In its concerted effort to unlock value proposition for its operating partners, HCP Inc. (HCP - Analyst Report), a leading real estate investment trust (REIT), has decided to acquire a portfolio of 133 senior housing communities for $1.73 billion. The properties would be acquired from a joint venture between Emeritus Corp. (ESC - Snapshot Report) and an affiliate company of The Blackstone Group LP (BX - Analyst Report).
The properties were initially acquired by the joint venture in 2010 and the operations were subsequently transitioned to Emeritus. Over the years, the joint venture invested about $42 million in capital improvements in the portfolio, resulting in an increase in occupancy from 80% to 88%.
Spread across a wide geographical contour spanning 29 states, the acquired portfolio includes a well-diversified spectrum of healthcare facilities totaling 10,350 units. By segment, the properties comprised of a mix of 61% assisted living, 25% independent living, 13% memory care and 1% skilled nursing facilities.
Emeritus, an existing operating partner of HCP, is one of the largest and most experienced operators of assisted living facilities across the U.S., providing a residential housing alternative to senior citizens who need assistance for daily living. The transaction enabled Emeritus to monetize its economic and promoted interests in the joint venture, unlocking $140 million of proceeds.
In concurrence with the deal, Emeritus would enter into a new triple-net master lease agreement and continue operating the communities. The lease would reportedly generate a contractual rent of $105.5 million in the first year, representing a 6.1% lease yield. The healthcare operator further committed to invest an additional $30 million to improve the real estate and operating performance of the portfolio.
At the same time, Emeritus would acquire the remaining nine properties from the joint venture for an aggregate sum of $52 million. HCP is set to provide a four-year debt financing for the acquisition, the interest rate of which is based on the 6.1% lease yield of the portfolio.
On the other hand, HCP expects to acquire the healthcare facilities substantially unencumbered by prepaying a significant chunk of the in-place secured debts. The transaction is intended to be financed in sync with its long-term leverage target of 60% equity and 40% debt. The company anticipates the deal to be accretive to earnings on an immediate basis.
In accordance with the turn of events, HCP has updated its guidance for full year 2012. The company has raised its adjusted FFO (fund from operations) guidance from $2.73 to $2.79 to $2.74 to $2.80. The company also expects cash NOI (net operating income) guidance in the same-property portfolio to be in the range of 3.75%-4.75%.
HCP is a leading healthcare REIT in the U.S. with one of the largest and most diversified portfolios in the healthcare sector and exposure to all types of facilities. The product diversity of the company allows it to capitalize on opportunities in different markets based on individual market dynamics, and provides a hard-to-replicate competitive advantage over its peers.
Healthcare is also relatively immune to the economic problems faced by office, retail and apartment companies. Consumers tend to continue to spend on healthcare while cutting out on discretionary purchases. The healthcare industry is the single largest industry in the U.S., based on Gross Domestic Product (GDP), and offers stability in a volatile market.
However, one of the biggest risks to healthcare focused REITs is government reimbursement rates, which are proposed to be reduced in the coming years. Deep cuts in Medicare have been proposed over the next five years by reducing or freezing payments to skilled nursing facilities, hospitals, and other healthcare providers.
With a large portion of HCP revenues being determined by government payout rates, forces beyond its direct control could negatively affect revenue and operator coverage ratios.
We maintain our Neutral recommendation on HCP, which presently has a Zacks #3 Rank that translates into a short-term Hold recommendation.
Note: FFO, a widely used metric to gauge the performance of REITs, is obtained after adding depreciation and amortization and other non-cash expenses to net income.