Healthpeak Properties, Inc. (DOC) Q2 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2013 HCP Earnings Conference Call. My name is Darla, and I will be your coordinator today. [Operator Instructions] Now I'd like to turn the presentation over to your host for today's conference call, John Lu, Senior Vice President. You may go ahead, sir.

Thank you, Darla. 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 currently available 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 2012. 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 to these measures to the most 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 terms are defined in our supplemental information package. I will now turn the call over to our Chairman and CEO, Jay Flaherty.

Thank you, John. Welcome to HCP's Second Quarter 2013 Earnings Conference Call. Joining me this morning are Executive Vice President, Chief Investment Officer, Paul Gallagher; and Executive Vice President, Chief Financial Officer, Tim Schoen. Let us begin with our results, and for those, I turn the call over to Tim.

Thank you, Jay. Let me start with our second quarter results. Our same property portfolio produced strong 3.5% cash NOI growth compared to the second quarter last year, driven by our senior housing triple-net and RIDEA portfolios. Cash same-store growth ramped up during the quarter, consisted with our forecast and represents the level of organic growth expected for the second half of 2013. Paul will discuss our results by segment in a few minutes. We reported second quarter FFO of $0.72 per share and FAD of $0.62 per share, representing year-over-year growth rates of 4.3% and 10.7%, respectively, driven by $2.5 billion of accretive acquisitions completed in the second half of 2012 and strong cash same-store growth in our FAD results. Note that 2 nonrecurring items impacted the comparative quarterly results: first, a prior year quarter included a favorable $0.02 recovery of past G&A expenses; second, results this quarter included an unfavorable $0.02 per share noncash adjustment related to straight-line rents in our hospital segment, which reduced revenues and FFO for the second quarter but had no impact on our cash same-store or FAD results. Excluding these nonrecurring items, the year-over-year growth rate for the quarter was 10.4% for FFO and 14.8% for FAD. Turning to investment transactions and balance sheet. During the quarter, we made accretive investments totaling $367 million that consisted of: first, GBP 109 million or $170 million multitranche U.K. debt investment on properties leased to Barchester Healthcare purchased at a 10% discount to par. The debt earns interest on a blended rate of LIBOR plus 3.14% and is scheduled to mature in September, 2 months from today; second, $102 million second tranche investment under our mezzanine loan facility to Tandem Health Care funded 2 months earlier than anticipated. As previously announced, the second tranche earns cash interest at 14% annually, bringing the blended yield to 13% on the overall $202 million facility; and third, $95 million related to the acquisition of 2 senior housing communities, along with other capital and debt investments. We funded these investments with free cash flow and $262 million under our $1.5 billion revolver, including GBP 109 million to match fund our Barchester debt investment through maturity. We have $1.3 billion of immediate liquidity from our revolver and cash balances before taking into account the anticipated par payoff of our Barchester debt investment on September 30. Debt maturities for the remainder of 2013 total $655 million at a weighted average interest rate of 5.9%, including $400 million of unsecured notes and $255 million for mortgage debt. Our balance sheet and credit metrics continue to improve over year-end 2012 levels. On a trailing 12-month basis, fixed charge coverage increased 20 basis points to 3.8x, and net debt-to-EBITDA improved 20 basis points to 5.1x. Our secured debt ratio declined 30 basis points to 8% at year-end Q2, which will further improve to 6.9% by year-end, based on our current refinancing plans. Finally, updates to our 2013 guidance. Our existing portfolio is performing in line with forecast. We continue to project full year cash same-property performance to increase between 2.5% and 3.5%. For the second half of 2013, cash same-store is expected to grow at or above the 3.5% level achieved this quarter. We are raising our 2013 FFO guidance by $0.02 per share to a range of $2.96 and $3.02 per share. The increase is driven by the following items not contemplated in our last guidance: a $0.04 benefit from our second quarter investment activities, including $0.03 related to a one-time gain from the anticipated par payoff of our Barchester debt investment, net of transaction costs, offset in part by the $0.02 non-cash charge recorded in Q2 mentioned earlier. We are raising our 2013 FAD guidance by $0.05 per share to a range between $2.46 and $2.52 per share, driven by the $0.04 accretive benefit from 2013 acquisition activity and $0.01 from several other items. At the midpoint of our updated guidance, 2013 FFO per share is projected to increase 8% compared to 2012 FFO as adjusted, and FAD is projected to grow 12% compared to last year. With that, I will now turn the call over to Paul. Paul?

Thank you, Tim. Now let me review the portfolio's second quarter performance. Senior housing. Occupancy for our senior housing platform was 86%, a 60-basis-point increase over the prior year and a 70-basis-point decline over the prior quarter. The sequential decline is attributable to seasonal occupancy declines and a severe flu season. Cash flow coverage for the portfolio was 1.10x, a 1-basis-point decline from the prior quarter, driven by outsized fixed rent bumps on our transitioned assets. Same property performance increased 6.4%, driven by contractual rent steps, including higher rents for assets transitioned to new operators and continued strong 2013 performance of our RIDEA portfolio. Post-acute/skilled nursing. HCR's normalized fixed charge coverage for the trailing 12 months ended June 30, 2013 was 1.24x, a decline of 4 basis points from the March 31, 2013 coverage of 1.28x. HCR's year-to-date 2013 revenues are above the prior year despite challenging volume trends in the acute care hospital industry and lower average lengths of stay for post-acute patients at HCR's facilities. Year-to-date admissions are up 2% compared to the prior year, with a lower average length of stay. A reflection of positive patient outcomes resulted in occupancy for the quarter ended June 30, 2013 of 84.1% or 120 basis points below the prior year. All of HCR's operating sectors have demonstrated strong cost control. In addition, home health and hospice continue to report results above prior year. Year-to-date, HCR has generated $60 million in free cash flow after rent, interest and maintenance CapEx. And total CapEx, including investments to maintain, upgrade and expand our facilities, is consistent with a $100 million annual run rate. Turning to our non-HCR post-acute/SNF portfolio. Cash flow coverage was 1.49x, a 1-basis-point increase over the prior quarter. Same property performance for the non-HCR portfolio increased 3.7%, driven by normal rent steps. On May 2, 2013, HCP acquired a GBP 120 million participation in a mezzanine loan facility at 90% of par, secured by 160 care homes leased to Barchester Healthcare, a leading operator throughout the United Kingdom. The loan is subordinate to a GBP 529 million CMBS loan, and both mature on September 30, 2013. The anticipated par payoff at maturity will provide HCP with a gain of GBP 12 million or $18 million, an annualized IRR of 32%. On June 24, 2013, HCP funded the $102 million second tranche of a $202 million mezzanine loan facility to an affiliate Formation Capital as part of the recapitalization of its Tandem skilled nursing portfolio. The loan has a blended yield to maturity of 13.3% and matures October 2017. The portfolio has a debt service coverage ratio of 1.81x. Hospitals. Cash flow coverage was unchanged to 5.35x, driven by strong performance at our HCA hospital at Medical City Dallas. Same property performance increased 3.3%, driven by increased cash rents on our recently repositioned Plano, Texas facility. Medical Office Buildings. Same property performance was up 0.2%, driven by rent steps, partially offset by a decline in occupancy of 100 basis points from the prior quarter to 90% related to the relocation of 2 major tenants to their own building. Excluding these relocations, the same property performance increased 1.9%. During the quarter, tenants representing 578,000 square feet took occupancy, bringing the year-to-date leasing total to 901,000 square feet. The year-to-date retention rate is 68%, and the average term for new and renewal leases is 66 months. Mark-to-market rents declined 1.2%, driven by the renewal of 4 long-term leases where HCP's tenant improvement allowance was minimal. We have 887,000 square feet of scheduled expirations for the balance of 2013, net of 362,000 square feet of month-to-month leases. We have executed 320,000 square feet of leases that have yet to commence and have an active leasing pipeline of 1.3 million square feet. Life science. Occupancy for our life science portfolio increased 10 basis points from the prior quarter to 91.6%. For the quarter, we completed 17,000 square feet of leasing, bringing the year-to-date total to 261,000 square feet with a retention rate of 58.7%. Same property performance was up 0.2%, driven by rent steps, partially offset by mark-to-market rent reductions and vacancy associated with the downsizing and consolidation of Takeda's South San Francisco operations into one of our San Diego properties during the first quarter. Excluding these items, same property performance increased 2.2%. Last week, we executed a 5-year 63,000-square-foot lease with Genentech for the entire building recently vacated by Takeda, expanding Genentech's total footprint in our South San Francisco portfolio to 857,000 square feet. The life science portfolio has 322,000 square feet of scheduled expirations for the balance of 2013, representing just 0.3% of HCP's annualized revenues. The expirations include 77,000 square feet in Durham, North Carolina at a recently acquired redevelopment project where we are converting office to lab space. Duke University has pre-leased 100% of the space for a 15-year term. The life science development pipeline consists of 3 redevelopment projects currently 70% pre-leased totaling 166,000 square feet and a development project that is 100% pre-leased totaling 115,000 square feet. Total remaining funding requirements for the development pipeline are $36 million. Sustainability. Yesterday, we published our comprehensive second annual sustainability report based on the Global Reporting Initiative framework. The report is available under the Sustainability section of our website. Additionally, we recently completed our sustainability reporting effort for 2012, which includes the submission of our first annual Dow Jones Sustainability Index assessment, our second annual Carbon Disclosure Project survey and our second annual Global Real Estate Sustainability Benchmark survey, which was combined with NAREIT's Leader in the Light Questionnaire. During the quarter, we received 2 ENERGY STAR labels, bringing the total to 104 across the MOB, life science and senior housing sectors. In addition, we received 2 LEED certifications, a LEED Commercial Interior certification for our 180 Kimball building at our South San Francisco life science campus and a LEED certification at our only Maryland senior housing development project. With that, I'd like to turn it over to Jay.

Thanks, Paul. We are very pleased with this quarter's 14.8% year-over-year growth in FAD per share, adjusted for the prior year nonrecurring item Tim mentioned. Let me now add additional color on 3 separate topics: one, this quarter's results; two, our senior housing development initiatives; and three, the current transaction environment. As previewed on our first quarter call, same property performance accelerated to 3.5% for the second quarter, with each of our 5 property sectors making positive contributions in the period. Senior housing led the way at a 6.4% same property performance increase, benefited from outsized contractual escalators on transitioned assets and continued improvement at our RIDEA joint venture with Brookdale, where a 5.6% increase in revenues raised margins by 210 basis points to 38.2%. We are pleased with the outperformance of our Blackstone JV acquisition of last October as year-to-date, year-over-year EBITDAR is up 11.8% and trailing 8 months lease coverage has moved up 2 basis points to 1.08x. HCR continues to face headwinds, notably the softness in admission and patient volumes experienced by the acute care hospital sector. As 90% of HCR's admissions represent discharges from the hospital sector, this dynamic negatively impacted HCR's occupancy during the first half of 2013. Notwithstanding this operating environment, HCR continued to invest significant capital in our properties while growing its cash balances to $162 million at quarter end. We began discussions with tenant to determine the fair market value of our 3 hospitals as part of their decision to exercise purchase options on these facilities. As disclosed on our Q1 earnings call, the sale of these 3 hospitals is expected to close in the first quarter of 2014. In our life science sector, same property performance and occupancy continue to grind higher. We are pleased with the additional tenant exposure to Roche/Genentech, which now constitutes 18% of our life science portfolio. The relationship expanded to a total of 857,000 square feet as a result of Roche/Genentech leasing the entire building in South San Francisco that was vacated by Takeda earlier this year as Takeda consolidated and expanded their operations to HCP's life science portfolio in San Diego. In our MOB sector, we are experiencing some delay in tenant decisions as physician groups and hospitals remain cautious on making longer-term commitments, given uncertainty surrounding the implementation of the Affordable Care Act. In addition to this quarter's successful Barchester debt investment, our sector leading that platform enjoyed good operating results at Four Seasons U.K. and Tandem Health Care, with trailing 6-month debt service coverage at both companies at solid 1.8x levels. Finally, to close out the quarter, HCP's credit metrics continue to track at A- levels, and our immediate liquidity is substantial. Let me now provide an update on our senior housing development initiatives. In the second quarter, HCP closed on a $22 million loan commitment for the development of a Class A senior housing facility in Doylestown, Pennsylvania. This loan commitment represents the seventh investment by HCP in our participating development loan program, bringing the total program commitments to over $140 million. Under the program, HCP provides approximately 80% of the total development costs, with HCP participating in up to 30% of the anticipated value creation. The total program consists of 690 units spread between 130 units of independent living, 380 units of assisted living and 180 units of Alzheimer's. Total development costs of $173 million approximate $250,000 per unit. The properties are located in Germantown, Tennessee; Olney, Maryland; Horsham, Willistown and Doylestown, Pennsylvania near the mainline area of Philadelphia; Roseland, New Jersey; and Houston, Texas. The 4 properties in lease-up were delivered on time, under budget and are performing at or above underwriting. 2 of the remaining 3 communities still in development are expected to be delivered in the third and fourth quarters of 2013, while the Doylestown property is scheduled for the first quarter of 2015. Brookdale Senior Living operates 5 communities, and Atria operates 2. Stabilized return on cost for the portfolio is estimated to be 12%, an attractive spread over current senior housing acquisition cap rates. Now in addition to the development loan program, HCP has a development joint venture, where HCP provides 72% of the equity for the construction of a high-end senior housing community in the Hyde Park neighborhood of Tampa, Florida. The property is now complete, 100% occupied with a waiting list and operated by Brookdale. The property achieved a 13% return on costs and upon refinancing of the third-party construction loan later this year is expected to return all of HCP's $8 million of equity, plus a profit of $4.5 million, resulting in an unlevered IRR of 17%. This anticipated monetization represents additional upside to our current 2013 guidance. As for the current deal environment, it is fair to say that Fed Chairman Bernanke's comments of 2 months ago and subsequent capital market volatility has impacted our near-term deal volumes. While we were not hard on any commitments at the time of the sell-off when the whistle blew, it remains to be seen how quickly the pause button that was pushed on May 22 resets on revised terms. Our raised guidance of this morning puts HCP on track to deliver a 2013 12% increase in FAD per share over our 2012 result. This is especially gratifying in light of the high percentage of contractual investments, either triple-net leases or debt obligations, that comprise HCP's portfolio. If achieved, our dividends pro forma FAD payout ratio for 2013 would improve to 84%, providing significant free cash flow for HCP to fund accretive investments. Please take a few minutes to visit our website and view our new GRI sustainability report, which was published yesterday. The report is comprehensive in nature and reflects the incredible hard work of HCP colleagues across our organization. Well done by all. Lastly, I want to congratulate Milton Johnson on his elevation of last night to CEO of HCA. Milton is a long-time friend and partner of HCP. We remember Milton fondly as the point person on our 2003 acquisition of HCA's Medical Office Building portfolio. Well-deserved and well done, Milton. That concludes our formal remarks. We are delighted to take your questions at this time. Darla?

[Operator Instructions] Your first question comes from the line of Nick Yulico with UBS.

Just had a question -- a couple of questions. One, Jay, I mean, you talked about senior housing, whether it's the Brookdale, RIDEA or the Blackstone, Emeritus assets seemingly performing a little better than your expectations. I mean, how is that affecting your thinking on -- are you looking at more senior housing these days, whether it's in development financing or RIDEA or triple-net, I mean, because of the performance you've achieved so far?

No, I don't think the -- what we're looking at is a function of our outperformance that we're realizing. I think we're going to -- given our 5x5 platform, we're going to see opportunities across all of our 5 property types, including senior housing, and then up and down our 5 property types, be it development, mezz debt investing, joint venture opportunities or just fee simple real estate. So I don't think that's the cause. I do think our results make us -- our results and the different ways in which we play the space, be it development, joint venture, mezz debt or fee simple ownership, make us a better informed and hopefully a wiser acquirer of properties in terms of both the economics and the structures we employ.

Okay. And then turning to the Barchester investment, your expectation is that you're going to be paid off at par in September. Is there -- is the expectation there that it's going to be a cash payoff? Or is there a possibility that you could get, say, an equity investment -- I mean, I know that's structured as an OpCo/PropCo. So is there a chance perhaps you could get an equity investment in some fashion there?

Our expectation is it will be a par payoff for cash on or before September 30, Nick.

Okay. And then just lastly on the life science lease that you did recently, does that -- can you talk a little bit about how the NOI impact there? I mean, are you going to be -- your same-store was hit by losing NOI from the expiration this year, and then you're releasing it, that starts next year. I mean, is that kind of a neutral NOI impact?

Actually, Nick, that lease will kick in in 2014, so it will be a positive for 2014.

Okay. But is it -- I mean, was it really similar to the previous rents?

No, it was leased at the high $2, and, again, I'm a West Coast guy, but $2 and -- a high $2 range on a monthly related basis.

Your next question comes from the line of Jeff Theiler with Green Street Advisors.

I just want to talk a little bit about senior housing and supply. We've seen some supply increases coming through the NIC data, especially in the freestanding memory care segment, where you obviously have a significant concentration of your properties, I think around 7,000 units or a little bit more from HCR ManorCare. Has HCR ManorCare adjusted its projections for this sector at all? And is this something you're concerned about impacting your lease coverage going forward?

No, not at all, Jeff. That's no blubber, either. We'll leave it to others to slice, dice and analyze the NIC data after the fact. Our job is to anticipate the trends and make strategic decisions to take advantage before they become reality. So as my comments reflect, we've been very active on the development front for the last 3 years in senior housing. And up until this morning, you can see we've been somewhat guarded on the program's success. But, I mean, these are attractive returns we're being able to realize, attractive spreads to the current acquisition cap rates. I think they make us a better buyer in terms of -- better buyer of senior housing properties in terms of understanding replacement costs. But at the end of the day, Jeff, big picture is that our income streams in senior housing, because of the outsized rent escalators and because of the triple-net structures, they provide a fair amount of insulation from competition of new supply relative to where we took -- owned our current portfolio in more of a RIDEA structure. So, again, we were fortunate to see this trend. We've profited from it, for our shareholders, in terms of the development initiatives we have. We're very comfortable with our existing portfolio's insulation from that. And hopefully, we'll continue to be able to take advantage of the ever-growing demand for senior housing product in the coming period.

Okay. Yes, great. Yes, I appreciate the triple-net leases shield you, to some extent, from fluctuations. Along those lines, with the HCR ManorCare, I just want to make sure I'm thinking about these coverages and the adjustments correctly. First off, they haven't taken any additional charges for reserves in '13. Is that something that generally comes about in the fourth quarter if it is to happen? Or do they look at it quarter-by-quarter?

No, the protocol for the industry is that, that's reviewed by external third-party experts twice a year. So...

Okay. So not in the first half of the year, so potentially in the fourth quarter, if at all. And so assuming there's no adjustment then, I guess the right way to think about it is kind of flattish to slightly up coverages through 4Q '13 and then about 0.2 turns increase in coverage as that charge burns off. Is that the right way?

Yes. If you just want to isolate the impact of the charge, absolutely. I think you're going to have some other things happening quite, quite favorably. But if you just want to zero in on the impact of the reserve rolling off, that's true.

Your next question comes from the line of Jack Meehan with Barclays.

I appreciate the color on the deal pipeline. When you talk about moving forward on new terms, is that more related to the cap rates resetting with the new financing environment? And have any of those opportunities gone away for the time being?

Well, I think when I talk about economics, I would -- it's a whole host of things, some of which is cap rates, some of which is the amount of capital that's needed to invest in the properties, some of which would be the -- if it's a triple-net structure, the magnitude of the escalators. So it's a whole host of issues that get factored in. But -- so I think that's the -- how to respond to your question on the economics. I think with respect to where the deals are, I mean, they're still there. I think -- yes, I think sellers are going to adjust their expectations, not with the frequency that the capital market adjusts. So we've seen -- as an example since May 22, we've seen -- we've kind of cuffed the increase in our cost of capital at about 110 basis points. And we have a first-class junior professional who runs that algorithm, that model for us. And I think -- I don't think he's ever run it as frequently as he have in the last 2 months. But the reality is, while our cost of capital has adjusted very quickly, sellers' expectations don't adjust that quickly. So I suspect, like I said, I think the pause button has been hit. And I suspect you'll see a good portion, if not all, of those transactions come back, albeit on revised terms.

Okay. Got you. And then just moving to hospital portfolio. I know it's really small, but the LTACHs in your portfolio, the coverage dipped 0.67. What's the remediation plan for those assets? Would you consider them selling back to the operator if they want to acquire them?

Well, everything's on the table with all of our assets. Tim is fond of saying we love our assets, but we're not in love with our assets. So yes, we're not big fans of the LTACH space. I think we've gotten just 3 of them. Those 3 are all with kindred master leased with coverages that are substantially above 10. So the near-term mitigation is -- there is no near-term mitigation required. At some point, we'll look at opportunities. I think the expiration of that particular master lease is still a couple of years out. But, yes, I think the takeaway there is that we're not a big fan of LTACHs. Particularly, when we see what's going on with our HCR portfolio, where you've got a lower-cost setting, it's kind of clear what's going to happen here, Jack. As a private sector, most notably, managed care, becomes more influential in driving where these outcomes go, they'll be driven away from the higher-cost inpatient rehab and LTACH settings to the lower-cost post-acute setting. So that's just a natural progression in terms of our viewpoint on where all this is going to end up.

Got you. And is some of that related to things around patient criteria and then new rates that we would expect? I'm guessing a final rule sometime soon. Or when do you expect some of that to play out?

Well, it's playing out right now. Yes, this isn't a function of this week's CMS reimbursement outcome. This is playing out in the marketplace. The big picture is you've got declining government reimbursement. Guess what, country can't afford 21% of their GDP going in health care. And the platforms that will be advantaged here in the coming couple of years is the time frame this is going to be play out, Jack, in our low-cost, high-quality settings that got concentrated to high-market share platforms. And you've heard me analogize what's going to play out in the health care space to what played out in the aerospace/defense industry in the last part of the decade of the '80s. And if you want to watch that movie, just pull up a chair, sit down and grab some popcorn. It's happening literally this week in the hospital space. You've seen Tenet and Vanguard come together. You see Community Health and HMA. It's just going to continue to play out this way across all these sectors. You're going to have these huge, enormous operating platforms get created. Volumes are going to go up. Revenues are going to go up quite a bit, albeit at lower margins. And that's how this is going to play out over the next couple of years. And at the end of the day, in post-acute, if you've got the lowest-cost setting and the highest-quality outcomes, that's why these relationships that HCR has cut with the UnitedHealths of the world, where they're partnered on these CMS test cases, are just so important, if you can just see it kind of play out during the next couple of years.

Your next question comes from the line of Emmanuel Korchman with Citi.

Jay, maybe we can stick to the comment you just made on Vanguard and Community Health. Have you guys looked at ways of participating in those deals? I mean, there were a couple of REITs that were announced by proxy that we're looking at, at the Vanguard transaction. Maybe any kind of thoughts you can share on those for us?

Well, Manny, we look at everything. I mean, that's our business. The deals that we ultimately close on in order to get through the filter of what we're looking at to what we have closed on is very, very small, certainly less than 10% of what we look at. In the hospital space, we've obviously and kind of uniquely -- I want to make sure we're talking about acute care hospitals, not rehab hospitals or LTACHs. But the acute care hospital, that's what created this company back in 1985 when Ken Roath took it public. We were seated from National Medical Enterprises with a couple of acute care hospitals, and then we acquired a few more as we bought out AMI's REIT at the end of 1990. So we understand the space. We've got 2 absolute jewels in our portfolio. I think a lot of you have seen Medical City Dallas, and I think some of you have seen our Hoag Hospital. I would say that for good hospitals located in growing urban areas with good market share, ultimately, the best buyer for those are going to be strategic buyers, particularly with what's going on with the Affordable Care Act, where you're going to benefit highly concentrated market share. So that's -- I think it's going to be difficult for any PropCo buyer structure to be competitive with what a strategic buyer would pay. But notwithstanding that, every now and then, opportunities pop up. I think Medical City Dallas is a good example, where you had a different dynamic, you had a low tax basis driving the seller's motivations there and we were able to add to our portfolio, quite frankly, the premier acute care hospital in the HCA empire. So we stay current, we look at everything, but at the end of the day, what comes through the filter in terms of what we put at the portfolio is a very, very small fraction of that.

Great. And then, Tim, correct me if I'm wrong, the straight-line rent adjustment that you guys announced, the charge you took in 2Q, that looks like it was related to HCA's Medical City Dallas. Can you give us more details as to what the charge is actually related to?

Yes. Yes, man, you're right, that's related to that hospital. It's a long-term lease with multi-tranches, but it related an over-accrual to straight-line rent. And it's a onetime charge that represented the accumulative adjustment. There's multiple tranches underneath that lease. And there was 1 tranche -- the lease runs through 2025. And there's 1 tranche that has a roll-down many years in the future, and that hadn't been accounted for.

So nothing about an actual change to any leases. That was just something that was [indiscernible].

No, no, no. No change to cash.

Perfect. And then if we jump back to Jay for one second. I guess we're beating the sort of the opportunity set down a little bit here. But if we look at the magnitude of deals or the volume of deals that didn't happen or that got delayed, could you provide some color as to how many deals we're talking about or how much product?

No, we don't -- we typically don't comment, Manny, on -- we'll tell you everything and then some about the deals we close, but the current state of the pipeline or the deals we're chasing or the deals that we passed on, we traditionally don't give any -- provide any color on this.

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

Jay, you mentioned earlier in your comments that you're providing 80% of the development costs in your loan commitment program and able to capture up to 30% of the value creation. I'm just -- can you explain how that mechanically happens?

Yes. Let me have Paul take that, Paul Gallagher.

Yes. We actually have a participation in the loan. And either through a capital event, whether it's a sale or a refinance, then we would participate in 30% of the excess over the cost. We also had a purchase option where we have the ability to buy the asset and actually keep it for long-term growth.

Okay. Great. Regarding the Barchester loan, that is a quick turnaround, the recent purchase and you're expecting a par payoff in September. Can you talk about how you were able to source that and why you get this nice bump and why other people didn't see it? Was it a relationship of some sort?

Yes. At the end of the day, everything starts and ends with our 5x5 model. So obviously, we had gotten quite current and quite smart on the U.K. caregiving market a year or so ago following the Four Seasons deal. And Paul and I spent a reasonable amount of time over there in the last 6, 9 months, and we had an opportunity to partner with one of our other very close relationships that we've just structured a separate transaction with. And we created a partnership here, and that's going to work out quite well.

So you're not inclined to give guidance, but, I mean, is the U.K. -- you see the same type of kind of pipeline of activity in your loan program in the U.K. in relative terms relative to its size that you are here in the States?

I think the magnitude of the opportunities over in the U.K., I don't know if you're comparing that to our senior housing development program, I would tell you that the senior housing development program is more of a kind of a flow business. We've got 7 communities in there, then separately, we've got the Hyde Park community that we're going to ring the cash register on later this year. That's more of a flow of properties coming in. We've got a very good development partner there. The U.K. opportunities are much more lumpy. If you think back in terms of what's happened here from our sector-leading debt platform, you've got to be thinking more of a Genesis, HCA, HCR sort of dynamic. So that looks different, but at the end of the day, the skill sets and the ability to execute in a timely fashion are the same.

Okay. My last question is, does the loan program actually get incrementally more attractive in an environment like this where there's chatter about rising interest rates and all the rest? Are you seeing more opportunity or is that just coincidental?

Are you talking about the senior housing loan program, Rich?

I'm talking about any kind of loan investments that you're able to make.

Well, again, it's tough to generalize. So for example, in a senior housing loan program, I'll tell you that it would be difficult, if not impossible, to replicate the economics in today's market that we were able to achieve when we launched the senior housing development program 2 years ago. And that's a function of there are more banks getting more comfortable, for whatever reason, to being a provider of construction loans. So that's -- I don't really think that has anything to do with rising interest rates. I think rising interest rates are probably going to manifest itself more from a standpoint of the private equity sector, maybe looking with some increased urgency to either exit or recapitalize existing positions now, given the move in rates and the speculation that continued tapering will march those rates higher. So kind of 2 different dynamics, Rich.

Your next question comes from the line of Michael Carroll with RBC Capital Markets.

Maybe a little bit off of Rich's question. Can you break out maybe the investment opportunities you're seeing on the property side versus the debt side? Are you seeing more debt deals and, hence, the reason of the several recent investment -- debt investments you were able to complete? Or is this just timing?

I think it's probably just timing, Mike.

Okay. And then how are you approaching, I guess, the international markets differently than domestic markets?

We approach all the market the same, Mike. We have a 5x5 model, and we look at everything that's out there. And we figure out on a risk-adjusted basis where the cream is. And we like to skim the cream and go forward from there. We've obviously developed -- particularly the U.K. market -- a fair amount of institutional knowledge on that space and institutional relationships and things like that. But everything goes through the same filter within the same 5x5 strategic model.

Are you also looking at, I guess, property investments instead of debt investments in U.K., too?

Again, that's one of the cornerstones of our 5x5 model. As you know, it's the preponderance of our 5x5 model from a product standpoint. We've got -- I think well over 95% of the entire investment portfolio is in fee simple real estate. So that's absolutely our default option. Every now and then, some opportunities present themselves that not only are very good risk-adjusted return opportunities for our shareholders but, importantly, provide some optionality to transition a debt investment to real estate. We like those and we're real high on those sorts of opportunities.

Okay. And then last one for me. Is there other any international markets outside -- out of the U.K. that you're looking at now?

The world is our oyster, Mike.

Your next question comes from the line of Juan Sanabria with Bank of America.

Just a quick question. You mentioned that you run a model and have been updating it regularly with regards to your cost of capital. If you were able to sort of dictate terms given what you know today with regards to capital pricing, what would you think cap rates should have adjusted from earlier this year? Or where should they eventually settle out? Is it 25, 50 basis points higher? What are your thoughts?

Yes. We'd probably be -- I think it's going to be a function of which of the 5 property types you're talking about. But I think in terms of where we would be comfortable, the high end of the range you just cuffed would be the low end of the range that we just start to get interested in. So it'd have to be at least that sort of adjustment.

Okay. And just with regards to asset acquisitions, how should we think of low-hanging fruit barring you guys getting together and agreeing on cap rates or asset values? What kind of low-hanging fruit -- are there any other opportunities with Blackstone as an example that you could act on over time or that we should expect you to be able to transact on?

Again, stay tuned. As I mentioned earlier, a very small portion of the opportunities that reside in our company at any given point in time end up being moved into the end zone in terms of points on the board, but we're extremely active across each of our 5 property types and up and down that 5x5 model right now, extremely active.

Okay. And just lastly on your development, should we expect the developments that you guys do to hold for the long term that you're kind of disclosing your supplemental package. Should we expect that to be growing? It didn't seem like it necessarily picked up significantly from the last quarter, but is that something that we should expect to grow over time?

Now are you talking about...

Given the acquisitions are tougher [indiscernible]?

Are you talking about the senior housing? Or are you talking just generally development or redevelopment?

Just generally.

I would say that I think redevelopment, we've done a fair amount of that, almost all of which has been in our life science and Medical Office Buildings sectors. I think you're going to continue to see us redevelop our portfolio. We like our portfolio. There's no obvious candidates aside from the handful of properties that are subject to purchase options that we anticipate exiting our portfolio. So maintaining and upgrading the properties that are in our portfolio, with an eye towards increasing the income stream from those, that's a very high priority. It's -- quite frankly, with the asset management skill sets we have that exist for -- independently for each of our 5 property types, that, quite frankly, is what those professionals spend the preponderance of their time on.

Your next question comes from the line of Rob Mains with Stifel.

Tim, I have a follow-up, the straight-line rent question. What should be the benefit in this quarter from a FAD perspective? What's the right run rate to be using after -- starting in the third quarter?

Well, that adjustment didn't affect FAD, Rob, but the $0.62, $0.63 is a pretty good run rate for the quarter. That was unaffected by any onetime items.

Right. But the straight-line rent item was the component of FAD. With a positive number, normally, that would be negative and that's because [indiscernible].

Oh, yes. Yes, yes, yes. I got you. For the overall company, a good run rate for the quarter is about $11 million a quarter, Rob.

Okay. And then kind of in a similar vein, I'm assuming from what you said previously that CapEx and TIs are going to be kind of backloaded this year?

Yes, there's some seasonality in those numbers, but they will be backloaded.

Okay. So the full year number that you've talked about in the past is still valid?

Yes, around $60 million.

Okay. And then G&A has kind of bounced around the last few quarters. What's kind of, again, a reasonable run rate there?

Just under $22 million a quarter.

Okay. Any reason it was up in the second quarter?

Transaction costs in the quarter.

Got it. And Jay, you touched on what's going on in the hospital sector. Is this something where you think there's an opportunity? Because it seems to be that the publics are buying one another, while the not-for-profits are kind of doing joint ventures or other kind of noncapital-intensive transactions. Is there an opportunity for REITs to participate in the hospital consolidation that you see?

Well, sure. I mean, yes, those are -- absolutely, it's right there. At the end of the day, I can only speak for our model. Things still need to clear the bar, whether it's price relative to replacement costs, or FAD accretion, or nominal cap rates, or in the case where we're looking at a RIDEA structure, economic cap rates. But from a spread standpoint, you take an unlevered IRR and you compare that to a weighted average cost of capital in the hospital space, to be very specific with the question you asked, we're going to require a higher return there. Because of our 5 property types, the hospital sector is the least real estate-intensive, most operating-intensive of our 5 sectors. So at the end of the day, we'll look at those returns. And, again, my comments on the earlier question about chances are strategics are going to conclude that they're better off owning the real estate, and they're going to be prepared to pay more than the health care REITs. I think there will be exceptions to that, but I think that's going to be more the norm, Rob.

Okay, that's helpful. And then I kind of lost track of what we're talking about 12 months ended June 30, 12 months ended 3/31. HCR ManorCare is that experience under sequestration?

They've done a great job managing their costs, so I think that's a push anybody counted on at the beginning of the year, some of the softness in the patient and the admission volumes you've seen in the sector. Notwithstanding that, they are continuing to generate a substantial amount of free cash flow after rent, after interest expense, after CapEx. So they're -- and more importantly than anything else, they're gaining market share. So this is -- they're positioned quite well for what's going to come down the road during the next 12 to 18 months with an increased penetration of managed care, basically doing a lot of what the government hasn't been able to do, which is to direct patient outcomes to lower-cost, high-quality settings.

Right. Okay. Then last question is a balance sheet question. You talked about how leverage has been coming down. Does the change in interest rates change your thinking about leverage either in your proclivity to use it or whether you prefer short or long term or anything like that?

No. Again, we underwrite everything with a 40 parts debt, 60 parts equity long-term capital structure. Importantly, for the people on this call, for the 40 parts that is debt, we put 0 component floating rate debt in there. It's all 10-year unsecured at our current levels, which is a function obviously of where the 10-year treasury is and our indicated spread to that 10-year treasury. So we look at everything that way. And the rating agencies understand that, and they're very comfortable with that. Away from that, we've got balance sheet maturities that have been laddered out quite well by Tim and Matt. And as they come up, we look at that. I think in particular, right now, we're also mindful of the fact that we're likely to have some capital coming back to us with respect to the Barchester payoff that we expect will happen in 2 months and then with the purchase options on Tenet hospitals. So all that goes into the thought process, but we wouldn't be changing our proclivity to either employ higher leverage or the frequency with which we visit the capital markets because of what's happened in the interest rate complex.

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

Just to stay on that theme, Tim, what kind of impact has the uptick and interest rates had on your budgeting and planning when you're looking at meeting your 2013 debt maturities?

Well, we don't really have very much moving around on the balance sheet, Todd, but for what we do, the remaining maturities this year have a coupon of -- in place coupon of 5.9%. And we could do much, much better than that in the unsecured markets on a 10-year deal.

Okay. And just back to the Barchester deal. Is there any chance that September comes and goes? Is there an extension option on the ability to pay that off?

Well, that would have to be negotiated with the creditor group. Again, I think based on what we know, I think that's highly unlikely. I think the high probability outcome there is a part payoff for the entire PropCo debt stack.

Okay. And that's expected to add $0.03 of accretion, but your guidance went up by $0.02. I may have missed what's the discrepancy there. I know it's $0.01, but is that related to any offset?

Well, again, we're looking at -- we're primarily focused on FAD. Our FAD, as Tim made mention in his comments, our FAD guidance for this year, we just increased by $0.05, Todd.

Okay. And how about your return expectations when you look at the mezz loan to Tandem Health that was consummated in 2012? If you were to make that same loan today, what do you think your return requirement would be on something like that?

Yes. A blended -- at a blended, we've got 2 tranches there, not 3, 2 tranches. And at a blended average yield there of kind of low 13s, given the cash flow coverage and the quality of that real estate, we think that approximates market today.

The risk profile hasn't increased that meaningfully in the last 2.5 months.

No. I mean, they've done a good job, and as I mentioned, the debt service coverage there is just over 1.8x. So we feel very, very good about that investment.

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

Jay, just kind of going back to HCR ManorCare, I kind of understand everything you're saying about their competitive position and given all the changes going on, on the health care side. But, again, we still have coverages that still seem to be going down quarter-over-quarter. I mean, with what you're expecting out of the company, when do you think we start to really see coverages turn around?

Oh, I think you'll see that start to happen second half of this year. You've got the admissions situation with acute care hospitals, I think that is what that is. I think you and others on this call have written extensively about the impact on the acute care hospital. With the effective implementation of the Affordable Care Act, hospital volumes are going to spike just because you've got more individuals that are going to be covered by insurance. And so that's a real important fact. Now given HCR's model, that's going to, just as night follows day, drive significantly higher volumes for HCR. The quid pro quo is those volumes will be at lower margins. But, I mean, that's a significant business fundamental that's out there just waiting to come into fruition once the Affordable Care Act is up and running.

Okay. That's helpful. And then the second thing that you mentioned in regards to capital kind of coming back to you towards the end of the year with Barchester, for example, that kind of combined with this idea of the pregnant pause and acquisitions that you were talking about earlier, I mean, how should we -- given the combination of those 2 factors, how should we really be thinking about acquisition volumes back half of 2013, first half of 2014 type of a time frame?

Stay tuned, Tayo. Again, we have a fundamental tradition of not telegraphing our -- either the amount or the timing of our acquisition activity. So when we're talking about either quarter-over-quarter 15% increase in FAD per share or year-over-year for this year 12% FAD increase, that's all organic, plus last year's activity. So anything we do most effectively is going to be the additive to those results.

That's helpful. And just last question for me. I mean, with what we're seeing on the hospital space, with all of the consolidation going on, would you expect a similar scenario to start to happen in other areas of health care services?

Oh, absolutely. It's just going to be a tidal wave over the next couple of years, an absolute tidal wave.

Your next question comes from the line of Michael Mueller with JPMorgan.

Mine were answered. I'm good.

Your next question is a follow-up from the line of Nick Yulico with UBS.

It's Ross Nussbaum here with Nick. I had a follow-up on this straight-line rent charge you took in the quarter. It sounds like that there was just simply an oversight on how the lease was accounted for historically. Is that how we should be thinking about this?

That's correct.

How did it -- I assume this lease has been in place for quite some time. How did it arise to your attention now?

Well, there's multi-tranches underneath that lease, Ross. And one of the lease components in future years rolls down, and it's really the burn-off of a TI loan. That's the way to think about it. That's the best way to think about it, burn-off of a capital improvement loan.

Are you going to have to declare a material weakness on the natural reporting front for this?

No, no, no. [indiscernible] for any 1 period, under $2 million in any way.

Okay. Jay, I understand that there's going to be some form of a hatchet job tonight on the assisted living sector on a public television network. I'm just curious what you know of it. And do you have any thoughts around it?

Well, we obviously know quite a bit. I think for a second -- third most important issue is that our sympathies are with the families whose loved ones was involved with the incident. But away from that, we've got a concentrated number of relationships with a handful of senior housing operators. And we think very highly of the quality of the care and the clinical protocols that those companies provide. And so away from that, probably most appropriate to direct your questions to those entities involved. So that's how I'd respond to that, Ross.

Your next question is a follow-up from the line of Emmanuel Korchman with Citi.

Yes, it's Michael Bilerman with Manny. Jay, just on the Barchester loan, was the issuer presented the opportunity to buy back loan at a discount at all?

Was the issuer provided...

Or the borrower in that case?

No, no. I mean, it was a CMBS structure that was put in place, Michael, back, it was '07. So they had the deal they were signed up for. We are looking at September 30, a hard, hard maturity.

Right. I just didn't know if they had the opportunity to buy back now for the price you did versus the confidence you have that they'll pay par for it in September 30. They could have obviously earned -- I'm very glad that you're earning almost $20 million in profit, but I was just trying to put those 2 together, if they had the opportunity to buy it versus paying par in September 30, why they wouldn't have done that.

That's probably something that you ought to address just to them. From our standpoint, ourselves, our joint venture partner felt -- did feel and continue to feel quite good about the underlying collateral and the likelihood of the September 30 result that we anticipate.

You don't view this as going into a potential transaction where you get hold of real estate or participate in some larger -- you view this really as just an investment pure payoff and you move on.

At this point, yes. I mean, obviously, when we make these investments -- at the time we made the investment, anytime we make an investment like this, we're constantly looking at the potential or the optionality to have that end up with a fee simple ownership in the underlying real estate. And that was absolutely important element of what we saw here. But we just couldn't make the numbers work to get to that result. And so we're going -- we've got the bird in the hand, and then we'll move on to the next opportunity.

Great. And then just lastly, just a little bit more on the deal environment. You dial back to late April when we have the call, and you talked a lot about how comprehensive the deals that you were looking at, not only by property type but also by size, the different types of sellers that were out there being very varied, talked about your 5x5 model and said, "Look, it's 80%-plus in terms of being able to fill up that chart in terms of where we're seeing opportunities and where we're evaluating things." And from your other comments, it now sounds like everything has sort of been on pause. I'm just wondering maybe you can sort of drill down a little bit about which sort of opportunities and which sort of deals do you think are the first to come back and which ones -- or which sectors may be still be percolating versus just being a complete halt on what was a very, very large deal environment for you.

Yes. I don't think anything's on a complete halt, but maybe you can help me answer the question. What's your -- you mentioned something about 80%. I didn't quite understand...

You said last time, so you -- going back to the first quarter call, you said 5x5, you have 25 boxes, your quote was 80% of the page would be lit up with opportunities.

Yes. That hasn't changed at all. But when you have a weighted average, at least I can only speak to our business model, but when you have 110-basis-point change in about the 3 or 4 weeks time in your cost of capital and you're looking at an array of investments, which we look at in a number of different metrics, replacement costs, FAD accretion, cap rate, but one of the important ones we look at is spread relative to our weighted average cost of capital, so if the weighted average cost of capital spikes by 110 basis points, that's going to certainly give us pause to look at what the revised and more realistic economics are on some of these things. But the deals themselves, the proclivity for the sellers involved to move forward, that hasn't changed at all. So I suspect, as I mentioned in response to one of my earlier questions, the markets move more quickly than do seller's expectations. And I suspect this will sort itself out. And I think you'll see in the second half of the year, you'll start to see some acceleration, but it's obviously been a shock to the system.

Is there anything that you are sort of looking at that's sort of gone to others or that you think is completely gone away?

Well, I think certainly, the Barchester opportunity, that was something that, all other things being equal, you might very well like to move forward on in terms of the underlying real estate. So I think -- now I think you're going to see that situation result in a par payoff. So that will be one example of where something is likely not to come back, but I think that will be more in the minority of the opportunities that we have in the pipeline right now.

Your final question is a follow-up from the line of Rob Mains with Stifel.

Jay, in the past, you've done some joint ventures with institutions. Obviously, the HCR ManorCare deal was a private equity. Have you seen increased interest by either joint venture or either institutions or private equity in the space, either just because it's more intriguing or because of what might have happened in the capital markets?

No. You mean specifically with the catalyst being kind of Bernanke's comments on May 22 or something else?

Either that or just the consolidation opportunity that you've been talking about, just whether you're seeing more activity on the part of institutions or private equity.

A little bit. I think even post-May 22, I think a lot of the distressed debt play has kind of gone away. There's more capital out there, the underlying portfolios are improving. So the distressed seller of debt, I think that's either they're going to hold on or they'll wait until maturity and take a par payoff. So I think that opportunity is not what it was a couple of years ago. Notwithstanding that, I mean, then you see you have a situation like we had 2 in the quarter that present themselves, but those are more needle in the haystack opportunities today. Away from that, I think whether it's in hospital land or post-acute land or senior housing land, you're going to continue to see consolidation activity. You've got a very fragmented industry that's quite large and the ability to realize cost synergies and increase market share in concentrated geographic areas. That's not going. If anything, that's going to accelerate. So I think you'll continue to see a lot of activity. And then that presents -- as a collateral benefit with the health care REITs, that creates an opportunity for us and our colleagues. And oftentimes, it's even more attractive than that because we've got -- with existing relationships and investments, we have somewhat of a seat at the table on those sort of situations. So I don't think there's been any change at all in the fundamental driver for the external growth aspects of the space.

At this time, I'd like to turn the call back over to Jay Flaherty, Chairman and CEO, for closing remarks.

Okay, everyone. Enjoy the rest of your summer, get a break and we'll see everybody in the fall. Take care.

This concludes the Second Quarter 2013 HCP Earnings Conference Call. You may now disconnect.