Birth of a REIT: Taking Stock of HCP and Its Spin Off

The skilled nursing spin-off of real estate investment trust HCP Inc. (NYSE: HCP) officially has been completed and is set to begin regular trading on Nov. 1.

While early trading will send some signals about what investors think of the spin-off, the success for Irvine, California-based HCP and its new entity, Quality Care Properties (QCP), will be determined over the next few years as both REITs take steps to stabilize their portfolios and capture shareholder value.

HCP’s Position 

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It will likely take years before it’s determined whether the spin is successful, and will require both HCP and QCP to make strategic changes. The most immediate impact will be to shareholders, who will receive one QCP share for every five shares of HCP they own.

Over the past few years, HCP has fallen behind its two main competitors, Welltower Inc. (NYSE: HCN) and Ventas Inc. (NYSE: VTR), and its stock has underperformed by comparison over a longer time period, according to a report from Green Street Advisors.

“In the short term, to HCP shareholders, success will likely be that the price of HCP stock after the spin and the QCP share price combined exceed the pre-spin price,” Britton Costa, an analyst with Fitch Ratings, told Senior Housing News. “Next is that the SpinCo [QCP] is able to once and for all resolve the issues that HCR ManorCare is facing to place both the tenant and the SpinCo on fairly stable footing, and grow it like any other REIT to diversify its portfolio in the long term.”

Once the spin is completed and ManorCare vacates HCP’s portfolio, the health care REIT will still have uphill battles to regain the ground it has lost, including managing its portfolio concentrations, recapturing shareholder value and finding a new top executive.

The REIT has undergone major executive shakeups as of late, including the departure of its CEO Lauralee Martin just as the spin was announced. In the midst of this major portfolio transition, the REIT is looking for a new CEO, which is expected to happen in the next year or so, Green Street says. Mike McKee, a 30-plus-year board member, began serving as HCP’s interim CEO in July.

One of the top concerns for HCP is its significant concentration of assets with Brookdale Senior Living (NYSE: BKD), the nation’s largest senior living operator. Post-spin, Brookdale, as a lessee or manager of HCP’s senior housing assets, will constitute about one-third of the REIT’s portfolio—a concentration significantly higher than HCP rivals Ventas and Welltower have with any one operating partner, according to the Green Street Advisors report.

By comparison, Welltower’s largest concentration of one operator is Sunrise Senior Living, at 15% of its portfolio; and Ventas’ operator Atria is 20% of its portfolio. Welltower, which has also struggled with one of its skilled nursing operators, Genesis Healthcare (NYSE: GEN), has only 14% exposure in comparison to the rest of its portfolio.

Reducing the Brookdale concentration will likely be a priority for HCP executives once the spin is complete, according to Knott.

“You’ve seen what can happen, when ManorCare had stumbles,” Green Street analyst Michael Knott told SHN. “When you have such a large concentration, you’re taking a lot of risks. It will take a long time to whittle that down, but every bit you can bring down [the concentration] is probably a good thing.”

The whittling down will likely incorporate several elements, including assets sales, a transition to other operators and the some conversions from triple-net to RIDEA, according to Knott.

“Their objective by doing all those things will be to reduce the concentration of Brookdale and improve the lease coverage they have now,” Knott said. “The third objective would be to raise proceeds from sales to reposition the balance sheet a little, which has been stretched after the spin.”

HCP is planning to raise $3.8 billion in proceeds through, in part, $900 million of pending or planned dispositions, Green Street reported. A significant sale of Brookdale assets could be in the offing, but chatter has it that the cap rate may be on the high side given the poor rent coverage and overall concerns about Brookdale, and larger senior housing issues such as fears of oversupply.

HCP has been a blue-chip stock for more than two decades, and its current struggles could potentially be offset by its strengths. Though, regaining ground will take time, likely several years, according to Knott.

“The company has a long way to go to prove it can be in the same discussion as Ventas and Welltower, both of which have admirable track records (especially Ventas) and platforms (HCN’s operator/partner stable is impressive; HCP seems inclined to gravitate toward this model),” the Green Street report reads. “However, there are talented pieces in pace at HCP, giving some well-founded reason for optimism that those pieces are gelling and will provide the firm an ability to begin catching up to its talented peers over time.

QCP’s Position

While it may seem like an easy comparison between HCP’s spin-off and that of Chicago-based Ventas Inc., which spun off its skilled nursing assets in 2015, the two health care REITs differ widely in the reasoning.

When Ventas spun off Care Capital Properties (NYSE: CCP), the market conditions may have allowed for greater rewards for its skilled nursing assets in a separate entity, while also helping Ventas’ core portfolio increase its private pay exposure.

“It’s a very different market and a very different motivation,” Knott said. “For Ventas, at the time the skilled nursing spin of CCP was announced, skilled nursing REITs were traded very richly. It was primarily a valuation-driven exercise. But, secondarily, Ventas had been aiming to reduce its government reimbursement profile and increase its private pay.”

Ventas also saw an opportunity in the space to act as a consolidator, as fundamentals in the skilled nursing industry were shifting, an opportunity not cited by HCP executives.

“Other than both being skilled nursing spin-offs from health care REITs, the similarities are few and far between,” Costa said. “In the case of Care Capital, Ventas didn’t want to have exposure to skilled nursing going forward, but thought there was opportunity to be a consolidator in the industry.”

HCP, by contrast, has been motivated almost solely by the need to get the ManorCare assets out of the portfolio, Costa added. It’s a point Knott echoed.

“By contrast, HCP’s spin out had nothing to do with the valuation environment and everything to do with the need to create flexibility and isolation,” Knott says. “There couldn’t be more different motivations between the two.”

Starting out as a REIT with one major tenant, let alone a troubled one like ManorCare, makes QCP an outlier.

“There are pure play REITs in all health care verticals; being sector-focused isn’t necessarily unique, but being a pure play REIT when it comes to a tenant is pretty unique,” Costa said.

QCP executives have several options to strengthen the value of its skilled nursing assets and potentially diversify its portfolio going forward, however, in part because of the current valuations of skilled nursing assets and the position of REITs. The biggest players have absented themselves from dealmaking for the majority of the year, as high prices have coincided with erosion in their cost of capital advantages. That is, even if it was not a primary motivation in the spin-off, QCP still could play a consolidator role.

“For skilled nursing pure play right now you have the opportunity to grow in a fragmented market that the biggest health care REITs have largely stepped out of,” Costa said.

Mark Ordan, formerly CEO of Sunrise Senior Living, has been selected to lead QCP. Ordan’s strength as a “turnaround artist” is something investors can look forward to as the new REIT breaks out. Ordan has been hailed as the “King of the Comeback” for his work with Sunrise, which turned its debt-laiden balance sheet around and saw its stock price more than double during his time there. Though it may not be obvious that the current strategy can turn QCP from an ugly duckling into a swan, Ordan’s presence may signal to investors it can be pulled off.

Written by Amy Baxter

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