After closely analyzing every one of its senior housing assets, real estate investment trust HCP (NYSE: HCP) has hit the accelerator to create a portfolio that will outperform the broader industry in the coming years.
“It’s hard to predict too far into the future in senior housing, just given the uncertainty about continued new supply and labor cost,” HCP Chief Investment Officer Scott Brinker said Thursday on the company’s Q2 earnings call. “But our key metric is, are we doing better or worse in the industry, and historically we did worse. And we think we’re building the business that’s going to do better.”
The company’s quarterly earnings provided some evidence of this. Its funds from operations (FFO) per share of $0.44 beat consensus estimates, and it posted 3.1% same-store cash net operating income growth in its senior housing triple-net portfolio. The REIT’s leadership increased their 2019 FFO guidance, and HCP’s share price was up 2.57% to close regular trading at $32.75 per share on Wednesday.
“Quarterly results were largely better than expectations on stronger organic growth and faster investment pace, which we believe will translate into strength in 2H19,” Stifel analysts wrote in a note on the earnings. “We expect HCP to continue to improve portfolio quality by expanding its core strengths, transitioning underperforming assets and diversifying by operator and asset.”
Strategic plan for senior housing
HCP’s reinvention comes in the wake of major changes, including in leadership and portfolio composition, that occurred in recent years. Notably, the Irvine, California-based REIT spun out a large, troubled portfolio of properties managed by skilled nursing giant HCR ManorCare in 2016, and since then has been trying to diversify and upgrade its holdings.
Currently, its senior housing portfolio represents about 37% of HCP’s net operating income, with the remainder coming from medical office and life science assets.
During the past year, HCP created a strategic plan for each of its senior housing properties. After considering such factors as local supply and demand, competitive positioning and physical plant quality, the HCP team designated each senior housing property as core, redevelop or sell. The company categorized its operating partners as grow, maintain, reduce or exit.
So far in 2019, HCP has disposed of about $500 million worth of senior housing while acquiring about $900 million. In the second quarter, its moves included amending leases with Vero Beach, Florida-based Harbor Retirement Associates (HRA). HCP is selling six non-core HRA assets and combined its remaining eight HRA properties in a new master lease to mature in 2028.
Also in Q2, HCP renewed a 10-property master lease with Bellevue, Washington-based Aegis Living for an additional 10 years, with 3% annual escalators.
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In one example of a growing relationship, HCP during Q2 closed on a previously announced acquisition of three Oakmont Senior Living properties for $118 million, and in July closed on an additional $284 million acquisition of five recently built Oakmont properties in California.
“These were almost 70% pre-leased the day they opened,” HCP CEO Tom Herzog said on Wednesday’s call. “… We think California is a good place to do business long-term, and we’d like to do more with Oakmont going forward — very active, high-quality developer and operator.”
Leaders with the REIT expect to improve the senior housing portfolio through a mix of acquisitions, new development and redevelopment, with top operators and premium real estate. They also are rebalancing toward RIDEA; today, about 70% of HCP’s same-store senior housing pool is in triple-net leases and 30% is in RIDEA. That should be reversed within two years.
High construction costs are one constraint on growth, at least through new development — which is helpful from a big-picture perspective, insofar as this trend eases oversupply that has hit certain markets in recent years. Per-unit costs for the recent acquisition of a Discovery Senior Living portfolio ran to about $350,000 to $360,000 a unit; HCP is also building four properties with Discovery in those same markets, and all-in cost for one of those projects is about $380,000 per unit, Brinker noted.
While HCP’s senior housing revamp is proceeding at a quick pace, it will likely be 2021 before the REIT’s earnings numbers start to reflect the current moves being made, Brinker noted.
Meanwhile, expect activity to continue. HCP has about $500 million of purchasing power at the moment and a strong pipeline of potential opportunities in senior housing and other asset types.
“It comes back to a very, very disciplined and consistent team, and everybody here knows exactly what we’re going to do to really get there as fast as the capital markets permit,” Brinker said. “And right now, they’ve been pretty accommodating, so we’ve been able to accelerate that strategic plan, which is exciting.”