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Morningstar | 2Q for HCP Sees Subsector Variance in NOI Growth; FFO Beat due to Disposition Timing

We do not anticipate a material change to our $25 fair value estimate and no-moat rating for HCP as the company slightly beat our low expectations but still saw an overall weak quarter. Same-store net operating income for the whole portfolio was up 0.7% in the second quarter, beating our estimate by 10 basis points. The senior housing operating portfolio's same-store net operating income growth was down 4.4%, 300 basis points worse than we expected year over year. Their Shop portfolio underperformed their healthcare REIT peers' Shop portfolios, reflecting HCP's lower-quality portfolio holding of a weaker market position against the high supply currently seen in the space. However, HCP's core Shop portfolio was up 2.9% in the quarter and it plans to sell or transition the management of the lower-quality noncore assets, so we think that HCP's core portfolio could perform in line with its peers once the quality issues are addressed through either dispositions or operator transitions. Where HCP outperformed our expectations was on medical office where they were up 2.5% for the quarter. Funds from operations came in a penny above our expectations at $0.47, though the modest beat appears to be based on timing of dispositions as the U.K. portfolio was sold a little later in the second quarter than we expected and more than half of the Shop portfolio held for sale got pushed into the third quarter. The midpoint of guidance was brought up by a penny to $1.81 to reflect the extra income received from the assets still held for sale. While we are likely to bring up our 2018 FFO to account for this change we do not see anything that changes our view beyond 2018 for HCP.

HCP announced a promising medical office building joint venture with Morgan Stanley Real Estate that will close in August. HCP will own a 51% interest in the $605 million JV. HCP's contribution will be a $320 million portfolio of 9 MOBs. Based on trailing NOI, the contribution values the 9 assets at a low-4% cap rate though they were only 80% leased. Considering that HCP expects them to fully lease up, the contributed assets would be valued at a low-5% cap rate, which is still a good disposition cap rate for these assets. In exchange for giving up partial ownership of these 9 assets Morgan Stanley will contribute $285 million to acquire a MOB portfolio anchored by the Greenville Health System at a 6% acquisition yield. Given the positive spread between the assets acquired and the assets sold we like the deal but question why HCP had to involve a partner at all given that they were the ones that sourced the Greenville acquisition.