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HCP Inc. (NYSE:HCP)

Q2 2009 Earnings Call

August 4, 2009 12:00 pm ET

Executives

Ed Henning – Executive Vice President and General Counsel

Jay Flaherty – Chairman and Chief Executive Officer

Paul Gallagher – Chief Investment Officer

Thomas M. Herzog – Executive Vice President and Chief Financial Officer

Analysts

Sheryl Skolnick – CRT Capital Group.

Jay Habermann – Goldman Sachs

Mark Biffert – Oppenheimer & Co.

Bryan Santino – Barclays Capital

Jerry Doctrow – Stifel Nicolaus & Company

Richard Anderson – BMO Capital Markets

Ross Nussbaum – UBS

Jim Sullivan – Green Street Advisors

John Arabia – Green Street Advisors

Operator

Welcome to the second quarter 2009 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 , HCP's Executive Vice President and General Counsel. You may go ahead, sir.

Ed 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 beliefs 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'll now turn the call over to our Chairman and CEO, Jay Flaherty.

Jay Flaherty

HCP had a strong quarter with each of our five property sectors contributing to an overall same property performance of plus 4.7%. Our leverage metrics are in terrific shape and are now superior to the levels prior to the start of our strategic repositioning activity in 2005. Last night we announced an accretive, add-on investment in the PropCo debt of HCR ManorCare.

As a result of these successes we are raising our 2009 FFO guidance. Joining me today are Executive Vice President and Chief Financial Officer, Tom Herzog, and Executive Vice President and Chief Investment Officer, Paul Gallagher. Let me start things off by turning the call over for the first time ever to Tom Herzog who will take you through our second quarter results. Tom?

Thomas M. Herzog

There are several key items that I will cover today. First, as Jay mentioned, yesterday we closed an accretive $590 million investment in the most senior tranche of HCR ManorCare's mortgage debt. Second, for the second quarter we reported FFO of $0.55 per share and $0.57 per share before impairment charges.

Third, we continue to strengthen our balance sheet and closed out the quarter with our financial leverage ratio at a new four-year low of 44% and our adjusted debt service coverage improved to 2.6 times for the second quarter.

Fourth, our FFO guidance for the full year 2009 was increased $0.06 per share as a result of our accretive investment in ManorCare. And lastly, we streamlined and enhanced our supplemental package.

First our new ManorCare investment. Yesterday we purchased a $725 million participation in the first mortgage debt of HCR ManorCare at an 18% discount to par. The investment represents 45% of the $1.6 billion most senior tranche of HCR ManorCare's mortgage debt which bears interest at LIBOR plus 115 basis points. The mortgage debt investment matures in January 2013, inclusive of a one-year extension available at the borrower's option and is secured by a first lien on 331 skilled nursing facilities located in 30 states.

In connection with this investment we obtained $425 million of favorable financing. The purchase resulted in a net cash payment by HCP of $165 million, which in the near term will be funded on our revolver. We have estimated an effective unlevered internal rate of return of approximately 13%, inclusive of the benefit of the favorable financing.

Despite the 72% favorable financing included in this transaction, in the near term we expect to manage the capitalization of our balance sheet to roughly maintain our quarter-end financial leverage ratio of approximately 44%.

Second quarter results, in Q2 we delivered FFO of $0.55 per share and $0.57 per share before impairment charges, compared to $0.50 per share and $0.55 per share before impairment and merger-related charges for the second quarter of 2008.

Three unusual items not included in our previous guidance, which together approximately offset, are as follows. First, in connection with the previously announced transition of 15 senior housing communities operated by Sunrise, we recognized an impairment charge of approximately $6 million or $0.02 per share related to the intangible lease assets.

Second, we recorded a favorable adjustment of approximately $6 million or $0.02 per share related to the correction of purchase price allocation of certain assets acquired in 2006. Finally, we recognized rental income of approximately $1.5 million, or $0.005 per share from a single tenant life science facility. Our same store property continued to perform well, producing a positive 4.7% year-over-year cash NOI growth during the second quarter versus the second quarter of 2008. Paul will review our performance by segment in a few minutes.

With respect to our investment and disposition activities during the second quarter, we funded $30 million of development and other tenant and capital improvements, primarily in our life science segment. Also during the quarter we completed the sale of two hospitals, including the Los Gatos Hospital formerly operated by Tenet, generating aggregate cash proceeds of $46 million and gains on sale of $31 million.

Lastly, our aggregate mark-to-market on our marketable securities increased in value approximately $58 million during the quarter, principally driven by our HCA debt investment. This increase does not impact GAAP net income or FFO, but rather is reported as an element of other comprehensive income in the consolidated statement of equity.

Now turning to our balance sheet, in May we completed a $440 million equity offering by issuing 20.7 million shares of common stock at $21.25 per share. The net proceeds from this offering totaled $422 million, of which $320 million was used to repay the remaining outstanding balance of our bridge loan with the remainder for general corporate purposes.

We ended the quarter with an overall financial leverage ratio of 44% versus 48% at year-end 2008. Our unsecured leverage ratio improved to 46% from 51% at year-end, and our 2Q '09 adjusted fixed charge coverage increased to 2.6 times from 2.3 times during the same period in the prior year. We are comfortably within all covenants of our credit agreements.

We continue to carefully assess the company's floating rate exposure on both sides of the balance sheet. After retiring the floating rate bridge loan during the quarter, we entered into a fixed-to-float interest rate swap on $250 million of our debt in order to more closely balance our floating rate exposures.

Floating rate debt represented approximately 13% of our total debt at quarter-end and continues to be reasonably match-funded with our HCR ManorCare mezzanine investment. For the remainder of 2009 our debt maturities include only $70 million of mortgage obligations.

Our 2010 debt maturities of $505 million consist of $206 million of senior unsecured notes and $299 million of mortgage debt. We have numerous sources of capital to comfortably repay or refinance these debt maturities. At the end of the second quarter we have $50 million drawn on our $1.5 million revolver net of unrestricted cash. Our revolver matures in August 2011.

Full-year 2009, we are increasing our 2009 reported FFO guidance to range between $2.13 and $2.19 per share as a result of an increase of $0.06 per share due to our accretive add-on investment in ManorCare. Our 2009 pre-impairment FFO equivalent is projected to range between $2.15 and $2.21 per share. In addition to the $0.06 adjustment for ManorCare, there were a number of moving parts considered in updating our full-year guidance, so I'll take a moment to walk you through the revised assumptions.

We continue to expect same property growth to range between 2.5% and 3%. We incurred a negative $0.02 per share related to lease intangible impairments offset by the favorable purchase accounting adjustment of $0.02 per share described earlier.

We expect a negative $0.02 per share due to the projection of lower rents in our Sunrise portfolio, offset by additional income of $0.02 per share in connection with the revenue recognition related to one life science facility.

A negative $0.02 per share related to G&A due to increased litigation costs resulting in full-year G&A that is now expected to approximate $78 million to $80 million. The increase in G&A was offset by numerous other items, representing a net positive impact of $0.02 per share. No additional acquisitions of real estate or debt investments, and no contributions of assets in the joint ventures and future impairments or similar charges, if any, are excluded.

A few words on our supplemental package, as you may have noticed, this quarter we streamlined and enhanced our supplemental package. Our objective was to improve the form content and to include certain additional disclosures to help you better understand our company.

Numerous enhancements were made to the document, including the following: weighted average interest rates by year for future debt maturities, financial covenants as defined under our line of credit agreement, shares outstanding of common stock and equivalents, quarterly year-over-year cash aligned by segment, the location and date of our closed dispositions, development spend for each project under active construction, and we just aggregated the maturities of our debt investments from our operating leases.

We also eliminated capitalized interest and interest accretion on debt investments from our supplemental cash flow information on page three. We made this revision, as we do not consider these items to be FAD adjustments on a normalized basis.

However, the cap interest and interest accretion components remain available in the supplemental package, in the investment and dispositions and owned portfolio summary schedules, respectively. We believe you will find our retooled supplemental package helpful and informative. I'll now turn the call over to Paul. Paul?

Paul Gallagher

Thanks, Tom. Before I get into the details of each sector, I would like to address the rollover exposure in our total portfolio, for the next few years. For the remainder of 2009, annualized revenues for expiring leases totaled only 3% of annualized revenue. Eighty-nine percent of this exposure rests in our MOB platform, which typically experiences 80% retention. For 2010 and 2011, the rollover exposure is 6.1% and 5.6%, respectively, again, with the majority of the exposure occurring in our MOB space.

Now, let me address our specific sectors. Senior housing – occupancy for the second quarter for our same-store senior housing platform is 86.6%, representing a 110 basis point sequential decline over first quarter and a 280 basis point decline over the prior year. With the exception of our Sunrise portfolio, we are seeing the rate of decline slow.

Our summarized portfolio, while previously stable, experienced its single, large quarterly drop, declining 140 basis points, to 88.1%] The decrease in occupancy is largely driven by the non-mansions, where occupancy is 86%, while the mansion occupancy remains at 92.1%.

As we have mentioned, most of our operators have and continue to demonstrate good operating flexibility, as sequential same-property cash flow coverage is holding steady at 1.13 times. The decline over prior year at cash flow coverage of 1.2 is due to one-time Sunrise credits received last year and the current deterioration in the performance of Sunrise's non-mansions.

For our current quarter the same-property performance results, we will again need to separate out our Sunrise portfolio, to provide a more accurate explanation of HCP's senior housing platform. Our non-Sunrise portfolio, same-property performance increased 1.3%. For Sunrise, recall the first-quarter performance decreased 21.6%. Half of that drop was a result of LIBOR-based rents and insurance credits that were received in 2008. The remainder of the decline was due to certain Sunrise portfolios where cash payments were not received in the first quarter.

Those payments, however, were received in the second quarter, resulting in a higher Sunrise same-property performance for the second quarter, of 9.8%. Normalizing this result by netting out those first quarter payments received in the second quarter, the current quarter's same-property performance for Sunrise was down 3.3%, and year-to-date same-property performance for Sunrise is down 6.3%.

On the Sunrise expense side, recall that we experienced positive signs that expense growth had slowed in the first quarter. Preliminary second quarter data shows expense growth remains under control. However, we have seen a marked decrease in revenue growth, with the mansion revenue growth flat and non-mansion revenue growth decreased at a rate of only 1.5%.

In June, we announced the termination of Sunrise management contracts on our 15 EdenCare communities, effective October 1. The replacement operators for these communities have been identified and the leases are close to being finalized.

When completed, our Sunrise concentration decreases to 12%. The EdenCare termination follows the transition of the operations on our [Aureus] portfolio, from Sunrise to [Emeritus] last year. Since the transition, we have already experienced increases in revenue for occupied room of 4.9%, and an increase in NOI margin of 280 basis points.

Hospitals – same-property cash flow coverage was 4.4 times. Year-over-year, same property cash NOI for the second quarter declined 12.4%, primarily driven by short-term rent relief at our Irvine Hospital, as [Hogue] invests up to $40 million of their own funds, to reposition the campus. Net of this, as well as another completed restructure of two rehab hospitals, our hospital NOI growth is flat.

We have received notice from Tenet that they will not renew their lease at our Slidell Hospital, when it expires in 2010. We are currently engaged in active negotiations with several potential replacement operators. As Tom mentioned, we completed the sale of our Los Gatos Hospital in the second quarter, realizing a substantial gain.

Skilled nursing – our skilled nursing portfolio continues to perform well. Year-over-year NOI for the second quarter, in our same-store portfolio increased by 4.1%, driven by contractual rent increases, with cash flow coverage increasing slightly to 1.6 times.

With regard to our existing HCR ManorCare mezzanine investment, the company reported strong first quarter results, lifting trailing 12-month debt service coverage, to 2.53 times, an increase of 41 basis points over the prior quarter. Approximately three quarters of this increase was driven by a decline in debt service, due to LIBOR, with the remainder driven by NOI increases, as a result of higher acuity and positive rate growth.

Medical office building, for the current quarter, same-property-adjusted NOI was up 4% over the first quarter of 2008. This growth was driven by increased base rents, continued success in our expense control initiatives and future non-rate impact of operating support revenues.

Our expense reduction initiatives resulted in a decrease in controllable operating expenses of $600,000, when compared to prior year quarter. Our previously discussed utility rate reduction at a portfolio of Texas MOBs was effective for the second quarter, and combined with energy controls throughout the portfolio resulted in a reduction of $230,000 in utility costs, compared to the second quarter of 2008. We also received a lease-termination fee of $714,000 at facility in Texas we have excluded from same-store results.

MOB occupancy for the first quarter was 90.7%, up from 90.5% at the end of the first quarter. During the second quarter, tenants representing 810,000 square feet took occupancy, of which 542,000 square feet related to previously occupied space, resulting in a retention rate of 79%.

These renewals occurred at a 15.6% higher base rent. The significant increase was driven by the conversion of over 160,000 square feet, from a net rate to a base-year structure. Absent this, our

mark-to-market increase was 3.6%.

As of the end of the second quarter, we have 1 million square feet of scheduled expirations remaining for the balance of 2009, including 340,000 square feet of month-to-month leases. Our pipeline remains strong, with 434,000 square feet of executed leases that have yet to commence, and 465,000 square feet in active negotiations. During the quarter, we moved one 38,000-square-foot MOB into redevelopment and sold two small condominium units in Virginia, for $605,000, resulting in a nominal gain.

Life science. Life science for the second quarter same-store cash NOI was up 16.2%, principally driven by increased occupancy and previously executed mark-to-market rent increases. Occupancy for the entire life science portfolio was 91.1% at the end of the second quarter, down slightly from 91.4% at the end of the first quarter.

As mentioned in our first quarter call, we would anticipate that going forward, renewal leases would most likely experience a decrease in mark-to-market rents. Our approach to leasing has been simple – retain tenants. This has allowed us to maintain cash flow with no downtime, and little or no TI expenditure

For the quarter, we completed 349,000 square feet of leasing of which 310,000 square feet related to previously occupied space that was renewed at an average decline of 13.6%. This leasing activity represented a quarterly retention rate of nearly 98% as we renewed 310,000 of the 317,000 square feet of near-term lease expirations.

And in the process we retained quality tenants such as Abbott Laboratories, Becton Dickinson and [Inflowmatica]. Our life science portfolio has limited lease expiration profile over the next two years. Lease expirations for the remainder of 2009 total of 184,000 square feet and represent only 0.3 of HCP's annualized revenue. Looking to 2010, we have 274,000 square feet of expirations, which represent only 0.8% of ACP annualized revenue.

Despite the general slowdown in tenant demand HCP continues to pursue a pipeline of leasing prospects of approximately 500,000 square feet for existing space. We have begun to see increased activity in the second quarter as large institutional clients seek space to accommodate expansion needs or relocate functions.

Switching to our development and redevelopment activities, the pipeline remains unchanged with our current development efforts aggregated approximately 515,000 square feet in the Bay area in five building that are 49% pre-leased. These projects represent new construction of three buildings at our Oyster Point campus where Amgen has pre-leased two buildings and the redevelopment of two smaller projects where we are converting office buildings to life science use.

We recently executed an LOI for one of these projects that if converted to a lease would bring the previous percentage on the pipeline to nearly 53%. As we've discussed in the past calls we continue to monitor the underlying credit and liquidity profile of our tenant base.

The composition of our tenant base is strong with approximately 87% of our rents coming from public companies or well established private entities. From a liquidity standpoint, life science tenants with less than 12 months of cash continue to represent only 2% of HCP's total base rent.

The biotech industry remains in its fifth funding drought since the 1980s and the IPO market has been shut for four quarters. But despite the current climate our early stage companies have recently experienced an uptick in funding. These early stage companies have raised over $315 million in the second quarter from multiple sources including public equity, venture capital and strategic alliances up significantly from the $125 million in the first quarter.

With that review of HCP's portfolio, I'd like to turn it back to Jay.

Jay Flaherty

HCP's diversified portfolio experienced broad-based momentum. In hospitals, our two largest operators, HCA and Tenet both pre-announced upside earnings surprises last week and have raised substantial funds in the high yield markets. Cash flow coverage for HCP's hospital portfolio now stands at a frothy 4.4 times, reflecting the success of the restructuring activities we completed last year.

Confirming the market's strong acceptance for the hospital sector is the price movement in our HCA toggle notes which have increased from their December 31 price of 78 to a price of 104. This represents an aggregate increase of $70 million in value for HCP shareholders. Last Friday's positive reimbursement news from CMS should further improve operating results going forward for the hospital sector.

The skilled nursing sector continues to perform exceptionally well, and our cash flow coverages now provide for more than adequate cushion for any potential reimbursement pressure resulting from pending healthcare reform.

In life sciences, we have had a successful run of good news resulting in exceptional real estate performance for HCP and positive operating results from our tenants. Roche-Genentech, Amgen, and Nuvasive continue to produce superior earnings results while tenants [Psychokinetics], [Exlexis] and [SunGard] all achieved significant fund raising milestones during the quarter.

In fact, July 2009 was the best month of announced partnering and financing activity for the biotech industry in several years. MOBs, our most offensive sector produced a solid 4% same-property performance gain, and experienced a 20 basis point increase in occupancy.

Our senior housing portfolio, the sector most exposed to the nation's current economic headwinds, managed a positive same-property performance and held cash flow coverages constant after exclusion of the Sunrise Communities. Last night Brookdale reported strong operating results for their second quarter. Clearly, HCP's strategic moves of the past three plus years have successfully created a uniquely diversified health care real estate portfolio and despite being eight quarters into the great recession, have generated out performance.

Pimco's 2009 investment outlook articulated their view of a winning investment strategy for the period ahead., and I'll quote, "stable and secure income are the order of the day. Shaking hands with the new government is still the prescribed strategy although it should be done at a senior level of the balance sheet."

Two weeks ago on Cowan and Steer's July 23 earnings conference call, they stated that quote, "the opportunity for well capitalized REITs to require high quality bank loans at attractive prices has never been better."

Combining these two investment insights we present Exhibit A, HCP's acquisition of a $720 million first mortgage interest in HCR ManorCare's PropCo. Being positioned in the 0 to 30% loan-to-cost slice of HCR ManorCare's capital stack is good. Having security in the first mortgage interests of the premiere skilled nursing portfolio in the country is even better. Realizing a 13% unlevered IRR on such investment is the best.

This investment had a trailing 12-month debt service ratio of 10 times. For the first quarter of 2009, this investment had a debt service coverage ratio of 21 times. Company-wide HCR ManorCare's quarter-over-quarter NOI increased 20% for the period ended June 30.

PropCo is currently sitting on $400 million of cash with $485 million of its original $700 million term loan outstanding, and has just $85 million of net debt. For the two years actual and projected through the remainder of this year, their property level performance has increased 18%' not bad for 19 months work.

As it relates to our existing mezzanine loan investment the trailing 12 months and first quarter debt service coverage ratios were 2.5 times and 4.2 times, respectively. Said another way, if you were to envision our mezzanine investment has a doughnut, it would certainly be a juicy, jelly doughnut and a golden one at that.

We have now book ended PropCo with 100% ownership of the 66% to 85% loan-to-cost mezzanine debt slice and a 45% ownership and control block of the 0 to 30% loan-to-cost first mortgage debt. Taken together we own 37% of the debt of PropCo. HCP's tactical add on investment will enhance our options of this strategic holding in a period of healthcare reform ahead.

With that, Paul, Tom and I would be delighted to take any questions you might have.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Sheryl Skolnick – CRT Capital Group.

Sheryl Skolnick – CRT Capital Group.

Congratulations on all of the strategic initiatives you've pursued, etc. I guess where I'm coming out on this is in view of the deterioration in the Sunrise portfolio and the opposite results from Brookdale, I'm wondering if you would comment on your comments, Jay, from the last quarter, which we that you saw a tremendous opportunity to invest in the properties in the assisted living area.

Given the fact that no new capacity is coming online, given the fact that seniors – we are all aging and the seniors are aging even more so, so that perhaps coming out of this great recession the company might be better positioned. In view of the second quarter results from these companies you've seen to date, are you still of like mind?

Jay Flaherty

Yes, probably. If anything, we're probably more emboldened. Again, just to review our earlier comments from this year, if you compare where we are right now in 2009 to where we were arguably at the depths of the last senior housing downdraft, which would have been in the fourth quarter of 2002 and then compare just a couple of quick metrics.

Back then, industry-wide occupancies were in the low 70% area. This morning, as you've heard in our portfolio and in Brookdale's last night and other portfolios, they're generally in the mid to high-80s today.

Back in 2002, you had a significant amount of supply that had been developed and was just coming online. Ultimately, with the benefit of hindsight we now know that it took four years to absorb all that supply. You have nothing like that today, as we sit here today. And finally, there was a fair amount of additional construction financing that was being put to work back in '02 to fund even additional developments in senior housing.

Obviously with the credit markets being what they are, that doesn't exist as well. Despite that, you've got one constant. The baby boomer is aging. And that demand year-over-year is going up anywhere between 1.5% and 2%. So if anything, I would probably say we've shortened up our target investment period here as being between now and the next two and a half to three years.

We think this is going to be very, very good time to deploy capital into the senior housing space. We think looking back two and a half, three years from now, if we're able to buy good quality real estate at attractive prices, our shareholders will do quite well.

I would view the Sunrise results that Paul has taken to as more of an aberration and not at all indicative of what's going on with certainly the remainder of our senior housing portfolio, as well as the economic fundamentals for senior housing as a whole.

Operator

Your next question comes from Jay Habermann – Goldman Sachs

Jay Habermann – Goldman Sachs

Question, you know, obviously two strategic decisions this quarter, the HCR ManorCare investment and then the Sunrise announcement. Can you speak first, I guess, on the investment, looking at the 13% IRR at this point, clearly attractive and it's collateralized. Are we to expect that you're probably not going to see much better opportunities? I'm just wondering what you're seeing at this point in terms of investment opportunities at this point in the cycle?

Jay Flaherty

Yes. Let me take you through the investment and then let's not forget to come back to your second question. I think you need to think about this on three dimensions. One is the performance of ManorCare, two are the merits of this incremental investment by HCP, and three, probably most importantly, where we're heading from here with this overall investment. Jay?

So let's talk about ManorCare performance. I think I kind of summarized that but in a nutshell, spectacular EBITDA performance. They're now sitting with practically zero net debt over at OpCo, debt service coverage ratios that are just incredibly strong.

And as I said here today, they actually have a variety of financing opportunities available to them. They would include HUD financing, which I think a lot of you have gotten familiar with the agency programs and senior housing offered by Fannie and Freddie and the HUD program for skilled nursing is just as attractive.

There's certainly REIT financing available out there. The high yield markets are once again wide open and have a voracious appetite for higher quality, best in class health care providers. And I'd point you in the direction of the several billion dollars that HCA has brought to market this year including another $1.5 billion last week of the first lien paper, which looks an awful lot like the investment we made yesterday.

And then ultimately you've got an IPO, and I'll come back to that as part of our exit strategy. So that's kind of the first dimension. The second dimension is just the story behind this investment. We were fortunate that we had this investment made available to us. In fact, we were quite fortunate.

This was a deal that was circled in the late winter at a time when obviously the credit conditions were far worse than they are today. The prospective buyer fell out when they were unable to obtain a necessary consent, and that occurred just last month.

We had a motivated seller and we were able to negotiate the same set of terms that have been negotiated by the previous prospective buyer back in the late winter timeframe and moved quickly to close the transaction.

Again, to answer one of your questions, what else is there? Man, we are looking at a 13% effective unlevered as equity or equity-like returns for nowhere near that sort of risk exposure, given where we are in the capital stack on this investment.

Now, let me go to really where we're headed from here. Three years ago, we made the strategic decision to significantly reduce our skilled nursing exposure. When we looked at our portfolio, which was 30% of the overall company portfolios three years ago, we had three concerns.

One was the age of our portfolio, a lot of those properties were in excess of 30 years old. Two was the high Medicaid census in our portfolio. And three were the preponderance of one-off properties, where we had one operator operating one property. Between 2006 and 2007, we reduced the owned real estate exposure in the skilled nursing sector of HCP's portfolio from 30% to 2%.

However, we always maintained that given the proper catalyst, we might re-enter the space. We believe pending health care reform represents such a catalyst. The best way to talk about our overall PropCo debt investment would be in the context of an exchangeable bond convertible with a conversion option into ManorCare's real estate.

Now, let me describe two very different scenarios as framing two very different, but both very attractive, exit strategies. Scenario one, we have benign health care reform. We have improving capital markets. And we have an expansion of the skilled nursing P/E multiples.

In this scenario, the private equity sponsor, Carlyle, is likely to take ManorCare public and it will look an awful lot like what it did before it went private in the middle of '07, which is to say a best in class, low cost provider to the skilled nursing industry with an investment grade balance sheet that owns all of its own real estate in fee simple.

In that scenario, we are likely to be on the receiving end of $1.72 billion of cash, which monetizes our investment plus the one quarter billion dollars of discounts that factor into the two purchases we've made.

Let me go to scenario two, and I'll try to give you two endpoints here. Alternatively, you might have a more challenging reimbursement environment coming out of healthcare reform for skilled nursing providers. You may see a deterioration in the credit markets.

In this scenario, HCP would exchange its debt investment into direct ownership interests in the real estate of ManorCare, again, realizing the quarter billion dollars of discount in the form of attractive low to mid-teen cap rate basis in the real estate. Now there's obviously a variety of gradations in between those two endpoints, which would include, but not be limited to, PropCo itself going public as a REIT, with OpCo remaining private.

We have set ourselves up as a heads we win, tails we win outcome. In the interim, we are receiving an attractive current income. With respect to timing, I think anything prior to a finalization of healthcare reform would be unlikely. But you should not expect a lot of grass to grow once health care reform becomes finalized. Most likely scenario would be some time next year, very much envision some resolution with these investments.

Jay Habermann – Goldman Sachs

All right. I guess –

Jay Flaherty

That's a little bit about how we got to where we are right now. We're obviously thrilled with the opportunity to make this investment and looking forward to what permutation and combination of the exit strategies we actually affect.

Jay Habermann – Goldman Sachs

Right. Yes. I wasn't diminishing the acquisition or the investment at all. I just was curious about what else, what sort of alternative uses you could be investing your capital in at this point and the returns you're seeing.

Jay Flaherty

Well, if I had to rank our sectors right now in terms of most attractive to least attractive, is that kind of what you'd like to get some input on?

Jay Habermann – Goldman Sachs

Sure.

Jay Flaherty

I would say, probably the two least attractive sectors to us right now would probably be hospitals and medical office buildings, kind of for different reasons. Our existing hospital portfolio is doing obviously quite well and with the CMS news last week and with the likely development coming out of the health care reform, that bill at the margin be further advantaged.

We think that a lot of the valuations will begin to reflect those sorts of good underlying fundamentals. So we like what we've got in hospitals, but we're not anticipating adding to that. In fact, increasingly, that's a much more complicated operating business as opposed to a real estate business.

Now medical office, we think the values there has only adjusted about 150 basis points or so from kind of peak valuations back in the third and fourth quarter of 2007. You're looking at mid to high seven cap rates today for high quality, on campus MOBs and that we feel we've got the superior investment opportunities in our remaining three sectors.

In no particular order, skilled nursing, you know, heath care reform is likely to be an enormous catalyst for deals. There are substantial concerns, privately held that include the addition of ManorCare, Genesis, [Saba], Golden, which is previously Beverly Enterprises, and others that are waiting for some certainty to come out of this health care reform. It is likely that healthcare reform is likely to kind of come to fruition later this year and I would expect 2010 to be an extremely active timeframe for the skilled nursing space.

In senior housing, as I mentioned in response to Sheryl's question. We think the valuations now justify re-entry by HCP, especially in light of these strong, immediate term fundamentals. And life sciences is, – it's more situation specific but there's a handful of opportunities that we see there right now. And then away from that, just as a general comment, whenever we can see equity or equity-like returns on debt investments that are also with high quality operators, like we've been able to realize with both HCA and HCR ManorCare, we would move on those.

Jay Habermann – Goldman Sachs

And in terms of debt investments relative to, as you said before, the equity investments, I mean, at this point do you sort of think you've maximized your position roughly, call it 14 or so percent of assets of the company, about a billion and a half of investment on roughly 12 billion?

Jay Flaherty

I think today we are probably in reasonably good shape. I do think however that 14% could largely look like an owned real estate portfolio 12 to 15 months from now. So, we have to be cognizant 15 months from now, but where we're going 12, 15 months from now.

Jay Habermann – Goldman Sachs

And lastly, what was the litigation charge? Could you just detail the amount there?

Thomas M. Herzog

Well, as far as the litigation charge, you mean as far as any contingent liabilities, or the amount that hit G&A?

Jay Habermann – Goldman Sachs

I think it you mentioned it in G&A. Just how much was that?

Thomas M. Herzog

Yes, we bumped up our G&A by $6 million in the projection for the full year. We didn't detail out the amount of litigation charges in that. But it is a component of it.

Operator

Your next question comes from Mark Biffert – Oppenheimer & Co.

Mark Biffert – Oppenheimer & Co.

Jay, I guess related to ManorCare, I mean, you talked a little bit about the health care reform and the potential with the rugs that came out last week it looked like skilled nursing facilities were going to see a bit negative out of that announcement that came out last week and I am just wondering if ManorCare has assessed what that impact would be to their coverage ratios and if you know that or could share that?

Jay Flaherty

Well, I think the expectation had been a net negative of 1.2. What came out last Friday night was a net negative of 1.1. So, this was all expected, in fact it was at the margin, very marginal, better than expected and we have certainly run all of those numbers, not just for our ManorCare investment, but also for our overall skilled nursing portfolio. And on average, you are probably looking at about 5 basis points of decline.

Since you mentioned the rugs, I think, again, going back to ManorCare and health care reform I've said this for the last couple of calls. I mean, the winners going forward here are going to have three criteria. They are going to be efficient operators. You should read that to mean good margins. They are going to have critical mass. You should read that to be market share. You don't have to be national. You can have a national platform and not have critical mass.

And then you've got to have quality outcomes. HCR ManorCare's, as is the case with HCA and Brookdale and a number of the other folks in our portfolio, their core strength is being a low cost provider, in a post-acute setting. And if you go back 10 years ago to 1999, when rugs were first adapted, I think it's very telling to note that there were six publicly traded nursing home companies back then. Four ended up going Chapter 11.

Only one was an investment grade credit before that period began and it ended up after that period was over as an investment-grade credit as well. And that company, of course was HCR. So we've got every confidence in this management team. They'll continue to execute superbly and we are very excited about kind of the next steps in terms of where this investment goes.

Mark Biffert – Oppenheimer & Co.

Could you also comment, and you paid an 18% discount on [nets]. How does that pricing reflect over to the mez piece where you paid a 10% discount and given that that's more junior to this debt and then do you think it matters because you plan on eventually converting that into equity?

Jay Flaherty

Well, again, the terms on this piece of paper that we bought yesterday, they were negotiated back in the late winter, kind of a February, March timeframe as opposed to today, so I don't think its reflective of what's going on today, point one. Point two, since we made our mez investment, the property performance of this portfolio is up18%. The cash to debt service coverage ratio which we underwrote at a 1.35 times in the fourth quarter of '07 and actually ended up being about 1.41 for the quarter, for the first quarter alone was north of 4 times.

I mean, Tom Herzog wishes HCP had coverage ratios like that. So the cash flow creation here, the value creation quite frankly, I think for both these pieces of paper there's an extremely good precedent out there, and for the piece of paper we bought yesterday it's the first lien note in HCA, and they raised $1.5 billion last week and the yields that came to market in the low eights.

So you should compare that to the effective unlevered 13% on our investment yesterday. And as I mentioned, for our toggle notes, they've moved from a 78 price to a 104. Those are a bunch of second and third position, kind of a silent second, third position pieces of paper. Those are yielding in the high eights this morning, so I think those are bookending PropCo as we have, those are two very, very good precedents out there those are I would tell you HCR ManorCare's credit metrics compare favorably to HCA's.

Mark Biffert – Oppenheimer & Co.

Okay, and then regarding the financing you took out on the investment, as well as the LIBOR plus 120 that you're earning, are there any caps or collars and what was the rate you had on the financing for that investment?

Thomas M. Herzog

There were no caps and collars as to the financing, it's at 72% LTV, but we're subject to a confidentiality agreement with the seller on this, so I am not going to be able to disclose the details of the financing.

Jay Flaherty

The debt, Mark, however is coterminous of the loan receivable that we acquired

Mark Biffert – Oppenheimer & Co.

Okay, let's see –

Thomas M. Herzog

Why don't I just take a minute because I had this question four or five times yesterday just clarify an item. As it pertains to the 13% unlevered IRR in the investment, if you do the math based on purchasing this at an 18% discount to par at LIBOR plus 120, what you would find if you do the calc is you would find the IRR to be over the three and a half year term including the one-year extension. You'd find it to be at about 10%.

How we have come to the 13% unlevered return with the benefit of the favorable financing is by taking into account the favorable rate included in that financing, present volume in that back and showing that essentially as a discount on the front end of the investment. So, what we're showing by way of doing that is not a levered IRR, which would be much higher. It is an unlevered IRR inclusive of the benefit of the favorable financing included in the transactions. So that's where the 13% comes from.

Mark Biffert – Oppenheimer & Co.

Okay, and then lastly, regarding leasing Life Science portfolio, you showed it a little bit differently this quarter versus last quarter, in terms of the development versus the redevelopment. What was the percentage leased in the development and the redevelopment separately?

Thomas M. Herzog

I don't have that broken down right now. I can get you that offline.

Operator

Our next question comes from the line of Bryan Santino – Barclays Capital

Bryan Santino – Barclays Capital

Good morning. Just wanted to get an update regarding I guess the 15 [eat-in] care facilities and I know you had disclosed that that termination occurs in October and then what you're thinking about when those facilities' management contracts are terminated.

Jay Flaherty

Well, no, the termination is already occurred. What I think Paul said in his remarks that we we're very far long in close to having all those leases finalized. And then we'd expect to be in a position to announce the details on that no later than October 1, potentially earlier.

Bryan Santino – Barclays Capital

But they're currently right now being managed by Sunrise until then?

Jay Flaherty

Yes.

Bryan Santino – Barclays Capital

Then on the Slidell facility with Tenet, can you kind of give us an update on the performance of that facility. And as you mentioned earlier hospitals being a tougher segment, can you provide us with some perspective on your thoughts for that facility going forward.

Jay Flaherty

When I said tougher that was in the context of a response to a question of where we are most attractive in terms of deploying incremental capital. The operating metrics for the hospital space are fantastic, and as I mentioned, look at price action in our HCA toggle notes. Look at the price action in the publically traded hospital operators. They got additional good news Friday night from CMS.

So the operating metrics are in great shape. I was just saying the valuations are beginning to reflect that, so we're always looking to try to create incremental value as we deploy capital that that sector is – we're very glad we did what we did back when we did it, most notably our Medical City Dallas acquisition. But at this point, difficult was in response to a question of the relative attractiveness of that.

Paul Gallagher

I would go on to say that with the transition of our Tenet hospitals being Tarzana, Irvine, and Los Gatos what we've seen in the past is that the underlying performance by Tenet – people see different opportunities and have come in and looked at maybe alternative uses and things of that nature. So we have the same sort of situation in Slidell we've got a variety of different people that are looking at a variety of different alternatives, and we feel comfortable where the outcome will come out once we get this property released.

Operator

Your next question comes from Jerry Doctrow – Stifel Nicolaus & Company.

Jerry Doctrow – Stifel Nicolaus & Company

On guidance and I'm trying to figure out what I'm missing but you were saying it was up $ 0.06 and what I'm reading I guess from your first quarter guidance is $2.15 to 2.21, and this guidance I guess with – before impairments is $2.15 to 2.21. So I'm just trying to understand where the $0.06 is or what I'm missing.

Thomas M. Herzog

Are you missing the equity issuance in May?

Jerry Doctrow – Stifel Nicolaus & Company

That basically would have brought it back down which I'm not looking at.

Thomas M. Herzog

Yes.

Jerry Doctrow – Stifel Nicolaus & Company

This brought it back up. Okay. And then just a couple other things, when you calculate your discount, we were another one of those ones struggling with the 13 to the 10, are you looking at sort of a comparison to kind of your – something like the rate you got on recent term loan financing and this is below that and that's what allows you to do the discount?

Jay Flaherty

Yes. We're looking at the rate inherent in the favorable financing versus what we believe we would finance a similar instrument at in the current market.

Jerry Doctrow – Stifel Nicolaus & Company

So a 3.5 year floating rate piece of paper. A 3.5 year floating rate piece of paper presumably or?

Thomas M. Herzog

Yes, and then reflecting that as effectively as an additional discount in the first [question].

Jerry Doctrow – Stifel Nicolaus & Company

On life science stuff, I think Paul talked about this, I think some of the stuff that Amgen was taking down and that sort of stuff, I think there was some possibility of it being sublet. So is there any sublet issues just in any of your markets that would be material?

Jay Flaherty

Well, they have been trying to sublease that and –

Paul Gallagher

Two Amgens still remain on sublease in the marketplace today.

Jay Flaherty

At six months they had a – one of the properties they took out. They decided to use it. So the sub – now we're talking about south San Francisco, right?

Jerry Doctrow – Stifel Nicolaus & Company

Yes.

Paul Gallagher

That the micro – submarket up there. The submarkets have actually come down at Amgen.

Jerry Doctrow – Stifel Nicolaus & Company

Roche, you had sort of suggested it might be moving additional space, and have we gotten any further clarification on that now that they've closed?

Jay Flaherty

We have nothing new to report on that at the present time.

Jerry Doctrow – Stifel Nicolaus & Company

There was one little deal with [Cyrus] where there was like a $1.1 million I think benefit that you were going to get and then I think there was some reference in here and that [Cyrus] put into default, so I was trying to clarify , A, if there's some one-time item in there for that and maybe clarifying what's going on with them?

Jay Flaherty

Well, what's going with them, as I said in the past, is that is an attractive real estate portfolio. We have a piece of debt that the real estate portfolio is collateral for. We in the last six months had that appraised. There is nice coverage there in terms of a value of the real estate relative to the outstanding balance we have.

They have made their July payment and in addition, we have a significant percent of the outstanding balance guaranteed by, personal guarantees, by some high net worth individuals. So I think that's an opportunity at some point where we might look to move some portion of that debt investment into outright ownership of the underlying real estate. As we look at it today, that is one distinct possibility.

Thomas M. Herzog

To add on to your question. Now, the $1.1 million payment was not taken in in the income in the current period. It's amortized over the long-term.

Operator

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

Richard Anderson – BMO Capital Markets

I just want to make sure and clarify for myself, that the $0.06 is all a function of the favorable rate and cash you are earning on your cash versus the investment in the paper, or at its 18% discount and that there's no sort of being gain, one-time gain in that $0.06? It's all sort of recurring. That's right.

Thomas M. Herzog

That's right, Rich. What it is is the $0.06 is simply taking the – let me get just a little bit more complicated. We bought this thing at a discount and with that you calculate an effective rate on the investment. Take that effective rate times the outstanding investment balance at that point in time and it produces a certain amount of income. That amount of income is what's producing the $0.06 per share for the balance of 2009. So there's no one timers in it or any accounting magic. It's just $0.06 of income on an effective interest method for that investment.

Richard Anderson – BMO Capital Markets

A question for you, Jay, just sort of a big picture conceptual if I may, you mentioned you're thrilled that the ManorCare investments and I can understand that. However, the market at least today isn't showing that they're thrilled with it and I think that may be a function of just some of the complexity inherent in these transactions, or the one announced last night.

So I guess I would ask you how you counter that argument that so-called complex transactions are in part what caused some of the problems for the REITs to begin with. How would you sort of say – how would you rebut to that view?

Jay Flaherty

Yes. I'm not sure why this is complex. It's a very attractive debt that –

Richard Anderson – BMO Capital Markets

It's an unconventional investment from a REIT perspective, though, I guess I would say. I'm just the messenger.

Jay Flaherty

Our eyes are always on the ultimate prize of having direct ownership in the real estate. We never – when we decided to exit the skilled nursing space three years ago, and to the extent we did, I cited the three concerns, high Medicaid census, the age of the real estate and the one-off operator. We would never have envisioned an opportunity to come back in with the exact opposite on each of those three dimensions. So the best quality mix in the country in this portfolio, and it all being in one overall master lease.

So the opportunity to come back in with what would be the golden portfolio in this space at a discounted price by virtue of the discounts we've been able to achieve in the debt purchase and as we hang out here and wait for the ultimate resolution, which could certainly be a 2010 event and get paid a handsome current return, we think that's just a fantastic result for our shareholders.

Richard Anderson – BMO Capital Markets

I'm not necessarily disagreeing but the market, for whatever reason, is today. In terms of –

Jay Flaherty

That's what makes a market.

Richard Anderson – BMO Capital Markets

You mentioned the Sunrise termination, the second round, the second pool of assets. I think [Mark] you said numerous operators as replacement potential. Is that right or would this more likely go to a single operator like the first go around?

Jay Flaherty

We're envisioning this going to three specific operators.

Richard Anderson – BMO Capital Markets

Tom, you mentioned your 2010 debt maturities in over $500 million, and you said there were numerous sources to address those needs. Can you prioritize those sources?

Thomas M. Herzog

Why don't I describe three very attractive alternatives that exist right now, in addition to others. The equity markets currently look great. The debt markets on an unsecured basis we would be on five-year unsecured debt in the mid-sevens right now. The agency financing also looks attractive and we have certain pools that we can consider there. Those would be in the low sixes.

Those are just three alternatives that would be very achievable today.

Richard Anderson – BMO Capital Markets

What would you say your equity cost of capital would be?

Thomas M. Herzog

That's difficult to tell. I mean you know what our FFO yield is as well as I. One could add a growth rate to that, but I'll probably steer clear at this point of just putting setting forth an equity cost of capital. And we do our internal costs of equity and WAC and whatnot that we use for internal purposes, but I'm sure everybody has their own point of view on that.

Operator

Our next question comes from Ross Nussbaum – UBS.

Ross Nussbaum – UBS

Guys, can you walk through just structurally for everyone the relationship between OpCo and PropCo over at HCR today?

Jay Flaherty

Sure. There is a 12-year master lease that runs between OpCo and PropCo. The master lease has 331 properties which represented at the time of the buyout all the stabilized real estate. There was a couple of properties that were in development that were excluded. As I mentioned, that was the portfolio that if you take the actual results of '08, first half of '09 and assume that the company merely meets their projection for the remaining six months, we will have been up 18% during that two-year timeframe.

The $1.350 billion of aggregate Carlyle cash equity that was put into to the buyout, about two-thirds of that sits below our mez investment over at PropCo. The remaining one-third is over in OpCo. As I mentioned, they've gone from having a $700 million term loan at the time of the buyout over at OpCo to having just $85 million of net debt today, so they've radically de-levered OpCo and they're sitting on approximately a cash balance of $400 million.

OpCo is subordinate to PropCo and I'm not sure what else you'd like to know, but that's kind of a brief summary of the OpCo/PropCo structure.

Ross Nussbaum – UBS

That's helpful. What is – I think you gave a coverage ratio in your press release last night on the $1.6 billion of senior debt. Is that coverage ratio relating EBITDA of PropCo?

Jay Flaherty

Yes.

Ross Nussbaum – UBS

Okay, so if I'm thinking about this, if I look at the interest rate and the coverage ratio, it would allow one to potentially back in, even if I use the higher 21 times coverage of something around $575 million of EBITDA at PropCo on an annualized basis?

Jay Flaherty

It's close, yes.

Ross Nussbaum – UBS

Is that roughly?

Jay Flaherty

Yes, roughly.

Ross Nussbaum – UBS

At OpCo, can you share with us where you think that number is I guess on EBITDAR basis?

Thomas M. Herzog

No, that'd be – we wouldn't be able to disclose that.

Ross Nussbaum – UBS

OK. But it's $575-ish million of EBITDA at PropCo is not a bad guess?

Jay Flaherty

That's in the right zip code, Ross.

Operator

Our next question comes from Jim Sullivan – Green Street Advisors

Jim Sullivan – Green Street Advisors

A couple of questions on ManorCare, they said the terms were circled back in the late winter. A couple of things have happened since that timeframe from the seller's standpoint, the banks involved, some of them were at risk in terms of their survival in that timeframe. That doesn't seem to be the case today.

For your comments, ManorCare's operating results and their balance sheet improved markedly, why wouldn't the seller here have re-traded terms that were discussed in the late winter timeframe, given the improvement on both the side of the seller and the borrower here?

Jay Flaherty

Jim, you'd have to take that up with the seller.

Jim Sullivan – Green Street Advisors

The unlevered return of 13%, I'm still having trouble understanding the concept of unlevered given that the 72% leverage is being layered in, albeit through present value calculation into that IRR. Can you help me understand the unlevered versus levered concept?

Thomas M. Herzog

Sure. If you took a straight unlevered return and [calc'd] based on acquiring the interest for 5$90 million and have it pay off three and a half years later at $720 million, big LIBOR plus 125, using the forward-curve during that intervening period. The [calc] number is somewhere in the neighborhood of about a 10% unlevered IRR.

If one then took into account the 72% favorable financing in isolation with no consideration of rebalancing in the future, which I indicated that we would intend to do because we do want to stay more in the 44% leverage ratio or so that we're currently at, but if one just simply did the levered calc, you would end up with an IRR that is 20% plus on a levered basis, which I'm not going to spend a lot of time speaking to, because again we intend to rebalance that.

It's not complete to think of the 10% unlevered IRR without though, the benefit of the favorable financing, because we have achieved 72% favorable financing at a spread lower than what we could achieve in the marketplace.

So if we take the favorable spread achieved in that financing, present value that back to today, add that in as an additional discount on the front end of the investment, and then recalculate the unlevered return with the benefit of that additional discount so that we don't lose sight of the fact that there's favorable financing, that achieves a 13% unlevered IRR with inclusion of the favorable financing, but that is not a levered IRR, which is a much higher number.

So I guess to add onto this if I could, I would think about it this way. We're looking at a 30%, and I'm going to repeat a little bit of what Jay said, because I think it's so compelling, it's a 30% LPV investment with huge coverage that ends up achieving equity-like returns.

In the event that they take a private and pay us off, we're going to end up with an enormous – I'm sorry, take it – thank you, Jay – take it public, we'll end up with an enormous return on this. But in the event that we end up in an equity position at a future date, it's with a premier portfolio of real estate that we've had an interest in for a long while that we just then purchase another tranche in this investment, if you will, at 1$30 million discount to par.

So all in, it just – it's like Jay says. It's a heads you win; tails you win type scenario.

Jim Sullivan – Green Street Advisors

And is it safe to presume that this is dollar financing, that favorable financing you referred to?

Thomas M. Herzog

Now Jim again, we're under an unusual confidentiality letter and that – we're not able to answer that question.

Jim Sullivan – Green Street Advisors

Fair enough, but with respect to the market rate calculation, what were the parameters when you tried to estimate what the market rate might have been? Was it a recourse deal, a non-recourse deal? Did you look at a 72% loan-to-cost kind of transaction, how did you figure out what the market rate was?

Thomas M. Herzog

Yes, well I will tell you this: we based it on the 72%, because even when we rebalance our portfolio, our capitalization, that 72% favorable financing is still going to be in place. As to recourse/non-recourse and all the other components that we incorporated, those are things that, again, I'm not going to be able to speak to.

Jim Sullivan – Green Street Advisors

All right. Can we switch gears to senior housing? I'd like to understand better as you transition some of the Sunrise-managed assets to what you call are more efficient operators. I'm very interested on the expense side – on the operating expenses where you see the greatest opportunity? It seems like some of the costs in your cost structure are fixed, some are variable, and some are variable and vary with occupancy; some are variable and over your discretion as the owner of the property.

Can you help me understand where the richest opportunities might lie in the operating expenses and cuts you can achieve there.

Jay Flaherty

Well, are you talking about senior housing opportunities generally? Or are talking specifically about our Sunrise portfolio, Jim?

Jim Sullivan – Green Street Advisors

Specifically in Sunrise.

Jay Flaherty

Well, I think we can't be terribly expansive there given the outstanding legal matter. I think Paul's comments related to its early days so far, but the success we've had on the Aureus] portfolio that we transitioned to [Emeritus], I think that that's a very relevant metric. I think some of the metrics that Brookdale put out last night are quite important. I think it's quite important to distinguish between independent living and assisting living.

If you go into our big independent living joint venture, there you see operating margins, and again, this is eight quarters into this downdraft, their horizon base operating margins are at 41%. So I think – I mean that's really only down from maybe 42%, 43%, so they've been able to hold their margin. Like all these efficient operators, they've all, to their credit, moved very aggressively to reduce costs.

I think I'm on record as having said that they've been able to hold their coverages constant in the move from, say, a 90 point occupancy down to a 86 or 86.5 where we are right now. I don't expect, were that 86.5 to move down to 80, I don't expect that that – that continues to be a linear function.

Paul Gallagher

Jim, I think one of the things to bear in mind our [Aureus] transaction was Brighton Gardens. This portfolio is a different type of product. And as the operators get in and start looking at the specific locations and type and configuration, what they're finding is, is they're finding a variety of different opportunities. We haven't quantified specific line items. We've targeted typically margin improvement over time and we've left it to the operators to actually dig in and find out where those various different opportunities are.

But given the configuration, some of the Brighton Gardens have skilled nursing, some do not. Some of them have more independent living than assisted living. We've got a variety of different areas where we can find cost savings.

John Arabia – Green Street Advisors

Hey Paul, John Arabia here. How long do you think it would take to ramp up to a normalized cost level?

Paul Gallagher

We've – in our [Aureus] transaction we assumed that it would take a total of five years to kind of get the full performance from the assets.

John Arabia – Green Street Advisors

And very quick follow-up question on senior housing, I think you had mentioned that in the second quarter you realized rent from Sunrise that had not been paid in the first quarter, is that correct?

Paul Gallagher

Yes.

Jay Flaherty

It was paid second quarter as well as first quarter, John.

John Arabia – Green Street Advisors

How does that affect the 4% NOI growth? Is that included in there?

Thomas M. Herzog

Well, what I've done is I've separated out our non-Sunrise portfolio, and that was the 1.3% growth. The Sunrise portion was the 9.8%.

John Arabia – Green Street Advisors

OK, I guess maybe we get Paul up offline, but I'm wondering what happened to that 4%, if you had pulled it somewhere and portfolio it out. Maybe we can follow-up offline.

Thomas M. Herzog

Yes, and I can give you that. John, you're talking on a year-over-year –

John Arabia – Green Street Advisors

Year-over-year for three months.

Thomas M. Herzog

For three months? Yes, so we were at 4% total for senior housing. If we excluded Sunrise – it bumped Sunrise up a bunch as you can imagine having that cash amount come in that had been deferred in Q1. So excluding Sunrise we would've been at 1.3%.

John Arabia – Green Street Advisors

But is it probably more representative to look at the first six months which normalizes the –

Thomas M. Herzog

Yes, let's look at the first six months, if you looked at the first six months excluding Sunrise, you're going to notice in the supplemental, John, the total senior housing at a negative 0.9% year-over-year for the six months. See that? If you exclude Sunrise, which would've been a large negative for the six-month period, we would be a positive 1.8% for the six months year-over-year.

Jay Flaherty

For senior housing, non-Sunrise.

Thomas M. Herzog

Senior housing, non-Sunrise, thank you.

Operator

That concludes the Q&A session; I will now like to turn the call over to Mr. Jay Flaherty, Chairman and CEO.

Jay Flaherty

Thanks everybody for your attention and interest in HCP. Have a good rest of the summer and we'll talk to you in the fall.

Operator

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

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