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HCP, Inc. (NYSE:HCP)

Q3 2010 Earnings Conference Call

November 2, 2010 12:00 PM

Executives

Beejal Northrup [ph] – Director, IR

Jay Flaherty – Chairman & CEO

Tom Herzog – EVP & CFO

Paul Gallagher – EVP & Chief Investment Officer

Analysts

Jay Habermann – Goldman Sachs

Michael Bilerman – Citi

Michael Mueller – JPMorgan

Brian Sakino [ph] – Barclays Capital

Rich Anderson – BMO Capital Markets

Jerry Doctrow – Stifel Nicolaus

Tayo Okusanya – Jefferies & Company

Robert Mains – Morgan Keegan

Ross Nussbaum – UBS

Operator

Good day ladies and gentlemen and welcome to the third quarter 2010 HCP earnings conference call. I will be your coordinator today. At this time, all participants are in listen only mode. Later we will conduct a question and answer session. Now, I would like to turn the presentation over to your host for today’s conference call, Miss Beejal Northrup [ph], HCP’s Director of Investor Relations. You may go ahead madam.

Beejal Northrup

Good afternoon and good morning. Some of the statements made during today’s conference call will contain forward-looking statements. These statements are made as of today’s date and reflect the company’s good faith belief and best judgment based upon currently available information. The statements are subject to the 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 have been furnished to the SEC today and is available on our website at www.hcpi.com.

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

Jay Flaherty

Welcome to HCP’s third quarter 2010 earnings conference call. Joining me this morning are Executive Vice President and Chief Financial Tom Herzog and Executive Vice President and Chief Investment Officer, Paul Gallagher.

Let’s start with a report on HCP’s most recent results and for that, I will turn the call over to Tom.

Tom Herzog

Thank you Jay. There are several topics I will cover today; first, our third quarter results, second our investment and disposition transactions, third our financing activities and finally, our full year 2010 guidance.

Let me start with our third quarter results. For the third quarter, we reported FFO of $0.54 per share before giving effect to an impairment charge of $0.23 per share compared to $0.52 per share before impairments and litigation provision for the third quarter of 2009.

There are several items I would like to point out. First, our same property portfolio continued to perform well, producing a strong 4.8% year over year, quarterly cash analogue growth. Paul will review our performance by segment in a few minutes.

Our third quarter results included the impact of two offsetting items that were not contemplated in our guidance. $0.02 per share related to gain on sales of HCA bonds and charge of $0.02 per share related to acquisition pursuit costs.

During the third quarter we recorded a non-cash impairment charge of $72 million related to our 35% interest in HCP Ventures II an unconsolidated joint venture that owns 25 senior housing properties leased by Horizon Bay.

Turning now to our investment and disposition transactions, first, on August 31, we entered into agreements with Sunrise that allowed us to terminate management contracts on 27 of 75 senior housing communities. We transitioned these 27 communities to Emeritus effective yesterday.

In exchange, we paid Sunrise $50 million, which after certain closing and working capital adjustments resulted in $41 million that was capitalized and will be amortized as deferred leasing costs in accordance with GAAP. As part of this arrangement, HCP and Sunrise agreed to dismiss all litigation proceedings between them. Paul will describe the terms of the new Emeritus leases shortly.

Second, during September and October, we purchased a $278 million participation in Genesis Health Care’s senior loan at a discount for $250 million, and a $50 million participation in a Mezzanine note at a discount for $40 million.

Third, during the quarter, we made real estate acquisitions of $63 million and capital investments of $36 million for construction and other capital projects. Year to date, this brings us to $640 million in real estate and debt investments.

Turning to dispositions, in September, we sold $73 million of debt investments including $65 million of HCA bonds and recognized gains of $6 million. We also sold three skilled nursing facilities for $10 million and recognized a gain of $4 million.

Subsequent to quarter end, we sold our remaining bond investments in HCA and one other issuer for $102 million, resulting in fourth quarter gains of $8 million. We also sold nine senior housing facilities for $27 million and recognized a gain of $15 million.

Next, our financing activities, in September, we prepaid without penalties $68 million of 6% mortgage debt, which was scheduled to mature in February 2011. Also, we repaid $200 million of senior unsecured notes at 4 7/8 that matured in September.

We ended the quarter with $320 million drawn on our revolver and had $1.2 billion of immediate liquidity from our revolver, cash and marketable securities.

Finally, full year 2010 guidance; based on stronger than forecasted performance to date, primarily in our senior housing and life science segments, we are raising our full year cash same property performance guidance to a range of 4% to 5%, up from 3% to 4% previously.

In addition, we are increasing our 2010 FFO guidance to a range of $2.18 to $2.24 per share before impairments and recoveries, which is $0.08 higher than our previous range of $2.10 to $2.16. This increase is driven by several items.

$0.02 from the increase in same property performance, $0.02 from accretive debt investments in Genesis, $0.03 from gains realized upon monetizing our HCA bond investments net of lost interest income, and $0.04 from a prepayment penalty related to the early payoff of a $34.5 million debt investment in our hospital segment that Paul will provide more color on shortly.

These increases were partially offset by reduced earnings from HCP Ventures II, acquisition pursuit costs that were not previously forecasted and several other small items.

I will now turn the call over to Paul.

Paul Gallagher

Thanks Tom. Let me break down the 2010 third quarter performance of our portfolio. Senior Housing; occupancy for the current quarter in our same store Senior Housing platform is 85.6%, representing a 30 basis point sequential increase over the prior quarter and a 60 basis point decline over the prior year. Facility margins across the entire Senior Housing portfolio are improving with cash flow coverage remaining t 1.6 times.

Current quarter, year over year same property cash NOI for the entire Senior Housing platform was 9.8% driven by rent steps and improved performance for 25 Sunrise assets transitioned to new operators in prior years.

During the quarter, HCP acquired another senior housing facility formerly managed by Sunrise for $14.75 million. HCP entered into a ten year lease with Emeritus with two ten year renewal options at an initial lease yield of 8.3% with 3.5% annual escalators over the initial term. In addition, subsequent to quarter end HCP entered into two master leases with Emeritus for 27 newly terminated Sunrise facilities. The leases have an initial term of 15 years with two 10-year extension options.

First year rent on the portfolio is $30.3 million, representing $1.5 million increase from current rents. Fixed rent steps over the first five years result in a compounded annual growth rate of 13.9%. After year five, rent escalates and the greater of CPI or 3%.

The unlevered IRR on the transaction including the $50 million termination fee paid to Sunrise and $9.5 million in CapEx, HCP has committed to fund is 42%. Also subsequent to quarter end, HCP sold a portfolio of nine senior housing facilities to the tenant Assisted Living Concepts for $27.5 million for a gain of $15 million. The sale represents a 7% cap rate.

Hospitals, same property cash flow coverage decreased 23 basis points to 4.7 times driven by expenses related to the opening of Medical City Dallas’s new children’s tower of last quarter. HCA began paying base rent on their new tower in June and will pay add rent on incremental revenue. Year-over-year same property cash NOI for the third quarter increased 16.9% and was driven by our new hold lease, which began paying full rent in June.

During the quarter and subsequent to quarter-end, HCP divested of its remaining $140.8 million holdings of HCA 9 and 5As toggle notes at a price of a 109% of par. HCP recognized a gain of $12.7 million, which provided a 13% return over the four-year hold.

Yesterday HCAs St. David’s hospital acquired MedCap’s Austin Heart Hospital. HCP received a payoff of the $34.5 million mortgage loan on the MedCap hospital and received an $11.3 million prepayment premium.

Skilled nursing, our owned skilled nursing portfolio year-over-year cash NOI for the third quarter in our same-store portfolio decreased 1.3% as a result of a lump sum payment received with a lease extension in the third quarter of 2009. Cash flow coverage remains strong at 1.48 times.

HCR ManorCare reported improved second quarter trialing 12-month in debt service coverage for the entire debt stack of 4.63 times, an increase of 13 basis points over the prior quarter. During the quarter HCP sold three skilled nursing facilities to the tenant for $10 million and recognized a gain of $4 million. HCP provided short-term 85% solid financing to the buyer at an interest rate of 11.5% as a bridge to a HUD debt execution.

HCP purchased participations in both of the senior term loan and mezzanine debt of Genesis HealthCare, one of the largest skilled nursing providers in the U.S. Genesis operates 137 owned, 43 leased and 42 managed facilities in the U.S. HCP purchased a $277.6 million participation and the $1.3 billion senior term loan at a 10% discount and $50 million participation in the $375 million mezzanine loan at a 20% discount.

The senior loan was priced at LIBOR plus 475 with a LIBOR floor of 1.5% stepping up to LIBOR plus 575 with the floor of 2.5% in 2012. The mezzanine loan was priced at LIBOR plus 7.5 with no floor and contains an exit fee. Both debt facilities mature in September 2014.

Inclusive of the discounts the senior loans scheduled interest rate steps and the exit fee on the mezzanine debt. HCP projects the unlevered IRR to the state of maturities for the senior debt will be 10.5% and 18% on the mezz debt. For the trailing 12 months ended June 2010, Genesis generated cash flow for a year-to-date debt service coverage of 2.66 times on a senior debt tranche and 2.02 times on the entire debt stack.

Medical office buildings. Same property cash NOI for the third quarter was up 1.4% over the same period 2009. The growth was due to normal rent steps and improvement in parking revenue on our Seattle and Houston campuses and a reduction in recoverable operating expenses. Quarterly same-store operating expenses were down $179,000 or 0.6% when compared to 2009. We were able to achieve these savings despite a spike in utility expense.

Our MOB occupancy for the third quarter remained stable at 90.8%. During the third quarter, tenants representing 803,000 square feet occupancy, of which 665,000 square feet related to previously occupied space. Our year-to-date retention rate was 85.3%, the highest average retention in over four years.

Renewals for the quarter occurred at 2.9% higher mark-to-market rents and included five major leases, totaling 282,000 square feet at an average term of over five years. Average term for new and renewal leases executing year-to-date is 55 months, an increase in term of 12 months over the same period in 2009. Our pipeline includes 329,000 square feet of executed leases that have yet to commence and 669,000 square feet in active negotiations, well in excess of the 736,000 remaining rollover for 2010.

We continue to advance our green initiatives. In October, we confirmed we received confirmation that our 1101 Madison Building in Seattle on our Swedish campus was awarded LEED Silver Certification. This brings our total LEED certifications to four throughout the portfolio. This property was also recertified as an ENERGY STAR building. In addition, we’ve received a new ENERGY STAR Award for MOB in Littleton, Colorado, bringing the total ENERGY STAR labeled properties to 15, five of which have received the award in multiple years.

As previously discussed, two MOBs were acquired on July 26 in an off-market DownREIT transaction. The properties are located in San Antonio, Texas and Bountiful, Utah and were purchased for $19 million at a cap rate of 8.8%.

Life science. The third quarter same store cash NOI for life science was down 1.5% over same period in 2009, but remains positive at 2.4% year-to-date. The decrease in same store performance for the quarter was primarily driven by an increasing vacancy, rent reductions experiences result of lease renewals in our Bay area portfolio. Occupancy for the entire life science portfolio increased slightly to 88.9% at the end of the third quarter.

For the quarter, we completed a 180,000 square feet of leasing and year-to-date, we’ve completed 436,000 square feet of leasing that has resulted in a retention rate of 68%. In addition, we’ve completed an additional 62,000 square feet of leasing that will commence in subsequent quarters. Our life science exposure for the fourth quarter of 2010 is only 48,000 square feet.

Looking to 2011, we have 408,000 square feet of expirations with nearly 60% in active negotiations. HCP’s life science development pipeline continues to consist of just three redevelopment projects and was reduced during the quarter from 252,000 to 227,000 square feet, as approximately half of are sold at redevelopment project in San Diego was completed and is now 100% occupied.

As a result of the completion of this project, our overall projected redevelopment funding requirements totaled $27 million. As we mentioned on our last earnings call, we completed a $29 million acquisition in the third quarter of a building that was 100% leased and located within our University of Utah Life Science Cluster at a cap rate of 8.5%.

Finally, the biotech industry financing environment remains strong with over $19 billion in capital activity in the third quarter, bringing year-to-date total to $42 billion. The capital flowing into the sector continues to be led by the $25 billion in partnership deals as Big Pharma continues its interest in the sector.

HCP’s tenants continue to attract capital including Exelixis which raised $60 million in upfront payments from Bristol-Myers Squibb and $500 million in potential milestone payments in connection with two collaborations and Portola Pharmaceuticals announced collaboration with Merck on their drug candidate for stroke preventions that included a $50 million upfront payment and up to $420 million at milestone payments.

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 under 0.5% of HCP’s annualized revenue.

With that review, I’d like to turn the call back over to Jay.

Jay Flaherty

Thanks, Paul. We enjoyed a strong quarter across the entire Company. Our real estate portfolio continues to exceed expectations, allowing us to raise our same property performance guidance for this year for the second time in the last three quarters.

The formidable rally in the high yield market driven by a reach for yield provided an attractive exit opportunity for HCP’s entire marketable securities portfolio, most notably our HCA toggle note investment.

HCP’s HCR ManorCare debt investment continues to benefit from strong cash flow generation at this leading post-acute provider. Yesterday, we completed the transition of 27 senior housing communities formally managed by Sunrise to Emeritus.

The economics of the new master leases with Emeritus validated HCP’s long held view of the incremental value potential of this portfolio. In addition to an immediate bump in year one rents of $1.5 million, the compound annual growth rate in rents for the first five years will be 13.9%.

HCP unlevered IRR on this transition is expected in excess of 40%. These events have contributed to HCP raising a low and high end of its full year FFO guidance by $0.08 per share to $2.18 to $2.24 per share.

I want to comment on our investment activity starting with our HCA toggle note investment and more broadly HCP’s sector leading debt investment platform. HCP initially funded a $300 million commitment as part of the HCA LBO exactly 40 years ago this month.

We subsequently added to our position in the post Lehman downdraft of late 2008 at discounted prices. We’ve now completely disposed of this position at a 5.5% yield to call valuation realizing an unlevered return of 13% for the four-year hold period.

What is particularly interesting about the performance of this investment is that this was a pre-crash mezzanine investment versus our investment in HCR ManorCare. While we are confident there will be a time in the future to celebrate the successful fruition of our HCR ManorCare investment. The 13% realized performance on our HCA bonds achieved through the teeth of the great recession is especially rewarding for HCP shareholders.

Let me turn to our most recent investments in Genesis HealthCare. We became quite familiar with the post-acute sector by virtue of our successful investment in HCR ManorCare. Similarly Genesis has performed nicely since its LBO in 2007.

HCP’s ability to underwrite the Genesis opportunity and close promptly to affect a quarter end execution has distinguished HCP as an investor for this type of paper. With expected IRR’s of 10.5% on the senior secured position and 18% on the Mezzanine tranche, we will achieve equity like returns with fixed income risk exposure.

The Genesis buy highlights an additional element of HCPs investment philosophy. Recall at our May Investor Day in New York City, I characterized HCP’s ‘‘5 x 5’’ business model as a means to an end, not an end in and of itself. I want to say that a key feature of our ‘‘5 x 5’’ model was it a created optionality for HCP to achieve our ultimate end, outright ownership of healthcare real estate.

HCP’s previous conversions of mezzanine debt positions and buyouts of joint venture partnership interests into 100% fee simple ownership of real estate are examples of this optionality being successfully realized. In this circumstance Genesis is presently organized as a C Corp with the potential to elect the PropCo/OpCo separation. If and when this process plays itself out, HCP maybe in the fortunate position of enhancing its already attractive return expectations on our Genesis investment.

Finally, we’re pleased to have Kendall Young joined HCP as Executive Vice President focusing on new growth initiatives for the Company in the senior housing sector. Kendall has broad experience in creating value for significant real estate platforms. Kendall is currently evaluating the merits of converting our independent living joint venture portfolio from a lease arrangement to a RIDEA structure.

Our preliminary view speaking of optionality is that the senior housing portfolio unlike the four Sunrise portfolios we’ve previously transitioned as leases maybe especially well-suited for a RIDEA structure.

With that, we’ll open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Jay Habermann from Goldman Sachs.

Jay Habermann – Goldman Sachs

Hey, Jay, good morning. Just starting with Genesis, can you give us some perspective, I guess how this Genesis of obviously disinvestment. And are you viewing this as essentially something you plan to hold to maturity and then you spoke about sort of the potential split-up between PropCo/OpCo? I mean is this also an investment that you would look to own the real estate longer term and potentially even bringing to the RIDEA structure that you mentioned before you are considering?

Jay Flaherty

Let me say that we like heads we win, tails we win investments and this certainly has all the hallmarks of that. We’ve obviously got ourselves quite familiar with the economic fundamentals of the post-acute space. We had been knowledgeable of the management team there and very similar to the way the two investments we made in the HCR ManorCare debt went down. There was some motivation on the part of the major commercial banks, be it for Basel III purposes or other purposes to affect monetization of those investments, and they had rather short timeframe. We were up to speed on the space, we knew the management team and we are able to get our arms around at an entry point from a valuation standpoint that made sense to us and make sense to us on a hold to maturity basis. So let me just stop there. Now with respect to a PropCo/OpCo separation, it may well be if that’s what got ends up happening that we are positioned to as part of that process realize an even greater return by stepping into, you are different, you are modifying that investment either becoming morphing to it like a different form of the debt investment and/or outright ownership of the real estate. I would stop short however of contemplating that this would go to a RIDEA structure, that’s generally in the skilled nursing post-acute space, that’s generally a space that we would probably not have as a priority for our RIDEA structure, we’d probably have that prioritize more over in the private-based senior housing space.

Jay Habermann – Goldman Sachs

I guess as well as you look at your ManorCare investment, are you seeing any sort of further resolution in terms of an outcome, whether it’s improving equity markets or other sort of strategies that they are considering for an exit?

Jay Flaherty

You’d have to talk to the shareholder. From our standpoint it’s a wonderful, I mean the outcome is just fantastic. The cash flow coverage keeps going up and the regular coupon payments at a face value amount now is $1.720 billion are increasingly well provided for us. So from that standpoint, we couldn’t be more pleased with that investment.

Jay Habermann – Goldman Sachs

I guess just going back to operations, at the start of the year I think you guys were talking about NOI growth more in the mid 2% range and now you’re talking about 4% and 5% year-over-year, and clearly the repositioning of Sunrise, the Hoag hospitals, but I guess if you strip those out of the numbers, the 4% to 5%, are you still sort of in that original 2% to 3% range, I guess what’s driving most of that increase year-over-year?

Tom Herzog

We had increased that previously as a result of that deferred rent payment that came in from one of our life science tenants and then it caused the most recent bump or the bump from a couple of quarters ago. The increase that we had of a 100 basis points is going to be really three different things. One is we had the increase from the Sunrise 27 transaction that we talked about where there is some bump from that. In our Life science division, we had higher recoveries and lower bad debt that would have been a piece and then when we looked at our guidance, when you put it together at the beginning of the year we had incorporated something in for bad debt due to tenants or operators that would fall out and that just didn’t materialize. Our portfolio held together very well and as a result of that, we were able to pick up the additional SPP growth in our projection.

Jay Flaherty

Jay, I’d step back to, I think and we’ve taken to this group to this calculus before, but if you drill into our senior housing sector, which is the largest of our five sectors, that’s about 37%, 38% of the NOI and you take a look at the impact of having now transitioned 58 separate communities from Sunrise to replacement operators, they took place in four separate transitions, three of those four transitions resulted in compound annual growth rate in rents for each of the first five years in the low double-digit percentage magnitude, the fourth transition which was the one we stepped into the ownership in June of this year, that’s going to be if you recall about a 5.7% compounded annual growth rate in rents for the first five years. So the economics that there’s been validated with these transitions is not just a kind of 2010, 2011 dynamic that’s going to continue to drive what I suspect will be outsized and senior housing sector leading industry growth metrics for the next several years, you just start compounding at ‘11, ‘12 and in this case on this transition 13.9% those numbers get quite substantial.

Jay Habermann – Goldman Sachs

I guess in the perspective I was looking in 2011, would you expect that case to continue or more in line with the year-to-date the target you had mentioned at the start of the year?

Jay Flaherty

Well, Tom, in the next call we will obviously with a fair amount of detail take you through all the assumptions, but I guess what I am suggesting is that the effect of the transitions that Paul and his team have put in place this year are going to benefit HCP’s shareholders for multiple years in the future, those are not kind of one-year phenomenon sorts of results.

Tom Herzog

I can add to that just a little bit, Jay. If we took 2010 in isolation and just looked at the transitioned assets that the Sunrise 27, Eden II and the Res, we’re picking up a little bit in excess of 1.5% total SPP growth cumulative up against the 4.5% in the guidance. If we look forward to ‘11, ‘12, ‘13 we’re going to see 1% growth as well on an overall HCP level. So there is going to be a lot of growth coming out of that, incremental 1% to our SPP growth. So it’s a substantial amount of growth coming out of those transactions.

Jay Flaherty

Its contractual by nature, because these we put in place with the leases, the master leases, those are contractual relationships that flow to the benefit of HCP’s shareholders.

Operator

Your next question comes from the line of Quinton Velali [ph] of Citi.

Michael Bilerman – Citi

It’s Michael Bilerman with Quinton. Jay, just going back to Genesis, who else I guess you are now 20% of the debt stack and who holds the remaining 80% and what sort of conversations did you have with JER and Formation prior to purchasing?

Jay Flaherty

I would say the ownership composition Michael of that debt is remarkably similar to the ownership concentration of the PropCo debt in HCR ManorCare. That group sees a lot of one another and with respect to the conversations we had with the two private equity firms that you mentioned, Formation and JER they were certainly the conversations that took place in advance of us moving forward on those acquisitions and they were quite supportive of us moving into those positions.

Michael Bilerman – Citi

Did they not have the opportunity to buyback and de-lever themselves?

Jay Flaherty

We are talking to them about that, but that was not something that at the present time, from my understanding have the wherewithal to execute in.

Michael Bilerman – Citi

So the other 80% is primarily held by the same partners that you have partners or partners like home partners the same investors that are in the ManorCare debt?

Jay Flaherty

I would call them partners. It’s not dollar for dollar, but there is an awful lots of the folks in the PropCo ManorCare debt are in – the debt in the C-Corp that is today Genesis HealthCare.

Michael Bilerman – Citi

Just a question is for Tom. I think just thinking sequentially for a moment, the $0.54 excluding the impairments in the third quarter, it would look like fourth quarter is about $0.60 to $0.66. I take it about $0.07 is just the debt gains in the prepayment on the mortgage loan and then may be pickup another penny on the debt investments that you have made that would certainly take you to 61, 62. What makes the range still wider in terms of the fourth quarter, is there any other things that are occurring and is there anything else that we are missing in terms of that sequential move from 3Q to 4Q?

Tom Herzog

You are right in that. When you do the math, you’re at $0.62 for Q4 and here is how you run it back down to a more normalized number. MedCap, that’s repayment at a premium that we spoke to in my call where we picked up $0.04, that’s one of the items that occurs in Q4. The HCA gains net of the lost interest income from selling those (inaudible) coupon notes, pick up $0.25. The Genesis is $0.02 of that number and then the JV II, not so much the impairment but the lack of straight-line rents going forward, because as you’ve might have seen in our footnote disclosure we discontinued straight-lining rents effective July 1, that was a $0.01. So that goes to the opposite direction. So if you take all those pieces into account, that take you from the $0.62 down to a more normalized $0.55.

Michael Bilerman – Citi

Right, but then the range for the fourth quarter of $0.06 wide, I don’t know if there were certain assumptions or certain things that you were projecting on occurring, it looks like a lot of the things that you mentioned are known events, so why would there still be such a wide range for the 4Q?

Tom Herzog

I just left the range as it was. It seems that $0.03 on either side of the mid-point was not unreasonable.

Michael Bilerman – Citi

Then, just lastly on the acquisition pursuit costs and I guess tying into hiring Kendall, was Kendall hired pre-Atria or post and were those $6 million was that related to that transaction?

Jay Flaherty

The $6 million was not all Kendall, is that your question?

Michael Bilerman – Citi

I guess was prior to pursuing the Atria transaction or post?

Jay Flaherty

We’ve been in decisions with Kendall for the better part two years, I think his actually start date was September 15, but we’ve been recruiting one another for the better part of two years.

Michael Bilerman – Citi

The $6 million, where is that in the P&L and can you break that up between transactions for us?

Jay Flaherty

Well, I think relative to that, we continually evaluate many transactional investment opportunities both on the buy-side and the sell-side and we do not comment Michael I think you know that on transactions that we are presently considering or those that we decide not to pursue. The only transactions we comment on are those that we chose to close because they are the ones that we believe will enhance shareholder value.

Tom Herzog

As to the geography of the $6 million, we have a little over $5 million of it in Q3, $0.8 million in Q1 and Q2 and that resides in G&A

Michael Bilerman – Citi

Is that all in the second, third quarter? That was deal that you abandoned rather than deal that you closed. Just want to make sure…?

Jay Flaherty

Let me just repeat what I just said. We don’t comment on transactions we’re presently considering or those we decide not to pursue. The only ones we comment on are those we chose to close because they are the ones that we believe will enhance shareholder value.

Tom Herzog

Just to the second part of your question, the new accounting in the new world is that you expense transaction cost for both deals that you complete and deals that that you will ultimately abandoned.

Operator

Your next question comes from the line of Mike Mueller of JPMorgan.

Michael Mueller – JPMorgan

Question about the accounting for I guess the Sunrise and Emeritus leases on the 27. If your rent starting at about $30 million, the CAGR over five-year period is about 13% to 14%, I think that takes you up to about $50 million at that point in time and then you’ve CPI escalators going forward. How do you treat this from a P&L perspective? Is it part of a straight-line, is it all straight line, are we going to see the bumps from year-to-year in FFO because it’s not straight-lined?

Tom Herzog

No. The lease of course is straight line, so there is going to be a GAAP FFO impact from that in little bit in 2010 and a bigger number in 2011.

Michael Mueller – JPMorgan

First year rent is $30 million, what’s the GAAP rent that you’re going to booking?

Tom Herzog

That’s a total GAAP rent of $53.5 million a year. So from that you can rather save you from having to do the math. That’s going to pick up $0.02 of FFO growth in 2010 and $0.06 in 2011. I think the second part of your question might have been, how are we treating the $50 million, the $50 million minus the $11 million of working capital adjustments and other expenses, which is what GAAP would help us do? That $39 million actually it’s $41 million inclusive of a couple million dollars of other items that are in Q1, Q4. That amount gets amortized for GAAP purposes over the life of the lease, but per the white paper explicitly states that that amortization has added back for FFO purpose so that will be counting on that.

Michael Mueller – JPMorgan

On the prior lease, the new transition data for the rent was $28 million, was that comparable to what the GAAP rent was on that lease?

Tom Herzog

Keep in mind that there was no straight lining on the space down.

Michael Mueller – JPMorgan

So it’s a 28 to 53 delta.

Tom Herzog

That’s the reason for the FFO pickup that I described in 2010 and 2011.

Michael Mueller – JPMorgan

Then, last question, do you think GAAP rates that you’re using on the debt investments with Genesis as well, are they about 10% and 12% or 13%?

Tom Herzog

Can you repeat that please?

Michael Mueller – JPMorgan

The interest rates that you are going to be recording under GAAP on the Genesis investments. As I know, you have the debt amortization. Is it about say 10% on the senior and 12% or 13% on the mezz?

Tom Herzog

If you take the discounts into account, it’s going to be about 10.5% on the senior and about 18% on the mezz base. So when you take all the components into account on the mezz piece; the amount of the discount, the escalating LIBOR that prepayment, but I won’t call it prepayment penalty that other penalty here. If you take all those into account and when you do that math if we hold it to maturity that’s going to be about 18%.

Michael Mueller – JPMorgan

That’s the IRR is that going to be the effective interest rate that you are going to book?

Tom Herzog

Same treatment as what we have applied to ManorCare.

Operator

Your next question comes from the line of Brian Sakino [ph] of Barclays Capital.

Brian Sakino – Barclays Capital

Just a question on the facilities you transitioned to Emeritus, I guess the 27. As you have a really strong rent bumps for the next five years and as I think about your initiative to kind of look at the RIDEA structure was that ever considered for this group of assets with I guess expectation that performance is really going to improve there?

Jay Flaherty

We obviously look at everything. I think you got to go back to the original thesis that we have at the time we first noted the Sunrise portfolio as part of the CNL transaction. If you take a look at where we felt there was value and we have been able to validate this not once not twice, not three times but now four times. The value that we perceived in those Sunrise portfolios was really more one of potential cost reduction.

I think we’ve said very consistently for the four years that we’ve owned this portfolio. That Sunrise does a pretty good job on the top line. Where they have struggled operationally with respect to our portfolio, which is all we can really speak to are higher acuity sorts of communities and then, with cost structures particularly in the non-mansioned portfolio. So if you go back and look at what we’ve transitioned, which at this point in the aggregate now between what we originally brought from CNL and five properties we’ve added is total of 58 properties.

We’ve been able to realize what we think, what we believe are market based cost structures and those were relatively straight forward for not only Paul and his team to underwrite, but also to convey the perspective replacement operators. That there wasn’t a lot of, you don’t have to make a big leap of faith as to what was going to happen with the occupancy or what the incremental ancillary revenue benefit was going to be, it was largely a cost reduction.

So as we got into that and we started transitioning these portfolio’s we determined that, since it was a pretty straight forward mathematical exercise both from our standpoint from the replacement operators standpoint, that really lent itself to more of a lease contractual, lease obligation and that in fact is what we’ve not put in place with all these transitions.

I would distinguish what we’ve done there with respect to, in my formal comments what might be in the offering with respect to our joint venture independent living platform, because there the cost side is, they are in reasonably good shape on the cost side there. That is really more of potential revenue play and that in our view lends itself much more to a more of a RIDEA structure as opposed to a contractual lease structure, I hope that’s some additional perspective for you.

Brian Sakino – Barclays Capital

Then would say, just to follow-up on that, the 35 that remaining under Sunrise management that are going to the RIDEA structure, you can see, you expect occupancy increases there that’s why those facilities are under that structure?

Jay Flaherty

I am a little confused by your question, first off, there is 48 not 35 and we have said nothing about pursing a RIDEA structure for those, I am not sure I understand your question.

Brian Sakino – Barclays Capital

I thought Sunrise had put out a press release saying that the 35 facilities were going to be in the RIDEA structure?

Jay Flaherty

Yes, you’d have to talk to Sunrise about that.

Operator

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

Rich Anderson – BMO Capital Markets

Is there another side to the rationale behind not pursuing a RIDEA restructure with Emeritus that being Emeritus doesn’t want to go that direction?

Jay Flaherty

Again, you’d have to talk to Emeritus about that. I am not sure I can add a whole lot more to the thought process that we went through. We’ve been, I think this is the third transition we’ve made with Emeritus formally managed Sunrise properties. But you have to pursue that line of inquiry with Emeritus directly.

Rich Anderson – BMO Capital Markets

Okay. One the Sunrise transition that you’ve accomplished, recall that the at least the first one resulted in the first year rent being down versus what it was but then a pretty substantial catch-up quickly thereafter. This latest one starts off right off the back with a higher, a little bit of a rent bump in year one. What is the difference between these transactions. Is the market just changing or is it something specific about the collection of assets that you transition?

Jay Flaherty

Well I think the first transition was the first one we all gone through and that was done back in November of 2008. So we are two years on, right the economy is at the margin. I won’t say it’s better but it’s stopped – started going down. And I think quite frankly Emeritus has had the benefit of having six quarters now of actual experience with respect to that first portfolio. Paul and Ken and I were up with Granger last week and he has got really hard data now to look at and you can see notwithstanding from the start of that transition to today, portfolio occupancies are off. I want to say they are 30 or 40 basis points off, not much but just off the touch.

The margins have expanded 600 basis points. And so and almost all of that is on the cost side. So again this is – we’re benefiting now from some actual experience and I think Emeritus has been thing from that in terms of what they’ve been able to achieve and their confidence in achieving results like that going forward and we’ve benefited as well. And that’s what you’re seeing reflected in the most recent set of terms for this new master reach Rich.

Tom Herzog

Okay, I would add one thing to that. There was an accounting item Rich back in 2008, where there were some deferred ramp that was received on those RAS [ph] assets and that caused a bump. So when you looked at the comparison from ‘08 to ‘09, there is a $1.2 million item in there that would have cost some noise. So that just adds what Jay is describing. But there was some accounting that causes the optics to look different.

Rich Anderson – BMO Capital Markets

Okay, thank you. To the Genesis transaction, just quickly, you speak a lot about the growth and the strength of the HCR ManorCare portfolio. Do you have the same level of anticipation and excitement for the Genesis portfolio, the underlying assets under the debt?

Jay Flaherty

I would make the following comparisons, the underlying portfolio is not as large in terms of numbers of the assets. I would say it is less diversified than HCR ManorCare. Genesis is largely more kind of in the northeast. I would say the quality mix of that Genesis portfolio is markedly higher, markedly higher than the norms for the other for profit and private skilled nursing operators. But is not at the level quality mix wise that the HCR ManorCare portfolio is. So those are just some kind of compare and contrast sort of comments or observations I’d make.

Rich Anderson – BMO Capital Markets

Okay, last question. What do you think in your mind for HCP an optimal kind of level of RIDEA exposure is for your overall portfolio?

Jay Flaherty

Again we’ve never run the company based on strict formulas, be it formulas for diversification across our five property types or concentrations within our five product rows. We tend to be very opportunistic and in fact somewhat contrarian. So I think our view would be – we take each situation as it develops, clearly if you’re in a scenario where you perceive that you’re at or near a trough in a particular space and you’ve got an operator that you’ve got real passion and belief and you’ve got alignment with that operator and the entry point from an evaluation standpoint is attractive, those would all come together to suggest or de-structure could be quite attractive, alternatively depending on where you are in the market or depending on your view of the operator or depending on what the opportunity is to create value in a particular portfolio and I’ve just referenced some of the cost opportunities in the Sunrise portfolios, that might lead you down a different path.

Rich Anderson – BMO Capital Markets

So there is not one criteria that you jump to. It’s really a combination of a whole host of things. But I mean there was enough stuff out there that was met your criteria to be involved in a RIDEA structure, would you allow the company to get aside say 40% or 50% RIDEA or do you think that that will be out of range?

Jay Flaherty

Again we’re going to be more opportunity driven Rich as opposed to hard and faster rules and what have been.

Rich Anderson – BMO Capital Markets

Okay, thanks.

Operator

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

Jerry Doctrow – Stifel Nicolaus

Thanks, hello. A lot of this has been covered Jay, but I wanted to ask sort of different way. So on Genesis, I guess, I was just wondering sort of strategically your thinking about skilled nursing, you obviously have made the investments in the debt, it sounds like on both ManorCare and Genesis, if I am hearing you correctly, you’d be willing to own the assets over the last several years you’ve been working down sort of skilled nursing to kind of reduce reimbursement risks. So what’s kind of your outlook on skilled nursing and again you just said you doesn’t wanted to sort of have targets but kind of is there a level of comfort in terms of how much skill you’d be willing to do?

Jay Flaherty

Well, all skilled is, I think the headline here is all skilled is not created equal. You use the word skilled.

Jerry Doctrow – Stifel Nicolaus

Okay.

Jay Flaherty

With respect HCR ManorCare and Genesis, we would use the ManorCare of post to Q but to cut to the chase we really drill into Medicaid exposure. And if you take a look at the substantial dispositions we’ve made in the skilled space, and just as a quick reference point. If you take a look at the equity exposure that sits today in HCP’s portfolio in the skilled space. Its 2% of the entire portfolios. It’s represented by equity exposure in skilled nursing.

So it’s been a conscious decision to move away from state based Medicaid exposures and if you were to go back and look at the metrics of each of those portfolios that we divested ourselves, you would see a heavy, heavy preponderance of state based Medicaid and then a very, very low quality mix. So that contrasts sharply with those very same metrics for HCR ManorCare, and Genesis. So that’s probably the most important answer to your question.

On top of that, we also look at the opportunity to make money for our shareholders and when we can as we’ve seen with the other $640 million of investments that we’ve made this year, when we’ve got the opportunity to take down off market acquisition opportunities that result in equity like returns with fixed income risk exposure, we just think that’s a wonderful result for our shareholder, and it goes directly to the franchise values that’s been created within this company over the past 25 years that we benefit from with each passing day. So again, you got a couple of different things going on, but that’s how I’d respond to your question.

Jerry Doctrow – Stifel Nicolaus

Okay and I guess, two follow-ups if I could, implicitly then sort of your relatively comfortable with the Medicare exposure that these guys have and sort of secondly should we be reading anything into the likelihood that you do a ManorCare deal based in fact that you’re now investing in Genesis in kind of expanding your opportunities?

Jay Flaherty

Well you’d become the national acquirer of the healthcare real estate space. So I’ll leave reading into things to you.

Jerry Doctrow – Stifel Nicolaus

Okay.

Jay Flaherty

But from our standpoint, again it’s really more about the entry point and the pricing and the returns that we can achieve. So unlevered returns in the low to mid-teens with contractual risk exposure is particularly in the current environment stacks up quite nicely and so that was really the thought process behind our determination there.

Operator

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

Tayo Okusanya – Jefferies & Company

Just a couple of very quick questions. The Genesis deal just wanted to make sure the LIBOR rate being referred to is one-month LIBOR not three months LIBOR?

Jay Flaherty

Yes, we used the forward LIBOR curve and it’s a one-month LIBOR.

Tayo Okusanya – Jefferies & Company

So it’s one-month. That’s one quick and then senior loan and the numerous step-ups involved in it with regards to LIBOR floors and as well as the spreads. Could you give us a sense on just how that works up until the 2014 maturity?

Tom Herzog

The LIBOR floor starts out at 1.5% from the point that we have made the acquisition and it bumps September of 2011 through September of 2012, I guess it stays to 1.5% with bumps in September of 2012 to September of ‘14 to 2.5%. The spreads also bump from September of ‘10 to September of ‘11 or at 4.75%. The spreads go from September of ‘11 to September of ‘12 to 5.5% and then from September of ‘12….

Tayo Okusanya – Jefferies & Company

Are they just kind of like equal annual bumps, both on the LIBOR floor and the spreads?

Tom Herzog

No these are different bumps.

Tayo Okusanya – Jefferies & Company

Yes, but are they like 25 basis points bumps over the next three years to get you from 4.75% to 5.75%?

Tom Herzog

Here is what they are your 4.75% spread from September of ‘10 to September of ‘11, 5.50% spread from September of ‘11 to September ‘12 and a 5.75% spread from September ‘12 to September 14.

Tayo Okusanya – Jefferies & Company

Then the LIBOR floor?

Tom Herzog

The LIBOR floor is 1.5% through September of ‘12 and from September ‘12 to September ‘14, there were at 2.5%.

Tayo Okusanya – Jefferies & Company

Then next quick question, the MOB portfolio, could you just remind us again how much of that of your investment is triple-net leases versus multi-tenant leases?

Jay Flaherty

I want to say to some transitions which occurred obviously only when the leases roll, I want to say the triple-net component of MOB is somewhere between 30% and 40% today.

Tayo Okusanya – Jefferies & Company

Then the Sunrise transition, the 27 new assets, understand the logic behind that, very strong growth of 13.8%. When you done the last deal, you were kind enough to kind of give us a very specific breakout of how the rent bumps are going to happen over the next five years. Could you do that with these 27 assets rather than just having a five-year CAGR?

Jay Flaherty

Do we have that handy?

Tom Herzog

Yes. In dollar amounts?

Tayo Okusanya – Jefferies & Company

That would be great.

Tom Herzog

So the year one and I am talking lease years rather than calendar years, which is effective November 1, the restructured lease is going to be at $30.3 million.

Jay Flaherty

That’s year one.

Tom Herzog

Year one, so that 12 month period start in November 1, 2010, in year two it goes to $33.8 million, in year three it goes to $41 million, in year four it goes to $46 million, and in year five it goes to $51 million.

Operator

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

Robert Mains – Morgan Keegan

Couple of numbers questions on the income statement, the other income of $6.7 million, that’s the gain on the HCA bonds?

Tom Herzog

Yes. That’s the biggest part of it.

Robert Mains – Morgan Keegan

Then, if I look at where you’ve broken out some of the other stuff that might be used to do a FAD calculation, there is a $55.6 of TIs, LCs, and CapEx. If I only get to a run rate, do I subtract 39 or 41, I wasn’t really clear from the footnote? It’s on 33 of the supplemental.

Tom Herzog

Yes, 39.

Robert Mains – Morgan Keegan

On same page, given what you are saying, can you tell us what straight lines will approximate in the fourth quarter?

Tom Herzog

I’ll tell you what I can do is, I can give it to you for the year and you get back end of the quarter. Straight-line, the last time I gave you guidance on the straight-line on a consolidated basis was at $45 million and that’s going to go to $47 million for the year, that’s all the Sunrise 27, that’s driving that. Then, as it pertains to the JVs, there is going to be a little bit of a tick down that you’ll notice and that’s due to the joint venture II impairment and discontinuance of recognizing straight-line rent in JV II. So when you see the difference flowing through, you will know that’s what that is.

Robert Mains – Morgan Keegan

Then actually, the last question I had was about JV II. On one hand, we’re seeing the impairment that were taken here, Jay you had suggested that kind of a top line related impairment rather than expense line related impairment, but also talking about possibly taking that in as the RIDEA structure. Can I surmise from that if I were look back from the vantage point of a few years ago that those leases might not have been the right leases for where we were in the cycle, but in terms of the facility operations in Horizon Bay, you still feel pretty good about the operator?

Jay Flaherty

Let me give you some facts. The year that we acquired that portfolio that was about four years ago today. That portfolio did $66 million Rob in NOI for 2006. As we sit here today with two months of the year to go, there is pretty high degree of certainty that that number for this year is going to be $64 million.

So now remember this is much more independent living, I think this is about 70% independent living. So that is not calculated with the needs based assisted living resident profile and a good chunk of it, I want to say as much as 40% of its in Costal Florida. So if you think about a portfolio that potentially got exposed to some rough stuff if you will, the independent living as opposed to assisted living or skilled and then Walton, Florida, our view is that the portfolio four years later at 64 versus 66 has actually held in there reasonably well.

The lease bumps in that lease that were put in place at the end of ‘06. I want to say they are averaged about 3.33%. So there is the math for you, I think what’s much more interesting is going forward given that if you drill into the P&L on that portfolio and the costs are for the most part in line is the opportunity for here to be some substantial top line growth over the next couple of years and that’s really what we are interested and making sure that we are in a position to capture that. There will be some execution involved with that for example some additional CapEx will be required and then there will some other things that we have to do, but that to us versus the four that we have transitioned from Sunrise suggest to us a very nice opportunity for a RIDEA structure.

Robert Mains – Morgan Keegan

That would also, more customized that you have got a JV partner who might not be interested in pursuing that?

Tom Herzog

Again, everybody likes to reach that thing to it, I’m just feeling the world reality. We are working very closely with our joint venture partner and again we are passionate about our belief that there is upside in this portfolio. It’s going to take a couple of years to get that portfolio positioned to realize that growth in top line and again I think that’s largely going to be a CapEx spend but that’s where we are with that portfolio as of right today.

Operator

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

Ross Nussbaum – UBS

It’s Ross Nussbaum here with Dustin. A couple of follow-ups here. On the Sunrise assets that transitioned over to Emeritus. I am just trying to get my arms around what is the EBITDAR of assets today, such that they can tolerate that level of rent increase?

Jay Flaherty

I think it was $33.5 million. Let me just verify that.

Ross Nussbaum – UBS

I guess where am going is obviously substantial rent payment but how are the assets going to be generating that much EBITDA growth over the next five years?

Jay Flaherty

Well again I think let me do a couple of things that will help you. If you go back and pull the, I can’t remember if it was August, I think it was August 31st press release, Ross. We profiled the metrics for the portfolio that was being transitioned versus the portfolio that was remaining. And a couple of key things that you all know, the NOI margin, let’s start with your question around the nose here. The NOI margin for the remaining portfolio of Sunrise assets we had is about 29%. The NOI margin for the portfolio that’s in question here, the 27 properties is 18.7%.

The occupancy of that portfolio is 81%. Okay, that’s 700 basis points lower than the occupancy for the remaining portfolio. So before we get into acuity and things like that, if you just look at the margin in the occupancy, this portfolio is an out-wired to the remaining Sunrise assets we have. And then when you go to the profile of the previous portfolios we’ve transitioned and take a look at where the metrics were at the time we transitioned, the opportunity here kind of jumps out, but from a standpoint of the landlord us, as well as the various replacement operators that we spoke with in terms of their interest level in taking this on.

So it’s a very, very attractive opportunity. And I think the results from our standpoint that demonstrate that and I suspect the results from Emeritus’s standpoint over the next couple of years if they do as well or better than they’ve done on the portfolios, they’ve already transitioned and I suspect they will, we’ll also bear that out Ross.

Tom Herzog

Hey Ross correction, $31.6 million was the EBITDAR.

Ross Nussbaum – UBS

Okay, thanks. On Genesis, just a follow-up. I thought earlier you had talked about the debt service coverage being two times. Was that on the last dollar exposure?

Tom Herzog

2.02 on the last dollar.

Ross Nussbaum – UBS

I’m sorry.

Tom Herzog

2.02 on the last dollar.

Ross Nussbaum – UBS

And can you comment on what you think the LTV is on your mezz?

Tom Herzog

On the mezz we think that we’re right in around 80% loan to value.

Ross Nussbaum – UBS

And then just switching over the life science portfolio. In terms of lease explorations for next year. Is there anything that you know of where you’ve already been advised that there is not going to be a renewal, I mean I guess another way of saying where do you think occupancy is next year on life science?

Jay Flaherty

While to answer your first question, the answer is no. We’ve not been advised that and I think as Paul said in his script we’ve got just over 400,000 square feet of explorations in life science for 2011. And we’re at negotiations relating about 60% of that 400,000.

Ross Nussbaum – UBS

Okay, thanks guys.

Operator

Ladies and gentlemen, that concludes the Q&A session. I’d now like to turn the call back over to your Chairman and Chief Executive Officer, Mr. Jay Flaherty.

Jay Flaherty

Thanks everyone. We’ll see you week after next at NAREIT and don’t forget to vote. Take care.

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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