HCP, Inc. Q1 2010 Earnings Call Transcript

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 |  About: HCP, Inc. (HCP)
by: SA Transcripts

HCP, Inc. (NYSE:HCP)

Q1 2010 Earnings Call Transcript

April 27, 2010 12:00 pm ET

Executives

Ed Henning – EVP and General Counsel

Jay Flaherty – Chairman and CEO

Tom Herzog – EVP and CFO

Paul Gallagher – EVP and Chief Investment Officer

Analysts

Adam Feinstein – Barclays Capital

Michael Bilerman – Citi

Jay Habermann – Goldman Sachs

Jerry Doctrow – Stifel Nicholas

Ross Nussbaum – UBS

Andrew Lo – Bank of America

Rich Anderson – BMO Capital

Rob Mains – Morgan Keegan

Todd Stender – Wells Fargo

Karin Ford – KeyBanc

Operator

Good day, ladies and gentlemen and welcome to the First Quarter 2010 HCP Earnings Conference Call. My name is Cheynelle and I'll be your coordinator today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions) Now, I would like to turn the presentation over to your host for today's conference call, Mr. Ed Henning, HCP's Executive Vice President and General Counsel. You may go ahead, sir.

Ed Henning

Thank you, Cheynelle. Good afternoon and good morning. Some of the statements made during this conference call contain forward-looking statements. These statements are made as of today's date, reflect the company's good faith belief and best judgment based upon currently available information and are subject to risks, uncertainties and assumptions that are described from time to time in the company's press releases and SEC filings. Forward-looking statements are not guarantees of future performance. Some of these statements may include projections of financial measures that may not be updated until the next earnings announcement or at all. Events prior to the company's next 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

Thanks, Ed and welcome to HCP's first quarter 2010 earnings call. Joining me today are Executive Vice President, Chief Financial Officer, Tom Herzog and Executive Vice President, Chief Investment Officer, Paul Gallagher. Let's begin by having Tom update you on our most recent results.

Tom Herzog

Thanks, Jay. There are three topics I will cover today. First, our first quarter results and investment activities; second, our balance sheet and financing activities and third, our full year 2010 guidance, which remains unchanged. Let me start with our first quarter results and investment activities. We reported FFO of $0.50 per share for the first quarter before $12 million or $0.04 per share of an impairment recovery. We have several highlights for the quarter, which include the following; first, our same property performance generated a strong 3.7% cash NOI growth during the quarter versus the first quarter of 2009.

Paul will review our performance by segment in a few minutes. Second, we placed into service three Life Science assets located in South San Francisco, representing 329,000 square feet and an investment to date of $245 million. Third, largely as a result of an acceleration with our Sunrise litigation activity, which Jay will elaborate on in his remarks, we incurred higher than anticipated litigation expense during the quarter and expect higher full year 2010 litigation costs. Accordingly, we are increasing our full year G&A forecast by $7 million.

Fourth, we recognized a $12 million partial recovery of impairment charges recorded in 2009 in connection with the bankruptcy of Erickson Retirement Communities. During the first quarter, we reached a settlement with the debtor and the other creditors, resulting in this recovery. Lastly, we made investments of $36 million through the acquisition of a senior housing facility for $9 million in February and funding of $27 million for construction and other capital projects primarily in our Life Science segment.

Turning now to our balance sheet and financing activities. In March, we prepaid a $200 million term loan that was scheduled to mature in August 2011. We funded the pre-payment primarily with our revolver. We continue to have strong credit metrics with our financial leverage at 43.5% and fixed charge coverage at 2.6 times. We are comfortably within all covenants of our credit agreements.

Our 2010 debt maturities of $300 million remain modest with $200 million of senior unsecured notes due in September and $100 million of mortgage debt maturing primarily in the second half of 2010. We ended the quarter with around $220 million of marketable securities and unrestricted cash and $1.2 billion available on our revolver.

Finally, full year 2010 guidance. Our guidance remains unchanged and we continue to expect FFO to range from $2.11 to $2.17 per share before the impairment recovery. We are increasing our G&A guidance from $70 million to $77 million, due to higher litigation costs. This increase of approximately $0.02 per share is expected to be offset by $0.01 from higher NOI and $0.01 from lower net financing costs, resulting from the prepayment of our term loan.

We are increasing our full year projected cash same property performance growth to a range of 3% to 4% versus previous guidance of 2.5% to 3.5%, due to a $4 million deferred rent payment received in April from a Life Science tenant. This will have no impact on FFO because we recognize rent from this tenant on a straight line basis. I will now turn the call over to Paul. Paul?

Paul Gallagher

Thank you, Tom. Let me break down the 2010 first quarter performance of our portfolio. Senior housing. Occupancy for the current quarter in our same store senior housing platform is 85%, representing a 50 basis point sequential decline over the prior quarter and a 270 basis point decline over the prior year.

Current quarter occupancy declines were driven by the anticipated drop in occupancy in our recently transitioned 15 property Sunrise portfolio and the continued softening in our Sunrise non-mansion portfolio. Rate increases, higher ancillary revenue and margin improvement led to an increase in sequential same property cash flow coverage for 1.13 times to 1.15 times.

Current quarter same property cash NOI for the entire senior housing platform was 10.4%. While our Sunrise portfolio generated 26.1%, current quarter same property increase, virtually all of the increase was attributable to, one, rents payable but withheld by Sunrise in the first and fourth quarters of 2009, that were collected in subsequent quarters, and two, the April 2009 expiration of 25% of the LIBOR based rents and subsequent conversion to fixed rents. Net of this, Sunrise same property cash NOI growth was up 0.9%.

This compares with the improvement in our non-Sunrise portfolio of 5.7%, which was driven by normal rent steps and fixed rent increases from two former Sunrise portfolios that we've transitioned to replacement operators. Our overall senior housing same property performance net of the Sunrise adjustments is 4.6%.

On April 15th, the U.S. bankruptcy court confirmed Erickson Retirement Communities plan of reorganization, which includes the sale of the company to Redwood Capital. Under a settlement agreement reached with Erickson and the other creditors, HCP will recover $12 million of the impairments taken in the fourth quarter of 2009. Subject to the satisfaction of certain closing conditions, the sale is expected to close this Friday, April 30th.

Hospitals. Same property cash flow coverage increased 12 basis points to 4.88 times. Same property cash NOI for the first quarter declined 3%. We anticipate same property cash NOI to turn positive in the second quarter as the operator of our Plano [ph] rehab hospital progresses with its turnaround strategy including the successful completion of a physician’s syndication.

Our hospital portfolio remains on track to deliver same property annual cash NOI growth of approximately 9% to 10% in 2010. During the quarter, we also reached a non-binding agreement with Cirrus Health for the restructure of its $80 million loan maturing December 31st, 2010.

The agreement is consistent with the terms used in determining a $4 million impairment that we took in the last quarter. Closing of the restructure is subject to final documentation and receipt of an updated appraisal of the pledged collateral. And the borrower has made interest payments consistent with the restructured terms since the first of the year.

Subsequent to quarter end on April 1st, 2010, HCP sold North Shore Regional Medical Center, formerly operated by tenant for $17.9 million to Ochsner Health System, realizing a small gain. HCP provided 85% seller financing for the real estate and an $8 million loan to purchase the equipment from tenant.

The five year financing is guaranteed by Ochsner. Ochsner Health System is the largest health care system in southeast Louisiana, owning and operating eight hospitals and over 38 health centers. The system is rated BAA1 by Moody’s and BBB plus by Fitch.

Skilled nursing. Our owned skilled nursing portfolio continues to perform well. Cash NOI for the first quarter in our same store portfolio increased by 3.9%, driven by contractual rent increases and fair market value rent resets on a master lease portfolio. Cash flow coverage remains solid at 1.54 times.

HCR Manor Care reported improved fourth quarter trailing 12 month debt service coverage for the entire debt stack to 4.42 times, an increase of 74 basis points over the prior quarter. This performance reflects an increase in total Medicare and managed care days, a strong year-over-year increase in Medicare and managed care rates and solid cost controls.

Medical office buildings. Same property adjusted NOI for the quarter was up 0.7% over the first quarter 2009. Growth was impacted by several large one-time positive adjustments in the year-ago quarter related to operating support revenue, tenant recoveries and expenses.

Absent these, NOI growth would be 2% for the quarter. Our expense reduction initiatives and ongoing impact of renegotiated natural gas contracts in Texas continue to provide positive results. Our quarterly controllable operating expenses declined $400,000 for the quarter, when compared to 2009.

HCP's active asset management platform includes several green initiatives, many of which have a positive economic benefit to HCP. In addition to being awarded NAREIT's leader in the light silver award in the fourth quarter of 2009, 12 of our buildings recently received the Energy Star designation.

This represents 25% of the 47 medical office buildings nationwide that have been awarded the Energy Star certification. We anticipate the certification of an additional nine buildings in 2010. HCP has been an Energy Star partner for five years. Through that period, we have benchmarked 319 of our properties in Energy Star's portfolio manager system, allowing us to identify outliers and reduce costs.

Our MOV portfolio occupancy has continued to outperform national trends. National vacancy rates according to Marcus and (inaudible) Costar have increased from 9.6% in June of 2007, to 12% in September of 2009. HCP's vacancy compares favorably, going from 9% to just 9.3% during that same time period.

Occupancy for the first quarter was flat sequentially, at 90.7%. During the first quarter, tenants representing 397,000 square feet took occupancy, of which 332,000 square feet related to previously occupied space. Our retention rate was 79%.

Renewals for the quarter occurred at 1.1% higher mark-to-market rents and included four leases representing 24,000 square feet that were previously above market. Absent these above market leases, the mark-to-market rent increase was 2%. Our pipeline remains strong with 452,000 square feet of executed leases that have yet to commence and 850,000 square feet in active negotiation.

Life Science. The first quarter same store adjusted NOI for Life Science was up 0.1% over first quarter 2009 levels. Increases from contractual rent steps and the recognition of revenue on buildings with completed tenant improvements were offset by increased vacancy, two large blend and extend leases completed last year and one time recoveries in the first quarter of 2009.

HCP's operating portfolio consisted – increased by 329,000 as three development assets were added to the portfolio. Two of these properties were 100% leased to Amgen. As a result of adding new space from the third unoccupied building to the portfolio, occupancy for the entire Life Science portfolio fell 1% to 88.8%.

For the quarter, we completed 162,000 square feet of leasing, all of which is related to previously occupied space that was re-leased at an average rent decrease of 21% and resulted in a retention rate of 83%. The decrease was driven by the renewal and expansion of a pure office tenant in the Bay area.

Our Life Science leasing exposure for the remainder of 2010 remains small at only 230,000 square feet and represents only 0.5% of HCP's annualized revenue. Looking to 2011, we have 425,000 square feet of remaining expirations which represent only 1.5% of HCP's annualized revenue.

HCP continues to pursue a pipeline of leasing prospects in excess of 650,000 square feet for existing space. Tenant demand for space has increased over prior year levels and we continue to monitor large institutional clients who have begun to seek space to accommodate expansion needs or relocate functions. HCP's remaining Life Science development pipeline now consists of just three redevelopment projects totaling 252,000 square feet, with projected funding requirements of $47 million.

Finally, the biotech industry financing environment remains strong, attracting over $9 billion of capital in the first quarter of 2010. HCP's tenants also continue to successfully raise capital as evidenced by our 147,000 square foot tenant, Rigel's recent announcement of its $1.2 billion partnership for its arthritis drug with AstraZeneca.

In addition the liquidity profile of our tenants remain strong with the Life Science companies in our portfolio with less than 12 months of cash representing less than 1% of HCP's annualized revenue. With that review of HCP's portfolio, I'd like to turn it back over to Jay.

Jay Flaherty

Thanks, Paul. Clearly, the key take-away for our first quarter is the continued outstanding performance of HCP's real estate and debt investments. Tom has indicated to you, the increased guidance that we have for same property performance expectations of our real estate portfolio in 2010.

Our debt portfolio has also improved during the first quarter, even from its outstanding results of last year. Of greater significance are the increased levels of tenant inquiry, foot traffic and leasing pipelines in our Life Science and medical office building sectors.

Through the recession, we have benefited from the defensive nature of HCP's portfolio, while continuing to create value from its attractive growth characteristics. Stepping back from property level trends, dialogue around portfolio and entity level opportunities is also quite active.

You may recall that we anticipated this increase in activity on our third quarter earnings call of last November, assuming healthcare reform was enacted between Thanksgiving and Christmas. While the January Massachusetts miracle and the subsequent political machinations in Washington, D.C. delayed final passage of health care legislation until just last month, our fundamental thesis that this bill and the continued unfreezing of the capital markets will be catalysts for substantial deal activity involving healthcare real estate remains in place.

Let me provide an update on our dispute with Sunrise. The Sunrise litigation is proceeding in two courts, The Delaware Chancery Court and the Federal District Court in Virginia. In both cases, HCP is seeking judicious confirmation that Sunrise has materially breached the management agreements and that HCP, therefore, may terminate the contracts and collect damages from Sunrise.

The Delaware trial has not yet been set, but we expect it to be accelerated from early next year into later this year. The Virginia case is on a much faster schedule, with discovery now completed and a judge trial set to begin five weeks from today on June 1st, 2010. We expect a decision by August. The Virginia case concerns a four property portfolio that two weeks ago on April 13th, Sunrise was notified that it had failed to meet the minimum return threshold requirements for two consecutive years. This failure was driven largely by the January 2008 revocation of Sunrise's Medicare certification for the skilled nursing beds that at one of the facilities and Sunrise's inability to backfill the resulting loss of Medicare residents with private pay residents.

To date, Sunrise has not been able to achieve Medicare recertification at this facility. The facility's occupancy is currently 58%. Sunrise has the right to cure this termination by paying the economic shortfall between actual property performance and the contractual performance threshold. If Sunrise does cure the termination, HCP will seek a declaration that the management agreements can be terminated and for damages. If Sunrise allows the contracts to terminate, then HCP will continue to seek damages for breach of the management agreements.

Last week, HCP's board of directors elected J. Alberto Gonzalez-Pita as Executive Vice President, General Counsel. Al has excelled in the General Counsel function with several large cap organizations and is especially well-practiced in the areas of mergers and acquisitions. We are delighted to welcome Al to HCP and look forward to working with him in what promises to be an exciting period ahead for our company.

I want to acknowledge publicly the outstanding effort by Executive Vice President, Tom Klaritch and Vice President Mike McKee in positioning us as the leader for sustainability issues in the medical office building sector. For those of you that have not done so, please review HCP's new Annual Report for a summary of the recognition that our company has achieved on this important topic.

Finally, we look forward to visiting with many of you and HCP's first ever Investor Day in three weeks on May 18th in Lower Manhattan. We would now be pleased to take your questions. In so doing, please limit your questions to two per time in the queue. Cheynelle?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from the line of Adam Feinstein of Barclays Capital.

Adam Feinstein – Barclays Capital

Okay. Thank you. I'm also here with Bryan Sekino. We'll keep it to the two questions. Maybe, I'll just start with a question, Jay, just about deal activity. Sounds like the dialogue's been heating back up. Just curious, I mean, just in terms of as you try to structure deals, just curious to get your feedback in terms of just how rational are people? For a while we heard a lot about buyers and sellers still had different point of view of the world and didn't seem like as many deals got done last year because of that, so just curious in terms of how would you characterize the tone of the dialogue and then a quick follow-up question.

Jay Flaherty

I would say that the tone of the dialogue is very sincere, very candid, very much focused with an eye towards trying to get some things done. I think the – you referenced last year as being a somewhat slower year. Obviously had the first half of the year, the capital markets were probably a partial cause of that. But as you got into the second half of the year and you started to see some improvement in the capital markets, you still had this at least for healthcare real estate transactions, you had the specter of this healthcare legislation that did not have certainty around it. And we made the comments back in November that when and if that certainty were to be – that uncertainty were to be removed and you actually had a bill that was passed, in our view you would see that be a real catalyst. That obviously got delayed from the kind of Thanksgiving to Christmas sort of time frame. It's now behind us.

I think people have spent a fair amount of time reading and more importantly understanding not just the impact on their business, but the timing of the impact on their businesses. And given that a substantial amount of the organizations, the healthcare operator organizations that are involved with this are either exclusively or largely owned by private equity firms who by definition look to exits over a three to five year sort of time frame. Where I think you're just about at the front end of that window, so you've got a couple things coming together. You've got certainty over healthcare reform. You've got capital markets stabilized. And you've got the concentration of ownership of a lot of these platforms with the private equity terms. You put all that together and I expect the second half of this year to be quite active.

Adam Feinstein – Barclays Capital

Okay

Bryan Sekino – Barclays Capital

Jay, this is Bryan. Just want to follow up. Appreciate your comments on the Sunrise facilities in litigation. Just want to get your thoughts in terms of your goals, should you get some kind of favorable ruling in the next year in terms of the turnaround, how to get those occupancy levels improving to more in line with the rest of the portfolio?

Jay Flaherty

Bryan, in light of the ongoing litigation, we won't be taking any questions or have any further comments beyond my formal remarks on the Sunrise litigation. Now, what you asked is partially to Sunrise litigation, partially related to more of an opportunity and relative to that opportunity, I'd direct you toward the two portfolios that we've already transitioned. I think those are relevant to answer that portion of your question.

Bryan Sekino – Barclays Capital

Okay. Thanks for the comments.

Adam Feinstein – Barclays Capital

Thank you.

Operator

Your next question comes from the line of Michael Bilerman of Citi.

Michael Bilerman – Citi

Yes, Jay, good morning. I was wondering if you could just elaborate a little bit more I guess on the deal activity as it relates to timing and impact to HCP. And maybe elaborate a little bit more, I think in the opening song you talked about being in the driver seat and I guess hiring Alberto, you now have more of that M&A experience within the company. Can you talk a little about perceptions of HCP being in the driver seat and that sort of element of potential growth?

Jay Flaherty

Well, as you know, Michael, we don't forecast or project acquisition activity. We look at I think the environment and the environment right now is I think getting quite interesting. Part of this relates to the answer I had to the previous to Adam's question. But clearly with the uncertainty over healthcare legislation behind us, clearly with more liquid, albeit even capital markets and clearly with a number of the private equity owned healthcare operations looking to monetize some or all of their investment, those were facts that are just kind of – they're pretty straightforward. So you obviously can't predict what if anything is going to happen.

With respect to where we sit, our balance sheet has never been stronger than it is on this very day, today. We've never been more liquid. And I think perhaps more importantly, we've got existing relationships across the five sectors of our portfolio with leading players that are apt to become involved in this transaction flow. I think if you go back for the last year and-a-half or so, gotten the question kind of repeatedly, what do you see as the impact of healthcare reform. And I think rather consistently I've said that the winners putting aside individual sectors or subsectors, the winners will have three criteria. They'll have critical mass and you should interpret that to mean market share, doesn't have to be national but clearly regional or local. They'll have to be efficient and you should interpret that to be appropriate margins. And they'll have quality outcomes.

And I think those will be – I think a good analogy to think about here with what's likely to happen is if you're to go back and look at what happened at the – in the kind of ‘88, ‘89 sort of timeframe after President Regan had prevailed in the Cold War, Berlin Wall came down, there was a substantial – what was described as being a Peace Dividend which was a material slowing of defense expenditures. That slowing of defense expenditures set in motion an unprecedented several year time frame of consolidation. I think that's very relevant for people to understand what happened there and I think it's directly applicable to what could happen over the next couple of years with respect to the healthcare sector.

Michael Bilerman – Citi

Okay. And just a second one for Tom. Just thinking about the ramp for the rest of the year, $0.50 in FFO for the quarter and I guess the higher litigation, so that's effectively $0.52. Your guidance has been maintained at $2.11 to $2.17 so you need a ramp to get to about a $0.54, $0.56 sort of quarterly run rate. What's the bridge from being at $0.52, adjusting for the G&A heading into the second quarter, up to those levels?

Tom Herzog

Yes, there are several things. The first quarter's always seasonally low as it pertains to add rents so we're problem by looking for first quarter, it might be more in the vicinity of 18%, 19% of the add rents that we expect for the year. So that will be one of the things that bumps up. We had a working capital funding with one of our hospitals that we incurred in the first quarter, so that was like a $1.5 million dollars, don't expect that to recur in the second quarter.

You mentioned the litigation expense being abnormally high in the first quarter due to the acceleration of litigation. And then we also had in connection with that term loan payoff that I had mentioned, that is accretive for about $3 million for the year based on the differential between the interest rate on the term loan and our revolver. That also came with a $1.3 million first quarter write-off of the unamortized debt fees. So all those things come – take all those into account when you look at the $0.50. That will bring it back to our guidance for the year of $2.14 as we look at it on a run rate basis.

Michael Bilerman – Citi

Okay. Thank you.

Operator

Your next question comes from the line of Jay Habermann of Goldman Sachs.

Jay Habermann – Goldman Sachs

Hey, good morning, Jay and everyone. Just following up on the acquisitions questions, obviously a lot of focus. I know you've spoken to that on the last several calls but can you talk about your capacity, your willingness to do large scale transactions? I mean, throughout this cycle you've balanced leverage pretty well, bringing leverage to the low point, I think today at about 43% debt to assets. So just curious, number one, how much in terms of capacity you're willing to take on? And number two, how much of that you think you could take down in your asset management platform?

Jay Flaherty

Let me take the second one first. With respect to capacity and our asset management program, I would say in Life Science, we've got substantial capacity. I would say the same for medical office. I would say the same for skilled. I'd say the same for hospitals, although as you've heard me previously state, I'm not anticipating much in the way of hospital acquisitions. I would say in senior housing, if we were to scale from here in that area, we may add some additional expertise there, particularly in a scenario where those senior housing structures might involve a structure beyond a triple net sort of structure. So I think that's how I would answer the second of your two questions, Jay.

With respect to the first one, which I guess goes to our – I mean, our capacity's obviously quite substantial. As we sit here today we're somewhere around a $16 billion market cap company with substantial immediate liquidity in the form of our cash balances, marketable security balances and available on the line, but also at this point we really have all of our markets open to us unsecured debt, secured debt, the equity markets and the potential for some further joint ventures. So that's nice. I guess we don't look at – we don't do big deals or small deals for that matter, do big deals or small deals, we do whatever the deal size is because they're good deals. You need to create in this business in our view the majority of the value creation's got to be created on the buy.

So I think our track record speaks to that, where we moved in, we moved into situations where there wasn't a lot of competition and/or we had some unique dynamic at work that tilted the playing field our way. I think you should expect that if and when we are to do something, that fact pattern would exist in those situations.

Jay Habermann – Goldman Sachs

Okay. So I guess should we expect leverage to remain closer to 40% or do you think it kind of creeps back up toward 50%? The second question was could you focus a bit on the types of returns that you're seeing perhaps for the segments that you're most interested in?

Jay Flaherty

I think we have a – we've got a long-standing track record and reputation of maintaining a very conservative balance sheet. There have been instances where because of some strategic opportunities, we moved above our internal and publicly stated guidelines but we committed to the various constituencies, the unsecured – our unsecured debt holders, our commercial banking group and our rating agencies that we would move those back down on a very specific timeframe and in all three instances after CNL, after Slough, after ManorCare, not only did we exceed the ratios that we committed to achieve, but we also exceeded those ratios, i.e. , did better in a shorter period of time than we had previously communicated. So I think we have a fair amount of credibility when it comes to that.

In terms of – I would tell you that in terms of our balance sheet management, I would say in the last year or so, we probably moved our kind of intermediate to longer term balance sheet guidelines from one of 50/50 debt to equity which is historically where the company has been, to a target today of more – closer to say, 40/60, 40 parts debt, 60% equity so I think that's evolved over the last 12 months. Tom Herzog has been very involved in that and so I think that's a good baseline for you. With respect to your comment or question about terms, we're active on a number of situations right now. It's probably – wouldn't be appropriate for me to comment in terms of return expectations at the present time.

Jay Habermann – Goldman Sachs

Okay. Thanks, Jay.

Operator

Your next question comes from the line of Jerry Doctrow of Stifel Nicholas.

Jerry Doctrow – Stifel Nicholas

Thanks, good morning. Two, quickly. One, Tom, just on the $1.3 million write-off, was that in interest expense?

Tom Herzog

Yes.

Jerry Doctrow – Stifel Nicholas

Okay. And then Jay, I guess everybody's asked about acquisitions. You've talked before about the sort of five-by-five strategy. Which sectors or investment types look to you most interesting as we go forward?

Jay Flaherty

Kind of top to bottom, I'll start with the bottom, least interesting would probably be hospitals and moving up – now, let's be clear. Let's define what we're talking about here. I would probably have a different array if we were talking more of an entity level opportunity, Jerry, as opposed to a portfolio level.

Jerry Doctrow – Stifel Nicholas

Okay.

Jay Flaherty

So let me just limit my remarks to portfolio sorts of situations.

Jerry Doctrow – Stifel Nicholas

Okay.

Jay Flaherty

I would say hospitals would probably be least attractive at one end of the spectrum. I would say that skilled nursing would probably be most attractive at the other end of the spectrum. One click above hospitals would probably be medical office, probably in the middle of the pack would be Life Sciences and one click below skilled would probably be senior housing. That's how I would evaluate the portfolio situations that we're tracking right now.

Jerry Doctrow – Stifel Nicholas

Okay. And in terms of just investment type property or entity acquisitions maybe with TRS look better than debt at this point.

Jay Flaherty

I think we're moving to a point where the equity investments are going to provide superior returns. There remain a very small number of probably like two or three situations where there is still possible in our view to get equity-like returns by being more senior in the capital stack in the form of debt investment. But I think some of the opportunities that have resulted in these enormous gains to the HCP shareholders, most notably the HCA toggle notes and the HCA Manocare debt investments that we made kind of in the teeth of the down-draft, I think that magnitude of opportunities is probably – in terms of those sort of size, I think those are probably by the board at this point.

Jerry Doctrow – Stifel Nicholas

Okay. That's helpful. Thanks.

Operator

Your next question comes from the line of Dustin Pizzo from UBS.

Ross Nussbaum – UBS

Hey, Jay, good morning, it's Ross Nussbaum here with Dustin. You had commented earlier in response to a question that you were thinking about looking at assisted living in the TRS structure versus triple net and that comment took me a little by surprise. That's a pretty significant strategic shift for your senior housing investments and maybe you can just add some color on is that the direction that you intend to go in the future on senior housing, given that the REIT laws changed a few years ago to let you do that kind of thing?

Jay Flaherty

Well, I think – good afternoon, by the way. I think the specific question I was asked was what would the impact be on our asset management infrastructure? I think the specific question is what is the capacity in our asset management structure by sector? And so when I was taking people through that question, I was evaluating – I was making a conscious evaluation of where we are in terms of the teams we have in place, particularly with our line of business organization structure which we evolved to about 18 months ago which is performing spectacularly well and then projecting incremental acquisitions there and I specifically carved out in senior housing, I carved out if we were to evolve towards a component of our portfolio having REIT, we would probably look to add some additional expertise and that was not at all an indication or a judgment or evaluation that we were going one way or another. I was responding to the specific question as to the capacity and capability of our existing asset management function.

Ross Nussbaum – UBS

Okay. So I'll take that to mean we should not expect any REIT like transaction in the immediate future?

Jay Flaherty

I think, Ross, we've got a long-standing history of not commenting publicly about our acquisition activity or budgeting our acquisition activity. It's not formulaic. It happens when it happens, if it happens and I wouldn't – you shouldn't anticipate any change from our track record in terms of how we've conducted our strategic activity.

Ross Nussbaum – UBS

Noted. Okay. My second question is on the MOB portfolio and I know there was some commentary up front. You got about 2 million square feet of leases rolling this year which is about 17% of that portfolio and I thought I heard something around 450,000 up for signature, another 800,000 of that is out for discussion which leaves another give or take 800,000. Is it – should we make the assumption that MOB occupancy still needs to head lower before it heads higher?

Jay Flaherty

Absolutely not. I mean, absolutely not. Our MOB sector is without a doubt the single most defensive sector. Our MOB pipeline is – if it's not in a record right now, it's certainly up material from where it's been the last year or two.

Paul Gallagher

I would also say that that number of square footage that rolls is pretty typical. And the amount of executed leases that we have is either on track or slightly ahead and the pipeline of leases that we have that we're negotiating right now is actually larger than where it was about this time last year, so we actually feel pretty good about the pipeline there.

Jay Flaherty

I would also add. One of the – it's interesting, perhaps the more significant impacts from healthcare legislation, not to be confused with healthcare reform legislation, is the likely increase on the part of physician, physician groups becoming actual employees of the hospitals and once that happens, a couple things are going to occur. They'll probably gravitate towards the better hospitals and they'll become employees. One of the things that that's going to do is particularly as some of these hospital systems, both the larger for profit and the larger nonprofit use this as a strategic weapon by turning these people into employees and we all know the rational from the doctors who have seen their income potential decline materially from their expectation when they started medical school. And which is also reflected in the fact that you've got medical school graduation numbers and applicants plunging nationwide.

In any event, this phenomenon where you're going to have more of these physicians not unaffiliated or more of an entrepreneur situation and gravitate towards being employees of hospitals, that is likely to provide some upward lift in terms of the demand for the MOBs and it's also likely to provide some additional upward lift with respect to the credit quality of the MOB tenancy, i.e., rather than have small, one-off physician groups. The majority of which are quite good at keeping the rents current, by the way, they'll actually become employees of nonprofit or for profit health systems that have significant either investment grade or significant credit ratings. I think those are all – those are some other dynamics that are out there that we anticipate our medical office building platform benefiting from.

Ross Nussbaum – UBS

Thank you.

Operator

Your next question comes from the line of Andrew Lo, Bank of America.

Andrew Lo – Bank of America

Thank you. Most of my questions have been answered. If I could just quickly ask two questions, if I could switch to cap rates, have they moved much from what you quoted last quarter? And is there a particular asset type that experienced significant cap rate compression?

Jay Flaherty

No. Not really.

Andrew Lo – Bank of America

Okay. And what about unsecured debt, at what rate can you issue a 10 year unsecured?

Jay Flaherty

It would probably be somewhere in the low to mid-5s today. It keeps getting better and better and better.

Andrew Lo – Bank of America

Low to mid-50s. Okay.

Jay Flaherty

It depends on what size, what tenor of maturity, five, seven, 10, what have you but those markets are – we've had some positive feedback from the rating agencies lately so we have – again, our ability to execute on the capital raising side has never been as good as it is right now.

Andrew Lo – Bank of America

Great. Thank you.

Operator

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

Rich Anderson – BMO Capital

Hey, thanks. Good morning to everyone out there. Can you hear me?

Jay Flaherty

Good morning.

Rich Anderson – BMO Capital

Okay. Just making sure, Jay, what would be your list of least to most interesting at the entity level?

Jay Flaherty

I would say any entity level opportunity that creates meaningful upside in terms of shareholder value for the company is something that we would take and consider very seriously. Those are situations that obviously don't come around too often. We've been active in that area, having done three or four large such situations in the last four or five years but that's very lumpy sort of situation, real not one that kind of lends itself to that sort of granularity, Rich.

Rich Anderson – BMO Capital

Okay. And then a follow-up to that, what has changed about the skilled nursing business over the past several years in your mind to put it at the top of the list from your portfolio, from a portfolio perspective? Now, I know your interest in looking back at my notes is at skilled nursing, that is sort of a low player in the Medicaid world or maybe nonexistent, I don't remember exactly how you put it. But nonetheless, it's still skilled nursing and an area that you as an organization had been over the past, say, ten years, been reducing your exposure to. More recently increasing it with HCR, I understand. But you're talking about equity type investments now. So I'm wondering if there has been any change in that world that has put it to the top of your list from a portfolio perspective.

Jay Flaherty

Well, there's two dimensions to answer the question. One is – and just to correct the record here, we have been prolific sellers of Medicaid skilled nursing exposure, so really it's apples and oranges to say that we sold a lot of Medicaid skilled nursing, which we did, at the same time we were adding HCR Manor Care skilled nursing because those are really two very different businesses. And on the previous calls we pointed out the differential in terms of the length of stay in those two subsectors and the difference in the source of the revenues, particularly the Medicaid exposure. It's really – it's really a different business, in our view. Just want to make sure that that stands on its own.

I think with respect to the other changed, I mean, you're only going to have deal volume when you've got willing sellers and willing buyers and I think one of the things that's changed in the skilled sector, I mean, if you take a look at the five or six largest either for profit – well, take a look at like the first, the top half dozen in terms of size for profit operators to skilled nursing, I think five of them, Rich, are controlled either majority controlled or 100% controlled by private equity terms firms now who obviously exist with a business model that is to make leveraged acquisitions and then take exits, be it in the form of complete sales of those investments or the subsequent going public.

You've got a somewhat similar – not as dramatic as you have in skilled nursing but you've got a somewhat similar dynamic going on in hospitals. I think the fact that you've got a lot of this ownership concentrated with groups that by definition are going to look to be taking either complete or partial exits, I think that is a change.

Rich Anderson – BMO Capital Markets

Got it. Thank you very much.

Jay Flaherty

Yeah.

Operator

Your next question comes from the line of Rob Mains from Morgan Keegan.

Rob Mains – Morgan Keegan

Yeah. Good morning, Jay.

Jay Flaherty

Hi.

Rob Mains – Morgan Keegan

Just got a couple numbers questions. First for Paul, could you go over again the 21% reduction in the Life Science renewals, what's behind that?

Paul Gallagher

Yeah. We had one large office tenant in the Bay area that renewed some of their existing space, about 80,000 square feet and then expanded another 40,000 square feet. Both of those were office leases and when you take the combination of the two together, that was about a 21% reduction. We had mentioned in the last call that we expected mark-to-market rents for 2010 to be in the 15% to 20% range, so that's within that range or at the top end of that range.

Rob Mains – Morgan Keegan

Okay. And that part of the world are office leases leasing weaker than Life Science leasing?

Paul Gallagher

Yes.

Rob Mains – Morgan Keegan

Okay. All right. And then expansion kind of exacerbated that.

Paul Gallagher

I don't know that it exacerbated. I think it was good that we were able to take an existing tenant and expand their use and move out their lease term.

Rob Mains – Morgan Keegan

Right. Okay. Fair enough. And then Tom, last call you were going over some of the components of your FAD. I know you don't give out FAD but what would go into it and you had mentioned that you expected second generation lease commissions and TIs and whatnot to total about $55 million. You were obviously well below that run rate in the quarter. Should we expect a big ramp in the next three quarters or kind of along the same trajectory, just with a lower Q1?

Tom Herzog

Yes. It was just timing, Rob, so the very low number in Q1 is expected to be caught up over the subsequent three quarters so we're still looking at $55 million for fad CapEx.

Rob Mains – Morgan Keegan

Okay. All right. That's all I had. Thanks.

Operator

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

Todd Stender – Wells Fargo

Hi, guys. Thanks. When you're discussing your lease renewals with current tenants, what topics relating to the healthcare reform and the impact that's going to have on the operator's business model are being discussed? And how are you factoring that into I guess your expectations on rent coverage?

Jay Flaherty

Well, let's just be clear. Healthcare reform I suspect probably is less of an impact in our senior housing and Life Science sectors, Todd. So I think if you take a look at our five by five model, I think your question – the playing field to discuss your question is probably within our skilled nursing and our hospital and our medical office building sectors, I think in medical office, I think the impact there has really been just one of a little bit of kind of a frozen environment, people not wanting to make long-term commitments until the ink was dry on the legislation. That is probably a component of why we've seen our leasing – our prospective leasing pipeline MOBs for example, move up a reasonable amount, just the uncertainty has been resolved.

So I think beyond that in terms of lease rates, I think that's a function of the local markets and as you know, the vast majority of all of our medical office building real estate is located on campus of number one and number two market shares. So that's – that really becomes more of a local market dynamic and is not heavily impacted by the healthcare legislation with the exception of the comment I made I think a couple questions ago that may well be over the next year or two you see a greater percentage of the tenancy that we have in our medical office building portfolios be directly aligned as employees with some of these large hospital systems, which we would take to be a good thing. So that's medical office.

If you move to skilled, there those are – our own skilled portfolio which is only about 2% of our overall portfolio, are at this point all – it's kind of four separate portfolios. So they're all unencumbered by any debt obligations and they're all master leased. And I think Paul took you through the coverage's there. They're 1.55 or 1.56, I forget which. So we certainly have done some kind of scenarios where we anticipated cataclysmic sort of reimbursement cuts there and given the fact that we're starting with 1.55 or 1.56 coverage ratios after recognition of the management fee. We've got an enormous amount of room there and I further add that again, they're master leased.

So I don't expect much in the way of an issue there, which then leaves us with the hospital sector and in the hospital sector we really reduced our exposure there. In fact, a substantial portion of our hospital sector is really in the form of some debt investments. So if you pull the debt investments away and take a look at the owned hospital real estate, there I'd take you to the coverage's in the aggregate of – I think they're 4.88 times, which those are – I'd be surprised if there are coverage ratios out there for the hospital, acute care hospital sector not LPAC, be very clear to differentiate between acute care hospitals and LPACs.

But with respect to the acute care hospital sector to have coverage ratios anywhere near those metrics. So I think again that the good news, if I take a look at the other side of the coin, I think those – I said this before that hospital portfolio, while it's very solid and covers at these unprecedented sort of coverage ratios is probably going forward more bond like in its potential to create incremental shareholder value for our shareholders as opposed to some of the exposures we have in our other sectors.

Todd Stender – Wells Fargo Securities

Thanks for going through that. I guess drilling into the skilled nursing, are operators bringing up the fact that they would have now provide healthcare insurance for their employees? I mean is that a – does that have merit or is that a talking point or renewal discussions?

Jay Flaherty

Well, we get – we really have not – I mean we're in a perfect world. We've got very substantial coverage. We've got very substantial master leases and we've got minimal if any lease expirations. So it's really a nonevent from HCP. To the extent we heard any concern over the incremental cost of providing healthcare insurance to operator employees, that's probably been more over on the senior housing side as opposed to skilled nursing side.

Todd Stender – Wells Fargo Securities

Okay. Thank you.

Jay Flaherty

Just quantify, lease expirations and skilled part – we have a schedule on page 11 of our supplemental. And I think you will probably see why it's complete the real answer to your question is it's a complete nonevent for HCP. We've got no remaining expirations in 2010. We have no expirations at all in 2012. And then when you go to 2011, we've got de minimus amount there. You might want to familiarize yourself with that schedule. I think you'll see that's – we're in very good shape there.

Todd Stender – Wells Fargo Securities

Okay. Thanks, Jay.

Operator

Your next question comes from the line of Karin Ford of KeyBanc.

Karin Ford – KeyBanc

Hi, good morning.

Jay Flaherty

Hi.

Karin Ford – KeyBanc

Wanted to ask about the M&A expertise of your new General Counsel. Was the thought there that would be helpful if dealing with potentially with private equity partners or sellers on the acquisition side or was it more for sort of a public-to-public type of transaction you guys were looking for help on?

Jay Flaherty

I think it was something much more general. Just struck us as an outstanding professional that we're very fortunate, his interests align with ours. So we'll be excited about bringing him into the company next month, much like we were very excited to bring Tom Herzog into the company last year.

Karin Ford – KeyBanc

Okay. So nothing specific, just general M&A expertise and his talent.

Jay Flaherty

He is a very gifted legal professional with a track record of having built and led the best-in-class legal groups in a number of very large market cap situations. So we're excited to bring him into the fold.

Karin Ford – KeyBanc

That's helpful. Second question just relates to your JV portfolio. You mentioned there was JV capital available that you guys might be taking a look at. Do you see any opportunities either in your existing JV portfolio for acquisition or adding additional JVs to that portfolio?

Jay Flaherty

Well, Karin. We look at everything. I think if you go back – you're familiar with our five-by-five model, I think it's instructive to think about our five-by-five model not just as being static at one point in time, but being a potential source of deal pipeline in and of itself and I'll point out two transactions that I think are relevant here. If you recall, when we made the first – so we've got our five-by-five model, the five columns or the sectors, the five rows of the products.

If you go back and look at when we made our first meaningful mezzanine loan investment it was at the end of '02 in a company called American Retirement Corp. the predecessor company to Brookdale. I think it's very instructive to a look at that transaction and note that over the course of the next couple years after we made that investment, driven largely by the amazing improvement in the profitability of that company. We voluntarily converted that mezzanine loan position into an equity ownership position, which today is a gorgeous portfolio of sale leaseback investments in some very high quality senior housing assets with very substantial coverage.

I think if you go and look at another row in our five-by-five model, you'll recall that when we first acquired the wonderful medical office building portfolio from HCA, the MedCap Division, their medical office building division. We unusually put that in a joint venture, Karin and over the course of a couple years, the investment criteria of that joint venture partner changed to the point where approximately three years later. We did something similar to what I just took you through on mezzanine loan investment. We converted that to 100% owned portfolio.

So we look at the five-by-five model principally as a way to source – to play in a bigger sand box. Our view is that with more opportunities, we are to be able to make better investment decisions as opposed to being just kind of a one trick pony, if you will. But I think what's more subtle behind the scenes, I think we've got a track record which I've just shared with you, is that we can sometimes move investments within that five-by-five model to a higher and better use for HCP shareholders. So that's probably a more indirect way of answering the question that you just asked.

Karin Ford – KeyBanc

Thank you.

Operator

Your next question is a follow-up from the line of Michael Bilerman.

Jay Flaherty

Michael, are you there?

Michael Bilerman – Citi

Yeah. Sorry about that. Just for the Tom, what do you think, if you had to go and get a floating rate term loan today, where would that be priced?

Tom Herzog

Floating rate term loan? If we just look at revolvers, conversations that we've had on revolvers, we're probably looking at LIBOR plus maybe 250 is some of the most recent information that I've received.

Michael Bilerman – Citi

I guess tie that to – I realize it's accretive to use an untapped line to pay back a $200 million term loan. But if you are going out and it sounds like transaction activity is certainly picking up and I know the ambitions of the company is not to do a $9 million deal a quarter, the idea is to do probably a multi billion dollars.

Jay Flaherty

It was a very, very fine $9 million acquisition we made in February.

Michael Bilerman – Citi

I'm sure it is on a $16 billion company is not going to move the needle. And I think when you're going to buy you're going to have to buy in size to get the appropriate return and the discount that you need. So I'm just wondering why eliminate $200 million of capacity that's arguably priced below market?

Tom Herzog

Well, we've got a – had an untapped line at this time. That term loan was co-terminus with the revolver. So at the time that we would renew our revolver, sometime probably early next year, the term loan would be taken out at the same time. So with that said, we had plenty of liquidity all kinds of room in our revolver and eliminating the term loan made sense.

Jay Flaherty

Michael, in your comment this morning, you made a comment that we will – quote directly. We will need to find investments especially to offset the mezz loan income. I guess that evidence is of you on your part that something might be happening to our mezz loan income. I can't comment on your perspective but all I can do is connects the dots.

If in fact, mezz loan income went away, it would go away presumably with the repayment in full of the obligations that are generating the income, which if you add all those obligations up. That's a very substantial amount of proceeds. So I think we're also trying to manage the balance sheet under a couple of different scenarios and not be in a situation where we're looking more like the balance sheet at J.P. Morgan in terms of liquidity and things like that.

Michael Bilerman – Citi

No. I'm thinking about it from the perspective in terms of that comment that clearly having $1.7 billion nominal out in the HCR ManorCare, $2 billion in total in mezz, it's earning about 7.5% FFO yield today that over time because of debt that has a maturity date relative to real estate assets that are in perpetuity, that you're going to have to find some offset other than just taking all the money back and sitting on the cash.

Jay Flaherty

I think that's fair. I think I'd be – if I were sitting – given the chair that I'm sitting in relative to you. I'd say I'm less concerned about achieving or even exceeding that return and I'm probably more focused on replacing that at the same or even higher return. But to your point, replacing it with something that's going to have more of a growth characteristic going forward as opposed to the very substantial amount of debt income we have right now which the good news is, as Paul indicated, take either one the HCA investment or the HCR ManorCare investment.

They're covering at coverage ratios that are approaching the coverage ratios we have in our hospital sector. So there's not a lot of credit risk there. But there's also not a lot of growth in those investment kind of projecting out 2011 versus 2010 and 2012 versus 2011. So that's the other element of what we're trying to capture at some point.

Michael Bilerman – Citi

I guess you bring four circle when you think about the dividend which in our numbers I think it depends how you treat the interest accretion, but even if you put the interest accretion aside, you're probably over funding the dividend by a small amount currently that as you replenish and exchange your loan book for hard assets and sounds like into an accretive manor, you'll grow into the dividend at that point.

Tom Herzog

When you think about the dividend coverage, look back to 2009 where we did a lot of deleveraging and in the process of deleveraging and growing into accretive acquisitions that we had put on the books over the prior couple of years. We are projected to come up slightly short in covering the dividend. But I think about it this way, Michael. All we have to look to is 2011, same property performance growth. If it's at 3%, that picks up $0.08. We're got the RES and Eden two portfolios that are performing as expected and we'll have some growth from that.

We've got the Hogue lease where as you'll recall that had zero rent for a period of time and then 50% and that's going to be fully paying. We've got the Oyster Point Sea asset that could be leased up. There's just a variety of different reasons why dividend coverage is not a great concern.

Jay Flaherty

Mike, we took a lot of very conscious decisions that probably had the effect of dampening the latter half of 2009 and 2010 earnings directly, because we thought the tradeoff in terms of the growth and the quality of the growth were getting kind of the second half of 2010, 2011, 2012 was superior and we're only six, nine months on having made those decisions. But everything we've seen to date suggests that if anything our expectations will be exceeded on those transactions.

Michael Bilerman – Citi

Right. No and deleveraging certainly has a pretty dilutive effect. So clearly, as you ramp your investments you'll get much more coverage as you move forward. Okay. Great. Thank you.

Jay Flaherty

Thank you, Michael. Are there any other questions? If not, thank you everybody for your time. Again, I hope we see most if not all of you in a couple weeks in New York City for our Investor Day. Thanks again for your interest in HCP.

Operator

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

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