‘Barely Recognizable’ HCP Endures Painful Brookdale Transitions To Re-Make Portfolio

Last month, HCP (NYSE: HCP) President and CEO Tom Herzog declared the Irvine, California-based healthcare real estate investment trust (REIT) was “back to playing offense” after a nearly two-year makeover of its portfolio, executive team and board. Those plans came more into focus Wednesday during HCP’s Q3 earnings call.

“The HCP of today is barely recognizable from the HCP of a few years ago,” Herzog said during the call.

For the quarter, HCP generated net income of $98.9 million, or $0.21 per share. Funds from operations (FFO) came in at $155.6 million, or $0.33 per share, and adjusted FFO was $0.44 per share. Total revenue was $456 million, up slightly from Q3 2017’s $454 million.


The earnings report and HCP’s ongoing repositioning efforts — including reducing its exposure to properties operated by Brookdale Senior Living (NYSE: BKD) and the pending, newly announced $1 billion disposition of Shoreline Technology Center in Mountain View, California — led Standard & Poor’s to upgrade HCP’s corporate credit rating to BBB+. The upgrade positively impacts pricing on HCP’s $2 billion unsecured credit facility, reduces the spread to 87.5 basis points from 100 basis points over LIBOR, and lowers the facility fee from 20 basis points to 15.

HCP’s Brookdale transition is almost complete

During a September presentation at Bank of America Merrill Lynch 2018 Global Real Estate Conference in New York City, Herzog announced HCP has reduced its exposure to Brentwood, Tennessee-based Brookdale assets from 34% to 21%, and is on pace to reach a target 16% pro forma. It completed the sale of 17 senior housing communities to an investment fund managed by affiliates of Apollo Global Management for $264 million and expects the remaining two assets in the portfolio to close by year-end for approximately $113 million.


HCP also has completed 35 senior housing operator transitions from Brookdale, and expects to complete another four by year-end, according to Herzog’s comments in September as well as supplemental information released in conjunction with the Q3 earnings on Wednesday.

As a result of this activity, same-store net operating income (NOI) from HCP’s senior housing triple-net lease portfolio increased 1.6% in Q3, while same store senior housing operating portfolio (SHOP) NOI decreased by 6.3%, HCP Chief Financial Officer Pete Scott said Wednesday during a call with investors and analysts.

“This is in line with our expectations and takes into account the previously announced rent adjustment with Brookdale,” Scott said.

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The Brookdale transition contributed to a wide performance disparity between HCP’s SHOP core assets and transition assets. The core portfolio’s same-store cash NOI growth increased 4.1% in Q3, while the performance of transition assets declined by 24.8% during the same timeframe.

“The transition from Brookdale to new operators has been painful,” Herzog said.

HCP has made rapid progress remaking its senior housing portfolio, Chief Investment Officer Scott Brinker said. In addition to the Brookdale transition and the dispositions, the REIT is redeveloping eight more transition assets, valued at $70 million, in an attempt to modernize the portfolio. The renovations include revived physical plants and installing more focused operators, which will allow HCP to make up for lost revenues down the line.

“We expect low double digit returns on cost,” Brinker said.

Cost was a primary factor in HCP’s poor transition property NOI, Brinker said. At those properties, HCP incurred higher expenses from overtime and contract labor costs, repair and maintenance expenditures to bring some properties back up to speed, and miscellaneous expenses such as insurance and writing off bad debt. There was 50% turnover of executive directors at these sites. All of this had an effect on occupancy, but now that new operators are in place and turnaround efforts are gaining traction, the outlook has improved.

“Occupancy decreased by 400 basis points, and with a 20% operating margin, there is a multiplier effect,” Brinker said. “We believe with these assets now stabilized, we can recapture these lost revenues over time.”

HCP’s transition portfolio has established operators such as Atria Senior Living, Sunrise Senior Living, Elmcroft by Eclipse Senior Living, Discovery Senior Living and Sonata taking over from Brookdale.

The core SHOP performance was a pleasant surprise. HCP’s core portfolio is small, at 32 properties, but it is stabilized with solid operators. Brinker specifically cited Sonata Senior Living, which assumed operations for four HCP-owned assisted living communities in South Florida in December 2016, as one reason the core portfolio’s performance was so positive.

Future triple-net to SHOP transitions, strategic acquisitions

HCP’s same-store triple-net NOI performance was in line with the REIT’s expectations, Scott said. But there is opportunity to increase the overall senior housing portfolio performance by moving away from triple-net in future lease structures.

Two-thirds of HCP’s senior housing portfolio is triple-net lease, the rents are being paid and the asset quality of this part of the portfolio is in good condition, Scott said. Moreover, the operating partners associated with these properties are high quality.

“This is the foundation for a good SHOP relationship,” Scott said. “It may be a good time to convert the leases over the next couple years, once business takes off again.”

Lease conversion negotiations may begin next year. Three leases are set to expire in 2020, and Scott said while there is nothing imminent, there is active ongoing dialogue with the operators, with Sunrise as one potential candidate for RIDEA conversion. For now, HCP is content to be patient while new senior housing construction slows. New starts have declined for three straight quarters, Brinker said. Deliveries will remain elevated through late 2019, but the demand-supply balance will begin to look more attractive.

Currently, HCP is skewed toward medical office and life science, which account for about 60% of the overall portfolio. Ultimately, the REIT expects to expand its senior housing portfolio through acquisitions again.

“In senior housing the landscape is changing quite dramatically and will continue to because of the operating environment and other factors,” Brinker said. “At some point there will be a tremendous opportunity to grow that business. We’ve been quite focused on capturing value, positioning ourselves to capture value from the assets we already own. But we are starting to think about perhaps external growth at the right time. I don’t think that’s tomorrow, but I do think you’ll see us be very active in that space as well over time.”

Written by Chuck Sudo

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