Good morning, welcome to the HCP, Inc. first quarter conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the Star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press Star then one on your touchtone phone. To withdraw your question, please press Star then two. In the interest of time, please limit yourself to one question and one follow-up. 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, 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 our expectations. A discussion of risk and risk factors is included in our press release in detail 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 today's call. In an exhibit filed to the 8-K we furnished to the SEC, we have reconciled all non-GAAP financial measures with the most directly comparable GAAP measures in accordance with Regulation G requirements. This exhibit is also available on our website at www.healthpeak.com. I will now turn the call over to our President and Chief Executive Officer, Tom Herzog.
Thanks, Andrew, 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 Klarich, our Chief Development and Operating Officer, and Troy McHenry, our General Counsel. Our first quarter results were in line with our expectations. Last night we reaffirmed both our full-year FFO as adjusted and total portfolio same-property cash NOI guidance. During the first four months of 2019, we were active on the investment front with activity balanced 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 in advanced discussions on additional acquisition opportunities, are not yet in a position to provide details.
We are confident in their 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 CambridgePark 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 the potential for future upside through densification and development opportunities. In medical office, we added three new projects to our HCA development program, bringing the total to approximately $100 million. This program allows HCA to meet demand at some of their most successful campuses while providing HCP new MOB investment opportunities that benefit from significant pre-leasing with HCA as our strong anchor tenant.
In senior housing, the transactions with Discovery and Oakmont create strategic SHOP relationships with two top-tier operators. Improve our portfolio with new Class A assets and strong markets. Scott has long-standing relationships with both of these operators, 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've 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. 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 expectations, our balance sheet is tracking in line with our stated commitments. Before I turn it to Pete, I'd like to acknowledge the contributions of two of our directors who retired from our board last week at our annual meeting. Pete Rhein, a director since our IPO 34 years ago, Jill Sullivan, who joined our board in 2004. We are thankful for their many contributions to HCP, I personally feel very fortunate to have benefited from their perspectives and sage advice, we'll truly miss having them on our board. With that, I'll 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, we are in the midst of a virtuous cycle. Capital funding for our tenants is strong, collaboration between biotech and pharma has increased exponentially, we have a more highly functioning FDA that approved 59 drugs in 2018, up from the historical average of 33. This has led to increased tenant demand in our three high barrier to entry markets, resulting in all-time low vacancy rates 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%. Leasing momentum remained strong throughout each of our core markets. In the quarter, we successfully executed over 300,000 square feet of leases and also signed LOIs totaling over 700,000 square feet, with many tenants looking to lock in their space requirements early in very tight markets. Within our life science developments, the strong market backdrop is resulting in leases getting signed oftentimes before steel is coming up from the ground. Turning to medical office, which represents 35% of our same-store pool. Our market-leading on-campus focus has consistently resulted in high tenant retention rates 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 healthcare 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. The structure of the lease allows each of us to mutually benefit from the success of the campus. 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. We 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. In 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. In recognition of these achievements, during the first quarter, Moody's upgraded our credit rating to Baa1. We ended the quarter with a net debt to adjusted EBITDA of 5.5 times. We have ample liquidity to support our acquisition and development pipeline, with $1.7 billion of availability under our line of credit. We do expect our leverage metric to increase to the high 5 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 tapped the ATM, raising approximately $160 million through forward sales agreements 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%-2.75%. We have fully identified $900 million of acquisitions and are ahead of plan from a sources and uses perspective. The initial cash cap rate across our acquisition is approximately 5%, which is within our guidance range, but at the lower end. The initial cap 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 cap 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, the sites are in core HCA markets, including Nashville, Kansas City, and Ogden. HCA will occupy 50%-70% of each building, which reduces lease-up risk and drives tenant demand for the balance of the space. Across the entire HCA pipeline, we still expect a blended, stabilized yield on cost to be in the 7%-7.5% range.
The yields on these three are above the high end of that 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% pre-leased on all projects delivering in 2019 and 2020, and over 60% pre-leased for the entire pipeline when including our recent starts. Let me highlight a few of the projects. First, at The Cove, phase 3. In the second quarter, we expect to deliver all 324,000 square feet. The space is 100% leased. Second, at The Cove, phase 4, we remain on track for an early 2020 delivery. Again here, the space is 100% leased. Third, The Shore at Sierra Point, phases 2 and 3, we've commenced construction. Fourth, at 75 Hayden, 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, and 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, two regionally focused, best-in-class companies who excel at 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 age from six years to 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, growing to the 6% range by year three as the lease-up properties stabilize.
We expect the portfolio to produce strong NOI growth with very little CapEx for years to come, generating an attractive 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 on four properties being developed by Discovery. We'll receive a mid-nines 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 exercisable one by one as each project achieves a predetermined occupancy threshold. Three of the four projects are expansions of the campuses we just acquired and will allow each campus to offer a full continuum from independent living through memory care. We're also excited to announce the $113 million Oakmont acquisition.
This three-property portfolio is located in California, a state where Oakmont has a track record of unrivaled success. The assets are just three years old on average. The year one cap rate is in the mid-fives, 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-fives 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 DownREIT 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 was 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 sales allow 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 is an important initiative, and that means either growing, exiting, or downsizing each relationship. 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 with roughly $60 million of annual NOI from triple net leases to a RIDEA structure. These properties were in 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, we've maintained control of the real estate by eliminating the third-party tenants, 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, D.C. MSAs. With current occupancy in the mid-80s, we think the portfolio has nice upside.
18 of the 35 properties converted in the first quarter, and we expect 14 more to convert in the next 60 days. The final three properties should convert by year-end, with the staggered closings driven by licensure. In the second quarter, we chose to convert four high-quality, high-performing assets operated by Oakmont from triple net leases to a 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. The conversions provide a modest benefit to FFO, are roughly a push to FAD, and were included in our 2019 guidance.
In closing, a 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 be replicated. Now back to the operator for Q&A.
We will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. That everyone may have a chance to participate, we ask that participants limit their questions to one and a related follow-up. If you have additional questions, please re-queue. Our first question comes from Jordan Sadler with KeyBanc. Please go ahead.
Thanks, good morning out there. First question, just Sunrise, I apologize I had to pop on a little bit late. It's a 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 that there was a bit of a funky structure. I'm curious if there was an event of default, and what sort of essentially catalyzed this transaction and then 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 event 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 has already converted, and the balance should convert by the end of this year. These are good assets. They were in a very complex deal structure that we inherited more than 10 years ago in the CNL acquisition. 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, 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. 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 MSAs in our view like Los Angeles and New York and Washington, D.C. Maybe the most important thing in leading us to make this decision was that each of these properties had a third-party tenant. It wasn't Sunrise, it 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 had the contract with Sunrise, and that was a very cumbersome arrangement. We eventually terminated all of those leases, and we now have entered into an aligned management contract with Sunrise, who we think is a really good operator. 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. 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?
Oh, there was no breach of the contract. 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 tenants as well as Sunrise that allowed us to move forward.
Okay. I guess then just to follow up on Discovery, and then I'll hop back in the queue. 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. I know you were focused on high-quality assets. That's what these look like they are. I guess I'm a little bit surprised. Doubly, these are CCRCs, and I know your history with some CCRCs, and as we've discussed over the years. 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?
Your thinking on CCRCs potentially ahead of a recession.
Hey, Jordan. It's Tom Herzog. I'll take that one. That's a fairly in-depth question, so let me touch on it from a number of aspects. First, let me just clarify one thing. The continuum of care across independent, assisted, and memory care, it doesn't have a SNF component. It doesn't have non-refundable entrance fees and whatnot. These are definitely not CCRC assets. They're just the typical continuum of care senior housing assets, which are fairly common. I'll just clarify that. As to how we're thinking about the investment mix from a big-picture perspective, I think that's quite critical. As you know, 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 pay businesses of MOB, life science, and senior housing.
We like our current mix, which is around 35%-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. I think over time, we'll maintain a similar balance. No change in our game plan on that front. As to our announcement yesterday of 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. 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.
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%-40% level of allocation as our disposition pipeline for the balance of the year is predominantly focused on senior housing assets. Importantly, our portfolio will be increasingly weighted toward modern assets in strong markets with some great new operators, which we think is critical.
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 two segments and our strong and uniquely positioned really, development pipeline, which we're going to capture a lot of value from that.
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 a target of 35%-40% senior housing, which we think is appropriate given the business plan that we set forth. 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 towards 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, hoping we could talk a little bit more about why you found the pricing attractive. Separately, you're buying at a low 4 yield to get to a 6 yield. Are you implicitly making an assumption here that an exit cap rate would actually be lower than 6%? Are you seeing anything that's suggesting just a lot of institutional capital coming to the sector that could be maybe 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. Yeah. The price, it's awfully close to the replacement cost. We're building through Discovery for similar projects really as we speak. We've got a pretty good sense of what it would cost to build these today. Our purchase price is pretty much in line with what it costs to build this quality of construction in these markets. That's always a good valuation metric as well, just because the average price per unit across the sectors will hold 360,000. It may well be 20-year-old properties or in different locations. 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 the low 4s, but we think that its stabilization, this 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's 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. The last piece is just we are doing 4 development projects with Discovery as well. Those will not be on our balance sheet. They're the developer and owner.
We'll provide a little bit of junior financing and then have what we think are really attractive purchase options. We said 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. In at least three of the four cases, those development projects are actually expansions of the properties that we just bought. As these campuses get bigger, there are greater economies of scale. That should actually benefit the margins at the existing properties as well as at the new build. 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. Tom, you wanted to add something?
Yeah. Nick, one other thing I would add is that we like the fact that we were 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 of assets within the senior housing portfolio with some really dynamic operators, which we think Richard and his team are. Considering where it's at in the market cycle, we really thought this was an opportunity. That was the other part.
Yeah, that's helpful. Just one other question on the portfolio. Can you talk about the supply impact that the assets are facing? I think some of them are on the Gulf Coast of 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?
Yeah, that's a good question. The two portfolios are a little bit different, and for sure, Florida is not a high-barrier market the way, say, 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 200-300-unit campuses that offer the full continuum, and that really is a differentiated product, even in Florida, where it's easy to build 80 units, it's not very easy to build 300 units. We think that will end up being a differentiator in the marketplace. There is some new supply. That's one reason that a couple of the properties haven't leased up as quickly, especially in Naples and Fort Myers. Over time, we think those are good, high-growth, demographically attractive markets.
Importantly, Discovery is based in Southwest Florida and has been operating in that marketplace for 25 years. We feel like they know that every market in that state better than just about anyone from a senior housing standpoint.
Appreciate it. Thanks.
You got it.
Thanks, Nick.
Our next question comes from Nick Joseph with Citi. Please go ahead.
Thanks. You talked about being in advanced discussions on acquisitions. What the size of the near-term pipeline, and how does it break down between the three sectors?
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 nearer term, it would be premature for us to signal that at this time. I will tell you that as we move beyond that and you look at our overall mix, I know I'm repeating myself a little bit, I think you can assume that we stay relatively in line with the mix that we have put together at the current date, which we do like. As far as the short-term movements, you could always see a little bit of movement, we're not deviating. You got to remember, when you look at life science, there are some pretty significant deliveries coming in life science. Pete Scott and the gang are looking at some other opportunities in life science.
When you go to medical office, you've got Glenn Preston and Tom Klarich that are working different deals. The HCA pipeline comes to mind. That leaves us room, of course, to also be looking at how to improve our portfolio and operator 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 it. I don't see it causing us to get outside of the mix that we've previously communicated.
Thanks. Just on the capital funding plan, you issued ATM equity in the quarter on a forward basis, and you have the forward equity still from late last year. How do you think about issuing additional equity in the near term, given where the balance sheet is today, your capital needs for the remainder of the year?
Hey, Nick, it's Pete. We did issue a little bit more under the ATM at the end of the first quarter as well as through April under forward contracts. 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 close Sierra Point Towers and the other acquisitions that we've talked about. We do have balance sheet capacity. I did mention in my prepared remarks that we're at 5.5 times right now. We can go up a little bit more into the high 5s, which we anticipate doing. From a sources perspective, we feel quite good right now to the extent that our acquisition pipeline grew beyond where it is today, we could opportunistically access the equity markets. For right now, we feel quite good about where we are from a sources perspective.
Thanks.
Our next question comes from Michael Carroll with RBC Capital Markets. Please go ahead.
Yeah, 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 for using a lot of contract labor by simply streamlining that, you'll see a lot of improvement. Just specifically on the expense side, have all of those initiatives been implemented already, and is that a good stabilized run rate, or should we expect the margin on that transition portfolio to trend closer to the core portfolio over time?
Hey, 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 for one Q. There's certainly still a lot of opportunity. Similarly, repair and maintenance, which was so elevated in 2018, has started to normalize, but it's still not at a level that we think is acceptable long term. 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. We're definitely not at a point where I would say that the expenses are at a normalized level, but they're getting closer. They're trending in the right direction.
Okay. How long does it take to really streamline those expenses? I guess, similarly on the revenue side, should we expect you to be able to stabilize that portfolio over the next one year, next 12 months, or is it longer than that?
Michael, I think one important thing to keep in mind is for the 38 assets that transitioned, only about half of those actually transitioned in the first half of 2018, and the balance transitioned in the second half of 2018. We do think it takes around 12 months to fully transition the properties and get back to a stabilized expense number. 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, meaning late in 2018, we're still suffering from some of the transitory expenses. By year-end 2019, entering into 2020, we think that portfolio starts to produce some nice results. 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, welcome back.
Thank you so much. 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. The question is, how does that linger into perhaps next year? Not looking for 2020 guidance, of course, unless you're willing. 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 a 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?
Let me start with that. I'm going to turn it to Pete. I'll talk big picture, and Pete can fill in. Rich, this is Tom Herzog again. Yeah, last year was kind of the final year of the transformation of the company, but there's certainly some spillover that lingers. The $500 million of dispositions, of course, they're going to come in at a little higher cap rate. Acquiring some assets at a bit lower cap rate on average is going to have some earn-in, which is also going to be good for 2020 and 2021. From an acquisition perspective, there's going to be some upside. The developments, we're going to see some earn-in on our developments. We've got some debt that's coming due that we've long since spoken to that's going to tweak the earnings back a bit.
I know you guys all have that in your models. As we look forward, though, into 2020, we're going to see the numbers start to stabilize with some moving parts. As we move out of 2020, those items fall away as well. We do have a number of positives that are coming in that also will offset some of the remaining items that just naturally are going to fall through in the repositioning from a timing perspective. Pete, what might you add to that?
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, that's pretty well known, we think, Rich, at this point. The dispositions are higher-yielding assets, 6.5%-7.5% cap rates blended through the year. We assumed a mid-year assumption. 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, there's a really nice positive mark-to-market opportunity within life sciences. We saw that this quarter as well. We think that runway is here for the next couple of years as well. The future upside opportunity in the senior housing transition portfolio is one other thing I would mention. We do have some headwinds, Rich, we certainly have, I think, much more upside potential that offsets those headwinds.
Okay, great. Just a question I've been asking on other calls. Have you been noticing any movement up or down on cap rate in the medical office world? 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 in growing it has been that cap rates are staggeringly low. I think high-quality assets, especially on campus, are still in the low fives. Off-campus or lower quality unaffiliated are at least 50 basis points higher than that. At least in our view, the transactions that have been on the market in the last two to 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 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, it seems to just keep growing. Tom, you wanted to add something?
One thing I'd add, Rich, is that when you've looked at the activity to the extent that you can see it from where you sit in these transactions, you've probably noted that we have been absent from 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 MOB with strong health delivery institutions, hospital institutions, and that we consider that to be very important, especially in the current environment, where there's going to be efficiencies sought in spend in the outpatient settings. We also do see certain competition in urgent care centers, retail clinics, et cetera, and we do like housing specialists in the on-campus setting.
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. 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% of leases expiring. Are there any known large move-outs that would bring the occupancy down for the year?
Hey, John, it's Pete here. I'll take a stab at that. We do have about 400,000 sq ft that expires towards the end of the year. The good news on that front is we've actually backfilled 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's a 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. A lot of that 400,000 remaining this year is actually under LOI.
Some of that, since the quarter end, has actually turned into leases as well. That number will come down as the year progresses. We do have a couple known vacates, and it does take a little bit of time to finish the TI work for the new tenants. We expect occupancy to tick down a little bit from 97%- 95%, but then tick back up as you head into 2020.
Can you also discuss the sequential improvement in your same-store SHOP NOI? I think, Pete, you mentioned that the first quarter is seasonally high for NOI, but I thought that was not the case, given the fact that it's another region.
Hey, John, it's Scott here. Part of it is that the fourth quarter wasn't a very good quarter. Also the fact that one, Q's always a seasonally high quarter, and the reason for that is that most operators charge rent on a monthly basis. They increase the rate on January 1st. 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. You end up with full revenue, but not full expense. Plus, you get the benefit of the rate increase, and for the most part, wages increase annually on March 1st, so that number is going to be elevated sequentially in the second quarter. Just from an absolute dollar standpoint, NOI always looks really good in the first quarter.
All that being said, we're still pleased that the transition portfolio is moving in the right direction.
Great. Thank you.
Thanks.
Thanks, John.
Our next question comes from Jonathan Hughes with Raymond James. Please go ahead.
Hey, good morning out there. Scott Brinker, I know the Oakmont Senior Living and Discovery Senior Living portfolio acquisitions were relationship-driven, 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. Would be great to hear any thoughts you have there about expanding the operator base. Thanks.
Yeah, happy to cover that. Getting the right family of operating partners is a critically important part of our strategy for senior housing, 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 mutually dependent on the operating partner. That means not just their systems and team, but also the relationship that exists between the REIT and the operating partner. 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 we could possibly fund. We're in a unique position where we can be pretty picky about what we do, the Oakmont Senior Living and Discovery Senior Living rose to the top of the list. I think they're as good as anyone at what they do.
Okay. Maybe what's your target number of operators you'd like to have in that portfolio, maybe how many do you have today?
Yeah, we had 25 a year ago. We're down to about 20 today. We've got 250 properties. Hopefully at some point, we've got more than 250 properties, but if it was just a static portfolio, I'd love to have 10-15 really high-quality partners, where we don't have over-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 we're important to them.
Okay, great. Just one more for you. Any changes or updates you can share on the senior housing platform in terms of processes or capabilities that you've built out since you joined a little over a year ago?
Yeah, 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. We've gone 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 it will be even better, and continue to improve that platform over time. I'm really, really happy with the progress that we've made on the technology and platform side.
All right. Look forward to hearing 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 creating more alignment in these new RIDEA contracts, the conversions. Can you talk, or maybe expand upon that a bit? How are these newer contracts different from the others or prior ones that you have experience with?
Yeah. I would just say that there's a lot of lessons learned over a decade of investing in the RIDEA structure. We've tried to set up contracts moving forward that the operating partner and the real estate owner share in the upside and share in the downside in a pretty dramatic way. I think when an operating partner's 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 just the length 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's going well, but at least in my experience, operating companies change over time. All companies change over time. New ownership, new management, new cultures. What worked five years ago may not work very well today, and that's certainly the case with the 30-year contract. We've been prioritizing much shorter contracts with flexibility for really both sides. If they're not happy with the relationship, they're able to move on, and there are some examples of long-term contracts in place that maybe the management companies aren't all that excited about.
That's been an important one for us in terms of aligning incentives, so that you really, on an annual basis, have to sit down with your partner and say, "Hey, do you want to keep doing this together?" I think that drives behavior in a positive way.
Okay. That's helpful. 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? What are the major buckets there, and can you tie that back to sort of rent coverages?
Sure. The $40 million or so that matures next year, $8 million of that was Oakmont, that just converted to RIDEA, so you can eliminate that one. The coverage there was slightly above one oh anyway. There's about $20 million of rent with Aegis, a super high-quality provider out of Seattle. 10 properties. The lease coverage on that after management fee is 1.25 or 1.3 times, so it's really strong. We'll see. They have a renewal right. We really like that real estate. The balance is about $14 million with Capital Senior Living. It's 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, and we would almost certainly look to sell those. I don't expect Capital Senior Living to renew that lease.
It's obviously their choice, I wouldn't expect it given the lease coverage is around 0.8, 0.9 times, depend on the time period used. 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 in addition, but that's 99% of it, if not 100%.
Great. Thank you.
Our next question comes from Tayo Okusanya from Jefferies. Please go ahead.
Hi. Good afternoon. Good quarter. Page 21 of the stock CapEx. I kind of look across SHOP life science and MOB, it looks like the recurring CapEx spend for this quarter is a little bit lighter than what you were running last year. Just kind of curious what's kind of driving that and how we should think about that in the context of AFFO.
Yeah. Hey, Tayo, it's Pete here. Good point you bring up, because our payout ratio was obviously lower this quarter. I would say you should look at it over a four-quarter period and not over one individual quarter. We did guide from a recurring CapEx perspective on the guidance page i n the back. That's what we expect from a full-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. I would focus on the CapEx and the guidance, and it might just be a little bit light in the first quarter, but we'll catch up.
Got you. Okay. That's helpful. The other question is just a clarification. The transitions happening that you announced this quarter from triple net to RIDEA, whether it's Oakmont or Sunrise. Again, just to confirm that the net impact of that is going to be positive to FFO this year?
Yeah. 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 FAD basis and actually modestly accretive on an FFO basis. If you think about Oakmont had $15 million of NOI, $14 million of rent. 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-$6 million of CapEx within that portfolio, if you look back to 2018. When we convert it into SHOP, that CapEx will go into FAD capital. There's a little bit of a pickup with regards to FFO, but neutral to FAD.
Importantly, though, if you think about what that means from an FFO perspective, the modest accretion, it's about $0.01. Again, neutral to FAD, that's on a full-year basis. Not all of these converted at the beginning of the year, only a few did. 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 at the beginning of the year. Also it helps to offset some of the known headwinds in our transition portfolio and then the ramping up of the development and redevelopment, which was also baked into our guidance as well. I just wanted to clarify the accretion from an FFO perspective, but the neutral aspect from a FAD perspective.
Got you. When you're kind of done with all these transitions on a pro forma basis, how much of your overall portfolio is going to be RIDEA-based?
It's hard to say exactly, Tayo, but certainly any acquisitions that we do going forward, I think it's fair to say that those would be structured in the RIDEA structure. There are a handful of leases that we have today that we may well keep them as leases for a long time. We don't dislike 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. I don't think it goes to zero.
I also don't 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. You will see the balance continue to shift over time towards RIDEA versus the historical mix at HCP would've been tilted towards triple-net.
Got you.
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. Hey, guys. I'm just curious what your thoughts are on developing SHOP in-house.
Well, I'll start, and Scott, you can jump in. Here's a thought, Lukas. The development of SHOP in-house, there are a few different ways to go at it. It could be participating in debt structures, it could be these junior debt with purchase options, or we could just do ground up, or we could do partnerships. The SHOP structure comes with a fairly long development period relative to the size and output of the asset ultimately. It then has a lease-up that extends for a long period of time, which creates a lot of drag. It becomes one of a decision.
Does 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 that get us to the same place, but on a less dilutive basis with that reduced drag. At this point, we've made the decision to typically stay away from just ground-up development of SHOP on book. That's been our rationale.
Great. Sticking with SHOP, how confident are you on hitting the 6% yield for the Discovery portfolio? Can you kind of give us a sense of the timing of that?
Hey, Lukas. Scott here. I am happy to take that one. The initial yield is in the low 4s. We are projecting that it gets to 6% by approximately year three. The occupancy today is in the high 70s. It has 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 did not build them, they actually took them over. There is a new operator in place, and those have taken a while to move as well. Ultimately, we are expecting sort of a low to mid-90s stabilized occupancy with a margin in the high 30s, which we think is totally achievable given Discovery's historical performance. We are pretty confident, and we have got a very incentivized management contract in place that also provides protection on our underwritten NOI.
Great. Thank you.
Thank you. We have got two more people in the queue, let us 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 in advance for not asking about life science, because I know you're killing it. I'll go back to seniors housing. When I look at the lease coverages with Brookdale, Capital Senior Living, they kind of deteriorated quarter-over-quarter. I know you're picking up a little bit of 2018, one quarter in arrears. Can you talk a little bit more about the trend you're seeing in those portfolios, how you think they'll trend through the year? Is there any dispositions or transitions to RIDEA that's kind of not contemplated in guidance that you're looking at now with regard to those portfolios?
Hey, Dan. It's Scott. I'll start. Tom may have some comments as well. I've already covered Capital Senior Living, I won't-
Right
...go back to that one. With HRA, we have active dialogue 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. They're really a distraction for HRA. We'd be left with seven or eight what we think are at least reasonable quality buildings.
We think those are viable long-term. We would expect HRA to continue to be the operator under a triple net lease. Just with less rent and about half the number of properties that we have today. With Brookdale, the coverage had declined a fair amount over the past year. The last quarter or so, it's been more stable. Brookdale really likes that portfolio geographically and from a real estate quality standpoint. We're not expecting any change in that master lease with Brookdale.
Okay. Real quick on Discovery again, do you have any exclusivity in terms of funding future development beyond the four that you're a junior partner with? I know Discovery's kind of a prolific developer down in Florida. 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'd probably stay away from talking about contractual future rights-
Okay
...with operators. I would just say there's a mutual desire to grow with both Discovery and Oakmont.
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.
Go ahead.
Yeah, congrats on the results. Just a question on life science. This quarter, I think your lease spreads are 21%. What do you guys see the overall mark-to-market today for that portfolio?
Yeah. Hey, Sarah. 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%-ish positive mark-to-market as we look at the expiring leases, and that's blended across all the markets. It's probably a little bit higher in San Francisco, maybe not as high in San Diego. 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. Thanks for all of you joining our call today. We always appreciate your continued interest in HCP. Bye-bye.
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