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Health Care REIT Inc. (HCN - Analyst Report), a real estate investment trust (REIT) that operates senior housing and health care real estate, reported third quarter 2012 FFO (funds from operations) of 75 cents per share, compared to 85 cents in the year-earlier quarter. The decrease in year-over-year FFO per share was primarily attributable to increased number of outstanding shares in the reported quarter.

Excluding one-time items, recurring FFO for the reported quarter was 91 cents per share, compared to 89 cents in the year-ago quarter. The recurring quarterly FFO beat the Zacks Consensus Estimate by 2 cents.

Total revenues during the reported quarter were $474.1 million compared to $370.7 million in the year-earlier quarter. Total revenues for the reported quarter were well ahead of the Zacks Consensus Estimate of $465 million.

Total same-store cash NOI (net operating income) increased 3.6% during the quarter compared to the year-ago period, including 7.0% growth in the senior housing operating portfolio.

During the reported quarter, Health Care REIT made gross new investments of $1.0 billion, bringing the year-to-date tally to $2.9 billion. These included $243.5 million worth of acquisitions of five healthcare facilities in the U.K. from Sunrise Senior Living Inc. . With a blended net operating income (NOI) yield of 7.2%, the properties were purchased from a partnership between Sunrise and an institutional investor.

The strategic purchase stemmed from the deal when Health Care REIT penned an agreement with Sunrise Senior Living to acquire all of its outstanding shares. The offer price of $14.50 for each of the Sunrise Senior Living share equated to a real estate value of approximately $1.9 billion.

Health Care REIT decided to pay approximately $950 million in cash and the balance through the assumption of debt at an average interest rate of approximately 4.9%. The transaction is likely to close in early 2013, subject to mandatory regulatory approvals and closing conditions.

With the deal, Health Care REIT is poised to acquire 20 wholly-owned senior housing communities from Sunrise Senior Living, along with its 105 joint venture properties (five of which are mentioned above). About 17 of the wholly-owned properties are located in the U.S., while the remaining three are in Canada. The bulk of the joint venture properties are also located in the U.S. (about 78), with the remainder in the U.K. (27).

The domestic portfolio is mostly concentrated in New York, Los Angeles, San Francisco, Washington, D.C., Philadelphia, Boston, and Chicago. Almost half of the acquired portfolio is located in the top 5 MSAs (metropolitan statistical areas). The acquisition would position Health Care REIT as one of the largest owners of senior housing facilities worldwide with over 58,000 units in the U.S., Canada, and the U.K.    

With a median age of eight years, the acquisition would enable Health Care REIT to own high-quality private pay senior housing communities in high-barrier-to-entry affluent markets. In addition, the company is likely to gain operational synergies as an experienced and dynamic management team from Sunrise Senior Living, with over 30 years of experience, comes on board.

Besides improving the economies of scale, the acquisition would further enable Health Care REIT to gain access to higher yielding embedded investment opportunities, as more and more ownership stakes in joint venture properties come up for grabs. The senior housing sector is a highly-fragmented market with limited new supply and positive growth indicators, with the over-85 demographic growing at three times the rate of the overall population.

According to the U.S. Census Bureau, the elderly population (aged 65 and older) is expected to jump 36% from 2010 to 2020 to 54.8 million people. The latest acquisition by Health Care REIT, therefore, reinforces the buzz in the healthcare REIT industry, spurred by an aging Baby Boomer generation’s increased demand for assisted and independent living facilities.

The acquisition brings two of the most complementary customer franchises to the same platform in the healthcare real estate market and increases the scale and diversification of the combined company. The acquired assets overlap with Health Care REIT’s health system, assisted living and senior housing portfolio and offers continuum of services.

On the other hand, the deal also enables Sunrise Senior Living to continue its investment in optimizing and expanding its facilities to meet the increased needs of the acute care patient population. Consequently, the transaction is a win-win deal for both of the participating companies.

Close on the heels of the acquisition of Sunrise Senior Living, Health Care REIT also decided to offload its management company business. To materialize the decision, Health Care REIT penned an agreement with the affiliates of investment firms Kohlberg Kravis Roberts & Co. (KKR - Snapshot Report), Beecken Petty O’Keefe & Company, and Coastwood Senior Housing Partners LLC, to form a new entity that would acquire the divested business. Health Care REIT would invest about $26 million for a 20% ownership stake in the joint venture.

The divested business would include the existing management contracts of Sunrise Senior Living along with the 125 communities set to be acquired by Health Care REIT. The newly-formed joint venture entity would subsequently induct all the employees of the erstwhile Sunrise Senior Living and operate under the ‘Sunrise’ brand.

During the reported quarter, Health Care REIT made about $56 million worth of investments in medical office buildings (MOBs) at a blended yield of 7.1%. These include the purchase of three MOBs (average occupancy of 98%) spanning 220,000 rentable square feet in aggregate and one development completion (13,400 rentable square feet, 100% leased).

At the same time, the company completed $611 million worth of investments in senior housing triple-net leases at a blended yield of 7.1%. Health Care REIT completed $133 million worth of asset sale transactions during the quarter.

Health Care REIT obtained a $250 million Canadian denominated unsecured term loan (approximately $249 million USD) to increase its Liquidity. The company was able to reduced debt to undepreciated book capitalization to 38% by the end of the quarter from 45% in the previous quarter. During the reported quarter, Health Care REIT issued 43.7 million shares for proceeds of $2.4 billion. At quarter-end, the company had cash and cash equivalents of $1.4 billion.

Health Care REIT maintained its quarterly dividend of 74 cents in the reported quarter, which marked the 166th consecutive quarterly dividend payment. The third quarter 2012 dividend marked a 3.5% year-over-year increase over the year-ago period. With superior results, the company increased its quarterly dividend to 76.5 cents (up 3.4%) or $3.06 per share annually for full year 2013.

Health Care REIT updated its recurring FFO guidance for 2012. The company has currently revised its recurring FFO guidance for 2012 from the earlier range of $3.53 - $3.63 to $3.49 - $3.53 per share.

We maintain our Neutral recommendation on Health Care REIT, which presently has a Zacks #3 Rank translating into a short-term Hold rating.

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.

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