Good day, welcome to the Healthcare Realty Trust third quarter financial results conference call and webcast. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch-tone phone. To withdraw your question, please press star then two. Please note that this call is being recorded. I would now like to turn the conference over to Mr. Todd Meredith, CEO. Please go ahead.
Thank you, Lexi. Joining me on the call today are Carla Baca, Bethany Mancini, Rob Hull, and Kris Douglas. First, I'd like to make a few comments about David Emery, our founder, who passed away on September 30th. This last week, my colleagues and I enjoyed a wonderful celebration of David's life with his family and friends. David was truly a visionary, a force of nature. He inspired everyone around him with his intellectual curiosity, his intuition, and his infectious charm and perpetual optimism. David had a remarkable degree of confidence in his abilities, yet he was acutely wary of hubris. He was a wise mentor, always leading by example. David was a Renaissance man, pursuing many interests, personal and professional, with great success and style, and he shared his achievements generously with family, friends, and colleagues. We will miss him dearly, above all, for his genuine and loyal friendship.
David was a wonderful human being who loved helping others succeed. When it comes to the healthcare REIT sector, David was a true pioneer. He had the vision to start the first MOB-focused REIT in the early '90s. Today, we have a great company built on a strong foundation, thanks to David's vision and leadership. The board appropriately bestowed upon David the title of Chairman Emeritus. His contribution to the sector and to Healthcare Realty will not be forgotten. Over the past few years, David did a masterful job transitioning leadership of Healthcare Realty, and he was especially pleased with where the company is headed today. Now for the quarterly results. Carla, if you'd go ahead with the disclaimer, please.
Thank you. Except for the historical information contained within, the matters discussed in this call may contain forward-looking statements that involve estimates, assumptions, risks, and uncertainties. These risks are more specifically discussed in a Form 10-K filed with the SEC for the year ended December 31st, 2018, and in subsequently filed Form 10-Qs. These forward-looking statements represent the company's judgment as of the date of this call. The company disclaims any obligation to update this forward-looking material. The matters discussed in this call may also contain certain non-GAAP financial measures, such as funds from operation, FFO, normalized FFO per share, normalized FFO per share, funds available for distribution, FAD, net operating income, NOI, EBITDA, and adjusted EBITDA. A reconciliation of these measures to the most comparable GAAP financial measures may be found in the company's earnings press release for the third quarter ended September 30th, 2019.
The company's earnings press release supplemental information, Forms 10-Q and 10-K are available on the company's website.
Thank you, Carla. I'll begin by touching on three key topics for the quarter. First, the strength of Healthcare Realty's operations. Second, our increasing acquisition volume and our ability to source new investments. Most importantly, how we see organic and external growth translating to FFO on a per share basis. In the third quarter, Healthcare Realty generated steady performance on strong operating results across the portfolio. Our largest driver, in-place contractual rent increases edged higher. This was boosted by renewals in the quarter, which had bumps above 3%. Our ability to generate healthy cash leasing spreads continues to correlate with high tenant retention, a testament to the demand for our prime locations where price is not the primary determinant of value. Expense growth is also well contained, expanding margins and translating to same-store NOI growth above 3%.
We see stability in the portfolio's internal growth in the years ahead, given the fundamental strength of our property locations, their alignment with leading health systems, and their critical role in current healthcare delivery trends. We are also bolstering the strength of our internal growth profile with selective acquisitions. Year to date, we've acquired 14 MOBs for more than $300 million, elevating our 2019 acquisition volume well above our historical pace. What differentiates us is the way we pursue investments. We like to avoid bidding wars and paying premiums for widely marketed offerings. Far this year, we've directly sourced 2/3 of our acquisitions through relationships with owners and brokers. What is really impressive, we've seen this exceed 75% where we've gained scale in key markets over time, such as Seattle.
Our knowledge of targeted markets and deep network of relationships allows us to buy more of what we want rather than bidding on what is for sale. With the success of our sourcing efforts, we expect to sustain a healthy pace of acquisitions going forward. We increased our acquisition guidance a second time for 2019, and we see a strong pipeline looking ahead to next year. We also improve our growth profile by selectively disposing of properties. While dispositions can be counterproductive initially, a disciplined amount of pruning is necessary to maintain a high-performance portfolio over the long run. Fortunately, looking into 2020, the costly rotation out of non-MOBs and smaller markets will be largely behind us. We have moderated our disposition guidance for 2019, and looking ahead, we expect a slower pace of dispositions at better cap rates. Much like acquisitions, our pace of development is also building momentum.
This quarter, we began a redevelopment in Memphis, which includes the acquisition and redevelopment of an existing MOB. Baptist Memorial, a market-leading health system with whom we've enjoyed a long-standing working relationship, called us when they needed a reliable partner to develop a strategic outpost for surgery and outpatient services. We expect a couple of developments and redevelopments to emerge from our embedded pipeline in the coming quarters. The company's accelerated investment pace, fewer dispositions, and steady organic performance is generating FFO growth per share in the second half of 2019. We expect more improvement in FFO per share in 2020, and matched with disciplined capital spending, we see incremental progress on dividend coverage as well. Relative to other property types in the healthcare sector, outpatient real estate continues to offer a compelling combination of steady returns and low risk.
We remain steadfast in our commitment to owning and operating quality medical office buildings and using our experience and refined strategy to deliver steady growth in FFO per share and create long-term value for shareholders. Now I'll turn it over to Ms. Mancini for a closer look at healthcare trends. Bethany?
Thank you. The 2020 presidential election and the race for the Democratic nomination continue to dominate headlines, and once again have brought health insurance policy to the forefront of politics. The array of Democratic candidates covers a wide range of platforms, calling for various forms of increased government funding of health insurance, whether through current policy under the ACA, a public option buy-in, or Medicare for All. While polling suggests voters are attracted to such ideas, support of Medicare for All drops significantly when faced with the high costs and the need for greater taxation and elimination of private plans to fund single-payer public health insurance. Political rhetoric of the day, however, does not signal a change in the direction of rising healthcare demand, clinical delivery trends, or relatively stable reimbursement rates.
In addition, the overall course of health policy legislation in Congress is not expected to change in the near term with a divided House and Senate. Current legislative efforts are centered on lowering the cost to consumers of pharmaceuticals and surprise out-of-network billing, along with funding hospital payments for uninsured patients. Even with some bipartisanship on these issues, strong lobbying by drug companies and hospitals and ongoing political debate will likely keep any new health policy at bay until after the presidential election and a new Congress convenes in 2021. We do expect a decision in the court soon on the outcome of the Texas v. Azar case and the standing of the lower court ruling last December, which declared the ACA unconstitutional.
It is likely the Fifth Circuit judges will issue a stay in the case, keeping the law in place until an eventual Supreme Court hearing, possibly not until 2020 or beyond. Several states are working on their own legislation to provide health subsidies and public insurance options, but are contending with the high cost of such plans. These efforts span multiple layers and branches of government and are evidence of the politically sensitive nature of healthcare and the value the nation places on supporting access to quality medical care. The population is aging, and demand for healthcare services continues to expand. The difficulty in curbing the growth of healthcare spending is acute, and the need for lower cost of care essential. Outpatient services are becoming increasingly critical to meeting the nation's demand for quality healthcare at a lower cost.
The push toward delivering outpatient care in its most efficient settings is being accelerated on multiple fronts, most recently by commercial insurers as well as providers. As of November 1st, UnitedHealthcare is shifting more of its medical spending to outpatient facilities and will no longer cover certain planned outpatient surgeries delivered in hospitals unless predetermined to be medically necessary in most states. Instead, the insurer will require outpatient surgery to be done in medical office and ambulatory facilities. Health systems, to increase leverage with insurers and capture market share, will continue to align with physician groups to offer services across the continuum of care in the most efficient and profitable settings.
We expect Healthcare Realty's medical office facilities and tenants and our relationships with health systems will continue to benefit from these primary drivers and deeply embedded macro trends. That will ensure the growth in outpatient facilities for years to come. Now I will turn it over to Rob Hull. Rob
Thank you, Bethany. I'm going to give you an update on investment activity and our outlook for the balance of the year. Acquisition volume so far this year of $316 million is at the high end of Healthcare Realty's historical levels. We have experienced notable success in our ability to source higher volume through one and two building transactions. We have been expanding and developing our investments team and related processes to execute on this growing number of opportunities. Combined with the competitive cost of capital, these efforts have secured 14 properties through 12 separate transactions this year. During the third quarter, we acquired four buildings totaling 175,000 square feet for $79 million. In Los Angeles, we purchased two MOBs for $61 million. The buildings are located next to Huntington Hospital, a 625-bed facility in Pasadena. These properties are well-positioned for strong NOI growth.
What really sets these buildings apart is a diverse roster of specialists, such as cardiology and women's health, who value the proximity to the hospital in this densely populated area. In Houston, we acquired an on-campus MOB located in the fast-growing Sugar Land submarket for $14 million. This acquisition expands our portfolio in the fifth-largest market in the country to over 620,000 square feet. It also adds a third high-quality relationship in the market with Houston Methodist. In Oklahoma City, we purchased an MOB adjacent to a leading health system campus and immediately next to a building we purchased last year, where we recently increased occupancy to nearly 100%. The new building is currently 76% occupied and produces a 6.3% cap rate. We expect the yield to increase into the high sixes by boosting occupancy to around 90%.
Already in the fourth quarter, we are off to a strong acquisition pace. We bought two additional properties in October. In Raleigh, we made our first investment in the market, a 57,000-square-foot MOB for $22 million. The building is in a rapidly growing area and is adjacent to market-leading WakeMed North Hospital. Also in the fourth quarter, we purchased a property in Dallas adjacent to Baylor Scott & White's Plano Hospital for $20 million. This building is anchored by a Baylor USPI surgery center. Leveraging our relationship with the hospital, we also executed a lease with the Baylor Outpatient Rehab Joint Venture. This lease was signed at closing, and we expect the build-out of the suite to begin soon. The property expands our presence on the campus, where we already own a 174,000-square-foot MOB we developed in 2004.
With year-to-date acquisitions totaling $316 million and a robust pipeline, we are moving up acquisition guidance for the year to $350 million-$400 million. Moving to development. We placed one project into pre-construction this quarter and have one or two starts expected in the coming quarters. In Memphis, we commenced pre-construction activity for the redevelopment of a 111,000-square-foot MOB. Baptist Memorial, looking to secure a leading orthopedic practice as a joint venture partner in a surgery center, needed a developer that could move quickly. What is important here is that the hospital reached out to us, given our long-standing relationship and development experience. The redevelopment has a total budget of $28 million with an expected stabilized yield of 7.6%, including the $9 million acquisition of the existing MOB from the health system.
We will have lease commitments representing 81% of the building, including the surgery center, orthopedic group, and several hospital practices. Occupancy is now 37%. The balance of the remaining leases are expected to take possession early in the first quarter of 2021. We also continue to make steady progress on additional future development projects in Washington, Colorado, Texas, and Tennessee, sourced from our embedded pipeline and existing health system relationships. Each development we are pursuing is expected to yield 6%-7.5% at stabilization, representing significant FFO contribution and value creation. Looking at dispositions. We have closed on $29 million in sales so far this year. We are reducing disposition guidance to $50 million-$75 million at cap rates from 6.5%-8%. The reduction is due to a few MOB dispositions originally targeted for sale in 2019 shifting into our plans for next year.
Going forward, we expect disposition volume will remain at this lower range, consisting primarily of MOBs, which will produce more favorable sales cap rates. Most recently, we sold three buildings for a total of $16 million, including an inpatient rehab facility for $14 million. I am pleased with the pickup in net investment volume for the year and the bright outlook for 2020. Now, I will turn it over to Kris to discuss financial and operational performance for the quarter.
Thanks, Rob. The third quarter showcased the same positive themes as the first half of the year, including a healthy acquisition pace and sustained internal growth. This translated year-over-year to a 3.2% increase in FFO per share to $0.40. Sequentially, FFO increased $500,000 over the second quarter. This was primarily as a result of a $1 million increase in NOI from net investment activity. The higher NOI was partially offset by a $500,000 increase in costs, mainly related to interest expense. As is typical in the third quarter, seasonal utilities were up $1.4 million sequentially over the second quarter. This expense increase was completely offset by rental rate escalations and operating expense reimbursements. In the fourth quarter, we typically experience a $600,000-$800,000 increase in sequential NOI due primarily to the reversal of the third quarter seasonal utilities.
For the trailing 12 months, same store NOI increased 3.3%, driven by a 3.6% increase in NOI from the multi-tenant properties and a 1.8% increase from single tenant. The performance of our multi-tenant properties continues to be reliably strong. Revenue per average occupied square foot increased 3%, while expenses were up just 1.8%, largely due to a 3% decrease in utilities. This reduction came from a combination of the mild winter we discussed earlier this year, as well as energy management investments. Our ongoing ability to drive multi-tenant revenue growth is due in no small part to our persistent efforts to maximize in-place contractual increases and cash leasing spreads.
In the third quarter, future contractual increases for the leases executed in the quarter were once again strong at 3.06%, while cash leasing spreads averaged 3.3%, highlighting our pricing power, especially with the outsized volume of renewals and 90% tenant retention this quarter. Not to be overlooked, average in-place contractual rent increases have improved 13 basis points over the last eight quarters, up to 2.93%. Achieving this in just two years is noteworthy and has compounding power when applied over our 12-million-square-foot same store portfolio. It represents not only the value of our leasing team's concerted efforts, but also the benefits of owning quality, high-demand properties. Turning to the single-tenant portion of our same store portfolio, the 1.8% growth in NOI was as expected.
With nearly 30% of our rent escalators being non-annual, quarterly NOI growth will fluctuate around the in-place average of 2.12%, depending on the timing of the non-annual increases. The next non-annual increase, which happens to be the largest at over 20% of single tenant base rent, is scheduled to occur in October 2020. Until that time, single tenant NOI growth will run below the in-place average. At the single tenant property level, we sold an inpatient rehab facility in Erie, Pennsylvania, as Rob mentioned. This leaves us with one remaining IRF on a 400-bed tenant hospital campus in Los Angeles, where we also own five medical office buildings. We just completed a five-year renewal for this inpatient rehab facility at a 7.6% cash rent increase with no TI.
The FAD payout ratio was 91% for the third quarter and year to date, as capital expenditures and second generation TI have been running at the low end of expectations. We expect maintenance CapEx will be higher in the fourth quarter and the full year 2019 FAD payout ratio to be at or below 95%. This is a reduction of approximately five percentage points over full year 2018. We expect additional improvement in 2020. Our balance sheet is healthy, with debt to EBITDA of 5.2 times at quarter end. We raised $72 million of equity during the quarter through the ATM, which was used to fund the $79 million of acquisitions in the quarter. Since the end of the quarter, we've issued an additional $78 million of equity to fund a growing pipeline of accretive investments, including two properties acquired in late October for $42 million.
As we approach the end of the year, performance and momentum across the portfolio are strong. Driven by internal growth, a solid balance sheet, and a rich pipeline of pre-funded investments, we expect the FFO per share growth we saw in the third quarter to continue in the fourth quarter and 2020. Operator, we're now ready to open the line for questions.
Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys.
If at any time your question has been addressed and you would like to withdraw your question, please press star then two. Your first question comes from Chad Vanacore with Stifel. Please go ahead.
Hey, good morning, all.
Morning.
All right. You've stepped up acquisition guidance, then reduced dispositions. Has anything changed in the competitive landscape for acquisitions that you see, either asking prices or competition from alternative buyers?
No, Chad. I think what you're seeing from our team is it goes back to sourcing process that we discussed on the last call and discussed today. You're seeing the benefits of us going into a market and identifying properties that we want to own, and then our team forming relationships with those building owners, brokers, and other groups in that marketplace that are giving us the opportunity to buy these buildings that are not necessarily being marketed. In many cases, you're not competing with a broad group of folks, it's allowing us to bring some nice assets into the portfolio. I think in terms of pricing, we're continuing to see stable pricing. I think there has been some deals out there that have dipped below five here recently, I think those were deals that were more marketed deals.
I think what we're looking at is still in that range of around five and a half. We expect to see that continue.
All right. Just on the flip side, your dispositions get pushed off into 2020. Is there anything going on there that is delaying your sale of those properties, or do you just feel more comfortable keeping them a little bit longer?
No, it's really just timing, general, specific to those sales. There's nothing in particular that's causing us to hang on to them longer, but it's just taking a little longer to close the transaction. We do expect those to be part of our disposition plan for next year, $50 million-$75 million. Those are largely MOBs that are in that lower cap rate range of 5.5%-6.5%.
All right. Just to bring this full circle, can you describe any of the key differences between what you're buying today and then what you're selling?
I think that what we're buying today is in good growing markets, aligned with leading health systems in those markets, multi-tenanted on-campus buildings or adjacent to campuses. In contrast to what we're selling, typically those are in smaller markets. Perhaps they're markets that aren't growing, and we don't see the growth potential in those markets that we do in some of these other markets. It's largely really assets that don't fit the strategic long-term plan of the organization, versus those assets we're buying have a higher propensity for growth and really fit our long-term goals.
All right. I'll leave it there. Thanks.
Thank you. Your next question comes from Nick Joseph with Citi. Please go ahead.
Thanks. I wonder if you can walk through the sales process for the IRF that was sold in the third quarter. Obviously, the cap rate was probably a little higher than expected, so any color there?
Yeah, that process was a purchase option, a fair market value purchase option, that was driven by an appraisal process, and it was different than what you typically see when you have appraisal processes in those types of agreements. This one took the average of three appraisals, one submitted by the buyer, one submitted by the seller, and then a third average. Oftentimes you'll see the appraisal that's furthest away from the other two be thrown out and the other two be averaged. In this case, all three were averaged. That was the way it was written into the agreement, and that incented the buyer to submit a low valuation, in this case, a valuation of zero, which was on the verge of absurd.
There were also some utilities that served the building that were provided by a third party that detracted from the value in the appraisal process as well.
Thanks. How many other assets have similar fair market purchase options in the portfolio?
We don't have any that are similar to that process.
That was just a one-off?
Yes.
Thank you.
Thank you. Your next question comes from Jordan Sadler with KeyBanc Capital Markets. Please go ahead.
Thank you. Good morning. First, I just want to offer sincerest condolences on the passing of David to the team. Then in terms of my question, what's causing sort of the continued increase in the activity, in the acquisition activity year to date, the sort of third consecutive bump up? I've noticed a little bit of a mix and a shift away from on-campus. I don't know if I'm overly reading into the 100 basis points uptick in the asset ownership mix here year to date. Any insights would be appreciated.
Jordan, thanks first for your comments, and thanks for your nice comments and your note as well. We saw that and appreciate it. I would say, for us, it really goes to the volume question. It goes to the sourcing process, and that's a multi-year effort. As Rob said, we've been expanding our investment team with some young professionals. They've been getting their legs under them, helping out our senior folks really attack these markets in a proactive way, as Rob described. I think we're just seeing the fruits of that, number one. To your question about distance from campus, I think there you have a little bit of a unique situation where earlier, I guess last quarter, we bought a couple of properties that were just beyond our own definition of adjacent to campus. I think they were 0.27-
0.27 and 0.3 maybe.
0.3 miles from campus. When you get into Seattle or a dense market like that, sometimes, there are certainly some attractive properties that may be just outside that definition. Pretty subtle difference there. No big change in strategy. We certainly are open to assets that are away from campus, more materially away. As you know, we have a history of being careful around that. It's not that we won't invest occasionally in some off-campus assets that really align with health systems and we think really have strong real estate characteristics. We just want to tilt towards campus, on or adjacent. No material change, but certainly, a willingness to look at assets that make sense, even if they're a little outside the range.
Fair to sort of characterize it as a little bit of a greater opening in terms of casting a little bit of a wider net to certain properties, or is that overstating it even?
It's probably overstating a little. I will say, in a market like Seattle, where we have such a strong presence, and we know that market really well, we have a lot of folks locally on the ground operating there, including one of our leaders of our leasing team, about half the country that she leads, and has been with us for 20 years. We just have a lot of resources there that know that market well. It's clearly a dense market. You might see it in situations like that. Los Angeles might be another market where we've had scale and would see something like that. It's probably not too much to read into that.
Okay. On the same-store NOI trajectory, I know you guys look at it on trailing 12 as sort of a better indicator, but I'm trying to look at this quarter to see if there's anything to perceive in terms of what's going to happen going forward. I noticed sort of the year-over-year decel, in multi-tenant, but also as you called out, the single-tenant side. As we look forward, will this sort of lowered rate be more of a steady state, or should it bump back up, and what would be the drivers?
Yeah. Good question. Kind of two pieces to that. I'll break it into the single tenant and the multi-tenant. On the single tenant, as I mentioned in my prepared remarks, we have seen the timing of our non-annual escalators is running through, and so we have over 25%, almost 30% of our properties that have not had an increase in the last 24 months. That is not because they don't have them, it's just because of the timing of them.
Okay
we did see the lower growth as a result of that this quarter, and that will continue until the next non-annual escalator occurs in October of 2020. You should expect to see that in the single tenant. On the multi-tenant, as you mentioned, we do believe that trailing 12 months is a better signal as to the performance of the business. That was 3.3% this quarter. Quarterly results can have a lot of noise due to fluctuations in individual line items, which is actually what did occur this quarter. We had an unfavorable comparison to third quarter 2018 due to $600,000 of expense reimbursement true-ups in that period. Excluding that $600,000, revenue per average occupied square foot, as well as total revenue, would've been greater than 3%, which is more in line with our expectations.
Moving forward on a trailing 12-month basis, we still expect in the multi-tenant NOI growth to be that ±3%. As pointed out, there will be fluctuations, quarter-to-quarter all the time.
Okay. Then, I guess within that same sort of framework, just expenses. Anything you're seeing on the expense front as you look forward, Kris, that sort of would knock you off sort of this low 1.8% trajectory you've seen over the last 12 months?
We have been benefiting from the expenses, as we've talked about this year, that are running below our historical average. We say long-term, we expect it to be more in that 2%-2.5% range. Right now we're running about 1.8%, and a lot of that has to do with utilities that are running -3%, which is great when you can get it. Part of that was due to the milder winter that we had in the first quarter, which really resulted in, on a quarter-over-quarter basis, basically flat overall expense growth. We're not gonna predict and project what the weather is going to be for the next year, but we are certainly benefiting from that.
We are continuing to see pressure on property taxes. I would say that there's nothing different there from what we see historically, especially as you're buying additional assets, you're developing assets that a lot of times there will be a catch up in the assessed value. Property taxes run well above the average, 4+%. With some cost controls in other places, we do feel like long-term, we can continue to control expenses more in that 2%-2.5% range.
Great. Thank you.
Thank you. Your next question comes from John Kim with BMO Capital Markets. Please go ahead.
Thank you. Good morning. On the acquisitions that you acquired during the quarter, which were, I think, primarily adjacent, can you comment on the pricing differential you're seeing right now between adjacent and on-campus acquisitions? Is it fair to assume that on these acquisitions, you acquired the fee simple interest with no purchase option?
John, I think when it comes to your question about on versus adjacent, really not seeing much difference in pricing there, if any. Our definition of adjacent is within a quarter mile, that's, in most cases, across the street from the hospital. Just not seeing a lot of price difference there. In terms of fee simple versus ground lease, I think it's a mix.
I think everyone this quarter.
Everyone this quarter was fee. We didn't have any that we bought on ground lease.
Yeah. The one that was in October.
Yes
in Dallas, that is a ground lease, but it's not with the hospital. It's a dense area, and the developer who put it together ended up ground leasing the land from someone who's owned it for some time.
Yeah. It's just economic, and there's no purchase options.
Got it. Okay. Todd, you mentioned a strong pipeline of acquisitions for next year. Any way you can quantify that at all and how that relates to the $350 million-$400 million that you planned for this year?
Sure. It's clearly early to really call out what the range would be for 2020, but as Rob suggested, and I did as well, we certainly see a strong momentum building going into 2020, and we'll clearly have more color on that as we get to the next quarterly report. All that to say, we certainly see an ability to continue at this level that you're seeing now. It's subject to a number of things, as you can imagine. One of the things we just talked about was the sourcing efforts, and that is clearly different than just bidding on what's for sale. We like that. It does give us a little more predictability, but it's also a lot more lead time and work to generate that pipeline.
Because of the back work we've done on that, again, some of these deals we bought this past quarter and even into the fourth quarter are the result of years of digging in a market with a broker, with building owners. It takes a while, but we're encouraged by what we see, and we think this level, whether it's that exact level of this year, but something on this order of magnitude, is certainly something we see being able to move towards in 2020.
Okay. I had a couple questions on your Memphis redevelopment. It looks like the asset will be 37% occupied during the redevelopment phase. Can you provide some color on what work is being done on this project? Also when you?
Yeah. Sorry, go ahead.
I was going to say, the 7.6% stabilized yield, what occupancy does that assume?
Yeah. Just I'll answer both of those questions. First on the 7.6, that is a stabilized occupancy in the low 90s. In the low 90% range. As far as what's being done, the building currently exists today. There's a surgery center inside of the building. We are redeveloping the building in the sense that most of the areas inside of the building will be touched. Some existing tenants will be moving around. The surgery center will be expanded. There will be some additional parking added to it. The hospital has some existing uses there now, but they'll be bringing some additional uses. It's really a comprehensive redevelopment of the asset, even though the asset is in place today.
The 37% occupancy represents tenants that are there today and will remain in place until such time as we either move them inside of the building or their new lease takes effect after the redevelopment of the property.
How big do you think your redevelopment program can be? It seems like there's a lot of on-campus, older vintage MOB out there.
Sure. There's certainly opportunity out there we're finding. I think that working with these health systems, we've done a number of redevelopments over the past few years. I think if you go to our embedded pipeline, we do think that there's some opportunity there. You expect to see one or two of those every year that we're working on. Those come from having relationships with the hospital. They oftentimes get into a situation where they need somebody to move quickly. They've worked with you before, they know that you can produce, oftentimes you get the call like we did here. I think there's some good opportunity there.
Great. Thank you.
Thank you. Your next question comes from Rich Anderson with SMBC. Please go ahead.
Thanks. Good morning, I'd like to also second the condolences to David. He made me a better analyst, better person, very genuine approach to people whoever he interfaced with. In the height of his role as CEO, he was always one who showed me respect, whether there was agreement or disagreement, or maybe he was blowing smoke up, but at least I felt that way. I did get a chance to email him before he passed. I'm going to assume that he did read it, and my condolences to everybody on the call.
Thank you.
One good thing is my vocabulary has improved, so I'll never say the word disirregardless, orientated, and I'll have conversations, but I will not conversate.
Very good.
Right. Now let's rigidly move on to the business of talking about medical office, which kind of feels wrong, but we've got to do it. We've got to move on. Are you seeing more in the way of PE investing in your space? Do you have capital flowing? A lot of the elephant hunting is now gone, as everyone's suggesting. Are there different types of capital flowing into the space that you see?
It's not palpable in terms of the short term. I do think if you look back over a multi-year period, certainly that's true, and you're seeing more private equity develop funds, whether it's private non-traded REITs under a new model. You've seen a number of very credible, large private equity groups develop an MOB program. They might partner with different smaller operators, developers, investors, and you've been seeing that for a while. It's really not new, but you're right. I think the pace of that is very high, and some of them are doing quite a nice job of really tackling the one and two-building approach. It's not without competition, and certainly, I would say, as we describe our sourcing process, we're not trying to suggest there's no competition.
There's always competition, even when you're talking with an owner about doing a deal outside of a marketed process. They're aware, and they're savvy, and they often will have either themselves or brokers that can do market checks. There's plenty of that, but I think it's, again, just developing deeper relationships and getting access to the deals that we see in the markets we want to be in. Really, I don't see the level of competition any more heightened than it's been in a long time. It's just different players. The public markets will tend to move around a bit more and have different costs of capital in shorter time periods.
We've seen continued rising pressure with private equity over some time, and I wouldn't say it has risen in the last year or so any more than what we've seen in the last three or four years.
Okay. The underlying business as described on this call in medical office generally is good, and perhaps getting better. I don't know that there's much in the way of criticism of what you guys are doing. Stock market increasingly fickle in its approach to any company is important to you as well, though, in terms of capital raising. You guys have underperformed this year, not a bad year in absolute terms, but still underperformed as investors are kind of seeking elsewhere, perhaps. Do you feel some sort of need to change your stripes a little bit? Are you doing that, I guess, on this call with the sort of lower dispositions, higher acquisitions, more development, redevelopment, so on?
I'm wondering if the perception of the stock market as an important partner for you to finance your business is influencing how you go about the world of medical office. If you were a private company, would you be going about things differently?
Well, there's no doubt the cost of capital is important, and for us, that's the public equity markets, the bond market. Obviously, we have other sources, too, bank debt. There's always joint venture capital and so forth. We've looked at all those, and we consider all those. I think for us, clearly, if you were private, you would have a different set of circumstances, and you may or may not, depending on who your backers would be, have a little different objective. I think for us, where we're at today, Rich, is really an accumulation of all of the work we've been doing to really clean up the portfolio over the last several years, really try to focus on MOB. You've seen a lot of the inpatient rehab sales over the last few years and really trying to streamline and get focused on the best MOB.
Not only the non-MOBs, but some of the weaker markets, weaker health systems, and trying to refine the portfolio. For us, the acceleration, I would call it now, in the business model and the ability to not have as many dispositions and have a higher degree of acquisitions, I think really is just a cumulative effect. Absolutely, it's an important ingredient to have a great cost of capital. If we don't have that, it obviously can impact the pace of our external growth. We know kind of underneath all that, the best thing we can do is have a really strong portfolio that generates those consistent results around that 3% level that Kris walked through. That's our main focus, and then how do we add to that?
We try to take advantage of that at times where all the stars align, and we can put capital to work very creatively. I think it's more just a cumulative effect rather than a change in stripes.
Okay. Perhaps the market is taking note of your single-tenant growth that came in on the lower end of things for the reasons you described. Is there a view that portfolio as a % of the total should be meaningfully lower than it is? If so, could it ever be a zero number?
It's at 10% today of NOI. It's less on square feet.
Right
It's about 10% of NOI. Our view is that's sort of reached a natural level that makes sense. Could it be a little less than 10%? Sure. Could it be a little more? That's fine, too. I think we like where it is, plus or minus. It really is a practical thing that if you look at the actual assets in our single-tenant portfolio, it's really a strong single-tenant portfolio, a good bit of it being on campus as well, and with really strong health systems. We think it's a good balance. Frankly, the relationships we have with health systems can often lead to a situation like that, where we might invest in an on-campus single-tenant facility, maybe even off-campus single tenant. I think 10% is probably about right and not some objective of ours to get to zero.
Okay. That's all I got. In closing, as I said to David in that email, it'll always be the Emory board. Carry on.
That's right.
Thank you.
Thank you for your comments on that. I can assure you his family was receiving a lot of emails and reading his emails to him in those final days. I'm sure he saw it and appreciated that. Thanks, Rich.
Great. Yep, thanks.
Thank you. Your next question comes from Daniel Bernstein with Capital One. Please go ahead.
Hi. Good morning. I offer my condolences as well, and just say that Rich missed low fungibility as a word that I refuse you might hear many years from Dave.
Dan, last week we had a nice celebration here at the office as well for colleagues and past alumni of Healthcare Realty, we put on one of our whiteboards all these various quotes that you guys have brought up and many more. We had a lot of fun with it, and he was very memorable in that way. Appreciate that.
Yeah, no, we'll miss him greatly. I wanted to ask, when we toured your facilities about a month ago, we talked some about the pricing power that you're now seeing, your MOBs, your releasing spreads have been very strong. Long-term, we had some concerns for the MOB industry about potentially increasing pricing power from, or pushback from hospital systems as they merge, as they get larger. I don't know if you could talk a little bit more on the call about the pricing power you are seeing, about the experiences you're having with the hospital systems right now, and just sustainability of the cash releasing spreads that we're seeing in your portfolio.
Dan, this is Kris. I'll start on that. We feel very positive about how we've been performing and the outlook moving forward. One of the things that we do each quarter is break down the distribution of our cash leasing spreads. I was trying to think of the right analogy, maybe it's basketball. You're not going to hit 100% of your free throws. Having 10% or plus that you end up with negatives, I think that's still pretty strong. You're gonna experience that in any particular period. The majority of what is occurring each quarter is still in that 3% to 4%, and that's what we've been putting up for several years and what we continue to look at.
We think that that's reasonable and sustainable based off of our history, but then also if you look at it from the pricing power really goes to what your replacement cost is. In a lot of these locations, as we toured in D.C., there's just not a lot of available land. Your competition would be somebody putting up some new construction. New construction costs, and especially with land costs in some of these dense areas, our experience is those are growing at, call it 5%+. We think that there is good sustainability to continue to be able to increase rents in that 3%-4% range.
That's really helpful. The other question involves occupancy. It's been pretty stable in the upper 80s, particularly in the multi-tenant. Given your comments earlier in the call about insurance carriers starting to require more outpatient use versus in-hospital, what's the right stabilized occupancy for a multi-tenant portfolio? Can we see that rise over the next 3, 5, 10 years from upper 80s into low 90s? Is there some other kind of structural impediment there? Maybe you want to keep some vacancy open for existing tenants to expand. Just trying to understand if there's some upside in your occupancy as well as the rates, maybe over a longer period of time.
Sure, Dan. I would say, we have been in sort of the high 80s, if you will, especially on the multi-tenant MOB portfolio. We would say that 90% is certainly achievable over time. What we've seen over a long period of history is annual absorption being more in the 25, 30, 35 basis point range. For us, on a practical level, we don't expect that to suddenly happen one year. It's not as though the space is in a convenient block somewhere where we can lease it all to one or two hospitals, even by market, and just solve that. It's obviously a complex, challenged to try to move these tenants around, if that's the case, and consolidate some space. That's an effort we're always going through and trying to accommodate folks, but it's an ongoing effort.
I think the other side of that is, even just for aside from the leasing side, is just portfolio management and always, as I mentioned, being proactive about selling assets that might be chronically living at 60, 70% occupancy, and we just don't see any near-term upside in occupancy or growing the rates. For us, it's a combination of those things, but achieving around 90% is probably the practical level on the multi-tenant side. Then your mix with single-tenant is what creates the blend. I think when you really pull back a lot of other people's data, they don't often provide the detail, but if you back into it, a lot of the multi-tenant MOB portfolios do live around that high eighties, 90% level. It seems to be a fairly industry-wide phenomenon.
Part of it also is shorter term leases and some constant expansion, contraction, and moving around does lead to a natural level. It's a smaller average tenant size, so there's just more of that frictional vacancy, if you will.
Okay. Okay. Then one last question. On the redevelopments, is there any significant disruption that we should be expecting? Are you going to leave those assets in the same-store portfolio or pull them out? Just want to understand how coming quarters, as you ramp that up, how we should think about that.
I would say it's case by case. The one that we talked about here in Memphis this quarter, clearly is a new asset to us. We're under contract, haven't actually purchased it. That clearly is not gonna be in same-store for a while. An asset that is already in same-store, more often than not, it will stay in there, but it just depends on the scope and magnitude of it. If occupancy is gonna fall to below 50 or 60%, that may be a candidate for saying we're gonna call that a redevelopment. The scope of the dollars would matter as well. It's case by case.
We've done it where we've kept it in same-store if we think that makes sense, and we've also selectively taken it out, and we'll be very clear about where that lives and describe that when and if we do that. I don't think in the end, one or two, as Rob mentioned, a year would have a material impact. We'll just be careful to describe that clearly to investors and to analysts.
Okay. Sounds good, and look forward to catching up with you guys next week at REITWorld.
Thanks, Dan.
All right.
Thank you. Your next question comes from Todd Stender with Wells Fargo. Please go ahead.
Hi. Thanks. Yeah, just wanted to second and third everyone's comments regarding David. He was really a scholar, obviously, and a gentleman, and will be missed. To his family, and you guys, all our best.
Thank you, Todd.
All right. Just shifting to, I guess, the redevelopment. You guys highlighted the Memphis property for redevelopment, and I saw it in your supplemental. It looks to be a new acquisition, but I didn't see it on your new deal list. I just wanted to hear a little more detail on that one.
Yeah, that's correct. It's not on our new acquisition list yet. We really thought about that and said, "Well, we don't want to necessarily double count those dollars." We haven't closed on the acquisition yet. We're under contract, and you'll see that obviously in the fourth quarter. We don't expect necessarily that that's part of the acquisition guidance. It's obviously not a huge purchase at $9 million. Again, that would be case by case. That one has more material dollars that we'll spend after the fact, so we felt like that made more sense to be put into the redevelopment side rather than the acquisition side.
The purchase price, $9 million, is in the budget, the $28 million budget. It's accounted for in that budget that we're showing.
Got it. Okay. Just with the equity activity lately, tapping the ATM, it's been a good low cost for you guys. On the broader theme of maybe raising the dividend or getting to that point, I know, Kris, you kind of highlighted that the payout ratio is declining. How are you guys thinking about that? Your balance sheet's in good shape. Probably teeing up the opportunities maybe for debt going into next year. I know it's kind of a few inputs there, I guess broadly speaking, how are you guys thinking about the dividend?
Sure. As Kris described it, we obviously were closer to 100% in 2018, and it looks like we'll be at 95% or better, as Kris described, for this year. We would certainly like to see that same level of progress, more or less, in going into 2020. I think for us, the key is it makes sense to be well into the 80s before we would really move the dividend. The nice thing is we're moving that direction, and we can start having those conversations. I think it's a bit early to put a bright line on it, but we're moving in the right direction. Whether that takes 2020 or into 2021, where we have a direct sight on that, we are moving in the right direction.
It'll just be a function, obviously, of how everything plays out for us, the volume of acquisitions, the internal growth, all those things, but with a pretty strong outlook on those. I think we expect strong progress, as both Kris and I mentioned, in 2020, and we'll certainly have more news to report on how we see that when we get to the end of 2020 and whether it makes sense if we're into the eighties and can begin to point that direction.
The only thing I'll add on the debt is, you know.
Well, we're certainly always looking at all of our options in terms of raising capital, debt being one of those. We want to make sure we're maintaining a conservative balance sheet to be able to take advantage of opportunities. Right now, we're in the lower end of our debt-to-EBITDA range at 5.2. We feel comfortable there. We would like to stay in that range. We do have the 7-year term loan that we completed earlier this year that has a delayed draw embedded in that we've been taking advantage of. We expect to draw down on that commitment in the first quarter, which will relieve the line of credit. We feel very good about our debt position at this point.
How much more to draw on that, Kris?
It's $150 million.
Okay, great. Thank you.
Thank you. Your next question comes from Omotayo Okusanya with Mizuho. Please go ahead.
Yes, good morning. I just wanted to add my own thoughts too, and condolences about David. When I was a young pup in this industry 16 years ago, he was just really good to me in regards to getting a full understanding of the MOB space, and I'm sure he will be missed, and condolences to you guys and as well as to his family.
Thank you, Tayo. We appreciate it.
In regards to my questions, most of them have been asked, but I just had a quick one about the acquisition pursuit costs this quarter. Again, just kind of curious, looks a little bit elevated. Was a lot of that just, again, the same old looking at a high volume of deals, or was there actually a big portfolio-type transaction you maybe have been looking at that didn't come your way, so to speak?
No. I'd say it's up a little bit from second quarter, but it's just the overall accumulation of all the transactions. As Rob mentioned, we've done 12 separate transactions this year. It's just the accumulation across all that. Nothing out of ordinary to talk about.
Okay, great. Appreciate that. Thank you.
Thanks, Tayo.
Thank you. This concludes our question and answer session. I would like to turn the conference back over to Mr. Meredith for any closing remarks.
Well, thank you everybody for joining us on the call this morning. We appreciate everybody's kind remarks about David. He will be greatly missed. We look forward to seeing everybody next week out in California at REITWorld. We'll be around today if anybody has any follow-up with us with additional questions. Have a great day.
Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.