As with many other real estate investment trusts, shares of Newport Beach-based Health Care Property Investors Inc. are on the upswing this year. But HCP, as the company is known, isn’t like most other REITs, which have seen their shares rise along with the markets for office buildings, industrial space and even apartments. HCP owns hospitals, nursing homes, assisted-living facilities and medical office buildings,a sector known more for the troubles of its tenants than for its upside potential. But company officials say their diversification strategy has moved HCP into the most promising healthcare property segments while limiting its exposure to more troubled segments. They’ve also pursued acquisitions,like last year’s $1 billion buy of Denver-based American Health Properties Inc.,that have helped spread out the company’s holdings. “Acquisitions have been very important for the company,” said Kenneth Roath, the company’s chairman, president and chief executive. “What we are really interested in is a steady cash flow growth in rents over time. We’re not interested in short-term flipping properties to make a quick buck.” HCP’s shares, trading at around 29 last week, are up 26% year-to-date. While that’s only about half as good as the best office REITs, HCP is a standout in its segment. The company’s $1.5 billion market capitalization puts it in the top tier of Orange County public companies. “It’s the bluest of the blue-chip healthcare REITs. It’s a bellwether of the industry,” said Warner Griswold, a healthcare REIT analyst with Green Street Advisors in Newport Beach. HCP, which counted $224 million in revenue and $114.5 million in funds from operations last year, was founded in 1985 and has some 40 employees at its MacArthur Court corporate office. The company owns or has stakes in some 425 properties in 43 states and holds mortgage loans on 25 properties.
Among healthcare REITs, only Healthcare Realty Trust Inc. of Nashville, Tenn., has fared better on Wall Street this year, posting a 40% gain. But HCP counts a market cap that’s nearly 60% higher than Healthcare Realty’s. “It’s one of the best-capitalized companies,” said John Roberts, a vice president at Hilliard Lyons, a Louisville, Ky.-based brokerage. “They have not had a debt-financing problem.” Smaller cross-town rival Nationwide Health properties Inc. of Newport Beach also has held its own with investors, up about 15% for the year, despite a focus on the hard-hit senior care segment. But other healthcare REITs clearly are out of favor, including Murfreesboro, Tenn.-based National Health Investors Inc. and Needham, Mass.-based Meditrust Corp. R. Bruce Andrews, chief executive of Nationwide Health Properties, said he has “a lot of respect” for his rivals at HCP. While HCP has diversified into areas Andrews said he doesn’t endorse,he singled out acute-care facilities, which he believes could suffer as less-costly treatments are sought,the executives at HCP “have done it very well,” he said. “They’re smart people who have done a good, conservative and consistent job in building their portfolio,” Andrews said. Part of HCP’s strong performance this year, Andrews said, owes to the fact that the company is more heavily weighted in two relatively strong sectors,acute-care hospitals and medical buildings,and less in two downtrodden ones,nursing homes and assisted-living facilities. And Andrews credited HCP, as well as his own company, with adhering to high underwriting standards. By aligning itself with good facilities and good operators, HCP has been able to weather the current tough market for healthcare properties, he said.
Both HCP and Nationwide Health have benefited in the past from lower borrowing costs than most rivals, because of their strong balance sheets. That has enabled them to get more favorable terms from lenders and a higher valuation from Wall Street, Andrews said. But as with any diversification strategy, HCP’s approach has meant a tradeoff of aggressive growth for consistent performance. That doesn’t bother HCP’s top institutional investor. “We like the company. It’s a survivor in the healthcare REIT industry,” said Steve Brown, a portfolio manager for New York-based Cohen & Steers Capital Management Inc., which holds 5.7 million HCP shares, an 11.2% stake worth nearly $170 million as of last week. HCP’s portfolio roughly breaks down to 27% acute-care hospitals, 26% long-term care facilities, 21% medical office buildings, 15% assisted-living and congregate-care facilities, 6% physician group practices and 5% rehabilitation hospitals. Having several kinds of real estate in a portfolio, company officials and analysts said, cuts the financial threat if a particular segment has problems. “Over the years, we have found that normally different segments of that industry are doing well, while maybe another sector is not doing so well,” Roath said. “Today, we have a rather unusual circumstance in which we find that many of the sectors are all experiencing difficulties at the same time.”
Acquisitions are a key part of HCP’s strategy. James Reynolds, executive vice president and chief financial officer, calls the company’s approach “a bit opportunistic.” “We would go to what we thought was the best investment for our investors at the time,” he said. HCP was one of three companies that saved Beverly Enterprises Inc., an Arkansas-based long-term care company that leases some of its properties, from a bankruptcy filing some years ago.
“We’ve made excellent returns on those properties over the years, and we’ve been able to buy additional Beverly facilities in the meantime,” Reynolds said. Last year’s buy of American Health Properties brought 68 new properties into the fold, including a strong hospital contingent. Green Street Advisors’ Griswold said he didn’t like the deal at first because HCP had to “issue so much equity at such pricey levels.” He’s since changed his thinking. “We were wrong,” Griswold said. “The diversification out of long-term care wound up being a big plus for shareholders.”
HCP’s acquisition strategy is tempered by its conservative style. Even with HCP shares near their 52-week high, Roath said he doesn’t think the timing is right to raise money through an offering or to take on additional debt.
“Unfortunately, we’re in a period of time that our cost of money does not permit us to issue new stock or even to raise significant amounts of debt, because we don’t want to leverage up the REIT more at this point,” he said.
HCP’s facilities are leased to nearly 100 healthcare providers, including several national players, such as Santa Barbara-based Tenet Healthcare Corp., the largest hospital operator in OC. National Medical Enterprises, Tenet’s predecessor, was an early backer of HCP, Reynolds said. At 18%, Tenet is HCP’s largest tenant. Locally, HCP owns Tenet’s Irvine Regional Hospital and Medical Center. “They have a well-diversified portfolio, the largest market cap and investment-grade credit,” said Rick Rubin, an analyst with Baltimore-based Legg Mason Wood Walker. In a recent report, Rubin and colleague Jerry Doctrow called HCP their “top pick in the sector.”
Still, the two analysts point to “bumps in the road” for HCP. Several large nursing-home chains are operating under bankruptcy protection, including Sun Healthcare Group, Mariner Health Group, Integrated Health Services Inc. and Vencor Inc. The latter accounts for about 4.7% of HCP’s revenue. “Certain of the company’s operators have recently experienced working capital shortfalls and reorganizations resulting in lower rental income or the possibility of lower future rents,” the analysts wrote. Roath called HCP’s involvement with Vencor “a very unusual situation.” He said it could be traced back to Vencor’s acquisition of Hillhaven, a nursing home company that was spun off by what’s now Tenet. “We never did leases directly with Vencor,” Roath said. Roath said the company has been lucky so far with struggling nursing homes. When a company such as Vencor files for bankruptcy protection, it’s not the same as when a shopping mall operator does so. “The difference is that you have patients in the facilities and you have to continue paying all of the bills,” he said. “You have to pay the doctors, you have to pay the rent, you have to pay the nurses, you have to buy the medicine and so forth.” HCP has continued to receive rent from tenants that have filed for bankruptcy, Roath said. Still, he said, in some cases an individual facility may not be producing enough cash flow to pay the rent. “If you own the property, you have the choice of taking it back and taking it to somebody else or you can negotiate a new, lower lease rate for the existing tenant if you want to stay with that tenant,” Roath said. According to Doctrow and Rubin, HCP’s exposure to troubled nursing-home operators is less than 10% of its total revenue. One area Roath said HCP is looking to expand in is not-for-profit hospital operators, which make up about 2% of annual revenue. Its not-for-profit tenants include Johns Hopkins University Hospital in Baltimore, Clarian Health in Indianapolis and Sharp Healthcare in San Diego. n
