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Health Care REIT, Inc. (NYSE:HCN)

Q2 2014 Earnings Conference Call

August 1, 2014 10:00 AM ET

Executives

Jeff Miller – Executive Vice President- Operations & General Counsel

Thomas J. DeRosa – Chief Executive Officer

Scott A. Estes – Chief Financial Officer

Analysts

Emmanuel Korchman – Citigroup Global Markets Inc.

Omotayo T. Okusanya – Jefferies LLC

Vikram Malhotra – Morgan Stanley & Co. LLC

Richard Charles Anderson – Mizuho Securities USA, Inc.

Juan Sanabria – Bank of America Merrill Lynch

Joshua Raskin – Barclays Capital

Michael Carroll – RBC Capital Markets

Nicholas Yulico – UBS Investment Bank

Karin Ford – KeyBanc Capital Markets

Michael Knott – Green Street Advisors

Michael Mueller – JPMorgan Chase & Co.

Rob Mains – Stifel Nicolaus

Todd Stender – Wells Fargo Securities, LLC

Operator

Good morning, ladies and gentlemen, and welcome to the Second Quarter 2014 Health Care REIT Earnings Conference Call. My name is Holy, and I will be your operator today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

Now, I would like to turn the call over to Jeff Miller, Executive Vice President- Operations & General Counsel. Please go ahead, sir

Jeffery H. Miller

Thank you, Holy. Good morning, everyone, and thank you for joining us today for HCN's second quarter 2014 conference call. If you did not receive a copy of the news release distributed this morning, you may access it via the company's website at hcreit.com. We are holding a live webcast of today's call, which may be accessed through the company's website.

Before we begin, let me remind you that certain statements made during this conference call may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although the company believes results projected in any forward-looking statements are based on reasonable assumptions, the company can give no assurance that its projected results will be attained. Factors and risks that could cause actual results to differ materially from those in the forward-looking statements are detailed in the news release and, from time to time, in the company's filings with the SEC.

I will now turn the call over to Tom DeRosa, our CEO. Tom?

Thomas J. DeRosa

Thank you, Jeff, and good morning everyone. We’ve been talking to you for sometime about the unique and powerful position that HCN has built in the Health Care real estate's base. We believe that our strategy of partnering with the best-in-class seniors housing and post-acute operators as well as strong regional health systems, we deliver the best sustainable growth to our shareholders.

I’m quite pleased to tell you that this quarter once again we can backup those words with results. Overall our operating portfolio generated 7.7% same store NOI growth, and the entire HCN portfolio had same store NOI growth of 4.4%. Now you don’t get that kind of growth from passive asset management, low cap rate asset aggregating, and solely relying on fixed increasers.

You get these results for being a value added partner in the healthcare delivery equation. Through our partners, we generated nearly $600 million in new investments in the quarter, and as you will hear from Scott Estes, record high FFO and FAD per share that is tracking above Street estimates. And you can’t deliver the kind of internal growth numbers that we announced this quarter without owning the best real estate. When I say partnering with the best operators, it should be given that our real estate is in the best markets. Scott Brinker will elaborate on that.

It’s not such a surprise that the best real estate in the best markets will enable you to charge the best rent. Layer on that, the best quality services and the cost savings and other operating efficiencies that HCN delivers, and you’ve built a powerful machine to deliver superior internal growth.

I’m particularly proud of the operating and performance enhancing initiatives that Chuck Herman and his team sphere head with our operators. HCN’s executive form brings together the leadership teams of top senior’s housing and post-acute operators to share in best practices and explore areas where this group can work together to drive down operating costs.

For example, our group food and furniture purchasing, as well group insurance purchasing is translating to real cost savings. These savings are showing up in that 7.7% same-store NOI growth for our RIDEA portfolio that I mentioned earlier. Again, so much of our external growth is driven by the strategic growth plans of our existing operating partners.

Our relationship management professionals work directly with our operators to identify acquisitions as well as plan new developments. Of the nearly $600 million in new investment activity in the quarter, 83% came from these operators. The best-in-class operators want to be on the HCN team. They see our unique value proposition.

HCN brings operating efficiencies, big picture vision, and expertise to the table; that’s a true differentiator from any other investor in healthcare real estate. And it’s why we are the partner of choice. These relationships are incredibly valuable, and have been forged over many years. Healthcare industry leaders like George Hager at Genesis; Chris Winkle at Sunrise, Patricia Will of Belmont, Tom Grape of Benchmark, Brenda Bacon of Brandywine, and the list goes on on our team and help to find our company in culture. Simply put you can’t find a group of best-in-class operators like these anywhere else.

The success of our model extends far beyond the investment platform. Our capital partnerships are similarly outstanding. During the second quarter, we completed an ambitious $1 billion equity offering and earlier this week we announced the closing of our new $3.23 billion credit facility. We have unparalleled and for some time now uninterrupted access to capital. This is our covenant with our operating partners to deliver the most flexible capital to help grow their businesses.

Other than becoming the CEO of HCN in April, which I think I covered on our Q1 call and in numerous meeting with investors and analysts, we’ve had a few other noteworthy milestones in the second quarter. Our Board elected Jeff Mayer as the director. Jeff is the former CFO of HCR Manor Care, and serves as the Director of HCA, one of the world’s leading operators of hospitals. Our ability to attract directors of this caliber speaks directly to the quality of our company and being a corporate governance leader. We are proud and delighted to welcome Jeff to our board.

On our last call, I mentioned that that we would be expanding our London office and John Goodey, who joined the company during the quarter to run our London office is on the call with us today here in Toledo. I worked with John in London and we’ve been colleagues for two decades. John will offer some brief thoughts about our global investment platform.

But first, I’ll turn the mike over to Scott Brinker for more detail on our outstanding operating and new investment result this quarter. Scott?

Scott A. Estes

Okay, thanks, Tom, and good morning everyone. I’m excited to share with you how (indiscernible) is building on its momentum. Our class-A portfolio is leading the way with another quarter of fantastic growth. Same store NOI grew 4.4% marking fifteen consecutive quarters above 3%.

We complimented that growth with just under $600 million of new investments, nearly all with existing partners. We have more than 30 partners out looking for opportunities in their core markets. When they find something attractive, they come to us for the capital, it’s a tremendous model. Our relationships drive consistent to deal flow and better pricing.

Let’s turn to the portfolio review starting with seniors housing. The demographic supporting this business are powerful. The target market is the age 80 plus population which will double in size over the next two decades. The near term outlook is also favorable. Demand is growing faster than supply in a vast majority of our markets. As a result, same-store NOI in the operating portfolio grew 7.7%. Occupancy, rate and margin all moved higher.

Success in seniors housing requires two things; good real estate and a good operator. We’ve been exceptionally disciplined about bold points. Quarter-after-quarter you’re seeing the benefits of that discipline. In organic growth rate that exceeds our benchmarks, often by a wide margin. Here are two numbers that demonstrate the quality of the portfolio. Our monthly rents are 50% higher than the national average, and housing values in our local markets are 75% above the national average.

The Sunrise Investment has been a tremendous success. When we announced the merger in late 2012, we told the market to expect a 6% initial yield. Just 18 months later our initial yield – our yield on investment is 7%. Half of the improvement is from NOI growth and the balance is from attractive prices that we negotiated on joint venture buy-outs.

The current market value of our $4.3 billion Sunrise investment is about $6 billion. Turning to triple-net seniors housing, the portfolio is all about predictable growth. Same-store NOI increased 3%, right in line with guidance. Payment coverage remains at comfortable levels and is at the high-end of the peer group.

Moving to skilled nursing, our rental income is well secured and growing consistently. Same-store NOI increased 2.9% in line with expectations. For public reporting we’ll soon separate our skilled nursing portfolio into two segments, post-acute and long-term care. Although they shared the same skilled nursing licensure, these are two very different businesses. They have different payers, patients and cap rates. Post-acute trades in the sevens while long-term care trade in the eights and nines.

We like the post acute business outlook because it helps reduce healthcare spending by getting patients out of the hospital. We continue to invest into this sector with top quality providers like Genesis.

Medical office, we own and manage nearly 15 million square feet of outpatient medical space. This is a highly predictable income stream for HCN due to the high tenant retention. Our in-house property management team is doing a great job keeping the buildings full.

As a result, same-store NOI increased 2.1% last quarter at the high end of guidance.

Investments, the market continues to be active. Capital is flowing into this sector because of attractive risk-adjusted returns. Our relationships are more important than ever, allowing us to find opportunity in a crowded market.

Our partners help us generate nearly $600 million of investments last quarter. The initial cash yield was 6.8%, very profitable given that our spot cost of capital is in the low fives. Our activity included follow-on acquisition with Revera, Genesis and Senior Lifestyles.

Follow-on business at attractive yield is our best measure of success, a forward-looking measure that our strategy is working. Why do the industry’s leading operators choose HCN? One, consistent low cost access to the capital markets. Two, a shared vision of making the industry better. It sounds soft, but it’s incredibly important. Remember that the best healthcare providers have a mission beyond profits. Three, scale, which is important for group purchasing.

Four, analytics an example is our expense benchmarking tool that leverages our 700 plus senior housing assets to give our partners new insight into their business. And five, strategic advice, by sitting on the Board of many of our partners, these make HCN unique.

We are playing on a different field than other capital providers. Dispositions, we raised $141 million of capital last quarter by selling non-core assets for a $13 million gain. We continue to be proactive in selling the bottom tier of our portfolio, this helps us maintain the highest quality income stream in this sector. Our investments so far have been concentrated domestically. The pipeline includes activity outside the U.S., John Goodey who now runs our London office is going to comment on international. John?

John Goodey

Thank you, Scott. Good morning, everyone. I’m excited to joined HCN at such a strong time for us. Our international investment plan will follow HCN’s well proven investment and partnering strategy, and is highly focused and foolproof. We see it as a logical progressive extension to our U.S. investment platform.

With the opening of our expanded international office in London, we believe HCN is in an advantage position and able to develop sustainable leadership in our chosen international markets. HCN has already build a number one position in the attractive UK prime elderly market, which is essentially the same as the U.S. assisted living industry.

Importantly, we are seeing strong same-store NOI and rental coverage increases across our UK portfolio. Working with our existing UK partners and beyond, we have a pipeline of high quality developments and investment opportunities; and as Scott said, we believe we will be active in the near term. Hopefully in the future, we will have the opportunity to host some of you in our new London office and tell you more about our investment opportunities.

With that, I'll hand over to Scott Estes, our CFO.

Scott A. Estes

Great. Thanks John and good morning everyone. My remarks today will focus on the three themes that have emerged over the last several quarters. First, our second quarter financial and operating performance exceeded expectations and exemplify our platform's earnings power.

Second, we support our financial performance with the prudent balance sheet management and a significantly improved our credit metrics and capital availability as of June 30. And third we were increasing our 2014, guidance for the second time this year to reflect the strength of our second quarter results.

I will begin my more detailed comments by taking a look at our second quarter financial performance. Our platform continues to generate superior earnings growth. Normalized FFO increased to a record $1.06 per share for the second quarter. While normalized FAD came in at $0.94 per share representing a strong 14% and 15% year-over-year increase respectively.

Results were primarily driven by the same-store cash NOI increase and $2.7 billion of investments completed over the prior 12 months. G&A for the second quarter excluding expenses related to our CEO transition came in at $32 million in line with our expectations. We will pay our 173rd consecutive quarterly cash dividends on August 20 of $0.795 per share or $3.18 annually representing a current dividend yield of 5%.

I note that our FFO and FAD payout ratio through the second quarter declined to 75% and 85% respectively. As we continue to strive to enhance our disclosure, I note that we’ve added pictures of every U.S. based asset in our RIDEA portfolio this quarter to the portfolio map on our website, as well as some photos of our most recent MOBs acquired during the quarter. And we will continue to add photos from our portfolio, as they become available.

Turning now to our liquidity picture in balance sheet in terms of capital markets activity the highlight of the second quarter was our secondary equity offering, which settled in early June. We completed the sale of 6.1 million shares of common equity at $62.35 per share, generating $1 billion in gross proceeds.

This was the largest overnight offering completed not just by any REITs, but by any company and any industry in 2014, based on total gross proceeds, which speaks to the capital markets continued support of our strategy.

In addition to the secondary offering, we issued 1 million common shares under our dividend reinvestment program during the quarter generating $62 million in proceeds. We also repaid approximately $75 million of secured debt at a blended rate of 5.8% during the quarter and assumes $12 million of secured debt associated with an acquisition at 4.1% rate.

On the bank capital front, this past Monday we were pleased to announce that we closed on a new $3.23 billion unsecured credit facility consisting of a revolving line of credit, U.S. term loan and Canadian term loan. This is the largest credit facility in the Health Care REIT sector and among the largest in the entire REIT industry providing us with considerable flexibility in financing our future growth. We have an option to up size the facility by an addition of $1 billion through an accordion feature and can borrow up to $500 million in alternate currencies.

Broadly speaking our new line enhances our liquidity and financial flexibility by increasing the capacity in a revolver by $250 million, lowering the average cost by more than 15 basis points and extending the duration through October of 2018 with an option to extend by an additional year at our discretion. This is an excellent outcome for the company and we’re appreciative of the outstanding support provided by the 28 banks that comprise our new syndicate.

As a result of our capital activity in line renewal, we’re in an outstanding liquidity position at quarter end. More specifically, we have the full $2.5 billion line of credit available and $207 million in cash and additional $318 million of pending dispositions throughout the remainder of 2014 and are generating an additional $60 million of equity per quarter through our dividend reinvestment program. We have limited near term debt maturities with only $123 million of debt maturing through year end 2014.

Our balance sheet and financial metrics at quarter end improved across the board as a result of our successful equity offering, all of which are now in line with our strategic target levels. As of June 30, our net debt to undepreciated book capitalization was 39.8%, our net debt to adjusted EBITDA declined to 5.7 times, while our adjusted interest in fixed charge coverage improved nicely to 3.7 times and 2.9 times respectively. As a result of the secured debt paid off during the second quarter, secured debt as a percentage of total assets declined 50 basis point to 12.1%.

I’ll conclude my comments today with an update on 2014 guidance and our supporting assumptions. I’ll begin with our same store cash NOI growth outlook. Given our strong second quarter results, we are increasing our 2014 forecast from the previous level of 3.5% to a range of 3.5% to 4%.

The increase is largely based on the strength of the seniors housing operating portfolio as our same-store cash NOI forecasts for the remaining components of our portfolio remain unchanged. In terms of our investment expectations, there are no acquisitions included in our guidance beyond what we’ve announced through the second quarter.

Our guidance does include $69 million of additional development conversions throughout the remainder of the year at a blended projected yield upon conversion of 8.1%. Our forecast now includes $450 million of dispositions at a blended yield on sale of 9.5% representing an increase from the previous expectation of $250 million.

The increase is primarily related to the potential sales of an additional acute care hospital asset later this year as we capitalize on another source of liquidity and wind down the disposition of non-strategic assets.

There is no change to our annual capital expenditure forecast of $66 million for 2014 comprised of approximately $46 million associated with the seniors housing operating portfolio, and the remaining $20 million from the medical facilities portfolio.

Our 2014 CapEx as a percentage of NOI for both segments is still expected to run in the 7% to 9% range, which we believe is an appropriate level to maintain the quality of our portfolio.

In terms of G&A, there is no change to our annual forecast of approximately $125 million for the full year, excluding the impact of our CEO transition expenses. And finally, we’ve increased our normalized FFO and FAD per share guidance for the full year as a result of our strong second quarter operating results and investment activity.

I think it’s important to note that the strength of our quarterly results allowed us to increase both FFO and FAD guidance by $0.02 per share, despite a $200 million increase in our disposition guidance and the additional shares issued through our June equity offering.

As a result, we are increasing our normalized 2014 FFO guidance to a range of $4.05 to $4.15 per diluted share, and our FAD guidance to $3.57 to $3.67 per diluted share, both of which now represent a strong year-over-year increase of 6% to 9%.

That concludes my prepared remarks, but I would finish by saying, we feel great about our financial results. Our enhanced credit metrics and the improved financial flexibility provided by our new line of credit heading into the second half of the year. And at this point in time, I will turn it back to you for some closing comments.

Thomas J. DeRosa

Thanks, Scott. I want to close by thanking everyone on our call for your support by awarding HCN the highest multiple among our peers. You recognize the unique value in our platform, a platform that can deliver the type of strong predictable results we’re sharing today, quarter-after-quarter.

HCN’s business is different, we’re deeply engaged in the healthcare industry, not just as a source of capital. We are unique in establishing a setup quantitative metrics and qualitative initiatives to help drive the seniors housing, skilled nursing and post-acute, MOB and acute care delivery systems forward.

Together with our partners, we are developing the most of effective environments to improve healthcare outcomes. Here’s a simple message; we are keeping people out of acute care hospital beds, that’s the key to driving down healthcare costs and living within the Affordable Healthcare Act. It’s a big and important job, and HCN is uniquely qualified to do it.

Holy, please open up the line for questions.

Question-and-Answer Session

Operator

(Operator instruction) And your first question will come from the line of Emmanuel Korchman with Citi.

Emmanuel Korchman – Citigroup Global Markets Inc.

Good morning. Thanks for taking the questions, Tom, maybe we can tell your last comment to – a comment that Scott made, with the hospital sale, I think Scott mentioned that you’re capitalizing on the opportunity, how much of that is overlaid with sort of your view for the Affordable Care Act, and sort of other ships in the medical landscape, and is that – is the hospital business one that you just don’t want to be in, in general?

Thomas J. DeRosa

I’d say, Emmanuel, right now, I would say the hospital business is not a prime focus of ours, but what we want to do is, align ourselves with the best hospital systems to work with them to develop the best outpatient facilities, that’s really what our focus is, and also creating links with our other sectors like seniors housing and post-acute. We think there are some powerful – there’s some very powerful connectivity that can be created between top-quality health systems, top-quality seniors housing, top-quality post-acute. So that’s really where we’re focused, but owning hospitals is not really priority for us today.

Emmanuel Korchman – Citigroup Global Markets Inc.

And then, John, welcome to call. A couple of quick questions for you, do you see yourselves focusing on acquisitions or development or both and maybe within what types of assets as we look sort of globally?

John Goodey

Sure. So I think firstly we are following the same model we have in the U.S., so our partners are brining us opportunities both in the developments and in the acquisitions, and you know obviously our sort of near $2 billion investment in the UK will give you an idea of where those opportunities in the short term will lie. Yeah I think beyond that obviously we’ve titled it international as opposed to UK.

So I think we do look over time to clearly look internationally. But I think again we’ll follow the same sort of strategy that we’ve used here in the U.S. and in the UK, and do that in a measured way, and do it only in the best markets and with the best operators.

I think it’s probably a little bit premature right now to say, we see this or this country as the absolute preferred country within Europe or beyond. But I think as we go forward we’ll be able to give a little bit more guidance on that, but right now, I’d say we’ve got a great pipeline of opportunity with our existing operators and within our existing country the UK.

Emmanuel Korchman – Citigroup Global Markets Inc.

Great. Thanks guys.

Thomas J. DeRosa

Thanks, Emm.

Operator

And your next question will come from the line of Otayo Okusanya with Jefferies.

Omotayo T. Okusanya – Jefferies LLC

Hi, good morning. First of all congrats on the really, really solid quarter that was good to see. Two questions from our end, first of all the, could you just give an update on Genesis there in regards to portfolio performance?

Scott M. Brinker

Otayo, its Scott speaking, Genesis is performing right on plan. So they continue to have solid payment coverage. Direct payment is well secured for gaining market share occupancy and quality mix are trending higher recently, so we are very comfortable with. Genesis has an operator we made a big investment with them three years ago, and our thesis was that they’ve best pet persecute provider in the space, and it done nothing to suggest otherwise in a three year sense.

Omotayo T. Okusanya – Jefferies LLC

Okay. Our patient volume trends improving in general are you starting to see more of that or its still kind of somewhat weak?

Scott M. Brinker

I would say it’s more flat, I mean it bounces around quarter-to-quarter depending upon the season, but overall it’s pretty flat.

Omotayo T. Okusanya – Jefferies LLC

Great. Okay, that’s helpful. Then second of – could you just talk a little bit, the environment in general for doing big acquisitions, I mean, on each quarter you guys continue to do very well with the original operators, but the world of billion dollar deals whether its seniors housing or MOB or what have you. What that were looks like – there will be a lot of transactions out there, what cap rates look like, who is bidding for this stuff responsibly winning some other stuff that kind of color would be helpful.

Scott M. Brinker

Otayo, its Scott speaking again. I’d say we are as capable as anyone of doing a big transaction structure and creativity access to capital standpoint, but that’s not the primary way that we’ve grown our business, the pricing there tends to be a lot tighter. We tend to buy big portfolios with similar quality assets, and our model has trend to be back our existing partners selective aquisition and development. So it’s much more disciplined, but there are times when it makes sense to buy a big portfolio. So you’ll see us look at all of that, we’ll just be more selective than some others.

Yeah, just echoing what Scott just said, Tyler, I think that, again our business model is different from others in this sector. We work very closely with the best operators, and look at acquisition with them, and work on their development plans together, and that’s why we like to say, we offer predicable new investment growth, because the fact is, there is going to be more and more demand for top quality seniors housing and post-acute particularly, just based on the demographic trends.

So we will continue to build those businesses with the operators, and will occasionally bring in other new operators, you’ve seen us to do that, we did in the first quarter, and where we don’t have visibility, necessarily is on the bigger deals, now you should assume that, there is no big deal that will be done that we won’t take a look at, and sometimes we’ll do them, and they make strategic sense for us, but you will never see us growing for the sake of just putting numbers on the board, that’s not how we run our business.

Omotayo T. Okusanya – Jefferies LLC

That’s helpful. Just diving in a little deeper on that, could you give us a sense of just what cap rates look like for some of the bigger deals in the marker for some of the major property type?

Scott A. Estes

Well, we didn’t participate in the last two, and they reported a yield around 6% or assets that at least in our mind were not of the quality of things that we’re buying. So that gives you a sense of where our bigger portfolios are trading at least for senior housing?

Omotayo T. Okusanya – Jefferies LLC

Okay

Scott A. Estes

Thank you.

Omotayo T. Okusanya – Jefferies LLC

Sure, thanks.

Operator

And your next question will come from the line of Vikram Malhotra with Morgan Stanley.

Vikram Malhotra – Morgan Stanley & Co. LLC

And the question, can you give us a bit more color on the MOB acquisitions you did, kind of where were they, what are seeing in the market today specifically in terms of competition, and just may be you gave some interesting stats on the quality of the portfolio as well, how does brand retention compared to what you’ve seen over the last year or so?

Scott A. Estes

Yeah, this is Scott speaking. We did $260 million of medical office acquisition in the quarter, and yield was just below 6.5% , 10 buildings; all of then affiliated with the health system, our examples of HCA, since Eurohealth showed big quality systems, the types that we want to be sponsoring our outpatient medical buildings. And the average age was 2010, so these are very modern buildings without much meat to roll, highly occupied, 95% plus on average; and so hopefully that gives you a sense of, the types of assets that we’re buying.

Vikram Malhotra – Morgan Stanley & Co. LLC

And just overall, in terms of the retention that you’ve reported in terms of tenant retention, is that pretty comparable to what you’ve seen over the last year or so?

Scott A. Estes

Yeah, it’s been pretty steady right around 80% for really several years in a row. Now Mike Noto and his team at our Internal Property Management Group do a terrific job of building relationships with tenants, and keeping them in our buildings, it’s a much cheaper way to maintain occupancies and trying to find a new tenant building out the space again. So it is clearly our preferred way to maintain occupancy.

Vikram Malhotra – Morgan Stanley & Co. LLC

Okay. And Tom, one thing, I mean now, obviously you’ve talked quite a bit to us over the last few months, and ever since you joined. But just as you’ve spent more time going over things, any incremental kind of thoughts, positives, negatives in terms what you either learned or what you, where you feel you can take things?

Thomas J. DeRosa

I would say that, no negatives come to mind. I think the surprise for me was how deeply connected the management team here is to the operators. That was something that, as a former director of the company, I can honestly say, I didn’t have a strong and appreciation for.

And now actually having met all of our operators and spent time with them, it’s really a – it’s such a differentiator for this company, and something that I want to make sure that is really appreciated by everyone on this call. And those are not on this call, because that is what is allowing this company really to deliver the kind of results that we delivered today.

Vikram Malhotra – Morgan Stanley & Co. LLC

Okay. Thanks guys, and congrats on the strong results.

Thomas J. DeRosa

Thank you.

Operator

And your next question will come from the line of Rich Anderson with Mizuho.

Richard Charles Anderson – Mizuho Securities USA, Inc.

Thanks, and good morning.

Thomas J. DeRosa

Hey, Rich.

Richard Charles Anderson – Mizuho Securities USA, Inc.

So a couple of questions, in terms of the International, can you, John, can you give us a sense of the, kind of the acquisition or investment pipeline that you’re seeing today, I mean what’s the level of deal volume that’s out there, and I think you’ll close on all of it, but that you may looking at.

John Goodey

I think, as we do in the U.S. we maintain a watchful eye over everything that educates us, even if we don’t wish to proceed on particular acquisitions. And I’d say the last six months, we’ve seen a tick up across Europe in assets that are coming to market both on HoldCo basis, but also on property basis as well. And also companies looking to recapitalize themselves both in the financial markets as well as through potential property sales.

So, I think the overall volume is good and as I noted before, I think we are going to be highly selective, so a lot of what there – there is not going to be a HCN style transaction. And clearly, we have confident in the certain area in the UK, that area has been active in the past. We see it being active in the future as well. And but I think beyond that I would say that we are – we have a very watchful and detailed eye over a number of sectors in a number of countries. So we can educate ourselves and we are working exactly where we wish to place our investments going forward. So the answer is, is the market is liquid? There is opportunity out there, much of it won't be for healthcare REITs, but some of it will be eventually.

Richard Charles Anderson – Mizuho Securities USA, Inc.

Okay. And maybe said a different way to Tom, US is 88% of the portfolio today. What do you think it could be five years from now?

Thomas J. DeRosa

John you give your view and then I will…

John Goodey

Sure. I think clearly and mathematically clearly the opportunity for us to grow the percentage because of the leverage of percentage Europe international and the U.S portfolio. I would say there is enough opportunity for us to, significantly change that if we wish, but we will be judicious in working out, and working on only the best transactions for us, but I would think mathematically, I would hope it will increase over time.

Thomas J. DeRosa

Rich. I will tell you that, that we still see such tremendous opportunities for growth in the U.S, so it’s very likely well, our non-U.S portfolio, when I include Canada in that, obviously will be growing. I think you are going to see the U.S. growing tremendously as well.

One of the same comments I will make about the UK that I find so interesting. John and I were working with a – I wouldn’t call it a prime elderly, because their assets weren't very prime, but it was a seniors housing company back in the late, mid to late 90s and we travelled all around the UK looking at a product that did not exist in the U.S. we didn’t have really government provided seniors housing in the U.S.

We had long term nursing home beds that people were in, but we didn’t – the government was not providing seniors housing in the U.S, in the late 90s. As you know, the private pay seniors housing business emerged in the 90s. What’s happened - so the U.K understand this product and it is available from the NHS, but as the UK has gotten more affluent particularly London and the southern part of England.

There is a recognition that one needs to be, that this – that one will be in this product when they get into their mid-80s, but there’s also a recognition that, I may have to pay for it. It’s not just a – my unalienable right that the government, the NHS will provide me long-term housing.

And that’s what’s interesting about the UK. So we are together with our operating partners, they are really helping to offer a product that is actually early days. I think we’re seeing the UK start to embrace the fact that, the NHS is not going to take care of my long-term care needs, that I need to do that myself.

And we’ve had dialog with people around the UK government, and they’re seeing us as really coming in there and helping to take pressure off the government. The NHS cannot be opting to all people for their healthcare needs, and we’re helping develop the whole notion that there’s a private pay option. And I think that’s really exciting.

Richard Charles Anderson – Mizuho Securities USA, Inc.

Okay. Another question, and it’s kind of big picture, it’s – the concept of – will the day ever come when you’ll think about breaking up the company a little bit in the sense that, may be this – the parts are more valuable than the whole, I don’t know that we’re there yet, but when I think about the medical office side of the ledger, I think those are more capital partners as opposed to your relationships that you have in seniors housing and post-acute. So do you think the day may come where you might look at a large portfolio that have – you have under the big umbrella and think about a SpinCo type of scenario?

Thomas J. DeRosa

You know, Rich, the way I look at the healthcare – at healthcare delivery is, I see the real opportunity is through connectivity. So I see how, and we see how seniors housing, skilled nursing, post-acute and MOVs sit together to improve healthcare delivery. And again, it comes to the point that I made, we need to get people out of acute care hospital beds. And if you’ve been, and I’m assuming you’ve been to Voorhees, New Jersey and seen the virtual system. That’s not a one-off, Rich. I think that’s a model by where healthcare needs to go.

And if you spoke to any component in that physical network we’ve created there, they’re all performing well above where they thought they would be. And at the end of the day, they’re providing a better outcome. And that’s what we need to do, and that’s how hospitals, that’s why I don’t take hospitals out of mix, because they’re going to be penalized if they keep getting back Mr. Jones with the same issue back in that hospital bed. There are negative financial repercussions to seeing an individual keep coming back to that same bed. They need to get them out of the hospital, they need to improve the outcome, and I think the connectivity is one of the ways we’re going to make that happen.

Richard Charles Anderson – Mizuho Securities USA, Inc.

So, on the topic of SpinCo, the answer is basically no at this point?

Thomas J. DeRosa

I never say never, Rich, but the way I see the world today, I would say that’s not something that we are spending anytime thinking about. And I understand that whole SpinCo world, because as you know, I used to run a mall company.

Richard Charles Anderson – Mizuho Securities USA, Inc.

Right. Last from me and real quick, maybe to Brinker or somebody else, but when you look at, you look at your portfolio of 60% some odd seniors housing, another 15% medical office, some hot property sectors, cap rates going down. If you look at the whole portfolio, could you hazard a guess on what you think a cap rate should be applied to your full NOI stream? Do you have any thought on that?

Scott M. Brinker

This is Scott Brinker speaking. I mean based on comparable transaction we’ve seen recently, and adjusting for the quality of our portfolio, I’d put senior housing little higher than 6%, same for medical office and skilled nursing is an interesting one. It’s…

Richard Charles Anderson – Mizuho Securities USA, Inc.

Careful Scott, I got my NAV model open here. So I’m just ready for the cap rate number.

Scott M. Brinker

We’re in the low-60s, so let’s see where you can come up. Skilled nursing is an interesting one. It’s about 15% of our NOI, and we really think of that as two separate businesses. There’s a post-acute business.

Richard Charles Anderson – Mizuho Securities USA, Inc.

Right.

Thomas J. DeRosa

It’s highly focused on Medicare, a much shorter stay, typically a much higher quality building, and then there is a long-term care model that most people associate with skilled nursing. Most of our skilled portfolio is post-acute, and we feel like that business has a tremendous outlook, hence you trade in the 7s, whereas long-term care has. I won’t call a bad outlook, but not as favorable. And those assets tend to trade in 8s and 9s. So before long, we are going to separate those two categories so that you can hopefully value differently the way we do. But again, so I would post-acute in the low 7s and…

Richard Charles Anderson – Mizuho Securities USA, Inc.

I guess 6.5 type number aggregating it all up?

Thomas J. DeRosa

At most. It’s probably lower than that given how much of the play is senior housing, and medical office.

Richard Charles Anderson – Mizuho Securities USA, Inc.

Okay. So I got, thank you.

Thomas J. DeRosa

Sure.

Scott A. Estes

Thanks, Rich.

Operator

The next question will come from the line of Juan Sanabria with Bank of America.

Juan Sanabria – Bank of America Merrill Lynch

Hi, good afternoon or good morning, sorry. Just hoping you could speak a little bit about the post-acute space again, differences in coverage levels between the two different styles of businesses you highlighted. And I don't know if it's too early, but if you could talk about the split within your overall exposure there between those two types of different assets?

Scott M. Brinker

Yeah, Juan, it’s Scott speaking. The payment coverages are pretty similar, we underwrite newer investments to a coverage in the 1.4 times range after management fee, so close to 1.7 and 1.8, and we do that, because reimbursement can be cyclical and we don’t want to take any risk on the income stream. So we’re perfectly comfortable at that type of a level. And then your second question was, if you can repeat it?

Juan Sanabria – Bank of America Merrill Lynch

Just a split, I guess the percentage of investments or NOI between two different types short-term, long-term stay?

Scott M. Brinker

Yeah, we’re still trying to figure out exactly how to segregate the two businesses, but roughly of our skilled nursing portfolio, two thirds would be post-acute, and one-third would be long-term care.

Juan Sanabria – Bank of America Merrill Lynch

Okay. And then on the RIDEA side of the business, can you talk at all the about any signs of cost pressures currently in the pipeline or in the foreseeable future either on food, labor, or insurance that may present more of a headwind for further margin expansion?

Thomas J. DeRosa

Food and utilities – well food and insurance are very flat, may be up slightly in part because of our group purchasing program, really no significant pressure on wages, so we still see rates exceeding the growth and expenses, so our margin was up 100 basis points year-over-year, and there should still be some opportunity.

Juan Sanabria – Bank of America Merrill Lynch

Okay, great. And just lastly, you’ve provided, I think, on the last call, not sure if it was in the Q&A or in the sort of organized statements ahead of time, the RIDEA growth by region on a same-store basis if you wouldn't mind?

Thomas J. DeRosa

Sure, Juan, it was 7.7 for the whole portfolio. The U.S. was pretty much in line with number, and then the UK was higher and Canada was lower, so similar trends till last quarter.

Juan Sanabria – Bank of America Merrill Lynch

Okay, that’s it from me. Thank you.

Thomas J. DeRosa

Sure.

Operator

And your next question will come from the line of Josh Raskin with Barclays.

Joshua Raskin – Barclays Capital

First question, just back on the dispositions, I just want to make sure, I understand the increase in the dispositions this year. Is it just solely that one hospital at $200 million, and then maybe a little more as to the catalyst for that sale, if it wasn't previously expected, is it just pricing has gotten a little bit better, if volumes or ACA have kicked in? Or were you proactively shopping? I'm just curious what the catalyst was there?

Scott A. Estes

Josh, how are you doing? It’s Scott Estes, I’ll start with our, the mix of the $450 million approximately for the year. So, within that $450 million projection overall about 70% of that is hospital assets that 15% skilled nursing 10% MOB and maybe 5% seniors housing. And yes the specific increase there is one potential sale that we think we’re could get among this year that was the driver of the increase, but Scott Brinker, any color you'd add to that.

Scott A. Estes

No

Joshua Raskin – Barclays Capital

Was that hospital – was that just a one off or are there some medical office buildings or anything else attached to it.

Thomas J. DeRosa

We do own the medical office building that’s attach to it. It’s a hospital in California that was expensive to build, and the lease rate was maybe just higher than the hospital wants to pay. So it’s a mutually good outcome, we’ll continue to own the outpatient medical building that’s attached, and the hospital is essentially buying the real estate back from us.

Joshua Raskin – Barclays Capital

Okay. So you're keeping the MOB. And the second question is just on the senior housing operating portfolio, I think last quarter you guys talked about weather, and a couple of things impacting, and you thought maybe the same-store NOI might have been closer to 10%. I'm certainly not scoffing at a 7.7% number in the quarter. But I'm curious if there was any pent-up demand on move-ins, or any sort of reversal of what you saw in the first quarter, in terms of those pressures. I mean did the second quarter benefit at all a little bit, or do you think this was a more of a pretty good run rate number?

Thomas J. DeRosa

Well, we hope it's a good run rate number. It's kind of hard to exceed, one thing that we are on into as even though the business is doing fantastic and occupancy is trending up, compared to quarters are just getting higher and higher as a threshold. So, we hope we can grow 8% rather that seems unlikely, despite the quality of the real estate, what we’ve told people though, and we continue to believe is that, we think we’ll outperform this sector consistently, because of the quality of the real estate and the operators.

Joshua Raskin – Barclays Capital

Got you. Okay. And then last question, maybe as you guys are seeing the CEO transition, and obviously you've done a lot of investments with your existing partners, your existing relationships, are you guys working on any new relationships, I don't know if it's bringing any sort of additional partners into the mix? Are you guys seeing any increase in external parties will call and that are interested in working with you guys?

Scott M. Brinker

Hi, Josh, it’s Scott speaking. I would say there is a handful of operators in the U.S., UK and Canada that we’d like to add to the portfolio, but its not a huge number most of our growth is going to be with existing partners. And I think that tells you another thing which is its very difficult to reproduce the market position that we are in. We feel strongly that the high quality operators are a scarce asset. And the investment majority of them have chosen to partner with HCN. So anyone hoping to partner with the caliber of partners that we have, we’ll be looking for a long time because they’re just not out there.

Joshua Raskin – Barclays Capital

Okay, thanks.

Operator

The next question will come from the line of Michael Carroll with RBC Capital Markets.

Michael Carroll – RBC Capital Markets

Thanks. On your comments you said that, senior housing demand is growing faster than supply in most of your markets. Can you give us some examples of what markets where our supply is the concern, and if that’s just a near term or long-term concern.

Thomas J. DeRosa

Sure, Michael. It’s mostly markets where there are low barriers to entry. So think of Dallas and Houston and Denver where there’s a lot of ground and relatively easy entitlements. So that’s where we’re seeing most of the new construction. I guess the good news is there’s huge population growth in all those markets. So for the most part, occupancies are trending up in virtually all of our markets despite some new supply.

But if you look at markets like New York City where many of you are on the call, if you’ve ever had to deal with placing a parent or grand parent in a senior’s housing facility, your options are quite limited. There is clearly in that market, which is the market that we have considerable assets in, there is tremendous demand that’s just growing.

And I think it’s – there’s going to be an issue, because there it is very difficult to find good quality places for all of the elderly Americans that will need to be in whether be independent or assisted living in the future. So we are working very closely with our operators, many of them who are the leading names in let’s say the New York City Metropolitan area. We’re working very closely with them to try and figure this out.

Michael Carroll – RBC Capital Markets

Okay. And then can you guys give us some color on the – I guess the transaction activity, it looks like you had a lot of good deals, that’s a pretty attractive yields. I mean are you seeing pressure on those yields or do you expect that you can continue to acquire assets around the mid-six range?

Thomas J. DeRosa

Our market is definitely competitive. That’s not surprising to us. The risk adjusted cap ratio is really strong against alternatives in the real estate space. So it isn’t surprising to us to see new capital coming to the space. With yields in the mid-6s like last quarter, we can still make a pretty strong spread or profit. Hopefully that continues. We do have a pretty significant pipeline. We’ll see if it closes. So I think that’s a reasonable estimate for where we’re trying to place deals, Michael.

Michael Carroll – RBC Capital Markets

Okay, great. Thanks.

Thomas J. DeRosa

Sure.

Operator

Your next question will come from the line of Nick Yulico with UBS.

Nicholas Yulico – UBS Investment Bank

A couple of questions. Scott, the same store guidance change for the senior housing operating segment I think it was closer to 6% last quarter?

Scott A. Estes

It is, we didn’t give a specific number. Obviously it’s been trending a little bit higher. We had advertised 6% last quarter. Our guess would be at least 6% to 6.5% given the start we have to the year in the senior housing operating portfolio.

Nicholas Yulico – UBS Investment Bank

Okay. And you’ve done about 8% year-to-date in that segment. I assume the year-over-year in the second half maybe gets tougher due to tougher occupancy comps. Can you remind us of the occupancy comps for the remainder of the year since we don’t have that data with the same store pool changing this year?

Scott A. Estes

I am trying to think about that. We don’t have specific numbers in front of us. Obviously in the supplements, you can see where the same store occupancy was trending in the third and fourth quarter of the year. It was only about 88.8%, 89.2% in the third and fourth quarter of last year were up to 89.3% as of this quarter. So the point is that it’s a reasonably high number but if it does well we can still enhance occupancy.

Nicholas Yulico – UBS Investment Bank

Okay. One way or another it seems like the third quarter and fourth quarter year-over-year same store numbers, you reported that segment December unlike the 4% to 5% range. That sound alright? I mean if you’ve already 8% year-to-date.

Scott A. Estes

Yeah, we would help to do better than that, we will see it’s possible. I mean (indiscernible) to say if we end up getting in 5% to 6% that should keep to you a great number and I stand by Scott Brinker’s comments that we still think that our relative portfolio performance will be great vis-à-vis the other assets in that category.

Nicholas Yulico – UBS Investment Bank

Yeah I mean that's what I was asking about the occupancy because it seems like in this quarter, you had the occupancy is going up, you had rate went up 3%. So whether those trends – it seems like the occupancy – unless there's a tough occupancy comp in the second half, it seems like your guidance here seems very doable for senior housing, and operating. And it's probably going to exceed that. Unless there's some occupancy issue we don't know about.

Scott A. Estes

No, occupancy is trending higher. So hopefully we’ll continue to beat the guidance.

Nicholas Yulico – UBS Investment Bank

Okay, got it. And then Scott, you talked about Sunrise now being worth about $6 billion of market value today. What yield are you using on that? Like an after CapEx type of cap rate?

Scott A. Estes

After CapEx, it generally hasn’t helped people think about cap rates, but something in the mid-5s given the scale and quality, locations, high quality operator, I think that’s being conservative given some of the pricing we’ve seen on big deals recently.

Nicholas Yulico – UBS Investment Bank

So it’s about, you said a mid-5 would that would assume, that would include maintenance CapEx, but it’s closer to six if it’s without maintenance CapEx?

Thomas J. DeRosa

I’m just giving you an NOI figure, so no CapEx deduction, which is typically all, the market report cap rates.

Nicholas Yulico – UBS Investment Bank

Okay. So mid-5 cap rate for Sunrise for the $6 billion.

Thomas J. DeRosa

Yeah. And that’s being conservative, we certainly wouldn’t sell it for that.

Nicholas Yulico – UBS Investment Bank

Got you. And if I go back to – it looks like you own, in the supplemental, you own about 10,000 units at Sunrise. That would imply that the per-bed valuation of Sunrise is somewhere around $600,000 a bed. And you bought it in the $400,000 a bed. I mean, at what point, for those of us also looking at multi-family, where per-bed valuations of $600,000 tend to be only in cities or coastal California, and you can actually build for that or cheaper today. I mean at what point – is there a ceiling in senior housing valuations, when your per bed gets up to these levels, that are now on par or even maybe exceeding the best multi-family across the country?

Thomas J. DeRosa

Yeah. It’s not that far above replacement costs, we’re building some assets with Sunrise right now. You have to keep in mind the locations. These aren’t market in suburban markets in Dallas, these are in infill markets in Los Angeles, and Long Island and London. And the cost of construction in those markets today is at least $400,000 per unit, that’s without any of the working capital or the five years it takes to get entitled.

So I know those numbers sound high, but that’s what it costs, and that’s the timeline to get something built in the markets where Sunrise portfolio is locate, so it’s a big number at 600,000 unit, I agreed, but it’s also very indicative of what it would cost to replace those building.

Nicholas Yulico – UBS Investment Bank

All right. And then I guess, just to follow-up, does that end point to in those markets, if there is a piece of land that could go for senior housing or multi-family, the yield to develop multi-family is going to be a lot higher at a similar per bed, which we point to it being that much more difficult to build senior housing than multi-family in some of these coastal markets, which benefits you guys?

Thomas J. DeRosa

Yeah. I think that’s true. And I think it goes to what I was, the point I was making before, Nick about just the New York City metropolitan area how difficult it is, for instance you’d be hard for us to find good quality seniors housing beds on the island of Manhattan. So, it’s – these markets are, they are toughs. But they need to have seniors housing alternatives.

Nicholas Yulico – UBS Investment Bank

All right. Thanks everyone.

Operator

And your next question will come from the line of Karin Ford with KeyBanc Capital Markets.

Karin Ford – KeyBanc Capital Markets

Hi, good morning, just a question on the development pipeline. You don't have any conversions after 2015, 2016, and 2017. There are zero right now. Is that by design, or do you hope to backfill that pipeline, and how are the prospects for it, if so?

Scott A. Estes

Yeah Karin, we are doing a fair amount of construction, not all of it is fully on balance sheet there are certain operators like Silverado and Brandywine where we do essentially a development lease and provide all the real estate capital. But we are also doing a number of programs with other partners in our portfolio that it’s more like a mezzanine program, where we’ve got a small amount of money to help them get the project funded or built, and then we have a purchase option, not an obligation, but in option generally at a predetermined price or formulate cap rate that allows us to buy the property either once it opens or wanted to stabilizes, and that price is typically below fair market value. And there’s a fairly large number of those that should result in some substantial acquisition volume and 2015, 2016 and beyond.

Karin Ford – KeyBanc Capital Markets

Okay. That's helpful, and that's the preferred method of investment in development from here?

Scott A. Estes

We do a fair amount of it.

Karin Ford – KeyBanc Capital Markets

Okay. And then just another question on the international investment side, what would you say is your required risk premium for investing in the UK, on an apples-to-apples basis? And do you see those premier going higher as you looking at additional countries around the world?

Scott A. Estes

It depends on the location. So we talk about the UK, but we really have to talk about specific markets within the UK and most of our assets are in London and there is no risk premium there, if anything it’s the reverse, given the dynamism of that market and depth of demand. The south of England is comparable, very high quality locations, fantastic demographics the further north you get, the higher the risk premium.

Karin Ford – KeyBanc Capital Markets

Okay. So no risk premium investing in London, versus say investing in a like product in the New York City area for example?

Scott A. Estes

Not today. I mean one would argue that London and New York are probably the best comps for each other and one could also argue that the growth characteristics of the London market would even outstrip New York.

Karin Ford – KeyBanc Capital Markets

Okay. And then just last question, the CMS ruling last night, the 2% rate growth for skilled nursing, what impact do you think that'll have on your Genesis coverage from here?

Scott A. Estes

No material impact, so its inline with expectations, it’s better than we’ve seen in certain recent year. So, that should allow them to maintain coverage.

Karin Ford – KeyBanc Capital Markets

Okay. Thank you.

Scott A. Estes

Thanks

Operator

And your next question will come from the line of Michael Knott with Green Street Advisors

Michael Knott – Green Street Advisors

Hi guys, question on senior housing operating. Just curious your thoughts, when you look ahead, what's your thought on the mix of top line growth that you're thinking about between say pricing power versus occupancy gains?

Scott A. Estes

Michael it’s Scott speaking, it’s really a location specific trade-off and an operator specific trade-off. Either one is fine with us, as long as they generate the revenue growth and the NOI growth, it’s been in the 4% to 5% range the last few quarters that seems to be the right trend looking forward.

Michael Knott – Green Street Advisors

And what's a full occupancy rate that you would strive for?

Scott A. Estes

The portfolio in the 89% range today its possible to get into the 92%, 93% range that would be really strong I don’t see that happen in next year, but you think about what’s possible I think that’s the high end.

Michael Knott – Green Street Advisors

Okay, thanks. And then it looked like this quarter you did more senior housing triple net investments on the RIDEA side. I'm just curious if that's representative of a shift in thinking or risk appetite, or just how the deals shook out?

Scott A. Estes

Yeah, it’s the latter, we like to invest using goal structures and this quarter it just happen the two of our big triple net operators came to us with opportunities.

Michael Knott – Green Street Advisors

Okay. And then sort of along those lines, when you're thinking about perspective investment activity, how much do you think about or consider target portfolio weightings? Is that a governor in some cases or an objective?

Scott A. Estes

Yeah, there is definitely a framework that we think about that guides all decisions. But we have to be opportunistic at some level and take what's available. But the important piece for us is that always buy a highest quality assets in back the top quality providers. That’s the most important decision, but we do think about the portfolio allocation in a strategic way and we don’t want to get too far out of balance.

Thomas J. DeRosa

All right. We just in fact presented that to our Board yesterday, just they are very interested in understanding the – our portfolio management metrics. So this something we talk about a lot.

Michael Knott – Green Street Advisors

Okay, thanks. And then just thinking about your investment activity going forward, I guess you don't include each acquisition in your guidance. So just more conceptually, when you think about investments over the back half of the year, how is the pipeline looking? You've been fairly consistent so far this year, $500 million, $600 million a quarter. Just curious, any thoughts on what we might expect to see?

Scott A. Estes

I think that, we are looking at a number of interesting opportunities in the – generally from the way that we source our opportunity, that’s we’ve talked a lot about on the call today Michael. And so I think our past performance is no indication of future performance I think you have been seeing us generate a similar level of new investment volume from our relationship machine. So I think that’s probably the best indication I could give you of where will be through the later part of the year.

Michael Knott – Green Street Advisors

Okay, and then a question, I guess this would be for Tom or maybe Scott Estes. But Tom, in your closing remarks, you mentioned that HCN trades with the highest multiple in the sector. And that essentially the equity market has re-rated HCN over time. As you think about ways to grow into that multiple in the future and to continue to attract investors, obviously you have internal growth, external growth. But curious how much time you guys spend thinking about the opportunity to get re-rated in the debt market over time, and is that another way to continue to grow your cash flow over time?

Thomas J. DeRosa

So, Michael I think about that all the time. It actually wakes me up at night. I would tell you, I think one of the things that I am really focused on making sure people understand is our internal growth capabilities. I think that’s a differentiator. I had one large investor say to me who invests in other sectors of healthcare including med tech, med device, biotech and said gee. I have a hard time finding names in those sectors that can grow internally north of 7% and they traded multiples two to three times higher than you. So that’s one of the things I think about all the time Scott you got a thought on that?

Scott A. Estes

The only perspective I would add is that we think about maximizing value all the time for both our equity and our debt holders and actually within our evaluation and compensation structure we have both relative, equity multiple components as well as the balance sheet and credit metrics and cost of debt components, so how we think about how we are doing successfully. So it’s definitely part of everything and we think we are doing well but want to do better on both fronts.

Michael Knott – Green Street Advisors

I guess just more specifically on the debt side, it seems like that could be an opportunity over time, right?

Thomas J. DeRosa

Sure. We clearly deserve a better rating.

Michael Knott – Green Street Advisors

Okay, that’s it from me. Thanks.

Thomas J. DeRosa

Thanks.

Operator

Your next question comes from the line of Michael Mueller with JPMorgan.

Michael Mueller – JPMorgan Chase & Co.

Hi, thanks. Just about everything has been answered so far. Except I guess we’re thinking about the international investments one more time, and looking out over the next year or two, what do you think the split will be between the UK prime elderly and any other product type in the UK or just elsewhere in the continent or some other place?

Thomas J. DeRosa

Yeah, I think from a – we are well invested in our relationship in UK environment, so we have extremely good contact with all of the providers there on the prime elderly side as well as in the other sub sectors there. I think given our footprint a bit like the U.S. for sure given our capability of generating investment opportunities from within our existing portfolio, it’s clearly going to be lead of what we do in the next 12 to 18 months.

We’ll come out of the UK prime elderly just because of the backdrop which we found ourselves in. I think we clearly want to grow outside of that, that’s our plan. As we’ve mentioned a couple of times before, some of these will be opportunistic as well as that’s trying to deliver proprietary transactions. That’s very hard to give you a balanced sense to say we envisage 50%, prime elderly of 50% other things or 25% in the consent extra. But I think we will continue to place our model over the opportunities we see in the marketplace to see what they fits us and working on that basis, we drive the absolute potentials that we deliver.

Michael Mueller – JPMorgan Chase & Co.

Okay, that’s it. Thanks.

Thomas J. DeRosa

Thanks.

Operator

(Operator Instructions) And your next question will come from the line of Rob Mains with Stifel Nicolaus.

Rob Mains – Stifel Nicolaus

Thanks, Scott. The de modification we talked between post-acute and long-term care, is this going to be the do you envision this being building by building or will it be kind of more portfolio or operator specific.

Thomas J. DeRosa

Probably building by building.

Rob Mains – Stifel Nicolaus

Okay. But don't you have a continuum that you got to draw a line of demarcation in the middle of?

Thomas J. DeRosa

Yes, well any building will be in one category or the others and some to our point will be purely post-acute and some will be almost purely posted long-term care. So we haven’t quite determined exactly what that dividing line will be but that’s the concept.

Rob Mains – Stifel Nicolaus

Okay. And then I do have one, since it's late, kind of in the weeds numbers question. In the quarter, you had a pretty significant increase in the FFO contribution from equity income of unconsolidated JVs, and included in that number was a $4.5 million true-up. I just wanted to know whether given that, we should use the current quarter as a run rate or something more akin to what we saw in Q1? And if you don't have that detail in front of you, I can call you back later.

Scott A. Estes

I do have it, Rob. In short that number should go down a bit more to a first quarter levels in the second half of the year, and with that line is – where HCN is a minority owner, so if there’s a thing such as transaction cost around the Sunrise management company deal or SRG acquisition where we’re a minority owner, there’s accelerated amortization of intangibles. So that number is a little bit higher by that $4.5 million this quarter, but it should essentially not be there next quarter.

Rob Mains – Stifel Nicolaus

Got it. That's very helpful. Thanks, that's all I had.

Operator

The next question will come from the line of Todd Stender with Wells Fargo.

Todd Stender – Wells Fargo Securities, LLC

Hi, good morning, guys. Just going back quickly to new development. Your construction yields remained fairly elevated at 8% plus despite acquisition cap rates that continue to head lower. How to you categorize pressure, if any on development yields? Just particularly are the arbitrage between building yields and market yields remains so wide?

Scott M. Brinker

Sure, Todd, this is Scott speaking. The capital that’s entering this space is looking at acquisition and development. So I think both are being impacted in similar ways, so there has been some acquisition cap rate pressure over the past 12 months, and the same is true development yields, we try to maintain a much larger spread whenever we fund development, just because of the internet risk. Both the lease-up as well as time, value and money. So generally we’ve been able to get in the neighborhood of 150 to 200 basis points of premium for development. And that’s what we’ll continue to regard.

Todd Stender – Wells Fargo Securities, LLC

Yeah. That seems like a longstanding spread. Has that come in a little bit recently?

Scott M. Brinker

No. I don’t think so. We have intentionally made these specific transactions, Todd.

Todd Stender – Wells Fargo Securities, LLC

Okay. And just in the past, I would say your development exposure, broadly speaking, weighed on your valuation, but really not anymore. Is that a fair assessment? Tom, you talked about valuation before. But have investors either have a higher comfort in your development, or just represented by a smaller percentage of the overall portfolio?

Scott M. Brinker

I think a little above there. I do think people have grown comfortable with our development capabilities. So overtime look about they come from again, they come from relationships.

Todd Stender – Wells Fargo Securities, LLC

Great, thank you.

Thomas J. DeRosa

Thanks.

Operator

And your next question is a follow-up question from the line of Michael Knott with Green Street Advisors.

Michael Knott – Green Street Advisors

Hey, guys let’s just come back to the pricing power question on senior housing and operating. Can you help me understand the pricing power that you have or you think have with respect of rates or service income? When we look at your average RevPAR being so high so far above the national average, just curious your sense of perspective of residence start to push back or it is some understand the pricing dynamic there and the power you have.

Thomas J. DeRosa

I am sure some has in its push back (indiscernible) on the equvalibrum and we hear about that from variety of sources occasionally.

Michael Knott – Green Street Advisors

But Michael for the last three or four years, the average rate growth in the operating portfolio is in the 3.5% to 4% as an average. And that’s roughly twice the national average that is reported by NIC. It’s also got twice the rate of inflation. You know part of that is the fact that occupancy has which is moved higher more but more importantly just where the bills are located. And afterwards sounded them in the higher quarterly. The buildings are provided a service that people are going to pay right. Michael, I think you’ve recently toured some of our LA area properties?

Michael Knott – Green Street Advisors

Yeah that’s right.

Scott A. Estes

Yeah so you understand that for instance the Belmont property on (indiscernible). If you are lucky enough to have – to be able to live there, I think because – Belmont will have tremendous pricing power because of that location, because of the quality service and I think that it has community of residence that for most part are fairly resilient financially, and while they may not like the increases that will be pushed on to them they are not going to move out because of that and they are getting superior service in a superior location.

Michael Knott – Green Street Advisors

Right and I understand Scott your comments as well about how strong it’s been past years I guess just looking forward do you expect that type of above inflation pricing power will continue?

Scott A. Estes

No, we hope so, not sure that it’s going to be twice as high as inflation like it has been. But we would expect a premium.

Michael Knott – Green Street Advisors

Okay thanks, and then on the disposition side I think you guys have now sold $2 billion or $2.5 billion if I recall over the past couple of years including this year in that total. And just curious when you think about ’15 and beyond, should we continue thinking of some dispositions when we think about where your earnings are going to come in or you mostly done?

Scott A. Estes

I think we’ll always recycle some level of assets and look to be proactive in managing the portfolio but my guess would be and it feels like the strategic disposition effort is winding down. So I think it would be a lower number than you’ve seen on average over the last two or three years.

Michael Knott – Green Street Advisors

Okay. And then on the balance sheet, Tom, we were all pleased to see the equity offering and see that leverage come down a little bit. Just curious your sense or Scott, your sense of how much more improvement you anticipate over the next couple of years with respect to your leverage and sort of turning to the last recent question that I asked about cost of debt and balance sheet.

Thomas J. DeRosa

Michael, I’m quite comfortable with the range that we are at and I think as I mentioned on may be the prior question or two, I think we deserve an upgrade. I think we are very focused on liquidity here and the quality of our balance sheet. I think we have a very good quality balance sheet. Our metrics are where they should be. I don’t think I would be in favor of raising equity just to pay down debt beyond where we are today.

I think we have a comfortable band that we’ve operated in with respect to the balance sheet over the last couple of years and I would expect it’s going to stay there, but another thing that wakes me up at night is our rating. And so I’m going to be spending some time with the rating agencies trying to get them to understand our business a little better and hopefully awarding us a higher debt rating.

Michael Knott – Green Street Advisors

Even if you don’t want to distrait the lever, what about continuing to just fund additional investment activity with greater proportion of new equity like you did this last quarter as a way to further improve the balance sheet?

Scott A. Estes

Yeah. We look at all possibilities Michael and I think that is what’s important to us is having as many ores in the capital waters as possible and we’ll always do – every decision we make is based on what’s in the best interest of the shareholder and that’s how we manage our balance sheet. And again, we are exploring lots of different ways to attract capital here knowing that the capital markets may not always be accommodating as they’ve been in the last few years. So again, flexibility is most – is paramount here.

Michael Knott – Green Street Advisors

Okay. Thanks for answering all the questions. We’d like to see even lower leverage. Thank you.

Thomas J. DeRosa

Okay, Michael. Thank you.

Operator

And that will conclude the question-and-answer portion of today’s conference call. We’d like to thank everyone for their participation, and this will conclude today’s call. You may now disconnect.

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