike.

[Lauralee Martin:]

One more question operator?

[Operator:]

Certainly, our final question comes from the line of Todd Lukasik from Morningstar. Your question please?

[Todd Lukasik:]

A couple questions on sale-leaseback over in the U.K., with the leasing market there, is it similar to expect the same type of rent escalators that you guys would normally see for a U.S. investment of that type?

[Tim Schoen:]

We usually use what is known as the RPI which the U.K. covalent of CPI and typically we have floors and ceiling very typical to what we have in the U.S.

[Todd Lukasik:]

Okay. Great. Then I think you mentioned 1.65 EBITDARM coverage to start out with, is that a level that you would expect to be maintained over time or is that either too high or too low at this point?

[Paul Gallagher:]

No. We would expect it to grow and that is norm over in the U.K. to quote an EBITDARM number if you quick that to a more normal EBITDARM number, it is about 135 coverage and it is pretty much a market type coverage in U.K.

[Todd Lukasik:]

Okay. Great. Thanks. That is all I had.

[Operator:]

Thank you. This does conclude the question-and-answer session of today's program. I would like to hand the program back to Lauralee Martin, President and Chief Executive Officer.

[Lauralee Martin:]

Thank you very much. Well, again, thank you all for joining us and let me close by remaining you that May 11th is our Investor Day in New York, and we hope to see many of you there. Thank you so much.

[Operator:]

Thank you, ladies and gentlemen, for your participation today’s conference. This does conclude the program. You may now disconnect. Good day.