HCP Inc. Q3 2008 Earnings Call Transcript

Nov. 4.08 | About: HCP, Inc. (HCP)

HCP Inc. (NYSE:HCP)

Q3 2008 Earnings Call

November 4, 2008 12:00 pm ET

Executives

Edward J. Henning – Chief Administrative Officer, General Counsel

James F. ("Jay") Flaherty III – Chairman and Chief Executive Officer

Mark A. Wallace – CFO and Treasurer

Paul F. Gallagher – Chief Investment Officer

Analysts

Richard Anderson - BMO Capital Markets

Jonathan Habermann - Goldman Sachs

Jerry Doctrow - Stifel Nicolaus & Co.

Chris Haley - Wachovia Securities

Michael Mueller – JP Morgan

Adam Feinstein - Lehman Brothers

Jim Sullivan - Green Street Advisors

Robert Main – Morgan, Keegan & Company, Inc.

Omotayo Okusanya – UBS

Stephen Swett - Keefe, Bruyette & Woods

Karen Ford – Keybanc Capital Markets

Dustin Pizzo – Bank of America Securities

Eileen Yin – Credit Suisse

Operator

Welcome to the third quarter 2008 HCP earnings conference call. (Operator Instructions). I would now like to turn the presentation over to your host for today’s conference, Mr. Ed Henning HCPs Executive Vice President and General Counsel.

Edward J. Henning

Some of the statements made during this conference call contain forward-looking statements. These statements are made as of today’s date, reflect the company’s good faith belief and best judgment based upon currently available information and are subject to risks, uncertainties and assumptions that are described from time to time in the company’s press releases and SEC filings.

Forward-looking statements are not guarantees of future performance. Some of these statements may include projections of financial measures that may not be updated until the next earnings announcement or at all. Events prior to the company’s next earnings announcement could render the forward-looking statements untrue and the company expressly disclaims any obligation to update earlier statements as a result of new information.

Additionally certain non-GAAP financial measures will be discussed during the course of this call. We have provided reconciliations of these measures to the most comparable GAAP measures as well as certain related disclosures in our supplemental information package and earnings release each of which has been furnished to the SEC today and is available on our website at www.HCPI.com.

I will now turn the call over to our Chairman and CEO Jay Flaherty.

James F. Flaherty

Welcome to HCPs third quarter earnings call. Joining me today are Executive Vice President Chief Financial Officer Mark Wallace, and Executive Vice President Chief Investment Officer Paul Gallagher. We’ve been on a mini roll since we last spoke with you in August, so let us get right to the details and for that I’ll turn the call over to Mark.

Mark A. Wallace

We continue to strengthen our balance sheet this quarter and recently took advantage of several opportunities in the capital markets. In August, we issued 15 million shares of common stock and received net proceeds of $481 million which were used to repay a portion of our bridge loan.

In September, we placed $319 million of secured Fannie Mae debt on 16 of our senior housing assets with a blended rate of 6.39% a loan to value of 60% and a blended term of 6.7 years. This financing was comprised of a $179 million tranche of eight-year debt on 12 properties at 6.625% and a $140 million tranche of five-year debt on four properties at 6.085%. We received net proceeds of $312 million which we used to repay debt outstanding under our line of credit.

On October 24 we closed on a $200 million senior unsecured term loan that matures on August 1, 2011 and used the proceeds to pay down our bridge loan. The credit facility is prized at LIBOR plus 200 basis points with financial and other covenants similar to our existing line of credit and bridge loan. The current interest rate on the term loan is 5.22% Bank of America and JP Morgan were lead arrangers on the transaction.

So far this year we have raised one $1 billion of equity capital, $643 million from asset dispositions, $578 million from the placement of Fannie Mae secured debt, and $200 million from the new term loan I just described. These transactions have generated net proceeds of over $2.4 billion which were applied to fully pay down our revolving credit facility, retire $300 million of senior unsecured and floating rate notes that matured in September, and reduce the outstanding balance on our bridge loan.

Our consolidated debt repayments for the remainder of 2008 are limited to $43 million of mortgage debt maturities and amortization. For 2009 our debt repayments other than the bridge loan are limited to $274 million of mortgage debt. For 2010 our debt maturities and amortization total $505 million and are comprised of $206 million of senior unsecured notes and $299 million of mortgage debt. Our institutional joint ventures have no debt maturing in either 2009 or 2010, and only $13 to $14 million of mortgage debt amortization.

During the quarter we issued 112,000 shares under our dividend reinvestment plan for proceeds of approximately $4 million. We also issued 292,000 shares upon the conversion of non-managing member down REIT units. Our credit metrics are in the strongest position in several years.

Our overall leverage ratio was down to 47%, our secured debt ratio stands at 16%, our unsecured leverage ratio at 51%, and we are comfortably within our credit facility covenants. While floating rate GAAP represents 12% of our total debt, our HCR Manor Care investment more than offsets that amount.

Our bridge loan has a balance of $320 million accrues interest at 3.92% and has an extended final maturity of July 31, 2009. At close of business yesterday we had $100 million of unrestricted cash and our $1.5 billion revolver which matures on August 1, 2011 remains completely undrawn.

Investment activity for the quarter was principally focused on our life science and medical office segments. We funded $34 million in construction and capital projects this quarter, bringing our year-to-date fundings to $126 million. Our East Grand building eight comprising 82,000 square feet was placed in service last quarter and occupied by Genentech in June. East Grand building seven and nine comprising of 147,000 square feet were placed in service in August and are occupied by Genentech as well. These three developments should contribute about $6.5 million to FFO in the last half of 2008 or about $14 million on an annual basis.

We continue to anticipate the core in [inaudible] to point to buildings A and B comprising 251,000 square feet to be complete in the fourth quarter of this year. Rent should commence in the fourth quarter of 2008 on building A and the first quart of 2009 on building B. Keep in mind that rent recognition under GAAP will be deferred until the related tenant improvements are complete. The Corn Shell of Oyster Point 2 Building C comprising 78,000 square feet should be complete in the fourth quarter of 2008 and we are actively pursuing tenants.

Redevelopment work began in September on 500 and 600 Saginaw at Seaport Center in Redwood City California representing two properties totally 89,000 square feet. Redevelopment plans include a $6 million connector between the two properties as well as other improvements to divert these buildings for the life science market. The redevelopment is scheduled to be complete in 14 months.

For the third quarter of 2008 we reported FFO per diluted share of $0.71 compared to $0.52 for the same period in 2007. The third quarter of 2008 included lease termination related impairment charges of $3.7 million and merger related charges of $840,000. This compares to $9.1 million of merger related charges in the third quarter of 2007.

We recognize lease termination fees of $18 million at the end of July from a tenant in connection with three early lease terminations representing 149,000 square feet at five of our life science properties in the Bay Area.

Our third quarter results include an impairment charge of $3.7 million related to intangible assets associated with these leases. The net 2008 FFO impact from this transaction is an addition of $12 million net of a $2 million reduction in NOI from the tenant vacating the space.

On September 19, we completed the restructuring of our tenant hospital portfolio and settled our outstanding disputes with tenants. This resulted in income during the third quarter of $47 million, of which $29 million is included in FFO and reported as a component of interest and other income.

Same property cash NOI growth through the third quarter was 2.1% led by life science at 16.5%, skilled nursing at 3.4% and senior housing at 2.2%. A life science same property cash NOI growth continues to be driven by rents at our Lusk campus in San Diego. Overall life science portfolio economic occupancy was 89.1% at quarter end.

Senior housing and skilled nursing sectors continue to benefit from contractual escalators and rent resets. Senior housing same store cash NOI growth also reflects year-to-date additional rents of $3.1 million from property level expense credits related to our Sunrise properties. These credits however were offset by a reduction of $2.1 million in year-to-date Sunrise rents that fluctuate with LIBOR interest rates and $2.5 million of additional rents received and recognized in the comparable 2007 period that related to 2006 property performance.

Medical office same store cash NOI growth of 1.9% reflects rent increases of nearly 2.6% partially offset by the expiration of four national leases that decreased the effective rent at those properties. Increased energy costs also affected our MOB results this quarter. Fortunately, we have recently entered into new contracts that should bring these costs back to normal levels beginning in the first quarter 2009. Overall MOB occupancy was 90.2% at quarter end.

Our hospital sector same property cash NOI growth continues to be affected by one hospital where we terminated the lease last quarter and additional rents at our tenant that are relatively stable with prior year levels.

Regarding guidance for 2008, we now expect reported FFO to range between $2.31 and $2.35 per diluted share. Our guidance for the full year includes the following assumptions. We expect to fund about $165 million in construction and capital projects this year principally in our life science sector. Asset dispositions for the full year are expected to be about $650 million with gains for GAAP earnings on these sales of about $230 million.

Our investment management platform should generate $6 million in fee income, same property cash NOI growth is expected to be about 2%. G&A should be about $74 million or roughly 6.25% of total revenues. Income tax expense is expected to be $5 million for the full year.

Merger related costs for the year should be about $4.1 million or $0.02 per diluted common share primarily the amortization remaining bridge loan fees. Consistent with the previous quarter our guidance contemplates no additional acquisitions of real estate or other investments and no contributions of assets in a joint venture and excludes future impairments or similar charges if any.

Last as Paul will talk about in a moment, we are currently in the process of transferring 11 senior housing assets from Sunrise to Ameritas. In connection with that transition we expect to charge off or impair about $12 million of intangible lease assets when the existing lease agreement is modified.

About $9 million of that charge is related to above market lease intangibles and would impact FFO in the period the lease modification takes place. Consistent with our normal practice our guidance does not include expected impairments that are contingent on future events.

I’ll now turn the call over to Paul.

Paul F. Gallagher

Now I’ll take you through the details of our portfolio. Senior housing, our senior housing year-over-year same store performance increased by 2.2%. Breaking it down, senior housing excluding Sunrise increased 5.3% driven by contractual rent escalators and a restructuring of our HRA portfolio.

Sunrise experienced a 2.2% decline due to the timing of the recognition of additional rents as well as reduction in LIBOR based rents. Occupancy for our same property portfolio is 89.4% representing 60 basis point decline quarter-over-quarter. While this is the third consecutive quarter we have reported modest occupancy declines, it represents no change in occupancy on a year-over-year basis.

As operators generate more ancillary revenue and implement better expense management, EBITDA across our senior housing portfolio remains stable and same property cash [will] coverage year-over-year has increased 1.06 times to 1.16 times.

Preliminary data from our operators for the third quarter indicates these trends are continuing. Occupancy for our largest operators Sunrise, Brookdale and Ameritas which represents 73% of our units is 90.3%, 91.4% and 89.6% respectively with cash low coverages of 1.25, 1.20 and 1.21 times respectively.

We are actively monitoring our operator concentration risk. As mentioned in last quarter’s call we are in the process of transitioning a portfolio of 11 properties from Sunrise to Ameritas which will have the affect of significantly increasing contractual rents from this portfolio while reducing our Sunrise projected NOI from 16.3% to 13.9%.

Our near-term lease risk in the senior housing consists of only one lease set to expire in 2008 with an annual rent of $72,000 that we are currently negotiating to sell to a local operator. We have no lease expirations in 2009 and only two small loan receivables totally $4.8 million that we expect to pay off.

Hospitals, in the third quarter ACP closed on the final tranche of our previously disclosed hospital portfolio sale to Medical Properties Trust with two hospitals valued at $29.9 million representing a cap rate of 8.6% and a gain of $9.4 million.

Additionally we completed our settlement with Tenant the settlement involved several moving pieces, so let me give you some detail. We sold our Tarzana Hospital for gross cash proceeds of $106 million. Three leases expiring in 2009 were extended for 5 years on the same terms. We purchased Tenant's 23% interest in a partnership of 7 assets for a gross price of $25 million. That price included $7.6 million of working capital resulting in the net purchase price of $17.4 million. The acquisition of the partnership interest provides HCP with a 14.5% cash yield on the incremental investment.

Our near-term lease exposures in hospitals has been significantly reduced as a result of our Tenant settlement and now consists of only 2 Tenant facilities that expire in February and May of 2009 respectively. One of these, our Irvine Hospital will be leased to [inaudible] Hospital for 15 years beginning February 2009. The other our Los Gatos Hospital is currently in the process of being transitioned to a new operator. Once completed and inclusive of the Tarzana sale are projected NOI associated with Tenant will be reduced from 5.5% to 2.8%.

After taking into account our hospital disposition this year and the Tenant settlement, our remaining hospital portfolio has been reduced to 21 assets. Year-over-year same property cash flow coverage excluding our well performing HCA Hospital at Medical City, Dallas was 2.66 times. Year-over-year, same property adjusted NOI declined 1%, but, excluding one facility where we've terminated the lease, there was a 1.6% improvement.

Skilled nursing, our skilled nursing portfolio continues to perform well. Year-over-year adjusted NOI increased 3.4% driven by contractual rent increases and same property cash flow coverage increase from 1.39 times to 1.47 times.

One lease is set to expire in the current quarter with annual rent of $637,000 and we have four leases expiring in 2009 with annual rents of $2.2 million. All of these leases are currently under negotiations and are expected to renew. One loan receivable with a balance of $1.7 million will come due in 2009 which we expect to pay off.

For our HCR Manor Care investment, year-to-date debt service coverage was 1.85 times with occupancy remaining stable at 88%.

Medical office, during the quarter we contracted to sell two medical offices buildings totaling 77,000 square feet for a gross sale price of $5 million and we will recognize a gain on sale of $1 million in the fourth quarter.

Year-to-date same property cash NOI for the quarter was up 1.9% on a year-over-year basis. This was driven by increased rents and costs recovery but was offset by the expiration of four master leases. On the expense side, savings as a result of positive appeals on property taxes were offset by increased utility costs that were primarily the results of a rate increase in taxes. We negotiated new utility contracts in Texas which will result in rate reductions of 33% effective in the first quarter of 2009.

Overall occupancy for MOBs ended the quarter down 10 basis points at 90.2%. Through the end of the third quarter we have renewed or released 1.8 million square feet of the 2.6 million square feet of space set to expire in 2008. Of the remaining 800,000 square feet of space scheduled to expire, 277,000 square feet has already been leased addressing 83% of 2008 expirations. In addition we have a pipeline of nearly 368,000 square feet of active negotiations.

During the quarter, we executed 213 leases totaling 623,000 square feet, of which 153,000 square feet was related to previously vacant space and the remaining 470,000 square feet related to the renewal of previously occupied space. These renewals occurred at 3.7% higher rents. Our leasing activity during the quarter resulted in a retention rate of 79%. For 2009, we have 1.75 million feet of expirations which is 800,000 square feet or 31% less space to lease versus 2008.

Life science, occupancy for the life science portfolio was 89.1% at the end of the third quarter, up 1% sequentially from 88.1%. The increase in occupancy includes the previously closed lease terminations in July representing approximately 149,000 square feet or 2.4% of the portfolio.

During the third quarter we began recognizing rental income on over 200,000 square feet of space in San Diego and completed approximately 57,000 square foot of leasing in the Bay Area. All the leasing activity related to previously occupied space resulted in mark-to-market increase of rents of 3.5%.

Our life science portfolio has limited lease expirations over the next two years. Lease expirations through the end of 2009 total 498,000 square feet and represent only 1.2% of HCP's annualized revenue. We have already addressed 159,000 square feet or 34% of the expirations through 2009 at mark-to-market increases in rents of 42%.

Looking forward into 2010, we have 558,000 of expirations which represent only 1.5% of HCP's annualized revenue. We have already addressed 132,000 square feet or 24% of 2010 expirations at mark-to-market increases in rents of 7%. Furthermore, the portfolio's lease terms range from 5 to 15 years with the average remaining lease term of approximately 7.5 years.

With respects to our life science portfolio, the composition of our tenant base is strong with almost 90% of our rents coming from public companies or well established private entities. The number of early stage life science companies is very small at approximately 2% of the entire life science portfolio and we do not expect to incur any material levels of bad debt expense, which is consistent with historical results.

HCP continues to pursue a pipeline of prospects in excess of 500,000 square feet for existing space. The deals we’ve seen recently have been shorter in term and are taking longer to execute as decision makers remain reluctant to enter new, longer-term commitments given the economy.

Switching to our development activity, we placed and serviced two buildings totaling 147,000 square feet in the Bay Area, which completed the build up of the 794,000 square feet campus that is entirely leased to Genentech through 2020.

HCP currently has five buildings totaling 418,000 square feet in our committed pipeline. Two of the five buildings representing 60% of the developable space are 100% leased to Amgen with cash rents commencing in the next two quarters.

Also during the quarter we began a $6 million redevelopment of two buildings in the Bay Area representing approximately 89,000 square feet which upon completion will be converted from office to first generation life science space. We anticipate our redevelopment efforts for these two buildings to be completed in the fourth quarter of 2009.

The future development and redevelopment pipeline remains unchanged representing 3.3 million square feet of expansion opportunity. We continue to have active dialogue with tenants with the focus on the Bay Area land. With that review of HCP's portfolio, I would like to turn it back to Jay.

James F. Flaherty III

You know the portfolio is in good shape when Paul is talking about completing year 2010 lease renewals in November of 2008. We are now 15 months into a severe economic downturn and the magnitude of this location is only beginning to be understood. Our crystal ball is no better than anyone else’s and we were certainly not rooting for a recession, but I think it’s significant to take stock of HCP in the current environment and understand why HCP is likely to outperform in the period ahead.

First of all, we are glad to be in the healthcare space. Last week, S&P’s chief economist David White said, “With an aging population and the largest healthcare spending in the world the nation’s medical sector could fair perhaps best of all. During economic downturns, sales of prescription drugs and medical devices tend to hold up better than nonessential goods. Generally, you are looking for things that are necessities not luxuries.” White said, “People get sick and need medical care regardless of the state of the economy.”

In addition, you may have seen the positive article in the New York Times business section over the weekend, concerning the prospects for medical office buildings, which represent 21% of HCP’s portfolio.

Secondly, our balance sheet, Mark has reviewed our credit metrics and there is considerable additional detail on pages 21 and 22 of our 10Q and page nine of our supplemental. Of note, our 47% leverage ratio 12% level of variable rate debt, a 5.91% average interest rate, and 16% secured leverage ratio. The LIBOR based variable debt is effectively hedged by our LIBOR based HCR Manor Care investment, which was yielding just over 11% as of this morning, no TED spread issue there.

As for the low level of secured debt in our capital structure, it is important to note that the crown jewels in each of our five property sectors, the Genentech and the Amgen campuses, the Swedish Medical MOB Portfolio, the Medical City Dallas and Irvine acute care hospital campuses, the Beverly Hills Sunrise Mansion and the Trilogy Skilled Nursing portfolios are completely unencumbered by secured debt.

We continue to be able to raise prodigious amounts of capital with $2.4 billion in proceeds generated year-to-date. Going forward, the strong relationships we enjoy with our commercial banks, institutional investors and the GSEs provide us with ongoing access to capital.

As to our debt maturities, a handful of recent street research reports have had difficulty accurately tracking the rapid pace of our de-leveraging actions. So let me sum it up this way, at September 30, 2008, HCPs existing cash balances and availability under its $1.5 billion line of credit are sufficient to fund required unsecured and secured debt obligations until the third quarter of 2011.

Third, our institutional quality diversified portfolio is performing well. Life science occupancy was 89.1% at quarter end and would have been 91.5% had it not been for the Bay Area lease termination we executed in July. Of much greater significance, since we last spoke with you, we have executed leases on over 400,000 square feet of life science space. HCR Manor Care's cash flow continues strong with $300 million plus in cash balances just 10 months after going private.

Last Thursday, HCR Manor Care launched a tender offer to de-lever a portion of their OpCo Term Loan B that is structurally subordinate to HCPs Mezzanine investment in [inaudible]. Coverage ratios in our hospital, skilled nursing and senior housing sectors are good and occupancies for our MOBs remain above 90%.

Peeking into the composition of our portfolio reveals diversification across five substantial property segments led by senior housing, which is down from 60% of the portfolio two years ago to 39% today. HCP has been a significant net seller of senior housing real estate for the past two years. Within that sector, Sunrise and Brookdale are expected to be 14% and 7% of 2009 projected HCP NOI respectively.

While these are some of the outstanding attributes of HCPs portfolio, let me also highlight three key exposures that are essentially non-existent in HCPs portfolio, State-based Medicaid, [L] Tax, and development risk. The red ink of state budget deficits has begun to reach horrific levels. As unemployment rises nationally in the months ahead, this situation will worsen. Already, five states have frozen Medicaid rate increases for 2009. This past summer, the State of California stopped all Medicaid reimbursements to nursing homes until the state budget was approved in September. We feel very fortunate to be positioned away from this risk.

Our exposure to L Tax is minimal with three properties representing less than 1% of projected 2009 NOI. I think it is important for the Wall Street research community to understand that the vast majority of properties categorized in HCPs hospital sector, represent flagship acute and rehab care hospitals as distinguished from L Tax. Remember, the LT in L-Tech stands for long-term not Lawrence Taylor.

With our Genentech campus being placed in service in the third quarter, and the Amgen campus being placed into service in the next two quarters, HCP has minimal 2009 development risk. Furthermore, any new construction starts would require significant pre-leasing commitments.

Fourth, minimal near-term lease expirations, Page 22 of our supplemental details our lease expirations by property sector. Adjusting for the successful restructuring of our tenant hospital portfolio, 2009 and 2010 lease expirations represent 5.8% and 6.6% of annualized revenues.

Fifth, quality of operator and tenant partners, the leading market share players in each of our property sectors are likely to add share at the expense of smaller, less efficient competitors in a current business environment. We expect to be a significant capital partner to finance their growth going forward.

The current environment, there has been concern raised over the state of the senior housing space in the United States. This has been particularly focused on the potential for problems in the residential housing sector to negatively impact senior housing. The residential home industry is facing major operating challenges at the present time, but I would make three observations relative to the state of senior housing in the fourth quarter 2008 versus the last time this space encountered a period of difficulty, which was six years ago.

One, the aging baby-boomer continues to age with 13% of the US population now over 65 years old. Two, industry-wide senior housing occupancies are hovering around 90% today versus the low 70% plus metric of six year ago, and three, there is no discernible supply of purpose-built communities under development today versus the tidal wave of supply that existed six years ago.

Taken together, these investment considerations would suggest that 2009 may become an increasingly attractive inflection point allowing HCP to transition from a net seller to a net buyer in the senior housing sector.

As you can see, HCP is set up nicely for the challenging period ahead. We are in the enviable position of having low-priced and long-dated in-place debt, premium asset quality with sustainable competitive advantages, top-notch product platforms with franchise values, negligible lease expirations, safe dividends, and balance sheet strength and flexibility. We have remained disciplined through 2008 and hope that our patience will be rewarded in the period ahead.

We would be delighted to take any questions at this time.

Operator

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from J. Habermann – Goldman Sachs.

Jonathan Habermann - Goldman Sachs

Jay, you walked through the existing balance sheet and sort of capital plans and you talked about the ability to cover the maturities through Q3 of 2011, which obviously sounds very, very good, but can you walk through just near-term capital plans in terms of development expenditures. How do you balance the decision to conserve cash and balance sheet strength at this point versus more opportunistic transactions, and then I guess further on to that is where do you need to see returns go in order for you to deploy capital again?

James F. Flaherty

With respect to development fundings, I mentioned, having placed in service the Genentech and the Amgen campuses either last quarter or in the next quarter or two, there's really not much of anything left with respect to required development fundings, Jay. So it's really a situation of what are the economics of any new perspective capital to be deployed.

I think you can see what we're doing here. We've been nibbling around the edges a little bit. We bought out the minority stake in the partnership we had with Tenant and that was at a 14.5% cash yield. We haven't closed it yet, but we're likely to buy out another minority stake in a senior housing community at a very attractive cap rate.

So I think I would describe us right now as kind of probing, nibbling around the edges trying to determine where we see value, but obviously our cost-to-capital has increased and you should expect that we will look to recoup that and then some with respect to the economics of any new transactions that we would move forward on.

Jonathan Habermann - Goldman Sachs

In terms of stepping back a minute though, the balance sheet where it is today do you need to see returns that would be 12%, 14% to sort of get you to deployed capital. Is that sort of what we need to see today?

James F. Flaherty

I'm not sure why it's relevant to the balance sheet. The balance sheet's in great shape. It's really a function of we're kind of probing here a little bit to see how good some deals we can get, what they're going to look like. I would think we would be at or above the metric you just suggested. Those are certainly where we're seeing opportunities right now, but again, we're in kind of a discovery mode here, probing a little bit, seeing where we can deploy some capital.

Jonathan Habermann - Goldman Sachs

As you sort of outlined your various points there, I think point number five you mentioned capital-to-fund growth in working with some of your partners. You mentioned it a little bit here in the comments but, do you expect more of the investments to be in terms of the operating level of the companies to participate more in the upside versus say traditional investments in the assets.

James F. Flaherty

I'm not sure I understand the distinction your making, Jay.

Jonathan Habermann - Goldman Sachs

Do you expect more of the investments to be along the lines of the Manor Care investments where you're going to invest more in the operating companies or more sort of in the assets, the traditional sort of health care investments of which HCP has done historically.

James F. Flaherty

I would suggest that our MOB and life science platforms have nice upsides in them. Paul had talked about the mark-to-market bumps that we've achieved just on the life science space. I think they're very significant. If you're suggesting that we're going to begin to take equity positions in operating companies, I don't think you should expect us to go there. At the margin we might do a little bit of that in conjunction with some other sort of investment, but that would be some extra gravy.

We want to stick to our five-by-five business model, its working great it really positions us nicely for the sort of economy we're in right now. We can move both across sectors and within products to wherever we see the greatest risk adjusted returns. I will tell you that year-to-date for the most part we've been seeing the highest risk adjusted returns kind of in the Mezz debt platform.

I suspect at some point here as we head into '09 and you get some sense of equilibrium in the capital markets, you may well see us transition back into taking more of an equity ownership stake in some of the real estate ,which historically we had done kind of in the '04, '05, '06 timeframe.

Jonathan Habermann - Goldman Sachs

Can you comment on and just expected asset sales. I know at this point you sound like you're most of the way there but is there much in the way of disposition activity you're considering as you move into 2009. Again, the balance sheet's in good position but just wondering what else you're thinking about at this point.

James F. Flaherty

I really think you should expect us to have concluded a very substantial period of capitol recycling. There’s one or two things that are out there that might be of some strategic import to one or two folks and we’re having some discussions, but they are in the aggregate, not substantial.

They would not move the needle and coming off a timeframe here of the last two years where we’ve recycled somewhere of $3 billion plus of capitol. I think now where the opportunities are going, I think you’re apt to see us become much more of a net buyer as apposed to a net seller.

Jonathan Habermann - Goldman Sachs

Maybe just one little one for Mark, can you comment on the run rate for the interest and other line item?

Mark A. Wallace:

I think interest and other for the fourth quarter should be about $33 million.

Operator:

Your next question comes from Rich Anderson - BMO Capital Markets.

Richard Anderson – BMO Capital Markets:

Could you give a little bit more color on the Sunrise and Ameritas the transitioning of Ameritas to Sunrise operations and what the thought process was behind that, and maybe a little color on the impairment which I guess you said is tied to above market rent, just a little bit more color on that please.

James F. Flaherty

Sure, well this was a lease that was booked at the time we acquired the portfolio, the Orius portfolio is one of 13 pools that Sunrise operates and came to us at the time we closed on the CNL acquisition in October of '06. So at that time there was a lease intangible that was booked.

At the time in which that lease is terminated you would write off the amount that was on the books that related to that because that lease is being terminated. Separate and apart from that, recall this is a portfolio of 11 purpose-built senior housing assets located in very fine locations up and down both the east and the west coast, 90% plus occupied, average life of about 8 years.

Most of them were built in either 2000 or 1999 very nice quality mix and our concern had been that the NOI margin on the portfolio was tracking below where we thought a portfolio of that asset quality ought to be. Specifically it was tracking for '07 at a kind of a 19.5% number, that’s gone up a little bit during 2008.

So, we had the ability to terminate that portfolio, which we did which we disclosed to you on the last call and we’re in the final stages of transferring the portfolio to Ameritas, which is just getting through the last stages of the licensing, and some time later in the fourth quarter or the first part of the first quarter we think that will be effective. Then we’ll ask Paul maybe to talk a little bit about the improved economics that will accrue to the shareholders of HCP.

Paul F. Gallagher

Yes, in 2008 we expect to collect rents in the neighborhood of about $18.7 million. The first year rent that we would receive from Ameritas is going to be about $17.5 million. However, that’s going to grow substantially over the first five years on a contractual base to about $30 million, so good economics to $30 million annually in the fifth year.

In addition, we’re going to fund about $3 million or half the cost to refresh the assets and Ameritas will fund the other $3 million. Our $3 million investment, once invested in Ameritas will end up paying rent on so, what we’ll have is a repositioned, refreshed portfolio of 11 assets with good contractual rent growth.

Richard Anderson – BMO Capital Markets:

In terms of how this was just a typically triple net lease structure with Sunrise, is that right?

James F. Flaherty

No, there was a management contract between the tenant and Sunrise, we own the real estate.

Richard Anderson – BMO Capital Markets:

Right, so you are not HCP there wasn’t any [inaudible] involved in this.

James F. Flaherty

No.

Richard Anderson – BMO Capital Markets:

When do you –

Paul F. Gallagher

You like that idea don't you?

Richard Anderson – BMO Capital Markets:

I like to pronounce it. It’s a cool word. So, if I could get it to fit in there I’d say it, but this impairment you expect in the fourth quarter or the first quarter, but one of those two. Is that right?

James F. Flaherty

Whenever we terminate the lease, we are not going to terminate the existing lease until we sign a new lease. We can’t sign the new lease until the states that are involved pass on the final licensing, but the economics going forward are going to be as policy was indicated to be far superior to HCP shareholders in terms of return on this real estate then we have experienced the last two years.

Richard Anderson – BMO Capital Markets:

Was this driven by just reducing your overall exposure to sunrise?

James F. Flaherty

Nope. All about making money and optimizing our real estate portfolio for the benefit of our shareholders.

Richard Anderson – BMO Capital Markets:

So why couldn’t Sunrise have done that because you had this out as a way to replace them and that’s the only way you could have upped the growth prospect, is that right?

James F. Flaherty

I didn’t get the last bit of that. What was that?

Richard Anderson – BMO Capital Markets:

You had this option to replace them and that was the only way you can change the terms of the lease over the next five years. Is that correct?

James F. Flaherty

Yes, we’re terminating the existing lease, which we will improve upon the economics materially and then we are going to enter into a new lease, which we’ve already negotiated. It’s just ready to sign. We’re just waiting for the - -

Richard Anderson – BMO Capital Markets:

But it required the replacing of the operator is what I am saying.

James F. Flaherty

Yes, right which drives the whole economics, again as I think I mentioned in the last call, recall that among the three or four very, very important strategic implications of our Sunrise portfolio are the fact that we own real estate across their product spectrum. So we’ve got a good chunk of that portfolio is at the high end Sunrise Mansions then we’ve got the next group down, which is the Brighten Garden portfolio of which this Orius portfolio is part of.

The next group beyond that is the Eden care and then we go to Maple Ridge. So I believe what I had said on our August call was that we think Sunrise does a very fine job with respected to that high end Sunrise Mansion, but we see them being less sufficient with those other product portfolios and this is a good example of that which is why we’re about to capture what we think our very significant and substantial increases in the economics commence what other portfolios in this sort of geography with this sort of regiment mix ought to be achieved.

Richard Anderson – BMO Capital Markets:

Do you see any other opportunities like this replacing operators to improve the economics in your portfolio with Sunrise?

James F. Flaherty

Well, I wouldn’t limit it to Sunrise. I think we’re in the business of owning very good real estate and making sure that we’re optimizing the returns on that. I mean Paul had just talked about how we’d move the Irvine hospital campus from tenant. We’re moving that to the gold standard in Orange County, which is Hoag Hospital. We’re in the process of doing something similar in Los Gatos. So this is what I believe our shareholders invest in us to do, so we’re all about trying to optimize the returns on our real estate. I think there is fertile hunting ground here just in general and we are all about getting after that.

Richard Anderson – BMO Capital Markets:

And for the 14% Sunrise exposure you expect in ’09 assumes this transaction and no others.

James F. Flaherty

That is correct.

Operator

Your next question comes from Steve Swett - Keefe, Bruyette & Woods

Stephen Swett - Keefe, Bruyette & Woods

Just a couple more comments on the transaction environment. You really haven’t seen asset sellers begin to capitulate yet in terms of the pricing they’re looking for?

James F. Flaherty

Not on a large scale.

Stephen Swett - Keefe, Bruyette & Woods

Your comments on the invest –

James F. Flaherty

I think for the most part that an important part of why that hasn’t happened is that for the most part, in general, you’re seeing healthcare real estate continue to perform pretty well.

Stephen Swett - Keefe, Bruyette & Woods

On the investment side, your comments on the senior housing space, I guess that’s an area of interest. Is it more because of the fundamentals that you alluded to getting better or is it also related to kind of where your portfolio is positioned or the pricing that you see in that sector versus the other opportunities?

James Flaherty

Well, it's those three plus one more, so let's pick them off. We think this is a good time to be starting to sharpen the pencil on senior housing. We ordered this move six years ago and made one of our most successful investments of all time which was putting the Mezz debt into what was American Retirement Corp. at the time so that they could make the cash put on the convert that was coming to keep them out of chapter, and in so doing got that secured by the crown jewels of that company at the time which we then subsequently converted into long-term sale lease backs which now sits under the Brookdale master lease.

I actually think on a risk-adjusted basis if you compare what that period was like six years ago to now, I actually think there's less risk involved here because of the other two points I made. You don't have that tidal wave of supply bearing down on you and you have industry wide occupancies almost 20 basis points higher than they were and you have a greater acceptance for the product. Now, I continue to think you're going to see some additional softness in occupancy here. In fact, the train's not going to come off the tracks but it will probably soften a little bit.

I think the operators are going to be hard pressed to be putting through the rate increases that they put through last couple of years in the next year or so, but if you can buy good real estate with good operators at a good valuation that's what were supposed to be doing, so that's one thing.

In terms of the property sectors, I think this is starting to become increasingly more attractive. I'll add one to the three reasons you had I'll add a fourth and I talked about this one on the last call as well. If you go back two or three years ago and looked at the prospective purchasers of senior housing real estate, they included the public companies themselves who were basking in very nice ramp ups in terms of occupancy, low double digit rate increases and that all translated into 30 and 40 times team multiples which gave them access to us an abundant amount of capital which smartly they used to move away from the healthcare REITs and own that real estate themselves.

In that timeframe, you also have the private equity crowd who were taking advantage of very, very attractive debt and you can pick off the transactions that occurred in that timeframe. They included the holiday deal that went in a [inaudible] cap rate and a host of other transactions, and then we obviously had the healthcare REITs that were out there as well.

If we fast-forward to the fourth quarter of 2008, the operators are a little challenged right now in terms of their stock prices and their ability to access the capital markets, generally speaking. The private equity crowd because they can't get the debt, either in the amount or at the rate they would like to get, are challenged to generate the IRRs to move forward.

In terms of healthcare REITs, we're sitting here with a very strong balance sheet with the highest set of credit ratings and we in fact have moved down from a 60% sort of concentration in senior housing just two years ago to the 39% today. So, it's a little bit of kind of the sun, the moon and the stars lining up. That said, no guarantees were going to do anything but it's becoming increasingly attractive to us I think.

Stephen Swett - Keefe, Bruyette & Woods

Did you state what you thought the write-off on the intangibles on the Sunrise lease was going to be?

James Flaherty

Yes, I said the portion that would impact FFO was $9 million.

Operator

Your next question comes from line of Rob Main - Morgan Keegan.

Robert Main – Morgan, Keegan & Company, Inc.

Paul, in your discussion of the same store metric center and [inaudible], in looking at the numbers this quarter versus last quarter a lot have come down. It kind of sounds like from the detail you gave us that there is one off type issues like MOB lease terminations. Am I correct that there is nothing that you see systemically that's affecting in the line growth?

Paul F. Gallagher

That would be right.

Robert Main – Morgan, Keegan & Company, Inc.

With the runway that we had in the second quarter, I know there's some special events going through there. We would be more indicative of where things might be going forward.

Paul F. Gallagher

The second quarter Rob or the third quarter?

Robert Main - Morgan, Keegan & Company, Inc.

The second quarter, you were in the threes in the second, twos in the third quarter, when I look into '09, where do you think would be a more reasonable expectations…

James F. Flaherty

Well, we've been kind of hovering between two and three. As we sit here today we're probably closer to two than three would be my assessment on what we're hearing, but –

Robert Main - Morgan, Keegan & Company, Inc.

Then one question for Mark, TI and what not in the quarter they've been down sequentially the last couple of quarters, what's a good run rate to use for that?

Mark A. Wallace

For '09?

Robert Main - Morgan, Keegan & Company, Inc.

'09, fourth quarter, whatever you want to give me. I'll take anything.

Mark A. Wallace

Lease commissions, TIs and CapEx we had 12.3 for the third quarter I think we'll be down to about 11 for the fourth.

Robert Main - Morgan, Keegan & Company, Inc.

Okay.

James F. Flaherty

A lot of that surrounds the [inaudible] that's coming out, right?

Mark A. Wallace

So that's going to trail off on

Robert Main - Morgan, Keegan & Company, Inc.

Jay, just to follow up on the opportunity you're seeing in senior housing potentially kind of shaping up, do you see that as an equity or a debt opportunity or both?

James F. Flaherty

In terms of what the form of our investment would take?

Robert Main - Morgan, Keegan & Company, Inc.

Yes

James F. Flaherty

Probably a little of both.

Operator

Your next question comes from Jerry Doctrow - Stifel Nicolaus.

Jerry Doctrow - Stifel Nicolaus & Co.

I just have a couple quick things, one just, I think you were buying debt if I read queue correctly, just any little color on what the thinking is or any characterization of that stuff. I'm assuming its healthcare related maybe operator debt but, just trying to get a little more color as to what the strategy is with that stuff.

James F. Flaherty

Well, I think we're looking for dislocations in the market. A, it's all healthcare and B, it's your absolutely or indirectly going to be tied to real estate because that's what we're supposed to be doing and that's where our expertise lies.

But, if the government of Iceland decides to off their entire leverage loan portfolio on a given day, which they did two weeks ago and there's a down draft in sort of valuations and a vacuum of buyers, we take note of that, maybe start to nibble a little bit. It's not going to move the needle, Jerry, but it would be kind of what we put in our opportunity subset of investing opportunities.

Jerry Doctrow - Stifel Nicolaus & Co.

Obviously a relatively small number, and right now it's all healthcare related, it's all debt and you're just giving it an opportunity.

James F. Flaherty

It'll be always healthcare related.

Jerry Doctrow - Stifel Nicolaus & Co.

One clarification - -

James F. Flaherty

It will always all be healthcare related, just so we're clear.

Jerry Doctrow - Stifel Nicolaus & Co.

On Sunrise I think you said specifically on the last call there were two more tranches within your 13 tranches that based on performance metrics at that time, if the performance didn't improve by yearend or whatever you would have the right to move. So, I just wanted to get an update on those two, whether that was accurate and whether that's still sort of the state of affairs.

James F. Flaherty

I know there's at least one more, I can't remember if I said two more or not, there's certainly one more, and we're watching that among a lot of things we're watching with Sunrise right now.

Jerry Doctrow - Stifel Nicolaus & Co.

There was another analyst that may have raised the sector of bankruptcy risks with Brookdale and Sunrise, do you want to comment at all on any concern you've got about that issue?

James F. Flaherty

Sure, let me make a general statement and the general statement would be I think either one of those two events I would categorize as being unlikely. At 30,000 feet I go back to our assessment of senior housing today, pretty good occupancies and, Jerry, you would know better than anybody else, but I don’t know what your reaction is to 90% plus occupancy, I guess [inaudible] but its pretty good I would think.

Jerry Doctrow - Stifel Nicolaus & Co.

Right, we actually agree I think on our assessment of senior housing.

James F. Flaherty

So, I think it's a good time to be looking at that. I think if you go to the specific companies with respect to Brookdale projected '09 to be 7% of our NOI, they've got in our situation it's got to bring it back to HCP's situation. We're in the fortunate position of having the crown jewels of the company, given our entry point which was six years ago when we we're able to put that piece in, October rents have all been paid. You've got a management team here that is seasoned and they're a bunch of pros, they've been in the movie before. I would suggest to you that this particular bit of difficulty they're working their way through was not self-induced. Yet, despite that we have enormous confidence in Bill Sheriff and Annie and the rest of the gang there to get through this.

Our overall portfolio of Brookdale, which represents a total of 24 properties, is 92% pooled in five separate master leases. They cover at about 1.25 to 1.3. They're 91.4% occupied and the nature of our relationship with Brookdale is through direct leases. So, in our view, very unlikely event that something were to happen there. You go into a scenario where the leases can either be rejected or assumed and given the quality of our portfolio with Brookdale and the performance of that portfolio we would have a very high level of confidence that those leases would be assumed and going forward it wouldn't be much of an issue at all with respect to HCP shareholders.

Now with respect to Sunrise, a little different nature of the relationship there which goes to the management contracts as opposed to the leases, but first let me say you have a new CEO and CFO there. I think they are working very hard to refocus that company's business model and make it profitable. They've had a few fireworks going off, that they inherited, that they're dealing with, but we see them to be very focused, very bright and very much on the pace of trying to affect a much more profitable business model going forward.

There's no unsecured debt in that company, not a lot of debt in general quite frankly, and you've got, obviously as is the case with Brookdale, you've got the main constituency here being the residents in senior housing, which I think everyone needs to never take their eye off the ball there.

So when we go to Sunrise HCP, the nature of our relationship there is management contracts. Once again we benefit from the fact that we have post Orius 90 properties they will represent 14% of '09 projected HCP NOI. They cover at 1.25 times they're 90.3% occupied, and you have the same issue here that you have with the leases. You'd either reject or assume the management agreements.

It is our strong sense that most if not all of the management contracts would be assumed. In the event that any of them were rejected we' be in a mode of having to find an alterative manager for that portfolio and I think that's a situation we would look forward to. Quite frankly, we've got a stable a very high quality senior housing operators located around the country that match up well with the geography of our Sunrise portfolio.

As we've proven just recently we've been able to extract some very significant additional economics for the benefit of the HCP shareholders as witnessed by this Orius transfer to [inaudible]. So, I think again the things that distinguish our portfolio, I think it's very, very important you might want to pull out my transcript from the last call, but I went through four very significant things as to why our portfolio is different from all the other Sunrise portfolios that are our there, and goodness knows with all the capital partners there's a lot of Sunrise portfolios out there but just to review one we own 100% of this real estate.

All the other Sunrise properties are owned in joint ventures where Sunrise is typically up a minority partner. Two, there is very, very low level of secured debt against our portfolio, and three, what debt does exist against our Sunrise portfolio is extremely low loan-to-value, and then fourth, 70% of our Sunrise portfolio is not branded as Sunrise Mansions.

So again, I think that's our quick take on what would happen in Sunrise, God forbid something happens there, and again I don't think that's going to present itself because we have enormous confidence in the management team there. It's probably more of an upside opportunity to HCP shareholders than anything else.

Jerry Doctrow - Stifel Nicolaus & Co.

If there's a bankruptcy filing, you don't have automatically the right to boot them out as the manager they decide whether they keep or reject management contracts?

James F. Flaherty

That's correct. It would be up to management to go through the management contracts and again whether they be assumed or rejected.

Operator

Your next question comes from Karen Ford – KeyBanc Capital Markets.

Karen Ford - KeyBanc Capital Markets

In light of your comments that pricing for Mezz debt had moved of late and your comments about being more concerned about the skilled nursing sector, what do you think the market rate pricing would be for your Manor Care investment today?

James F. Flaherty

Well, here are the facts. We made the investment 11 months ago. Since then they've generated $300 million of cash flow. They are in the process of de-levering our tenant, which is OpCo by a very significant amount, witness the Dutch auction tender that they launched last week.

The operating metrics are stronger today than they were at the time we made the investment and we made that investment with an eye towards holding it to maturity, which now is only three years away from the initial maturity.

So not surprisingly, Paul Ormond and his management team have exceeded any potential underwriting assumption that we made by a very significant amount. So we look at that from a standpoint of a hold to maturity, and is the investment worth more today on a fundamental basis, and from our assessment and we watch that very carefully it's a grand slam, albeit only one year into the investment.

Karen Ford - Key Bank Capital Markets

Just given the return requirement changes over the last few months, even with the improved credit statistics and improved operating performance though, do you think that required returns on an investment like that would be higher today than where it's currently yielding?

James F. Flaherty

Well if you're asking me if I would sell any of the investment at the price we invested it in a year ago, the answer is no. I would suggest to you in the skilled space there isn't another investment like this.

There's only one Manor Care, there's always been only one HCR Manor Care. No one has the quality mix this company has. No one owns all the real estate in this space, everything else is usually in the hands of healthcare REITs. It's a unique, unique investment. It's a strategic investment for both us, given the first loss nature of the company, and for them, given the importance of adds to the capital stack.

We look at that investment in the context of the finest investments that sit in our portfolio, whether it's HCA's Medical City Dallas campus, whether it's the Amgen and Genentech campuses and assets like that. So we couldn't be more pleased and more excited with that investment.

Karen Ford - Key Bank Capital Markets

If you were to be a buyer later this year or in early '09, say of senior housing, what would be the company's short-term and long-term plans to fund that?

James F. Flaherty

Well I think the long-term would remain unchanged. We always manage the balance sheet to be conservative. Historically we used a 50/50 sort of metric as the metric. We obviously are more conservative than that metric today. So long-term no change, short-term there would be a change.

The last two or three strategic moves we've made, C&L, Slough, Manor Care, we used interim credit facilities to close the transaction day one, and then refinanced the interim credit facilities with the permanent capital over the next 6 to 12 months and obviously that permanent capital included things like equity issuance, unsecured debt issuance, secured debt issuance, asset dispositions, and joint ventures.

The change going forward would be that on a short-term basis, you should expect to have us have all the permanent capital in place at the break, as opposed to the tactics we've used in the last couple years, and we just think that's being prudent with respect to an important subset of our capital partners, which are our fixed income investors. So zero long-term change in the capital strategy, but a significant change in the short-term to affect these transactions.

Operator

Your next question comes from Tayo Okusanya - UBS.

Omotayo Okusanya – UBS

Some of your peers who have MOB top portfolios or who have a significant amount of TIs and CapEx do provide AFFO or FAD numbers, is that something you guys will consider at some point?

James F. Flaherty

Let me ask Mark to respond to that.

Mark A. Wallace

Yes this is Mark. We lay out all of the components to get you to AFFO or FAD in the supplemental and so all the information is available.

James F. Flaherty

And Mark's delighted to spend time with you Tayo, to take you through that.

Omotayo Okusanya – UBS

I'll do that with him. I'll talk to Mark off line. Second thing is I know you may have gone through this and I may have missed it, but the development projects that are going to be coming online on Oyster Point. I know for the three projects you have percentage pre-leased at 60%, but could you give me the previous amount for each particular project?

James F. Flaherty

Oyster Point we have two. We got A, B and C. A & B are 100% leased to Amgen and C, which comes online we're actively talking to tenants, but as of now there's zero pre-leasing on that particular building.

Operator

Your next question comes from Adam Feinstein - Barclays Capital.

Adam Feinstein - Barclays Capital

I like the definition of L-Tech with the Lawrence Taylor comment earlier. I think sometimes people mix that up, but just wanted to ask you and it's late in the call here and there's been a lot of calls today, I guess it's just two questions for you.

One, with all the stress in the hospital marketplace, in terms of for profits these days with issues around capital, and everyone's more focused on their balance sheet, do you see an opportunity where more MOB opportunities are going to be out there, just meaning I remember when HCA created Medcap to free up capital on their balance sheet and some of the other guys over the years, just curious if you think we'll see more deals because of the current environment in terms of MOBs that are owned by hospitals, and then I just have a quick follow up.

James F. Flaherty

I think you'll see a couple things. Obviously the four profits have some challenges in terms of raising capital, but the poor non-profits, who historically have used the tax-exempt market, those auction rate preferred situations going upside down, they've just obliterated the tax-exempt market.

So unless you're in a fortunate position of having an enormous philanthropic base, like our about to be new tenant at Irvine Hospital Hoag Hospital, you're really up against it. So we're getting inbound calls from some of the premiere tax-exempt hospitals in the country, not just talking about potential interest on our part for the MOBs, but just across their entire capital needs.

So like I said, this really goes back to my response to the question Jay asked in terms of what's driving the senior housing. It's a combination of the underlying attractiveness of the businesses, the opportunity to maybe have some of these things re-valued, but also in terms of these folks alternative capital sources, they've really for a whole bunch of reasons. No debt for the private equity crowd, they're hurting, the senior housing crowd, their PE multiples have contracted to the point where it's tough for them to be selling equity right now, for the non-profit hospitals, the tax exempt markets have become quite challenged.

It's a whole slew of issues, but as we sit here and look at the playing field across our property types, while the individual reason why a particular property type might have a lot less capital alternatives today certainly differs the overall messages. There's the universe of capital providers that we compete with has shrunk drastically in the last 18 months.

Adam Feinstein - Barclays Capital

Then just a follow up question here, I noticed a lot of questions on senior housing so I don't want to go back through it all, but just one thing I noticed as looking through your supplement was occupancy rates on the CCRCs continues to be very high. How comfortable do you feel with that? Do you think we'll continue to see occupancy running at, I think it was 94% I saw earlier?

James F. Flaherty

I don't know that on the CCRCs it's necessarily the occupancy per say, but it's deterrence, the amount of rollover that you have with the CCRCs that drives the actual economics, so that's where our focus has been is rolling the various different units.

Paul F. Gallagher

And I would also say Adam, and again, I don't believe you were covering us at the time we made that investment. But our CCRCs are the crown jewels of what was American Retirement Corps, and that was a tough one. They traded that to stay out of bankruptcy when we made our investment six years ago. So I don't really think you can take our CCRC portfolio and necessarily think its representative of CCRCs in general out there.

So I think I'd just caution you with respect to that. If we could do more like that, we'd love to, but the other communities of that ilk that we tracked very carefully are all sitting in the hands of private companies that the last thing in the world they want to do is part with that because it's gold.

Operator

Your next question comes from Jim Sullivan - Green Street Advisors.

Jim Sullivan -– Green Street Advisors

Sunrise was pretty good at crafting long-term management contracts that were essentially no cut types of contracts. What was the provision that allowed for you guys to move ahead with replacing them?

James F. Flaherty

Well it's all about how you got what you got. So these came to us through C&L. C&L had gotten them when they bought the Marriott portfolio, Jim. I think it's fair to say in the period of time since Marriott cut those management contracts they've done a nice job of improving the quality of those management contracts to the benefit of the manager, i.e. Sunrise. So we have some kind of hold over things that again, I don't believe are representative necessarily of the other management contracts that Sunrise has today.

Jim Sullivan - Green Street Advisors

I'm curious on your perspective with respect to the disruption at the property level when you switch a manager, it would seem to me that someone showing up with mom or dad and they're looking to find a comfortable place for them to be that the change in the manager would be disruptive, at least in the short-run. Can you comment on that?

James F. Flaherty

Yes, let me have Paul talk about that because I remember, we were struck by in this Orius transfer. Right after we announced it, I think the next day Ameritas had their President and COO on site. He might talk a little bit about the sensitivity and your right to be tuned to, but he might describe how Ameritas has stepped in there, and quite frankly, Sunrise has been very, very helpful as well.

Paul F. Gallagher

It was very much a coordinated event. They got in, they had high-level meetings with senior management at Sunrise and then they deployed teams to the various different facilities and had hand off meetings and things of that nature, and quite frankly since we've announced the termination, the property level performance in that Orius portfolio has either maintained or slightly improved.

Jim Sullivan - Green Street Advisors

And what's Sunrise's incentive to be helpful in that process?

James F. Flaherty

They're a quality organization and they've got other properties that are licensed by those states and the last thing they want to do is have any harm come to their reputation as a quality operator.

Jim Sullivan - Green Street Advisors

In the sub 20% profit margin that you talked about, how much of that would you attribute to their corporate challenges, the dismantling of their development infrastructure, etc., to perhaps leading them to take their eye off the operating ball?

James F. Flaherty

Zero, what you’re referring to has occurred in the last 18 months, in my view. These margins that we quoted, those were margins that are on the portfolio, which is obviously only two years that we saw prior to that and then in the interim period.

This was really as I said, we’re in a fortunate position of our Sunrise portfolio is 100% owned, low absolute amount of secured debt against it, low loan-to-value and we cut across four different product platforms. The Sunrise Mansions, which is the highest end product they have, they are very, very good at that. When you start to tick down our perception is there a little less sufficient and, that’s what this is all about. This isn’t about any taking their eye off the ball or anything like that.

Operator

Your next question comes from Chris Haley – Wachovia.

Chris Haley - Wachovia

The $319 million of financing that you discussed on several assets of a little over a dozen assets, did you offer an LTD on that financing?

James F. Flaherty

I think it was 60% on the Fannie Mae.

Chris Haley - Wachovia

And on the hospitals sold, you previously offered your sale cap rates? I didn’t see that in this supplemental. Did you offer –

James F. Flaherty

Yes, I think I mentioned on the two that were part of the last tranche of the medical properties trust that was on 8.6% cap rate.

Paul F. Gallagher

I think the whole portfolio was about a 9.1% or a 9.2% and this last two that closed were 8.6%, so the ones that closed before them were a little higher then that average Chris.

Chris Haley - Wachovia

Paul I’ll stick with you on the two questions about the first medical office building portfolio and then life science. On the MOBs, you mentioned that you had a fair amount of activity in the month of October and you had several good backlog into November, December. Can you give us a sense as to where things are at the margin in terms of rent structure, your ability to pass through these costs that you mentioned that impacted your third quarter. Just give us a sense of marginal economics, roll ups or inducements.

Paul F. Gallagher

First off the velocity remains consistent we’ve been able to achieve 3.7% mark-to-market increases on the new leases. We are in the process of going through portfolio wide converting gross leases to triple net. That’s about 40% of the portfolio now. We expect that to increase over time, but we haven’t seen any pushback from an economic standpoint, with prospective tenants.

Chris Haley - Wachovia

So the inflation 3% plus of rollup, you also seeing that carry into the fourth quarter. What would you expect in 2009 based upon your experience?

Paul F. Gallagher

Well, typically when we roll the new rents to market they’ve been averaging historically anywhere from 3% to 5%.

James F. Flaherty

I happened to have heard earlier today, our largest tenant in all of our MOBs just renewed in bulk for '09 at a 5.1% metric, Chris.

Chris Haley - Wachovia

Paul, can I go back to you on the life science? Can you refresh us, when you look at the deals that were announced in the life science development projects, where did they shake out in terms of to generate a rate of return? What is the rate of return on these developments projects with these leases that were done?

Paul F. Gallagher

Well, if you remembered, they were 100% pre-leased to Amgen and Genentech and I believe the returns were when we bought those in the low 6% return on cost.

Chris Haley - Wachovia

So today, I thought you had mentioned that there were several leases that were pre-committed leases that were new during the quarters. Did I hear you incorrectly?

Paul F. Gallagher

There was a combination of, are you talking development, or –

Chris Haley - Wachovia

Development.

Paul F. Gallagher

No, Chris those are all either vacant space or renewals, there was no leases relative to any development properties.

Operator

Your next question comes from Michael Mueller – JP Morgan.

Michael Mueller - JP Morgan

Quick question for Mark, if we take the $0.71 and back out the non-core as a one-time item of about 17, you get this $0.54, analyzes in the mid two teens. Are there any other one-time type items that are skewing that run rate or income waiting to come on? I know you are going to have the life science development projects coming on, but do you think that’s a good starting point for thinking about '09?

Mark A. Wallace

I think the $0.54. I think those are the items you mentioned are the key ones. They affected the quarter as you said. In the fourth quarter we will have the development projects coming online then the additional leasing, and then obviously as I said earlier, some of the expenses in the MOB sector will be moderating as well.

Michael Mueller - JP Morgan

I think you mentioned earlier about CapEx in the quarter dropping off sequentially. Can you try to quantify how much lower could '09 be versus '08, I guess largely be driven by the life sciences.

Mark A. Wallace

Right, and we will give you perfect information on that, Michael, on the next earnings call.

Operator

Your next question comes from Dustin Pizzo – Bank of America Securities.

Dustin Pizzo – Bank of America Securities

This is Erica on the phone with Dustin. Most of our questions have been answered and maybe I missed it, but could you provide any additional color on what caused the occupancy on the California MOB portfolio to fall to about 84% from 94% this quarter?

James F. Flaherty

Yes, we had two large single tenant buildings where the tenants vacated.

Dustin Pizzo – Bank of America Securities

I guess can you comment on the higher level of weaknesses in the off campus portfolio this quarter on the occupancy front?

James F. Flaherty

Can you say that again?

Dustin Pizzo – Bank of America Securities

Just as far as the off campus, the weaknesses there versus the on campus.

James F. Flaherty

I think that’s probably like on campus we’re at 82%, plus or minus of the entire MOB portfolio sitting on campus, number one. Number two, markets your hospitals you’re going to have much higher attention rates, and at the margin higher occupancy. That’s just a little bit of its apples and oranges. Generally, you should expect lower attention rates and lower occupancy on our off campus portfolio then our on campus.

Operator

Your final question comes from Eileen Yin – Credit Suisse.

Eileen Yin – Credit Suisse

I know you just mentioned that the bankruptcies are your top operators is very unlikely and that even in the bankruptcy you can find a replacement tenant, and should be a positive, but is that a long-term plan to diversify on your top tenants as a risk management?

My second question is, can you just comment on the few properties in Michigan and Washington States that have EBITDA cash flow of below one and is there any cost default on these properties because of this?

James F. Flaherty

I’ll take the first one I certainly won’t take the second one. With respect to the first issue, we have no long-term plan to diversify a way from our senior housing operatives. We spent too much of our shareholders money in the last several years to get there. So, being Sunrise does a very, very good job as we described already on this call, same with Brookdale, same with Ameritas.

One of my great frustrations given the way the accounting works is that you all don’t get to see the operating metrics coming off of our horizon day portfolio and the reason for that is, is that’s a portfolio about $1.2 billon invested capital in general that sits in a joint venture with an institutional investor.

All independent living, probably the portfolio we use the most to take a gauge on what’s going on because it’s a lot of independent living and it’s a lot of Florida. The management team there, [Chilo Bess], Steve Benjamin, John DeLuca, they do a tremendous job and they’re clicking along at 92, 93% occupancies with 41% operating margins.

So you guys don’t get a chance to see that, but in general I think one of the core strengths of the entire company is the quality of the operator and tenants across all of our sectors and certainly senior housing is no exception. So, when we look at Sunrise, and Brookdale and Horizon Bay, and Aegis and Ameritas, and Atrie and Ericsson, we’d love to do more with those folks, assuming that we can get the economic result for our shareholders. So with that, I’ll turn the second part of your question over to Paul.

Paul F. Gallagher

With respect to Michigan, we have assets with Sunrise, Brookdale and HRA, and each one of those portfolios are in the high 90% pooled range, so those assets will be pooled in other portfolios, and in Washington we have Sunrise and Aegis assets, and again those are pooled assets as well, so they would be part of a larger operating core.

Operator

With no further questions in the queue, I would now like to turn the presentation back over to Mr. Jay Flaherty Chairman and CEO for closing remarks.

James F. Flaherty

Thanks everybody for your interest. For those of you that are planning on being down in San Diego the week after next, we look forward to visiting with you there, and for the rest of you, if I don’t talk to you between now and then have a great holiday season and enjoy it. Take care.

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