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Senior Housing Properties Trust (NYSE:SNH)

Q2 2012 Earnings Call

August 1, 2012 1:00 pm ET

Executives

Timothy A. Bonang – Vice President, Investor Relations

David J. Hegarty – President and Chief Operating Officer

Richard A. Doyle, Jr. – Treasurer and Chief Financial Officer

Analysts

Philip DeFelice – Wells Fargo Securities, LLC

Jana Galan – Bank of America/Merrill Lynch

Omotayo Okusanya – Jefferies & Co.

Jarrell Golotti – Morgan Stanley

James Milam – Sandler O'Neill & Partners L.P.

Phillip Martin – Morningstar, Inc.

Daniel Bernstein – Stifel, Nicolaus & Co., Inc.

Operator

Good day and welcome to the Senior Housing Properties Trust Second Quarter 2012 Financial Results Conference Call. This call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Timothy A. Bonang

Thank you, and good afternoon, everyone. Joining me on today's call are David Hegarty, President and Chief Operating Officer; and Rick Doyle, Treasurer and Chief Financial Officer.

Today's call includes a presentation by management followed by a question-and-answer session. I would also note that the recording and retransmission of today's conference call is strictly prohibited without the prior written consent of Senior Housing.

Before we begin, I would like to state that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on Senior Housing's present beliefs and expectations as of today, August 1, 2012.

The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission regarding this reporting period.

In addition, this call may contain non-GAAP numbers including normalized funds from operations or normalized FFO. A reconciliation of normalized FFO to net income and the components to calculate AFFO, CAD, or FAD are available in our Supplemental Operating and Financial Data package found on our website at www.snhreit.com.

Actual results may differ materially from those projected in any forward-looking statements. Additional information concerning factors that could cause those differences is contained in our filings with the SEC. Investors are cautioned not to place undue reliance on any forward-looking statements.

And now, I would like to turn the call over to Dave Hegarty.

David J. Hegarty

Thank you, Tim, and good afternoon everyone. Thank you for joining us today on our second quarter earnings call. During the second quarter, we continue to make progress on our business plan of acquiring and maintaining high quality private pay properties, leased to strong credit tenants and our taxable REIT subsidiary, while maintaining our historically solid financial profile, 94% of our NOI, today is derived from private pay resources, and we maintain the lowest exposure to government reimbursement programs, I have all the power to trade at healthcare REITs.

For the second quarter, we’ve reported normalized functional operations, our FFO of $0.45 per share, and our Board of Trustees declared a quarterly distribution of $0.38 per share, which represents 6.7% yield based on yesterday's closing stock price and a payout ratio of 84% of our FFO.

Since April 1, we have closed on $227 million of acquisitions and in July we successfully raised $650 million of gross proceeds from equity and debt offerings. Both offerings were upsized due to significant investor interest and allowed us to maintain a healthy balance sheet, while positioning us for future growth with no additional capital needs for the foreseeable future.

On our last several earnings calls, I’ve discussed our pending acquisition activity and I'm happy to report that during the last 60 days most of this backlog has closed. Looking at our acquisition activity since April 1, we have completed $227 million of acquisitions, of which $45 million represents completion of the Bell portfolio we announced last year. The weighted average yield on these $227 million of acquisitions was 8%.

We assume $64 million of mortgage debt along with these acquisitions at a weighted average interest rate of 5.6%. In fact, yesterday, we closed on the previously announced acquisition of a sale lease back of four private pay senior living communities with the new third-party private regional operator by the name of Stellar Senior Living for $37 million. The lease was underwritten at 1.2 times rental coverage based on historical results and the initial yield will be 8%.

Today, we have a $142 million of pending activity, of which $99 million represents one remaining senior living community located in (inaudible) New York from the B portfolio we announced last year. We expect all the pending acquisitions to close during the third quarter.

In addition to these acquisitions, we’re on pace to fund $30 million to $40 million of revenue producing capital improvements to our triple net lease tenants this year, which yields us 8% on amounts funded. Not including our 2011 pending activity so far in 2012, we’ve acquired our announced $225 million in new investments which put us on track to meet our expectations of acquiring $300 million to $400 million in 2012. Most of our investment opportunities continue to be small portfolios, and one-off private pay senior living communities in medical office properties.

In the Senior Housing space most investment opportunities have been with private operators and investors looking to monetize their real estate or exit the operating businesses altogether. We've been successful in acquiring individual assets and small portfolios of high-quality private pay senior living communities. And we expect to continue our growth in the same manner. We also see positive signs for acquisition opportunities in the medical office space. The Supreme Court’s recent decision should positively impact acquisition opportunities, hospital systems by allowing them to accelerate their decision making. We continue to see an increasing demand for outpatient services.

Our recent survey by Modern Healthcare stated that’s have been a surge in outpatient services and just the past year. For instance, they reported that there was a 41% increase in the number of healthcare systems operating freestanding chest pain clinics, a 35% rise in emergency services facilities, and 32% increase in dialysis centers.

Furthermore, according to the Census Bureau approximately 10,000 people a day are turning 65, adding to the demand from medical services. The ageing demographics and potential impact of the Affordable Care Act we’ll had millions more to the insured population. The increasing demand for medical office buildings is undeniable, which is why we continue to see as an attractive area of growth for our company.

Moving on to our financing activity. We are active in the capital markets during July, and lead the growth $650 million consisting of $300 million of the common stock issued at a price to $21.75 a share and $350 million of 30-year senior unsecured notes at 5.8%

Our closing stock price yet that was $22.75 on the 5% above our operating price. Part of the proceeds from these offerings we use to pay off the $360 million balance on our revolver, and we intend to use remaining proceeds to repay $200 million of our Fannie Mae secured debt currently at 6.4% on September 1, as well as upon pending acquisitions.

Now turning to the performance of our portfolio; first, I’ll review our senior living triple-net lease products. These results reported on a rolling 12 month basis as of March 31, 2012. Occupancy increased across independent assisted living, but skilled nursing occupancy declined. These results were in line with recent industry data. Recent National Investment Center or NIC data reported independent living has the greatest improvement in occupancy with assisted living and memory care also improving.

We’ve seen a continued shift in the skilled nursing sector towards higher acuity short-sighted patients, which has caused the turnover to increase impacting occupancy. Since the recession, skilled nursing patients have opted to deferred care and also chose other home community based services, which has impacted occupancy as well. Assisted living and memory care facilities are also gearing for lighter acuity residence in private patients and patients with private resources.

Clearly there have been strains on government reimbursement programs affecting skilled nursing operators and we’ll continue to decrease our investment in skilled nursing, while focusing on private pay senior living and medical office buildings. Our current exposure to skilled nursing is only 4% of our NOI.

Starting with our large tenant, Five Star’s lease properties had combined occupancy of 84.4%, which was down from 85% compared to last year, essentially flat compared to last quarter. Five Star’s occupancy trends have been mostly increasing for independent living and assisted living, while skilled nursing has continued to decline. Rental coverage on a EBITDA basis range from between 1.17 to 1.4 times across our four leases and was 1.3 times in the aggregate. Five Star’s coverage was down overall primarily due to lower Medicare rates implemented last year and negative trending skilled nursing occupancy. Five Star reported its results for the second earlier today and occupancies continue to trend slightly high for independent assisted living.

Five Star is our largest tenant and its employees mentioned significant steps they made to enhance the valuation. They continue to generate profits quarter after quarter for the last 14 consecutive quarters. They recently obtained a $150 million secured line of credit in addition to the $35 million working capital line of credit and have agreed to sell their pharmacy business for a net $39.9 million reflecting a gain on their investment of $24 million.

Our next largest senior living tenant is Sunrise Senior Living. Sunrise’s lease properties saw a slight uptick in our occupancy compared to last quarter, but overall coverage declined to 1.53 times. The declines primarily relate to the reduction in skilled nursing Medicare rates. To remind you, Sunrise will continue to lease four communities from us until 2018 with the Marriott Guarantee. But we came to a mutual agreement with Sunrise in May to terminate the remaining 10 leases with 10 communities, which will be moving into our taxable REIT subsidiary.

We expect to complete the majority of this transfer over the next 30 days to 60 days. We continue to monitor the performance of the 10 properties as the transition progresses and will evaluate their condition to determine what kind of capital is necessary to improve the operation and performance.

Next, Brookdale lease properties saw a nice improvement in occupancy and rental coverage, and our other triple net lease properties continue to perform well with occupancy and rental coverage holding steady at two to three times.

Now looking at our managed senior living portfolio, occupancy for the June quarter increased to 87.7% from 87.2% last quarter.

We do not yet report same-store data in this part of the portfolio, as we do not own these properties for the full second quarter of 2011. Many of the properties and units recently added to this portfolio happen independent living, which explains the slight decline in average daily rate this quarter. NOI declined by $327,000 due to higher expenses primarily from higher utilities, insurance premiums, and real estate taxes.

During the first one or two quarters as a new longer and operator of acquired properties, we typically experience the decline in occupancy, coupled with an increase in operating expenses, particularly real estate taxes. Once (inaudible) re-branded and full transitioned, the overall operation was stabilized, and we expect NOI to grow from there. Overall we feel good about the performance of these properties and are excited by the growth potential.

We spoke $2.3 million in capital improvements in our senior living portfolio during the quarter, which was up significantly from last quarter. And I will point out that we are aggressively investing in these assets given the current low cost construction, and are working to transition these assets, we brand them, and evaluate capital lead across the spectrum to put these properties in the best shape so we can reap the benefits over the long term.

We also expect the transition of the 10 Sunrise properties to our managed portfolio to increase our capital spending of – capital expenditures spending as well. As we transition these properties, we anticipate some initial cash flow volatility, and once we’re operating properties, we will be able to determine our own capital expenditure budget.

Moving onto the medical office building component of our portfolio. The second quarter, our medical office building NOI increased 16% year-over-year as we now up to 112 properties with over 8 million square feet. This growth has primarily come from new acquisitions. Recent acquisitions have established new relationships with Straub Medical Clinic in Hawaii, Northside Hospital in [Atlanta], Georgia and Washington DC Children's Hospital as well as expanding our relationship with Emory Clinic in Atlanta.

On a same store basis, occupancy was down to 94.2% from 96.8% last year, and the same store NOI declined slightly as well. The decline in occupancy and NOI is mostly attributable to 124,000 square feet vacant building located in the suburb of Philadelphia that we discussed last quarter that we’re still trying to reposition and release or sell.

During the quarter, we had 26,000 square feet of new leases, and we renewed a 185,000 square feet. Overall, we saw rental rates on renewals to climb slightly this quarter, but we don't believe the decline in renewal rates is represented of a trend in our portfolio. [Nevada] represents one last lease at a property located in New Mexico, which was renewed at a slightly lower rate, but was offset by a longer lease term.

Now with that, I’ll turn it over to our Chief Financial Officer, Rick Doyle, to review our financial results.

Richard A. Doyle, Jr.

Thank you, Dave, and good afternoon, everyone. I will now review our year-over-year quarterly financial results. We reported normalized FFO for the second quarter of $73 million or $0.45 per share, up 17% in the aggregate and 2.3% on a per basis from last year.

Looking first at the income statement, rental income increased to $111 million mainly due to external growth from investments in medical office buildings and leased senior living communities we’ve made over the past year. Residents fees and services from our managed senior living portfolio grew to $36 million from the 24 communities with over 3,300 units we owned as of June 30, 2012 compared to $844,000 from the 10 communities with 824 units for the same period last year. Percentage rent from our senior living properties increased 7% to approximately $3 million driven from occupancy and rate increases at our triple net senior living communities.

Property operating expenses for the quarter increased to $41 million compared to $11 million last year, which was in line with our expectations as we added a significant number of both managed senior living communities and medical office buildings to our portfolio. Of the $41 million of property operating expenses, $15 million were derived from our medical office buildings and $26 million were derived from our managed senior living assets. Excluding our pending acquisitions, we believe this is a good run rate.

General and administrative expenses increased to $8.1 million compared to $6.8 million last year, which is in line with our expectations and we believe this is a good run rate. As a percentage of revenues, G&A decreased to 5.5% compared to 6.7% last year. Interest expense was up 20% to $28 million. Interest on our debt has increased since last year due to the $274 million to mortgage debt we have assumed with acquisitions, the issuance of $300 million of unsecured senior notes in December 2011, net of the repayment of 19 mortgage loans for $48 million in 2012 and the repayment of $225 million of 8.58% unsecured senior note in January 2012.

We expect interest expense to increase by $2 million to $3 million in the third quarter due to our financing activity subsequent to quarter end, which includes the issuance of $350 million of senior notes with an interest rate of [515] days issued in July, $56 million of mortgage debt adding weighted average interest rate of 6.1%. We will assume with acquisitions. Offset by the repayment of $200 million of the variable rate Fannie Mae mortgage loan at an interest rate of 6.4% on September 1. Because we cannot utilize the proceeds of our July debt offering to pay out Fannie Mae debt until September 1, our interest expense will be unusually high for the third quarter.

Moving to the balance sheet. we closed our $125 million investments during the quarter, comprised of one senior living community and four medical office buildings and assume $57 million of mortgage debt. we also invested $7.8 million into revenue producing capital improvements at our triple net senior living communities for the second quarter.

Subsequent to the quarter, we closed our $98 million of acquisitions of five senior living communities, and two medical office buildings, and assumed $7 million of mortgage debt. the weighted average capitalization rate for these acquisitions since April 1 was 8% based on estimated annual NOI. We still have $142 million of pending activity comprised of two senior living communities, and two medical office buildings, it will assume $59 million of mortgage debt, the majority of what we expect to close during the third quarter.

At quarter-end, we had $20.4 million of cash on hand, $360 million outstanding on our revolver, $750 million of unsecured senior notes and $863 million of secured debt and capital leases making our total debt to book capitalization ratio of 45%. Our targeted leverage using debt to total book capital is in the range of 40% to 45%. Our credit statistics remain extremely strong with EBIDTA over interest expense of 3.6 times and debt over annualized EBITDA of 4.8 times.

Following quarter-end, we sold 13.8 million common shares raising gross proceeds of $300 million and issued $350 million of 5.625% unsecured senior notes due 2032. We used a part of these proceeds to repay the entire outstanding balance on our revolver and intend to use the remaining proceeds to repay $200 million on a Fannie Mae secured debt on September 1 and to fund our pending acquisitions.

Following our equity offering, our weighted average shares outstanding for the third quarter will be approximately $175 million. We do not anticipate having any additional capital needs for the foreseeable future.

Today, we have nothing drawn on our revolver and approximately $250 million of excess cash available for pending the closing of acquisitions and the refinancing of Fannie Mae debt. And taken into account our recent financing activities on a pro forma basis, our debt to book capitalization ratio would be under 40%.

Our recent financing activity has helped fuel our growth in acquiring high-quality properties that increased the size of our portfolio allowing us to improve our overall cost of capital in the diversity of our property type and tenants. However, our FFO per share will be temporarily reduced by $0.03 to $0.04 in the third quarter versus the second quarter, because we’ll be holding excess cash pending closing acquisitions in the refinancing or our Fannie Mae debt.

In closing, we believe that the healthcare supply and demand fundamentals are positive and growing for the healthcare weak sector. Our high quality portfolio purchased at rational prices along without conservative financial approach, access to capital, and current dividend yield of 6.7% makes us an attractive option for investors.

With that, Dave and I are now happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question is from the line of Philip DeFelice with Wells Fargo Securities. Please go ahead.

Philip DeFelice – Wells Fargo Securities, LLC

Good afternoon, this is Phil DeFelice for Todd Stender.

David J. Hegarty

Yeah, hi Phil.

Richard A. Doyle, Jr.

Hi, Phil.

Philip DeFelice – Wells Fargo Securities, LLC

You mentioned the rate associated with the mortgage debt on the assets closed in Q2 was 6.1%, is this similar to the $59 million you expect to assume in Q3, and what are you plans for these mortgages?

Richard A. Doyle, Jr.

Yeah, we expect average – weighted average rate that on the pending acquisitions about 6.1%.

Philip DeFelice – Wells Fargo Securities, LLC

Do you plan on holding until its maturity and how does the (inaudible)…

Richard A. Doyle, Jr.

Yeah, we do, we always look into see if we can pay those off during the acquisitions, and I’ll see what the terms are – on these, we will hold them until close to maturity, so we will assume those.

Philip DeFelice – Wells Fargo Securities, LLC

Okay, thank you. Regarding your asset purchase in Hawaii, which is one of the largest single asset purchase of the grouping, it looks like the property is very well leased, nearly 100% and has an average lease term of about four years. Wondering if you could talk a little bit about the lease roll over schedule over the next couple of years and how you are thinking about rentals and retention for that asset?

David J. Hegarty

Sure. Well, that asset is the unique asset because it’s physically located adjacent to the Straub Medical Clinic in Honolulu. And it has in fact much of the parking in the garages that are in our building supports the hospital. So the tenant roll over, as you said, it’s pretty much full, it does have an accurate tenant which is highly rated insurance company that is almost half the building. And they are in there for I believe another seven more years as a tenant and the rest of it is mostly the Straub Medical Clinic itself plus a number of physician groups and so on.

So I think there is – it’s pretty much a waiting list currently over the space. So we believe that it’s going to constantly be occupied by healthcare related tenants and we are frankly not terribly concerned about the lease roll over risk as far as increasing vacancy or anything. We think that it should be a positive for us as leases roll over.

Philip DeFelice – Wells Fargo Securities, LLC

As far as lease rates go, you believe that current rates are below market?

David J. Hegarty

We do.

Philip DeFelice – Wells Fargo Securities, LLC

Okay.

David J. Hegarty

Yeah.

Philip DeFelice – Wells Fargo Securities, LLC

Right.

David J. Hegarty

(Inaudible) I mean that’s probably the – that type of healthcare asset and we are hoping that this is a smaller version of that, but it seen us we are clearly able to push north of $70 a foot and again continue to have a huge waiting list, and we’re constantly full there. So, I’m expecting on a smaller scale similar dynamics.

Philip DeFelice – Wells Fargo Securities, LLC

Okay, that’s helpful. And then occupancy in your TRS managed portfolio, is up another 70 basis points sequentially, 500 basis points from Q2 of last year. How you’re thinking about the potential for further improvements currently?

David J. Hegarty

Well, now we can break, but I imagine, our expectation is that that trend will continue to improve from the year. Independent living was one of the savings they can hit the hardest with the recession, and as now we’re seeing the rebound, the greatest in that particular type of product type. And so our crop is holding up very well and continuing to grow on the independent living side. So, I’m expecting definitely better results going forward from those properties.

Philip DeFelice – Wells Fargo Securities, LLC

Great. Thanks for taking my questions.

David J. Hegarty

Thank you.

Operator

And our next question is from the line of Jana Galan with Bank of America/Merrill Lynch. Please go ahead.

Jana Galan – Bank of America/Merrill Lynch

Thank you, good afternoon.

David J. Hegarty

Good afternoon.

Richard A. Doyle, Jr.

Good afternoon.

Jana Galan – Bank of America/Merrill Lynch

You mentioned in your prepared remarks that hospitals were starting to accelerate their decision making on the investment sales side of MOBs. I was curious what you’re seeing similar trends in the leasing activity?

David J. Hegarty

Yes, we are seeing at that there has been a pick up in activity since the Supreme Court ruling. I think hospitals tend to move a little bit slow anyways in signing up, but I think that now there is a sense of urgency with accountable care, organizations to be informed, and I believe activity has picked up from what we can tell in our properties.

Jana Galan – Bank of America/Merrill Lynch

Then maybe a more big picture question MOBs, you know just trying to follow recent trends, do you feel the industry is moving towards shorter-term leases or maybe is there a difference between the on-campus versus off-campus in terms of lease term?

Unidentified Company Representative

I think people in this – the nature of the healthcare environment is such where people do not want to commit for long-term anyway. So, I think people, physicians in hospitals are reluctant to sign long-term commitments beyond what they feel they have to. I think people all do realize that there is going to be an increase in demand for the space. So, I think you’ll see development pickup. but I think that bodes well for existing space too that people want to take up as much outpatient space as soon as possible. But I thought that it’s still hesitation to execute long-term leases unless it’s for the whole building or to be the primary anchor for the building in those tenants want to sign long-term. but otherwise, the smaller physician groups are trying to stick to pretty much the more or less five years terms.

Jana Galan – Bank of America/Merrill Lynch

Thank you very much.

Unidentified Company Representative

You're welcome.

Operator

Our next question is from the line of Tayo Okusanya with Jefferies. Please go ahead.

Omotayo Okusanya – Jefferies & Co.

Hi, good afternoon. Just a couple of question, the Sunrise, the transition to the TRS managed by Five Star, could you talk a little bit about what the financial impact of that change would be in regards to, you have the nice triple net leases before, now you’re kind of moving more towards the TRS structure? What that will mean for the bottom line?

Unidentified Company Representative

Sure. Well, our expectation first is that, we expect seven or eight of the properties to come on-line in the next 30 days to 60 days, and then there's two properties that are – because of the states they're in we’ll take much more longer for licensing up to six months longer.

And from an operational perspective they are more or less neutral to what we're currently getting in rent from the properties. So, it could be a little bit less, it could be a little bit more, but not materially different from what we’re currently getting. And our expectations that we will be making some changes in the operations will be putting some of the properties. We will be putting a fair amount of capital proven money into make them more competitive today. But again, I don't anticipate significant change in operating performance. And then we believe from there, we should have upside potential. I do believe that the properties could be performing better with some capital spent on the specific plant.

Omotayo Okusanya – Jefferies & Co.

Got it, thank you. That's helpful. And then $126.7 million of deals due to close, the biggest piece of it is the New York piece, about $99 million, can you give us an update on when you expect that to close at this point?

Unidentified Company Representative

It’s really a $142 million pending deals to close Tayo, and you're right $99 million relates to the Yonkers, New York in the last week and we do anticipate we are moving very close time to try and close that in the middle of the third quarter, before even the third quarter finishes that’s our goal.

Omotayo Okusanya – Jefferies & Co.

That’s helpful. Then I may have missed this earlier on because I got on the call a few minutes late, but the decline in occupancy for the MOB portfolio this quarter as well as the reason for that again.

Unidentified Company Representative

The main reason was, we still have the property that is vacant in Philadelphia marketplace that was – in the beginning of May it became vacant I believe. So that’s still in our numbers, otherwise it’s nothing of any significance with any other properties like that.

Unidentified Company Representative

Just a small decline on [Europe].

Omotayo Okusanya – Jefferies & Co.

Got it. And then lastly just acquisition outlook, you guys announced a bunch of other deals again during the quarter, which is great and I understand the whole pre-funding situation and how that would impact 3Q earnings, we are kind of beyond that, you know when I kind of thought, thinking about, what could the back half of this year look like from an acquisition perspective and the potential impact in regards to 2013 earning?

Unidentified Company Representative

Okay, if I was challenging that we had a great quarter and then what are we going to do next to top that, but I envision that it’s going to be more or less the same of the one-off, a decent size deal. 11 communities as well as the $10 million to $20 million, say $10 million to $25 million MOBs that are in the pipeline. So, I don’t – I’d say at the moment there are a few portfolios out there that we are looking at. There could be a couple of hundred million dollars, but I don’t – I couldn’t tell you today whether or not we will be the winning bidder although. So, I caution you just to envision more of the same of this $50 million a quarter let’s say of acquisition maybe better.

Omotayo Okusanya – Jefferies & Co.

Got it. So, for the year you’re going to roughly at about $400 million or so?

Richard A. Doyle, Jr.

I think we say $300 million to $400 million, and I expect to be in that range.

Omotayo Okusanya – Jefferies & Co.

Okay, got it. On year-to-date, you have what – some acquisitions?

Richard A. Doyle, Jr.

Well, since we close – since April 1, $227 million, and we did $11 million, so about $238 million for the full-year.

Omotayo Okusanya – Jefferies & Co.

Okay. All right. Thank you very much.

Richard A. Doyle, Jr.

Thank you.

Operator

And our next question from the line of Jarrell Golotti with Morgan Stanley. Your line is open.

Jarrell Golotti – Morgan Stanley

Good morning, gentlemen.

Richard A. Doyle, Jr.

Hi, Jarrell.

Jarrell Golotti – Morgan Stanley

I have a question in regard to debt investments, the Five Star; Bridge Loan has already been paid down. Now just wondering, if you’re considering further investments in debt going forward, or have you seeing much right now?

Richard A. Doyle, Jr.

Right. I mean, we have not seen a lot. We have not targeted debt to invest in as an asset class to invest in. There are some opportunities though on our case-by-case basis. So, we’re evaluating about possibly going, but again I’d say it’s not a targeted sector or type of investment.

Jarrell Golotti – Morgan Stanley

Okay. And so the Five Star leases, the rent coverage ratios are be continued to decrease that gradually having to do with the Medicare rate cuts. How much more do you expect, the coverage ratios to decline or what is the target number for – when always setting down when medication goes through, and everything stay with us?

Unidentified Company Representative

Overall, for the full lease because I think we went from like 1.32 to 1.3 times coverage. So it’s conceivable when you roll in two more quarters of the lower Medicare rates. It could come down another 20 basis points, or so. But as you can see from the charts and the supplement the – one lease is trending down, well actually couple of them are trending down, but the lease number four, which was the one before originally concerned about is crossing the 1.2 times coverage and trending upward. So, I think net, net there won’t be that significant change in current coverage ratios. I've mentioned two Medicare rates are going to increase October 1 by about 2% and then we’ll have to see what happens in January with the sequestration decrease. Again all the more reason why we try to focus on private pay.

Jarrell Golotti – Morgan Stanley

Got it. And then both you and Five Star were talking about, the fact that a lot of the residents in or patients rather in skilled nursing are migrating more towards – either a post acute setting or and assisted living setting, that being said if you have a strategy of either divesting from sniff acids or going more into a post acute care model?

Unidentified Company Representative

Well we will not be going into a post acute care model or investing. And on the skilled nursing side, we have repeatedly said that we intent to gradually exit the skilled nursing business. I don't really envision a wholesale – out right sale of everything, but it tend to be more some regions of the country and individual assets. But I guess, now down to 4% and we continue to try to bring that down.

Jarrell Golotti – Morgan Stanley

And my last question is related to something else that Five Stars said on their call, it was about how cap rates are at a four to five year low for assisted living or Senior Housing in general. I just wanted to get a sense of where yields are trending in your transaction pipeline, and do you see them compressing, do you see them flat for both the Senior Housing space and medical office building?

David J. Hegarty

I do see them compressing probably for the truly top of the line Class A product. It’s probably high 6s, low 7s at this point for initial returns. And I think that some of the other assets that’s been running around sort of 9%, so cap rates are coming down into the mid 8s. But it’s still – when you're looking at individual assets there's a limited universe pursuing it and it all depends on what capital is available for finance those transaction. And Fannie and Freddie are still readily available. And still want to see significant increases in bank financing or life insurance company financings in any significant way in our space.

Jarrell Golotti – Morgan Stanley

All right. Thank you very much.

Richard A. Doyle, Jr.

Thank you.

David J. Hegarty

You're welcome.

Operator

And our next question from the line of James Milam with Sandler O'Neil. Please go ahead.

James Milam – Sandler O'Neill & Partners L.P.

Hey guys. Just wanted to ask a question as you think about some of those capital spending into the senior housing portfolio and even some of that in the MOBs, have you guys – I guess the way Peter quantify what is going to be sort of maintenance capital expenditures versus maybe for the Sunrise portfolio capital spending that's really designed to improve the properties performance and can be thought of more as the kind of an ROI and investment type of capital spending.

David J. Hegarty

Certainly on the Sunrise portfolio, we have not had the chance to do that yet, until we start to really take over the properties and get in there and actual engineering studies done. So, that still can be determined on existing assets. Clearly, we are trying to do as much as we can to revenue enhancing. One bucket of capital expenditures that have been to Five Star and some of private operators predominantly to freshen the property, as well as expand the physical plant of the properties to add more units.

So I would – and we get a return of at least 8% on the amount funded in cases which are most revenue enhancing to us. But with the MOBs and the managed properties, again it’s still very early and we are starting to put the capital in there and most of that is to just refresh the property at this time. Less so to expand or add revenue enhancing type of capital improvements.

James Milam – Sandler O'Neill & Partners L.P.

Okay, so I guess if it's mostly refresh type of spend, you would expect that number. You are accelerating some of that now, but that number should start to decline overtime I guess?

Richard A. Doyle, Jr.

Yeah, that’s our expectation [Milam]. Yeah, we could taken these however, this is our chance. So, really making impression and pump the money in, first of all given the state of economy, that construction cost and so probably at the lowest, it gone to be for a while. So we should spend the money today. And (inaudible) transition anyway if you may as well fifty issues today, and show that you’re really committed to the property. So, we are pushing people to identify years and spend the money today, so that we don’t have to down the road.

James Milam – Sandler O'Neill & Partners L.P.

Okay, that makes sense. And then my last one just as you guys are out and obviously you look at, as you said some of the smaller one-off deals, $10 million size acquisition. Do you guys see anybody that is maybe thinking about selling or that could potentially drive more transaction activity just ahead of any potential changes at the end of the year what the tax go it in the fiscal cliff, and I guess therefore looking forward too.

Richard A. Doyle, Jr.

Well, there’s certainly number of people who are taking through that exercise whether or not the capital gains, which clearly more attractive this year, and push the uncertainty of the future. And a number of transactions in the marketplace today have asked for a special preference will be given to close before year-end. So it’s definitely a consideration. And we do see a little bit of repeat business and deals we’ve done in the past that, they were very happy with the way the transaction occurred, and we would like to start to do something before year-end. So, it is affecting people decision and couldn’t really quantify to you how much of the fault into that category. but I would say what we’re looking at is probably $200 million of that type of decision factored opportunities out there?

James Milam – Sandler O'Neill & Partners L.P.

That helps, thank you.

David J. Hegarty

You’re welcome.

Operator

And our next question is from the line of Phillip Martin with Morningstar. Please go ahead.

Phillip Martin – Morningstar, Inc.

Good afternoon.

David J. Hegarty

Hi, Phil. Good afternoon.

Phillip Martin – Morningstar, Inc.

Dave, just a question with respect to, well, I guess when you look at your active acquisition pipeline. What percentage of the total would include the addition of a new third-party relationship with a potential for?

David J. Hegarty

certainly on the MOB part, I would probably say two-thirds of it is new relationships. I’d say in a couple of cases that they’re very potentially, could be some future transactions coming up that relationship. But I’d say if we haven’t made a wholesale of new joint venture relationship with anyone. So, I won’t say it will open up a huge amount of opportunity. But I do envision a few repeat customers for opportunities to expand with.

Phillip Martin – Morningstar, Inc.

And would that also include on the triple net and TRS managed assets as well?

David J. Hegarty

yes, definitely.

Phillip Martin – Morningstar, Inc.

Okay. And when you look, and I guess with respect to the triple net leases renewing in 2013, I know on page 28 of your supplemental, there is about $18 million worth of annualized revenue there, up for renewals, what portion of data is triple net lease? I’m assuming the greater portion is triple net lease. Can you give us some insight into our lease rates in growth discussions on the triple net portion?

David J. Hegarty

Actually, there is not a lot in the triple net portion.

Phillip Martin – Morningstar, Inc.

Okay.

David J. Hegarty

MOBs, we have a number of short leases with Cedars-Sinai, so we constantly have quite a bit of space rolling over every year and we’ve seen nothing, but rental increases at that property. We do have a couple tenants, but not a significant that we expect to renew. I expect the renewals to be more of a nature of the five-year renewal as opposed to branded 15 year term or tenure as is probably the initial term. We’re finding that people are not willing to commit to much long-term leases.

Phillip Martin – Morningstar, Inc.

And that’s even on the Senior Housing side, Senior Housing triple net side?

Richard A. Doyle, Jr.

Well, the next renewal on that is in 2013 about $18 million, you’ll see there on page 20 of those supplemental.

Phillip Martin – Morningstar, Inc.

Yeah.

Richard A. Doyle, Jr.

And that relates to the 10 leases right now with Sunrise.

Phillip Martin – Morningstar, Inc.

Gotcha, okay.

Richard A. Doyle, Jr.

And so once we transition those over to our taxable REIT subsidiary that will be eliminate.

Phillip Martin – Morningstar, Inc.

Okay. So, really that number is more like $10 million when you exclude Sunrise?

Richard A. Doyle, Jr.

No, that is all of Sunrise.

Phillip Martin – Morningstar, Inc.

That’s all of Sunrise, okay.

Richard A. Doyle, Jr.

That is all of Sunrise.

Phillip Martin – Morningstar, Inc.

That’s all of Sunrise, okay.

Richard A. Doyle, Jr.

That is all of sunrise, yes.

Phillip Martin – Morningstar, Inc.

Okay. Okay, that clears that up.

Richard A. Doyle, Jr.

It’s just to be clear about that. It’s ten of the property of those Sunrise. The four of the properties were moved down to 2008 since they already extended their lease from 2013 before the properties to 2018.

Phillip Martin – Morningstar, Inc.

Correct, okay. Okay, that clears that up. Thank you very much.

Richard A. Doyle, Jr.

Thank you.

David J. Hegarty

You’re welcome.

Operator

(Operator Instructions) And we’ll go to Daniel Bernstein with Stifel, Nicolaus. Your line is open.

Daniel Bernstein – Stifel, Nicolaus & Co., Inc.

Yeah, good afternoon.

Richard A. Doyle, Jr.

Hi, Dan.

David J. Hegarty

Hi, Dan.

Daniel Bernstein – Stifel, Nicolaus & Co., Inc.

Hi. So, the first question I had on the Stellar Senior Living acquisition, I think that just a situational sale leaseback, are there other opportunities or there other assets that Stellar has that you might be interested in or they would be interested in selling to you?

David J. Hegarty

Well, not in their existing portfolio. And we do expect to continue to grow with them and finance number of their acquisition. So there will be no revenue for us. You’re right, it’s standard triple net lease long-term with the 4% growth in revenues of the properties that very similar for existing triple net lease.

Daniel Bernstein – Stifel, Nicolaus & Co., Inc.

Okay, do they have a purchase option on that at some point or…?

David J. Hegarty

No.

Daniel Bernstein – Stifel, Nicolaus & Co., Inc.

Okay. And I just wanted to get the TRS stuff properties and few questions on there. Obviously, what’s the same-store numbers that is 23 properties in 1Q and 24 properties in 2Q? Can you provide sort of clarity as to what the same-store performance was sequentially. Obviously, a little bit – more independent living in the second quarter that additional property brought down the rate. But can you provide just for the 23 property sequential occupancy and rate?

Richard A. Doyle, Jr.

Well, the occupancy had moved up a bit. and the rates are pretty much stayed the same just between Q1 and Q2. so there really haven’t been that much change in the rates. If revenues are up $700,000, I think, and so the expenses are up pretty much by another $250,000 more clearly. And so it’s really on the expense side, I think that it’s been some more volatility, and one of the things that does hurt us is, as we buy these properties, particularly in states that are looking for real estate tax revenue that be very quick to reassess an increase to real estate taxes, and you can’t necessarily build them back for the tenants until the next rate increase goes into effect. So, that’s something that just we hope to stay ahead of the curve on properties that are going to experience rate increase, real estate tax increases.

Daniel Bernstein – Stifel, Nicolaus & Co., Inc.

Okay, so based on the margin compression errs, is more real estate taxes, were there additional kind of expenses you’re putting into the facility we’d get them up to whatever standard that you think they should be?

Richard A. Doyle, Jr.

Right, right.

Daniel Bernstein – Stifel, Nicolaus & Co., Inc.

Okay. So on that the timing of that is it usually look at one or two quarter transition of adding whatever personal changes putting in CapEx, is it going to take in a quarter or two before we really start to see some stable, some good comparison numbers for those portfolios, so for that we use the same-store portfolio.

Richard A. Doyle, Jr.

Yes, because typically, I’d say more or less it’s sometimes two quarters to work through the transitional costs, and it could be in all kinds of transitional matters like changing the signage of the property, changing the menus, and maybe – just going through and giving some branding of some updating of carpets or more paper and stuff like that. So – like I say it’s more volatile in that first two quarters or so and that it should level out and then our experiences that we are seeing with other properties is that, once you’ve done that you start to really reap the benefits.

Daniel Bernstein – Stifel, Nicolaus & Co., Inc.

So, you transition that $99 million reap property transition, the other 778 Sunrise assets we’re going to see some fluctuations in the TRS occupancy rate margins over the next couple of quarters and very hard to read into what’s really going on there, that’s essentially what I am…

David J. Hegarty

With that – that’s exactly correct. Most operators typically don’t allow you to get in and get your hands on operations for even – for that matter even talk to the employees and the resident families until couple of weeks before the acquisition – transfer takes place and you really can’t do a thing until you get in there and start to rank yourself.

Daniel Bernstein – Stifel, Nicolaus & Co., Inc.

Okay. And on the 10 properties that you’re going to transfer from the Sunrise lease to the TRS, I understand those are a little bit more sniff heavy or has a little bit more, few more sniff units than some of your other assets into TRS, how are you going to alter some of those, what kind of CapEx you’re putting? Are you transitioning those sniff units to more higher acuity? Essentially, what do you need to do to improve the operations of those 10 properties trying to get to that?

David J. Hegarty

Right, a couple of things. I mean it’s still very early, and probably its another conference call or a two, before we can get into that in any meaningful way. But just initially you are right that every one of 10 properties have a skilled nursing unit in it, and the results for Q1 and Q2 of this year pretty much reflect the new Medicare rates. And so I think once you get in there, we still get to evaluate what can be transition to a memory care unit, or if it's just a refresh and maybe privatize some more other rooms to truck for Medicaid and higher acuity resident still all to be determinate and evaluate it.

Daniel Bernstein – Stifel, Nicolaus & Co., Inc.

And then, that's all from me. Thank you very much.

David J. Hegarty

Thank you.

Richard A. Doyle, Jr.

You're welcome.

Operator

And I will now turn it back to Mr. Dave Hegarty for the closing remarks.

David J. Hegarty

Well thank you all for joining us today. And we’ll be presenting at the Wells Fargo Midwest REIT Forum in Chicago in the middle of August. And Bank of America Merrill Lynch Global Real Estate Conference in mid-September in New York. So we look forward to updating you with those conferences, and talk with you again in late October for a third quarter results. Have a good day.

Operator

And ladies and gentlemen this will conclude our conference for today. We thank you for using the AT&T executive teleconference service. And you may now disconnect.

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