By Lorna Pappas

Even if a process is working well, James "Jay" F. Flaherty III loves to experiment with the different perspectives, risks and strategies that can make something even better. He says change is fun, and it usually is a learning experience.

He's brought his penchant for discovery and reinvention to HCP, Inc. (NYSE: HCP), the $15.0 billion health care REIT for which he serves as chairman and chief executive officer. Since joining the company in 2002, Flaherty and his team have revolutionized HCP's entire business model. In the process they have sold or repositioned three quarters of its portfolio. He essentially "turned the company upside down," he says, by shifting the original two property types—acute care hospitals and nursing homes—to HCP's smallest two property sectors today.

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AGE: 51 EDUCATION: BA in Accounting, University of Notre Dame; MBA, University of California, Los Angeles FAMILY: Wife and three children, ages 16 to 24 FAVORITE SPORTS TEAM: The University of Notre Dame HOBBIES: Spending time with family FAVORITE VACATION SPOTS: Skiing and golfing in Colorado and relaxing by the ocean in Mexico MOST RECENTLY READ BOOK: “Mao: The Unknown Story,” by Jung Chang COMMUNITY/PROFESSIONAL ACTIVITIES: Board of Governors, NAREIT; Board of trustees and member of the investment committee, University of Notre Dame; former board of directors, Quest Diagnostics.

Symbolic of the transformation, the company name was altered in 2007 from Health Care Property Investors, Inc. "because it wasn't the same company anymore," he says.

Change has been good. Currently, HCP's portfolio is the largest and most diversified of any U.S. health care REIT. In March 2008, the company was added to the S&P 500, making it the only health care REIT on the flagship stock index today. Through June 30, 2008, HCP produced an 18 percent compound annual total return to shareholders since its IPO on May 23, 1985, the first IPO for a health care REIT. Its last full fiscal year (2007) was HCP's most successful in its 23-year history, including FFO growth of 18 percent, investments of $4.7 billion, dispositions of $1.0 billion, joint venture contributions of $1.7 billion and $6.3 billion of capital raised.

Even the current turmoil in the commercial real estate markets creates opportunities for buyers, Flaherty says, especially within what he calls a "low risk" health care segment poised to serve the needs of the nation's 76 million aging baby boomers.

Flaherty's bold approach to new ventures is well suited to the dynamic world of health care real estate. Recently, Flaherty sat down with Portfolio to discuss HCP's enormous transformation and the key motivations behind it.

Portfolio: What was the strategy behind the many adjustments you've made at HCP?

Flaherty: There is no precedent in the REIT industry for the scale of repositioning this company has undergone in the past few years.

When I joined HCP as president in 2002, the company was heavily exposed to state-based, government-reimbursed revenue streams. That business model was diversified to include revenues derived from and spread among five health care sectors, anchored by the highest-quality client relationships in each.

Currently, within those sectors, we had 267 properties in senior housing, 107 in life science, 256 medical offices, 25 hospitals and 51 skilled nursing units. We are weighted toward relatively new properties located in high barrier-to-entry markets with minimal exposure to state-based Medicaid risk.

In the past six years, three quarters of our entire portfolio has either been sold or moved to a new operator. Today HCP continues to acquire, develop, lease, sell and manage health care real estate, as well as provide mortgage and other financing to health care providers.

While the strategic repositioning of our portfolio has received significant attention, the menu of products we now provide across each property type also has evolved from sale and leasebacks to include joint ventures, development, mezzanine investments and downREITs, which are joint ventures between the REIT and the property owner.

Investors like this diversification. With an array of five property and five product types—which we call our "5 by 5" business model—we provide a good return for shareholders in almost any economic environment. With the many different arrows in our quiver, we can take full advantage of the opportunities offered by the health care industry, which, based on GDP, is the single largest industry in the United States, projected to represent 16.6 percent of U.S. GDP in 2008.

Portfolio: What was the driving force behind the final composition of HCP's business model?

Flaherty: When you're taking risks and making changes, oftentimes the answers already exist—you just have to identify the best people and companies in the industry, then do a lot of listening.

Specifically for us, we benefited enormously by visiting ProLogis (NYSE: PLD) and Kimco Realty Corporation (NYSE: KIM), two great industrial and retail real estate companies, respectively. Jeff Schwartz and Walt Rakowich of ProLogis, and Milt Cooper and Dave Henry of Kimco, were very good to us by offering their perspectives on the moves we were considering and sharing the success and details of their own business models. In the end, our approach was not original thinking. We basically played copycat by importing many of their best strategies in the industrial and retail spaces into the health care segment.

Portfolio: Tell us briefly about the companies that comprise your portfolio.

Flaherty: We have constructed what we believe is the best-in-class dream team of health care providers in each of our five sectors, and we are honored to be their partners.

Aegis, Brookdale, Emeritus, Erikson, Horizon Bay and Sunrise are the leading relationships in our senior housing segment, which represents 39 percent of our portfolio today. Within our medical offices sector, which comprises 21 percent of the portfolio, Ascension, HCA, Norton and Swedish Medical head the list.

Last year HCP acquired SEGRO PLC's life science portfolio, which resulted in 20 percent of our portfolio being invested in best-in-class life science laboratory and office facilities leased to leading pharmaceutical and biotechnology companies such as Amgen, Genentech and Pfizer.

We also acquired the Medical City Dallas campus, consisting of two acute care hospitals operated by HCA under long-term leases, and six medical office buildings. HCA and non-profit Hoag Hospital head our hospital segment, representing 11 percent of our property group.

We invested in the mezzanine debt of HCR Manor Care in December 2007, which is the country's premier operator of skilled nursing and sub-acute, short-term rehabilitation facilities, as part of that company's going-private transaction with The Carlyle Group. HCR Manor Care leads our 9 percent exposure in the skilled nursing segment.

Compared to peer companies, which tend to concentrate on just one or two health care sectors, we not only focus on five segments, but also are in them in a major way, partnered with the players I have just mentioned as tenants and operators.

Our tenacity in courting these sector-leading relationships has positioned HCP to create attractive risk adjusted returns for our shareholders well into the next decade.

Portfolio: You spent 20 years with Merrill Lynch & Co. What aspects of this experience have had the most impact on your role at HCP?

Flaherty: I held a number of different senior management positions at Merrill Lynch, including those in investment banking, capital markets and private equity, in New York, London and Los Angeles. I was a managing director of the firm, served on its investment banking operating committee and was head of its global health care group, where I led the company's health care franchise. I brought a well-rounded financial background and substantial relationships with senior health care executives to HCP's operations.

I also brought my affinity for reinvention. After a few years in any one position at Merrill Lynch, I'd get restless and start looking for another opportunity for improvement by changing the approach. Over time I've taken many risks, been successful and grown more confident about experimenting with different processes, both at Merrill Lynch and here at HCP.

Portfolio: Were new ventures and reinvention a big part of your earliest years?

Flaherty: Not really, at least not until I met my wife, who influenced my appreciation for change and willingness to take the risks associated with it.

We met at the University of Notre Dame, where we both graduated in 1979 and then married. At that point we began to relocate often, going from the Midwest to Boston for the start of our careers, out to California for my MBA, back east to New York to begin my career in investment banking, and then back to the west coast, where we've been for about twenty years.

One thing that's never changed is my kinship with Notre Dame. Two of my three children are fourth generation graduates of Notre Dame. Additionally, I'm on the board of trustees and serve on the University Endowment's Investment Committee.

Also not changing for years to come are the great number of aging U.S. baby boomers in demand of health care properties and services. HCP is positioned to catch that demand, which will continue for the next several decades.