Healthcare Realty Trust Incorporated
Q3 2017 Earnings Call Transcript

Published: 2 Nov 2017

[Operator:]

Good day and welcome to the Healthcare Realty Trust Third Quarter Analyst Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation there will an opportunity to ask questions. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Todd Meredith, please go ahead.

[Todd Meredith:]

Thank you. Joining on the call today are Kris Douglas, Rob Hull, Doug Whitman, Carla Baca, and Bethany Mancini. Miss Baca will now read the disclaimer.

[Carla Baca:]

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 our Form 10-K filed with the SEC for the year ended December 31, 2016 and then subsequently filed Form 10-Q. 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 operations, FFO, normalized FFO, FFO per share, normalized FFO per share, funds available for distribution, FAD, FAD per share, net operating income, NOI, EBITDA and adjusted EBITDA. A reconciliation of these measures to the most comparable GAAP financial measures may be found on the company's earnings press release for the third quarter ended September 30, 2017. The company's earnings press release, supplemental information, Forms 10-Q and 10-K are available on the company's website.

[Todd Meredith:]

Thank you Carla. Healthcare Realty's again delivered steady results in the third quarter and strong operations across the board. The company's portfolio is performing well, beyond what most expect from MOBs. In terms of internal growth and solid fundamentals including nearly 4% same store NOI growth, over 80% tenant retention, and cash leasing spreads consistently above in place contractual rent growth, trends that we see carrying into the quarters ahead. By comparison we often see other companies reporting flat to modest cash leasing spreads diluting contractual rent growth. Typical real estate conventions says to avoid short-term leases. But with hospital lines, on campus MOBs we have found that longer lease terms can be a false positive. We view short-term lease renewals as opportunities rather than risk. Intentionally 15% to 20% of our leases expire each year which for us is about 100 leases a quarter or less than two each day. Observing behavior and outcomes lease by lease the life blood of our business we gain continuous insight into how portfolio composition is linked to performance. The company's solid fundamentals are the product of cumulative portfolio refinements made over the last decade. Our MOB mix has increased from 72% to 93% over this time period. We have shifted from 55% multi-tenant to now 88%. And we have improved the ratio of MOBs located on or adjacent to hospital campuses from 64% to 86%. This transformation at times has impacted near-term results with physicians Healthcare Realty for more sustainable growth over the long-term with much lower business risk. We have observed that REIT investors are becoming more discerning of the distinguishing characteristics of MOB portfolios including health system affiliation, key property attributes, and demographics. Our 10 point fungibility scale incorporates these and many more factors, simplifies our underwriting, and provides a quantitative framework for rational decision making. We're decisive if properties or portfolios measure up especially those with rare scores of 8, 9, or 10. The Atlanta portfolio is a perfect example, one that stands apart. Just as important when fungibility scores don't measure up we remain disciplined. This scoring system has been particularly useful this year with so many large portfolios in the market, mostly portfolios that have not met our standards or warranted premiums. Healthcare Realty's strategy, one that emphasizes long-term intrinsic growth is shaped by our view of how shareholder return is realized specifically in the MOB sector. With appropriate emphasis, internal growth has the potential to account for 80% or more of total shareholder return with minimal need for capital and much lower execution risk relative to external growth. That said external growth including acquisitions and development plays an important role when it reinforces internal growth well beyond any initial spreads. In addition developing properties can generate attractive returns and set the foundation for robust cash leasing spreads and annual bumps in the future. But development can also conflict with the REIT model having unpredictable timing, lease up risk, and requiring patience as properties reach stabilization, all of which underscores the importance of balancing development opportunity with affordability. Still development and redevelopment provide competitive differentiation and value creation, an external growth strategy with meaningful internal growth potential, a worthwhile pursuit when contracted with high volume acquisition based strategies that are easily replicated in a competitive landscape and highly dependent upon ideal market timings and conditions. Not to over simplify but more is not always better. Paying more for more properties is not better. Better is better. A disciplined acquisition approach is certainly better. Building and redeveloping the best properties is better. And most important, compounding internal growth is always better. Now I will turn it over to Ms. Mancini to share our perspective on current healthcare policies. Bethany.

[Bethany Mancini:]

Healthcare providers seem to have settled into a regulatory environment of consistent uncertainty and recurring state of health policy dispute and political wrangling over insurance for the uninsured. We see physicians and health systems moving on from the effort in Washington to reform Obamacare policy pursuing clinical and operational strategies for growth, a positive for the industry as it must expand to meet the needs of aging population and higher demand for healthcare services. Republicans and Congress are also moving on from major health insurance legislation transitioning to tax reforms after several rounds of unsuccessfully trying to unwind major portions of the Affordable Care Act or ACA. However constituents continue to pressure their Congressmen to address the ACA and its troubled individual insurance exchanges. These issues drive headlines and perception but in reality represent a relatively small subset of the insurance population. Even so President Trump's decision last month to end Federal subsidies to insurance companies, payments that help lower premiums were 9 million enrollees on the exchanges ignited matters and placed the spot light back on Congress to fund these payments. Two Senators, Alexander and Murray subsequently came to a Bipartisan agreement to craft legislation that would authorize funding for the subsidies and give States more flexibility in their exchange policies. It remains to be seen if this legislation receives enough support on both sides of the aisle and from the President who praises the effort but dislikes the details. And through which legislative vehicle it could be passed. The Federal subsidies will amount to only $7 billion this year, only 2/10th of 1% of the $3.2 trillion healthcare industry. But any positive development for the ACA however small is likely to improve sentiment for the healthcare providers plagued for years by the uncertain prospect of another far reaching attempt at health reform. With or without a Healthcare Bill, the Trump administration will continue to pursue its agenda for health insurance policy and deregulation via executive orders to improve the exchanges and address the burden of over 1400 ruled that currently govern insurers and providers. The potential expansion of less expensive insurance options could be beneficial to insurers and patients alike. States are also acting independently of Congress to obtain waivers from the Center for Medicare and Medicaid Services, the CMS and gain more flexibility from ACA rules in better insuring their constituents, an effort welcomed by the CMS as the agency proposed its own rule last week to allow States more freedom to interpret the laws essential benefit. Neither health systems nor physicians have been considerable beneficiaries of the ACA insurance exchanges and providers have been relatively quiet on the issue. But high deductible plans and out of pocket costs are increasing for consumers across the Board having an impact on in patient hospitals as consumers seek lower cost avenues for their healthcare. Outpatient service expansion is playing a critical role with hospitals and physicians taking advantage of reimbursement incentives for quality and savings. And Medicare policy allows more procedures to be done in an outpatient setting, arguably much greater drivers to outpatient growth than any current political activity. In addition outpatient capabilities have increased and inpatient admissions for thousands historically very stable have begun to decline. Since 2005 outpatient professional jobs have grown at double the rate of inpatient jobs with employment trends favoring physician offices and ambulatory settings to hospitals. According to a recent BLS report, the healthcare industry is projected to lead the nation's employment growth through 2026 adding 4 million new jobs. As the population ages we expect the growing need for physicians, medical support personnel, and office space to increasingly benefit Healthcare Realty and the demand for medical office facilities in hospital centric locations. Todd.

[Todd Meredith:]

Thank you, Bethany. Now Mr. Hull will provide an overview of our investment activity. Rob.

[Robert Hull:]

2017 is on pace to be one of the more productive investment years at Healthcare Realty. In the third quarter the company announced the acquisition of eight medical office buildings in Atlanta for $194 million with an expected 2018 yield of 5.2%, a rare opportunity to acquire a portfolio of exceptional on campus properties. Seven of the buildings are located on three WellStar campuses including three properties on the 633 bed flagship Kennestone campus. WellStar having a single A rating is the leading healthcare provider in Atlanta. These seven properties have a combined fungibility score of 7.8 which compares favorably to the company's portfolio average of 7.5. On Nov 1st we closed on the first four properties from the Atlanta portfolio for a combined purchase price of $112 million. The remaining four Atlanta properties totaling $82 million will close in mid December subject to the timing of loan assumptions. Also on Nov 1st, the company invested $12.7 million in a MOB located in Seattle adjacent to single A rated Overlake Medical Center where Healthcare Realty developed and owns a 190,000 square foot medical office building. This acquisition is 96% occupied and expected to produce the first true yield of 5.4%. These investments reflect an emphasis on aligning with high caliber health systems, superior building locations, and markets with strong demographic trends, key factors that are additive to the long-term growth prospects of the portfolio. Recently we have seen multiple large portfolios come to market and as you often hear us say we look at everything through our lens of internal growth. Using our 10 point fungibility scale we price each property's propensity for growth and competitive strength to avoid misapplying value for the sake of chasing size. Most portfolio premiums seem to be more about scale than quality. Just because it's a portfolio of MOBs it doesn't mean each property deserve the same low cap rate. Relative to the Atlanta portfolio we are not seeing other large portfolios worthy of a premium. Instead we remain focused on a solid pipeline of one in 2 billion opportunities priced in the 5.25% to 6% range. Our recently closed acquisitions bring year-to-date investments to $205 million at a combined fungibility score 7.7. In addition to the four remaining Atlanta assets we expect to make a couple of investments by year-end and are moving our acquisition guidance up to $275 million to $325 million. Turning to dispositions, we have left our guidance for the year unchanged at $120 million to $125 million. As a quick update, in October we received notice from a hospital in Roanoke, Virginia exercising its purchase option on seven assets for just over $45 million. We expect the transaction to close in mid April of 2018. Our development pipeline remains active with construction commencing next month on our $64 million MOB in Seattle on UW Medicine-Valley Medical Center campus where we own two other buildings. Development is 60% leased and we are in active discussions with two prospective third party tenants that should take the building to over 70% leased. Each of these prospective tenants is currently located in an MOB about one mile from the hospital. Prior to the start of this development the hospital would not have been able to accommodate the two tenants given the limited amount of vacant space on campus. In our recently completed Denver MOB, our first tenant, a hospital owned surgery center took occupancy in the third quarter and we expect another tenant to take occupancy in December. We are experiencing positive leasing momentum with a pipeline of prospects which has its own track to achieve over 85% by the end of next year. Development remains an important piece of our business model as it gives Healthcare Realty an opportunity to get a property scoring 9 or 10 on a fungibility scale while targeting risk adjusted returns of 100 to 200 hundred basis points above similar stabilized assets. Our pipeline continues to be focused on existing relationships in campuses where we already have a presence. In a couple of markets like developers including the seller of the Atlanta portfolio serve as an extension of our capabilities and allow us to leverage their local relationships cultivated over many years. I'm pleased with the superb investments our team has made this year. We expect to begin 2018 with a healthy pipeline of opportunities while maintaining the discipline to invest in only those assets that support our internal growth focus.

[Todd Meredith:]

Thank you Rob. Now Mr. Douglas will provide a summary of our financial and operational results. Kris.

[Kris Douglas:]

Normalized FFO in the third quarter was $45.2 million effectively flat relative to the second quarter as a result of net interest expense savings of approximately $500,000 from the August equity offering and rent increases of $300,000 offset by an approximately $900,000 increase in net operating expenses. Operating expense increase was primarily attributable to seasonal utilities which typically reverse in the fourth quarter. The proceeds from the 8.3 million share equity offering in August will be used to fund the Atlanta acquisitions throughout the fourth quarter as well as the partial bond redemption that closed yesterday. The net effect of these transactions once fully funded will be annual accretion of approximately $0.01 per share. However, there was noise in the third quarter results due to timing of the closings which will also impact fourth quarter. Normalized FFO per share in the third quarter was $0.38 down $0.01 from the second quarter as a result of the equity -- August equity offering to fund the investments closing in the fourth quarter. There is no expected sequential increase in FFO per share in the fourth quarter from these transactions due to only a partial quarter contribution from the investments. However, we do expect up to a penny increase in FFO per share in the fourth quarter from the reversal of the third quarter seasonal utilities. First quarter 2018 FFO is expected to increase by $0.01 per share over the fourth quarter given full quarter contributions of the Atlanta acquisitions and the bond redemptions. For those trying to fine tune their models I will point you to the other items of note on pages four and five of the supplemental for additional information on the sequential quarterly impact of the August equity offering, the Atlanta acquisitions, and the partial bond redemption. Moving to operations, total same store NOI for the trailing 12 months increased 3.9% consistent with second quarter results. Multi-tenant NOI increased 5.2% while single tenant net lease NOI decreased 0.4%. As was the case in the first and second quarters, single tenant net lease performance was affected by strategic lease restructurings earlier this year and the timing of two non-annual rent increases. However, both of these leases recently had rent increases in excess of 5% and as a result the negative growth we experienced in the last two quarters from the single tenant net lease properties will begin to reverse in the fourth quarter reaching normal growth levels of approximately 2% per year in the next few quarters. For the multi-tenant properties, a combination of 2.4% growth and revenue per occupied square foot and an 80 basis point increase in average occupancy drove year-over-year 12 month revenue growth of 3.4%. This revenue growth combined with a modest operating expense increase of 0.9% provided operating leverage and resulted in multi-tenant same store NOI growth of 5.2%. Two of the major drivers of the multi-tenant revenue model are cash leasing spreads and contractual rent increases both of which contributed to steady internal growth in the third quarter. Cash leasing spreads in the quarter continued to outpace contractual rent increases which is a reflection of the quality of our portfolio. Cash leasing spreads for the quarter averaged 4.6% for the 385,000 square feet of same store renewals, 88% of which had cash leasing spreads of 3% or greater across 22 separate markets. 52% of the leases commencing in the quarter had cash leasing spreads between 3% and 4% and in the future we expect the majority of leases to continue to fall within this range. While cash leasing spreads are important, the majority of annual revenue growth comes from employees contractual rent increases which improved to 2.8% in the third quarter from 2.7% a year ago. One of the main drivers of the increase has been an improvement in the percentage of revenue with annual contractual increases which has moved up from 82% five years ago to 92% currently. This quarter on page twenty of the supplemental we provided additional disclosure on the components of our employees contractual rent increases. As we look toward 2018 we're well prepared to fund future investments. Net debt to EBITDA at the end of the third quarter was 3.8 times and on a pro forma basis assuming the closings of the Atlanta properties debt to EBITDA is 4.5 times. This is substantially below target guidance of 5 to 5.5 times which provides financial flexibility to accretively fund future growth opportunities. Over the past few months several of our properties in Florida, Texas, and California were impacted by floods, hurricanes, and wildfires. Fortunately damage our properties from these natural disasters was minimal and the financial impact was immaterial with net 2017 income statement expense from these events expected to be less than $200,000. Through the commendable efforts of our asset management team the properties reopened quickly limiting the effects on our tenants.

[Todd Meredith:]

Thank you Kris. Operator that concludes our prepared remarks. We are ready to begin the question-and-answer period.

[Operator:]

[Operator Instructions]. The first question is from Jordan Sadler with KeyBanc Capital Markets. Please go ahead.

[Jordan Sadler:]

Thank you, good morning. Kris, just first I wanted to clarify the guidance looking forward into next quarter Kris if I could, I know you're expecting it seems a penny of uplift from the utilities reversal in the quarter but I'm also curious wouldn't there also be a contribution from the continued core growth in the quarter and why is it that the bond redemption isn't having a greater positive impact on the quarter given that you are basically sitting on cash today?

[Kris Douglas:]

Yeah, so a couple of items there. First, it's up to a penny of benefit from the seasonal utilities, depending on what the actual utility expense is for the fourth quarter. There will also be some contribution from internal operations. When you look at that historically on a same store basis over the last three years sequential increase has averaged between $600,000 and $700,000 from same store. Part of that will include the reversal of the same store utilities but there should be also some contribution from just overall internal growth. So not saying we aren’t expecting any, we're just kind of isolating some of the bigger moving pieces with the seasonal utilities as well as the Atlanta acquisitions and the bond redemption that occurred this quarter. And I don't know Jordan if you have had a chance to take a look at the additional information in the supplemental as it relates to the sequential change in FFO from the equity offering, Atlanta closings, and bond redemption. But there's several moving pieces there. Right now we're going to get two thirds of the benefit of the bond redemption in the fourth quarter. And we will also have -- that will be offset partially by the fact that we did have cash interest income in the first quarter given the fact we were sitting on cash. But that was earning 1% versus we will be basically earning 5.3% for the two quarters of the bond redemption. For the two months of the quarter.

[Jordan Sadler:]

Two months, yeah, I follow you. And the Atlanta mortgages, those are you've already assumed Atlanta mortgages or those are the ones that are closing in December?

[Kris Douglas:]

Those are the ones that will close in December given -- that's the reason they're closing this late because they have to -- we have to go through the banks and the lenders on the loan assumption process.

[Jordan Sadler:]

Okay, so I think -- I mean I did see that disclosure, it does say you're expecting the sequential increase in FFO, the fourth quarter and it sounds like you clarified in the call a little bit regarding the utilities but it does seem a little bit conservative given that November 1st you paid down the bonds with cash and these Atlanta mortgages are kind of still a month and a half away from being assumed. But correct me if I am wrong?

[Kris Douglas:]

No, I mean in terms of the interest expense when you look at it you will for the fourth quarter you'll get a little under $1 million benefit from the bond redemption and you'll have about $100,000 of interest expense from the assumed mortgages. So that's what brings you down to about $200,000 overall benefit from the interest expense. We will have the interest income for the first month of the quarter but that will offset the interest income that we had in the third quarter. So you really have to think about it from a sequential basis not just what occurs in the quarter.

[Jordan Sadler:]

Alright and we can follow up offline. I appreciate the color there. The -- also just kind of coming back to the acquisition pipeline, it sounds like you've got a little bit more keyed up here but how should we be thinking about the pace over the course of let's say the next 6 to 12 months, I know there are some opportunities out there, it sounds like the portfolios don't make sense relative to your sniff test. Do you expect the volume to be kind of go forward to be consistent with what you did in 2017?

[Todd Meredith:]

Yeah Jordan, we upped our guidance here at the end to roughly the midpoint of $300 million. You know looking out to 2018 we've got a good pipeline of activity. It's still early but we would see that the initial guidance we gave of around 200 million for this year is probably what we're looking at for next year. Certainly if there are opportunities to do more than that we will but at this point in time that's not the pace that we're planning for next year. Jordan we will update that next quarter and I think as you've seen us do in the last couple years we will usually start out at a level that we're very comfortable with and then see how the year shapes up and we might move it up throughout the year.

[Jordan Sadler:]

That is helpful and Rob it sounds like you were say in a couple of portfolios that are being shopped out there today are likely to come inside of the range of the target that you guys lay out there in your guidance in terms of cap rate expectations, is that about right?

[Robert Hull:]

Yeah, I mean we looked at the portfolios that are out there and we've scored them and we think that they're going to go outside of the guidance that we've given. And so given where our implied cap rate is right now the range of 5.1 to 5.4 and given the quality of those portfolios we don’t see a reason to get aggressive on those. So, you will see us participating in that process.

[Todd Meredith:]

You know another way to look at it too Jordan is these fungibility scores and not to oversimplify it but we kind of see some of these portfolios other than Atlanta scoring below our average and Rob mentioned our average is about 7.5 and if it's close we'll certainly look hard but again it's back to how aggressive do you want to get, do you want to pay a premium and was obviously mindful of our own implied valuations. So, if we are at 5.1 to 5.4 and something is not scoring as well as our existing portfolio, we don't see a reason to pay low 5 caps or even below unless it's going to be additive to our portfolio and long-term performance.

[Jordan Sadler:]

Thanks guys.

[Operator:]

The next question comes from Vikram Malhotra from Morgan Stanley. Please go ahead.

[Vikram Malhotra:]

Thanks, just wanted to clarify, so post the rule [ph] for the Atlantic transaction sort of what you have remaining. Can you just remind me what are sort of the rent bumps, any expectations for growth -- additional growth in terms of explorations on the Atlanta portfolio and just on the acquisitions that you have baked in can you maybe give us a sense of what are you looking for now and anything you're sort of turning away that may not meet your metrics in terms of rent bumps or potential growth?

[Todd Meredith:]

Yeah, Vikram on the Atlanta portfolio, I stated before that in place bumps on those are in the low 2s. We look at consistent with what we're doing across the country, we look at it as an opportunity to increase those as leases roll to more in line with where our portfolio is performing now. So in that 3% range. In the next five years about over 50% of those leases will roll so we view it as a long-term steady process that will occur and so that's where we look to see opportunities in that portfolio. I mean and can you repeat the second part of…

[Vikram Malhotra:]

Based on the acquisitions that you're now focused on or the opportunities, kind of are you just focused on assets with certain types of rent bonds or certain opportunities that sounds like you're traditionally focused on assets with rent bumps call it in the high 2s, so I'm just wondering is that still the case, are you sort of maybe expanding your box a little bit in terms of what you're looking at?

[Kris Douglas:]

I think it's more of we look for the -- not necessarily we're focused on assets that have rent bumps that are currently in the high 2s, it is more about the opportunity. So we go back -- it goes back to our score system and our fungibility scale, where we see opportunities for propensity for good rent growth and long-term value over a good period of time. And so, the assets that we're looking at they're one off assets that are aligned with good health systems and good markets with growing demographics and generally on campus. So that is the criteria that we start from and then in terms of being able to adjust the growth we look for those opportunities and we'll take advantage of them as we can.

[Todd Meredith:]

I think one of the key things too Vikram that we see is the most -- a big kind of dividing line between what we do like and not like in some of these portfolios will have a lot of single tenant and our general view is that single tenant assets are tougher to move from two to three if you will. And so you're going to see us lean more towards multi-tenant and I mentioned that in my remarks. We've shifted that to a great degree over the last five to ten years. And so you'll continue to see us do that. It's not to say we won't have some single-tenant assets but we will certainly lean towards multi-tenant where we have more opportunity as Rob described.

[Vikram Malhotra:]

Okay and then just to clarify on the or any color on the watch lists just given kind of what we've seen to a certain types of hospitals over the last call it three to six months, anything you're monitoring, any specific campus or hospital that you're monitoring?

[Todd Meredith:]

No, nothing big that's on the radar. Obviously we watch the headlines that are out there on things like community but the two hospitals that we were on with CHS seem to be performing well. Our occupancy has been growing over the last two years and we've also had pretty good success in those as it relates to cash leasing spread. So from the standpoint of what's happening in our buildings on those campuses, indications are positive and we're not hearing any negative news or concerns related to those two specific hospitals.

[Vikram Malhotra:]

Okay, great, thanks guys.

[Operator:]

The next question comes from Michael Knott with Green Street Advisors. Please go ahead.

[Michael Knott:]

Hey guys, question for you as you start to think about 2018, curious just on the multi-tenant occupancy front. What do you think the likelihood is that that occupancy rate can continue to rise again next year like it has been, I am just curious your longer-term target for that particular metric and sort of how you think about that longer-term target and how it might be affected by some of the leasing restrictions in the on campus ground leases?

[Todd Meredith:]

Sure Michael, we're at 88% on the multi-tenant and a little closer to 90% if you look at the overall. But just looking at the multi-tenant at 88% we certainly think that that can breach 90%. It's not -- it is going to all happen in 2018. I think we do see continued positive absorption going through 2018 and as you have seen -- if you have seen -- if you look at our disclosure on absorption over the last year going back a year you'll see that it's positive. So we see that trend continuing. I think it is a multi-year process but we certainly see progress and we will put out clearly some guidance next quarter at how we see that occupancy range going in for the year of 2018. But generally I'd say we look to get that over 90% but it's a two to three year process. It will be a combination of leasing activity, absorption, but also what we're buying being more highly leased and also what we're selling that may be underperforming and chronically lower occupancy that it's time to sell. So it's a combination of all those things that we think will bring it to the low 90% range.

[Robert Hull:]

And Michael I would say that the ground lease restrictions I don't think really kind of play into that leasing calculus that Todd just described. I think we've experienced very strong leasing in terms of cash leasing spreads, tenant retention, renewals and so on in our ground lease properties as compared to our fee simple properties. So, I don't think that that really has a big impact on the absorption that Todd just described.

[Todd Meredith:]

We have actually seen, we have some information in our presentation that our on campus occupancy is higher than our off campus occupancy.

[Michael Knott:]

Right, okay, that's all helpful, thanks for that. Just curious you've talked a lot on this call of the fungibility scores that you all use. I know there's details in the presentation but just curious maybe for the benefit of those on the call who haven't seen it before or maybe who have but just curious if you could take just a second to sort of explain sort of simply how you guys think about the score, how that's constructed because I think MOB quality is something that REIT investor struggle with how to sort of tag all the different aspects of quality and just curious how you guys construct those?

[Todd Meredith:]

Sure, yeah, we obviously have a process there and we do this on when portfolios come out we do it initially based on just a visual review where we go see the properties, we spend time there. I think the important piece there is it is getting a sense of a competitive landscape, trying to pull comparable buildings, look at what the alternatives are for tenants. And so that is kind of your competitive strength piece. And in our view that is something you have to spend time there in the market. We usually will not score properties of the fungibility score if we haven't gone through that exercise. And then the other side is really putting all the different factors together and looking for that propensity for growth. So part of that is what Rob talked about with the opportunity is if there are all 10 year leases, 15 year leases with low growth built in and we can't get it the expirations and increase the rent profile, that's going to impact our view of the ability to grow those rents. So it's kind of those two broad categories. There's a lot of details behind that. Everything from things like parking and convenience to the quality of the building, the ability to re-tenant the space, there's a lot of physical aspects. But we kind of put it all under the broad category of propensity for rent growth and competitive strength. Clearly we've seen certainly the report you guys have put together. I think it's a great first version that you put together and I think it helps investors. We would agree with a lot of those things and those characteristics. Clearly you guys put hospital affiliation as a number one item, we would agree with that. We have the materials about we call it our diagram but three key things being hospital affiliation, the strength of that health system, that's a combination of the campus you're on plus the health system you're affiliated with. But also on campus we think that's an undervalued component. And then lastly the demographic piece. So those are kind of three big pieces that also go into that framework that aren’t included in our fungibility scoring process. And certainly we will I think as more eyes are on this issue of quality we're going to be putting more and more out. We think we've been ahead of that game but we like where it's going and want to continue to support that.

[Michael Knott:]

Yeah, thanks for the help on -- helping investors with that over time. Just last question from me and then I'll get back in the queue but just curious any comments you guys have on sort of real time prospects or how you are feeling about development, redevelopment type opportunities that you may be looking at or thinking about or discussing with health systems?

[Todd Meredith:]

Yeah, we've got some good conversations going on with health systems and then some of our development partners I mentioned in my script. We feel good about 2018 and we've year in and year out been targeting a 50 million to 100 million in new development starts and we see opportunities to do that next year. Where we can increase that volume we certainly will if there are good opportunities out there. And again the opportunities that we're looking for generally the on campus opportunities, those buildings that are going to score in the 9 and 10 range on our fungibility scale. So we really think that that's an opportunity to get at those assets. So, 2018 is looking good.

[Michael Knott:]

Thank you.

[Todd Meredith:]

Thank you.

[Operator:]

The next question comes from Seth Canetto with Stifel. Please go ahead.

[Seth Canetto:]

Hey good morning.

[Todd Meredith:]

Good morning.

[Seth Canetto:]

First question just looking at the driver for the annual revenue growth which is in place, contractual rent increases. I know you guys mentioned that that's drawing as a percentage of your total portfolio, is the goal to get all in place contractual rent increases on an annual basis and what do you think that can go to in 2018?

[Kris Douglas:]

I mentioned in my prepared remarks that we added some disclosure on page 20 of our supplemental and kind of broke out the pieces and we look at it in terms of annual increases, non-annuals, and then no increases. So those are flat over the term. If you look at that we've been -- we've really been increasing the percentage of the annual up to 92% not expecting that to go to 100% but any incremental certainly helps on that. Then you also have what is inside of that, the mix of CPI versus fixed as of right now historically CPI has been running a bit behind our fixed increases. CPI is ticked up a little bit but still not running. Our fixed are running closer to that 3% range. So that's certainly a goal to continue to get as much as we can in that fixed annual increase bucket. But certainly understand that for various reasons we talked about last quarter we had a tenant that was adamant that they wanted a flat rate over the term and so we agreed to it. Though we ended up getting I think was close to a 40% cash leasing spread. So that ended up being a great outcome for us still. But understand that we're not going to get 100% of the leases to have fixed annual increases.

[Todd Meredith:]

The other issue you have with that is acquisitions and clearly we monitor that in what we acquire. But from time to time you buy some assets that have non-annual or no increases and again it's back to how quickly can we change that. But if we're at 92% today getting to 95% is great. It's more just about the progress and making sure if we have those we're pricing those appropriately.

[Seth Canetto:]

Okay, great, and then just as those leases roll you mentioned CPI historically the way it has been running below the fixed increases so is the goal to try to get more of them on fixed?

[Kris Douglas:]

That is historically what we've been doing and I would say that would continue but as of right now on our annual increases it's a very small percentage that have CPI. The majority have already been moved over to fixed annual increases. And one of the reasons that we're comfortable with that is given as Todd talked about in the open was our average lease term. We're okay with having leases that turn every three to five years given our strong retention. So CPI just start picking up when you have an opportunity at 15% to 20% releases that you have obtained to reset those. This is one of the reasons that we're comfortable with going with fixed increases versus CPI.

[Seth Canetto:]

Okay great, and then just shifting to the reposition portfolio, can you just provide more color around the decrease in occupancy of those 15 properties?

[Kris Douglas:]

Yeah, there actually was a movement in terms of the properties inside of that bucket. It had a lot to do with we sold one property, we also have one property that moved out of reposition and back into the same store.

[Todd Meredith:]

That one was 100% occupied.

[Kris Douglas:]

That was a 100% occupied and 145,000 square feet. So as you move that out that that will drop the overall average.

[Seth Canetto:]

Alright, great. Thanks for taking my questions.

[Operator:]

Your next question comes from Todd Stender with Wells Fargo. Please go ahead.

[Todd Stender:]

Hi, thanks. Just a quick one from me on the balance sheet. You've got the mid four times debt to EBITDA that will certainly help with your ability to tap the debt markets at favorable rates and especially making great investments with cap rates in the 5% range. But when your stated range of 5 to 5.5 times range, how high will that truly go, is that something we could see maybe touching 5 or you think you would push it even higher, you do have the room but you also get the multiple benefit and you're stuck with keeping debt so low?

[Todd Meredith:]

Sure, I think it's a fair point and from our standpoint if you just kind of run numbers off a pro-forma 4.5 you can probably do 400 million or more in acquisition and development and still stay within 5.5. So as we said about our pace earlier of acquisition I don't see in 2018 it barring a larger transaction which is not as common for us that we would be touching the high end. So it probably is reasonable to think staying closer to the low end in the normal course and certainly as you point out there's certainly nothing wrong with that. But we also agree we like the benefit of being able to create some additional spread on good acquisitions and that will certainly play into 2018. So, it is 5ish, a little above 5 is probably reasonable to assume barring a larger acquisition pace.

[Todd Stender:]

Thanks Todd and then you really don't have any debt maturities coming due over the next several years, could we expect some shorter-term debt than we are used to seeing from you guys just because you have the holes in your debt maturity schedule?

[Todd Meredith:]

I wouldn’t think so. I think if we did do additional debt obviously you have the line to fund things in the short-term. But we did anything I think we would be looking to lock in more longer-term debt to match -- kind of match the term of the investments that we would be making.

[Todd Stender:]

Great, thank you.

[Todd Meredith:]

Thank you.

[Operator:]

[Operator Instructions]. There are no more questions registered at this time.

[Todd Meredith:]

Well, thank you. We appreciate everybody's time today. We know there were a lot of other calls and activities today so we appreciate everybody's time and we will be available around today for any follow-up questions and we hope everybody has a great day. Thank you.

[Operator:]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.