HCP Starts Recovery After ‘Major Surgery’

After engaging in a “complex and multifaceted journey” to recovery, one of the biggest health care real estate investment trusts (REITs) has reached a turning point with its recent accomplishments and is ready to move forward.

HCP Inc. (NYSE: HCP) completed its spinoff of Quality Care Properties (NYSE: QCP)— its skilled nursing assets with troubled tenant HCR ManorCare—and announced a major disposition of 64 properties leased by Brookdale Senior Living (NYSE: BKD) for $1.125 billion. The actions are part of the long-standing efforts to right a ship that has experienced significant challenges in the last few years.

With these initiatives completed, the REIT is still facing some lingering issues, but is ending the year with some accomplishments under its belt. In other words, the REIT has gone through “major surgery, but the patient’s looking good,” one analyst said of the changes during a quarterly earnings call with HCP executives Tuesday.

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Overhanging Issues

The Brookdale deal reduces HCP’s concentration with the senior living operator from 35% of its portfolio post-spin to 27% once the transaction is completed. It’s a significant step in the REIT’s goal of achieving a target range of 20% to 25% exposure to the tenant.

Analysts agreed that the REIT was making progress with its goals upon announcing the 64-property sale, though ongoing changes still make HCP a less certain bet than its industry peers, Ventas Inc. (NYSE: VTR) and Welltower Inc. (NYSE: HCN).

Still at the top of the to-do list for the REIT, which executives have been touting as “HCP 3.0” in wake of its ongoing revamp, is choosing a new chief executive officer, which is something that will be announced in the coming weeks and definitely by the end of the year, Interim CEO and President Mike McKee, who also is chairman of the board, stated Tuesday.

“HCP moved decisively to address some of its Brookdale issues, accomplishing a lot with its transactions,” Michael Knott, analyst with Green Street Advisors, told Senior Housing News. “The company has been in a state of evolution. That next handoff is a transition within that evolution, but it does inject more uncertainty than at Ventas or Welltower.”

At the same time, HCP is exiting an additional 25 non-strategic properties leased with Brookdale, which will either be transitioned to another operator or sold. Executives also noted that there is some flexibility in how the assets will change hands, with HCP adding up to potentially three new operators to the portfolio. From those dispositions and transitions, HCP expects $160 million to $170 million in proceeds.

“We sat together and agreed on 25 assets that were non-strategic to Brookdale, generally non-strategic to HCP,” Justin Hutchens, CIO of HCP, said during the earnings call. “The majority of those assets we will sell. They’re underwater. …There’s a few we may keep where it wasn’t a core market for Brookdale, but it fills in for a different operator, primarily some regional operators.”

To reach the target Brookdale concentration range of 20% to 25%, HCP executives stated they had no immediate plans to divest other Brookdale properties. Though, they noted that further reducing the Brookdale concentration could come naturally as the REIT continues to reposition itself.

“We’re going to monitor that portfolio very closely, as we have been,” McKee said. “We’re in almost daily communication with the team at Brookdale and that will continue. The natural flow here coming out of what we’ve accomplished is going to naturally reduce that concentration.”

Supply Headwinds

Prioritizing a reduction of its Brookdale concentration makes sense for HCP, as Brookdale’s latest quarterly earnings reveal.

Brookale reported a dismal third quarter, with competitors taking an “unprecedented” bite out of the nation’s largest senior living provider’s earnings. Brookdale’s stock was down nearly 20% by end of day trading on Tuesday. Brookdale is seeing the “highest numbers of new competitors” in its secondary markets, CEO Andy Smith said Tuesday.

However, HCP executives were more bullish on oversupply concerns, stating that the REIT is more insulated due to its specific senior living segments. Compared to assisted living, absorption in independent living was higher in the third quarter, according to data from the National Investment Center for Seniors Housing & Care (NIC). Of HCP’s triple-net senior housing portfolio, 70% is assisted living, and the remainder are independent living and CCRC assets.

“2017 could carry the brunt of new supply as it pertains to assisted living,” Hutchens said. “When we stepped back at looked at our portfolio …. we feel that we’ll be less impacted that the general industry because of the segments we’re in— independent living and CCRC. And some impact in assisted living, but that has been factored into the outlook.”

With competition becoming an increasing problem for Brookdale, HCP’s exposure, even at 27% of its portfolio, is notably high when compared against its health care peers, Ventas Inc. (NYSE: VTR) and Welltower Inc. (NYSE: HCN).

“At one point, [HCP] had 45% exposure to Brookdale and ManorCare,” John Kim, an analyst with BMO Capital Markets, told Senior Housing News. “To reduce [the Broodkale concentration] to 25%, honestly it’s still high relative to other REITs. It’s pretty significant. …While coverage is high, it’s definitely better than it was before.”

However, not all senior living real estate operators are seeing the same impact as Brookdale. Capital Senior Living (NYSE: CSU), which operates about 130 communities compared to Brookdale’s 1,100 communities, reported strong demand and record move-ins during September. The company may be less exposed to supply headwinds due to the markets it operates within—it has only a handful of communities in three of the top 10 metro areas with the highest levels of construction versus inventory identified by NIC.

‘Handcuffed’ by Position

Looking ahead, HCP expects improvements in its senior housing operating portfolio (SHOP). In 2017, HCP will have 190 additional units on line that were out of commission during 2016, according to Hutchens.

“They were being repurposed,” Hutchens said of the units. “They will open in 2017 and will be repurposed to independent living, memory care, assisted living and even a little bit of sub-acute. The benefit of filling those units is being factored into the SHOP forecast. It’s about 25% of that forecast.”

The REIT also completed $254 million in acquisitions during the third quarter, including a previously announced $186 million portfolio of seven properties on the East Coast and two life sciences building in San Diego, California, for $49 million.

While HCP appears to be checking items off its to-do list, there is not much room for growth until its remaining overhanging issues have come to a head, which may be holding back the REIT from being acquisitive.

“[They are] a little bit handcuffed because of their leverage,” Kim said. “Net EBITDA is still above six times. That doesn’t provide them the opportunity to acquire, and the share price is down. Cost of capital hasn’t improved.”

HCP anticipates using proceeds from the spinoff and Brookdale sale to deleverage the company. These latest transactions, in addition to the 25 Brookdale assets HCP is transitioning or selling, will improve the company’s balance sheet by paying down its credit line and maturing debt. The balance sheet has been a top priority for the REIT since it began announcing the wave of changes.

“Near-term growth in earnings will be restrained by some of the other more important objectives that need [to be] accomplished for the sake of maximizing long-term value,” Knott said.

For the third quarter 2016, the blue chip REIT announced a dividend payout of  $0.37 per share. It reported FFO of $0.65, missing analysts’ expectations by $0.06. Though, the REIT beat revenue expectations by $19.5 million, reporting third quarter revenue of $654.3 million—a drop of 0.6% on a year-over-year comparison.

HCP’s stock trended up on Tuesday following the earnings release, but sagged slightly on Wednesday below $30 per share. HCP’s stock price hit above $36 per share as recently as September.

Written by Amy Baxter

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