HCP, Inc. (NYSE:HCP) Nareit's REITweek 2019 Investor Conference June 5, 2019 8:45 AM ET
Tom Herzog - President & Chief Executive Officer
Pete Scott - Chief Financial Officer
Scott Brinker - Chief Investment Officer
Tom Klaritch - Chief Development & Operating Officer
Conference Call Participants
Nick Yulico - Scotiabank
Okay. It's 8:45, so we'll start. Welcome everyone to our next session with HCP. I am Nick Yulico, Head of the U.S. REIT Research Team at Scotiabank. We have HCP with us today, one of the leading health care REITs. Think what I'll do is, why don't I turn it over to you CEO, Tom Herzog and give a little introduction to the company and the rest of the management team here.
Great. Thanks Nick and good morning everybody. First of all I'll introduce our team. To my left is Pete Scott, our CFO. In his left is Scott Brinker, our Chief Investment Officer, and further to the left is Tom Klaritch, our Chief Development and Operating Officer. And of course Barbat Rogers, our IR person sitting in the front row in the audience.
So, I'll start with a summary of HCP. We own a $20 billion portfolio of high-quality private pay health care real estate in the three segments of medical office, life science, and senior housing. Each of these segments benefits from the explosive growth that's taking place in the baby boomer population.
37% of our NOI comes from senior housing currently and the balance is primarily split between MOBs and life science. MOBs that we own are primarily on campus and our life science properties are primarily located in San Francisco, San Diego, and Boston.
On the external front, we create significant growth from our development pipeline which is a $1.3 billion pipeline currently. We have over 60% of our properties that are pre-leased or development properties and $600 million of it has already been funded. Plus we have a shadow pipeline through our land bank that will result in $700 million plus of additional future development spend which we'll time as demand warrants.
Our balance sheet is strong. We have BBB+ Baa1 credit ratings, a net debt to EBITDA of 5.5 times. But we'll generally run it more toward the high fives. We're widely recognized as an industry leader in ESG and have had a decade-long focus around ESG. We've received numerous awards from all the prominent ESG reporting organizations. And recently we're named to the Corporate Responsibility Magazine's 100 Best Corporate Citizens List which was just recently in 2019.
After a three-year massive repositioning effort across virtually all components of our business we're now focused on accretive growth. As we've stated in the last earnings call, over the last couple of quarters, we've announced $1.4 billion of new acquisitions and new developments and we've also raised $0.75 billion of equity during that same time period.
Taking a closer look at our year-to-date 2019 activity, in senior housing, we rebalanced our portfolio with $550 million of acquisitions managed by two leading senior housing operators Discovery and Oakmont. You can expect to see us pursue additional senior housing opportunities as we go forward, but our concentration in senior housing will remain in the 35% to 40% range. It should be noted though at the same time that our disposition activities are primarily senior housing-related within the non-core part of that portfolio.
Importantly, as we think about senior housing, our portfolio will be increasingly weighted toward modern assets and strong markets with some great new operators.
Shifting to Life Science. Year-to-date, we have announced $100 million of acquisitions in Boston and plan to expand further there over time. In addition in the next few weeks, we'll close our $245 million Sierra Point Towers acquisition in South San Francisco. A large portion of our life science growth we are picking up through development activity and the development pipeline in life science specifically is $1.2 billion. Our life science development projects are delivering -- that are delivering in 2019 and 2020 are currently 100% pre-leased.
In the medical office, we are further expanding our proprietary program with HCA through the addition of three new development projects that sum up to $70 million in estimated spend. In that program, 50% to 70% of each of the properties that we develop are going to be leased by HCA, which makes of course the balance of the properties a lot easier to lease through tenant demand when you've got an anchor tenant, such as HCA. That relationship with HCA for us spans three decades, and we do expect that program to yield about $100 million of new development project starts per year for the next few years.
With our portfolio repositioning now completed our strong balance sheet; we are now very well positioned for growth. But not just for the sake of growth, rather we are focused on accretive risk-adjusted investments that will drive strong TSR over time.
So with that Nick, I'll turn it over to you for Q&A.
Q - Nick Yulico
All right. Great. I'll ask some questions to start us off, and then if we have any in the room we'll go to those as well. So why don't we start off with the Life Science segment? I think one of the things we like about stories is your expanding exposure to this segment. And you have a development pipeline. You've also done some very interesting acquisitions that have some future development opportunities, some redevelopment as well. Maybe Pete, do you want to go through the Life Science segment a little bit? Remind us kind of your market exposures? What are sort of demand trends? And what are the projects you have underway right now?
Yes. Thanks, happy to take that. So our portfolio is concentrated in three markets: San Francisco, San Diego and Boston. San Francisco is our biggest market by far, especially in South San Francisco. We have about four million to five million square feet. It's growing with some of our development projects there. We have The Cove, which we've now fully leased that and delivered the first two phases. The third phase is delivering now. The fourth phase will deliver next year.
And then we have our cousin development to The Cove called The Shore, which is about a 10-minute walk away from there. The first phase is fully pre-leased at this point in time. We've accelerated the second and third phases of that as well and have a lot of interest from tenants on that project.
In San Diego, it's about two million, 2.5 million square feet. We have our big exposure in the Torrey Pines submarket, which we think is the top submarket within that overall market there. And that's an area where we had some redevelopments as well as a big development project; we'll look to kick off over the next year or so, which we're calling The Boardwalk. More to come on that.
And then Boston is a new market for us. When I started at HCP about two and half years ago, we didn't have any exposure in the Boston market. We now have about 500,000 square feet of in-place properties and a couple of development opportunities as well there. That market is doing quite well for us. We have a partnership with King Street Partners there. They're our local boots on the ground. We would like to continue to grow in that market to get to scale. We think it's quite important to be at scale within each one of our markets to satisfy tenant demand as they grow and can grow with us. So that's certainly a market we've earmarked for some additional growth.
And Tom as we think about the company right now you have the mix of senior housing, medical office, life science, I mean, how do you think about the appropriate mix between those three segments going forward?
Yeah, Nick. I think we'll stay in the 35% to 40% mix for senior housing. The balance splits somewhere between life science and medical office. Currently, finding life science easier to grow in than medical office, there's more opportunity for us. We've had a lot of really great development opportunities through the current pipeline that we have through the land bank. In medical office, pricing has been a little bit tighter and the opportunities for the on-campus type product that we prefer have been fewer, so we have tended more toward development of MOB like I said earlier with HCA. But we really will stick with the private pay components of health care real-estate in those three segments. We believe in the baby boomer growth creating huge demand over time. We don't like the stroke of the pan risk that comes with the government reimbursed-type product, so we will stick with those three segments and probably roughing in those proportions. But I will tell you, as time goes forward opportunistically, it will always look a little bit different than it feels today. But that's our intent as we sit here today.
Senior Housing, you made investment with Discovery recently. I know, it was a recycling of capital, but it also felt like it was your biggest acquisition in senior housing in some time. By debate about what's going on with senior housing whether we're near a trough on fundamentals as whether the supply impact is going to ease. I mean, what got you excited about the Discovery acquisition? And what are you – what's your view on senior housing right now?
Yeah. Last quarter we did make two fairly large acquisitions in senior housing and after being a big seller of senior housing in the previous three years. And I would say the – our outlook on the fundamentals in the business are more favorable today than they would have been 18 months ago, but that wasn't the primary driver for the acquisition. One of the unique things about senior housing is the very wide disparity in performance either by market or by operator and Discovery has been really a leader in the Southeast Florida in particular in that particular property type. They like to do large continuum of care campuses. They've done it successfully for two decades and they've been a strong performer throughout.
So it was more driven by the fact that, it's modern real-estate it's three years old, it's exactly what we want to own, and I would say high barrier to entry markets but high-growth markets, and importantly campuses that Discovery will be excellent at operating for a long period of time. So we view this as a decade-plus ownership for HCP and a good example of how we're intending to remake our senior housing business incrementally and over time.
For sure we do feel like the fundamentals front looking from where we sit today are better than they would've been 18 months ago. And we do expect to see some strong growth out of that portfolio as well as the Oakmont portfolio that we also acquired in the second quarter.
And can you talk a little bit about the amount of capital right now that you're competing with as you're looking at Senior Housing transactions in the market? And we've gotten a sense that there's a lot of capital that wants to get into Senior Housing. So how competitive is it? What are the cap rates? And how are you able to make a mark and line up with operators and build that business?
Yes. I mean there's -- continues to be strong interest in all three of our asset classes really. I mean medical office on campus is still going to be bid into the low 5s, if not below. Life science the most recent trends in the core markets have been in the low 4s. So a strong interest in those two segments for sure.
In Senior Housing the interest is primarily from the public REITs. I mean the -- their cost of capital is more favorable. And you saw one of the big REITs did a big acquisition announced yesterday at a mid-5 cap. Those are good assets. And it to me underscores the fact that there is a lot of interest in the segment.
The other activity that we've seen for higher quality properties in Senior Housing even if the assets are 10 and 20 years old cap rates in the mid-5s, maybe the high-5s, so it made us feel really good about the two acquisitions that we made recently given the age of the assets as well as the locations with yields in the mid-5s and up to 6%. That's stabilization for branded product.
Yes. It almost feels like -- to me that your -- we're starting to see a little bit of cap rate compression in Senior Housing and maybe in other aspects of health care real estate. Would you agree with that?
Yes. I'm not sure if there's compression there may be especially in Senior Housing where private equity has always been one of the big buyer pools and the cost of debt today is really low which is attractive to them.
So there's been more than $10 billion of private equity raised specifically for Senior Housing in the last two years and that doesn't even account for the KKRs or the Apollos or the TPGs that are targeting Senior Housing but it is part of a broader investment pool. So there are certainly a lot of demand, I don't know if cap rates have gone down but they're certainly not going up.
As we think about Tom the medical office business, the partnership you have with HCAs talk a little bit about how that came about and what's the opportunity going forward?
Sure. The -- we've been in discussions with HCA for about a year. They really had a pent-up demand for additional medical office space in a number of their campuses. And we were able to work -- to put the program together where we would build where they had the need across the -- their portfolio across the country.
And we started that with one building in Myrtle Beach. That project has gone very well. It started out with the assumption that it would be 47% pre-leased. We're almost to 95% pre-leased on that asset. And we recently started another three projects this past quarter. Looking forward we anticipate that program to develop about $70 million to $100 million in development spend over the next at least four to five years at this point.
And the yields you're getting on that?
The yields have been in the 7% to 7.5% range, so pretty strong yields on those.
Okay. I guess turning to maybe operators for a bit. I mean operators are a big topic in health care often. You still have a meaningful exposure to Brookdale. Maybe you can give us an update on where that relationship sits? And then, as we think about the rest of the senior housing net lease operators you have, how people should think about whether there's more conversion to RIDEA as you've done or maybe asset sales to deal with -- address some of that exposure?
It's Tom Herzog, I'll start and then I'm going to turn it over to Scott Brinker. As to Brookdale, our concentration at year-end will fall below 15% as a result of growth in our portfolio. I break that down into three buckets. We have the SHOP exposure, which is something less than 5%. We have the triple-net exposure, which is something greater than 5% call it 5.5%. And then we have some CCRCs. The SHOP, we have sold hundreds of millions of dollars or really you could quantify it in the low billions of assets from these pools with Brookdale and have kept the best of the SHOP assets that we have within our portfolio and feel that Brookdale has an opportunity to manage those well.
From the triple-net perspective, we do have the Brookdale credit, which looks to be in fine shape. So those lease terms are 5- to 7-plus years. So we feel fine there. And the CCRCs are less exposed to the new supply that's coming on the market. And they've done a nice job operating those. So we're comfortable for the time being and we're working closely with Cindy and her team. And so we're hoping that that plays through well as we go forward. There's certainly going to be some upside. From the standpoint of operators and how you're looking at it, Scott, why don't I turn that over to you?
Yes. A couple of comments on operators. We historically had what we've referred to as a barbell where we had 25 operators over 250 properties, but it did not average 10 a piece, it was more like very high concentration with one or two on one and -- extreme end of the barbell and then 10 to 15 really small relationships and one of our strategic goals over the past year or two and going forward is to reduce the pool of operators new visits with from 25 down to 10 to 15. And we want to have critical mass with each one, but not overconcentration. We want to make sure that we're important to them and that they're important to us. And we have seen operators get better or worse over time as they have new leadership, new strategy, new ownership. So we're trying to maintain flexibility in all of our contracts to accommodate that.
And then the triple-net portfolio you asked about -- Tom talked about the Brookdale exposure. That's the vast majority of our triple-net rent is from Brookdale. Historically, HCP's senior housing portfolio was about two-third triple-net and the balance was RIDEA. Last quarter, we announced two conversions of existing assets from triple-net to RIDEA with Sunrise and Oakmont. Those conversions were done by choice, so that was not by a necessity; it's actually modestly accretive, not dilutive. High-quality operators, high-quality properties and today our mix is closer to 50-50. And when you think about that 50%, it's still triple-net in addition to Brookdale. We really have three major tenants beyond Brookdale.
One is Aegis, which is a high-quality provider on the West Coast, primarily in Seattle and California. That lease matures next year, but it has strong rent cover and we expect them to renew the lease, which should be a good outcome and we're happy to continue owning those assets and Aegis does a really good job managing them.
We have another lease it also has about $20 million of rent similar to Aegis with HRA. And we've actually restructured that agreement, so that we can create a more stable master lease going forward. We'll end up selling roughly half of the portfolio and holding the other half and HRA does a good job with those assets. So we feel like we've successfully restructured that one to move forward.
And then the final meaningful lease within the portfolio is with Capital Senior Living. And that's actually two separate leases. Most of the rent, which is about $20 million a year, matures next October. And the rent covers a little bit below 1.0. That's all in the supplemental. So there are no secrets there and we have active dialogue with Capital Senior Living about how best to deal with those assets. I think their likelihood is that they will not renew that lease and that we would end up selling a handful of the buildings that we don't think are long-term performers. And others we actually like the assets but feel like maybe another operator would be better positioned geographically to manage them. So I think that's the likely outcome with that. And that accounts around 95% of the triple-net rent if not more. So I'll probably leave it at that.
So one of the interesting aspects to the company, I think is you've done a lot on -- with the balance sheet. You've done a lot to address some operator issues you had to deal with. It feels like you're back on the path towards earnings growth, dividend growth. Maybe you can talk about what are some of the components that's going to drive that as you get over the next couple of years. We have development deliveries, how much acquisitions may help? And perhaps those wealth -- how should we think about core growth within the segments?
Yeah. So, as we look at the company that we were seeking to put together over the last few years as we came together as a team and we modified our strategy, we put in place a new C-Suite, we've sold $12 billion of assets within the portfolio we delevered refreshed the board. It really was a restart.
Our vision was that we would own like I said earlier, three core private pay segments within health care. And we would be clearly in the real estate business of high quality real estate with long-term growth prospects. So that took a lot of discipline to get to that place because a lot of these moves were dilutive and came with a degree of pain. But we have turned the corner on that.
As we look forward now, we do have a high-quality portfolio that we expect will produce good growth. We have good relationships with partners and operators to be able to work with some of the real high quality folks out there as we continue to grow our portfolio in a positive way with the types of folks that we want to do business with over the long-term. And we have a balance sheet in place that is going to allow us to do this on a very safe basis.
So as we approach the business, we do it from the standpoint of a REIT that has I think good growth prospects and we will grow as we're trading at a premium and we can do so accretively. But at the same time with a bit of a conservative bent to how we go at it. And we think that there is a place for many investors for a REIT that is set forth with that type of a game plan. So that's how we're going at it
Why don't we see, are there are any questions in the room?
Did I -- I think I'll repeat that. You're talking about the development potential in South San Francisco and land values and how we're feeling about demand and the like. Is that the question? I'll turn that to Pete Scott and Tom Klaritch.
Yeah. Its good question and I mentioned The Cove and The Shore before. So, The Cove, we bought the land in 2011 and began development of that project in 2014. When we began the project, the underwritten return on cost was around 7%. Given where rental rates have gone and the success we've had leasing up that project, we're actually looking at north of 8% now in the low 8s. And the two phases that will deliver the third and the fourth phase are actually going to be in the 9s. There are lower returns on the first two phases, because there's some infrastructure work that we put in. Parking garage in the second phase and then also in the first phase we built all of the amenities out as well. So, really, really strong yields on that project.
At The Shore, the yields are in the low to mid-6s on that, which is still quite strong relative to cap rates. That's land that we have owned for over a decade. And the basis was quite high if you were to look at more of a market value on that land. When we started the construction there, our yields would've been on a cost basis in the low to mid-7s on that. Although even with the higher basis, it's still quite strong in the 6s.
What are the key differences between you and Alexandria in your Life Science business? Thank you.
Yeah. When you think about our Life Science business, it's actually a big differentiator for HCP. We have a significant concentration in South San Francisco. We actually are the dominant landlord within that market. If you think about the San Diego market, we have a strong presence in the San Diego market. Although, we're probably number three from a size perspective relative to the other large landlords Alexandria being one, BioMed being the other.
And then in Boston, as I mentioned, we've started accumulating properties in that market. We're not focusing on the East Cambridge market. We're focusing on the West Cambridge, as well as the suburban markets, Lexington being the location of our Hayden development there. So, that's an area of growth for us. We're clearly not as big as some of our competitors in that market. But to sum it up, dominant landlord in South San Francisco, a strong position in San Diego and a growing position in Boston.
Maybe just a question on the dividend. You've had a stable dividend for a few years if you've worked through the company transformation. It feels like you have some embedded growth in your portfolio. So, how should we think about potential for dividend growth going forward?
This is Pete again. I can take a stab at that. Our dividend is at $1.48 right now. Annually, the payout ratio is in the mid-90s, although fully covered. As we see earnings growth in 2020 relative to 2019 as well as in 2021, a lot of that is driven too by the development pipeline and the deliveries especially the fact that they're pre-leased. We do see earnings growth as we look forward. We would like to get our payout ratio back into the 80s. So I would not anticipate the dividend growing lockstep with earnings. Obviously, it's something we'll evaluate as we get to the end of year and have discussions with our Board, who ultimately determines the dividend.
Any final thoughts you guys want to leave with the investors in the room?
Well, I guess I would be repeating myself. But we went through quite a transformation in the evolution of HCP. And we really have got it positioned in a place from a portfolio, balance sheet and team perspective, along with having built a lot of systems and have cut a place that we think positions us very well to grow in the future. We're going to do so carefully, but we're very excited about where we're headed. So thank you guys for attending. Much appreciated.