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Good morning, and welcome to the HCP, Incorporated First Quarter Conference Call. All participants will be in a listen-only mode. [Operator Instructions] And as a note, this event is being recorded.
I would now like to turn the conference over to Andrew Johns, Vice President of Finance and Investor Relations. Please go ahead.
Thank you, and welcome to HCP's first quarter financial results conference call. Today's conference call will contain certain forward-looking statements. Although we believe the expectations reflected in any forward-looking statements are based on reasonable assumptions, our forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from expectations.
A discussion of risks and risk factors is included in our press release and detailed in our filings with the SEC. We do not undertake a duty to update any forward-looking statements. Certain non-GAAP financial measures will be discussed on this call. In an exhibit of the 8-K we furnished with the SEC, we have reconciled all non-GAAP financial measures to the most directly comparable GAAP measures in accordance with Reg G requirements. This exhibit is also available at our Web site at www.hcpi.com.
I will now turn the call over to our President and Chief Executive Officer, Tom Herzog.
Thanks, Andrew, and good morning everyone. With me today are Pete Scott, our Chief Financial Officer; and Scott Brinker, our Chief Investment Officer. Also here and available for the Q&A portion of the call are Tom Klaritch, our Chief Development and Operating Officer and Troy McHenry, our General Counsel.
Our first quarter results were in line with our expectations, and last night, we reaffirmed both our full-year FFO as adjusted and total portfolio same property cash NOI guidance. During the first four month of 2019, we were active on the investment front with activities launched across all three lines of business. Our capital allocation and investments have been driven primarily by our strong relationships with top tier partners. We are also advance discussions on additional acquisition opportunities but are not yet in position to provide detail. However, we are confident in there completion. And as a result have raised the necessary funding capacity with our recent forward ATM activity.
In Life Science, we closed on the previously announced acquisition of Cambridge Park Drive in Boston, and are on track to close this quarter on the acquisition of Sierra Point towers in South San Francisco. These transactions expand our portfolio of high quality Life Science assets. Benefit from the strong sector fundamentals and offer attractive initial yields with potential for future upside through identification and development opportunities.
In Medical Office, we added three new projects to our HCA development program, bringing the total to approximate $100 million. This program allows HCA to meet demand at some of the most successful campuses will provide HCP new MOB investment opportunities that benefit from significant pre-leasing of HCA as our strong anchor tenant. In Senior Housing, the transactions with Discovery in Oakmont creates strategic SHOP relationships with two top tier operators plus improve our portfolio with new Class A assets and strong markets.
Scott has longstanding relationships with both of these operators. And their advanced infrastructures, market expertise and long and successful track records make them excellent additions to our group of preferred operators. In summary, we are pleased by the strong start we had to the year. Our earnings and same store performance are on track. Our Life Science and MOB businesses are performing a bit better than expected.
And while there continues to be softness in senior housing fundamentals, our senior housing performance was relatively in line with our expectations. We have locked in our 2019 acquisition goals and have an attractive acquisition pipeline. Our development projects are progressing ahead of expectation. And our balance sheet is tracking in line with out stated commitment.
Before I turn it to Pete, I would like acknowledge the contributions of two of our directors who retired from our board last week at our annual meeting. Pete Rhein, our Director since our IPO 34 years ago and Joe Sullivan who joined our board in 2004. We are thankful for their many contributions to HCP. And I personally feel very fortunate to have benefited from the prospective and sage advice. And I will truly miss having them on our board.
With that, I will turn it over to Pete. Pete?
Thanks, Tom. Starting with our results, we are off to a strong start. For the first quarter 2019, we reported FFO as adjusted of $0.44 per share and blended same store cash NOI growth of 3%. Let me provide some details around our major segments. Starting with Life Science, the market backdrop is very favorable. And we are in the midst of a virtuous cycle. Capital funding for our tenant is strong
Collaboration between biotech and pharma has increased exponentially. And we have a more highly functionally FDA that approved 95 drugs in 2018, up from the historically average of 33. This has led to increased tenant demand in our three high barriers to entry markets resulting in all-time low vacancy rate and increasing rental rates. As such, within our Life Science segment, which represents 25% of our same store pool, we reported strong cash NOI growth of 6.5%. This was driven by a combination of positive factors including 330 basis points of increased occupancy, a positive 21% lease mark-to-market, and robust contractual rent escalators. We finished the quarter with portfolio wide occupancy of 97%.
We see momentum remains strong throughout each of our core market. In the quarter, we successfully executed over 300,000 square feet of leases and also signed NOIs totally over 7000,000 square feet with many clients looking to lock in their space requirement early in very tight market. Within our life science development a strong market backdrop is resulting in leases getting signed often times before steel is coming up from the ground.
Turning to medical office, which represents 35% of our same-store pool, a market leading on campus focus has consistently resulted in high tenant retention rate and steady NOI growth. This was evident in the first quarter as we achieved a strong retention rate of 80% and cash NOI growth of 4.2%. Additionally, our Medical City Dallas campus contributed in excess of 100 basis points to our growth within the MOB segment. Medical City Dallas is one of our trophy campuses. It consists of 2 million square feet of integrated health care real estate with an additional 2 million square feet of expansion opportunities. And currently generates over $38 million of NOI for HCP.
We are fortunate to have such a strong partnership with HCA and the structure of the lease allows each of us to mutually benefit from the success of the campus. And the rate of growth today is greater than it has ever been before. We have added a short video of Medical City Dallas to the featured properties on our website. I will strongly encourage you to view it so you can get a better understanding of this irreplaceable property within our medical office portfolio.
Moving now to senior housing, performance was in line with our expectations with cash NOI declining 0.7% in the first quarter. The senior housing triple-net which represents 24% of our same-store pool, growth was positive 2.4%.
SHOP which represents 10% of our same-store pool, declined by 7.7%, but was in line as we expected a more challenging first-half of the year. Our SHOP portfolio continues to be impacted by our transition portfolio as well as from a supply/demand imbalance due to new deliveries. However, we are encouraged by the positive 29% sequential growth in our transition portfolio albeit the first quarter is typically, a seasonally high quarter for NOI.
Turning now to the balance sheet, our repositioning efforts over the past couple of years have resulted in a much stronger credit profile and an improved cost of capital. Recognition of these achievements during the first quarter really upgraded our credit rating to be Baa1. We ended the quarter with a net debt to adjusted EBITDA of 5.5 times. We have ample liquidity support our acquisition and development pipeline with $1.7 billion of availability under line of credit. We do expect our leverage metric increase to the high five times through the course of the year as we utilize the excess debt capacity created from the 2018 Shoreline transaction.
During the first quarter and through the early part of April, we taxed the ATM raising approximately $160 million with forward sales agreement at a net issuance price above $31 per share. As Tom noted, we intend to use these proceeds to fund our acquisition pipeline.
Finishing now with our full-year guidance, we are reaffirming our FFO as adjusted per share range of $1.70 to $1.76 and total portfolio cash NOI STP of 1.25% to 2.75%. We have fully identified $900 million of acquisition and are ahead of plan from a sources and leases perspective. The initial cash CAAP rate across our acquisition is approximately 5% which is within our guidance range but at the lower end. The initial CAAP rate is reflective of the high quality nature of the asset and the near term growth opportunity as the property stabilizes.
On a stabilized basis, we see the cash CAAP rate at approximately 6%. With regards to future unidentified acquisitions, we are not updating guidance for the balance of the year which is more customary. You can find additional details on our guidance on page 44 of our supplemental.
With that, I would like to turn the call over to Scott.
Okay, thank you Pete. With a number of successful repositioning actions behind us, our cost of capital has improved and allowed us to start growing the company again. I'm excited to share details of our investment activity, all in line with our strategy to own high quality life science, medical office, and senior housing real-estate in attractive markets.
In medical office, we're pleased to announce the commencement of three additional medical office developments with HCA, the world's leading for-profit hospital company. The aggregate spend will be roughly $70 million. And the sites are in court HCA markets including Nashville, Kansas City, and Oakmont. HCA will occupy 50% to 70% of each building, which reduces lease up risk and drive tenant demand for the balance of the space. Across the entire HCA pipeline, we still expect the blended stabilized Milan cost to be in the 7 to 7.5% range. Yields on these three are above the high end of their range.
First quarter was also active in life science. As previously announced, we closed the $71 million acquisition of 87 Cambridge Park Drive in Boston. Our business plan to achieve a 6% stabilized yield in 2020 is on track and gives us even more confidence about the development opportunity on the adjacent land parcel that we acquired in February for up to $27 million.
Looking forward to the second quarter, we're on track to close the $245 million Sierra Point Towers acquisition.
The towers are an exciting addition to what will become a 1 million square foot Class A life science campus at the shore at Sierra Point. This campus will extend our market leading position in South San Francisco, a life science hub, where demand continues to exceed supply. On the development front, our total pipeline stands at $1.3 billion, which is fully funded within our plan.
We are 100% prerelease on all projects delivering in 2019 and 2020. And over 60% pre-released for the entire pipeline when including our recent starts. Let me highlight a few of the projects. First at the code, phase three. In the second quarter, we expect to deliver all 324,000 square feet. The space is 100%. That came at the code stage for, we remain on track for an early 2020 delivery. Again, here the space is 100% which are the short Sierra Point pages two and three. We commenced construction and for 75, 80. We completed the new parking structure, allowing us to commence foundation and site work for the 214,000 square foot development. The project remains on schedule that we are seeing strong tenant demand. These projects will generate significant earnings and NAV accretion at stabilization.
Moving to senior housing, we're excited to announce acquisitions with Discovery and Oakmont to regionally focus best-in-class companies to accelerate both development and operations. These acquisitions are strategic to where we're taking our senior housing business, including a relationship driven growth strategy, improved operator diversification, and alignment, modern physical plants, and higher quality real-estate.
The Discovery portfolio is weighted towards independent living and concentrated in high growth markets in Florida, a state where Discovery has unmatched experience and expertise. The properties range in eight from six years we just recently opened with an average age of just three years. The properties offer extensive amenities and modern designs, the purchase price was $445 million. We expect an initial yield in the low fours, run to the 6% range by year three, as lease up properties stable. We expect the portfolio to pretty strong NOI growth with very little CapEx for years to come generating and attracting total return.
Discovery co-invested in the portfolio and agreed to a highly incentivized management agreement. So there's outstanding alignment of interest. We're also providing up to $40 million of junior financing core properties being developed by Discovery. We will receive a mid-90s current return along with purchase options at a 6.25% cap rate, creating a high quality $300 million acquisition pipeline.
Importantly, these are purchase options, not obligations and are exercised one-by-one as each project, which is a predetermine occupancy threshold. Three of the four projects are expansions of the campuses we just acquired and allow each campus to offer a full continuum of independent living through memory care.
We're also excited to announce the $130 million Oakmont acquisition, this three property portfolios located in California, a state where Oakmont has a track record of unrivaled success. The assets are just three years old on average. Capri is in the mid-5s which we consider attractive in light of the quality of the real estate and operating partner and the very low CapEx given the age of the assets. The mid-5s initial yield may prove to be conservative given the properties are 98% occupied today, well above our underwriting.
Roughly 5% of the purchase price consideration was in the form of downgrade units issued at just under $31 per share and we assume $50 million of third-party debt. We also negotiated a highly incentivized management agreement. So this partnership has strong alignment. There's also a mutual desire to grow the relationship. 1Q is an active quarter for senior housing asset management. We continue to proactively tackle key challenges and transform the business from every angle. We're making rapid progress on our platform and infrastructure.
Most importantly, the team is fully in place and we have positive relationships with our operating partners. We continue to move non-core properties out of the portfolio. In the first quarter, we sold 11 senior housing assets and one life science land parcel for $129 million which is a blended 4.5% cap rate on sale. The asset sale has allowed us to exit low quality real estate and eliminate three small operator relationships. Historically, we had an operator barbell characterized by over concentration on one end and not enough critical mass on the other end. Eliminating that barbell isn't an important initiative and that means either growing, exiting or downsizing each relationships.
The announcements this quarter demonstrate our success tackling this initiative and there's more to come. In addition the non-core sale proceeds are being recycled into strategic assets and relationships. We also proactively converted 35 Sunrise properties and some $60 million of annual NOI from triple net leases to our RIDEA structure. These properties were at highly complex and cumbersome deal structures that we inherited more than a decade ago in the CNL acquisition. The conversion to RIDEA is a good outcome for HCP.
In particular they control the real estate by eliminating the third-party candidates and we now have a direct management contract with Sunrise. In addition, these are good assets nearly 60% of the NOI comes from attractive submarkets in the Los Angeles, New York City and Washington DC MSAs. And with current occupancy in the mid-80s, we think the portfolio has a nice upside. 18 of the 35 properties converted in the first quarter and we expect 14 more to convert in the next 60 days.
Final three properties should convert by year-end with the staggered closings driven by licensure. Also in the second quarter, we chose to convert four high quality, high performing assets operated by Oakmont from triple net leases to our RIDEA structure. The assets are located in major California markets including the Bay Area and Los Angeles and produce $15 million of annual NOI. The 39 Sunrise and Oakmont conversion properties will enter full-year shop SPP in 2021. Also the conversions provide a modest benefit to FFO, roughly a push to fab and were included in our 2019 guidance.
In closing, key takeaway is that leading providers across all three lines of business are choosing to team up with HCP as the real estate partner to advance their business strategy. We believe this is a competitive advantage that cannot easily replicate.
Now, back to the Operator for Q&A.
We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Jordan Sadler with KeyBanc. Please go ahead.
Thanks, and good morning out there. First question, just Sunrise, and I apologize I had to pop on a little bit late, busy day. The conversion, can you talk about the catalyst here. I know you'd spoken in the past as coverage had slipped on this, but I know there was a bit of a funky structure. So, I'm curious if there was an event of default and what sort of essentially catalyzed this transaction and the staging of at least the 17 and then the next phase of conversions that are anticipated? Thanks.
Hey, Jordan, good morning. It's Scott Brinker here. I would encourage you to listen to the call; we did cover the Sunrise conversion a bit. I'll go into more detail here as well. There definitely was not any events of default. This was an opportunistic proactive choice by HCP to make this conversion. The total Sunrise triple net portfolio was about 48 assets. We've agreed with Sunrise to convert 35 of those to RIDEA, about half of that is already converted, and the balance should convert by the end of this year. And these are good assets. They were in a very complex deal structure that we inherited more than 10 years ago in the CNL acquisition that they're in the triple net reporting bucket but they don't always function completely like triple net leases in the traditional sense.
They were subject to a very complex waterfall that ultimately determined how much rent HCP was paid, and that's why we've always said that the reported rent coverage was not always completely indicative of Sunrise's ability to pay rent, because at the end of the day the waterfall determined what rent was paid, and that's what we ended up booking as our earnings. They're good assets. They're roughly 20 years old, but they're in good shape overall, and they're in good markets. More than half the NOI comes from really attractive NSAs in our view, like Los Angeles, and New York, and Washington, D.C. And maybe the most important thing in leading us to make this decision was that each of these properties had a third-party tenant, so it wasn't Sunrise that was our counterparty.
They have been the manager on these for 20 years, but although we own the real estate we had a tenant -- a third-party tenant that was making the decisions about the real estate ultimately. And they have the contract with Sunrise, and that was a very cumbersome arrangement, so we eventually terminated all of those leases, and we now have ventured into an aligned management contract with Sunrise, who we think is a really good operator. So, that's the background, but this was 100% our choice, opportunistic. This was not because the rents are underwater and we had no other choice.
I get it. So that makes sense to me. The piece that I feel like I'm missing, because it seems like a good economic decision on your point is what caused you guys to be able to terminate the contract? You had the ability to terminate the contract at will with the underlying tenant or they breached the contract?
There was no breach of the contract. I mean, I think we should avoid any conversation about what the contract did or didn't allow, but we were able to reach a reasonable conclusion and outcome with the third-party tenant as well as Sunrise that allowed us to move forward.
Okay. And I guess then just a follow-up on Discovery, and then I'll hop back in the queue. I think -- I guess I'm struck by two things, one, I think the pretty big acceleration in your investment activity in the quarter, particularly around seniors' housing, I'm not totally surprised, but a little bit surprised because I thought you kind of were of the view that the recovery in seniors' housing could be a little bit longer-tailed. And I know you were focused on high-quality assets, and so these look like they are, but I guess I'm a little bit surprised. And then doubly, these are CCRCs, and I know your history with some CCRCs and as just as we've discussed over the years. So maybe can you just frame up your view of the world a little bit here and what changed for you that these became attractive now, and then your thinking on CCRCs potentially ahead of a recession?
Hey, Jordan, it's Tom Herzog. I'll take that one. So, that's a fairly in-depth question, so let me touch on it from a number of aspects. But first, let me just first clarify one thing. The continuum of care across independent assisted and memory care, it doesn't have a SNF component, it doesn't have nonrefundable entrance fee and whatnot. These are definitely not CCRC assets. They're just the typical continuum of care senior housing assets which are fairly common, so I'll just clarify that.
As to how we're thinking about the investment mix from the big picture perspective, I think that's quite critical. As you know, and I think as everybody knows, we established a strategy a little over two years ago with the clear intention of owning a high quality portfolio in the three private paid businesses of MOB, life science, and senior housing. We like our current mix, which is around 35% to 40% senior housing, with the balance split between life science and MOBs. I think going forward; this allocation probably ebbs and flows a bit depending on opportunities. But I think over time we'll maintain a similar balance. So, no change in our game plan on that front.
As to our announcement yesterday, the senior housing acquisitions of Discovery and Oakmont, these investments represent a reallocation of dollars within senior housing rather than a reallocation of dollars within our portfolio to senior housing. So let me provide you some context on how to think about that. Over the last five quarters, we've sold $1.5 billion of senior housing assets, and only yesterday did we announce a rebalance of our senior housing portfolio with these $550 million of high quality acquisitions. And to be clear, we have some additional senior housing opportunities in the queue expected over the coming months. Still, our senior housing share of the portfolio will remain in that 35% to 40% level of allocation as our disposition pipeline for the balance of the year is predominantly focused on senior housing assets.
And importantly, our portfolio will be increasingly weighted toward modern assets in strong markets with some great new operators, which we think is critical. Now when I pivot to the life science and MOB businesses, in addition to the relationship-driven investments that you've probably noted over the last couple of years, which are frequent, a large portion of our growth is going to come from the development and redevelopment, given the lower cap rates in the current market in those segments, and our strong and unique -- uniquely positioned, really, development pipeline which we're going to capture a lot of value from that. And then given this, with that pipeline going forward, we may have opportunity to make some other strategic senior housing acquisitions beyond the simple recycling from non-core to core, but by still staying fully within our targeted mix with the target of 35% to 40% senior housing, which we think is appropriate given the business plan that we set forth. So, despite the fact that you've just seen some transaction volume on that side, it is very much right in line with the plan that we've been working toward for the last two-plus years.
Okay, thank you.
You bet.
Our next question comes from Nick Yulico with Scotiabank. Please go ahead.
Okay, thanks. Going back to the Discovery acquisition, and hopefully you could talk a little bit more about why you found the pricing attractive. I mean, if we look at it, it's about $360,000 a unit, which was on the high end of senior housing transactions in the market over the past year. And separately, you're buying at a low four yield to get to a fixed yield. Are you implicitly making an assumption here than an exit cap rate would actually be lower than the 6%. Are you seeing anything that's suggesting just a lot of institutional capital coming to this sector that could be pushing cap rates down for this type of asset over the next couple of years?
Hey, Nick, it's Scott. I'll take that one. Yes, the price, it's awfully posted as a replacement cost. You are building through Discovery for our similar projects really as we speak, so we've got a pretty good sense of what it would cost to build these today and our purchase price is pretty much in line with what it costs to deal this quality of construction in these markets. So that's always a good valuation metric as well just because the average price per unit across the sector is below 360,000, it may well be 20-year-old properties or in different locations.
So I don't know that that's always as relevant. In terms of the yield, we don't like to, as a first preference, do big acquisitions that start out in [indiscernible], but we think that it's stabilization of portfolio at a 6% cap rate is going to be awfully attractive with strong growth thereafter. There's very little CapEx leakage. And I think that's always important when you think about a cap rate on a 20-year-old building, a 7% turns into a 5% pretty quickly, whereas here, there is virtually no CapEx leakage. That's true of the Oakmont portfolio as well. And that's certainly important. We don't really think a whole lot about the exit cap, because we wouldn't expect to hold these for an awful long time.
And the last piece is just -- we are doing four development projects with Discovery as well. Those will not be on our balance sheet, the developer and owner will provide a little bit of junior financing and then have what we think are really attractive purchase options. We set 6.25% cap in the press release. Those could easily turn into high sixes if not 7% cap rates, because our purchase option is really in year three, which at that point the projects aren't fully stabilized and then at least three of the four cases those development projects are actually expansions of the properties that we just bought. And as these campuses get bigger, they are great economies of scale. So that should actually benefit the margins of the existing properties as well as the new build. So over time we think this is going to be one that not only are we thrilled to own and showcase for investors, but will ultimately provide really attractive returns as well. And then Tom, you wanted to add something?
Yes, Nick, one other thing I would add is that we like the fact that we're able to capture these two deals while the sector is at a trough in the operating cycle. Given the moving pieces of our portfolio and our circumstances, we consider this a major plus. As we've talked about, we're seeking to move to some higher quality portfolio assets within the senior housing portfolio with some really dynamic operators, which we think, Richard, and his team -- and considering where it's at in the market we really thought this was an opportunity. So that was the other part.
Okay, that's helpful. Just one other question on the portfolio, I mean, can you talk about the supply impact that the assets are facing? I think some of them are on the Gulf Coast to Florida, which has a fair amount of new supply underway. How do we get sort of comfortable with the supply dynamic in the markets that these assets are?
Yes, that's a good question. So the two portfolios are a little bit different. And for sure, Florida is not a high barrier market that Western California is. What we like about the Discovery portfolio is just the scale of the communities. Either as of today or post expansion, these are going to be 200 to 300 unit campuses, but offer the full continuum. And that really is a differentiated product even in Florida, where it's easy to build 80 unit, it's not very easy to build 300 units. And we think that will end up being the differentiator in the marketplace, but there is some new supply and that's one reason that a couple of the properties haven't leased off as quickly, especially in Naples and Fort Myers, but over time, we think those are good, high growth, demographically attractive markets. And importantly, Discovery is based in South West Florida and has been operating in that marketplace for 25 years. So we feel like they know that every market in that state better than just about anyone from a senior housing standpoint.
Appreciate it, thanks.
Yes.
Thanks, Nick.
Our next question comes from Nick Joseph with Citi. Please go ahead.
Thanks. You talked about being in an advanced discussions on acquisitions, what's the near-term pipeline and how does it break down between the three segment?
Nick, this is Herzog again. You talked to the potential pipeline beyond that which we've just announced, is that correct?
Correct.
I would put it this way in broad strokes. As we're looking at some opportunities over the near term, but it would be premature for us to signal that at this time, but I will tell you that as we move beyond that and you look at our overall mix, and I know I'm repeating myself a little bit. But I think you can assume that we stay relatively in line with what the mix that we have put together at the current date which we do like.
So as far as just short-term movements, you can always see a little bit of movement, but we're not deviated. You got to remember when you look at life science there are some pretty significant deliveries coming in life science. Peter Scott and the gang are looking at some other opportunities in life science. When you go to medical office, you've got Glenn - President Tom Klaritch that are working different deals, the HCA pipeline comes to mind and that leaves us room of course to also be looking at how to improve our portfolio, and operate or mix for what we'd like to be the next generation of how we handle senior housing. Not just from a portfolio perspective but as we're building the infrastructure, the team et cetera, we think there's some real upside and opportunity for us there and we're going to seek to capture. But I don't see it causing us to get outside of the mix that we've previously communicated.
Thanks. And then just on the capital funding plan you issued ATM equity in the quarter on a forward basis that you have before the equity is still from late last year. So how do you think that issue and additional equity in the near term, given where the balance sheet is today? I think your capital needs for the remainder of the year?
Yes, Hey Nick, it's Pete. So we did issue a little bit more under the ATM at the end of the first quarter as well as to April under forward contract. Most of our forward contracts, that we've issued already it's in the high 500, we'll settle a lot of those at the end of this quarter, as we closed Sierra Point Towers and the other acquisitions that we've talked about. And then, we do a balance sheet capacity I did mention in my prepared remarks that we're at 5.5 times. We can go up a little bit more into the high fives which we anticipate doing so, from a source's perspective we feel quite good right now to the extent that our acquisition pipeline grew, beyond where it is today then we could opportunistically access the equity markets but for right now, we feel quite good about where we are from a source's perspective.
Our next question comes from Michael Carroll with RBC Capital Markets. Please go ahead.
Yes thanks. I just wanted to touch on the senior housing operating portfolio and the transition assets I know Scott you previously mentioned that the operator is using a lot of contract labor by simply streamlining that, you'll see a lot of improvement. I'm just specifically on the expense side have all of those initiated it's been implemented already and that's a good stabilized run rate or should we expect the margin on that transition portfolio to trend closer to the core portfolio over time?
Michael, Scott here. I would say it's getting closer to a stabilized number but there's still a fair amount of contract labor and overtime, in the financial statements even from 1Q. So there's certainly still a lot of opportunity similarly repair and maintenance which was so elevated in 2018, it started to normalize but it's still not at a level that we think is acceptable long term. So I would expect further improvement in that expense category as well. There's still other things flowing through the financials that are impacting operating expenses this quarter. And I think that will continue for at least another quarter or two as well especially corporate overhead and support is elevated. So we're not -- we're definitely not at a at a point where I would say that the expenses are at a normalized level but they're getting closer. They're trading in the right direction.
Okay. And how long does it take to really streamline those expenses and then I guess some early on the revenue side. I mean should we expect you to be able to stabilize that portfolio over the next one year or next 12 months or is it longer than that?
Yes, Michael, so I think one important thing they keep in mind is for the 38 assets that transition. Only about half of those actually transition in the first-half of 2018 and the balance transition in the second-half of 2018. So we do think it takes around 12 months to fully transition the properties and get back to the stabilized expense number. So the assets that transition early in the process are the ones that are showing the biggest improvement and the ones that transition late in the process mean late in 2018 were still suffering from some of the transitory expenses. So by year-end 2019, entering into 2020, we think that portfolio starts to produce some nice results. But right now we're still on the wrong side of the trough that we went through in 2018 and we need to climb out of that. That probably starts in the later half of 2019 in terms of showing year-over-year growth.
Which has also been included in the guidance that we set forth for the year, just to be clear.
Okay, great. Thank you.
Thanks.
Our next question comes from Rich Anderson with SMBC Nikko. Please go ahead.
Thanks. Good morning out there.
Hey, Rich and welcome back.
Thank you so much. So just kind of going through all the moving parts here, this is perhaps the last year of the transformation of the company in terms of the work that had to be done but then the question is how does that linger, how does that linger into perhaps next year not looking for 2020 guidance of course unless you're willing. But when I think of all the different things, you have $500 million of dispositions generally expensive acquisition environment value add stuff like Discovery, you got to fund development, you talked about raising leverage metrics a little bit $900 million of acquisitions, a lot of big chunky stuff going on. Is it fair to say that perhaps a lot of the work gets done in 2019, but the implications on per share growth are more of a transition in 2020?
Now let me start with that then I'm going to turn it to Pete. I'll talk baked picture and Pete can fill in. Rich, this is Tom Herzog again. Yes, last year was kind of the final year of the transformation of the company. But there's certainly some spillover that that lingers. The $500 million of dispositions, of course they're going to come in a little higher cap rate acquiring some assets at a bit lower cap rate on average is going to have some earnings which is also going to be good for 2020 and 2021.
So from an acquisition perspective, it's going to be some upside. The developments we're going to see some earn-in on our development. We've got some debt that's coming due that we've long since spoken to that's going to that's going to tweak the earnings back a bit. So I know you guys will have that in your models. And as we look forward though into 2020, we're going to see the numbers start to stabilize with some moving parts. But as we move out of 2020 those items fall away as well.
But we do have a number of positives that are coming in, that also will offset some of the remaining items that that just naturally are going to fall through in the repositioning from a timing perspective. Pete, you can take that?
Yes, I think you covered it pretty well. I would just say obviously the bond refinance this year has a bit of a headwind as you head into next year but that's pretty well known, we think Rich at this point then the dispositions are higher yielding assets 6.5% to 7.5% cap rate funded through the year. We assume to mid-year assumption. But as Tom just said, there's a lot of upside as well with the developments coming online. We've increased our disclosures on those. There's a nice ramp-up in 2020 and 2021 on those. We've got some nice lease escalators in place as well across our MOB and life science platforms is a really nice positive mark to market opportunity within life sciences, we saw that this quarter as well. We think that runway here for the next couple of years as well. And then the future upside opportunity in the senior housing transition portfolio is one other thing, I would mention. So we do have some headwinds Rich but we certainly have I think much more upside potential that offset those headwinds.
Okay great. And then just a question, I've been asking in other calls, have you been noticing any movement up or down on cap rates in the medical office world or is it sort of stable given higher quality stuff that you own. I'm just curious your perspective on medical office specifically in terms of the cap rate environment?
I would say, we love that business, and we'd love to grow it. The challenge we grow it and spend the cap rates are stubbornly low. So, I think high quality assets, especially on campus are still in the low fives off campus or lower quality unaffiliated, or at least 50 basis points higher than that. And, at least in our view, the transactions that has been on the market in the last two or three quarters, including the ones that we see today, they do come at a higher cap rate. But we think that reflects the asset quality, more or so than a change in cap rate, or market demand. We just haven't seen anything to suggest that institutional demand to invest in medical office has declined, if anything that seems to just keep running, Tom you wanted to add something.
So the only thing I'd add Rich is that when you look at the activity to the extent that you can see it from yourself and these transactions, you've probably noticed that we have been absent for many of them. Not saying they're not good strategically for somebody else, but we have very much protected what we believe to be a high quality portfolio as far as location of the on campus and we will be with strong health center, delivery institutions, hospital institutions, and that we consider that to be very, very important, especially in the Korean current environment where, there's going to be efficiencies saved in and spend in the outpatient settings, but we also do see certain competition and urgent care centers retail clinics et cetera. And we do like housing specialists in the on campus setting. So that's caused us to steer away from a number of those different portfolios that have come to market just based on how we look at it strategically.
Okay, okay, great. Thanks very much.
Thanks, Rich.
Our next question comes from John Kim with BMO Capital. Please go ahead.
Thanks. Good morning. On life science, it outperformed this quarter. For the remainder of this year, you have 4.5% lease expiring. Are there any known large move outs that would bring the occupancy down for the year?
Yes, hi John. It's Pete here. I'll take a step at that. You know, we do have about 400,000 square feet that expires towards the end of the year. The good news on that front is we've actually backfill a lot of that, under LOI at this point in time with actually some nice positive mark-to-market, two in particular, Qualcomm, which we knew was going to actually vacate because that day redevelopment we do have Merck vacating as well, at the Hayden campus, but we've known that for years now and we've been able to backfill those. So a lot of that 400,000 remaining this year is actually under LOI some of that quarter and is actually turned into leases as well. So that number will come down as the year progresses. But we do have a couple, no vacate, and it does take a little bit of time to finish the TI work for the new tenants. So we expect occupancy to tick down a little bit from 97 to 95, but then tick back up as you head into 2020.
Okay, and then can you also discuss the sequential improvement in your same store shopping LOI, I think Pete you mentioned that the first quarter is seasonally high NOI but I know that's not the case? Given the fact…
Hey, John, it's Scott here. I mean, part of it is that the fourth quarter wasn't a very good quarter. But also, the fact that want to use always a seasonally high quarter in the region for that is that most operators charge rent on a monthly basis so and they increase the rate on January 1, so you get a nice increase in revenue, but the first quarter only has 90 days of expenses. And a lot of the expenses are either daily or based on utilization. So you end up with full revenue but not fully expense plus you get the benefit of the rate increase. And for the most part, wages increase annually on March 1 to that number is going to be elevated sequentially in the second quarter, so it's just from an absolute dollar standpoint NOI always looks really good in the first quarter. So, all that being said, we're still pleased that the transition portfolio is moving in the right direction.
Great, thank you.
Thanks.
Our next question comes from Jonathan Hughes with Raymond James. Please go ahead.
Hey good morning out there. Scott, I know the Oakmont Discovery portfolio acquisitions were relationship driven but curious about the potential for expanding your reach with new senior housing operators. I've seen articles from industry sources that have highlighted a shortage of quality operators that subsequently led to lower transaction volume. Just would be great to hear any thoughts you have there about expanding the operator base? Thanks.
Yes, happy to cover that and getting the right family of operating partners is critically important part of our strategy for senior housing and I mentioned on the call, part of that is reducing the number of operating partners that we have. Our goal is really to have critical mass with a very select group of operating partners that we have a lot of confidence in not only their business strategy but their real estate but also the quality of the people and the relationship that we can have with them because it really is a partnership for the REIT to have a successful real estate portfolio is usually dependent on the operating partner. And that means not just their systems and team but also the relationship that exists between the REIT and the operating partners. So we're making a lot of progress on that.
I think there is enormous upside that will be a differentiator for our senior housing business over time. The fact is right now, we have more opportunity to do things in senior housing than you could possibly fund. So we're in a unique position where we can be pretty picky about what we do in the Oakmont in Discovery rose to the top of the list, I think there is good as anyone at what they do.
Okay, maybe yes. What's your target number of operations like to have in that portfolio. Maybe how many do you have today?
Yes, we had 25 a year ago. We're down to about 20 today and we've got 250 properties, so hopefully at some point we've got more than 250 properties. But if there's just a static portfolio, I'd love to have 10 to 15 really high quality partners where we don't have all the concentration with any one partner. But we've got a really strong critical mass of assets with each one of them, so that they're important to us and more important to them.
Okay great. And then just one more for you, any changes or updates you can share on the senior housing platform in terms of processes or capabilities that been built out since you joined a little over a year ago?
Yes, we've got a great team here. I'll start with that. There isn't a single opening on that team that needs to be filled. That's a really important piece. I'm extremely pleased with the quality of that team. They're helping build out pretty dramatically a change in the way that we report, the way we forecast, the way we have relationships with operating partners on top to bottom with every single asset and operator that we own and come up with a strategic plan for those assets. I think the business intelligence platform we've got the first version of that now up and running, I think a year from now would be even better continue to improve that platform over time. But I'm really, really happy with the progress that we've made on the technology and platform side.
All right, looking forward to hear more about it. That's it for me. Thanks for the time.
Thanks, Jonathan.
Our next question comes from Vikram Malhotra with Morgan Stanley. Please go ahead.
Thanks for taking the question. Scott, you mentioned the creating more alignment in these new RIDEA contracts, the conversions. Can you talk and maybe expand upon that bit like how are these newer contracts different from the others or prior ones that you've had experienced with?
Yes, I would just say that there's a lot of lessons learned over a decade of investing in the RIDEA structure and tried to set up contracts moving forward to the operating partner and the real estate owner, sharing the upside and sharing the downside in a pretty dramatic way. And I think when an operating partner is willing to sign that kind of a contract that says a lot, they have confidence in their abilities and their projections and that's meaningful to us and we're willing to let them participate a little bit more in the upside as long as they are willing to participate in a really, really meaningful way in the potential downside.
The other thing is the life of the contract, the concept of a 30-year management contract in the hotel business seems to be an industry standard, I think a lot of the management companies wanted something similar in senior housing as we transition to the management contract structure. That's fine if everything is going well but, at least in my experience, operating companies change over time. All companies change over time, new ownership, new management, new cultures and what worked five years ago may not work very well today. And that's certainly the case with the 30 year contract. So, we've been prioritizing much shorter contracts with flexibility to really both sides. If they are not happy with the relationship they are able to move on. And there are some examples of long term contracts in place but maybe the management companies are not that excited about. So, that's been an important one for us in terms of aligning incentives to it. You really on an annual basis have to sit down with your partners; they didn't want to keep doing this together. I think that drives behavior in a positive way.
Okay, that's helpful. And then just as a follow up, can you expand or just remind us of the 40 million or so of rent expiring in the triple-net segment? Who are the major buckets there and can you tie that back to rent coverage?
Sure. The 40 million or so that share, 8 million of that was bookmarked -- just converted to RIDEA, eliminate that one. The coverage there was slightly above anyone. There's about 20 million of rent with Aegis, super high quality provider out of Seattle, 10 properties with least coverage on that. After management is 1.25 or 1.35 times, it's really strong. We see they have the renewal rate. We are doing like that real estate. And then the balance is about 14 million with capital senior living, its nine assets, the lease matures late next year. Of the nine, two or three are just really not good real estate. They don't produce much NOI. We would almost certainly look to sell those. I don't expect capital senior living to renew that lease. It's obviously their choice but I wouldn't expect that given the lease coverage is around 0.8-0.9 times depending on the time period leased. But then the other six assets are actually quite good and we'd be happy to own them whether it's with capital senior living or with another operating partner. I think really that covers the 40 million. There may be a small handful of buildings but that's 99% if not 100%.
Okay, thank you.
Our next question comes from Tayo Okusanya from Jefferies. Please go ahead.
Hi. Good afternoon. Good quarter. Page 21 of the CapEx, when I look at cross crop, life science and MOB, it looks like the recurrent CapEx spend of this quarter has been a little bit lighter than what you were running last year. Just curious what's driving that and how we should think about that in the context of AMFO?
Yes. Hey Tayo, it's Pete here. Good point you bring up because our payout ratio was obviously lower this quarter. I would look at it over a four quarter period and not over one individual quarter. We did guide some of our current CapEx perspective on the guiding stage in the back. That's what we expect from a whole year perspective. Sometimes the CapEx spend is a little bit lighter in the first quarter, a little bit heavier in the fourth quarter. It's not evenly divided throughout the year but I would focus on that CapEx and the guidance and it might just be a little light in the first quarter but we'll catch up.
Got you, okay. That's helpful. And then the other question, it's just a clarification. The transitions happening that you are now first quarter from triple net to RIDEA, Oakmont or Sunrise, again, just to confirm that the net impact of that is going to be positive to FFO this year?
Yes. Why don't I take that here, Tayo, because it's a good question as Scott mentioned in his prepared remarks, it's neutral on a bad day for us, and actually, modestly accretive on an FFO basis. If you think about Oakmont, Oakmont had 15 million of NOI, 14 million of rent. So there's a little bit of a pickup from an FFO perspective, but it's immaterial. When you go back to the sunrise structure, it's quite complicated as we've talked about, but our rent payment that we receive is net of CapEx, it was about $5 million to $6 million of CapEx within that portfolio. If you look back to 2018, when we converted into shop, that CapEx will go into FAD capital, so there's a little bit of a pickup with regards to FFO, but neutral to FAD, and importantly though, if you think about what that means, from a FFO perspective, the modest accretion, it's about a penny. And again, neutral FAD that's on a full-year basis, not all of these converted at the beginning of the year, only a few did. And importantly, and we've touched on this, we've been working on these conversions for quite some time now. So it was fully baked into our 2019 guidance as beginning of the year and also it helps to offset some of the known, headwind in our transition portfolio and then the ramping up of the development and redevelopment, which was also baked into our guidance as well. So I just wanted to clarify the accretion from an FFO perspective, but the neutral aspect from a FAD perspective.
Got you. I may have kind of done with all these transitions on a pro forma basis. How much of your overall portfolio is going to be reviewing?
To say exactly tie over it's certainly any acquisitions that we do going forward, like it's fair to say that those are the structures in the data structure. There are a handful of leases that we have today that we may well keep them as wishes for a longtime. We don't despite the triple-net structure as long as there's adequate alignment of interest meaning the tenant is equally happy paying the rent and collecting the net cash flow after the rental payment, we're happy to do triple-net leases, so I don't think it goes to zero. And I also know, I think you're going to see us convert low quality real-estate, if it's not functioning properly under a triple-net lease. We're not just going to convert it to RIDEA I think we'd be more likely to exit those properties. We're going to be very careful about what goes in that RIDEA portfolio but you will see the balance continue to shift overtime towards RIDEA versus the historical, Mexico, HCP would have been tilted towards triple-net.
I would add we have done some of those calcs. As you can imagine, there are a couple of moving pieces remaining that will become more clear over the next quarter or two, and then we'll be able to provide the actual breakdown.
Okay. Great, thank you.
Thank you.
Our next question comes from Lukas Hartwich with Green Street Advisors. Please go ahead.
Thanks. Hi, guys. I'm just curious what your thoughts are on developing shop in-house.
Well, I can -- I'll start and Scott you can jump in. Here's a thought Lukas that the development of shop in-house. There are a few different ways to go at it, it could be participating debt structures, it could be these junior debt with purchase options, or we could just do round up or we could do partnerships. The shop structure comes with, fairly a long development period relative to the size and output of the asset ultimately. And then we have a lease up that extends for a long period of time, which creates a lot of drag. So it becomes one of a decision thus one take on that much drag, which of course when I speak to drag, I mean drag on earnings in shop, when we have opportunities to either acquire fully developed shop assets, like we just did, or enter into some of these other arrangements like get us to the same place, but on a less dilutive basis with that reduced drag. So, at this point, we've made the decision to typically stay away from just ground up development of SHOP on book. So, that's been our rationale.
Great. And then thinking about SHOP, how confident are you on hitting the 6% yield for the Discovery portfolio? And can you kind of give us a sense of the timing of that?
Hey, Lukas, it's Scott here. I am happy to take that one. The initial yields in the low fours we're projecting it to get to 6% by approximately year 3. The occupancy today is in the high 70s. It's been improving nicely the past couple of months and quarters. A number of those properties are either newly built and newly opened, and three of the nine were actually -- Discovery didn't -- not build on, they actually took them over. So there is a new operator in place and those have taken awhile to move as well. But ultimately we are expecting sort of a low to mid 90s state wise occupancy with the margin in the high 30s which we think is totally achievable given Discovery's historical performance. So, we are pretty confident, and we have got a very incentivized management contract in place that also provides protection on our return NOI.
Great. Thank you.
Thank you. We have got two more people in the queue, so let's continue with questions. Thanks.
Our next question comes from Daniel Bernstein with Capital One. Please go ahead.
Thanks for taking the question. I'll apologize for not asking about Life Science because I know you are killing it. I'll go back to Senior Housing. When I look at the lease coverages at Brookdale, [indiscernible] Senior they kind of deteriorated quarter over the quarter, I know you are picking up a little bit of 2018 one quarter in rears, but can you talk a little bit more about the trend you are seeing in those portfolios? How you think they will trend through the year? And is there any dispositions or transitions to RIDEA that's kind of not contemplated in guidance that you are looking at now with regard to those portfolios?
Hey, Dan. It's Scott. I will start comment -- I have some comments as well. I have already covered Capital Senior Living. So I won't go back to that one. With HRA we have active dialog with HRA about that portfolio. It's 14 assets. Four of them are already in the process of being sold. I think two or three more will likely be sold. These are the lower quality assets. They don't produce much NOI anyway. It's really a distraction for HRA. And we will be left with seven or eight what I think are reasonable quality buildings. And we think those are right in the long term. And we would expect the HRA to continue to be the operator under those -- under triple net lease. But just with less rent and about half the number of properties that we have today. And with Brookdale, the coverage had decline a fair amount over the past year. Over the last quarter or so, it's been more stable. Brookdale really likes that portfolio geographically and from a real estate quality standpoint. So, we are not expecting any change in that master lease with Brookdale.
Okay. And then real quick on Discovery again, do you have any exclusivity in terms of funding future development beyond the four that you are junior partner with? I mean I know Discovery is kind of a [indiscernible] developer down in Florida, so just any exclusivity or any rights to develop with them in the future?
We clearly have the contractual right to buy the four. And I would probably stay away from talking about contractual future rights with operators. But I would just say there is a mutual desire to grow with both Discovery and Oakmont.
Okay, okay. I'll hop off. Thank you.
Thank you.
Our next question comes from Michael Mueller with JPMorgan. Please go ahead.
Hi, good morning guys. This is Sarah on for Mike.
Hi, Sara.
Yes, congrats on the results. There is a question on Life Science. So this quarter I think your lease spreads were 21%, what do you guys see the overall mark-to-market today's [indiscernible] portfolio?
Yes. Hey, Sara. I think you said the lease spreads are 21% which I had in my prepared remarks, positive 21% which is accurate. We've quoted before what we think our mark-to-market is for the next few years. And it's probably about 15-insh percent positive mark-to-market as we look at the expiring lease as a net blended across all the markets. It's probably a little bit higher in San Francisco, maybe not as high in San Diego, but generally it's pretty robust and we see that through the next couple of years.
Any further questions, Sarah?
At this time, there are no further questions.
Thank you, Operator, and thanks for all of you joining our call today. We always appreciate your continued interest in HCP. Bye-bye.
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