Healthcare Realty Trust Incorporated
Q3 2016 Earnings Call Transcript

Published: 3 Nov 2016

[Operator:]

Good morning. And welcome to the Healthcare Realty Third Quarter Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to David Emery, Chairman and CEO. Please go ahead.

[David Emery:]

Thank you. Good morning, everyone. Joining us on the call today are Todd Meredith, Kris Douglas, Doug Whitman, Carla Baca and Bethany Mancini. Ms. 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 the Form 10-K filed with the SEC for the year ended December 31, 2015 and in 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 and normalized FFO per share. 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 ending September 30, 2016. The Company’s earnings press release, supplemental information, Forms 10-Q and 10-K are available on the Company’s website. David?

[David Emery:]

Thank you. We’re pleased to report another solid quarter. Our steadfast commitment to the company’s loan held strategy centered on low risk, high intrinsically valued properties continues to drive performance and deliver sustainable growth. Property level operating metrics remain robust. Cash leasing spreads, re-leasing spreads and other spreads and contractual bumps for the third quarter were strong across the portfolio. I want to recognize Julie Wilson’s leadership and her team of professionals and their extraordinary execution of our property operation and leasing strategy. This foundation of internal performance broadens the bandwidth of the company’s opportunities and affords us the ability to be even more discerning with acquisitions and development projects. While MOBs in general share favorable attributes in the view of most investors, we see several critical value and performance differentiating factors mainly campus proximity, hospital strip and certainty of renewals and a positive rent growth profile through shorter term leases. In contrast off-campus facilities generally have lower annual bumps and a propensity for lower term single tenant net leases, complicated by the lack of visibility around market conditions out 10 to 15 years often making terminal value a rosy guess. Over the past three decades, trends in the healthcare industry towards outpatient settings have provided a brisk tailwind for Healthcare Realty. The rising demand for healthcare services and the heightened expansion of outpatient modalities have enabled the company to build portfolio properties with quality growth metrics, and very low business risk profile. We remain confident and continue to see the coming quarters and years as positive for executing the company’s strategy and enhancing valuations. Now, as we do each quarter, let’s turn it over to Ms. Mancini to summarize our views on current events and trends related to the healthcare industries. Bethany?

[Bethany Mancini:]

National headlines surrounding the Affordable Care Act or ACA, its health insurance exchanges, and Medicare payment reform continue to drive the perception of uncertainty and turbulence in the healthcare industry. The five largest national insurers are reporting heavy losses on their ACA policy with unstable dynamics and mispriced risk, causing several to abandon the exchanges altogether, only half of the anticipated 22 million enrollees have enrolled and high premiums are discouraging healthy patients from joining and offsetting the cost of sicker at-risk patients. But to offer some perspective, the largest insurers cover less than 30% of the exchange policies and the smaller insurers are still optimistic that with an expanding insurance pool, any more seasoned actuarial experience, they will be able to price their product appropriately. However, skeptics view the exchanges as inherently flawed, a safety net highly regulated insurance product not subject to normal market pricing and profitability. Either way with only 4% of the population enrolled on the exchanges, it remains to be seen how or even as physicians in hospitals will be impacted and if the incoming President will support needed changes to the ACA. The health insurance industry is calling for free market adjustments such at tightening enrollment requirements and allowing the insurers to price according to real cost and allowing policies of lower cost catastrophic coverage. A Democrat presidential win will likely mean fewer of these adjustments and potentially more federal subsidies. While a Republican win could result in less mandated insurance and more support for free market policy. These issues demonstrate that the ACA is primarily about insurance, not healthcare delivery. Regardless of the outcome of the election, or the solvency of the health insurance exchange, healthcare providers and insurers alike are expected to continue to pursue growth in physician led outpatient care as a clear strategy for profitability with lower cost, consistent demand and better post reform reimbursement. According to the U.S. Census Bureau, ambulatory care settings posted the strongest gains in healthcare spending in the second quarter of 2016 over the prior year. Physician office spending jumped 8.1% and outpatient care centers recorded a 9.2% increase in spending. In our experience on-campus medical office real estate is demand driven with steady growth even throughout economic cycles, political events, budget deficits, and major health policy legislation. Furthermore, when working with large not for profit health system, the interest in expanding medical office space is related more to how the space will be integrated with the mission and strategy of the health system to deliver healthcare not with fluctuations of health insurance payers. Another ACA related concern is mounting of healthcare providers as they grapple with the flood of Medicare reimbursement reforms by the Center for Medicare and Medicaid Services or CMS. Since the beginning of 2016, CMS has introduced nine new payment plans in an aggressive effort to transition physicians and hospitals from a fee for service based system to a value based pay for quality system including bundle payments, alternative pay model and site neutral payment equality. CMS recently addressed physician Medicare reimbursement under MACRA, the Medicare Access and CHIP Reauthorization Act and in a good sign CMS offered in its final rule more flexibility for providers and exemptions for smaller practices. The CMS rule indicates their intent to extract inefficiency in a dated reimbursement system and promote alternative payment models that save money and provide the best care not to eliminate smaller physician practices. Congress has urged CMS to slow its pace and learn what were expressed from the model already being implemented in test markets. There is no rush since the movement toward value based reimbursement is likely here to stay regardless of the outcome of the election. Earlier this week, CMS issued its final rule for Section 603 site neutral Medicare payments for hospital based outpatient services, delivered a new facility located off the hospital campus, generally more than 250 yards from the hospital, which will be reimbursed at the lower physician office Medicare rates starting in 2017. CMS stated in the rule that its regional offices will continue to use the same reasonable approach they have always used in determining rare exceptions to the rule while still somewhat vague, their intention is clearly to limit new development and expansion of off-campus hospital based outpatient department not to penalize existing locations. Any on campus hospital outpatient services will continue to be reimbursed at the higher hospital rates. The complexity of these reimbursement policies and the ambiguities of regulating off-campus Medicare services underscore the stability and lower reimbursement risk in contrast of on campus investments, 75% of the company’s outpatient facilities are located on campus or within 250 yards of a hospital and we expect any hospital outpatient departments in off-campus facility to be grandfathered in under their current hospital rates. The extent the latter enhances our off-campus tenant’s propensity to renew leases will be limited to the exact amount of space within a facility that meets the 603 standard. Moreover, some off-campus providers are already being reimbursed under the physician payment schedule and are unaffected by 603. In general, we find on campus properties have better reimbursement support and enate value that drives growth metrics being integral to the health system with a steady pace of positive renewals and less risk of losing hospital affiliation. Overall, Healthcare Realty’s portfolio comprises of broad base of physician tenants across more than 30 specialty affiliated with top credit rated health system in top MSA markets, as our tenants benefit from relatively lower concentration of Medicare and Medicaid patients and high rent coverage, Healthcare Realty’s ability to capital on inherent growth in its properties should remain secure despite an uncertain political and regulatory environment. David?

[David Emery:]

Thank you, Bethany. Now on to Mr. Meredith for a more specific in relation regarding recent investments and development activities. Todd?

[Todd Meredith:]

The company’s’ recent investment activity is highlighted by several acquisitions. As you may recall, the use of proceeds of the equity offering in July included $150 million for acquisitions. Based on a healthy pipeline, we anticipated investing the proceeds within 12 months. Now, four months later, the company has closed $144 million of acquisitions, locking an accretion sooner than expected. The company acquired two properties in September for $98 million, one, for $53 million is an 87,000 square foot MOB in Seattle on UW Medicine’s Valley campus, the same place where we acquired a property in April. While others made offers at the same price level, our recent acquisition and upcoming development of another MOB on the campus separated Healthcare Realty from the competition. Also in September for $45 million, the company acquired a 104,000 square foot MOB in the Washington DC area. The property is located on Loudoun campus of Inova Health, a dominant AA plus rated system in the strong demographic market of Northern Virginia. In mid-October, the company acquired three additional properties for $46 million. This includes $36 million for a pair of properties in Baltimore on the campus of Upper Chesapeake Health Medical Center part of A minus rated University of Maryland Medical System. The third property in Seattle totaling 30,000 square feet is located on Providence’s Swedish Edmonds campus with another smaller property under contract for $5.2 million within [ph] on four MOBs on this campus. With the addition of these properties in the Seattle MSA, the company will soon have invested over $450 million in 16 properties totaling 1.1 million square feet and spread among eight campuses associated with five different investment grade not for profit health system. The company’s portfolio in the DC Baltimore area has expanded to over $120 million invested in six properties and 459,000 square feet associated with three invested grade systems on four different campuses. Year-to-date, the company has acquired eight properties valued at $224 million and expect a steady start to 2017 based on our current pipeline. Cap rates have ranged between 5.5% and 6% this year consistent with what we’ve seen in the market for top tier properties with an occasional cap rate in the low fives or even below 5% for distinctive properties. For some time now, off-campus cap rates have been compressing relative to on campus. Many buyers appear to be buying aggressive prices for off-campus, mostly single tenant properties that assume the current tenants will renew and their rent will keep increasing. Unlike on campus MOBs, these off-campus properties can face oversupply risk. In most off-campus locations, the landlord has weaker pricing power because tenants have many alternatives causing property value to vanish after the first or second lease cycle, a combination of rent roll down and outsize tenant concessions at lease expiration is more probable at the off-campus single tenant facilities which can shrink terminal values and IRRs. There are few large portfolios in the market that have yet to trade with scale being emphasized more than quality. These portfolios are being marketed by – mostly by financially oriented sellers looking to take advantage of a low cap rate environment or seeking liquidity events. While we would normally expect cap rates for these portfolios to be less aggressive due to weak alignment with health systems, inferior locations and generally smaller, we may see new investors bid up the properties to achieve scale in the MOB business. Shifting to development and redevelopment, the company has a growing pipeline with a number of potential starts likely to occur over the next couple of years. Examples include the $64 million on campus MOB in Seattle mentioned earlier, a $10 million redevelopment in Tacoma, a $11 million redevelopment in Charlotte, a $22 million build-to-suit in the Midwest and a $70 million excuse me development in the heart of Seattle’s First Hill Medical District. These types of developments and re-developments offer the potential for returns of 100 to 200 basis points higher than equivalent acquisitions in an attractive way to enhance the portfolio for many decades. To mitigate risk, we intend to limit development commitments to around 5% or less of gross invested assets and carefully manage the carrying cost of un-leased development space. Turning to disposition, Healthcare Realty sold two MOBs for $23.9 million at the end of October. We continue to see 2016 disposition cap rates averaging between 7.5% and 8.5%. And based on our current outlook, we would expect the company’s 2017 disposition volume to exceed 2016 levels. We see bright prospects ahead for making investments. The company’s proven approach reflects the targeted effort to craft the most well regarded and sustainable MOB portfolio through selective acquisition, development and redevelopment. We know which properties we want and the ones we don’t. More than just initial accretion, we require investments to be additive to the portfolio’s internal growth profile. Eventually, all investments become same store properties. More than most, Healthcare Realty’s value is based on the low risk, internal growth potential of its medical office portfolio and the company is focused on expanding net value by investing in quality not just quantity.

[David Emery:]

Thank you. Now, on to Mr. Douglas to give an overview of the results of operations and other financial matters. Kris?

[Kris Douglas:]

Operating results for the quarter were strong and we made steady progress when on deploying the capital raise this summer. Third quarter FFO per share was $0.39. There were several items of note for the quarter, first, as outlined at the time of the equity issuance, there was 0.25 of dilution in the quarter from the 9.2 million share offering comprised of 0.35 from increased shares offset by $0.01 from decreased interest expense. The $144 million of acquisitions closed in late September and early October will eliminate approximately half of the dilution we experienced in the third quarter. second, the typical spike in the third quarter utilities increased utility expenses $1.7 million over the second quarter of 2016. We recouped a portion of the higher utility cost through operating expense reimbursements, the net result was approximately $0.01 per share reduction in FFO sequentially, about the same second quarter to third quarter impact we saw in 2015. The uptick and seasonal utility expenses generally reverse in the fourth quarter. Lastly, we benefited from continued strong performance from internal growth driven by 4.3% increase in total same store NOI for the trailing 12 months including 5.7% for the multi-tenant properties and 0.8% for the single tenant net lease properties. The difference in our multi-tenant and single tenant NOI growth rates continuously to be primarily driven by higher concentration of CPI escalators in the single tenant net lease properties. In the last 12 months, CPI escalators for the single tenant net lease properties average 1.3%. We also had two single tenant net lease renewals this year in which we reduce rental rates in exchange for extended terms, 11 years for one lease and 20 years for the other. Excluding these two renewals, NOI for the single tenant net lease properties grew 1.3% over the past 12 months, consistent with the average CPI escalator. These two single tenant net lease renewals with rare [ph] reductions are in contrast to the 5.9% average cash leasing spreads on the 249 multi-tenant renewals year-to-date, and it illustrate why we continue to shift the portfolio to a larger share of multi-tenant on campus medical office buildings. For the multi-tenant properties, trailing 12 month same-store revenue increased 4.9% as a result of a combination of 4.4% growth in revenue per occupied square foot as well as a 40 basis point increase in average occupancy. Sequential quarterly occupancy increased 20 basis points which bodes well for continued strong revenue growth in the quarters ahead. Trailing 12 month multi-tenant same-store operating expenses increased 3.8% which is higher than we would expect long term due to the $2 million fourth quarter 2015 property tax catch-up payment we discussed on the February conference call. Excluding the portion of the $2 million that was related to periods outside the last 12 months, operating expenses would have grown less than 1.5%. We expect to continue generating strong multi-tenant same-store NOI growth through the remainder of 2016 and into 2017 as indicated by the following metrics; third-quarter tenant retention was 90.1%. Multi-tenant contractual rent increases that occurred in the quarter were 2.8% while the future contractual rent increases for the leases commencing in the quarter were 3.2%. This points to accelerated contractual rent growth in future periods. Same-store cash leasing spreads in the quarter were 4.3% of the 92 same-store renewals in the quarter comprising 314,000 square feet we only had one negative cash leasing spread on a 1600 square-foot lease while there were leasing spreads of 3% or greater on 88 leases totaling 265,000 square feet in 18 separate markets. Now, some color on tenant improvement commitments and spending. For the 390,000 square feet of total multi-tenant portfolio renewals in the quarter, tenant improvement commitments average $1.04 per square foot per lease year and for the almost 1.3 million square feet of renewals in the last 12 months, the committed TI was $1.45 per square foot per lease year, which is indicative of an expected long-term rate for renewals because of 158,000 square feet of net absorption in the last year, second-generation TI spending is up 25% or $3.8 million compared to the previous 12 months. New leases generally have longer terms than renewals in the TI cost per square foot per lease year for new leases can average three times the cost of renewals. Tenant improvement cost for new leases of second-generation space averaged $4.16 per square foot per lease year for the last 12 months and $5.54 for the third quarter. As we experience net absorption, we expect TI spending to track proportionally. I’ll conclude with a few comments on the balance sheet and debt metrics. The $305 million proceeds from the July equity offering were used to fund the $144 million of acquisitions closed in September and October, $11 million of development spending, $17 million of mortgage debt repayments, a $50 million term loan repayment and a temporary reduction in the line of credit. Accordingly, the equity offering improved our debt metrics, debt to total book capital decreased 620 basis points to 33.5%, fixed charge coverage ratio increased from 3.5 times to 3.6 times and net debt to EBITDA improved from over six times to five times. We expect to maintain these improved leverage metrics moving forward which provides not only safety but also financial flexibility and ample dry powder.

[David Emery:]

Very good. Operator, I believe we are ready to open the call for questions and hopefully answers.

[Operator:]

Thank you, sir. We will now begin the question and answer session [Operator Instructions] Our first question comes from Jordan Sadler from KeyBanc Capital Markets. Please go ahead.

[Jordan Sadler:]

Thank you. Good morning.

[David Emery:]

Morning.

[Jordan Sadler:]

Morning. So, first question is regarding the prepared market commentaries surrounding the portfolios that are for sale and the aggressive pricing that you might see. I was hoping you might be able to shed a little bit more light on anticipated pricing levels and maybe if you could characterize the nature of these portfolios a little bit more relative to your portfolio?

[Todd Meredith:]

Sure, Jordan. I would say that obviously these are in the market and so we don’t know what the cap rates will be, I think what we’re seeing is that while it doesn’t necessarily fit for us and I would probably just for characterization point to a few characteristics we often refer to meaning the campus proximity these that we see have less on campus asset or even adjacent assets much lesser penetration into the top health systems, not-for-profit investment-grade health system the top 100 as we define them and also just generally in smaller markets more tertiary markets, secondary and tertiary markets. So when you look at all that for us that would be dilutive kind of regardless of pricing, so we obviously would think that that would indicate based on quality that you might see cap rates on these that are 6% or higher but there is obviously a lot of capital sources, capital chasing portfolios out there and I think there is quite a few people looking to get a big start in the MOB business, you just hear a lot about that, so we obviously are speculating on that. So there remains to be seen probably is enough to kind of keep those prices pretty aggressive whether or not they are above or below six we will have to wait and see.

[Jordan Sadler:]

It sounds like these pricing levels may have been formed your decision or least your guidance to expect greater dispositions next year, is that the case, is it a function of pricing or is this more a function of the ongoing focus on accretive growth or growth accretive asset management?

[Todd Meredith:]

I would say it’s both, I would say certainly we are more focused on the strategic side of that as you just said accretive to internal growth profile and fitting into the portfolio in that way but certainly, the view of the market being very attractive in terms of cap rates for dispositions accelerates our sort of our thinking on that as well. So we certainly keep both of consideration and as I mentioned I think you will see 2017 be probably above where we would be for 2016 for disposition volume.

[Jordan Sadler:]

Is it, in terms of quantifying that, is that expected to be substantially above or just you know, slightly above it and I guess I am trying to understand if you are looking to maybe swap out a larger chunk of the portfolio opportunistically?

[Todd Meredith:]

So our guidance this year is 50 to 75, so certainly we will put out new guidance next quarter and start to give you a sense of that but certainly above the top end of that that, I don’t think we’re looking at obviously it’s a lot of dramatic portfolio changes going on in this particular niche of the REIT world, so I don’t think anything…

[Jordan Sadler:]

I know, give us something.

[Todd Meredith:]

Yes nothing of that order of magnitude more in line with kind of where we are on the disposition acquisition side.

[Jordan Sadler:]

Okay, thanks.

[David Emery:]

Thank you.

[Operator:]

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

[Vikram Malhotra:]

Thank you. I just want to understand as you look for the portfolio here out over the next 12 months and I am not looking for specific occupancy guidance but where can occupancy grow and maybe if you can break it up between sort of the way you split the portfolio on off-campus that would be helpful?

[David Emery:]

Sure, I think you see our multi-tenant properties if you kind of use same store as a basis, you see our multi-tenant properties a little below 88%, I think, you probably heard us and others has that long term, we certainly see the ability to push that above 90% and that’s really of course the biggest part of the portfolio and what will drive overall occupancy including our single tenant properties, we are at 90% but if you just strip back to the same store multi-tenant, we would see the ability to get that into the low 90s over time, that’s a multiyear process, it’s not going to happen in the next 12 months as you outlined but I think we will make progress on that. I think, Kris talked about good net absorption results this year and I think, we expect similar type of progress next year. So, it’s kind of a slow and steady march north of 90% and that’s going to come not just through leasing and net absorptions but also as I mentioned on the disposition side looking at properties we would also sell, they may not be contributing or we don’t see the potential to continue growing and contributing to occupancy and rent growth.

[Vikram Malhotra:]

Okay, that’s helpful. Just on expirations, can you maybe point out any large tenants in the 2017 and 2018 expirations and then just given the news on hospitals in general but also, you know, some of your top tenants more recently, could you give a sense of community specifically, what type of properties are they – that you own, you know, just how old they are, the size et cetera would be helpful?

[Kris Douglas:]

Yes, this is Kris. I guess, I will start with the community question. We have four assets, about 200,000 square feet that are on two separate community campuses and these are community campuses that have been around for a while, they were not HMA hospitals previously and the performance of those hospitals from what we can tell continues to be strong, in fact the hospitals have in the last year or so has actually increased their occupancy in our buildings by about 10% a little over 20,000 square feet, the 200,000 that we have which is a good indication as to the growth that is occurring at those local hospitals, so we still feel good about those hospitals.

[Todd Meredith:]

And another trend on the community side, I would say, these two hospitals are each over 300 beds, so often times too, you see a little more vulnerability with smaller hospitals. These are pretty substantial community hospitals.

[Vikram Malhotra:]

Okay and then on the expiration – yes…

[Kris Douglas:]

And then on the expirations, I would say in the multi-tenant, I don’t think that there’s anything of note to point out on the multi-tenant renewals, expirations that are coming up is kind of normal course on that side. On the single tenant, I think we have talked about, we had talked about last quarter, we do you have five properties they are all under one master lease. They expire at the end of 2017 and those properties also are the ones we talked about that have associated purchase option. Our expectation as of right now is probably more likely that the purchase option would be exercised rather than the renewal of the master lease. But we will have more color on that as we move through – move into and through the first half of 2017.

[David Emery:]

I would say Vikram too, that’s about, I think in our disclosure about $47 million, those five properties Kris referred to and that also factors into our disposition outlook for 2017. But they are, the purchase options and the expirations are at that every end of 2017, 12/31/2017, so would not have any 2017 impact, but you would be looking into 2018

[Vikram Malhotra:]

Okay and then just last very quickly on the – just from a disclosure standpoint, I believe, you used to disclosed CapEx between revenue and non-revenue enhancing. I think, you sort of lump that together, any reasons for that?

[Todd Meredith:]

I think our view Vikram is that you know you can split those hairs, but I think most people would tend to lump them in terms of thinking about what are your obligations to for TI to run, or for CapEx to run the portfolio. So we just decided to put those together. They were fairly small separated numbers so we put them back together.

[Vikram Malhotra:]

Okay but there is no, you don’t expect the split that you’ve been seeing roughly it’s been fairly constant but you don’t expect that to change?

[Todd Meredith:]

The revenue enhancing, I think ebbs and flows depending on the opportunities we see, where we can obviously apply some capital to accelerate some of the you know, those cash leasing spreads, the annual contractual bumps and so forth. So it ebbs and flows but no, I wouldn’t say that’s certainly something that’s an ongoing part of our capital spending program.

[Vikram Malhotra:]

Okay, thank you very much.

[Operator:]

Our next question comes from Chad Vanacore from Stifel. Please go ahead.

[Chad Vanacore:]

Hi good morning, all.

[Todd Meredith:]

Good morning.

[Chad Vanacore:]

Alright, so it looks like we are seeing cap rate compression across the industry and both properties you gave this quarter were sub 6%, now is this 5.5% to 6% cap rate the yield assumption we should expect going forward and let’s just note that it looks like 5.5% has been about right for you this year?

[Kris Douglas:]

Sure, I would say the compression we’ve seen is probably more specific to on versus off. I think, we been at this 5.5% to 6% range for a while now. I think, we may have tweaked our guidance 25 basis points earlier in the year but just a huge change in recent months, I would say obviously with cost of capital stock prices backing up a little, we will see where that takes things whether it’s temporal or more permanent. So we will see and I think for us what we are buying is really at the top end of the quality scale and I think that that mid five to upper fives has been pretty consistent. The off-campus is really where we were talking about seeing more compression relative to that that 5.5%.

[Chad Vanacore:]

What’s the spread you are seeing between with the high-quality on campus that you are buying and then off-campus that maybe you wouldn’t look toward?

[Todd Meredith:]

Well, you know, we have a view that it should be a lot wider than it is, I would say that you can it could be anywhere from negligible to 25-50 basis points, and you are kind of using a similar – and assume that two assets are fairly similar in quality, physically and so forth. But if you just get down to the fundamental of location which we think are even more important in terms of the value and you know preserving growth and terminal values, our view is that ought to be 100, 200 basis points if you really get into the math of it and that’s just not being factored in for a lot of situations.

[David Emery:]

And I would add that when you say that that compression in the 25-50 basis point kind of difference is in similar size markets. I would say it’s still wider if you are comparing a large coastal MSA compared to a tertiary market.

[Todd Meredith:]

And probably almost conversely, we’ve seen probably a little bit of of expansion of separation of cap rates in the smaller markets, I would say just generally to that point, you probably starting to see some backing up of more rural tertiary market cap rates.

[Chad Vanacore:]

Alright, you mentioned increased competition coming in, where is that competition mostly coming from?

[Todd Meredith:]

It kind of changes over the years. We used to have a lot more non-traded activity, I think certainly we all know that that’s a quieter group of folks and in today, I think you see more interest from foreign sources of capital, sovereign wealth, and other foreign sources, as well as some private equity groups, you are seeing a lot of interest, I don’t think we’ve seen a huge move by any of those parties yet, but certainly in healthcare you have and MOBs, I think are certainly something they are looking at it, and the big difference there is they are all looking for pretty massive scale in terms of an entry point as well as ability to grow beyond that. So I think that’s the little bit of a rub with the MOB spaces, you either have to bite off one of these larger portfolios to get started or they generally aren’t looking at M&A necessarily. So, I think it just becomes a little tougher to get into the MOB business expect to kind of pick their entry points carefully.

[Chad Vanacore:]

Okay. And then you said they look for massive scale, what kind of scale are we talking about? Because the industry itself is you know it’s more of a niche and smaller than some other sub-segments?

[Todd Meredith:]

What we are hearing is in the billions, one billion, two billion as a starting point and ability to grow from there. it’s, you know, I think maybe private equity might consider something a little different than that to get going but that’s certainly from the more of the sovereign you know foreign capital sources perspective.

[Chad Vanacore:]

Alright, thanks for all the questions. I will hop back in the queue.

[Todd Meredith:]

Thanks.

[Operator:]

Next question comes from Rich Anderson from Mizuho Securities. Please go ahead.

[Rich Anderson:]

Thanks, good morning.

[David Emery:]

Good morning

[Rich Anderson:]

So you mentioned, you know the appetite for MOBs which is you know, not new to anyone in this call but for 2017 dispositions, would you, if you were to hazard a guess right now taking into account the purchase options, do you think you are still like in an eight cap type number, or does it materially compress from your perspective, I know, what you are saying about the market, but just from what you are thinking about selling?

[Todd Meredith:]

You know, obviously what we end up selling in a lot of cases or things that maybe aren’t core to us, so maybe they are off-campus single tenant, maybe some of them aren’t MOBs, so it obviously depends on that mix. I think, if you just narrow it down to MOBs even if it is off-campus single tenant, again that compression we’ve seen, we like that. That certainly helps the case for selling some of those. So it’s really just going to come down to the mix as to whether that range is consistent with what we are seeing this year. My guess is it’s just at this point, we will put our guidance on this next quarter, it’s probably somewhere.

[Rich Anderson:]

And then if you or someone were to approach you and said, you know, as we – we will take out your entire single tenant net lease portfolio, I mean, is that something that you think is important to the story or is there a price where you could say, yes, we would love to be full on multi-tenant only or do you appreciate the diversification to some degree?

[Todd Meredith:]

We are comfortable with some single tenant, because our health systems that we work with, physicians we work with, it’s still relevant in some cases, I think we are just very careful about what those assets look like, where they are located, what we have in terms of expectations for the renewal at the end of the lease. So it’s not to say with a blanket statement that all off-campus single tenant is terrible. It’s just, we had a lot of experience over the years with lots of different approaches to delivery of healthcare off-campus and we think we know what we – what works and what doesn’t for real estate owners which is very different than most providers.

[David Emery:]

Yes, I think that a lot of them long term net lease, it depends on where it is, and what it is and it’s topography from standpoint of relating to the hospital, so it’s not just because it’s a long term net lease, it’s not necessarily to make it bad, it’s usually is as Todd says, when you combine it with location.

[Todd Meredith:]

Now, if you have somebody that is interested in four cap rates, we are all yours.

[Rich Anderson:]

Okay, there you go, that’s right. That’s the number I was looking for. Let me start working on my NAV model.

[Todd Meredith:]

That would be great.

[David Emery:]

Rich, we also do have some on campus single tenant MOBs and I would say, no, we are not looking to exit those kind of think on the asset circumstance.

[Rich Anderson:]

So next question, I think David, you mentioned in the beginning, you alluded to shorter term leases on campus, I think you said that. And I am curious if you can comment about how you are thinking about, when you renew leases are you looking to shorten the lease term to capture market rent growth or you looking to lengthen the lease term to capture stability?

[David Emery:]

I just think it get the bigger mix, I think the, you know, the way it turns out is kind of where we are sometimes the term has to do with the occupancy of what kind of occupancy it is, like a surgery center or if the tenant has a lot of their own tenant finish money in it, sometimes the smaller tenant, the shorter term, lot of it is just playing to the audience. In other words, if you have a small physician who would like – has some uncertainty about each retirement growth those kind of things, they might want to do two or three years, you might have a group who has just come together, spent a whole lot of money, they might like to have seven. So a lot of it is not necessarily, we just know and you know from an efficacy standpoint, the more opportunity you have to read – to talk about the rent, the better off you are, so.

[Rich Anderson:]

Right, so but, I mean, in your – from the perspective of you guys, would you prefer to have shorter-term leases to there, you are working, I mean like forget about what the tenant wants?

[David Emery:]

It is there, it’s an unqualified, yes.

[Rich Anderson:]

Okay, that’s right, go on.

[Todd Meredith:]

If those properties are located on campus.

[David Emery:]

Yes, right.

[Todd Meredith:]

On campus multi-tenant is generally the case and I think importantly, because this is I think some folks look at this as though you are trying to influence their behavior on term and I think to David’s point we’re not. We are literally trying to just take advantage of the behavioral dynamics that are in place and as David said, get more sort of at best to get up and talk about, you know, where the rent is going. And its – what they want.

[Rich Anderson:]

One could look at that and say, well this is the whole thesis of for medical office and you guys have maticular stability, and then in the same token you are saying, well, we prefer shorter term leases which you know kind of is the counter contradiction to that in some degree, how would you respond to that?

[David Emery:]

Well, I disagree with that.

[Rich Anderson:]

Okay.

[David Emery:]

I think it may be syntactically different but practically it’s not because the shorter-term two year lease on an on campus physician that’s in a building attached to the hospital, the lease has not, it really has no bearing on their tenure or stability or any of those kind of things and we’ve all seen from a stability standpoint particularly on campus if somebody leaves it doesn’t really matter. We’ve got, usually have somebody else wanting the space or expansion or those kind of things, so.

[Rich Anderson:]

Okay.

[David Emery:]

So they are all real estate axioms of long term bonded leases, some have security and stability, it just doesn’t apply in this where you have this stickiness related to on campus facilities.

[Todd Meredith:]

Well I think, whether it’s apartments or whether, it just, it depends on the dynamics of the real estate involved. But I think that’s the part it’s so different in healthcare when you talk about triple-net, you know, senior housing versus medical office buildings. Just a very – type.

[Rich Anderson:]

Okay, and so then the last question I have is on ground leases and is the topic that came up, it comes up quite a bit with HTA, and you know their thesis is the lack of ground leases them the flexibility to lease their spaces as the way they see fit, which is you know an interesting perspective and I get that. But, I mean, what is your view on that? Because if you were to ask me, I believe, there is some perspective where you want to lease the space to the liking of the hospital and to the extent you diverge from the central thesis of the relationship then you could create long term problems. Do you view it that way or is that just sort of logically stupid?

[Todd Meredith:]

You just made our case, Rich.

[Rich Anderson:]

Okay, okay.

[David Emery:]

I think, you might just take a note of the case – look at casually re-leasing spreads and maybe that will answer your question.

[Rich Anderson:]

Okay, thanks very much.

[Todd Meredith:]

Thanks Rich.

[Operator:]

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

[Michael Knott:]

Hi guys, good morning.

[Todd Meredith:]

Good morning.

[Michael Knott:]

Question for you, you mentioned 16 excuse me, 17 dispositions or laid out [ph] strip 16, do you have any early thoughts on that same question, as it pertains to acquisitions, I don’t know if you commented on that in your prepared remarks?

[Todd Meredith:]

Certainly, didn’t make any specific volume numbers, I mentioned of numbers but I certainly think that we see a strong pipeline and an ability to maintain the pace that we are at currently and you know obviously, it depends upon capital markets but with good disposition activity, I think we’ll have, certainly have capital to put to work and you know could easily see based on the pipeline staying at the levels we are in currently in 2016.

[Michael Knott:]

Okay, that’s helpful. Thanks. And then on development, I am curious, just to get couple of thoughts from you guys, it sounds like you are seeing maybe greater volume of opportunities on that front, and so I am just curious if that’s right, number one, and then number two, just more broadly, I am curious to get some more thoughts on how you think about that 5% limit that you have for yourself, and how you think about that, does it pertains to the balance sheet and just whether that sort of target comes from lessons learnt from the past, just curious to have you expand on the thought process behind that, I find it interesting self imposed limit? Thank you.

[Todd Meredith:]

Sure, sure. Certainly, the pipeline for development not unlike acquisitions, I think it’s very robust and as I listed off a few examples we are seeing good development and redevelopment volume in the pipeline. So you know that is true, I think it’s a fair statement. The development by nature is a slower process, so and it can be a little bumpier and choppier in terms of starts and consistency and we really development as supplemental to our growth. Internal growth gained the main focus but acquisitions being a little more predictable in terms of pace but development being more thoughtful and strategic in terms of what relationships, what locations we want to pursue and expand. So you know, it’s just kind of we are seeing an uptick in opportunity as you described. So in terms of the 5% you know certainly it harkens back to what we’ve been through and we don’t anticipate any kind of collision of forces that would put us in that spot in terms of the market with the Affordable Care Act change and the recession say forth but I think we all recognize that it’s tough when you have that much un-leased space on your balance sheet, it’s a lot to carry and we want to make sure, we don’t do that. But at the same time, we don’t want to miss you know the opportunity and using our skill set to create value, so I think it’s a just creating a little balance and recognizing that the cost of that and the risk of that.

[Michael Knott:]

Okay. And then I think on the last call just related to finish up that point, you guys talked about your balance sheet targets, I am just curious are those – those two must be somewhat interactive, right and just can you remind us what those targets were I think five times debt to EBITDA maybe?

[Kris Douglas:]

Yes, we had said on the debt to EBITDA kind of the low to mid fives which is you know where we are today. We are at the low end of that range and part of the idea of being in that range is to create, you know, enough stability and safety for developments as we do fund them and come online.

[Michael Knott:]

Right. And then just quick one for me just on the CapEx front, the new leasing CapEx of I think mid $5 per foot per year above the 12 month average, just curious if that was higher than you guys expected or was there a specific situation there that you knew about and just curious any color there and where that made trend?

[Kris Douglas:]

That’s a number is with a lot of these numbers that move around from quarter-to-quarter depending on specific circumstances of what is going on, we did have one lease in the last quarter that did increase it a little bit. I think, we have generally said that you know, on renewals $1 to $2 is a good range with around the $50 is an average and then on new leases that can be around three times that. So let’s call it in $4 to $5 range, with somewhere around 450 is a good average. I will say, we wouldn’t be surprised if we saw that tick up a little bit especially given the fact as you see in our portfolio, kind of shift in terms of the mix of assets that we have and some higher cost but then also higher rent markets like Seattle, and LA and DC obviously there would be a different expectation for a TI cost associated in those markets versus your more middle of the country markets.

[Michael Knott:]

Right, thanks for the color. Appreciate it.

[Todd Meredith:]

Thank you.

[Operator:]

[Operator Instructions] Our next question comes from Tayo Okusanya from Jefferies. Please go ahead.

[Tayo Okusanya:]

Hi, good morning. My question goes back to the kind of on off-campus situation, again noting that you guys are very much higher quality on campus as the focus, but you still kind of see this incredibly low cap rates on some off campus stuff, you still see a lot of dollar chasing that stuff, cap rates are compressing versus the on campus stuff. What are you guys going to take for you to kind of see that spread kind of go back to historical levels, or do you feel the world has really changed where, you know, the off campus stuff has become much more important to the healthcare systems and is therefore kind of valued better than it was or whatever you want to call it?

[Todd Meredith:]

You know, our experience is that you have to go through the lease cycles to really kind of feel the pain of what could or possibly happen in those situations, and again it’s not that all of them are going to go through that but many – much more will there in the off-campus setting than on campus. So it just, I think takes buyers, and we have a lot of capital obviously, you know, people start to look through some of those things and I think, it just is going to take experience running those and people, investors have different objectives, they not be looking for as high of contractual rent bumps, and cashing leasing spreads and tenant retention and they have a more of a macro view on cap rates or where things are going. So, you know, that just takes, there is a lot of different folks and different strategies but our view is for what we are doing, the multi-tenant just fits the profile more directly. So whether or not, you know, we’re – we don’t certainly think we are missing anything in terms of that opportunity. I think 603, the 603 rules sort of underscores the fact that there was a sort of rampant build up of off-campus hospital outpatient department sort of chasing that reimbursement a little bit and CMS curbs it. And that’s the kind of thing that you run into as Bethany described when you go off-campus it’s a little more volatile out in those types of setting. So staying close to campus sort of protects you from some of that.

[Tayo Okusanya:]

Got it, alright. That’s helpful. Thank you.

[Todd Meredith:]

Thanks, Tayo.

[Operator:]

This concludes our question and answer session. I would like to turn the conference back over to Mr. Emery for any closing remarks.

[David Emery:]

Thank you. We appreciate everyone being on the call today and I guess, next call in 2017 and its February. So with that said, have a good rest of the year. We will talk to you then. Good day.

[Operator:]

Ladies and gentlemen, the conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.