Thomas M. Herzog
HCP President and CEO Thomas Herzog

Greatly reducing the concentration of Brookdale Senior Living properties in its portfolio has been part of a “whirlwind of activity” that has led to Irvine, CA-based HCP being “very unrecognizable from the HCP of just a couple of years ago,” President and CEO Thomas Herzog said Wednesday during the real estate investment trust’s third-quarter earnings call.

Brookdale now accounts for 17% of HCP’s net operating income, down from 35% two years ago, he said.

Most recently, in the third quarter, 35 communities were transitioned from Brookdale to other operators, including Atria Senior Living, Sunrise Senior Living, Elmcroft by Eclipse Senior Living, Discovery Senior Living and Sonata Senior Living, as planned, HCP said. The REIT expects that four more transitions will be completed by the end of the year.

“The transitions from Brookdale to new operators have been painful, and performance declined significantly prior to the replacement operators assuming control,” Herzog said. “The reduced occupancy impact will carry forward through at least the first half of 2019. Fortunately, the vast majority of the transitions are complete, and we are finally seeing stabilization. We remain confident that in the hands of new and engaged operators, we will recapture a significant upside to this group of communities over time.”

Occupancy in the transitioning portfolio is down approximately 400 basis points (4%) year over year, according to HCP Executive Vice President and Chief Investment Officer Scott Brinker. “And then we also had a significant elevation in certain expenses that, we think, is more temporary — contract labor, overtime, vacant positions that needed to be filled, a huge increase in repair and maintenance to get the properties back up to the right standard, and then some miscellaneous things that add up, like insurance expenses,” he said.

Fifty percent of the community executive directors left their positions and needed to be replaced, Brinker said. “So that puts additional pressure on occupancy,” he noted.

Also in the third quarter, HCP completed the $264 million sale of 17 Brookdale-managed communities to an investment fund managed by affiliates of Apollo Global Management. The REIT expects the sale to Apollo of two additional communities in the portfolio to close by the end of the year for approximately $113 million.

Originally, 22 properties were to be sold to Apollo, but the management company used by Apollo had a noncompete restriction that was not waived as expected, so HCP held on to three of the communities, Herzog said. Replacement operators have been found for two of the properties, he added. “The third property is actively being marketed for sale,” he said.

An additional 10 Brookdale-managed properties were sold to third parties in the quarter, HCP said.

Expectations for the future

Herzog said he expects that senior housing “will be a strong business over time within HCP’s balanced and diversified portfolio of private-pay healthcare real estate.”

“At some point, there will be a tremendous opportunity to grow that business,” Brinker agreed. “We’ve been quite focused on … positioning ourselves to capture value from the assets we already own, but we are starting to think about external growth at the right time. I don’t think that’s tomorrow, but I do think you’ll see us be very active in that space.”

Deliverables in HCP’s portfolio and in the sector at large will be “quite elevated” next year, Brinker said. “But it has now been three straight quarters of these starts declining, and in some cases, pretty materially. So as you start to look out beyond this current wave of deliveries, the demand and supply dynamics start to look a lot more attractive, especially given that the demographic growth rate is going to accelerate quite a bit over the next five to 10 years.”

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