Healthpeak Properties, Inc. (DOC) Earnings Call Transcript & Summary

5:10 session at Citi's Global Property CEO Conference. I'm Michael Bilerman. I'm here with Nick Joseph. We're pleased to have with us Peak Properties, formerly known as HCP, formerly known as Health Care Property investors. We're here with Tom Herzog, currently CEO; formerly, at one moment in time, CFO, Pete Scott. Why am I blanking? You didn't like that.

CFO.

Yes. This session is for investors, clients only. If media or other individuals are on the line, please disconnect now. Disclosures are up here and on the web. You can go to liveqa.com, Citi 2020. Tom, I'll turn it over to you to introduce the company and Pete and 3 reasons why investors should buy PEAK stock today, and then we'll begin Q&A.

All right. Well, thanks, Michael. So I'll make my remarks brief, so we can save most of the time for Q&A. Healthpeak has a total capitalization of roughly $25 billion. We own a balanced portfolio of private pay, health care, real estate in the 3 primary core segments of medical office, life science and senior housing. Since we presented at the same conference a year ago, our strategy has remained unchanged. However, 2019 was a very active year for us. We sold about $1.5 billion of noncore assets. We announced over $3 billion of new investments into high-quality real estate. We expanded our life science Boston portfolio to 1.8 million square feet inclusive of the upcoming development project, CambridgePark Drive. We substantially completed the repositioning of our senior housing business. We gained control of the unique CCRC portfolio. We reduced concentration of Brookdale from 16% to about 6% today, be a little closer to 5% at year-end just based on our growth. We converted almost 40 triple-net leased properties to SHOP. And finally, we completed our exit from the U.K. From an MOB perspective, we expanded our HCA development program with over $150 million of development under construction. On the capital markets front, we raised $1.5 billion of equity, bringing our total, since Q4 of 2018, to $2 billion, all at premiums to NAV. We issued $2 billion of long-term debt used in part -- or used part of the proceeds to repay $1.7 billion of near-term maturing debt. We realigned roles and responsibilities of our team with key leadership promotions, including the promotion of Scott Brinker to President. With the addition of Sara Lewis, we expanded our Board to 8 directors, with an average tenure of 5 years. We continued our decade-long focus on ESG, receiving numerous recognitions for participation in over a dozen ESG-reporting initiatives. And towards the end of 2019, we announced our new name, Healthpeak Properties, a change that represents the culmination of efforts to reposition our strategy, our portfolio, our team and our balance sheet. Now that the repositioning is fully behind us, we are squarely focused on accretive growth. We have a $1.5 billion acquisition pipeline with Oakmont and Discovery in the senior housing side over the next 3 to 4 years and several investment opportunities in life science and medical office. We have an active $1.3 billion development pipeline, that's almost 60% pre-leased and already well-funded. We have a shadow development and redevelopment pipeline of about $1.5 billion. We continue to conservatively manage our balance sheet with BBB+, Baa1 ratings, net debt to adjusted EBITDA of 5.6x, and have ample liquidities to support our growth strategy, with approximately $2.5 billion of near-term borrowing capacity and over $500 million of availability from our equity forwards. So with that, Nick and Michael, we'll turn it back to you.

Great. Well, you mentioned ESG as one of the focuses, which is our leading question, which is of increasing importance to all your company's stakeholders. What is one thing, Tom, that PEAK is doing to improve your overall ESG score over the next 12 months?

I'd say there really are probably 2 things. You asked for one, I'll give you two. One of the biggest focuses we have right now is on the diversity and inclusion. We did win the silver award at Nareit for that this year, which we appreciate it. And there will be a lot of work done toward that again in 2020. The second one is just disclosures around climate change.

Tom, you talked about all the repositioning in the portfolio over the last 12 months, but really, it's been over the past few years. Now that the portfolio is more where you would like to see it, how do you think about the long-term growth rate maybe from a TSR of the company that's in place now?

So Nick, if I was to take that just in big, broad numbers, which sometimes is the easiest thing, because we can cut through cycles and aberrations in individual years. And to speak, I guess, modestly with the numbers, I would look at it this way. If we have, say, 2.5% same-store growth, which with a portfolio like ours, that seems very achievable, I take that 2.5% and I would then subject it to leverage of 30% to 35% and maybe make that 3.25% FFO growth from that source. Second thing I'd do is I would add in the development accretion that will occur from our portfolio. We have about $0.04 of that this year. We have $0.03 to $0.04 dialed in for the next couple of years. But I think in a normal year, it's probably more in the vicinity of $0.02 to $0.03. So call that maybe 2% growth on top of the 3.25%. I then would probably reduce something for pruning that will occur in our portfolio every year. Every year, the portfolio gets a year older, so some pruning is required. And say that we have $300 million of that per year at maybe a 200 basis point spread, call that a little over $0.01, we could just round that down to probably 0.6%. And I know these numbers won't all add up exactly, but let's just say for sake of discussion that that came to 3.5% to 4% growth, maybe plus a little. And then on top of that, when we're trading at a premium, the way I look at it is, at that time, we should be doing accretive transactions. If we're not trading at a premium, I should probably be spending more time on my mountain bike. So assuming we're trading at a premium, there would be some accretive growth, and perhaps, we're able to add 1% or so maybe even 1.5% to our growth if the premium is strong, leading us to maybe somewhere between 3.5% and 5% FFO and AFFO growth. Add to that a dividend somewhere in a 4% range, and I think that produces a good solid year-after-year TSR. That's how we think about it.

That's helpful. Maybe start on the life science side. You've clearly developed scale in 3 different markets, most recently, Boston. How much additional scale do you need in those San Diego, South San Francisco or Boston? Or are you there? And how are those cluster markets leading to the discussions with tenants?

Good question, Nick. I'll take that. We have grown from nothing in Boston a couple of years ago to just under 2 million square feet. It's actually 1.8 million square feet. We'd like to get a little bit bigger in our west Cambridge as well as the Route 128 corridors where we have scale. I would say that being above 2 million square feet is probably a good barometer for us and maybe even a little bit bigger than that. If you look at where we are in San Diego, we're around 2.5 million square feet and growing. We just kicked off our Boardwalk development there. And in South San Francisco, we are about 4 million square feet of 8 million that's owned by landlords. Genentech has a big presence there. They have about 5 million square feet. But of the landlord owned -- and obviously, that's growing. There's a lot of supply in that market. But currently today, we think we have a pretty high market share within the South San Francisco market. And that's been really important to us. We did add a slide into our investor deck, which I encourage everyone to take a look at, that talks about the cluster strategy. And if you look at tenants coming into our portfolio in earlier stage financing rounds, they typically will take much smaller suites within our campuses. And as they have success, we've had the opportunity for them to grow with us. There's a few examples, Global Blood Therapeutics, MyoKardia, Denali. Hopefully, some more to report in the not-too-distant future as well on leasing successes there. So having scale is critically important in those markets. And I think we're certainly there in San Francisco and growing. We're there in San Diego, although we'd like to continue to grow. We're getting closer in Boston. So that's an area where we're continuing to look at developments and acquisitions.

How proactive are you in discussions with those tenants when they need additional space? Are you reaching out to them? Are they reaching out to you? And are they well aware that you're able to fulfill their expansion capabilities?

Yes. Tenants will tell us that they decided to lease something in a Healthpeak property or campus because they know that they have growth opportunities, especially within San Francisco, where it's our largest market. If you think about the structure of how we asset-manage each market, we have individuals on the ground in San Francisco as well as San Diego. We have a partner in Boston for most of our assets, King Street. They are our boots on the ground currently. And those individuals have lots of conversations in those markets with tenants and with the brokerage community. So we know pretty early on when our tenants are looking for more space. It used to be in life sciences, tenants would only look out 6 to 12 months to make leasing decisions. Given the rapid growth within that market and the lack of available space, that's actually increasing now to 1 to 2 years out. We signed a lease with Johnson & Johnson recently that they will not actually probably start the lease until early 2022. So that's a few years out. That's been a more recent phenomena as the window in which tenants are looking to lease space has increased pretty significantly.

What sort of risk do you see to the life science space more broadly, if we did see health care changes from a political standpoint, either on drug pricing or anything else that stifles R&D or potentially stifles R&D?

Yes. We spend a lot of time focusing on funding that's going into the life sciences space. A lot of tenants within biotech don't make money. So they're heavily reliant on funding in order to continue their research and development. That's been very strong for the last couple of years. I would say venture capital funding is very strong. The public markets, both IPO as well as the follow-on market, has remained steady as well. But the one area that we don't talk enough about, in my opinion, that's quite important is the amount of investment that pharma is making into biotech. And if you look back after the patent cliff in 2011 and 2012 where pharma lost a lot of revenue streams as a result of drugs coming off patent, the amount of investment they started putting into biotech and life sciences went up dramatically. That phenomena, we think, is here to stay. So you don't need all 3 to be functioning in this virtuous cycle in order for the life sciences space to continue to do well. Right now, they are. But that's obviously where we spend most of our time as a team looking at fundings into our tenants to make sure that they're well capitalized.

And as you think about complementary acquisitions or development, what level of either pre-leasing or strength do you need to see before executing?

If you look at our big projects, The Cove, The Shore, we've done them in phases. So we did The Cove in 4 phases, The Shore in 3 phases. We typically want to have pre-leasing done within each phase before we accelerate the next phase. We spend a lot of time looking at supply-demand dynamics within each one of our markets because it's typically been a spec development business, which obviously comes with risk. We manage that risk as much as we can from a funding perspective as well as from a phasing in of development. So to date, everything has been done spec and delivered at 100% leased at the time we get a certificate of occupancy, but that's been managed from a risk perspective internally. I don't know, Tom, if you want to add anything to that.

Yes, I'd probably add a couple things. As we look at the overall development pipeline, we will look at the level of pre-leasing that has occurred in that particular market before we start a new project, in addition to, as Pete said, looking at having a phase pre-lease before we break ground on the next phase. It's -- that's life science. When we start thinking about medical office, it's different. There, we're doing development with a hospital or a health care systems provider. And in that particular case, that asset will be typically anchored, and we will start the project knowing that it's going to be 40% to 60% pre-leased, which is the case when we do deals with HCA, which we've done a number of them through a program that we have.

I'd say, as you think about potential acquisitions, you've been able to create this relatively balanced portfolio between senior housing, medical office and life science. As you think about transactions, I guess, within sort of the goalposts, which ones are you willing to sort of expand or not relative to that diversification that you've endeavored to have?

Michael, on that one, we really do like all 3 lines of business. They all benefit from the same baby boomer demographic. They all operate in different cycles. We think that the mix of the 3 create a stable earnings growth pattern and, therefore, over time, dividend growth pattern. We speak to 1/3, 1/3, 1/3 because it's convenient and it's easy. The fact is...

How about that 0.0001%?

Yes, that's right. We're missing that piece. But the fact is, is that due to real-life opportunities that come up, there will be times when we fall outside of the 1/3, 1/3, 1/3. I'll just -- I'll speak to how I think about it. I like life science a lot from the standpoint of there continues to be tremendous demand for this -- for space in the 3 hot beds of San Francisco, Boston and San Diego. And we've done lots of work on projecting demand and supply, and the demand has continued to exceed the supply in our estimates for the next 2 to 3 years as far as at least the eye can see. And the leasing rates have just gone up. So that's been very favorable. MOBs, I like for an entirely different reason. It's been slow and steady. 2.5% same-store growth. Occupancy remaining at 92%. Retention in the 80% range. We like the on-campus and heavily anchored off-campus assets because that's where the specialists reside, the more resistant to urgent care, to retail clinics, to telemedicine. And we like that almost ballasting the ship that we get from MOBs. And in senior housing, it's an entirely different dynamic. There, you've got obviously a massively expanding senior population that is going to be coming on heavily in the next few years, and I'm talking about the 80 to 85-plus population. The caregiver ratio continues to go down, and the penetration rate keeps going up. So that's a very good formula. What you don't know is exactly what will the new supply look like. We have chosen over the last 3.5 years to sell or transition $4.5 billion of our senior housing portfolio, which is, frankly, the majority of it, in place of purchasing assets in the higher barrier, higher price point markets with what we consider to be top operators. So a very different strategy, while also building infrastructure and building a team that we think is going to manage it well. I think that's probably the most inefficient business I've ever seen in real estate, meaning there will be big winners and big losers, depending on whether it's done well. And I think we're positioning ourselves to do very well over the longer term. So that's -- it's putting the 3 together that we think is going to create a company that has the diversified portfolio through the cycles and should produce some strong TSR over time.

How do you think about making sure -- you mentioned the transition that you've seen across your senior housing portfolio. How do you make sure and underwrite that operator risk to know that you have the right partners going forward?

That's a tricky question because it's difficult. It involves years of relationships oftentimes. It involves a lot of things that we study as to what results have been, the quality of care, looking at the regulatory aspects as to how they've performed. We're very interested in what markets they perform in, what their infrastructure and systems look like, just a whole variety of different things. And that's the type of expertise you only build through years of operating in that industry. And with that, it was one of the most important factors of my hire of Scott Brinker when we brought him in, and then he brought in Jeff Miller behind him, who was the COO and, at one time, the GC at Welltower, both lots of experience in senior housing and high-quality professionals. I think it is through that experience that you make those decisions. And it is very, very relationship-driven. We choose who we think the best operators are, and frankly, they choose who they think the best partners for them are. And if that match is made, then we've got a good relationship. And then on top of that, the contract -- the management contract that we enter into is also extremely important. If you have a bad contract that hooks you in with an operator for many years with no escape and they're not doing well, you're kind of stuck. So all these things come into play when determining how to best put in place the correct operator arrangements.

I think last year at this time, one of the things that Scott was tasked with was enhancing the asset management, the data analytics in the senior housing portfolio. Do you think that you're on par with kind of best-in-class within your peer group now? I know there are a lot of improvements that you are seeking on those 2 fronts.

Yes, I do think that that's the case. About 3 years ago, I came out of a multifamily background, as many of you know. I've been CFO of 2 different S&P 500 multifamily REITs and understood something about how this stuff works. But I can tell you, senior housing is a very, very different business despite the fact that it does share some qualities with apartments. From an asset management perspective, when I stepped in, it became clear to me that we did not have the proper infrastructure, both from a team perspective and the way it was designed, and certainly, from systems and how we were working with our operators. When Scott came in and then Jeff Miller came in, they had been involved in building or at least providing the senior-level advisement and what was to be built with these asset management systems and data systems. And my question for Scott at the time, and then subsequently Jeff, is, can we duplicate what are some very good systems that are in place out there with Welltower? And they said, indeed, we can, and I think we can make it better. And I said, well, then, let's make that happen. So we've been working on that. We started about a year before they arrived. It really took off upon the arrival of those 2 individuals. And we now have it built out, certainly, a very strong Phase 1. We've been doing demos. As we have investors visit our offices now, we'll be doing demos with that product. And I think it is going to be a vast improvement to the asset management function that we have at Healthpeak. I've been very pleased with what I saw with the data and the analytics and the reporting that's able to come out of them. And the beauty is -- and this is nothing all that fancy, but you can pull up to a property now with an iPhone and you can pull up the right app and have data that it used to take people days to pull together, you can have with a push of a button. So that -- it is rapidly changing inside of our company, and I think we've come a long way.

Tom, part of the repositioning in senior housing portfolio more recently is kind of the acquisition of -- at least wholly-owned on the CCRC front. What's attractive about that business? And then what's the opportunity to grow it from here?

I like CCRCs greatly, frankly. The problem with CCRCs is that's very hard to get a foothold and gain scale. There's a huge barrier to entry. When you think about a CCRC, it -- let me put it in simple terms, because a lot of folks are less familiar. When a senior enters a CCRC, it's a lifestyle decision. A typical entry fee in our product would be about $200,000, and an average rental amount might be $5,500. If you took the rental amount minus the operating expenses, it's probably running at a 12% margin. The entry fee acts similar to a prepaid rent. Similar is not the right word. Identical to a prepaid rent. And that prepaid rent is then amortized over the service life of that entry fee because those services have to be performed for the service life, which is typically 8 to 10 years based on actuarial tables. And with the inclusion of the entry fee earn-in, that creates about a 25% margin product. These assets are very difficult to develop. They sit on huge plots of land that are in-fill. The 13 assets that we acquired sit on top of over 700 acres of land. The average length of stay is 8 to 10 years for a senior. The average length of stay in an IL or an AL is somewhere from 2.5 to 3 years. It is a younger senior that enters the CCRC. So we're catching the earlier wave of baby boomers. Think in terms of age 80 versus age 85, the average [ ED ] who runs the community in an IL, AL is more in the vicinity of 2 years. In a CCRC, it's more in the vicinity of 7 to 8 years. The ability to go buy more of these assets is very difficult because they just don't come to market. So if you don't have -- or we happen to have been able to amass a portfolio that constitutes 12% of our total NOI, to replicate that would be almost impossible. But identifying assets for sale typically by not-for-profits that meet our standards are something we'll be able to do, and we would like to be able to expand that business as we go forward. They come in at very nice yields, but there's a lot of expertise that's required. And it helps to have scale because you want a lot of seniors inside of your communities that spread that risk out for how long people frankly live inside of those communities for their length of stay, and that then produces the right outcome of the turnover of tenants as you continue to release those properties as you go forward. But it's a much more stable pattern of revenues because you have a clientele of seniors that have, again, that 8 to 10-year service life inside of the property.

What sort of yields do you see on CCRCs when they do trade?

We purchased these in and around a 10 cap. It depends on whether you've got more refundable versus nonrefundable fees. The refundable fees, by the way, do not get recorded in income ever. They act as an evergreen liability. When one senior departs, another senior, when they come in, that refundable fee then is reimbursed to their family. But it acts like a security deposit. So you never do record income on it. It's the nonrefundable fee that gets amortized into income. As to margins or cap rates, I think, probably 9% might be typical, somewhere in that range. And again, there's a lot of expertise involved in the know-how to actually operate these, both in accounting, actuaries and a variety of other things to be successful in this business.

There are questions from the room. Go ahead.

Welltower recently talked about a lower price point senior living product. Do you see that competing with the CCRC at least for the first several years that senior would be in that facility?

Good question. And you're talking primarily of 55-plus product that I've heard of. The 55-plus product, in my view, no way competes with CCRCs. CCRCs are a property that you can enter. There's very much of a care but hospitality component to it, and it's an end-of-life decision. The 55-plus is like moving into a 55-plus apartment community. I'll let Welltower speak though to what they're doing. I can tell you that Brinker and I did a lot of work on the 55-plus product about 9 months ago. I have the background to have spent years in multifamily and years in senior housing. And so we studied it greatly because it felt like insatiable demand that would be out there. The difficulty comes in, how do you choose to lease this product? Do you lease it like you would with seniors? Or do you lease it like you would with millennials and others with the pricing models? It's a very, very different product to lease. Seniors make decisions much differently. You don't hand them an iPad and send them through your community and then have them go home and online sign your lease. You don't know how long they'll stay. They're not month-to-month leases inside the 55-plus product. What happens as seniors age, ultimately, in-house care becomes part of the equation, at some point, possibly foodservice. We looked at what type of amenities would ultimately be added. Does it ultimately morph into an assisted-living community? The battle took place between, is it going to be leased as an apartment or as a senior? We had so many different things that we talk to the developers at the time that we're developing that product, many of them on a fail basis. Now at the same time, I will say this, I hope Welltower is successful in this. I'll be watching it closely and with great interest. And if it works out for them, I'm going to be trying to figure out how to emulate it. So I wish them good luck on it. I haven't been able to figure it out yet.

Tom, COVID-19 has got different impacts, different pieces of your business, right? It demonstrates, COVID-19 coronavirus is certainly...

Yes.

From a life science perspective, demonstrates that we need tenants that will develop drugs to combat the number of diseases that are around the world. Two, your medical office building portfolio. In some cases, people don't want to go to a hospital where they can get infected, medical office maybe where they can get treatment. Whether you're senior housing, should us get into one of those facilities clearly could have a pretty damaging event on a single asset or geography. So I guess, how do you -- how are you protecting yourself? And how do you sort of see it playing out for the company?

Well, one of the things I would mention first is it is certainly a serious matter. Within our 34% -- I'll just speak to it from a business perspective and then we get to the real question. Our company constitutes, as I said earlier, 34% senior housing. Of that, about 15% is SHOP, about 7% to 8% is triple-net, and 12% is CCRCs. That should add up to about 34%. The CCRCs are probably not affected as greatly because the average turnover is about 12% per year. The triple-nets, we just redid all of our triple-nets. We only have 3 major relationships remaining, and the coverages are good. Within the SHOP though, of course, from a business risk perspective, is something we have to keep an eye on. Much more importantly, though, is the human element to it. And our operators, which we've been in touch with routinely on a daily basis, in fact, are implementing their normal protocols. A lot of it's dictated by CDC requirements and the like. There's been added vigilance and communication; monitoring on a daily basis by the senior executives; setting up command centers; designating special teams to deal with the crisis; increasing oral and written communications for residents and employees who have focus on hygiene, contact, protocols; confirming with vendors that we're able to get the supplies that we need, in particular, around pharmaceutical, medical supplies; ordering extra supplies; developing staffing contingencies, if there's lockdowns or there's an issue where an employee becomes ill; extra training; resident intake protocols, if somebody's been traveling abroad...

No. There's no downtime.

So we're done or are we still going?

Well, the music is about to go on. It's going to be Guns N' Roses. It's going to be loud.

The bottom line is we're taking all kinds of precautions and doing everything we can with this virus.

All right. Can we do rapid fire over -- yes. Will your property sector have more or fewer public companies a year from now?

Fewer.

Same-store NOI for the health care sector overall in '21?

On average, 2.5%.

10-year treasury yield a year from today?

I'm going to give you my same boring answer. We follow the forward curve. So I'd look to that.

When will the U.S. enter a recession?

We don't see it happening in 2020.

So '21 -- if I have to put a number on a spreadsheet, what year should I put in?

Why don't we say 2021, 2022.

Okay. Thank you.