DOC

Business Context and Reporting Period

Company: Health Care Property Investors, Inc. (HCP)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2006
Business Overview: HCP is a Maryland REIT investing in healthcare-related real estate, including senior housing, medical office buildings (MOBs), hospitals, and skilled nursing facilities. As of December 31, 2006, the portfolio included interests in 731 properties. The company's strategy focuses on opportunistic investing, portfolio diversification, and conservative financing.

Key Financial Metrics

Note: 2006 results include the acquisition of CNL Retirement Properties, Inc. (CRP) effective October 5, 2006, and significant gains from discontinued operations.

Material Changes vs. Prior Period

• Merger Activity: The most significant change was the merger with CNL Retirement Properties, Inc. (CRP) and CNL Retirement Corp. (CRC) on October 5, 2006. The aggregate consideration was approximately $5.3 billion ($2.9 billion cash, 22.8 million shares of common stock, and assumption/refinancing of $1.7 billion debt). This transaction more than doubled the company's asset base.
• Revenue Growth: Total revenue increased 46.8% to $619.1 million, driven primarily by the CRP merger and the consolidation of HCP Medical Office Portfolio, LLC (HCP MOP) in November 2006.
• Net Income Surge: Net income increased 141% to $417.5 million. This was largely due to $310.9 million in income from discontinued operations, primarily gains on the sale of 83 properties (including 69 skilled nursing facilities) totaling $275.3 million in gains.
• Debt Expansion: Total debt obligations increased 217% to $6.2 billion to finance the CRP merger and other acquisitions. Variable rate debt increased from 15% to 27% of total debt.
• Portfolio Composition: The portfolio expanded to 731 properties. Senior housing now represents the largest segment by investment value.

Guidance, Outlook, and Risks

• Dividend Outlook: The Board declared a quarterly dividend of $0.445 per share for Q1 2007, representing an annualized rate of $1.78, a 4.7% increase over 2006. The Board intends to consider dividend increases annually.
• Capital Markets: The company successfully delevered post-merger borrowings in January 2007 through equity issuances and senior note offerings, reducing variable rate exposure. Senior debt is rated BBB (S&P/Fitch) and Baa3 (Moody's).
• Key Risks:
  • Operator Concentration: Tenet Healthcare (9% of 2006 revenue) and Sunrise Senior Living (5% of 2006 revenue) are experiencing significant legal, financial, and regulatory difficulties. Failure of these operators to pay obligations could materially reduce revenue.
  • Regulatory Environment: Changes in Medicare/Medicaid reimbursement rates and fraud/abuse laws could impact tenant ability to pay rent. Specific concern exists regarding California Senate Bill 1953 seismic safety requirements for a hospital operated by Tenet.
  • Interest Rate Risk: Approximately 27% of debt is variable rate. A 1% increase in rates would increase interest expense by approximately $17 million.
  • REIT Status: Failure to qualify as a REIT would result in significant corporate taxation and reduced distributions.

Investor Verification Checklist

• CRP Integration: Verify the progress of integrating CRP operations and the realization of projected cost synergies.
• Major Operator Solvency: Monitor the financial stability of Tenet Healthcare and Sunrise Senior Living, given their significant revenue contribution and current legal/financial challenges.
• Discontinued Operations: Confirm that the $275 million gain on sales of skilled nursing facilities was a one-time event and does not represent recurring income.
• Debt Maturity Profile: Review the debt maturity schedule, noting significant principal repayments due in 2008 ($902.8 million) and 2009 ($900.9 million).
• Seismic Compliance Costs: Assess the potential remediation costs for the Tarzana, California hospital under SB 1953 and the allocation of costs between HCP and Tenet.