Greg Stapley - President & CEO Dave Sedgwick - VP, Operations Mark Lamb - Director, Investments Bill Wagner - CFO.

Josh Raskin - Barclays Capital Jonathan Hughes - Raymond James Chad Vanacore - Stifel Nicolaus Paul Morgan - Canaccord Genuity Jordan Sadler - KeyBanc Capital Markets Todd Stender - Wells Fargo Securities John Kim - BMO Capital Markets Michael Carroll - RBC Capital Markets.

Welcome to CareTrust REIT's Third Quarter 2016 Earnings Call. Listeners are advised that any forward-looking statements made on today's call are based on management's current expectations, assumptions and beliefs about CareTrust's business and the environment in which it operates.

These statements may include projections regarding future financial performance, dividends, acquisitions, investments, returns, financings and other matters, all of which are subject to risks and uncertainties that could cause actual results to materially differ from those expressed or implied here.

Listeners should not place undue reliance on forward-looking statements and are encouraged to review the Company's SEC filings for a more complete discussion of factors that could impact results, as well as any financial or other statistical information required by SEC Regulation G.

In addition, CareTrust supplements its GAAP reporting with non-GAAP metrics such as EBITDA, adjusted EBITDA, FFO, normalized FFO, FAD and normalized FFAD.

When viewed together with its GAAP results, the Company believes that these measures can provide a more complete understanding of its business, but they should not be relied upon to the exclusion of GAAP reports.

Except as required by federal securities laws, CareTrust and its affiliates do not undertake to publicly update or revise any forward-looking statements or changes arise as a result of new information, future events, changing circumstances or for any other reason.

Listeners are also advised that the Company filed its 10-Q and an accompanying press release yesterday. Both can be accessed on the investor relations section of CareTrust's website at www.CareTrustREIT.com. A replay of this call will also be available on the website. At this time I would like to turn the call over to Mr.

Greg Stapley, CareTrust's Chairman and CEO..

Thanks, Vince. Good morning, everyone and thanks for joining us today. With me are Bill Wagner, our Chief Financial Officer; Dave Sedgwick, our Vice President of Operations, who joins from our East Coast office; and Mark Lamb, our Director of Investments. Q3 was another great quarter for CareTrust with $46 million in new investments.

This brought our total capital deployment year-to-date to about $191 million at an average 9.1% initial cash yield. And we continue to fill the pipeline, setting ourselves up for what could be a solid finish to this year and a, hopefully, fast start to 2017. Just as importantly, we remain on track for the achievement of our long term goals.

For example, our current leverage remains at about 5.1 times on a debt to run rate EBITDA basis and at about 36% on a debt to enterprise value basis which is well within our target ranges of 4.5 to 5.5 times and 30% to 40%, respectively. Our tenant base continues to diversify with two new operators joining the portfolio this quarter.

This growth has placed our largest tenant, Ensign, at 56% of run rate revenue with lease coverage of 2.12 times. And our next largest, Pristine, is now at 18% of run rate revenue, even after adding a pair of new acquisitions to their master lease in Q2.

Our weighted average cost of capital which together with our internal hurdle rate is what we look at most closely in our investment decisions, has improved year-to-date, helping us to become even more competitive in the market.

We activated our ATM for the first time this quarter, raising a modest amount of equity, but more importantly, opening a new avenue for capitalizing some of the smaller deals that we actually tend to like.

Finally, as we draw close to year-end and have more visibility now, we have been able to tighten our guidance when we get toward the higher end of we had earlier announced. We continue to view the current M&A market as somewhat overheated, contrary to what you might be reading in the press.

Nevertheless, we're still finding good acquisitions that we can pair with great operators to make solid investments which we expect will pay dividends for years to come. Above all, we have remained disciplined in our growth.

That discipline centers on making investments only with operators whom we believe will excel in good times and still shine when the operational headwinds blow which inevitably they do from time to time.

This advances our overarching objective which is to build a diversified and well-covered portfolio that will produce solid returns through both up markets and down. As we go forward, Dave will briefly address our operating relationships as well as some broader industry dynamics and then Mark will provide some details on our growth and pipeline.

Bill will then conclude with the financials.

Dave?.

Thanks, Greg. In Q3, we welcomed two new skilled nursing and seniors housing operators to the CareTrust portfolio, West Harbor Healthcare and Covenant Care. West Harbor's principles are former colleagues from our days as operators. We know their capabilities and are really excited to grow with them.

Covenant Care is also well-known to us and is a very well-regarded national operator, based right here in our backyard. We acquired two SNF/AL communities from one of their previous landlords and enjoy excellent lease coverage out of the gate with them.

These two outstanding operators share much in common with the others with whom we have been building our portfolio. Additionally, we have vetted a number of other exceptional operators with whom we're already looking to grow in additional markets.

Now let me offer three brief thoughts on the operating environment for skilled nursing and how some of our operators are handling the current and pending changes.

First, don't forget that on October 1 our skilled nursing providers received a 2.4% increase to the overall Medicare rates for the fiscal year 2017, one of the healthiest increases we've seen in years.

Second, for the last 10 to 15 years the SNF sector has been adapting to increasing pressures by Medicare, hospitals and health plans to deliver care better, faster and cheaper.

The operators who have thrived in this environment are those who combine an unwavering commitment to their employees, residents and patients with the operational and financial ability to capitalize on the changes that come their way.

We stay close to what's happening on the ground with our operators and the sector at large and we see a significant variance in how these changes are affecting different states and markets even within those states.

In some markets, the pressures and competition are very real and yet, for many others, alternative payment models and accompanying changes are still many months and even years away, giving the operators ample time to prepare which we believe our operators are doing.

Our experience indicates that the best operators will adapt and remain strong, as they have done for many years and through all kinds of cycles. A perfect example of this dynamic is our largest tenant, Ensign.

Even though they have lately had some challenges unrelated to bundling or reimbursement or other headline risks that get so much attention, they report that their overall skilled length of stay for both Medicare and managed care have essentially held steady over the past year.

More importantly for us, we're pleased to report that through Q3 they are showing 2.12 times lease coverage in our portfolio, a slight increase over Q2. So while there will always be some operators who underperform in changing markets, there are others who not only survive but thrive.

Those are the gems that our long experience as operators helps us uncover. Third and finally, keep in mind the reason for Medicare's current efforts to innovate, the dramatic demographic impact that is headed our way.

We expect that even after the ongoing rearrangement of the payment systems, the projected growth in the Medicare-eligible population will be net positive for providers across the healthcare continuum.

With that and our growing bench of great operators, we remain very optimistic and feel like we're better positioned than ever to grow and do well for the foreseeable future. With that, I will hand it over to Mark..

Thanks, Dave and hello, everyone. After completing $146 million in investments during Q1 and Q2, we started off the second half of 2016 with another $46 million in investments across four separate transactions. Q3 transactions were completed at a blended going in cash yield, inclusive of transactions costs, of 9.4%.

As Dave noted, these deals added two new relationships in California, plus a pair of tack-on preferred equity deals to an existing tenant relationship. By the way, both of those preferred equity investments are currently under construction and should be a nice source of high-yield investment growth for us over the next few years.

The current market for skilled nursing properties continues to be fueled by private equity and syndicated investors. We're seeing one-off opportunities as well as small, medium and large portfolios with pricing still a bit overheated.

On the senior housing front, we continue to see a fair amount of attractive opportunities in secondary and tertiary markets that we're working to pair with our existing operator base, in addition to the new operator relationships we have been cultivating. As for the pipeline, we remain cautiously optimistic.

Please remember that when we quote our pipe we only quote deals that we're actively pursuing which meet the yield and coverage underwriting standards that you are accustomed to seeing from us. And then only if we have a reasonable level of confidence that we can lock them up and close them.

Despite the somewhat frothy environment, we're still seeing some good opportunities. Today the pipeline is right around $125 million of assets under serious consideration. The composition of the pipe continues to be a healthy mix of both seniors housing and SNF assets. With that I will hand it to Bill..

Thanks, Mark. For the quarter, we're pleased to report that normalized FFO grew by 110% over the prior-year quarter to $16.3 million and normalized FAD grew by 96% to $17.1 million. Normalized FFO per share grew by 40% over the prior-year quarter to $0.28 and normalized FAD per share grew by 36% to $0.30.

Given our most recent dividend at $0.17 per share, this equates to a payout ratio of 61% on FFO and 57% on FAD which again represents one of the best covered dividends in the healthcare REIT sector.

As you'll recall, we did our initial stock offering last year during Q3 in advance of $175 million investment that closed at the beginning of the fourth quarter. This resulted in some dilution on a per-share basis for Q3 last year which is helping drive the quarter-over quarter per-share percentage growth numbers this year.

In yesterday's press release we increased the low end of our annual guidance range by $0.01 on both normalized FFO and FAD per share to $1.09 to $1.16, respectively and maintained the high end of the range on both normalized FFO and FAD per share of $1.10 and $1.17, respectively.

This guidance includes all investments made to date and relies on the following six assumptions. One, no additional investments, nor any further debt or equity issuances this year. Our outstanding balance on our revolving line today is $103 million. Two, no rent escalations for any of the leases that would adjust in the last quarter of the year.

Our total rental revenues for the year are now projected at approximately $92.3 million. Three, our three operated independent living facilities are projected to do about $300,000 in NOI this year. Four, interest income of approximately $700,000.

This is down from $900,000 in 2015 because the accounting rules limit the amount that we can recognize on our 2014 preferred equity investment which capped out in the second quarter. The back half of the year includes the income from the $4.5 million of new preferred equity investments we did in Q3 which should bring in a little over $100,000 in Q4.

Five, interest expense of approximately $23.5 million which includes the $326,000 write-off of deferred finance fees associated with the GE payoff last February. In our calculations, we have assumed a LIBOR rate of 1%.

That plus the current grid-based LIBOR margin rates of 185 bps on the revolver and 205 bps on the seven-year term loan, make up the floating rates on our revolver and term loan. Interest expense also includes roughly $2.3 million of amortization of deferred financing fees.

Six, GNA should be between $9 million and $9.5 million which equates to under 10% of total revenues. G&A also includes $1.6 million of amortization of stock comp.

These amounts do include costs associated with our 404 implementation this year and I'm pleased to report that our total implementation costs should come in below our original estimate of $500,000. During the quarter, we briefly began selling shares under our ATM program for the first time.

We sold approximately 183,000 shares at an average price of $15.61 resulting in gross proceeds of $2.9 million. As for our credit stats, calculated on a run rate basis as of today, our debt to EBITDA is approximately 5.1 times, our leverage is about 36% of enterprise value and our fixed charge coverage ratio is approximately 4.1 times.

We also have $14 million of cash on hand. And with that I will turn it back to Greg..

Thanks, Bill. Let me just mention one final thing. This quarter marked our first attempt to produce and publish a supplemental.

In our continuing effort to be as transparent and communicative as possible, we've tried to identify the data points that we think will be most useful to investors in understanding our business, objectives and continuing progress.

With only two years of operations under our belts, we obviously can't provide a lengthy history of trend line in any single data point, but we're committed to providing what we can. And we welcome comments and input that would help us to make future versions of our supplemental more relevant, useful and user-friendly to you.

So if you have any ideas, just please give us a call. We hope this discussion has been helpful. We thank you again for your continued interest and support. And with that, we would be happy to answer any questions.

Vince?.

[Operator Instructions]. Our first question is from Josh Raskin of Barclays. Your line is open..

First question just on Covenant, I was wondering if you could just give us a little more background on those guys. I think you mentioned national operator. Maybe just size and scope and then what the discussions are in terms of potential growth for them as a partner..

Sure. So right now they are roughly at about 50 buildings across -- a good portion of that is in California and then they have some Midwest assets. We really like the assets that they are running and the opportunity that came to us.

We have competed against them for years and, more than anything, the buildings themselves had really, really strong coverage. They are located in the Central Valley which is a very good market from a post-acute setting and so that was one of the things that really attracted us to them.

In terms of growth, we just brought them into the portfolio this quarter and haven't had a lot of conversation around tacking onto these assets. But should opportunities come about, we definitely would like to do so..

How were they financing their growth previously? Who were they using? Was it REITs or were they using other financing?.

You know, that's a good question. I think they are owned by a private equity firm and I think that there was some capital that was coming out of the private equity firm in addition to debt. So I think those were the two primary kind of financing vehicles..

They also the large slug of facilities with -- I believe with HCP that will now, I believe, have gone to QCP. We're still tracking that down. But they are a good operator; we have known for a long time. As Dave said, they are right here in our backyard and we were just thrilled to get them into the portfolio..

Perfect. Just on Ensign, I noticed the coverage did tick up. I think you guys talked about that last quarter and I know we're one quarter in arrears, but still a little bit surprised just based on the results from Ensign. I know you guys talked about how you had a better slice of their assets.

As you think about sort of coverage going forward and you're looking at yours, anything in terms of how you are thinking about coverage going forward? Would you be -- would you expect that coverage to remain relatively steady going forward as well?.

Are you asking about coverage for Ensign or coverage for the whole portfolio?.

Just for Ensign..

We don't expect coverage with Ensign to deteriorate, that is for sure. It may fluctuate slightly from quarter to quarter within our portion of their portfolio, but those are really stable assets that we know really, really well.

I think, as we mentioned, Ensign has announced last quarter that they were having a couple of problems that really have nothing to do with their more mature portfolio or with any kind of reimbursement or other kind of predominant industry headwinds.

It had to do with a couple of very specific internal challenges that they had had, one with an acquisition and one with the implementation of a new HR payroll system. And we believe that they will solve those problems. In fact, they show that they already are solving those problems and will get them done here in the next quarter or two.

But in terms of our portfolio and the coverage there, we expect no material deterioration in that.

I think it'll just continue to climb, because while most of those facilities are -- have been in their portfolio for a long time and are in their mature bucket, there's still a few that I think are in their transitioning bucket that have not hit full stride yet. And we will continue to drive that up, if anywhere..

Okay. Then, lastly, I think on the preferred process you said -- the investment there, you said that they were in construction. Curious how far along they are. When do you think those are assets that will actually be operating? And then any color on geography or anything else that's useful..

Sure. Both of those assets -- the two new preferred equity investments are in Idaho, in a major metropolitan market in Idaho. They are both under construction.

They just started in August-September -- one in August, one in September I think -- and we think the construction timeline for those is roughly 12 months, with a startup and licensing period of up to six-ish months after that.

Idaho takes a long time relative to other states for licensing new facilities and so that could push us out a full 18 months from now, but we're cautiously optimistic that those guys will be up and running in about a year..

Our next question is from Jonathan Hughes, Raymond James. Your line is open..

First of all, thanks for the enhanced disclosure. Much appreciated and very helpful. Earlier you mentioned an overheated M&A market.

Does that mean cap rates have compressed of late? We saw a large portfolio deal yesterday -- what some may have thought was a better than feared yield of 9% -- so just trying to figure out what you are seeing versus recent comps we have..

This is Mark. I would say there's a smattering of buildings out of the market right now and I think portfolios in general, the larger portfolios are obviously trading at lower cap rates.

We're just seeing a mixed bag of skilled nursing assets that aren't cash flowing that are still trading, on a per-bed basis, well above numbers that we feel comfortable buying at. And so when we say overheated, we're talking not only cap rates, but then also per-bed metrics that exceed our comfort levels..

Okay, so looking at beds and cap rates. All right.

Could you just give us some details maybe on the pipeline? What the asset mix is; cap rates embedded in that?.

Yes, the current pipeline I think we have quoted it around $125 million. Again that is serious stuff that we think we could close. It looks about like our existing portfolio, roughly 75% SNF, 25% seniors housing right now. That fluctuates from time to time.

In terms of cap rates, on the seniors housing side, we're holding steady in the 8s, depending on the quality of the asset. We may be a little higher, a little lower in the 8s.

And then on skilled nursing, we're sort of baseline cap rate is -- our going-in yield is about 9.5% and we may take that up or down again depending on location, age and quality of the real estate and other factors..

Okay.

Then also the fast start you mentioned to 2017, can we take that as a bigger acquisition volume in the first half of next year and then maybe slowing in the second half?.

That's what this year looks like, Jonathan, but I would not anticipate 2017 to look like 2016. It's this time a year ago we had a lot more stuff that was coming along than I feel like we have right now and so I think you will probably see a steadier flow through next year rather than the frontloaded year that we saw in 2016..

Then just one more.

Could you give us some color on any new supply in your senior housing markets? Any recent new openings there or pressure on your tenants in terms of personnel retention costs?.

I don't know that we can speak authoritatively to personnel retention costs, other than to say that as we talk to our operators we do ask them about labor and they do say that labor costs are a challenge.

But remember that with respect to our seniors housing portfolio, we tend to gravitate toward the secondary markets where the barriers to entry are a little higher, where you can do better with the sort of B+ level assisted-living that we like to invest in, rather than the A+ stuff that gets so darn competitive in the big metro areas.

And so we're not seeing new supply coming in and threatening any of our existing seniors housing portfolio anywhere that I can think of right now.

Mark, any place you can think of? Dave?.

No, everybody that we have talked to -- and granted these are secondary and even tertiary markets -- we're not seeing the big Class A operators coming into those spaces and building brand-new assets..

Our next question is from Chad Vanacore, Stifel. Your line is open..

So you make the statement that you are cautiously optimistic on the pipeline, but there seems to be plenty of SNF assets trading in the market.

So can you explain the cautious part of the optimism?.

I would say finding -- the cautious part is making sure that the operators are comfortable stepping in. There are a lot of assets out on the market that are being paired off from REIT or both publicly-traded operators as well as what we would term super-regionals, who are chopping off nonstrategic assets.

And so it's one of those things where our operators that are currently on our bench, if they like them and feel like they can take them and turn them and do really well with them, those are assets and acquisition targets that we're actively pursuing.

Just because there isn't an abundance of SNFs on the market doesn't necessarily mean that it's fitting our box. And so we're partnering with our operators to find opportunities that work for them and us..

Otherwise, Chad, we just don't want to overpay and, frankly, right now there's some private equity and some offshore money coming into the market and setting pricing for some of the portfolios that we think is not -- it certainly doesn't, as Mark says, fit our box. And so we're long term thinkers.

We're not going to do something just because some spreadsheet says we should. There's a lot more to our investment decisions than that and, as Mark said, it starts with who the operator is going to be and how comfortable they feel with the occupancy overhead that the price you pay is going to represent.

And so what that is doing for us is it's driving us to do what we have become really pretty good at which is beating the bushes for the off-market deals, for the one-offs, for the small operators who want to do sale lease-backs and focusing on those kinds of things rather than the big, sexy portfolio transactions that others are doing..

All right.

Either Mark or Greg, what is the rough underwriting criteria that you are using on new SNF investments right now?.

Its asset, market and operator-dependent, so just in general, call it, 9.5 in one-four coverage, but as Greg alluded to -- for skilled nursing. As Greg alluded to, there's a whole host of variables that we will adjust up or down for, but really as we base case all of our deals coming in the door, it's going to be 9.5 with one-four coverage..

Okay.

Then just thinking about your Ensign portfolio, how much of that portfolio is actually considered in that transitional bucket or in stabilization by Ensign?.

It's been a while since I looked back at that and sort of counted them up so I can't answer that question as we sit here. But I can get that information to you..

And then just one last one.

When do the rent escalators on Ensign leases start kicking in? Is it 2Q 2017? And then at what level?.

Chad, it's Bill. They kicked in this year on June 1. They are CPI-based with a cap of 2.5% and the increase this year, given CPI, was not real material. I think the leases went up about $400,000 to $500,000..

Okay.

And then at these same levels today, we expect about the same in 2017?.

If inflation doesn't -- it is CPI-based, floor and cap and so if inflation doesn't change next year you would have another modest increase next June..

Our next question is from Paul Morgan, Canaccord. Your line is open..

Sorry if I missed this, but in terms of your pipeline and kind of where we stand in the fourth quarter, do you see the pace of investments for the rest of this quarter making 4Q line up around where Q3 came in or should we expect something different and maybe looking into early 2017?.

Paul, it's Greg. I've been doing these transactions for 30 years and I can tell you that as you sit on November 1 and try to predict exactly when a deal is going to close -- will it close in the next 60 days or 90 days? Will it flow into 2016 or maybe carryover and close in the first part of 2017 is really hard to say.

We do have stuff in the pipeline, as we mentioned. We're trying to close some of it this year and -- but as we sit here this moment, we can't guarantee that we will get anything done by 12/31. If that doesn't happen, we certainly would be optimistic about a good, solid first quarter..

And could you talk a little bit about how your operators are -- what their appetite for growth is like right now relative to where it was, say, a year ago and whether there's any concerns that you hear most common from them, whether it's like you talked about length of stay in the SNFs or labor cost inflation or supply in certain markets? Is there any of those or any others that maybe have made a few people cause a little bit relative to where they were thinking about growth earlier or is it about the same?.

Paul, this is Dave. Our operators are, by and large, anxious to continue to grow. They are experiencing some of the same labor pains as you've seen throughout the sector recently, but not to an unusual amount. Nothing that they haven't experienced before and so they are dealing with that.

There really isn't anything that is keeping our operators from wanting to grow. We're actively pursuing deals with just about all of them to some degree. Everybody is anxious to grow still. And what is important to remember is that there's a lot of markets where these top-line pressures just don't exist yet.

There's hospitals, there's health plans in many markets where the bundled payments and the other innovations are years away and so the broad market or appetite for growth remains pretty healthy..

And then just lastly, you highlighted how you've got one of the best covered dividends in the sector and how strong the FFO and FAD per-share growth has been.

How do you think about where the payout ratio makes sense for you and when dividend growth might look a little bit more like earnings growth as the platform builds?.

Well, at the moment and I emphasize at the moment, our thinking with respect to our dividend policy is that we're still -- still maintain a bit of a startup mentality and still want to plow as much of our earnings back into the Company as we can, while paying a reasonable and fair dividend out to investors, including ourselves who are all owners of the Company.

That said, we hope to grow this things such that it would be able to pay more.

And as long as we can keep that dividend really well covered which it is now -- I think, if I'm not mistaken, it may be the best-covered in our space; not by a lot, but maybe by a hair -- we're really comfortable right there and would expect to continue to stay right in that zone for the foreseeable future..

Our next question is from Jordan Sadler, KeyBanc Capital Markets. Your line is open..

I wanted to clarify; I heard the word overheated a bunch of times during your remarks and in the Q&A here. It sounds to me like that sort of context really is a function of the larger portfolio trades that we're seeing over the course of last week or so and maybe, to a lesser extent, in your core or target assets.

Is that a fair comment or are you seeing the same overheating in your targeted assets?.

You know, Jordan, that's a pretty fair comment. Certainly, as Mark alluded to, large portfolio deals get just a ton of attention and have attracted a big investors. We don't have to be a big investor in order to move the needle here.

And I will tell you candidly that on some of the smaller kind of deals that we target, we have actually been disappointed recently with pricing that was significantly above where we believed it ought to be. And so we will continue to monitor that.

But we're not discouraged or anything because we said we remain optimistic that we can continue to source deals through our extensive network of contacts in the industry, through our operators who, as Dave said, are all anxious to grow and through the back channels and the off-markets that those kind of contacts have historically produced for us that have [indiscernible] deals.

And so, yes, we're not going to be doing any $0.5 billion deals in the near future, I don't think, but I think we will continue to see enough that we like to grow with..

Then as it relates to the 2.4% increase that went into effect a little over a month ago, how should we think about how -- given the margins and mix of your tenants, the impact on coverages? Any sense?.

Jordan, this is Dave again. As you think about our coverages, you always have to start with remembering that we're starting from an unusually high number because of the superior coverage that we have with the Ensign Group. Remember that went from 1.86 out of the gate up to -- what is it? -- 2.12 today.

That takes our whole overall coverage up quite a bit. We're certainly not bringing in new deals up in that area. Like Mark said, we underwrite at 1.4 and so as we grow we expect that lease coverage overall to decline.

However, as you drill down into the different assets that we have acquired, even there you have some that are stable that we expect to maintain where they are at and maybe go up and down nominally based on the lumpiness of the business.

And then we have another group of assets that we have also -- that we favor which are kind of Medicaid shops that aren't affected really at all by things like CJR, because they were never getting the hips and knees to begin with. And so they really have some upside in going from Medicaid shops to growing their skilled mix.

In some cases we would expect that some of our assets that are more stable are going to maintain and in other cases we're going to see some modest improvements to lease coverage in other parts of the portfolio.

But as we acquire assets over the long haul, that high number that we've enjoyed from Ensign is going to continually drop into where you would expect over time..

And then I don't know if I missed this; if I did I apologize.

But any way of offering some insight into the progress on Liberty a year later?.

So Liberty is doing well. We have been spending some real quality time with them, reviewing how their progress has been going. Mark and Greg and I actually spent a couple of days with them recently in the building, meeting with their senior team. And we left really encouraged that they are making the right decisions.

Remember, they have a pretty big ask ahead of them taking that Medicaid portfolio and converting it to a shorter term rehab-type portfolio which requires a substantial investment in systems and people. We projected that there would be a drop in lease coverage as they put that plan in place. So they are on track.

They have seen some really -- they have had some really nice wins across the portfolio. They have seen skilled census improve. But as old operators ourselves, what we're probably most excited about is the important decisions that they are making for long term success.

They are investing in culture and training their people and improving the capabilities to be able to take more skilled patients in the future. And we expect that their lease coverage will climb in 2017 and really, really positive on Pristine still..

Our next question is from Todd Stender, Wells Fargo. Your line is open. .

For the preferred equity investment, you are obviously comfortable with a 9% yield on the real estate. I'm sure if you made a loan to the tenant, you would be in the mid teens.

How do you determine the risk and reward when you look at a preferred investment like that and how do you arrived at that yield?.

The preferred is actually -- it's a floating rate, not -- and it's got a floor of 12%. Then when we exercise our option I believe it steps into something in the 9%s and I believe it is the in-place lease rate. So I'm not sure where the 9% is coming from that you are quoting. I will tell you--.

I guess in relation to -- you are comfortable buying real estate at a 9% and you probably lend money I make at 15%. I just wanted to see how you arrive at that yield of 11.7% or 12%..

So I'll tell you the lease rate we're comfortable at we actually would be comfortable at a 9% on these particular assets. They're located right across the street from the largest health system in the state of Idaho.

They are 100-bed buildings which we expect to get the lion's share of the discharges from the hospital and so these facilities should own those markets for the next 10 to 15 years..

Todd, it's Greg. I think I understand what you're asking in terms of what your expectation would be if we're putting out, say, mezz debt..

Exactly, exactly. Is there a spread over, say, a real estate investment? How do you arrive at that? Maybe there's comps you point to..

There's not comps that we would point to. Basically what we were trying to do is create a product that we could use to again, as long term thinkers, to help good operators create new assets that we will have an option to buy.

We place some value on that option to buy and maybe that's 300 or 400 bps on this rate over a year or two until the asset is stabilized. As Mark says, we hope hopefully exercise that option and take the asset out. If we never did exercise the option and take the asset out, in the meantime we've gotten somewhere in the 12% range.

The 11.7% you are seeing is basically 12% adjusted for some transaction costs that we've put in there..

Is that a cash coupon you receive or does this get embedded in your cost of the building when you purchase it?.

Well, the prep accrues and then when we take it out we get credit for it on the purchase price. The other thing I would just mention is that this is an existing tenant relationship for us and that 12% rate that they are getting is a relationship rate..

Then, Bill, you tapped the ATM for the first time in the quarter.

How do you look at that? Is there a yardstick you use to measure when to issue? Is it simply so as the stock trades below NAV, then you hit it? Or is it -- are you looking as an AFFO yield, maybe on a cost of capital? How do you look at when to actually issue?.

First off, we can issue only when the window is open and that's tied to our insider trading policy, so the windows are not real large every quarter. Then when we do decide to make a trade, we do look at NAV. We look at where the stock is trading and we're not going to issue at a below NAV price..

We're also looking at what's in the pipeline and how we want to match fund that..

And then, Greg, since you asked about maybe opportunities to improve your supplemental, page 7 you've got your occupancy in coverages. Can you guys offer maybe year-over-year comps? I know there's maybe not as much seasonality in your business as say multifamily, but just looking at what last year was.

And if you could break out a same-store pool as well?.

You bet. We'd be happy to do that. With the caveat, Todd, that, as I said, we just don't have a lot of history with these.

And when we look at pre-acquisition occupancy and other pre-acquisition financial metrics we tend to be a little bit cautious about putting them out to where they could be relied on by anybody, because we don't necessarily rely on them..

And then last piece, and I don't know if this would be a supplemental thing, but I think where you guys have a distinct advantage over your competition are your lease escalators.

As simple as that sounds, we see some of the larger SNF operators subject to 3% or sometimes even 5% annual fixed rent escalators that we, as analysts, think that may be difficult to achieve. You guys have more tenant-friendly escalators, so maybe if you could highlight that.

I don't know if that's appropriate on a tenant-by-tenant basis or lease basis. I think that is a distinct advantage for you guys..

Thanks. We will take a look at that..

Our next question is from John Kim, BMO Capital Markets. Your line is open..

To follow up on Todd's comment, it looks like on some of the acquisitions you made recently you have put in place a 3% escalator.

Is that a change in how you are structuring transactions going forward?.

I think you are seeing one acquisition we did where we purchased an existing lease that was in place and that was the Covenant Care transaction back in August. The rest of them are CPI-based escalators with zero floors and caps between 3% and 3.5%. So, no, we haven't our [indiscernible]..

Your preferred book is growing.

It's still less than 2% of your assets, but how big do you envision this becoming?.

Not big. That's really kind of a strategic thing for us. It's relationship based and development is something that we don't want to get into too heavily..

And, Greg, I think you mentioned the interest accrual stopping from one of your assets.

Is that because that converted into the asset?.

No..

John, it's Bill. It's an accounting rule concept that doesn't allow for us to continue recognizing interest income. However, the income does accrue, call it, off-balance-sheet and not in our P&L statement.

So we're getting credit for it and when we choose to either put the investment back to the common member or purchase the property, we will get credit for that..

Okay.

And then finally I think the subject of QCP was brought up and I know it's early days for that company as a standalone, but do you have any views on whether or not QCP is more inclined to sell assets to help improve their balance sheet and would that be of any interest to you?.

We have not talked to anybody at HCP or QCP about that. I don't think -- we're anxiously waiting to see what Mark Ordan decides to do and that's going to be a really interesting story for 2017 I think. But we don't know. We would be interested in some of them..

You would?.

There would be a zillion caveats that came with that, including that they have to be priced right and so forth. And the ManorCare, they had some issues they've got to work out if we were ever to think about taking a ManorCare asset.

But there are other assets in their portfolio we're aware of that I would say that we would be interested that are non-ManorCare assets..

But from the ManorCare care side, high Medicare mix tenants, that doesn't turn you off?.

A little bit, honestly. Remember that what we really like, kind of the investment nirvana for us, is not the facility that is 99% occupied and 60% skilled mix and hitting on all cylinders. We love the facilities that are a little bit more of a Medicaid shop that are stable and cash flowing, but maybe 80% occupied.

And still have that 10% to 15% occupancy upside there for an incoming operator who knows better than the outgoing operator how to do it; can tap into to really grow the value of that investment and lease coverage on that investment. So that's what we're looking for.

I think there's some -- ManorCare probably doesn't fit that box which is why I said there's about a zillion caveats, including pricing, that would have to come with those assets. But there are other assets within the former HCP skilled nursing portfolio that we're aware of that we would like..

Our next question is from Michael Carroll of RBC Capital Markets. Your line is open. .

How are you guys underwriting the skilled nursing facility development projects that you made the preferred investments on? What is the development cost per bed and what is the expected coverage ratios that you are looking for and the skill mix that you expect those facilities to have?.

We will have to get back to you on the development cost per bed, but I can tell you it's probably -- it's about $140,000 of that, if my memory serves me correctly. We can get that to you.

The interesting thing with this preferred structure that we have with this in-place tenant is they actually want to leave a lot of coverage, like north of 1.5 to 1.6 coverage in the building when we strike, if we exercise our option. So this particular -- these buildings are prototypes, they're 99 beds. There's a healthy mix of Medicaid.

We're not underwriting to 50% quality mix. It's right in line with metrics in the state of Idaho.

And so we take what their pro forma projections are which we think are very reasonable to what's taking place in the market and then we stepped up the coverage a little higher than normal, up in the 1.5, 1.6 range and that's really kind of how we took a look at it, very conservatively..

Then how do you plan on growing I guess the portfolio through investments? I know most of your deals over the past few years have largely consisted of buying assets and replacing the operator with one of your better relationships that you have.

Is that still the model and should we expect that going forward?.

It's a model, but it's not the only model.

We're also contemplating doing some good sale-leaseback transactions with existing operators that we really like who, for whatever reason, would like to take some money off the table, whether it's rationalizing their capital structure, exiting a retiring partner like we did with the priority deals last year or this year.

We really haven't redlined any of that kind of stuff at all. But we do tend to see, I think -- and I don't know why, but we do tend to see more deals where we would be re-tenanting the building..

Then before completing a transaction, how do you get comfortable with the operator in that they will be a winner in the new reimbursement environment? What are you actually looking for with those operators? How much time do you have?.

It really is a lengthy process and probably -- to summarize, to be brief, we look for folks who have the orientation to, first and foremost, value and invest in and put a priority on their employees; the culture of the facilities and the company; and doing right by the patients and residents that they care for.

And also have the financial sophistication and understanding to adapt to whatever Medicare throws at them, because what we understand, what we see today is what we see today, but three years from now the changes may be different.

So we want folks who are smart, who have a track record of doing that, of adapting and thriving in taking assets from maybe Medicaid to short term. Those who are able to -- have demonstrated that tend to have the sophistication requisite to adapt to future changes as well.

But that first part of what I said is probably just -- not probably, is as important as the second half. When you are talking about a business that cares for people, the culture that they create and their commitment to their people is very important.

And so we look for stuff that doesn't really show up on any underwriting spreadsheet when we meet with those guys and we're looking really for the total package..

Thank you. There's no other questions in queue at this time, sir..

Thanks, Vincent. Thanks, everybody, for being on the call. If you have any other questions or anything else, you know where to find us. We look forward to your calls. Take care..

Ladies and gentlemen, men, thank you for your participation in today's conference. This concludes your program. You may all disconnect..