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Senior Housing Properties Trust Inc. (NYSE:SNH)

Q3 2008 Earnings Call

November 6, 2008 1:00 pm ET

Executives

Tim Bonang – Director of Investor Relations

Dave Hegarty – President and COO

Rick Doyle – Treasurer and CFO

Analysts

Tayo Okusanya – UBS

Jerry Doctrow – Stifel Nicolaus

Chris Pike – Merrill Lynch

Kevin Ellich – RBC Capital Markets

Philip Martin – Cantor Fitzgerald

Stephen Swett - Keefe, Bruyette & Woods

Mark [Bifford] - Oppenheimer

Operator

Welcome to the Senior Housing Properties Trust third quarter 2008 financial results conference call. This call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to the Director of Investor Relations, Mr. Tim Bonang.

Tim Bonang

Good afternoon everyone. Joining me on today’s call are David Hegarty President and Chief Operating Officer, and Rick Doyle Chief Financial Officer. Today’s call includes a presentation by management followed by a question and answer session.

Before we begin today’s call I would like to state that today’s conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and federal securities laws.

These forward-looking statements are based on Senior Housing's present believes and expectations as of today November 6, 2008. The company undertakes no obligation to revise or publicly release the results of any revisions to the forward-looking statements made in today’s conference call other than through filings with the Securities and Exchange Commission or SEC regarding this reporting period. In addition this call may contain non-GAAP numbers including funds from operations.

A reconciliation of FFO to net income can be found in our Q3 supplemental operating and financial data on our website at www.snhreit.com. You will also find there the components to calculate AFFO, CAD or FAD.

Actual results may differ materially from those projected in forward-looking statements. Additional information concerning factors that could cause those differences is contained in our 2007 Form 10K on file with the SEC and third quarter Form 10Q to be filed with the SEC within the next day. Investors are cautioned not to place undue reliance upon any forward-looking statements. Now I would like to turn the call over to Dave Hegarty.

Dave Hegarty

Thank you for joining us during this very busy reporting season. We’re pleased with the results of the quarter and the strong financial position we're in today. In fact, based on several research reports SNH is considered one of the top REITs in the entire REIT industry for our liquidity and our strong balance sheet.

Let’s first focus on the results for the third quarter. For the quarter we reported funds from operations of $0.41 per share and if not for significant amount of un-invested cash we had for the first half of the quarter our FFO would have been higher.

The results do not fully reflect the impact of the new investments made during the quarter and we view this as a transitional quarter. During the quarter, SNH made new investments totaling $359 million and an average cash yield of 8.2% and a GAAP yield of 9.0%.

We acquired 23 medical office building and clinics totally 672,000 square feet for $149 million, which were part of the HRPT acquisition. We acquired 10 private pay senior living communities with 563 units for $76 million, one 89,000 square foot multi-tenant and medical office buildings not affiliated with HRPT for $18.6 million, four wellness centers developed and leased by Life Time Fitness for $100 million, and funded $14.8 million on improving financing on existing properties.

We funded these acquisitions by using cash on hand, proceeds of $21 million from the sale of three properties to Five Star, the assumption of 18 mortgages totaling $61 million at a weighted average interest rate of 6.6% and borrowings on the revolver.

At quarter end we had only $93 million outstanding on our $550 million revolver. Subsequent to the quarter end, we acquired a 79,000 square foot diagnostic center in Austin Texas for $29.8 million, which was part of the HRPT transaction, and a 249 unit trophy retirement community in Bloomington, Indiana for $29 million.

Now I’d like to have Rick review the quarter results with you and the properties acquired and then I’ll discuss the operating trends, the acquisition environment and the outlook for SNH.

Rick Doyle

For the third quarter 2008 our FFO was $47 million compared to $34 million for the third quarter 2007 or a 38% increase. On a per share basis FFO was $0.41 for the third quarter in both 2007 and 2008.

FFO results for the third quarter 2008 were hindered primarily because the net proceeds of our June equity offerings had not been fully redeployed until over halfway through the quarter. In addition we’ve received $21 million of additional cash on July 1 from the sale of three properties to Five Star.

We have provided a number reconciling items on page 14 of the supplemental package to allow you to calculate FAD, AFFO, CAD or a comparable other number and under all calculations they are $0.01 higher than our FFO.

After we have acquired all of our medical office buildings from HRPT, we will begin providing complete office type statistics. There were no capital expenditures or leasing commissions of any consequence during the period.

Revenues for the third quarter 2008 were $59.7 million compared to $45.2 million for the third quarter 2007. This was the result of acquiring 68 properties since July 1, 2007 including 29 medical office buildings.

Interest expense was modestly higher as a result of increased borrowings on the revolving credit facility in the 2008 period in the assumption of 18 mortgages totaling $61 million with an average weighted interest rate of 6.6% during the third quarter of 2008.

General and administrative expenses increased by approximately $700,000. The increase primarily relates to the 68 properties we acquired since July 1, 2007, higher legal fees and non-cash stock compensation.

Percentage rent earned from our tenants was $2.3 million for the quarter, which is a $600,000 increase from the same quarter last year or a 35% increase. These revenues dropped to the bottom line, and as we acquire properties, future growth in percentage rent is built into the leases.

On July 1, we sold three underperforming assisted living facilities formerly leased to New Seasons, to Five Star for $21.4 million and recorded a modest gain of approximately $266,000 on the sale of these three facilities. Subsequent to quarter end, our board declared a dividend of $0.35 per share, which is a payout ratio of 85% of the quarters FFO. The board reviews the dividend on a quarterly basis.

On our last call, I described each of the medical office, clinic and laboratory buildings that we have acquired through August 8 from HRPT. To briefly recap, we have acquired five properties in June for a total of $84 million, primarily leased to the University of Pittsburgh Medical Center, HCA, Qwest Diagnostics, Army Care and stem cells.

In July, we acquired three properties for a total of $39 million primarily leased to Hematology/Oncology Associates of Central New York, Atlanta Center for Medicine and Affiliates of Emery Clinic in the primary and multi-specialty physicians practice in Anaheim, California.

In August, we acquired 20 medical clinics for approximately $110 million. Eighteen of these clinics are leased to Fallon Community Health Plan in Central Massachusetts and one is leased to Health Insurance Plan of New York which is actually subleased to Maimonides Medical Center in Brooklyn, New York and one is leased to Children’s Hospital in Philadelphia.

By quarter end, we had closed on a total of $233 million of the $555 million of the medical properties to be acquired from HRPT Properties Trust. On October 31, we acquired a multi-tenant diagnostics center in Austin, Texas for $29.8 million. We anticipate acquiring three biotech laboratory buildings located in La Jolla, California and leased to the Scripps Research Institute late in the fourth quarter. The purchase price is $115 million.

The remaining $187 million for properties are expected to be acquired in the first quarter of 2009. These purchase prices are fixed pursuant to purchase and sale contracts. On August 25, we announced the acquisition of four health and wellness centers operated by Life Time Fitness for $100 million.

The four properties are located in Romeoville, Illinois, Omaha, Nebraska, Alpharetta, Georgia and Allen, Texas. These properties were all built in the last four years. They were leased to Life Time for 20 years at an initial rental rate of 9.1%. Lifetime is a New York Stock Exchange listed company.

During the quarter we also acquired 10 private pay senior living facilities. Two were discussed extensively before. They are two assisted living facilities where they total 112 units located in Birmingham, Alabama. They were acquired on August 1 for $14.1 million and were leased to Five Star.

On September 1, we acquired eight independent living facilities in communities around Indiana containing 451 units for $52.1 million. In connection with this acquisition, we assumed $50.5 million of Fannie Mae debt with an interest rate of 6.5%. These properties were leased to Five Star by adding them to lease number three. The initial rate for these transactions was 8% on the amount funded.

On September 30, we acquired a six-year-old multi-tenanted medical office building for $18.6 million located in Syracuse, New York, adjacent to two of the medical buildings we acquired from HRPT. The medical office building has 89,000 square feet and 12 tenants. The largest of which is Central New York Family Care, which leases 42% of the building to 2016. The initial cash cap rate is 8.5%.

At the end of the quarter on October 31, we also closed on the acquisition of 249 unit retirement community in Bloomington, Indiana for $29 million and leased it to Five Star. This acquisition is very unique as the community was founded by alumni of Indiana University, which has the third larges alumni association in the country. It was selected the top retirement community this summer by AOL Money and Finance and was cited in the Wall Street Journal on September 13 as an ideal retirement community.

Finally, during the third quarter we also funded $14.8 million of capital improvements to Five Star for improvements in expansions at properties leased by them. At September 30, we had $457 million available on our $550 million revolving credit facility. The credit facility has an accordion feature to increase the capacity to $1.1 billion.

The retirement community in MOB acquisition closed on October 31 totaled approximately $59 million and today we have $416 million undrawn on our revolver. We continue to be lowly leveraged with debt representing only 25% of our book capitalization and 17% of our market capitalization. We have no debt coming due until 2011.

Now, I’ll turn it back to Dave to discuss other activities in the quarter.

Dave Hegarty

I'd first like to point out our current business plan and our plan is to first closely monitor the portfolio in these tough economic times, to look for opportunities, to have risk adjusted returns in today's market, prudently manage our liquidity and look for opportunities to grow cash flow in order to increase the dividend.

Our underlying portfolio properties continue to perform very well. Our tenant operating statistics are a quarter in the rears but worthy of a brief discussion. On Tuesday the NIC came out with its second quarter key financial indicators and our properties compare favorably to the second quarter occupancies.

Our properties that are primarily independent living experienced a sequential decline in occupancy from the March quarter to the June quarter from 91% to 89% in year-over-year from 90% to 89%. The NIC data suggests stabilized independent living properties were 89% occupied for the second quarter, so our properties are trending with the industry.

In contrast, our assisted living properties increased on occupancy to 90% in the June quarter from 87% in the March quarter. The NIC data for assisted living average occupancy was 88% for the June 2008 quarter.

Finally, the skilled nursing properties experienced a decline from 87% to 85% sequentially and the NIC data indicates average occupancy for skilled nursing facilities in the second quarter was 84%. These occupancy levels appear to be holding steady for our portfolio for the third quarter.

This occupancy data illustrates that the need driven assisted living units continue to perform well and the independent living is more susceptible to problems in the housing market in the overall economy.

Nursing home occupancies in our portfolio have declined primarily for several reasons. Some of the rural locations are experiencing a decline in eligible population, a few of the private operators are making substantial renovations currently to be competitive, and last but not least private pay patients are choosing assisted living facilities over nursing homes.

Coverage of the rent due to us under our leases reflects the underlying trends better. Coverage's continue to be very strong but have been impacted by the economy. Our lease number one with Five Star has 100 properties in it and is 1.31 times coverage compared to 1.27 times coverage in the March quarter and 1.27 times coverage a year ago. These are mainly assisted living properties and nursing homes.

The lease number two had a dip in coverage from 1.59 times to 1.47 times but it is essentially the same as the 2007 quarter. This lease contains 30 large retirement communities and two rehabilitation hospitals. The dip in coverage is because most of these properties have a large independent living component which is fairly the impact of the weak economy and, as Five Star discussed last night on their earnings call, reimbursement at the rehab hospitals has declined.

Lease number three represents 23 nursing homes and all acquisitions that have occurred since March 31, 2008. Since the new acquisitions are underwritten at about 1.2 times the rent, the new properties pull down the existing lease coverage. The lease still covers overall the rent at a strong 1.53 times coverage.

Lease number four represents the seven former New Seasons assisted living facilities that are now leased to Five Star. Until Five Star took over on July 1, 2008 the coverage ratios had declined from 1.28 in the March quarter to 1.08 times in the June quarter. This reflects how quickly things were deteriorating at these properties once a sale had been announced.

Five Star has since made many significant operational changes and as expected it will take a few quarters to see results dramatically improve. Five Star reported their third quarter earnings results yesterday and they were very respectful in this current environment. They generated $2.6 million of EBITDA for the quarter and about $5 million of cash flow from operations.

The 14 properties released to Sunrise still have strong lease coverage but they have slipped from the previous quarter to 1.43 times. Again, this is mostly attributable to the fact that these properties have a large component of independent living and several are located in Florida and Arizona, two of the worst housing markets in the country.

These leases are guaranteed through 2013 by Marion International, which is a BBB/Baa2 rated company.

The lease with Brookdale is maintaining strong coverage at over two times. Each of our properties with Brookdale is assisted living or Alzheimer's care and they have strong coverage which reinforces that assisted living is not being fully impacted by the economy.

The private operators had a different coverage's quarter but most of that's attributable to two operators closing wings to remodel them to compete in the future and it's viewed as a temporary dip.

On the performance of the wellness centers continues to be very strong despite the weak economy, coverage of the rent at the Life Time Fitness locations and the Wellbridge locations have over two times coverage of the rent and the trend has been improving.

Membership has been steady or growing at our centers. Were the economy has had an impact on that industry has been at the new locations where new memberships have been slower than budgeted in the ancillary revenues from personal training services to spas and foodservice have been softening.

Our properties are stabilized properties. Life Time reported earnings on October 23 and reported $0.55 per share of earnings and over $61 million of EBITDA for the quarter. The occupancy at the medical office buildings has remained at 98% and we have had a few new tenants at our multi-tenant buildings coming in at higher rents than in-place rents.

When we complete our acquisitions the whole HRPT portfolio we will begin providing several office property statistics. While all of this is to say that I am very comfortable with the cash flows of our underlying portfolio to support our current rental revenue stream.

As Rick discussed, we invested $359 million during the quarter at an average initial cash yield of 8.2%. This was funded using our cash on hand, the sale of three properties for $21 million, the assumption of $61 million of long-term debt which had a weighted average annual interest rate of 6.6% and the balance was funded by borrowings on the revolver.

The senior living investments leased to Five Star in the MOB acquisition with HRPT all had been committed to back in the spring and the rates of return were locked in at that time. However cap rates for senior living properties and medical office properties have increased and I expect future transactions to be 25 to 50 basis points higher for senior living investments and 100 to 150 basis points higher for the medical office buildings. We have rejected many investment opportunities we would have considered before as we are increasing our return hurdles and with our capital position we can be more selective.

Generally, owners of real estate are not selling in this environment unless they have to. However, we still see a continuous flow of one-off our properties in small portfolios. We expect there will be increased pressure on operators to sell in 2009 as more debt comes due or investment funds face redemptions.

We will be conserving capital as there will be attractive deals in the foreseeable future and we will continue to evaluate possible secured financing options. Substantially, all of our assets are unencumbered and most are worth more than our historical costs. We do not have any meaningful debt maturing until December 2011 when our revolver matures and you count the one-year extension at our option on the revolver. As you can see on page 16 of our supplemental package we are well within all of our debt covenants.

As I said before we're among the top of all REITs for liquidity and strength of our balance sheet. As you know the dividend provides a flaw for all REITs stock prices and so the security of the dividend is sacred. As Rick mentioned, our payout ratio is currently 85% of our funds from operations.

This means we're generating $25 to $30 million a year of excess cash flow to provide a cushion for the dividend should any operator experience difficulties or any unforeseen needs. Now the surplus cash is currently being used to fund improvement financing, make new investments and to prepay debt.

Before opening up the call for questions, Rick and I will be at the NARI conference in San Diego in two weeks and we'd be glad to meet with any of you. In addition, we're offering a property tour on Tuesday afternoon November 18 in connection with the conference. We will tour the three biotech buildings in La Jolla, California leased to the Scripps Research Institute for the next 11 years, an Alzheimer's facility in Encinitas that we acquired on March 31 and leased to Five Star, and a large rental CCRC we own in Rancho Cordova, which is also leased to Five Star.

These are three very different representative properties and if you have not signed up please contact Katie Johnston in investor relations. In addition, in December Rick and I will be at the UBS Healthcare REIT and Operator Conference and RBC's Healthcare Conference which are both being held in New York.

With that I'll turn it over to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Kevin Ellich – RBC Capital Markets.

Kevin Ellich – RBC Capital Markets

Just wondering there's been a lot of activity going on and I was just wondering how does the pipeline look now? Are you still seeing good opportunities and Dave I missed one of the comments that you made right at the end there about cap rates. I was wondering if you could go over that again.

Dave Hegarty

As far as opportunities we're seeing out there, the volume of opportunities we're seeing has slowed down. I think what people have decided to do is there were people motivated to close on transactions before yearend and so that window is quickly closing. We are not seeing many transactions right now rushing to close before yearend.

Those people I believe are going to wait until now January to market other properties. So, I think it's a little bit quiet right now. We are still seeing several one-offs and a couple small portfolios and so on, so there are still some opportunities to consider out there.

Cap rates have moved up. It's a little challenging to discuss the cap rates in a sense because for the REIT we've been charging historically about 8% for our initial rental rate and I referred to the fact that I expect our initial rental rates required to go up another 25 to 50 basis points on future transactions in the senior living space.

When people buy a property outright for ownership of the real estate and the operations, those cap rates are now more in the 9 to 10% range for independent assisted living and obviously higher for skilled nursing and we have not pursued skilled nursing at all. In the medical office buildings are similar we're seeing some transactions out there. I think the rush for yearend transactions has slowed down and now people are waiting until the beginning of the year to put properties on the market again.

Kevin Ellich – RBC Capital Markets

Rick, I don't know if you could address this but I was wondering if any of your debt is callable. I see the fixed rate unsecured notes the interest rates are a little bit higher than the other debt, any opportunities on that front?

Rick Doyle

We don’t have any of our debts recallable and it won't be callable for another couple of years, 2012.

Operator

Our next question comes from Tayo Okusanya – UBS.

Tayo Okusanya – UBS

In regards to 3Q operating trends could you give us a sense of what you're seeing versus the general downturn in 2Q?

Dave Hegarty

The operating trends of the retirement communities?

Tayo Okusanya – UBS

Yes

Dave Hegarty

Well, I guess for the spring and summer they had declined but from what I've been able to tell they seem to be holding pretty steady for the last several months and so hopefully that's a flaw. Like I say, the assisted living is holding up very well.

In fact, I think Five Star commented that they are converting a number of units that are in independent living over to assisted living in Alzheimer's care because that's where the demand for the foreseeable future will be. Of course independent living is hurting because of the housing market and that's not necessarily being resolved any time soon. So, I expect that to continue to be under pressure.

Tayo Okusanya – UBS

What occupancy did Five Star report in third quarter versus second quarter? Was it up, down, flat or?

Dave Hegarty

Well, their occupancy was down a little bit from the second quarter. Not a lot I think it was about 88.2 from 88.4 or something but again the difference is like the assisted living is actually up but the independent and skilled is down. There's a lot of more subtlety things going on people are moving from, occupancy only tells part of the story.

There's quite a bit of discounting going on out in the industry. The actual revenue per unit per month has been down and that's probably going to continue to be under pressure as everybody's competing to just fill units. I think its going to continue to be under pressure for at least another quarter or two.

Tayo Okusanya – UBS

In regards to some of your most recent contracts where you kind of have these new rent forms that come online in 2010, should we expect that to be your standard type of contract going forward or going to have these participating rents going forward?

Dave Hegarty

Each operator we have different structures with depending on what's negotiated and what their sensitive to and what we are and all of our leases with Five Star have this percentage rent formula and almost every time you have the way its worked historically has been that the year we acquire the property its really not been under Five Star's operation for a full period so they have to make their adjustments and get in there to operate as they way they would.

So, we may get the first full year of operations under their watch becomes the base year and the following year becomes when they start to pay us percentage rent based upon the growth and revenues. So, for the acquisitions that are occurring or have occurred in 2008, 2009 is the base year and 2010 we start to participate in that.

Tayo Okusanya – UBS

What's that percentage again?

Dave Hegarty

It's 4% of the growth and revenues at those properties, and to very property specific calculation it's not an overall lease calculation. They can't offset the properties that decline in revenues, let's say.

Tayo Okusanya – UBS

Could you remind us, for one of your tenants I'm not even sure if it's Five Star, there's an opportunity to do a rent recap some time in 2010.

Dave Hegarty

No, I think what you might have been referring to was when we originally did the rehab hospitals

Tayo Okusanya – UBS

Yes, that what it was.

Dave Hegarty

We had sort of a continuing rent in there that we weren't sure if this was normal stabilized but subsequent to that, that was recast and that provision was dropped out. The current rent of our $10.3 million was the base plus it has gone up because of improvement financings. I think it's about 10.6 right now is their locked in rate.

Tayo Okusanya – UBS

So, you don't have the rent [inaudible] on that stuff anymore.

Dave Hegarty

Correct. I guess based if we had to do it today the rent would probably go down or at least stay the same. I don’t think there'd be any upside at the moment.

Operator

Our next question comes from Jerry Doctrow – Stifel Nicolaus

Jerry Doctrow – Stifel Nicolaus

David, you had talked about the initial yields and that sort of stuff and again, I think you repeated it for senior housing. On the MOBs I think you were saying it was going to be up 100 to 150 basis points conceivably. What's kind of the base number that you had in mind when you were saying that?

Dave Hegarty

Well, I was referring to like the HRPT acquisition that was a negotiated transaction back in the spring and those prices are locked in and the cash cap rate was 7.1 and 7.9 was the GAAP yield. The recent transaction we did was 8.5 cash yield. I think it's about 9.1 or so GAAP yield. I was referring to basically the differential between the deal back in the spring versus today's [inaudible], so 8.5 to 9% or so.

Jerry Doctrow – Stifel Nicolaus

And that would be true for HRPT or anyone else something in that range.

Dave Hegarty

For HRPT's acquisitions?

Jerry Doctrow – Stifel Nicolaus

Not the stuff you already got locked in but isn't there some other stuff that you have the option of buying from them. Is that at a fixed rate, or that would be negotiated in the future?

Dave Hegarty

What that is I think you are referring to the right of first refusal that we have. Those assets would have to be put on the market, and all we can do is match what other people are willing to pay for those if we are willing to do that. The market's going to determine what the cap rate's going to be and then we do not have to buy it or we would.

Jerry Doctrow – Stifel Nicolaus

Right at the beginning you talked about the acquisitions you made in the quarter and it was a cash yield of like 8.2%. What was the GAAP yield on that again? I just didn't hear it.

Dave Hegarty

9%.

Jerry Doctrow – Stifel Nicolaus

Last thing, I know you were going to put out these stats when you get everything bought, but since we have to deal with estimates today any sense about CapEx spending, TI costs on the I guess particularly on the MOB stuff that you would have acquired, because I do not have any good way to get a run rate on that stuff. Do you have a sense of what it might be?

Dave Hegarty

Sure, for the quarter initially we had a couple of new tenants come in. I think the overall leasing commissions and everything else was under $20,000 so, it really wasn't of any consequence this period. Next quarter I don't anticipate there to be anything meaningful either because I think, at least present knowledge is that we close on the Le Jolla properties during the fourth quarter and there's no CapEx or leasing commissions or anything affiliated with that.

It will be a 2009 thing you would have to factor into your estimates and they're working on the budgets for 2009 as we speak, and we we'll be in a better position to give you an idea of that on our next quarterly conference call.

Jerry Doctrow – Stifel Nicolaus

Any sense on straight line I guess as well for the quarter given everything? I guess you gave us the GAAP and the cash yields and that - -

Dave Hegarty

Also, on the supplemental on page 14, the straight line rent that was included in the September quarter was $523,000, I’m sorry no, the straight line rent in the fourth quarter was $82,000. The amortization deferred finance fees was $523,000.

Jerry Doctrow – Stifel Nicolaus

In terms of just dealing with that for the quarter you've given us the cash yield and the GAAP yield, so for the acquisitions we can just try and factor it in from that?

Dave Hegarty

Right.

Operator

Our next question is from Chris Pike – Merrill Lynch.

Chris Pike – Merrill Lynch

Just wondering what your thoughts are on campus, off campus. Refresh our memory in terms of what the HRP, I know that David went through some of the acquisitions and talking about some of the portfolio with respect to being closed for two on campus type facilities. I know a lot of that stuff also is medical office whether it be down in DC or in other markets, so how do you guys view positives, negatives? What percentage of the portfolio is on and off? Just your general thoughts there.

Dave Hegarty

Most of our portfolio is off campus. I say off campus, but in several cases they're a block away. The one in Washington DC is literally one block away from the George Washington University Hospital there. I guess the greatest risk or concerns we've had is that when you're on campus almost always you're required to lease the land from the hospital and that puts you sort of at a disadvantage in negotiations for rental increases and other things are lease renewals and so on.

Interesting enough, because of the proximity and the co-dependence between the hospital and the MOB’s, those often is also the lowest cap rates. We have chosen not to aggressively pursue those. We'd rather own the property outright and make our own decisions down the road. As it turns out, that's also how we were also able to get a little bit higher cap rate, because not everybody wants standalone, multi-tenanted medical office buildings a block away from a hospital, whereas we are very happy with that product.

Chris Pike – Merrill Lynch

I guess and implicit in that is to the extent some of your peers established relationship with faith based alpha profits and things of that nature. It is safe to assume that going forward with this structure and this strategy you're really not going to be on campus.

Dave Hegarty

That's not going to be the general rule. That's correct we're not going to be on campus as a rule. We are going to be more in proximity very often with major tenancy of doctors that are affiliated with those hospitals, but the hospital itself may not control our destiny.

Chris Pike – Merrill Lynch

In an ongoing trend of, I guess doctors becoming employees of hospitals and I guess within the industry it's a trend that's going to continue to grow. If that goes through fruition, do you think that puts you at a disadvantage?

Dave Hegarty

No, I think people are very much concerned about a shortage of doctors and healthcare professional in general in this country just because the demographics are going to increase the demand for it and people are trying to build medical office buildings to accommodate the demand, so I don't foresee a real issue with that.

Operator

We will go next to Philip Martin – Cantor Fitzgerald.

Philip Martin – Cantor Fitzgerald

David you spoke quite a bit about occupancies holding and doing reasonably well even in this environment, and again you may have addressed this a bit earlier too, but how about monthly resident rental rate at the community level? Is that holding right now? It's probably community to community and its care type by care type, but what's going on with that rental rate and the margins?

Dave Hegarty

You have hit on exactly the difficulty and try to nail that down or to be general about it, because a, at the end of the day this business is a local business. In a community the majority by far of the population of the residents there comes from the nearby 5 to 10 mile radius of the community. You can look at a state or a county or whatever and see several properties doing extremely well and other properties hurting.

It's more reputation. It's more what the services are exactly that they are offering. It's very difficult to generalize, but there is quite a bit of discounting going on out there and I don't think that that's showing up in everybody’s numbers yet. It is starting to, but I don't think it is fully being felt yet. We're just seeing the competition out there, and people are offering all kinds of incentives and lifelong contracts and so on to draw in residents.

People are moving from say that $4,500 a month unit down to the $3,000 a month smaller unit and things like that are happening. For the facilities that are 90% full, they are able to still push through the 4% to 5% or more rent increases each year. We've seen Five Star in generalize has raised their rates about 5% on a same store basis. They are still expecting to get another 5% increase going forward.

Philip Martin – Cantor Fitzgerald

So, being the largest operator, they're still able to have some pricing power and push rents a bit here.

Dave Hegarty

Correct.

Philip Martin – Cantor Fitzgerald

You may have just answer the next question, would you expect that? Using your crystal ball and I know we're living in uncertain times, I guess we're always in uncertain times, but - -

Dave Hegarty

More so now.

Philip Martin – Cantor Fitzgerald

That’s right, more so now, but from a coverage standpoint where do you think that coverage could drop to next year. Certainly, it sounds like independent living is a bit more exposed for obvious reasons, but where do you think the coverage could go here?

Dave Hegarty

I think that I would expect coverage to pretty much level off and from what I’ve been able to see from lots of different operators out there is that the occupancy seems to be holding at this level, and we know that there's no new supply coming on line of any consequence and the demand is continuing to tick.

There’s also a significant amount of pent up demand out there that people have been deferring their decision, but typically that means they're becoming less healthy and will need the services more than ever. So, my prediction for what it’s worst is just that things have bottomed out and we're holding at this level and I expect it to move up from there.

Philip Martin – Cantor Fitzgerald

More of a question in terms of is there a number and this might be in the supplemental, but is there a number out there in terms of the value of the security deposits, letters of credits, corporate guarantees that you have against your rental stream?

Dave Hegarty

No, I don’t think specifically. We have some security deposits but most of our largest credits are dependent on the guarantees of the parent company. So, like Five Star obviously guarantees everything, but Mariette guarantees the Sunrise lease, Brookdale guarantees the Alterra/ Brookdale lease, and so on. We always get a corporate guarantee and then the smaller operators we get cash security deposits.

We have not been fans of letters of credit because as we’re seeing now that many of the banks that backed the letters of credit are not necessarily going to be around when it comes time to renew that letter of credit. Then people have to go hunting for where they can get another party to give them a letter of credit and that may not be available and we don’t want to trigger a default under our leases because somebody can’t get a letter of credit.

So but I’m sorry no it’s not disclosed per say in any of the supplemental because it isn’t really something you can. There's no monetary value to guarantee that we can put on it.

Philip Martin – Cantor Fitzgerald

In terms of a security deposits what’s roughly the value of the security deposits you have. It sounds like its mostly corporate guarantees.

Dave Hegarty

That’s right. We have a couple hundred thousand dollars of yes, Rick's pointed that the medical office buildings have many security deposits usually one month or two months security deposits and that’s going to be a total of $4 million or so. On the private operators it’s more like a few hundred thousand dollars of security deposits and that’s anywhere from two to six months.

Operator

We’ll go next to Stephen Swett – KBW.

Stephen Swett - Keefe, Bruyette & Woods

I imagine once the New Year comes around and maybe the acquisition pace picks up again, you guys believe you have capacity to continue to buy. Can you just kind of lay out your thoughts on your various potential sources of capital, unsecured debt, secure debt, equity asset sales and how you would view those as likely sources for further acquisitions.

Dave Hegarty

Sure. They're all on the table. We have capacity on the revolver and there is an accordion feature to that which that would have to be tested. I don’t if all that would come to fruition. That’s one option the revolver isn't due until 2011. We also periodically sell assets. Typically they’re the less desirable assets rather than our trophy assets. So that’s another source.

We on and off had discussions about secured financing with either the agencies or some insurance companies. Also equity’s another option that we have to see what's happening with stock price, what opportunities there are to invest. That would be [inaudible] and so on, but we make those decisions as we see opportunities out there and when we have a need for the money.

As far as secured financing, that is something that we have been on and off exploring like I said, and that’s something that takes time to do. So we’d probably take time to procure that.

Stephen Swett - Keefe, Bruyette & Woods

In terms of your portfolio I imagine you have an awful lot of unencumbered assets that you could use without starting to run up against your various covenants?

Dave Hegarty

That’s correct. We’re only about 6 or 7% encumbered debt on our properties so substantially all of our portfolio is available to encumber, and as you know many of these properties we bought way back. Like for instance the 30 properties in lease number two where bought back in 2002 and our investment per unit is around $90,000 per unit. Those are large CCRC’s so those would probably be worth substantially more than what they are on our books for.

The Sunrise facilities are similar high end quality assets that are unencumbered and then pretty much everything else we bought at very low price per unit values and are worth 50 to 100% more of what they're on our books for.

Stephen Swett - Keefe, Bruyette & Woods

Then in terms of equity I think it’s been a long time since you sold stock in the mid teens. So I imagine your comment on equity as an option would be at some higher price than where the shares are today?

Dave Hegarty

Sure, yes.

Operator

Our next question is from Mark [Bifford] - Oppenheimer

Mark [Bifford] - Oppenheimer

Just wondering you talked about IL versus AL and how IL is underperforming the AL group. I’m wondering if there is any opportunity in any of your assets to do some type of conversion to an AL from an IL and what that would entail.

Dave Hegarty

Sure Mark. First of all I guess as a landlord it’s not our decision per say. We have to consent to it but we are not the ones to initiate that change. What is happening is Five Star has announced that they were going to convert something like about 150 or something units over to assisted living and Alzheimer’s care.

I think that’s the best way to capitalize on the environment the way it is now because obviously it’s not going to change say over the next probably the next year or two or more. So that would be the best way to switch the best use of those units and I think I would expect that several of the Sunrise properties could also be converted through an AL or Alzheimer's use and periodically they have done that.

I think definitely the assisted living is the market to be in to capitalize on the environment we're in today.

Mark [Bifford] - Oppenheimer

So, in terms of what you're looking at in terms of acquisitions right now where do you see the best risk adjusted returns and what type of [inaudible] because when I look at the acquisition you guys made of the wellness centers and in terms of your focus of property types to me wouldn't there be better opportunities in maybe the senior housing side.

Dave Hegarty

Well, I guess a couple of thoughts on that. I've noticed several of our competitors have been going into skilled nursing facilities to acquire and obtaining higher cap rates on those type of properties. We have consciously decided not to pursue skilled nursing facilities because we questioned some of them the long-term buyabilty of them and we just know that once new budgets get proposed and so on that there's going to be a lot of pressure on the various states and on the Medicare system to try to figure out ways to cut back funding and that's where the higher returns have been.

On the private pay senior living facilities, there are very few opportunities that still would get us a higher return than the fitness center transaction that we just did. So, I think we're still into the eight to nine range for initial yields for assisted and independent living and CCRCs.

There may be other potential as far as like if we bought a distressed situation and turned it around and maybe under a TRS structure or something like that, realized a higher return in the long run but that has not been our business plan to-date.

That would be a case-by-case situation. I'm not going to say that we're going to do that in a meaningful way in the foreseeable future. So, I think it's very hard for us to get above, say a 9% initial return for any asset class that we are willing to go into right now.

Mark [Bifford] - Oppenheimer

I'm just wondering, on the fitness centers and the research that you've done through past recessions on those type of fitness centers and how they've performed, do you feel pretty comfortable with the margin you had to go forward with it, I take it.

Dave Hegarty

Yes, obviously not all centers are alike and we're willing to do these transactions because first of all, they're new facilities, they're very high end and they're more of a sort of a comprehensive country club type setup with the pools, the family events and they're large facilities that accommodate many different demographic groups.

The membership for these facilities is typically between say 6,000 and 10,000 or 11,000 members and all of these have achieved those levels of membership, and so at two times coverage of the rents they would have to experience significant drops in membership of services to not be able to pay the rent to us. So, you have to choose wisely in making those investments but these were ones that we felt comfortable with.

Mark [Bifford] - Oppenheimer

Then just quickly, my last question on the HRPS since you have yet to acquire next year, how much assumable debt are you taking from that?

Dave Hegarty

None with those.

Tim Bonang

None with the remaining properties have any debt with them.

Mark [Bifford] - Oppenheimer

So you'll be using your line to finance that?

Tim Bonang

Yes, we will be.

Operator

Your next question comes from Kevin Ellich – RBC Capital Markets.

Kevin Ellich – RBC Capital Markets

Just a couple of follow-ups, I guess, Dave, we've had a lot of discussion about the senior living properties and I was just wondering big picture, what's your take on how the economy's impacting your portfolio? I guess the second part of that question is under the new administration, are there any other types of properties that are more attractive to you now versus before the election?

Dave Hegarty

I would say, first your question about the economy and I think we went into quite a bit of detail about that. What it's really doing is it's affecting the confidence level of seniors who are typically private pay and whether they're willing to make the decision to move into these retirement communities knowing that either they haven't sold their house or that they're looking at their investment portfolio and seeing it decreasing in value and wondering if it's going to keep going that way.

So it's shaken their confidence and that has pretty much, the brunt of that has been felt on the independent living side of things. Like I say assisted living seems to be holding up very well and the skilled nursing, I think to some degree, is probably a flawed business model anybody with private pay resources is not going to skilled nursing if they can avoid it.

As far as the political landscape and affect that would have on our investment decisions, that's probably a bit positive for Medicare, Medicaid, because I think they all try to figure out more ways to keep those programs operating and viable for people.

People with the best of intentions still have to try to balance the budgets and as we found out with the prospective payment system back in the late '90s that they can make mistakes and cut rates too far and they don't react until everybody's in bankruptcy and have to regroup. So we've just been there before and we're not willing to take that gamble again.

Kevin Ellich – RBC Capital Markets

Just going back to your comment about skilled nursing being kind of a flawed business model, is that only for those that are private pay or why do you think it's flawed?

Dave Hegarty

Well fundamentally there are some exceptions like, say many in the Medicare facilities or some others that are private pay and Medicare-based may have a better chance, but the typical nursing home is still 60 or 70% Medicaid funded, another say 20% Medicare and the remaining 10% or so coming from private pay.

Medicaid is going to try to hold rate increases to zero or 2% or 3% the most, while the cost of living for paying of nursing wages, benefits, utility costs, food costs and everything else are going up by more than 2 or 3%.

So you can't run a facility under a Medicaid funded system so they have to depend on Medicare to make up for the shortfalls on Medicaid and Medicare has been, the lobby efforts have been very successful in getting the last several rate increases but again, that system's going to come under more pressure.

Just similar to the prescription drug plans there's going to have to be some sort of a shifting of the landscape in the payment mechanisms there and typically, that's not good for the nursing homes.

Kevin Ellich – RBC Capital Markets

Then my last question is going back to the wellness of your fitness centers. Is there more opportunity on that front or in other types of healthcare related facilities like pharmacy we've talked about that in the past? Then also, what type of metrics will Life Time and the other wellness centers use or track how they're performing relative to the economy.

Dave Hegarty

First on the statistics, they are very close to the vest with a lot of the information and probably gives some indication to memberships and maybe even revenues but we're going to have to work through that probably for the next supplemental at yearend and we'll try to get as much as they'll allow us to disclose.

As far as other opportunities out there, within the RMR organization we see numerous investment opportunities from all different facets. Periodically we review them for whether or not they'd be a fit for us but there's nothing at the moment that we're planning on doing anything outside of this space.

We do look at them and frankly, I don't know how much opportunity there is in the near-term and that's these areas of business, but we would still stick to triple net leased something related to health and wellness and the healthcare field.

Operator

Due to time constraints, I'll turn the call back to Mr. Hegarty.

Dave Hegarty

I just wanted to thank you very much and as I said, we're more than happy to meet with you at NARI or please join us on a property tour. Thank you.

Operator

We thank you for your participation in today's call and have a wonderful day.

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Source: Senior Housing Properties Trust Inc. Q3 2008 Earnings Call Transcript
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